We have been very sensitive to the teen space over the last 60 days (since Q1 earnings were reported). We expected more favorable weather to provide the needed boost that typically comes with spring seasonal temperatures. However, we don't feel this has taken place for most of the retail space with few exceptions (see later note), and this applies especially to the teen retailers. Lets look at a few of these names in more detail:
American Eagle Outfitters (AEO) - Our first concern is driven by fashion misses which can be quite contagious. A significant fashion misstep can lead to multiple months of misses until the retailer gets back on track. Compared to their competition, we found that AEO had a very uninspired assortment during this 60 day cycle - in general it felt uninspired and lacked newness The most glaring miss was the lack of dresses in all lengths and fabrications. We felt AEO had the weakest presentation relative to their competition, hands down. The overabundance of men's cargo shorts was also critical miss, which we believe is one of many factors that might lead to an increase in markdowns and a GM deficit. We have been closely monitoring traffic patterns and felt the foot traffic has decreased. We would rate this period of May 1 through July 4 to be worthy of a 5 out of 10.
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Abercrombie & Fitch (ANF) - Without question the most promotional name in the space. Though many of the events are anniversary events from last year, the feel of both Hollister and Abercrombie is of great concern. On consecutive weeks during the month of June, the level of promotion increased from 40% off up to 60% off. Coming off a very disappointing projection of this quarter, we feel ANF has the greatest risk of missing already low expectations. Inventory levels, which they said on their last conference call would be light for this quarter, could potentially lead to an even greater miss than expected. Our last visit prior to July 4th found many ANF stores to be dangerously light in inventory, leading us to believe that they might be "giving up" on the quarter and reloading for the important back to school period which begins in less than 10 days. We will closely monitor the new floor sets which will be hitting most of their stores by the end of this week, but ANF is one of our favorite fashion leaders in this space and we are hoping for a significant rebound for back-to-school. ANF is not and never has been as promotional in recent memory, and this raises our concern to its highest level. We are always hesitant to get aggressive in this name due to the unknown factors of both online sales and off-shore business.Taking historical trends in both of these categories into account, we still are very negative on this name. Combining low inventory levels in a highly promotion time period leads us to believe there is tremendous gross margin pressure over and above the expectations they voiced during the Q1 2013 conference call. We see little opportunity for GM increase and therefore are quite negative on this name. We would rate ANF a 4 out of 10.
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Aéropostale (ARO) - We are quite impressed by the dramatic improvement in product assortments throughout this time period of May 1 though July 4th. There was a drastic reduction in logo wear and a significant improvement in trend-right categories, with dresses being one of many bright spots in their assortments. Our concerns are the initial markups which leave us questioning the strategy. We see ARO as the value driven retailer in this space and wish their pricing policies reflected our sentiments. If the product continues to show enormous strides of improvement, which we have no doubt they will, our last hurdle is foot traffic. Our recent mall checks still raise concern regarding foot traffic. We are seeing the "B" and "C" locations getting more foot traffic and our assessment is that the value-driven locations are seeing both improved foot traffic and top line sales, while the "A" locations are having a more challenging time. We see ARO having the greatest upside in this space. We would like to rate ARO as the best in class, but the concerns on all important foot traffic leads us to give them a 6 out of 10 rating.