Torrid (ticker: CURV) is an omni-channel plus-size apparel retailer targeting American women in their 20s and 30s. The company operates over 600 stores located primarily in malls throughout the US and Canada.

I expect CURV’s share price to rebound from the 4/6/2023 price of $4.25 to $10-20 by the end of 2023, with further appreciation beyond that level in 2024+ if a buyout doesn’t occur before then.

A more detailed downloadable slide deck PDF of this thesis with charts and photos is available at this dropbox link here (note that the slide deck was published on 3/28/2023): https://www.dropbox.com/s/08gbfxztod7uq8x/Torrid%20Investment%20Thesis%20%28full%20length%20version%29.pdf?dl=0

Investment thesis summary in 3 points

(1) Torrid’s stock price has fallen by nearly 90% since its 2021 post-IPO peak, but the issues that drove the stock price down are largely self-inflicted and are on the cusp of a reversal

• Torrid’s inability to adequately meet surging demand for its products in 2021 led it to overcompensate by ordering too much inventory. This inventory began to arrive at its stores just as inflation struck and demand softened starting in early 2022
• Management responded by heavily discounting products starting in mid-2022 to right-size inventory to meet current demand levels – this process finally came to an end a few months ago
• The negative margin impact of this inventory reduction will be transitory; growth and historical profitability should recover quickly starting in the next quarter or two

(2) Torrid’s business model should endure over time: a focus on fit over fashion addresses crucial plus-size customer pain points that other retailers ignore

• The offering resonates extremely well with customers, who respond through uniquely high levels of customer loyalty and repeat purchase behavior
• The company’s hybrid in-store and e-commerce model has a long history of excellent store-level economics and a healthy margin of safety on company-wide profit margins

(3) I expect the transitory margin and growth pressures to abate within a couple of quarters, leading to a normalization of the stock’s valuation multiple and a relatively quick rebound in share price

• The ultra-low valuation multiple of ~4x NTM maintenance free cash flow could enable the company to eventually repurchase large portions of the outstanding shares unless the stock price appreciates to higher levels quickly
• Investors can expect to make multiples of their money on this investment even in the absence of any future store growth or margin improvement beyond what should come from the near-term normalization of discounting and inventory alone
• Although a modest proportion of shares (1.2m of a total of 104 million) are sold short as of the last reporting date in mid-March, they represent a much more significant percentage of the public float. If the company’s outlook shows signs of improvement for the rest of 2023 during the upcoming May 2023 earnings call, this short interest could combine with a shareholder base that is reluctant to sell to create a potentially severe short squeeze

Relative valuation

Although I think Torrid’s intrinsic value will be what drives up the stock price up over time, it is worth considering relative valuation as a shorthand for demonstrating just how underpriced the stock is. Torrid is a superior business in comparison to apparel retailers such as Gap (GPS), American Eagle (AEO), and Urban Outfitters (URBN), yet trades at a large discount to those retailers on a go-forward FCF basis. While these retailers lack the plus-size specialization of Torrid, all four companies are roughly comparable omni-channel mall-based apparel retailers with a strong e-commerce presence. All four sell plenty of plus-size clothing.

To help normalize for recent NWC fluctuations and margin volatility for each competitor, I totaled up the cumulative FCF for each of these four companies since 2019 and compared their average annual FCF to each company’s respective current market cap. I found that CURV trades at 5x its average annual FCF over this four-year period, versus 15x for GPS, 21x for AEO, and 37x for URBN. CURV generated ~$350m of cumulative FCF over these four years, versus ~$600m for GPS, ~$500m for AEO, and ~$220m for URBN. Yet, those companies have an average market cap of $2.3bn, which is more than 5x that of Torrid.

Over this four year period, CURV grew revenue and EBITDA at a higher rate than these three competitors did, and reduced its share count by the most of the group (AEO grew diluted share count by 23%). Yet, CURV stock is down nearly 90% from its peak in August 2021 as compared to -64% for GPS, -60% for AEO, and -33% for URBN.

