Malls nowadays are crowded with apparel retailers, but not necessarily people, thanks to Web-based shopping.
That reality places a premium on correctly identifying the root causes for why one apparel retailer is outperforming a competitor. For every case like American Eagle Outfitters (AEO, nailing its styles and marketing, and financials) there will be an Aeropostale (ARO, continues to hemorrhage customers, money and stock value). Here are the musts that an apparel retailer has to be showing investors in the new reality of weak mall traffic and pressured ticket prices on merchandise. I remain bullish on American Eagle Outfitters (pullback should be bought) in large part as it delivers on every single front mentioned below.
A hook to drive traffic to a store, and close the deal: Ever so succinctly, American Eagle has recast its denim line as technically superior to competitors. By coining its new denim fits as "flex denim," the company has gone to the consumer with a unique marketing message that creates initial interest and, ultimately, sales at full price. The pants aren't necessarily different than other denim on the market now featuring greater flexibility, but the marketing has stuck out in a crowded field.
Moreover, the company is out there marketing new denim jeans made from recycled coffee beans. Good message, good way to charge more to Trader Joe's shopping millennials and older teens. In fact, American Eagle Outfitters noted its average unit retail prices were up 20% year over year in the third quarter as it offered consumers more quality behind the garment. Same-store sales still surged 9% in spite of the higher prices.
The company is seeing increased full-price selling and stronger store traffic relative to the mall. In other words, it's doing a ton right.
Quality gross profit margins: Apparel retailers have done all sorts of things to cut costs from their economic models from removing buttons on a cardigan, to using cheaper materials to shuttering hundreds of stores to reduce rent. While those efforts have improved the economics of hawking sweaters and jeans, at the end of the day it's the margin being driven on the garment that is most important. That is especially critical today given the rise of H&M, Forever 21 and Zara, which is collectively pressuring merchandise prices. If an apparel retailer could receive its full price on an article of clothing amidst very competitive industry conditions, it's an unabashed positive sign that execs are doing something right and consumers notice.
Using American Eagle as an example, the company's merchandise margin, which is the profit earned on merchandise, surged 310 basis points year over year. I can't tell you how unheard of in apparel retailing that type of result is today. By comparison, Pacific Sunwear's (PSUN) merchandise margin fell 90 basis points from the prior year in the third quarter. Its results stunk, American Eagle's were superior -- it's that simple.
Justified, out-of-the-blue expansion opportunities: Many investors and analysts have forgotten that it's OK for an apparel retailer to open new stores. In their eyes (and hey, I get it ... more stores need to close in this country), closing stores is the only surefire way to a profitable future. However, if a retailer is proving itself with its existing concept, or a newer one, by all means one wants to see management taking the risk and expanding. By expanding with a proven concept displaying strength, the company puts itself in a position to take market share from shrinking competitors.
American Eagle's Aerie intimates business, left for dead by many on Wall Street, continues to forge an impressive turnaround. New leadership has expanded assortments and enhanced the economics of selling bras and panties to innocent young females. In the third quarter, same-store sales surged over 20% and, importantly, profit margins for the business are finally in line to the American Eagle brand.
Execs have forecast a doubling (sales) of the Aerie business over the next five years. I believe it's attainable as the chain expands beyond 11 existing markets and grows the number of categories it sells.