Laggards Poised to Leap

 | Nov 25, 2013 | 10:00 AM EST  | Comments
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coty

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aro

It's hard to believe Thanksgiving is only a few days away, and not just because today's temperature is supposed to be above 80 degrees Fahrenheit here in balmy Miami. With this, we are down to the last few weeks of 2013 -- and this year has given equity investors plenty for which to be thankful. The overall market is up better than 25% for the year in a remarkable rally that's seen few decent pullbacks along the way.

However, as we celebrate our winners in 2013, it is probably a good time to be looking at some laggards that have significantly underperformed the market for the year. Making a few smart longer-term selections right now might make for some good stocking stuffers that will bear good tidings for our portfolios in 2014.

Retail, in particular, has been an uneven performer over the last few months. While the high end has done well with a few notable exceptions, the low and middle tiers of retailing have been challenged. Here are a couple of retailers that have performed poorly this year, but whose longer-term prospects are much brighter.

Avon Products (AVP) -- This global purveyor of cosmetics has had better years. The company has been challenged by everything from poor sales to lousy decisions by previous management. It has even seen allegations of bribing foreign officials, something that looks to bring a large settlement with the Securities and Exchange Commission. However, it's important to keep in mind that the stock is now one-third lower vs. the price at which Coty (COTY) offered to buy the company in 2011.

Avon brought in a new CEO in 2012, Sherilyn McCoy, and she is making slow progress at turning around the enterprise. The company has exited unprofitable countries such South Korea and Vietnam. It has also recently sold off its jewelry business, marking an end to a disastrous foray into that space.

Once the company gets these problems behind it, it should have a much brighter future. Avon gets more than 80% of its sales from overseas. The company also has a major presence in faster-growing emerging markets, especially Brazil -- which is the third-largest beauty market in the world, behind the U.S. and Japan. The stock sells for roughly 8x its 2008 earnings, and its price-to-revenue ratio is around half the level that competitors like Coty go for.

Teen apparel has probably been the ugliest part of retail over the last year. High unemployment among teens, among other factors, has hit all the major teen retailers hard this year. Abercrombie & Fitch (ANF), American Eagle (AEO) and Aeropostale (ARO) have all seen their earnings and stock prices crater in 2013.

This holiday season could prove to be pretty dismal but, longer-term, I like Aeropostale as a turnaround candidate. It is already being targeted by activist investors. Hirzel Capital Management, for instance, recently upped its stake in the firm to 6%, and stated its ownership is no longer "passive." Crescendo Partners has an 8% stake and wants Aeropostale to put itself for sale at 30% to 50% above its current stock price.

Aeropostale does have a solid balance sheet with no net debt, as well as more than $100 million in cash in the coffers. The stock is also selling at less than 5x the earnings it made in both 2010 and 2011, and it should have easier same-store-sales comparisons in 2014. Finally, the recent drop in gasoline prices should be beneficial to the entire sector. Aeropostale is down by more than half from its recent highs in 2012, and I think the current price level is a good entry point to start to build a position.

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