Torrid demonstrates capital efficiency that is in another league entirely when compared to these competitors. Over this four year period, Torrid’s average cash ROA was 14% vs 1% for GPS, 4% for AEO, and 2% for URBN. Similarly, Torrid’s average cash ROIC was 305% over this period vs 18% for GPS, 26% for AEO, and 11% for URBN.

CURV’s capital efficiency is largely derived from how much less it must invest in capex versus these competitors. Over the past four years, CURV has invested just 12% of Adjusted EBITDA into capex versus 61% for GPS, 41% for AEO, and 58% for URBN, all while growing more quickly than those competitors did. Cash conversion from EBITDA to FCF for CURV is also superior to that of competitors: since 2019, CURV converted 55% of Adjusted EBITDA to FCF versus 15% for GPS, 24% for AEO, and 15% for URBN.

Despite these stark differences in how EBITDA flows through into actual cash available to shareholders, many, if not all, sell side analysts use the average EBITDA multiple of this peer group to select a price target for CURV. It’s not just the sell-side that is using this misguided approach to valuation: many buy-side investors continue to value Torrid’s competitors on the basis of EBITDA multiples. For example, the ValueInvestorsClub buy thesis on AEO linked here relies solely on assumed EBITDA multiples to drive valuation.

In my view, this clear mispricing creates an opportunity for investors to acquire shares in an excellent business at a price that is unlikely to be this low for very long.

Simplified 24-month target price under different scenarios

In the interest of simplicity, all three cases shown here assume 3% annual comparable store sales growth and 35 new store additions per year.

Assumptions by case: Bear / Base / Bull

• NTM FCF less stock comp by 2025: $110m (bear) / $150m (base) / $190m (bull)
• Assumed exit multiple of NTM FCF less stock comp: 12x / 17x / 22x (note: this base case exit multiple is equivalent to 15x FCF if one doesn’t deduct stock comp)
• Cash generated and added to balance sheet by exit date: $140m / $180m / $220m
• Implied exit market cap: $1.5bn / $2.7bn / $4.4bn
• Current market cap: $440m
• MOIC assuming no buybacks or dividends occur: 3.4x / 6x / 10x
• Implied undiscounted share price in 2025: $14 / $26 / $42
• Implied discounted share price today: $12 / $22 / $35

Reasons for why Torrid shares are so mispriced

• Use of comparable company EBITDA multiples as a basis for valuation: In general, EBITDA should not be used to compare equity valuations of companies that have modest debt levels – especially given how different FCF as a % of EBITDA is between companies. Yet, these multiples are the key driver of valuation in almost all publicly available writing on CURV.
• Size: the small size of the public float inhibits many institutional investors from owning shares in sufficient quantities, so it is often just ignored completely.
• Volatility: Torrid’s small float and illiquidity create a setup for occasional bouts of extreme price volatility – it seems plausible that some more conservative investors shy away from even learning about Torrid as to not expose their portfolios to this level of price movement.
• Novelty: the company IPO’d less than two years ago and lacks an established investor base in comparison to retailers that have been public for decades.
• Investor lack of familiarity with Torrid: despite having a national store footprint, most public equities investors are firmly outside of Torrid’s target demographic and few have direct first-hand exposure to the company’s stores or brand.
• Temporary limit on repurchases of shares: I don’t think I’ve ever seen a situation before in which a company could realistically repurchase its entire public float in any given quarter, but that is where Torrid sits today. However, Sycamore (rightfully) refuses to sell any more of its stake at prices below $10++. So, until the price recovers enough for Sycamore to sell some of its stake, the company is likely limited in its ability to repurchase additional shares. A special dividend could be used as an alternative to address this unique situation.
• Mistaken treatment of lease liabilities as debt: Bloomberg and some other investment data services sometimes add retailers’ total lease liabilities (no matter the cost of those leases or whether they are cancellable or not) to be added to their calculation of “total debt” in a way that investors who don’t do the research themselves might be led to think that this company is much more levered than it is – and that the EV / EBITDA multiple is higher than it really is. For Torrid, such an assumption adds $220m of “debt” from leases, even though there is an offsetting right-of-use asset and many of the leases can be cancelled.
• Rates-driven market swings: the increase in rates and high inflation has led to many small growth companies (plus those that were recently growth companies until the past couple quarters) to be severely punished by the market to a degree that is much greater than what a 1-2% change in the long-term interest rate environment implies for these companies’ intrinsic value per share.

