Two Retailers With Comeback Potential

 | Feb 19, 2014 | 2:00 PM EST
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Let's start with the basics. Retailing is a tough business. Barriers to entry are low. Inventory obsolescence is quick. Amazon (AMZN) is disrupting the traditional retail model with internet shopping and is now building distribution centers everywhere. The list goes on and on as to why retailers are difficult investments.

Yet difficulty creates opportunity in investing. The retailing industry has certainly had more than its fair share of struggling companies that failed to recover -- Circuit City and Blockbuster. There are also some today that may be on the verge -- J.C. Penney (JCP), RadioShack (RSH) and even Sears Holding (SHLD).

On the other hand, some of the most successful investments have been made inside retailing when the underlying business was a complete mess and Mr. Market had cashed in his chips. Remember Deckers Outdoor (DECK) and Ugg shoes? Shares are up over 100% in the past 12 months. Ralph Lauren (RL)? Shares are up nearly five-fold in five years.

Two retailers now offer promise of a Deckers-like comeback. American Eagle Outfitters (AEO) and Aeropostale (ARO) are names that could be rewarding in the coming months and years.

American Eagle's shares trade for less than $14, valuing the company at $2.6 billion. When you study past retailing failures, it's often the balance sheet that prevents the company from coming back. J.C, Penney is dealing with that problem today. American Eagle doesn't have that problem with over $200 million in net cash on the balance sheet. The current price values the company at 75% of sales while others like The Gap (GPS) trade for 120% of sales.

Aeropostale is a similar idea and looks even cheaper than American Eagle. The company's market cap of $510 million is nearly one-fourth of the $2 billion valuation the company had nearly two years ago. Again, there is no balance sheet problem and there is no debt and a $70 million cash surplus. The current price values ARO at 22% of sales.

American Eagle and Aeropostale are known brands that have fallen out of favor but the teen market is easily appeased. In fashion retailing, it's not uncommon for consumers to fall out of favor with the brand. It happens and even names like Ralph Lauren aren't immune.

But because fashion tastes can be volatile, it's just as easy to get consumers back with trendy designs. American Eagle and Aeropostale can do that. If they do, the shares are dirt cheap at today's prices. Even absent a complete turnaround, the strong balance sheet, brand recognition and current stock price are intriguing as is.

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