Was the Easter Bunny Mean to Retailers in April?

Warm weather in the latter stages of April has brought bargain-seeking consumers back into the malls. If a retailer was visibly strong in its promotional tactics, then their April comparable store sales (comp) will likely surpass consensus estimates when all is said and done. We believe that Aeropostale Inc. (ARO), American Eagle Outfitters Inc. (AEO), Pacific Sunwear Inc. (PSUN), and Old Navy (division of Gap (GPS)) led the charge this spring, conveying to customers an appropriate balance between price and quality.

In the aggregate, retailers have begun to discount merchandise at a quicker pace than in prior years at this juncture in the season, despite inventories being very lean. Ultimately, we do not see a host of 1Q09 upward earnings revisions on the April sales releases. Margin upside was likely tempered from unfavorable weather early in the month, and later in the month from increased discounting (that went beyond first markdown).

Jeans appear to be selling at a brisk pace, especially premium washes (Guess (GES) no longer reports monthly sales, but it could be benefiting; the same could be said for True Religion (TRLG)). Aeropostale, on the end of the price spectrum, likely captured its fair share of trade down jeans business in specialty given prices that are going unmatched by competitors (outside of mass merchants).

Across the specialty apparel sector, we observed very little in the way of new merchandise trends; seasonal scarves and leggings are still the rage with accessorizing women and guys remain in love with the polo. The lack of strong trend was on display in shorts, where plaid and cargo once again dominated the racks.

Our reasoning on retail equities is unchanged from comments expressed in March, or for that matter since the year began. The S&P Retail Index (RLX) has had a phenomenal stretch, rising approximately 47.0% from the early March low on the notion the free spending ways of yesteryear will return to consumer land. We do not agree with Mr. Market; consumer de-leveraging after years of largesse and an effort to rebuild savings are strong deterrents to the type of spending incorporated into retail consensus earnings estimates in 2H09. After the realization by consumers that tax rebates and administration stimulus measures are temporary, one should aptly expect the U.S. savings rate to return to trend of 8.0% or so (perhaps higher).

Referencing our ratings, we remain underweight most specialty apparel companies, save for ones we have characterized as special situations. However, even those special situations such as Ann Taylor (ANN) and Pacific Sunwear have bounced materially from our original upgrades, so there is caution creeping back into the construct. Discount retailers look to be a better bet, in spite of the stocks falling out of favor with the big money players as of late (they undoubtedly chased the specialty apparel names, which have a higher chance of faster earnings growth should the economy course correct).

Among our discount retail coverage, we just issued an upgrade on Target (TGT) based on our belief the credit card business troughed in 4Q08, and could emerge as solid earnings contributor in 2H09 as bad debt expense stabilizes. Wal-Mart (WMT), the star sector performer of 2008, is still a good buy; we think performance coming out of the spring is much stronger than the recent stock performance indicates.

Authored by Brian S. Sozzi, an Equity Research Analyst for Wall Street Strategies, Inc. (www.wstreet.com) covering companies in the Retail (hardline and softline) sector.

Disclosure: None