Abercrombie Report Endangers American Eagle - TheStreet

Investors hate retailers more than Darva hates Rick. Just ask

American Eagle Outfitters

(AEOS)

.

The favorite of teens who want to look cool without spending a small fortune on a new pair of jeans has seen its shares plunge 25% since rival

Abercrombie & Fitch

(ANF) - Get Report

reported slower-than-expected fourth-quarter sales growth.

It's not that American Eagle has done anything wrong itself. In fact, in early February it said it would beat Wall Street's expectations for fourth-quarter earnings, and on Thursday the company authorized a share buyback. But these days investors, worried about interest rates, are salivating for any excuse to yank money from retail and shove it into tech stocks. "Retailers are a source of funds, not a place to put funds," says Richard Jaffe, an analyst with

PaineWebber

. And despite their own strong numbers, American Eagle and other specialty retail favorites such as

Pacific Sunwear

(PSUN)

have paid a particularly steep price.

Less Twinkling

Here's how American Eagle was grounded. Everyone is now worried about higher interest rates and tough sales comparisons with the previous year. Yeah, everyone knew both were coming, but investors freaked out when they actually arrived. Even retail superstars like

Home Depot

(HD) - Get Report

and

Wal-Mart

(WMT) - Get Report

are down more than 20% this year so far.

Downtrend
Once-hot retailers hit the skids

Source: BigCharts

And specialty retailers -- many of which posted pretty incredible monthly sales figures recently, attracting some of the mo players -- were particularly vulnerable to investor unease. When Abercrombie disappointed, investors started looking around to see who else was posting stellar sales gains that might not be sustainable.

Not surprisingly, their gaze landed on American Eagle. Comps rose 15% in fiscal 1997, 32% in 1998 and 22% in 1999. This year, American Eagle comps will rise more like 6% to 8%, analysts estimate. Sure, the company remains highly profitable. But again, investors are given to pitching tizzy fits when single-digit sales gains actually materialize, no matter how prepared they should be.

Acknowledging that penchant for tizzies,

Morgan Stanley Dean Witter

analyst Sharon Pearson lowered her rating on American Eagle from outperform to neutral last week. It's not that she thinks the company is foundering: She predicts EPS growth of 20% over the next few years, and says the company will continue to steal market share and will continue to open new stores. No, the downgrade was "specific to the valuation impact of a potential slowing in the pace of momentum, not a concern regarding the strategic initiatives of the company or the strength of its brand," she wrote in a research note. (Her firm hasn't done recent underwriting for the company.)

That Other Problem

American Eagle shares may also have taken a hit for another, seemingly legitimate reason. Abercrombie ended its fourth quarter with high levels of inventories, and many analysts fear a round of price-cutting will be necessary to clear out those extra goods. If Abercrombie discounts, so the thinking goes, it will compete more directly with lower-priced American Eagle goods. American Eagle might then be forced to cut its own prices, which could hit margins.

But that's nonsense, says Lee Backus, analyst with

Buckingham Research

. "Abercrombie was being very promotional in the fourth quarter, and at the same time American Eagle had better margins," he says. It also posted 13% comp growth during the quarter. "They got right through it with no problems," he continues. (His firm hasn't done banking for either company.)

Also note that Abercrombie and American Eagle's price points are miles apart. For example, Abercrombie is talking about reducing the price of its T-shirts to $24.50 from $29.50. But graphic T-shirts at American Eagle are on special for $12.50, says Marcia Aaron, an analyst with

Deutsche Banc Alex. Brown

, who rates American Eagle and Pacific Sunwear shares strong buy and says they're her best picks in specialty retail these days. (Her firm hasn't done recent banking for either company.)

So everyone is screaming that American Eagle, PacSun and the like are now ridiculously cheap, considering they're profitable as heck and have been bullied for doing not a thing wrong. But how investors will react when lower comps and further interest-rate hikes actually materialize: a rally as people load up on undervalued retailers, or more selloffs?

"That's the $64,000 question," says Aaron.

Make it the multimillion-dollar question.