Explaining The Difficulty Of Investing In Teen Retailers

by: Valuentum

Teen retailer American Eagle (NYSE:AEO) reduced its second quarter earnings outlook. After a relatively weak first quarter, the firm was generally optimistic about its prospects heading into the second quarter, predicting flat same-store sales and earnings per share of $0.19-$0.21. However, earlier this week the firm said earnings per share will now be closer to $0.10 for the second quarter, a decline of 50% compared to the same period a year ago. Same-store sales that were predicted to be flat will actually be down 7% year-over-year (compared to 8% growth in the same period a year ago). Thus, same-store sales are only about 1% higher than they were two years ago.

Though the firm has implemented a significant number of changes, including getting product to market faster, shuttering underperforming American Eagle and aerie (Victoria's Secret competitor for teens) stores, and focusing on returning excess cash to shareholders, the firm's second quarter certainly does not look encouraging. Total revenue declined 2% year-over-year during the quarter, and management specifically identified weakness in women's apparel as the main driver of lackluster performance. For teen retailers, women's assortment can make-or-break the business as the segment tends to generate greater revenue than the male segment.

Though the poor performance may be company specific, management noted that July was a highly-promotional month and that the firm had to slash prices to compete. Such aggressiveness likely isn't good for teen peers Abercrombie & Fitch (NYSE:ANF) or Aeropostale (NYSE:ARO). None of the "traditional" teen retailers have fared too well during the past few years, and we'll have results to confirm such weakness later in August when the group reports (American Eagle issues full second-quarter results August 21).

More importantly, we think the weakness in American Eagle's earnings proves a broader point that we've tried to communicate: investing in teen retail is really difficult. Valuations can look attractive and growth prospects flush, but teen consumers are fickle and have relatively low brand loyalty. Teen shoppers tend to look at what peers are wearing, so when one company gains popularity, its success can compound. And the opposite can also be true.

Further, with teen unemployment so high (roughly 24% of the 16-19 age group is unemployed), clothing budgets can often become constrained. This leads to teens perhaps seeking value at fast-fashion retailers such as h&m or Zara, and we are also seeing teens grow more friendly with TJ Maxx (NYSE:TJX) and Ross Stores (NASDAQ:ROST).

On top of budget issues and fickle brand loyalty, even product consumption can change. For instance, shoes, particularly high-end models made by Nike (NKE), are incredibly popular at the moment. If a teenage male shells out $260 for the latest LeBron shoe, then there won't be much money left for clothing.

Valuentum's Take

Teen retail is not a very attractive industry. The group's target consumer is inherently volatile and unpredictable. Still, if we found a secular growth story (one that is more dependent on growing a young concept that battling the vicissitudes of teen spending), we could grow interested in adding a firm in the group to the portfolio of our Best Ideas Newsletter. However, we see no great opportunities at this time.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.