Torrid’s public float and trading volume

Torrid’s public float is small: Sycamore continues to own 79% of the outstanding shares. The number of shares owned by non-Sycamore entities is ~20 million. Even at its peak, the public float was worth just $400m. The size of the IPO was limited because Torrid had little use for incremental new capital – Sycamore sold just 12 million shares as part of the IPO and the company retained none of that cash.

Despite a small float, it is still possible to build a material and ultimately valuable position: excluding the elevated trade volumes during the first earnings report after the IPO, the 5 quarterly earnings leading up to the March 2023 report have generated trade volumes averaging 9 million shares in the two weeks following any given earnings announcement. This volume even exceeded the total share count of the public float in some quarters.

Corporate history

Torrid was launched in 2001 by the LA-based apparel retail chain Hot Topic. By 2008, revenue exceeded $150 million from approximately 125 stores. Hot Topic and Torrid were sold to Sycamore Partners for $600 million in 2013 in a take-private deal.

Sycamore Partners is a New York-based PE firm with $10+ billion of committed capital that specializes in retail investments. Sycamore’s returns have been spectacular: By 2017, Fund I had generated a 43% IRR after fees vs an industry average of 19% over that time period. Even with the multi-billion dollar mark-to-market loss on Torrid since its IPO, Fund I’s gross MOIC was still 2.0x with a net IRR of 25% through June 2022.

Torrid was formally spun-out from Hot Topic in 2015. The company first filed for an IPO in July 2017, but later that year retracted the plan to go public, citing market conditions. Torrid successfully completed an IPO in July 2021, selling 12.65 million shares at $21 per share (top of guided range). The standard 180 day lockup period following the IPO prevented Sycamore from selling additional shares until early 2022. By the time the lockup period had expired, shares had fallen to $10 – down more than 70% from its mid-$30s peak.

The plus-size women's apparel market

The plus-size women's apparel market is an $85 billion per year industry and accounts for just under half of the country’s total spend on apparel by women. Nearly 70% of America’s ~130 million women now qualify as plus-size (size 10+). Yet, of the 50,000 women’s specialty retail apparel stores in the US, under 2% are dedicated plus-sized stores. This equates to around 1 plus-sized store for every 50 mass-market store. Therefore, the vast majority of plus-size women are not purchasing from a dedicated plus-size retailer.

The plus-size portion of the market is growing at 2x the rate of the non-plus-size market, not only due to demographic change, but also due to this portion of the market being historically under-served. A 2016 study revealed that the average clothing size of American women increased by nearly one size every five years in the two decades preceding 2010, for a total increase from size 14 to size 16/18 over that period.

Apparel spend per person is materially lower for plus-size women than it is for non-plus-size women. A recent study commissioned by Torrid found that 78% of plus-size women would spend more on clothing if they had more options consistently available in their size and fit. To me, this suggests that Torrid’s addressable market is quite large and underserved.

Issues with plus-size shopping at mass-market retailers

Plus-size shoppers report numerous issues and problems with the retailing experience offered by mass-market apparel retailers. For example, most mass market retailers, brands, and clothing manufacturers simply design clothes for non-plus-size women before “grading up” the product to make it available to plus-size women – this approach causes serious problems on fit across different product lines. In addition, plus-size shoppers report an elevated frequency of out-of-stock sizes and as well as express disappointment over finding that certain products aren’t offered in plus-size at all by some mass-market retailers. Further customer frustration emanates from retailers’ habit of allocating just a section or a corner of a mass-market store towards the plus-size category in a way that effectively segregates these sizes from the rest of the store’s merchandising efforts.

