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By Brian Sozzi

Being ahead of the curve is vital for an investor. With the crucial part of the holiday season behind us, I tell you how to play the sector ahead of the December same-store sales results on January 6. Note that Wall Street Strategies' institutional equity research product is included as part of the Thomson Reuters, Bloomberg, and Factset consensus financial estimates.

Company Name: Abercrombie & Fitch Co. (NYSE:ANF)
* Rating: Buy
* Action: Upgrade from Hold
* Price Target: $65.00
* Action: Raised from $56.00

The Sexy Performer From Teen Apparel in December

I upgraded my recommendation on Abercrombie & Fitch to Buy from Hold today, and took the price target to $65.00 from $56.00. The raised price target is worked off a 23.4x P/E multiple on my refreshed FY11 EPS assumption of $2.77 (up from $2.64), as I expect favorable two-year comp comparisons for much of FY11, a more receptive market for accessible luxury teen apparel, and a more productive store base to support multiple expansion. Market focus is likely to shift from the upside potential of Abercrombie & Fitch's comps off of easy comparisons to the restoration of margins post AUR reductions in FY10. Ways in which I anticipate Abercrombie & Fitch to restore its margin integrity include: (1) post holiday closures of underperforming stores; (2) greater contribution of D2C sales and international sales to total sales; and (3) increased expense leverage from positive comps at a time in which AUR pressure is subsiding.

Abercrombie & Fitch is poised to announce the best comp in December relative to its teen apparel competitors, owing to strong pre-planned promotions at the namesake divisions and Hollister. Promotions of 40% off everything at Abercrombie & Fitch, abercrombie kids, and Hollister, which were not materially different than those on Black Friday, drove strong traffic and conversion. Consumers responded to the quality of the merchandise offering at a promotional price that was far stronger than was peers were conveying.

Company Name: Aeropostale (NYSE:ARO)
* Rating: Sell
* Action: Reiteration
* Price Target: $20.00
* Action: Reiteration

Bad News in the Cards From Aeropostale?

The writing is on the wall at Aeropostale. Not only was Aeropostale running a 50% to 70% off the store promotion for a good portion of November, resulting from poor inventory content and too much of it, in addition to competitive pressures, but promotional cadence was increased at the start of December. Aeropostale utilized a targeted promotional stance on key items such as t-shirts ($5 Riot) and hoodies in December, underscoring a muted customer reaction to the commodity products being sold. Additionally, keep in mind that Aeropostale entered December with hardly any post Black Friday momentum.

I lowered my 4Q10 EPS estimate to $0.92 from $0.93 (guidance: $0.94 to $0.96), and reiterated a Sell rating and $20.00 price target. While the market waits on pins and needles for a potential takeover of Aeropostale in light of recent management shuffling, I think attention to the fundamental story near-term is more of a pressing issue that could knock added wind from the share price.

Company Name: Gap (NYSE:GPS)
* Rating: Buy
* Action: Reiteration
* Price Target: $25.00
* Action: Reiteration

Out of Stocks Equate to a Surprisingly Strong Quarter?

I reiterated my Buy recommendation on Gap and price target of $25.00. When all is said and done, I think holiday 2010 will have been kind to Gap on the profit line, perhaps more so than consensus has modeled. I point to generally consistent promotions at the Gap and Banana Republic divisions in November and December, with no large raises in the days leading up to the Christmas holiday. When I did in fact observe new promotional signage in the windows at Gap and Banana Republic, it centered on "up to" on markdown items instead of the entire store.

In the weeks preceding Christmas and thus far after the holiday, I could not help but to have noticed out of stocks across the board at Gap and Banana Republic tops for men and women. Conversely, if there is downside risk to my views it's situated with markdowns in the bottoms category at Gap (an area of investment for the company) and an increased promotional cadence at Old Navy (to compete with Aeropostale) starting mid-month. Nonetheless, I think Gap is in play as one that stands to raise its guidance on same-store sales release day.

Side notes: Since December 3, Co-Founder and Director at Gap, Doris Fisher, has unloaded 4.29 million shares of the company. The sale prices have ranged from $21.01 to $21.48. I am not privy to information on what sparked the stock sales, but have to wonder with someone so emotionally tied to a company if there is not more behind the moves other than diversification (potential sale of the company, disappointing numbers, etc.).

Banana Republic has launched personal styling services in 34 stores, a service typically not synonymous with the world of mall-based specialty retailing (for publicly traded companies).

Company Name: American Eagle Outfitters (NYSE:AEO)
* Rating: Hold
* Action: Downgrade from Buy
* Price Target: $14.00
* Action: Lowered from $19.00

Onto the Sidelines

I downgraded my recommendation on American Eagle Outfitters to Hold from Buy. One thing was abundantly clear to me in December mall tours, if the style of the merchandise and the promotion were correct than the teen customer responded. Unfortunately for American Eagle Outfitters, its chief competitor Abercrombie & Fitch nailed it this holiday season, pre-planning powerful promotions at its divisions in both November and December. I think American Eagle's BOGO 50% promotion was not enticing enough to drive strong conversion or traffic, and subsequently I observed a fair amount of 30% off signage in the back of the store post Christmas.

My 4Q10 EPS estimate moved to $0.44 from $0.46 as a result of the risk to margins I foresee from above plan markdowns.

Company Name: Target (NYSE:TGT)
* Rating: Buy
* Action: Reiteration
* Price Target: $67.00
* Action: Reiteration

Target Likely Hit the Mark in December

With Wal-Mart's (NYSE:WMT) merchandise assortment still influx, specifically the basics only softlines department in a trade up consumer environment and lack of awareness that items are being put back in the consumables department post project impact, I believe Target is a share gainer. The significant acceleration in comparable store sales in November from October indicated that Target's launch of its 5% RedCard reward program mid-month was a difference maker, getting consumers into the stores more frequently to purchase food, consumables, and the occasional discretionary item. In discussions with contacts, the overarching takeaway has been the abundance of customer traffic, consistently, at Target stores that boast a P Fresh format. Improved consumer sentiment pre-holiday adds lighter fluid to the base of wood that is Target's refurbished food and health and beauty departments in many locations and the 5% RedCard reward program.

Target shares trade on a P/E multiple of 13.3x my FY11 EPS estimate of $4.50 (consensus: $4.42). I believe the stock could support a P/E multiple approaching 15.0x, which would still be a discount to the five-year P/E multiple mean of 16.5x, given the ramp in comp growth that is likely in FY11 as Target cycles comp deceleration in 1H11 and inflation in food/consumables is added to the mix.

Company Name: Costco Wholesale (NASDAQ:COST)
* Rating: Hold
* Action: Downgrade from Buy
* Price Target: $75.00
* Action: Lowered from Reiteration

Risk Reward Starting to Shift Ever so Slightly

Costco shares have been on a hot streak, rising 18% since my rating upgrade to Buy on September 21. The market has become increasingly bullish on Costco in front of a potential membership fee increase over the next 12-months and an acceleration in new unit growth. With the stock inching closer to our $75.00 price target, I think a downgrade in our rating is appropriate. In order to boost my price target, I would require confirmation of successful cycling of tough headline international comps in coming months (dollar stronger this time around) and a further signal (or announcement) of a membership fee increase. The stock trades on a P/E multiple of 20.5x my FY11 EPS estimate, a premium to the sector, and towards the upper-end of the five year P/E multiple range.

Source: Playing the Retail Sector Prior to Same-Store Sales Results on Jan. 6