Hunting for Opportunities Among Teen Retailers

Teen apparel retailers are going through a difficult period because of lackluster demand and an aggressive competitive environment. However, uncertainty usually creates opportunity, so let's look at three well-known industry players -- Urban Outfitters , Gap , and Abercrombie & Fitch -- in the search for investment opportunities in the sector.

Urban Outfitters is still trendy
Urban Outfitters is doing materially better than other players in the industry, especially when it comes to its higher-end brands, Anthropologie and Free People. Sales during November and December increased by 8% to $716 million on the back of a 3% increase in comparable retail segment sales. Wholesale segment sales were remarkably strong, with a 21% increase during the period.

Comparable retail segment sales grew by a whopping 21% at Free People and 11% at Anthropologie. The Urban Outfitters segment, on the other hand, showed a 6% decline in comps.

For the 11-month period ended on Dec. 31, total company sales grew by 11% to $2.9 billion, comparable retail segment sales increased 7%, and wholesale segment sales increased 19%.

Urban Outfitters has been consistently outgrowing competitors in recent quarters, so the news should come as no surprise. The stock trades at a considerable premium to other players in the industry, with a price-to-earnings ratio above 20, but such premium is well justified based on the company's superior performance. 

Gap is a steady performer with a moderate valuation
Gap announced a 2% increase in total sales for the November and December holiday shopping season, while comparable sales increased by 1% year over year during the period.

These numbers aren't very impressive, but they're still much better than the steep revenue declines that other companies in the industry are reporting. Even better, Gap announced that earnings for fiscal 2013 are now expected to be in the high end of its previously issued guidance of between $2.57 and $2.65.

Chairman and CEO Glenn Murphy sounded quite pleased with the company´s results: "We delivered solid overall performance across our global brands this holiday season, on top of last year's strong results."

Gap may not be as trendy as Urban Outfitters' Free People and Anthropologie brands, but strong earnings guidance in such a challenging scenario speaks well about management´s ability to sail through the highly promotional retail environment while sustaining profitability.

Besides, Gap trades at a much lower valuation than Urban Outfitters, with a P/E ratio around 14. The stock also pays a 2% dividend yield, versus no dividends for Urban Outfitters.

In all, considering both performance and valuation, Gap seems to be offering a solid alternative for investors.

Can Abercrombie make a turnaround?
Investors in Abercrombie & Fitch had a tough year in 2013. The stock is down by more than 33% over the past 12 months, and that's including a big increase of more than 12% on Friday.

The reason for that explosive one-day jump was that the company reported better-than-expected holiday sales. Investors should beware, though, that posting sales figures above expectations doesn't necessarily mean the company has growing, or even stable, revenue.

Total comparable sales for the nine weeks ended on Jan. 4 decreased 6%, with comparable U.S. sales decreasing 4% and comparable international sales falling 10%. Total direct-to-consumer comparable sales were much stronger, with a 25% increase during the period.

Importantly, the company now expects full-year adjusted non-GAAP earnings per share to be in the range of $1.55 to $1.65, a considerable increase versus the prior guidance of $1.40 to $1.50.

Abercrombie has been suffering from declining sales and lackluster profitability over the past several quarters, so it's far too early to tell if the company can, in fact, make an effective turnaround. However, the company seems to be taking a few steps in the right direction by closing unprofitable stores and implementing cost-cutting measures.

On a price-to-sales basis, Abercrombie is materially cheaper than its competitors, with a ratio of 0.6 versus a price-to-sales ratio of 1.9 for Urban Outfitters and 1.1 for Gap.

Turnarounds are always difficult, specially more under challenging economic conditions. On the other hand, Abercrombie is certainly offering material upside potential from current valuation levels.

Bottom line
Urban Outfitters offers superior performance and higher growth prospects in exchange for a well-deserved valuation premium. Gap is successfully sailing through the storm while trading at a very reasonable valuation. As for Abercrombie, the risks are clearly much higher in this case, but the company has a lot of room to recover if it can streamline its operations and reverse the decline in revenues. Depending on investors' philosophy and risk tolerance, there are different alternatives for every style in the teen fashion rack.

The future of retail
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Fool contributor Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Urban Outfitters. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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