Don't Miss 50% Upside Because Of Short Sellers

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When short sellers start circling the wagons, they can drive a stock down and keep it down for quite some time. 

That goes even for a company that has no debt -- and has been consistently increasing shareholders' equity. 

One such company also has high margins and generates impressively high returns on invested capital. Over the past four years, this company has maintained a return on invested capital ( ROIC ) of 35% or higher. 

This company is Vera Bradley ( VRA ) , which, with a short interest of more than 50%, is one of the most shorted stocks in the market. While VRA has more than disappointed investors over the past 12 months, the market could be offering investors a great entry point for the long term.

The short interest in Vera comes as competition in the women's accessories market has been heating up. The success of Michael Kors ( KORS ) over the past year and a half has kept the short interest relatively high at Vera. But Kors appears to be much more of a threat to Coach ( COH ) than to Vera. Rising inventory levels had also managed to catch short sellers' attention. This was a result of too many Vera products flooding the market, but a refocus on strategy should improve inventory management.

Any sign of a turnaround over the next several quarters could well spur a short-covering rally, with the days to cover (that is, how many days it would take for all shorts to cover their position based on average trading volume) at 35. So once the market realizes that Vera is for real, then the short squeeze could be fierce.

Vera is a leading designer and retailer of accessories for women. The company is best known for its handbags, and bills itself as a lifestyle brand. Its products are in the accessible luxury category, which appeals to a larger clientele base. The company has a cultlike following. This comes as the company's products offer immense versatility. 

New designs are released frequently to keep the brand fresh and encourage customers to shop for the company's latest offerings. This allows the brand to appeal to all demographics. 

Irrespective of how the short-sellers feel, there is money to be made in Vera. The investment thesis is supported by three pillars. First, shares are extremely undervalued, and the company is incredibly cheap compared with its peers. Second, the company has a great business and a strong customer base. Third, the company has no debt. 

Flickr/Jungle Jim's International Market
Vera is best known for its handbags, and bills itself as a lifestyle brand. Its products are in the accessible luxury category, which appeals to a larger clientele base.

While CEO Michael Ray has done a great job in managing the company, he's not a "retail guy" -- he's more of a "finance guy" (which shows in how well run the company is financially). Ray is also the son-in-law to one of Vera's co-founders. Overall, his decision to retire as CEO is a major tailwind for the company. 

Vera needs to bring in a retail/marketing CEO to increase sales and better connect with customers. The company's products are still in favor, as can be seen in Vera's sales, which more than doubled between 2009 and this year.

The new CEO also needs to reduce the overall merchandise assortment. Even Ray has acknowledged that the company has too many patterns, too many styles and too broad a selection. The company needs to reduce the number of stock keeping units (SKUs) and improve product line management. The good news is that the company is aware of this issue and has already cut 20% of the SKUs from next spring's collection.

There is also a need for the company to expand its outlet stores, which it has the balance sheet to do. This is where the company can sell its discontinued items. Vera can then increase the exposure of its latest items -- not discontinued items -- on its website. An increase in outlet stores would help drive sales and move discontinued products. 

The company needs a sales outlet strategy that doesn't weaken the brand, but strengthens it. This is especially true with Vera, where it has found that its full-price and outlet shops cater to different clientele. The outlet stores cater to those who don't mind last year's style at a discount, and the other group favors the latest and most recent styles.

Vera already has a strong e-commerce business. In the second quarter, website traffic increased 20% compared with last year. Vera has had 45 million visitors to its website this year, and its Facebook page has 1.4 million followers. The retailer now has more than 2 million customers in its growing database.

Vera has a strong relationship with Dillard's ( DDS ) . The company invested in Vera Bradley fixtures for more than 100 Dillard's locations. Dillard's has 283 locations across the U.S., and the company has shown an increased willingness to support the Vera Bradley brand.

Vera is also compelling from a valuation perspective, trading below major peers. Vera trades with a forward price-to-earnings (P/E) ratio of 10.5, where Coach is at 12.8 and Michael Kors is 22. On an enterprise value/EBITDA (earnings before interest, taxes, depreciation and amortization) basis, Vera is at 6.6, compared with Coach's 8 and Kors' 19. 

Risks to Consider: The first risk is that the overall macro environment remains weak, where the accessible luxury category is consumer discretionary. The company's handbags are not necessities, and so their purchase can be delayed. That has had a significant effect on the company over the past two years.

Action to Take --> Vera is in the early innings of its long-term growth story, and investors with patience will be well-rewarded. The company has high insider ownership, and once a new CEO is appointed, a lot of uncertainty will be removed. The potential upside is to $30, which is a price-to-sales multiple of 2 on Wall Street's 2015 sales estimates, driven by a returns to positive comparable store sales and improvements in its merchandise assortment.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Investing Ideas , Stocks

Referenced Stocks: COH , DDS , KORS , ROIC , VRA

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