Shareholders of Zumiez would probably like to forget the past six months even happened. The stock dropped 28.7% and now trades at $16.40. This may have investors wondering how to approach the situation.

Is there a buying opportunity in Zumiez, or does it present a risk to your portfolio? Get the full breakdown from our expert analysts, it’s free.

Despite the more favorable entry price, we're swiping left on Zumiez for now. Here are three reasons why we avoid ZUMZ and a stock we'd rather own.

Why Do We Think Zumiez Will Underperform?

With store associates called “Zumiez Stash Members”, Zumiez (NASDAQ: ZUMZ) is a specialty retailer of street and skate apparel, footwear, and accessories.

1. Shrinking Same-Store Sales Indicate Waning Demand

Same-store sales is a key performance indicator used to measure organic growth at brick-and-mortar shops for at least a year.

Zumiez’s demand has been shrinking over the last two years as its same-store sales have averaged 6.8% annual declines.

2. EPS Trending Down

Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.

Sadly for Zumiez, its EPS declined by more than its revenue over the last five years, dropping 25.5% annually. This tells us the company struggled because its fixed cost base made it difficult to adjust to shrinking demand.

3. Short Cash Runway Exposes Shareholders to Potential Dilution

As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.

Zumiez burned through $10.47 million of cash over the last year, and its $211.1 million of debt exceeds the $99.3 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.

Unless the Zumiez’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.

We remain cautious of Zumiez until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.

Final Judgment

We cheer for all companies serving everyday consumers, but in the case of Zumiez, we’ll be cheering from the sidelines. Following the recent decline, the stock trades at 17.4× forward price-to-earnings (or $16.40 per share). While this valuation is reasonable, we don’t see a big opportunity at the moment. There are more exciting stocks to buy at the moment. We’d recommend looking at the Amazon and PayPal of Latin America.

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