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When you walk into American Eagle Outfitters (NYSE: AEO ) you might not see as many people as in the past. There are many good reasons for this trend. The same could be said of the teen and young adult retail industry as a whole. This current dynamic has important implications for Foolish investors looking to make investment in the retail space.
A Vicious Cycle
American Eagle targets 15 to 25 year-old consumers in the United States and Canada. The United States youth unemployment rate in July came in at 16.3%, the highest July reading since 2010. According to asa.org, 60% of college students borrow money to help cover their costs. Currently, there are approximately 37 million outstanding student loans, totaling $902 billion-$1 trillion in student loan debt. The average student loan debt is $24,301.
Because of these trends and a 2% hike in the payroll tax, American Eagle and its peers aren't receiving nearly as much traffic as in the past. This leads to American Eagle and its peers having to use promotions in order to drive sales. These promotions are relatively effective in regards to driving traffic. However, they cut into margins, which then negatively impacts the bottom line.
All three companies have at least held their own, but recent performance hasn't been impressive. However, the bottom line is more concerning:
All three retailers are facing vicious headwinds, primarily based on necessary promotions and intense competition.
Aeropostale recently admitted to weak traffic and high costs, which have the potential to cut into margins and earnings. Aeropostale is also currently grappling with a negative net margin (0.94%) and return on equity (5.47%). The one thing it has going for it fundamentally is a debt-free balance sheet. However, its cash position of $100.29 million isn't as impressive as American Eagle's of $404.87 million. American Eagle also sports a debt-free balance sheet, and it yields 3.60%.
Abercrombie & Fitch is facing an even steeper uphill battle than Aeropostale simply because fewer people see its brands as cool compared to the past. Ironically, this stems from the company making a statement about wanting to only hire cool employees in order to attract cool shoppers. In 2006, CEO Mike Jeffries stated, "We hire good-looking people in our stores. Because good-looking people attract other good-looking people, and we want to market to cool, good-looking people. We don't market to anyone other than that." Despite this being an old quote, it went viral on social media sites earlier this year. Abercrombie & Fitch's challenges go beyond public relations nightmares. The company's products are also high priced while its target market is looking for bargains.
Abercrombie & Fitch's comps declined 10% in the second quarter year over year, and it expects an even larger decline for the current quarter. Abercrombie & Fitch does have a strong balance sheet with $335.02 million in cash and $203.63 million in long-term debt, and it yields 2.20%, but this would be an extremely high-risk investment.
Focusing on American Eagle
In the second quarter, net revenue slipped 2% to $727.3 million year over year, and comps plummeted 7%. This indicates a decline in repeat shoppers, especially considering the comps increase of 8% the company saw in the year-ago quarter. Transactions-per-store dropped 3%, conversions were flat, and average transaction value declined 4%. There's not much to like.
The good news is that American Eagle's cash position will help it weather this storm, whether that means returning more capital to shareholders, improved marketing, or even an acquisition to help fuel growth. American Eagle has stated that it's focused on strengthening its assortments and improving its marketing, as well as tightening its inventory and expense management. In other words, it's primarily focused on the bottom line.
That said, it hasn't completely given up on the top line. It plans to grow via new store growth, remodels, and technological upgrades. A new distribution center will be implemented to help support omni-channel growth.
If you're looking for an investment where upside potential outweighs downside risk, then you're looking in the wrong place. There are simply too many headwinds for the three aforementioned companies. However, if you're adamant about investing in one of these companies, then American Eagle offers the most light at the end of the tunnel. But it's certainly not a bright light.
A much better way to invest in retail
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.