These 3 Apparel Retailers Are Looking for a Win

It's entirely possible that over the past three years you've ruined all your good shirts, ripping them to shreds in an Incredible-Hulk-style rage over your retailer stocks' performances. While we're not through the hard times yet, three apparel retailers are still making shirts and cash aplenty. However, only one of them is dressed for success.

Do you have these in a large?
The apparel industry has been hit by a number of issues over the past five years. Cotton prices have risen from $0.58 in 2007 to their current price of close to $1. This includes a horrific spike a year ago when the price climbed above $2 due to shortages in India. As cotton makes up the bulk of clothing, retailers have been hit hard.

Gas prices have also fluctuated wildly, hitting their high in 2008, falling, and then re-approaching that high again in 2012. Both of these commodity issues have been layered on top of unemployment woes and general consumer belt-tightening. The resulting conditions have laid bare all of the weaknesses in retailers' businesses.

Let's take a look at three apparel retailers and how they're managing their margins. When times get tough, it's that bottom-line margin that has to take the brunt of the impact. Strong brands and good management can help minimize the damage.

Fly like an eagle... or brick
American Eagle
(NYS: AEO) had its first year of same-store sales growth since 2008. This growth has come at a huge price, though. The company has had to flog holiday promotions to increase sales, and this has cut deeply into its bottom line, with net income margins falling all the way down to 4.8%. A reliance on promotions that results in falling margins sounds like a typical brand failure.

This might result in a great turnaround play in the future, though. American Eagle has a P/E of 22, which shows that a lot of growth is baked into the price. If this were to drop a bit, and if management were to address the brand issues, then this could be a potential turnaround play. American Eagle has a broad footprint with over 1,000 stores. If it can leverage that distribution capability with better margin management it will do well.

Flexing brand strength
You'll find lululemon athletica (NAS: LULU) on the opposite end of the retail spectrum. Analysts love the stock and it has a ridiculous net margin of 18.4%. The difference between it and American Eagle lies in the brands' strengths. Lululemon has no problem selling $80 pants -- that's the sale price -- and it rakes in the financial rewards of having a strong brand name.

Unfortunately for investors, the stock is as expensive as the pants -- and it doesn't make my legs look good. While people often buy expensive clothes, the current P/E of 58 puts the stock out of my price range. There's a lot of expectation in that price, and while the company will undoubtedly do well, I don't know if it will do that well.

Discount designer
Looking at the cheaper stocks (I like to shop the bargain rack), we find Guess? (NYS: GES) . Guess? has done what American Eagle needs to do: It turned itself around. The company's shares have been on a little ride this year, picking up from around $29 in January to $36 in March and then falling after the company announced earnings. Currently the retailer trades at $29 with a P/E of 10.5.

The fall from grace was due largely to income outlook, not income production. Investors were scared off by management statements about the fragility of Europe and how consumers may not spend as much, especially in the first quarter. But instead of worrying about what might happen, let's look at what has happened. Last year the company's North American operations made up 42% of total revenue. That segment saw same-store sales decrease 3.5%. However, the company actually increased its net income by 40 basis points.

It was able to do that by charging more, on average, for its products and by increasing overall efficiency. Whereas American Eagle has been struggling to sell at full price due to its lackluster brand, Guess? has been able to sell its products for higher margins due to the renewed strength of the brand. That brand strength has shown every indication of continuing to recover, making Guess? an excellent choice for a bounce-back investment.

Red-soled shoes as far as the eye can see
While all three companies could do well, Guess? looks undervalued and set for strong growth. American Eagle has a ways to go before it can turn things around, and Lululemon's price makes me wary. If I want to replace all these torn shirts I'm going to need to make some cash, and a few shares of Guess? could really help.

2012 is poised to be a good year not just for Guess?, but for four of the best stocks in the market. Read the Fool's special free report detailing The Motley Fool's Top Stock for 2012. It doesn't cost you a thing but could make you a bundle. Read it here now.

At the time this article was published Fool contributor Andrew Marder doesn't own any of the stocks mentioned in this article. The Motley Fool owns shares of Guess? and Lululemon. Motley Fool newsletter services have recommended buying shares of Lululemon and creating a stock repair position in Guess?. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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