Making the Most Out of Teen Apparel

The triple "A" teen apparel companies continue to feel the pressure from high teen unemployment and the rise of fast-fashion retailers. But is there an opportunity for deep value investors?

May 31, 2014 at 9:00AM

Teenagers just are not shopping, which comes as teen unemployment remains above 20%. The other issue facing the likes of Aeropostale (NYSE:ARO), Abercrombie & Fitch (NYSE:ANF), and American Eagle Outfitters (NYSE:AEO) is that when they do go to the stores, teens have changed the way they shop. These big-three apparel retailers have seen their market share decline at the hands of fast-fashion retailers, leaving these retailers scrambling to find a niche and once again resonate with shoppers. They have yet to stop the bleeding, and things got a little worse last week.

The recent pain for teen-apparel investors
Aeropostale has been one of the worst stocks to own over the last year or so, with shares down 70% from their 52-week high. Earlier this month shares dove 17% in a single day after the company posted weaker-than-expected fiscal second-quarter results. Aeropostale's first-quarter comparable-store sales tumbled 13%. Once a bright spot, online sales were actually down 18% quarter over quarter.

A couple of things that Aeropostale is doing to help mitigate the decline include closing stores and focusing on its trendy brands. Last quarter it decided to close its mall-based P.S. kids' stores while also cutting jobs at its headquarters. One of its trendy brands it is focusing on is the YouTube star, Bethany Mota.

Despite these efforts the company has had six straight quarters of losses, and Aeropostale has been burning cash. The company did get a lifeline from Sycamore Partners earlier this year, which includes a $150 million credit facility. However, the deal that will inject cash into the company wasn't completed at the time of its earnings announcement. This may have spooked some investors.

But the deal was finalized just a couple of days ago. Sycamore already owned 8% of the company and could own another 5% given its convertible preferred shares. The deal appears to be instrumental to Aeropostale, as it will hopefully give the company enough runway to right the ship. The deal also includes a partnership with MGF Sourcing, which will help diversify and strengthen Aeropostale's production of clothing.

But not every retailer is feeling the same pain
American Eagle also had a weak quarter; however, its stock didn't see the same pullback. Its shares only fell 5% on the news. Comparable-store sales were down 10% year over year. This comes after comps were down 5% in the previous quarter, and they should be down by high single digits next quarter. The company posted negative comps for all four quarters of 2013. American Eagle still has one of the strongest brand names. One of the specific things it is doing is focusing more on product assortment by adding more compelling brands.

The biggest and best?
Abercrombie & Fitch has held up the best over the last year. Shares are only down 25% compared to Aeropostale's 79% fall and American Eagle's 44% decline over the last year. Abercrombie has been looking to hedge the decline of teen shoppers in the U.S. by expanding into international markets. More than 35% of its sales are from outside the U.S. It is also closing underperforming stores.

Abercrombie has a number of brands, with Hollister accounting for slightly more than half of its sales. The company also appears to be revamping its Hollister stores. This could be a move to compete with the fast-fashion retailers, such as H&M and Forever 21. The other opportunity for Hollister stores is to expand into international markets, with a focus on China.

How shares stack up
Aeropostale is still posting negative earnings and has an incalculable P/E ratio. On the plus side, it has no debt. It trades at a price-to-sales ratio of approximately 0.2. Meanwhile, American Eagle trades at a P/S ratio well above Aeropostale's at 0.6. It has positive earnings, which allows it to trade at a P/E ratio of 13 based on next year's earnings estimates.

Another positive for American Eagle is that it has no debt and pays a 4.6% dividend yield. On the other hand, Aeropostale does not pay a dividend and Abercrombie's dividend yield is 2.1%. Abercrombie trades at a similar valuation to American Eagle, trading at a forward P/E of 13.4 and a P/S ratio of 0.7.

Bottom line
For investors looking to play the apparel retail market, there appear to be better investments than Aeropostale. It is a deep value investment that doesn't suit the majority of investors; however, for investors who are looking for an investment in the space, American Eagle offers a very high dividend yield, and Abercrombie has impressive exposure abroad.

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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