Retail stocks are back! Specifically teen retail stocks!
For the past several years, the narrative that malls were being forced into extinction by Amazon.com, Inc. (NASDAQ:AMZN) dominated the retail picture. Retail stocks dropped. AMZN stock roared. Long digital retailers, short brick-and-mortar retailers was an easy trade that made some people a ton of money.
But that trend has suddenly shifted.
2017 holiday season was one of the best on record. In November, retailers reported strong Black Friday numbers. In December, third-party reports rolled in confirming that holiday 2017 was shaping up to be fabulous. And in January, retailers reported strong holiday numbers.
Retail stocks have been in rally mode ever since.
This multi-month rally is far from over. The thesis that all retailers were going extinct always seemed foolish to me. These guys aren’t dinosaurs doing nothing in the face of digital-commerce encroachment. They were actively building out digital sales channels, enhancing in-store experiences, cutting costs and figuring out delivery.
Now, those efforts are yielding positive results. Its only up from here for the still depressed group.
Here are my 3 favorite retail stock picks for the next several quarters.
Teen Retail Stocks to Buy #1: Tilly’s Inc (TLYS)
My first pick is a company that I have long considered to be the cream of the crop in teen retail: skate, surf, and snow-oriented Tilly’s Inc (NYSE:TLYS).
Tilly’s has all the features of a strong retailer. Comparable-sales growth is positive on both a one and two-year basis. The positive comparable-sales growth narrative is accompanied by promising unit-growth potential, making TLYS one of the few retailers which offers both positive comps and unit growth potential.
Gross margins have consistently been trending up, which coupled with positive comps, shows that demand for TLYS product can go up alongside price. Operating expenses are coming out of the system, and the opex rate is falling. Earnings are up.
Moreover, the company just declared a special dividend, implying that holiday sales were really good. Tilly’s also has a really big tax rate, so corporate tax cuts will translate into big benefits for this retailer.
On the valuation front, TLYS stock trades at a rather expensive 21-times forward earnings multiple. That is pretty big for what is supposed to 13% earnings growth per year over the next several years. It equates to a PEG (price-to-earnings/growth) ratio of 1.8, far above the industry’s 1.4 PEG ratio.
But TLYS deserves that premium because of its huge cash balance. More than 25% of the company’s market cap is covered with cash in the balance sheet. Factor that back in, and the PEG ratio on TLYS stock drops to below the industry’s PEG ratio.
All in all, this is a winning retailer trading at a reasonable valuation.
Teen Retail Stocks to Buy: American Eagle Outfitters (AEO)
My second pick is a retailer that has a bunch of attractive features, but also a burgeoning intimates business which could drive huge growth in the medium-to-long term.
Like Tilly’s, American Eagle Outfitters (NYSE:AEO) has all the features of a winning retailer. Comps are positive on a one and two-year basis. Gross margins are still compressing, but they are starting to stabilize. And I think the company is looking at gross margin expansion starting next year. Meanwhile, operating expenses are falling back, and will continue to fall back thanks to real estate optimization plans. Earnings growth is coming back into the picture.
That’s all fine and dandy, but the best thing about AEO is the company’s Aerie brand. Management talks up the Aerie brand, which focuses on women’s intimates, as the company’s next billion dollar brand.
But its much more than just talk. Comps at Aerie rose 19% last quarter, building on a 21% increase last year. Clearly, momentum in the brand isn’t slowing. Meanwhile, traditional intimates giant Victoria’s Secret just wrapped up a rather poor holiday season. Comps rose just 1% in December, following a 1% decrease last year. It’s pretty clear that Aerie is stealing market share.
Meanwhile, the stock trades at one of the most attractive multiples in the group (only 15-times forward earnings). Granted, earnings growth is muted over next several years thanks to store closures, but if margins keep rebounding and Aerie keeps gaining steam, earnings growth could come roaring back (it’s already expected to inflect into positive territory this quarter).
In that case, AEO stock looks dirt cheap at just 15-times forward earnings.
With a dirt cheap valuation, positive comps, inflecting margins, and a super-charged Aerie segment, AEO is a must-own in the teen retail sector.
Teen Retail Stocks to Buy: Francesca’s Holding Corp (FRAN)
My last pick on this list is the most surprising because it doesn’t have any of the features of a winning retailer. Its actually been one of the worst performing teen retailers lately.
But I think Francesca’s Holdings Corp (NASDAQ:FRAN) is a diamond in the rough.
FRAN has struggled recently. And when I say struggled, I mean “comps down 18% last quarter” struggled. Yes, comps have been very ugly as the company has failed to build on initial success. Yes, gross margins are getting hammered. And yes, operating expenses aren’t coming out of the system fast enough, and operating margin compression is worse than gross margin compression.
So why do I like FRAN stock?
Because if you zoom out and stop looking at the one-year numbers, things aren’t so bad. In each year from 2010 through 2013, FRAN’s comps rose in excess of 10%, including two 16% growth years. That sizzling growth was followed by two down years (-2% in 2014 and -5% in 2015). Those down years were followed by two up years (+3% in 2015 and +2% in 2016). Now, we have another down year, with comps down 9% year-to-date.
If you add up all those comps since 2010, FRAN’s comparable sales have risen 42%. That is miles above anyone else in this sector.
In other words, FRAN is down this year, but they aren’t out.
Coming into the year, comps were up more than 50% since 2010. It was only natural that they slid back some. And it isn’t the slightest bit worrying. Comps should bounce back next year because this is a niche retailer with strong appeal among trendy, fashion-oriented young women.
Meanwhile, gross margins are falling back, but they are still pretty high for the retail industry. The company is still opening a ton of new boutiques, giving revenue growth potential a boost. And earnings are expected to grow around 10% per year over the next several years (thanks to a depressed base this year).
But FRAN stock trades at just 11.5-times forward earnings, making it dirt cheap for those robust growth prospects.
It may take a while for this sinking ship to turn around, but once it does (and it could within the next few quarters), FRAN stock could explode higher given its cheap valuation and strong long-term growth prospects.
As of this writing, Luke Lango was long TLYS, AEO, and FRAN.