These anecdotal challenges are supported by data: a 2017 UTNE survey of plus-size women found that only 18% of respondents could locate a plus-size mannequin at a mass market retailer selling plus-size clothing, 14% said they could easily locate images of people who looked like them in the store, and just 13% said they could see the store entrance from the plus-size section, implying it was typically hidden in the back of the store.

Overall, I think mass-market retailers will continue to improve their plus-size offerings in coming years, but will still fall far short in meeting customer needs as compared to a specialized offering such as Torrid’s.

Sizing varies significantly across brands, products, and time periods

Other plus-size apparel retailers offer clothing from multiple brands, which creates problems for customers as consistency in fit between brands is non-existent. A multi-decade shift to brand-centrism has allowed each brand to develop its own sizing system. Because Torrid is vertically integrated, it sells very few third party branded goods; other brands are generally only sold at Torrid in areas such as sunglasses or other accessories.

Fit and sizing have also steadily changed over time in a way that further complicates fit challenges. So-called “vanity sizing” allows clothing manufacturers to flatter customers by revising sizes downward

While vanity sizing is not a bad thing per se, this practice does still make the shopping process more difficult for those seeking consistency. Research published in The Washington Post last year illustrates how a size 8 dress today is about the same as a size 16 dress in 1958.

Furthermore, note that being able to find one’s correct size is a problem affecting women more so than men. This is because many men’s garments are sold by measurements (e.g. 34 inch arm and a 16.5 inch neck size on a dress shirt) as opposed to broader size categories (such as XL). Studies show that most women wear about three different sizes, while men typically go between two sizes. This difference is borne out in online return rates for women’s apparel versus men’s apparel. Women’s clothes are returned 50-75% more often than are men’s clothes. Torrid’s e-commerce return rate is just 9%, which is much lower than the ~20% industry average.

Torrid’s product offering and customer value proposition

Torrid employs in-house teams of specialized designers, artists, and product engineers to internally develop products that account for the vast majority of sales. Unlike other brands, Torrid does not rely on mannequins during the design and fit process, instead opting to fit all products on plus-size models, staff, and a select group of engaged customers.

Torrid uses a data-driven design process. The company has created a database of fit specifications based on years of testing, measuring, and cataloging over 13,000 garments each year on its models 1

Rather than having sizes range from 10-30 in a typical plus sizing approach, Torrid simplifies the experience by re-sizing all items down to a simpler size 00 (the smallest size, equivalent to a size 10) through size 6 (equivalent to a size 30).

Torrid has a vertically-integrated approach to sourcing and manufacturing that allows for the incorporation of sales data and customer feedback into the sizing of additional inventory purchases. Overall, my research suggests Torrid has been highly effective in leveraging its data advantage to build-out the industry’s best processes for creating plus-size apparel that meets its customers’ complex needs.

Torrid combines its deep online catalogue of apparel with a specialized in-store experience focused on fit. The in-store shopping experience at Torrid has received Net Promoter Scores of around 90 – I don’t know of many apparel retailers with such measurably high levels customer affinity.

Loyalty and connection with customers

My research has unveiled an unusually high level of brand loyalty for Torrid’s customers. This brand loyalty is borne out in the fact that in normal pre-pandemic times, 96% of revenue from existing customers in one year is retained and repeated in the next year without adding any new customers. In 2020, 2.9 million out of 3.2 million active customers were members of the loyalty program (90%+).

Unlike is the case with many other apparel retailers, Torrid’s customers often report feeling a highly emotional connection to the company. For the first time, some new customers can shop in a way that non-plus-size customers have always shopped at mass-market stores: everything in the store will fit, and everything is available in her size.

Torrid’s e-commerce presence complements its store network

Torrid’s e-commerce offering has accounted for a growing proportion of sales and now accounts for roughly 2/3rds of total revenue. Online sales have grown at a 31% CAGR in the past 5 years, which significantly exceeds the overall growth rate.

