American Apparel's Problems Highlight Broader Industry Weakness

American Apparel looks mired in problems at the moment as it seeks a capital injection amid controversy surrounding alleged sexual misconduct by its now ousted CEO, while competitors Lululemon and American Eagle Outfitters are suffering from management issues of their own.

Jul 2, 2014 at 1:21PM

As if investors needed any more reason to be skeptical of the fashion-retail industry, things seem to be going from bad to worse over at American Apparel (NYSEMKT:APP). After CEO Dov Charney was ousted following allegations of sexual misconduct toward employees, the company is now seeking a new credit facility. This seems to be part of a wider trend where retailers like American Eagle Outfitters (NYSE:AEO) and lululemon athletica (NASDAQ:LULU) are struggling to stay afloat in a brutal retail environment, partly as a result of management issues.


Source: WikiMedia Commons

Fading glory
The story of American Apparel is turning into an American tragedy. The brand, founded in Los Angeles in 1997, initially made its fame as a homegrown producer of clothing. Whereas most fashion retailers relied on dubious Southeast Asian sweatshops for the production of their merchandise, American Apparel proudly advertises that its products are made in the United States by workers earning decent wages.

The brand quickly grew to be a hipster favorite, using racy advertising to market its product lines. As such, sexuality has always been a feature of the company's business model and one that initially worked very well, but it seems CEO Dov Charney has taken things a bit too far.

He has now been fired from the company he founded amid charges of sexual intimidation. Some of the allegations are bizarre, including stories of masturbating in front of reporters, giving vibrators as gifts, keeping a female employee as a sex slave, and asking female employees to masturbate in front of him. The move by the company's board comes at an inauspicious time for the company as it struggles with slowing sales, rising losses, and a high debt load.

Charney isn't taking this lying down though, and has with the help of an investment firm managed to increase his stake in the company to 43%, up from a previous 27%. This means he needs the support of only 7% of the company's other shareholders in order to retake control of the company he founded. According to commentators, Charney has a fairly good chance of success.

Industry woes
Less than a week after this unfortunate news, reports have surfaced that the company is looking to raise capital, which sent the stock plunging more than 20% on the day. Apparently, the CEO's exit may lead current lenders to call in their loans, putting the company at risk of default. American Apparel is according to management also looking to shore up its balance sheet in order to be better able to respond to shifts in the market and consumer preferences. ..

American Apparel is far from the only US fashion retailer that is struggling at the moment. Lululemon and American Eagle Outfitters are also having issues related to their leadership, or lack thereof, although these problems are of a different nature. Yet, American Apparel's underlying sales problems are indicative of a broader trend in the industry.

Lululemon, which produces athletic and yoga apparel, is having some management drama of its own. Founder Dennis Wilson stepped down as chairman in December, as a blunder with overly sheer yoga pants and his comments about overweight customers not fitting into them cost the company millions of dollars.. Like Charney, Wilson appears to be fighting to regain control of the company he started. Rumors have surfaced that he may be teaming up with banks or private equity in order to acquire a larger stake in the company, sending the stock higher following the news.

Perhaps more worryingly, the company simply isn't performing well financially, its first-quarter earnings report showing a 3.1% decline in product margin, while profit tanked around 60%. Moreover, the news that CFO John Currie will be retiring next year doesn't help investor confidence in the company's management team at a time when this is sorely needed. As such, investors would be wise to approach the company cautiously until its management problems are sorted out. 

American Eagle Outfitters, which caters primarily to the teen market, is itself on the lookout for a CEO, which is not helping the company deliver a sustained turnaround. For its last report, profit tanked by 86%, as the company is in the midst of a turnaround program which involves store closures and a renewed focus on the online channel. .

However, the success of these efforts hinges on the company's ability to revamp its product lines, which according to analysts have fallen out of favor with consumers. As such, the company is losing market share to competitors that are better at keeping up with shifting fashion trends. Assuming the company doesn't come up with a hugely improved product assortment soon, sales are expected to remain under pressure in the coming quarters and investors should stay wary. 

 The Foolish takeaway
American Apparel, a bastion of American manufacturing in the fashion-retail space, has gotten itself into some serious trouble, as founder and CEO Dov Charney has been fired as a result of allegations regarding sexual misconduct. The move comes at a bad time for American Apparel, as a weak performance and default worries have prompted it to look for a fresh capital injection. However, the company is not the only apparel retailer struggling these days. Lululemon is fighting off management problems of its own, and American Eagle Outfitters is having trouble delivering a sustained turnaround in the absence of a CEO.

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Daniel James has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica. 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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