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TheStreet Open House

A Beaten-Down Apparel Stock to Try on for Profits

DELAFIELD, Wis. (Stockpickr) -- The apparel sector is heating up at as other areas of the market, such as biotech and technology, are struggling mightily.

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Just take a look at the performance of small-cap apparel player American Apparel (APP) over the last month. This beaten-down troubled retail stock has exploded higher during that period by over 50%. Shares of APP bottomed in late March and early April at 46 cents per share, and the stock has exploded higher to an intraday high last week of 82 cents per share. I recently pointed out the opportunity in shares of APP in April 24's "A Small-Cap Stock With Very Big Potential" at around 50 cents per share.

Once a sector comes into play, the money tends to flow from one name to the next as traders look to get ahead of the momentum. Another troubled and beaten-down small-cap apparel player that has put in a strong performance of late is Body Central (BODY), which has ripped sharply higher by 38% over the last month. I flagged shares of BODY in April 8's "Big Funds Love This Small Stock -- Should You?" at around $1.15 a share. Shares of BODY hit an intraday high on Friday of $1.34 a share, and the stock looks likely to head even higher in the near-term if that level gets taken out with volume.

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Both Body Central and American Apparel are distressed small-cap retail players with challenging fundamentals and uncertain futures. The market, has at least for now, decided that these small-cap retailers were beaten down to attractive prices that made them worthy buy candidates. Since both of these names are clearly the more risky plays in the apparel space, it's possible the momentum players will start coming after other names that don't carry as much risk.

Don't get me wrong: I still think APP and BODY can trend much higher, but traders need to understand they are high-risk apparel stocks facing tough turnaround situations.

A new apparel name that's starting to catch my eye here is American Eagle Outfitters (AEO), which operates as an apparel and accessories retailer in the U.S. and Canada. Through this companys family of brands, it offers clothing, accessories and personal care products at affordable price through its online channels and at over 900 retail locations. The company's online channels ship its products to around 100 countries across the globe.

American Eagle Outfitters has been hit hard by the sellers over the last six months, with shares off by 21%. This stock has dropped sharply from its six-month high of just over $16.50 a share to its recent 52-week low of $10.83 a share. Most of the reason for American Eagle Outfitters' poor performance is due to the sharp drop in its operating income, which went from $394.6 million in 2012 to just $141 million in 2013. That marks a 64% drop, most of which was due to the wrong product changes and the overall depressed condition in the U.S. apparel market. The company also blamed bad weather, which I never like to see a retailer do, but we must acknowledge 2013's winter was a harsh one across most of the country.

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Despite those problems, American Eagle Outfitters is still flush in cash with around $429 million on its balance sheet and little debt. That cash is going to come in handy as the company ramps up sending to build out its online presence and marking and for its international expansion plans. American Eagle Outfitters, along with the rest of the leading retailers, know that falling mall traffic is a trend that can't just be blamed on a touch macro environment, but it's more of a symptom of American consumers' shopping smart online. American consumers might visit a store to get an idea on fashion trends and how a brand fits, but they will browse online to find the best promotions and deals. Once you gain the American consumer's loyalty, a strong online presence can push sales at both the stores and online if the marketing approach is right.

In regards to its international expansion, during the last quarter American Eagle Outfitters opened up 16 new stores in Mexico and took ownership of six franchise stores in China and Hong Kong. That brings its total international footprint to 66 stores in 12 countries. The company also plans to move into the U.K. in 2014, has recently entered the Philippines and plans to enter Thailand. The moves to China and Mexico could start to pay dividends soon for American Eagle Outfitters since both countries have a rapidly growing middle class with expanding disposable incomes. For example, consider the growth in China's middle class, which is expected to help its apparel market hit $220 billion by 2016.

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The company's e-commerce growth was a source of strength during a tough 2013, with online sales increasing by 24% in the first quarter, 11% in the second quarter and 17% in the third quarter. The company is ramping up spending to develop its omni-channel platform, which is a seamless approach to shopping at all the available channels such as brick-and-mortar stores, mobile, Internet, catalog and more. American Eagle Outfitters also plans to open up a new distribution center in Pennsylvania by mid-2014, which will allow them to ship products to U.S. consumers within two days.

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