Torrid’s e-commerce penetration is much higher than average for the industry and for similar retailers. Management hasn’t disclosed the margin differences between online and in-store customer purchases, but has instead simply explained that Torrid is “agnostic” to how the customer shops. The final Hot Topic 10K from 2013 reports that in 2012, Torrid e-commerce sales represented just 20% of total sales. Therefore, in the 10 years since, e-commerce penetration increased by 4-5% per year. Most similar apparel retailers have e-commerce penetration in the 30-40% range.

New customers are typically first exposed to Torrid through a store visit, but most of these new customers subsequently become omni-channel customers, meaning they shop online and in-store interchangeably. Omni-channel customers spend 3.4x more per year at Torrid than do single-channel customers. Omni-channel sales capabilities include BOPIS (Buy Online, Pick Up In Store), shop by store, ship from store, order in-store, and virtual video-based styling.

Torrid’s store network

Stores vary in size and format by market and mall type (Class A, Class B, and strip mall). My store visits included stops at two locations with modestly different formats than each other, but both were broadly similar. The average store size is about 3,000 square feet, which is significantly smaller than average for specialty apparel retailers. By comparison, a typical American Eagle, Gap, or Athleta store is roughly double the size at around 6,000 square feet. Although smaller than average for stores of its type, Torrid’s stores are not nearly as small as the 1,500 square foot inventory-lite “guideshops” used by some retailers such as Bonobos who rely on online fulfillment for all orders placed in store. Torrid’s abnormally high e-commerce penetration rate is what enables it to have small stores; loyal customers know that there is much more selection and inventory available online.

Store network advantages

Torrid stores offer a number of benefits over online-only competitors. The store network:

1. Serves as a low-cost source of customer acquisition that is immune from fluctuations in online advertising costs
2. Allows Torrid to attract customers who feel uncomfortable buying apparel before trying it on first, even if free returns are offered
3. Lowers costs by reducing online return rates and enabling BOPIS optionality instead of costlier air freight shipping
4. Helps foster brand loyalty and emotional brand connection through in-person interactions with like-minded employees and other shoppers
5. Buffers the company from competitive threats seeking to copy Torrid’s model. It has taken 20 years to build up the current store base, and would take at least 5-10+ years for a new offering to build up such a store network. The time needed to build out a large store network serves as part of the business’s competitive moat

Store-level economics

Prior to the onset of COVID, nearly all of the company’s 600+ stores generated positive store-level contribution, even excluding the incremental contribution from e-commerce purchases of customers who shopped at specific stores.

According to the company’s IPO prospectuses (both the 2017 and 2021 versions), new stores typically generate a positive store-level contribution in their first year of operations, resulting in a short payback period of <2 years (~17 months according to the 2017 prospectus) and highly attractive cash-on-cash returns. New stores cost just $200-250k to open, including both net capital expenditures and pre-opening expenses.

As of the 2021 IPO, leases with terms longer than one year had required minimum rent payments of roughly $60 million per year for the next five years (<5% of revenue). Therefore, leases provide relatively little fixed overhead risk to the company. The 2017 S-1 explained that “A majority of our store leases, and all store leases signed since 2013, include performance-based termination provisions or ‘kick-out’ clauses” in a way that further reduces risk to Torrid. Commitments to new store leases become binding just four months ahead of store opening, enabling the company to easily slow its store count growth if needed.

Expansion of Curve (and CURV)

The Curve line of intimates continues to evolve as a growth driver for Torrid: Some Torrid locations have recently expanded the size of Curve sections within the store, while others have not. This strategy is part of an A/B test process to identify the returns on making such a change. By FQ4 2022, this expanded Curve assortment had been rolled out to 74 stores. By FQ1 2023, Torrid again increased the number of expanded Curve stores to 1/3rd of the total. The test showed promise for Curve’s ability to improve per-store performance – the expanded Curve selection resulted in a mid-teens sales uplift for Curve products at each store on average.

Stores that expanded Curve selection had above-average overall comparable store sales growth, suggesting that any cannibalization of other product lines resulting from the Curve expansion was more than offset by higher sales of Curve. Management reported on the March 2022 earnings call that Curve customers spend 3x what non-Curve customers spend, and that 50% of customers had yet to try an item from Curve.

