These Apparel Retailers Are Having a Tough Time

It hasn't been long since analysts Lorraine Hutchinson, Paul Alexander, and Jessica A. Lebo of Bank of America warned that competitors need to start paying attention to privately-held retailer Forever 21. Forever 21 is growing at a terrific pace, and the fast-fashion retailer is becoming a major threat to the rest of the industry.

No one knew that the warning would turn out to be prophetic, but the woes of the following three companies are proof. American Eagle Outfitters (NYSE: AEO  ) , Abercrombie & Fitch (NYSE: ANF  ) , and Aeropostale (NYSE: ARO  ) together are called the "3As" in the U.S. apparel market.

They are all faced with similar problems and seem to be heading toward a worrisome future because they are all losing their target customers. Their target customers -- teens -- are no longer enamored by logo-centric clothing and are moving to cheaper, fast-fashion outlets like H&M, Zara and Forever 21, as well as well as Urban Outfitters.

The headwinds
Teens and the young millennial generation are now spending more money on electronics and less on fashion. In general, spending on cars and homes is threatening apparel sales. One of the big problems that the 3As face is a narrower clientele than that of H&M and Gap, which draw shoppers of all ages. Teens want to be fashionable, but they don't want to spend a lot of money, and fast-fashion works very well for them. That's why retailers like Forever 21 are performing well.

The playing field is more crowded than ever, as international fast-fashion rivals are aggressively expanding in the United States and are putting pressure on pricing. H&M saw sales increase of 10% during the first half of 2013, and the company also launched a U.S. e-commerce site. Uniqlo is planning to open six more stores in the U.S. this fall, with a goal of having 200 by the end of 2020. Forever 21's sales rose 82% in the period of 2007-2012. All of these events are only adding to the woes of the 3As.

Another common factor was the weather. Unseasonably cold weather struck across the country in the first quarter and in the beginning of the second quarter, weakening demand for T-shirts, shorts, etc. For apparel retailers, if their seasonal items don't sell well, this has a very big impact on the underlying business.

In addition, teens are facing lower employment levels this year, according to Challenger, Gray & Christmas, and their parents are grappling with higher payroll taxes, gasoline prices and a slow job recovery. This has forced them to move to fast-fashion retailers in a bid to save money.

The losers
American Eagle's same-store sales, a key metrics for retailers, nosedived 7% in the second quarter after a 5% decline in Q1. Then it guided for another drop "in the mid- to high-single digits," according to the company's post-earnings conference call-- that doesn't sound too good.

Not very long ago, the biggest problem that Abercrombie & Fitch had to deal with was that its CEO, Mike Jeffries, was very vocal about his aversion to "fat" or "not-so-cool" kids wearing his company's clothes. Fast forward a few months, and on the heels of surprisingly disappointing second-quarter earnings the apparel retailer appears to be facing a different demographic problem now: teens are ditching Abercrombie and its sister brand Hollister faster than ever.

For Abercrombie, same-store sales tanked 10% during the second quarter, leading to worse-than-expected earnings and revenue. Further difficulties are expected going forward. The company wasn't in a position to offer guidance beyond the third quarter "due to a lack of visibility given recent traffic trends."

The company is trying to win back customers by opening a new flagship store in Seoul, Korea, this year. It is also planning 20 international outlets under the Hollister brand. However, even if the expansion is successful, it will take time for sales in those markets to have an effect on the bottom line. 

Aeropostale's earnings also moved south this past quarter. Sales dropped 6% to $454 million, which was actually only marginally lower than analyst estimates. Same-store sales crumbled 15% over the year-ago quarter, even when including e-commerce sales. Looking ahead, management is expecting a net loss in the third quarter in the range of $0.21 to $0.26 per share.

Conclusion
In the short term, investing in these three apparel retailers is like catching a falling knife. Availability of cheaper options has clearly hurt them and given these companies' outlooks, there might be further downside in the future.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.


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