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The world of retail is a finicky one where consumers’ perception of merchandise assortments can make or break a retailer’s numbers in any given year. Consumer tastes are always changing, making it difficult for corporate buyers to anticipate what fashions will captivate shoppers’ interests when they make purchase orders for goods months before they hit store shelves. Some buyers are simply better than peers at identifying merchandise people will want. The same holds true for specialty retailers that design and manufacture their own merchandise.

A number of retailers continue to look to celebrity endorsements and lucrative private-label lines to increase diversification and prop up margins. Sometimes these bets (or the merchandise selection in general for that matter) don’t strike a chord with consumers, and retailers are forced to clear merchandise via increased discounts and promotions, at the expense of margins. Also, one retailer may become more aggressive with pricing, forcing peers to follow suit. Thus, it is important to monitor how much clearance activity has taken place recently.

Often times, even desirable merchandise and a solid strategy aren’t enough to overcome a challenging environment. Astute retail investors consider the buying power of a retailer’s clientele, and how current and future macroeconomic factors, such as home prices, the unemployment rate, the savings rate, payrolls, indebtedness, and recent stock market performance play into where and when people choose to spend their hard earned disposable income. Also, if a retailer's store count is concentrated in a specific region, investors should consider the economy of said region when conducting analysis. 

We screened the Retail Soft Lines, Retail Hard Lines, and Retail Store Industries and came up with a list of 80 profitable companies. We only considered those with sales growth above 10% in the past year and long-term price appreciation potential above 70% (see list at the bottom of this page). Two companies that stood out for their recovery potential are Urban Outfitters (URBN) and American Eagle Outfitters (AEO).

Urban Outfitters

Urban Outfitters is a specialty retailer of fashion apparel, accessories, and home goods. The company sells its products in 491 stores throughout the United States, Canada, and Europe, as well as through its online, mobile application, catalog, and customer contact center platforms.

Urban operates under five brand names: Urban Outfitters offers women’s and men’s fashion apparel, footwear, and accessories, for ages 18 to 28, as well as apartment wares and gifts (45% of July 31st revenues); Anthropologie has casual apparel, accessories, shoes, home furnishings, gifts, and decorative items for women aged 28 to 45 (41%); Free People sells a mix of causal women’s apparel, intimates, shoes, accessories, and gifts for those between the ages of 25 to 30 (7%); Terrain offers sophisticated outdoor living and gardening products for both women and men (less than 1%); and BHLDN consists of the company’s wedding collection (less than 1%). However, Urban Outfitters has only two reportable segments: Retail (those listed above) and Wholesale (consists of the Free People brand), which accounted for 6% of revenues.

During the July period, retail sales advanced at a healthy clip, owing to a 9% increase in comparable retail net sales, with the largest gains from the Free People (38%) and Anthropologie (9%) brands. Indeed, these two categories have been bright spots for the company, owing to higher traffic, especially regarding its direct-to-consumer channel, and an increased number of transactions. Meanwhile, the Urban Outfitters name has struggled of late, largely due to a “merchandise miss” last quarter. This will likely result in increased markdowns and put pressure on margins for the balance of fiscal 2013.

The retailer has posted double-digit sales growth over the past five years. This trend is expected to continue both this year and next, with earnings per share projected to climb in the 17%-18% range. Share-net growth will likely be supported by the company’s recent 10 million share buyback program, improved margins from its profitable brand names, and store expansion. Although the stock price recently reached an all-time high, the midpoint of our long-term price projection is still roughly 50% above the Value Line median. 

American Eagle Outfitters

American Eagle Outfitters, founded in 1977, is a global retailer that offers high quality, on-trend clothing, accessories, and personal care products under the American Eagle and aerie brand names. The company’s business segments are comprised of 921 American Eagle brand retail stores (offers clothing, shoes, and accessories for men and women aged 15 to 25), 135 aerie retail stores (intimates and personal care products to girls), and AEO Direct (its various e-commerce platforms). By the end of the July period, American Eagle’s total store count was 1,056, in addition to 57 international franchise stores.

The retailer’s short-term outlook is worrisome, amid a difficult retail operating environment. Fiscal second-quarter (ended August 3rd) results were worse than expected, due to a lackluster women’s product assortment and decreased store traffic. Moreover, increased markdowns, which pressured margins, resulted in a 52% share-net decline. As a result, management plans to implement cost containment measures, reinvigorate its merchandise assortment, and improve marketing initiatives. Still, these soft trends persisted in the fiscal third quarter (ended November 2nd), as these initiatives may take time to bear fruit (Note: Preliminary results were reported on November 6th). In fact, comparable-store sales decreased 5%, compared to a gain of 10% last year, with earnings guidance updated to approximately $0.19 a share. This implies a share-net decline north of 50%. Nevertheless, performance is likely to bounce back in fiscal 2014.

These shares have pulled back in price of late and are resting near their 52-week low. Investor sentiment reflects the company’s disappointing performance, so far, this year. That said, price appreciation potential for the 2016-2018 time frame is exciting, as we expect performance to progress nicely over the long term, with share net reaching around $1.85.

 

Company

Ticker

Industry Name

Dick's Sporting Goods

DKS

Retail (Hardlines)

Weight Watchers

WTW

Retail (Hardlines)

Williams-Sonoma

WSM

Retail (Hardlines)

Abercrombie & Fitch

ANF

Retail (Softlines)

Amer. Eagle Outfitters

AEO

Retail (Softlines)

Chico's FAS

CHS

Retail (Softlines)

Urban Outfitters

URBN

Retail (Softlines)

Big Lots Inc.

BIG

Retail Store

Dollar General

DG

Retail Store

At the time of this article's writing, the author did not have positions in any of the companies mentioned.