Is This Teen Retailer Ready To Trade Higher?

Wet Seal (NASDAQ: WTSL  ) is a small retailer, but is still part of the teen industry that has been crushed over the last few months. Competitors Aeropostale (NYSE: ARO  ) , American Eagle (NYSE: AEO  ) , and Abercrombie (NYSE: ANF  ) have all seen horrific fundamental performances, yet Wet Seal is starting to show signs of moderate improvements.

A telling tale of performance
Like I said, all four retailers focus on teens, but a rise in e-commerce and a change in style has left all with rather sloppy fundamental performance. Over the last month, the stock performance of these companies are as follows:

Company

Stock Performance (before 8/27)

Wet Seal

(16%)

Abercrombie

(27%)

American Eagle

(24%)

Aeropostale

(43%)

Aeropostale's industry-worst performance was due to the nature of its earnings report, which was simply terrible. Wet Seal had lost the least value, but had not yet announced earnings.

How are the fundamentals?
On Tuesday, Wet Seal announced earnings after the market closed, and is currently trading higher by 9%. It was the first of the four companies to actually trade higher following its report. With that said, let's take a look at a few key metrics from each company's report; metrics that are most important.

Company

Sales Growth (year-over-year)

Comp Growth (year-over-year)

Gross Margin Growth (year-over-year)

Wet Seal

1%

3.7%

680 basis point

Abercrombie

(1%)

(10%)

160bp

American Eagle

(2%)

(7%)

(360bp)

Aeropostale

(6%)

(15%)

(740bp)

Take a minute to soak in the three key retail metrics for each company, and then realize who flourished.

Wet Seal had the greatest overall sales growth, comparable growth, and improved its gross margin the most. Compared to other retailers, Wet Seal's quarter was phenomenal.

Other than Wet Seal, I think the market mostly got performance-for-earnings right. Abercrombie and American Eagle's quarter was similar, with Abercrombie's comps declining more rapidly, but American Eagle seeing its gross margin fall faster.

Aeropostale was by far the worst, in all three of the noted categories, and is why the stock declined 43% in the last month. However, it was also the company's harsh guidance to close stores at a faster rate and its anticipated decline in comp sales.

Both Abercrombie and American Eagle noted a weakening environment toward the end of the quarter, yet Wet Seal reiterates mid-single digit comp growth expectations.

What about valuation?
While we see that performance matches fundamental performance -- suggesting the market correctly traded these stocks – valuation must also be considered. Clearly, Wet Seal had the best quarter, but is it cheap enough to buy, and is any other retailer presenting value?

 

Wet Seal

Abercrombie

American Eagle

Aeropostale

Market Cap

$345 million

$2.78 billion

$2.82 billion

$660 million

Trailing P/E

n/a

11.92

13.21

n/a

Forward P/E

16.23

11.07

12.59

31.22

PEG Ratio

1.01

1.14

1.76

n/a

Price/Sales

0.60

0.63

0.82

0.29

Operating Margin

(6%)

8.6%

11.3%

0.46%

At first glance, you might look at Wet Seal's forward P/E ratio compared to Abercrombie and American Eagle and then assume that no value is present. However, this is where operating margins come into play, Wet Seal is a company with margins on the rise, and with a lot of room to improve. Abercrombie and American Eagle do not have this luxury in a competitive pricing environment.

The more important metric is PEG, which is expected growth over a longer period of time compared to valuation. With this metric, Wet Seal is clearly the cheapest of the bunch.

Aeropostale is the cheapest on a price/sales basis, followed by Wet Seal. Aeropostale should have room to improve its margins as well. However, because of Aeropostale's rapid fundamental declines, the market has priced it as a worst case scenario.

On the other hand, Wet Seal is priced below Abercrombie and American Eagle, and because of Wet Seal's fundamental improvements, investors should like its prospects moving forward.

Final thoughts
Wet Seal is cheap and is fundamentally improving in a sluggish teen retail environment. Aeropostale is cheap, but its fundamental decline apparently has no end. Abercrombie and American Eagle have strong margins, yet with fewer consumers coming into their stores, I am not sure how investors can be optimistic about maintaining those large returns.

In my opinion, Wet Seal is set apart as the best in this space. I have looked at stock and fundamental performance, and valuation, which all suggest Wet Seal as a good buy. With that said, teen retail outlooks can change in the blink of an eye -- apparent with the three noted companies -- and if buying Wet Seal, I'd closely monitor the company's performance. But at this point, following a great quarter, it looks as though Wet Seal has room to run higher. 


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