Separate from the decision to expand the Curve selection within existing Torrid stores, Torrid started a trial in 2022 of 10 Curve-only stores to evaluate their success as a standalone retail concept. They have named this new store concept “CURV”.

American Eagle has been successful in pursuing a similar strategy, when it introduced the Aerie store concept. Aerie has grown quickly to 292 intimates-only stores, as compared to 876 American Eagle stores as of the most recent quarter. This ratio of intimates sub-branded stores to core stores is nearly 1:3. If Torrid were to expand CURV store count to match this ratio, it would imply a CURV store count exceeding 200. Aerie has been a huge hit with customers: management reported that Aerie crossed the 10 million customer threshold in Q3 2022. This is 2.5x Torrid’s entire customer base. I’m clearly not the only one who views Aerie as an ideal template for the growth of CURV: according to Linkedin, Torrid has hired at least a few former Aerie employees to help run aspects of its Curve and CURV businesses.

Given that (1) most new customers are first introduced to Torrid through a store visit and (2) 7 of the top 10 first purchases by new customers are from Torrid’s Curve line, it seems like a reasonable decision to expand the CURV store count to see if Torrid can replicate some of Aerie’s success.

Torrid’s customer behavior

Whenever possible, investors should seek to have a deep understanding of how customers interact with a retailer across multiple years. This can enable investors to have greater confidence in the repeatability and sustainability of recent trends. Due to a dearth of customer data and sales attribution, most traditional brick-and-mortar retailers lack the ability to provide investors with information on customer loyalty, purchase frequency, cohort performance, or customer lifetime value. Without this information, a “known unknown” risk emerges – an investment is more challenging to underwrite if investors lack any data on historical customer behavior.

An investment in Torrid does not share this same unknown risk – investors are given the data needed to form an accurate picture of the company's customer behavior. Torrid customers’ uniquely high adoption rate of its loyalty program (90%+ of active customers) enables the company to have a level of understanding of customer behavior that is largely unparalleled amongst brick-and-mortar retailers. In 2020, Torrid was able to use this loyalty program data to attribute 98% of revenue to individual customer files (up from 86% in 2016). Members of the top two tiers of the loyalty program, Torrid VIP and Loyalist, are the company’s most valuable customers and spend significantly more than typical customers. Torrid Loyalists spend $500+ annually, while Torrid VIPs spend $1,000+ annually. In 2020, Torrid VIP and Loyalist members represented 16% of active customers and 41% of sales. On average, customers in these two categories purchased more than 9 times per year, spending $750 per customer.

Torrid’s high proportion of sales attributable to specific, unique customers enables it to have a precise and nuanced ability to measure customer lifetime value (“LTV”). Torrid spends roughly two-thirds of its marketing expense on new customer acquisition. The remaining one-third of marketing spend is focused on generating incremental repeat purchases from existing customers.

For the 2015 cohort, new customers were acquired for an average of $32 in customer acquisition cost (“CAC”), as detailed in the company’s prospectus. That 2015 customer cohort proceeded to generate an average of $239 of incremental contribution profit per customer over the subsequent 5 years (net of attrition), generating a 7x+ return on Torrid’s investment in customer acquisition for that year. That 2015 cohort’s average annual sales per active customer increased from a first year spend of $262 in 2015 to $375 in 2019.

Customers acquired in the 2016-2019 cohorts have exhibited a similar increase in average sales per active customer over time. Torrid was able to retain over 95% of 2018’s total revenue in 2019. This means that if not a single new customer made a purchase from Torrid in 2019, revenue would fall by less than 5%. Very few retailers have demonstrated such levels of revenue retention and customer loyalty.

The cost of customer acquisition has grown from the $32 per new customer in 2015. However, this increase in CAC was accompanied by a sizeable increase in average spend per customer over that period. Average spend per customer increased by 9% from $306 in FY 2020 to $335 in FY 2021. As a result, the LTV / CAC for the 2015-2019 cohorts has remained strong over time despite increasing customer acquisition costs.

