Lovesac Company (NASDAQ:LOVE) is emerging from legal issues involving former executives and is on track for its share price to stage a rebound.

The rebound will be driven by its growth, improving operational quality, and shift to sustainable profitability, but there are risks.

Among these are significant risks of shareholder dilution and a high level of short interest that remain unaddressed.

The question for investors is how great an opportunity for upside there is, and how the risks of stock price decline offset it. 

Lovesac Is Growing, and the Analysts Like It

Lovesac’s growth is underpinned by its increasing store count, which has risen by 21 compared to last year, with sales in that channel up 18%. The weak areas are in the digital and other categories, which contracted by 9% and 40.5%. 

Operational quality resulted in a 60-basis-point contraction in the gross margin and a 310-basis-point contraction in SG&A expenses. The net result is that the GAAP losses contracted by more than 1,600 basis points, and the adjusted loss by more than 2,000 basis points, allowing management to issue strong guidance.

The guidance for the year was increased, with revenue expected to range around $725 million and EPS expected to be around $1.05, both above the consensus forecast reported by MarketBeat. 

Lovesac’s Share Buyback Is at Risk

The net result is a 7% decline in shareholder equity and insufficient cash to ensure operations can continue while repurchasing shares.

Add in the fact that guidance includes an 11.6% increase in the expected average share count between the Q2 and full-year forecasts, and the odds are high that the share count will be increased or at least offset the impact of buybacks. 

Short interest has decreased significantly from its highs but remained elevated at more than 20% in May. With this in play and shareholder dilution a possibility, it is unlikely that short interest will continue to fall over the summer. The risk is that shorts will pile back into this market, lowering the share price. 

Even if Lovesac can rebound from its mid-June price points, gains could be capped at resistance targets near $22.50 and $25 unless another catalyst emerges. 

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The article "Analysts Love Lovesac, But Investors Should Be Cautious" first appeared on MarketBeat.