3 Comeback Kids in Retail

by Will Ashworth | March 20, 2012 10:00 am

3 Comeback Kids in Retail

Retail stocks have been having a good 2012 so far. The total return year-to-date for the S&P Retail Select Industry Index is 16.41%, 11th best out of 23 industry indexes. Virtually every apparel store is having a winning year. February retail sales were broadly positive[1], and the U.S. economy appears to be getting stronger.

Although gas prices continue to be a major concern, I don’t believe they’ll slow this train down. Retail stocks across all categories should continue their rise for the remainder of 2012. The easiest way to play this is to buy the SPDR S&P Retail ETF (NYSE:XRT[2]), which seeks to replicate the S&P Retail Select index.

But for those interested in specific stocks, here are three retailers that have stumbled but look set to be comeback kids — and are, therefore, attractive now.

Urban Outfitters

Investing is more about looking forward than backward, and in that respect, Urban Outfitters (NASDAQ:URBN[3]) has much to look forward to. For instance, its online sales grew 16.3% to $505 million in 2012 and now represent over 20% of its total revenue. Retailers intent on sustaining profits must do a good job in this area because the margins are so much higher online than for physical stores.

Today, stores act like billboards telling customers what’s for sale. Rising gas prices combined with worsening traffic congestion and the relative inconvenience of “going shopping” will only make e-commerce more vital with each passing day.

On the inventory front, Urban Outfitters managed to turn it over 6.45 times in 2012 compared to 5.8 times a year earlier, achieving its highest turnover ratio in at least five years. That’s critical when your merchandise has been poorly received. If it isn’t selling, get rid of it quickly and make sure you do a better job next time.

During the first quarter, full-price selling started to return, an indication the merchandise has improved. Lastly, Urban Outfitters plans to open 55 to 60 stores in fiscal 2013, increasing square footage in its retail stores by low double digits. That’s great news. With just 429 stores globally, it has plenty of expansion available when and if it sees fit.

Personally, I’d like to see it stick to the current rate of store openings because bricks-and-mortar retail is expensive. Long-term, Urban Outfitters’ margins will come back and when they do, so too will its stock price, now around $28.

Guess 

What’s happened to Guess? (NYSE:GES[4]). The one-time darling of denim has seen its stock, now trading around $32, lose 15.5% of its value in the last year. Fourth-quarter earnings announced March 14 were mediocre. Management, at a minimum, expects earnings-per-share in 2013 of $2.50 on revenue of $2.74 billion. Analysts were expecting $3.21 per share on $2.84 billion in revenue. This knocked 10% off its stock on March 15.

Guess is definitely on sale. Its enterprise value is now less than 5 times EBITDA. Abercrombie & Fitch (NYSE:ANF[5]), whose operating margins are half those of Guess, has an enterprise value 7.5 times EBITDA.

Guess investors appear to be focusing too closely on its European business instead of its Asian business. While Asia represents less than 10% of Guess’s $2.7 billion in overall revenue, sales there grew by 25% year-over-year. This will become an important part of its business in years to come.

In the meantime, its European and North American businesses are still very profitable. Factor in the fact its North American wholesale and licensing businesses generate operating margins of 25% and 90%, respectively, and what you have is an extremely healthy business. With zero debt and $5 per share in cash, you’re currently paying $11 for $1 in earnings.

Guess shares haven’t been this low since 2009. Same-store sales might be negative, but its long-term prognosis surely isn’t. Guess remains a strong generator of cash, with a stock that’s available at a deep discount. I love it when a stock goes on sale.

rue21

This stock is a classic case of Jekyll and Hyde. rue21 (NASDAQ:RUE[6]) is a value-focused teen fashion retailer that went public in November 2009 to a great deal of fanfare. Priced at $19, it jumped out of the gate fast with a 28% first-day return. Since then, it has tacked on an additional 12.2%.

Unfortunately, its stock is an underachiever. On three occasions in the past 28 months, it hit $35 only to drop back within days. The last time it did this was July 2011, reaching a high of $37.63, only to fall to $22 by September. Since the beginning of 2012, it’s up 24%, and is now just under $27.

It’s on its way back to $35. Positives in 2011 included a revenue increase of 19.8% to $760.3 million, gross margins improving 70 basis points to 37.7% and diluted earnings per share jumping 28% year-over-year to $1.55. The only fly in the ointment was flat same-store sales.

In 2012, rue21 expects same-store sales to grow in the low single digits. Frankly, as long as it continues to expand margins, I couldn’t care less about same-store sales. rue21′s profitability is higher now than it’s ever been, yet its stock trades at a similar valuation to Aeropostale (NYSE:ARO[7]). That’s just nuts. In the immortal words of Charlie Sheen from the movie Wall Street, “It’s a comer!”

As of this writing, Will Ashworth did not own a position in any of the stocks named here.

Endnotes:
  1. February retail sales were broadly positive: http://investorplace.com/2012/03/overall-retail-sales-hit-new-record/
  2. XRT: http://studio-5.financialcontent.com/investplace/quote?Symbol=XRT
  3. URBN: http://studio-5.financialcontent.com/investplace/quote?Symbol=URBN
  4. GES: http://studio-5.financialcontent.com/investplace/quote?Symbol=GES
  5. ANF: http://studio-5.financialcontent.com/investplace/quote?Symbol=ANF
  6. RUE: http://studio-5.financialcontent.com/investplace/quote?Symbol=RUE
  7. ARO: http://studio-5.financialcontent.com/investplace/quote?Symbol=ARO

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