Competitive landscape

There are three types of competitors to Torrid:

1. Plus-size specialty retailers with a brick-and-mortar presence: This group includes Ashley Stewart and Lane Bryant, among others. Ashley Stewart reportedly operates 89 stores and targets an older customer than does Torrid. Lane Bryant operates 450 stores, but generally targets a somewhat older (up to age 55) customer demographic as well
2. Online-only plus-sized retailers: Chic Soul, Universal Standard, Girlfriend collective, as well as some online-only retailers that previously operated stores, such as Catherines, Eloquii and Avenue
3. Non-specialized, mass market retailers account for the rest of Torrid’s competition and make up the majority of the market: This includes vertically-integrated mass market apparel retailers with plus-size sections, such as Old Navy, Athleta, and Forever 21. It also includes less vertically-integrated mass market retailers with plus-size sections, such as Wal-Mart, Target, Kohls, and Macy’s

2020-2021 operational challenges

A combination of internal operational missteps and huge swings in the macro consumer spending environment have led to a “perfect storm” of simultaneous challenges to comparable store sales growth rates and margin pressures. As the pandemic hit the US in March 2020, Torrid closed many stores and revenue growth suffered as a result. The quarter ending in April 2020 saw a -38% YoY decline in revenue and a YoY EBITDA margin decline from 17% to -5%. Prior to the onset of the pandemic, Torrid had recorded 35 consecutive quarters of comparable store sales growth.

Next, as most stores reopened, demand for the company’s product exploded at a torrid pace. Quarterly growth rates from late 2020 through mid-2021 were incredibly volatile: +5% to +10% YoY growth in late 2020 accelerated to +108% YoY growth in early 2021. Just as revenue growth accelerated upon store re-opening, Torrid encountered supply chain problems felt industry-wide that reduced their ability to meet demand. Logistics delays and import issues also contributed to inventory challenges.

In addition, the company was still in its first couple of years of operation of its new distribution center. Operating processes at this facility were still being refined and efficiency was modest at the time. Serious labor shortages at the distribution center also contributed to Torrid being constrained in its ability to meet demand.

In response to this surge in demand and the company’s struggle to have enough inventory to meet it, Torrid stepped-up its inventory purchases to help ensure adequate supply. This reaction was reasonably characteristic of large portions of the apparel industry.

2022-2023 operational challenges

Just as the company was finally importing enough inventory to meet demand in 2022, macro pressures led to cost increases. Cost inflation in materials was significant: in mid-2022, the company reported that its materials cost inflation was up over 10% YoY. Inflation in logistics, distribution, and shipping costs also remained elevated. A tight labor market existed throughout 2022, so hourly wages for store and distribution center employees had to be increased. Some of these cost increases were initially passed on to the customer through price increases, but others weren’t.

Finally, in late 2022, industry-wide macro consumer demand plummeted – right at a time in which the company already had elevated levels of inventory in response to not having enough during 2021. Macro demand declined due to interest rate increases, price pressure on consumer wallets, and the absence of further stimulus payments. Many other specialty and apparel retailers have endured similar issues with declining demand and too much inventory. Facing a more price-conscious consumer and an overbought inventory position, Torrid was forced to massively discount its products starting in mid-2022. Discounting led to margin contraction, revenue deceleration, and fixed cost de-leveraging. Adjusted EBITDA margin in Q3 fell by 7% YoY. The most recent two quarters (ended October 2022 and January 2023) have been most affected by discounting.

Management previously explained in detail how, starting in January 2023, the inventory will have been right-sized, cleaned up, and the discounting will end. The March 2023 earnings call revealed that inventory has since been appropriately down-sized and remains current. Importantly, the planned end to the discounting and inventory clear-out process was not reliant on an improvement in consumer demand. Instead, the company has explained that it is just right-sizing the inventory levels based on the assumption that current levels of macro consumer demand will persist.

