Torrid Holdings Inc. (NYSE:CURV) 2Q24 showed signs of revenue inflection after a challenging start to the year. The company is applying better assortment management techniques that may prove positive in future quarters. Gross margins have improved through less clearance, but this has been absorbed by higher SG&A.

On the valuation side, Torrid’s price is basically flat compared to when I last evaluated it last quarter. This implies an earnings yield of 5%, which, I believe, is too low for a retailer of Torrid’s quality. The expectations for future growth embedded in the stock are high, negating some of the upside. The stock remains a Hold.

Positive 2Q24

Signs of revenue inflection: Torrid had a rough start for the year, with sales down 9% on a comparable basis in 1Q24 because of lower clearance from early 2023. In contrast, the 2Q24 results were much, much better. Comparable sales were still negative, but only 0.8%. Further, full-price selling improved almost 7% YoY. Torrid still expects the full-year sales to be slightly down, but the positive 2Q24 is a good sign. Still, as always, a swallow does not make a summer.

Assortment improvements: During the call, management commented on some interesting assortment improvement initiatives. In my opinion, retailers have to be very nimble in how they source inventory to always offer what customers want. If customers change their fashion requirements, the retailer should be fast to recognize it. The same goes for pricing.

Regarding this, management commented on having more space for ‘chase’ inventory, which is ordered while in season based on current store sale data. By the end of the year, this type of inventory should be 10% of all inventory, going into 15% in the future.

Another example of flexibility was provided for denim bottoms, which moved from 65% skinny last year to only 25% skinny this year. Denim trends changed quite earlier than this year, so Torrid was pretty late to the wide-bottom party, but still, it is good to see improvements here.

Finally, the company is launching three capsules at the end of this year and early 2025. The capsules will feature different lifestyles, allowing customers to have more novelty and a broader choice. This is also important for a retailer. Torrid’s model is not about creating trends but rather offering its customers the trends that are working, only in plus-size.

The pricing strategy is strange: Doing some work on customer opinions, I found that Torrid has a very strange pricing strategy. Customers on Reddit and YouTube always seem to complain about the brand’s prices being high (this can be checked on their website, with tees going above $40), while at the same time running sales all the time. For example, one YouTuber commented on a recent 60% off sale of everything on Labor Day. The company also offers Torrid Cash, which ends up implying a discount of 30% on every item. I do not understand why the company does not keep a lower price policy, with full price selling.

Margins flat: By doing less clearance than last year, Torrid gained close to 320 bps in gross margins, allowing it to post higher gross profits despite lower revenues. However, these improvements were lost at the SG&A level, up 300 bps, mainly from performance bonuses and strategic technology investments. Performance bonuses were not paid last year, but I do not see much reason to pay them this year either.

Faster store closures: Management also announced that on top of the 10 to 15 planned closures for this year, it will close an additional 20 to 25 expiring leases in enclosed malls. The company wants to go from 65% enclosed mall stores today, to about 50% in three to five years (with the remaining in open-space malls).

Valuation remains unattractive

Last quarter, I provided a model for Torrid’s earnings at different levels of margin and revenue. The model has not been changed given that Torrid’s fundamentals have not changed (and that revenue growth was a variable, not an input).

The model expected flat volumes (not sales) for the year, with the potential for Torrid to improve its contribution margins (gross margin plus lease costs) based on better clearance management. It also incorporated SG&A fixed at $440 million (inclusive of lease costs, which are reported as part of COGS but are fixed), interest of $40 million, and a tax rate of 30%. Based on an outlook of gross margin improvement of 200bps, no SG&A increases, and flat volumes like guided, the company is expected to generate net income of $31 million or an earnings yield of about 5% at the current market cap of $660 million.

Conclusions

In my opinion, a retailer like Torrid, which has not shown a history of pristine operations nor growth and that has debt, requires at least 12/15% of return to be considered fair, more of that to consider the stock as an opportunity. This implies that the company needs to post earnings growth above 7% to be considered fairly valued.

I do not believe Torrid can sustainably generate that level of growth, or at least it has not been able to generate it historically and has not yet shown signs of a meaningful business model change that would allow that in the future. The company also faces an important challenge from weight-reduction drugs like Ozempic, which are reducing the size of its core demographic.

I still believe Torrid is a Hold at these prices for those reasons. The stock should offer a higher earnings yield (trade at a lower price) in order to be attractive.