Teen Retailers: Trouble in Paradise?

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Teen retail is having a brutal year. Revenues, profits and stock prices have all been hit hard. Abercrombie & Fitch (ANF), Aeropostale (ARO) and American Eagle Outfitters (AEO) have seen their stock prices drop by 25%, 30% and 19%, respectively, through Dec. 5.

What the heck is going on?

Is it possible that Zara, Forever 21 and H&M have permanently stolen their thunder? Can ANF, ARO and AEO get their mojo back? I'll look at all the possible scenarios facing all three teen retailers in a very competitive teen market. By the end you'll know if any are worth owning.

Teen Market Changing

Teens seem to be going anywhere where clothing innovation has a pulse, and lately, that hasn’t been the major teen retailers. Wendy Liebmann, CEO of WSL Strategic Retail says it best in a CNBC article from August: "There isn't a lot of innovative clothing out there for anyone, and there are plenty of other places to buy clothes if you want."

Consider Gap (GPS) for a moment. It was stuck in a major rut until 2012 when structural changes implemented by CEO Glenn Murphy and his team delivered better merchandise leading to same-store sales growth in seven consecutive quarters through the end of October. Since the end of 2011, Gap's stock has doubled in value, compared to a 49% gain for the SPDR S&P 500 (SPY). Retail is a cyclical game. Some analysts are downgrading GPS stock, figuring a slowdown is ahead despite the fact its November comps were much better than analyst expectations. Gap stock will be fine.

And Gap’s not alone. As mentioned previously, Zara, Forever 21 and H&M have all seen revenues increase at the expense of teen retailers like Aeropostale who've been forced to sell more expensive fashionable items, moving away from its traditional logo business. Firms like Japan's Uniglo continue to innovate their way into American pocket books. By 2020 Uniglo expects to have 200 stores open, most of which will be quite a bit smaller than its 89,000 square-foot 5th Avenue shop but still doing plenty of business.

When you take all the new retail options available in the U.S. from other parts of the world and combine this with an insatiable demand by teens for electronics, it's obvious that something had to give — unfortunately, the 3A's suffer the brunt of these changes.

Faint Hope

InvestorPlace’s Kyle Woodley believes ANF's best option right now is to let CEO Michael Jeffries contract expire at the beginning of February and turn the page on a tumultuous 25-year run. That's not a new idea, but this time there's enough ammunition to give institutional investors like Engaged Capital the rope they need to finish the job.

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Jeffries has two failed brands on his watch — Ruehl and Gilly Hicks — along with an international expansion that Belus Capital Advisors' Brian Sozzi believes has been far too aggressive. If any company needed to fix itself away from the bright lights of Wall Street, Abercrombie would be it. Jeffries has to go, and the company must be taken private before anything changes at ANF. This brand is too strong to wade aimlessly.

Meanwhile, ARO stock has dropped by almost a third in 2013 for good reason — its business is in disarray. Its Q3 report produced a loss of 29 cents per share — five cents worse than analyst expectations, along with a 15% decline in same-store sales. In the fourth quarter, it expects to lose at least 24 cents per share, double what analysts were expecting.

The Fly on the Wall reports that BMO Capital Markets sees ARO stock price providing good long-term value. I tend to agree. ARO’s stock hasn't consistently traded below $10 since 2005. CEO Thomas Johnson has significant experience at several retailers other than ARO, so I wouldn't be surprised if this teen retailer was making money once again in 2014.

Lastly, there's American Eagle. AEO stock delivered Q3 earnings December 6, that while bad, were still positive, unlike Aeropostale. Adjusted earnings per share of 19 cents met analyst estimates. In Q4 AEO expects EPS between 26 cents to 30 cents, well below the 39-cent consensus estimate. While it's currently having a hard time coping with the highly promotional retail environment teen retailers are facing, there are signs its future will brighten. AEO announced in its earnings release that its new chief merchandising officer is Chad Kessler, former head of merchandising for Urban Outfitters' (URBN) namesake brand who also spent 16 years in various positions with Abercrombie.

Kessler should be a welcome addition. Also lost in the bad news is a 17% increase in same-store sales growth for its online business. In 2012, AEO generated approximately $476 million in e-commerce revenue and looks to do  more than $500 million in fiscal 2013. Of the trio, AEO stock looks like the best of the teen retailers for the long haul. With today's drop, investors should be considering pulling the trigger.

Bottom Line

If you're looking to own one of these teen retailers long-term, the smartest bet in my opinion is AEO stock. Despite moving through some very choppy waters, it has the best business of the bunch.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.