In addition, it should be noted that although the inventory levels have become too high**, this issue** didn’t occur because the products went out of fashion; it occurred because management over-corrected to unprecedented volatility in their business that had had limited their ability to meet consumer demand. Going forward, there should be much less volatility in inventory balances. Discounting and promotional activity will slow, and margins should recover to historical levels fairly quickly.

Management changes

Faced with margin pressures and disappointing sales performance resulting at least partially from management’s decision making, Sycamore decided to reshuffle and replace most of the key executive team.

In May 2022, CEO Liz Munoz transitioned to become the Chief Creative Officer. In this role, her focus can shift entirely back to her historical core competencies: product, design, marketing, and merchandising. Although the stock price performance was poor under her tenure as CEO, I think it is worth re-iterating that this underperformance was mostly due to macro pressures and flaws in inventory forecasting as opposed to any deeper issues with product-market fit or customer loyalty. I think Munoz remains important to the business in ensuring the company’s brand and customer relationships remain strong.

Longtime CFO George Wehlitz left the company in mid-2022 in a planned retirement and was replaced by Tanner MacDiarmid, who served as an interim turnaround expert and CFO. Months later, Tim Martin became the permanent CFO and COO of Torrid. Tim was previously the CFO of specialty retailer Guitar Center.

Lisa Harper replaced Liz Munoz as CEO. Harper previously served as the CEO of Hot Topic back when Torrid was owned by that company. Harper has served on the Board of Torrid (and previously, Hot Topic) since 2008. Prior to joining Hot Topic, she served as the CEO of the specialty retailer Gymboree. More recently, she had served as the CEO of the department store chain Belk.

Harper is extremely motivated to improve the company’s share price: she owns 5.9 million shares (~6% of the company) as of Torrid’s IPO. At Torrid’s peak post-IPO valuation, her stake in the company was worth about $200 million. The decline in the stock price has created a mark-to-market loss of around $170 million in the past 18 months.

Upon appointment as CEO in May 2022 (when the stock price was around $6), Harper was given 300,000 performance stock units with an interesting vesting schedule based primarily on share price, not years of service: 25% of the units vest once the stock price exceeds $15, 50% vest at $20, and 75% vest at $25. Only if the share price exceeds $30 do 100% of these units vest. Clearly, both Ms. Harper and Sycamore were comfortable in a pay package that only fully paid out with a stock price hitting its peak levels once more.

Capital allocation

The company instituted a $100 million share repurchase program in December 2021. Back then, the share price was more than triple what it is today. In Q4 of FY 2022, share repurchases totaled $23.4 million. Including the additional share repurchases in the subsequent two quarters, total share repurchases have totaled $55 million.

In the medium-term (12-24 months) I expect capital allocation to favor capital return to shareholders in lieu of using all available cash flow to reinvest heavily in store count growth, technology and systems upgrades, or growth marketing.

In the short-term (next 3-12 months), I’d expect the company to take a balanced approach to capital allocation and invest some amount of cash into each of those avenues.

Fortunately for CURV shareholders, the current management team seems to have a strong grasp of the best uses for their cash.

The stock price is so depressed relative to normalized FCF and my estimate of intrinsic value that the potential returns from share repurchases certainly exceed the estimated returns from instead using that cash flow to grow the company’s store count or make a large investment in new customer acquisition.

In a setup such as this with no leverage or liquidity concerns, capital return to shareholders is the generally the highest-returning use of cash. However, as discussed previously, Sycamore is likely to elect to hold off on incremental share repurchases in the short term until the share price recovers to more moderate levels. The company could also consider a special dividend or regular dividend.

Conclusion

I expect Torrid to benefit from normalizing margins and revenue growth by the end of 2023 at the latest. As this occurs throughout the year, I expect the share price to trade up to $10-20 with ample upside beyond that. I expect a PE fund to acquire this company within a year or two at a price exceeding $20 per share. Overall, I think the current share price represents a highly attractive entry point for new investors in the stock.

Note: Comments should not be construed as investment advice. Readers should do their own research. This post will not be updated as the situation changes. Opinions are my own. I have an investment in the company.