News out of the teen apparel sector hasn’t been good of late, leading the industry’s top names sharply lower, including a 10% one-day drop at Aeropostale, Inc. (NYSE:ARO). However, Abercrombie & Fitch Co. (NYSE:ANF) and American Eagle Outfitters (NYSE:AEO) both felt the pinch, too.
It’s About Style, Most of the Time
Teens have plenty of trendy shops at which to shop. The key word is, of course, trendy. This demographic has notoriously fickle shopping habits. That said, there are basics that never seem to go out of style, such as jeans. In the basics space, Aeropostale, Abercrombie & Fitch Co. (NYSE:ANF), and American Eagle are core retailers.
While every teen-focused retailer, even those that sell basics, eventually makes a mistake on the fashion side, that’s just part of doing business. Jim Roumell and Ted Crawford of Roumell Opportunistic Value Fund (RAMSX) noted to me that the companies here often take turns as the trendsetter of the moment. While that can bring about investment opportunities, there is more going on right now than fashion misses.
Sale!
The biggest problem in the industry today is the lingering impact of the 2007 to 2009 recession. During that period, stores went into sale mode across the retail landscape. The goal was to keep customers coming in the doors.
While that has worked to some degree, the economy remains in a painfully slow recovery marked by still-high unemployment, particularly for teens. Thus, discounting has become the norm, not the exception.
Profit margins went from the high teens/early twenties before the recession at Abercrombie and American Eagle to the single digits. At lower-end focused Aeropostale, Inc. (NYSE:ARO), profit margins went from the low teens before the recession, jumped to the mid-teens coming out of the recession, and now are in the low single digits. While fashion is a big issue, margins are the industry’s problem right now.
Extreme
Aeropostale, Inc. (NYSE:ARO) took the biggest hit recently and is well off of its highs. However, the company has no debt and generates plenty of cash. It has to rework things, but it doesn’t need to rush a fix out the door. That could make now an opportunistic time to jump aboard a key industry player working to right the ship.
Management has been closing underperforming stores, expanding overseas, and investing in its supply chain. These efforts should led to stronger long-term results. In fact, sales seem to have stabilized between the company’s fiscal 2012 and 2013. As the company works on the back end, however, it remains stuck in discount mode. That’s the long-term issue to watch right now. If Aeropostale can start to raise prices, profit margins and the bottom line will quickly recover. That could lead to a swift ascent for the shares.
Another Big Drop
Although Abercrombie & Fitch Co. (NYSE:ANF)’s one-day decline at around 8% wasn’t as bad as Aeropostale’s 10% fall, it was no less gut wrenching. Abercrombie focuses on the high end of the market and that has allowed profit margins to recover somewhat since the recession despite continued sales. While improved, profit margins at around 8% are still well below the nearly 20% achieved prior to the recession.
Teen employment could be a big issue here, since parents are more likely to spend less on a child’s clothing than a self-employed child would. That’s a tailwind for Aeropostale, Inc. (NYSE:ARO)’s discount model, but a clear issue for Abercrombie’s higher priced duds. Unlike its discount competitor, however, Abercrombie & Fitch Co. (NYSE:ANF)’s sales have increased in each of the last four fiscal years and are now well above their pre-recession peak.
Watch the discounting here, if it stops, profit margins are likely to head quickly higher.
The Best Positioned?
American Eagle Outfitters (NYSE:AEO), meanwhile, appears to have broken free of the discount spiral. That allowed the company’s profit margins to jump back into the low double digits in fiscal 2013. That’s still a long way from the early 20s that the company was achieving before the recession, but is much better than its peers.
Still, the company hasn’t completely gotten away from sales, it has just been able to better manage the impact. So, a weak economy continues to be an issue. That said, if the economy starts to pick up, including an improvement in teen employment, American Eagle is likely to be the first to benefit since it is already on a more solid footing.
Moreover, the company’s sales have grown steadily over the past three years and international expansion should be an added tailwind. American Eagle Outfitters (NYSE:AEO) is probably the best choice for more conservative accounts looking at the teen space.
The Big Turn
The teen apparel industry is in the doldrums right now for several big-picture reasons. American Eagle Outfitters (NYSE:AEO) has been handling this storm better than its competitors and is a good option right now. However, those seeking the biggest turnaround candidate should take a look at Aeropostale, which is well off of its recent high water mark of around $30 a share.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
The article Teen Apparel Hits A Wall originally appeared on Fool.com.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
