Stay Away From This Apparel Retailer

The retail sector, no doubt, is going through a rough patch. There has been a marked shift in consumer behavior in the teen-apparel segment of the market. The uncertainty of the economic recovery, teens holding fewer jobs, and the switch toward buying electronic gadgets instead of expensive fashion apparel have indeed left the teen apparel industry in a state of weakness. There seems to be negative sentiment going into the holiday season as well.

One after another, there have been announcements of dismal quarterly reports from the teen-apparel retail industry, and Abercrombie & Fitch (NYSE: ANF  ) seems to be one of the worst hit.

American Eagle Outfitters (NYSE: AEO  ) , another teen apparel retailer, is in the same boat as Abercrombie. Michael Kors (NYSE: KORS  ) , however, has been able to outperform thanks to its affluent customers.

What gives?

Another less talked about fact is the continuously-dropping birth rate in the U.S. According to the Centers for Disease Control and Prevention, the U.S. fertility rate has fallen to a record low in 2011 . This continuous decline also means that there are fewer teens out in the market, and this trend might continue for a few years.

In addition, the recession has hit young adults the hardest . There has been a buzz around dropping unemployment rates, but everyone has ignored the fact that according to government data, the current level of employment of adults aged 18-24 is the lowest since 2010 at 54% . In addition, there's a gap of 15 percentage points between the employment rates of the young and all ages of working adults. Also, young adults have seen the greatest drop in weekly earnings (down 6%) than any other age group over the past four years.

With fewer jobs per young adult and lower weekly earnings, a shift in consumer behavior was imminent. Young adults want to spend more on electronic gadgets such as smartphones and tablets rather than staying loyal to designer clothes and footwear. They are instead flocking to cheaper fashion retail outlets like Forever 21, H&M, and Zara, to name a few.

Weak results

Abercrombie & Fitch took the worst hit as this shift in consumer behavior occurred. A statement from CEO Mike Jeffries further alienated the company's target customers.

As a result, Abercrombie posted second-quarter results that included a 20% decline in earnings. Domestic sales declined 8%, and comps tanked by 10%. This domestic decline was partially offset by international sales, which increased 15%. This was not enough to increase Abercrombie's total sales, though, which fell to $945.7 million from $951.4 million in the year-ago quarter .

Abercrombie expects this trend to continue going forward. In fact, it wasn't in a position to offer guidance beyond the third quarter due to a lack of visibility given recent traffic trends . Despite all odds, the company is trying to get back on track by expanding its international operations. It is opening a new flagship store in Seoul, Korea, this year. In addition, a total of 20 international outlets under the Hollister brand are planned.

However, even if the expansion into international markets to reduce Abercrombie's domestic dependence is successful, it will be quite some time before sales from these additional initiatives have an effect on the bottom line.

Retail sales were behind estimates in August. Consumers are buying automobiles, appliances, electronics and furniture, and cutting back on clothing, building materials and sporting goods. This isn't an encouraging indicator for the apparel retail business going into the holiday season .

What's working and what's not?

This is why a focus on international business is even more important. For instance, Michael Kors is aggressively moving into China as it looks to tap a market which is expected to grow at an annual rate of 7% through 2016 . By 2020, it is expected that China will become the world's second-largest clothing market. Kors plans to open 100-125 stores in the nation in the next few years .

In the previous quarter, Kors' same-store sales improved a staggering 27%, while revenue of $640.9 million was way ahead of the $572 million expected. Expansion in China should help Kors keep its impressive growth rate intact and also make its business more diversified.

Expansion into international markets seems more important than ever now as the apparel market in the U.S. slows down. For example, American Eagle's same-store sales were down 7% in the recently-reported second quarter. This was on top of a 5% decline in the previous quarter. Looking ahead, management expects a mid- to high-single digit decline in the current quarter .

Even American Eagle is looking at international shores for growth. The company has planned six stores for Mexico this year, and it has also managed to successfully license stores in Israel, Japan and Poland .

Conclusion

Apparel retailers, especially those catering to teens, have found the going difficult lately. Abercrombie, especially, has been the worst hit of the lot. A steep decline in same-store sales and the fact that it has alienated customers make a comeback difficult and investors should wait for its planned expansion abroad to yield some concrete results. Until then, this is a stock to stay away from.

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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