Teens Still Love Jeans

The demise of the denim retailer has been greatly exaggerated, some observers say.
Author:
Publish date:

Are gas prices finally taking a significant chunk out of consumer spending? Is there a denim glut? Will the back-to-school season meet expectations?

These are the questions making the rounds on Wall Street as investors eye the trendy teen apparel retailers that have worked wonders for stock portfolios over the last few years. The sector has been a downer so far in August, weighed upon by a flurry of disappointing sales and earnings projections from the second-quarter reporting season.

Now, investors are looking towards the third quarter's back-to-school shopping rush and asking, "Dude, where's my upside?"

Very few clothing retailers have made it through their second-quarter conference calls without mentioning denim numerous times. Jeans are in, say the teeny-boppers -- especially the fashionable, expensive kind. That's been the word on Wall Street for the last year, but some retailers may have taken the fad too far. Couple that with the ever-present concerns that consumer spending may be nearing the end of its decade-long upturn, and traders have some hard decisions to make.

"Look, we've all got our concerns about consumer spending in general, but teens are going to be one of the last groups to stop spending," says Andy Graves, analyst with Pacific Growth Equities. "Plus, we're still in a very strong fashion cycle for denim. For those retailers that are in touch with their customers, high inventories are going to be a good thing."

The scrappy group of teen apparel retailers that have been especially good at keeping their fingers on the pulse of youngsters lately have delivered a windfall to shareholders. After virtually all of them posted huge gains in the bull market of 2003,

American Eagle Outfitters

(AEOS)

added 188% in 2004,

Aeropostale

(ARO)

added 61%,

Abercrombie & Fitch

(ANF) - Get Report

gained 93%,

Hot Topic

(HOTT)

rose 42%, and

Pacific Sunwear

(PSUN)

was up 5.5%.

This year, however, there are signs of the inevitable slowdown. For instance, Hot Topic has shown signs of losing touch with its crowd of young rebels. The self-professed destination for alternative-minded teens has posted a string of same-store sales declines and earnings disappointments that have analysts wondering if the company will ever be fashionable again.

Meanwhile, even some of the most popular stores have shown inventory gains that have given rise to talk of a denim glut. Abercrombie reported that its inventories increased to $364 million at the end of the second quarter, up from $227 million at the end of the first quarter -- primarily reflecting a jump in denim merchandise. Its stock dropped 3.6% in one day on the news.

Dan Hess, the chief executive of Merchant Forecast LLC, told

TheStreet.com

that the concerns are overblown.

"I think the environment is relatively healthy," Hess said. "Some of the teen retailers have alarmingly high levels of inventory, but the denim cycle will still benefit those retailers that have positioned themselves well."

Hess has a team of over 100 analysts running channel checks at malls across the country. His firm sells their findings as independent research reports to hedge funds and mutual funds looking to trade on the information.

"There are plenty of retailers out there that are going to sell through their entire denim assortment, and it's going to be a very good third quarter and second half of the year for them," he said.

On the basis of his findings, Hess still likes Abercrombie, largely because of the recent success of its Hollister chain. If Abercrombie's brand is viewed as the preppy, East Coast-style old-world look, then Hollister counters as its West Coast-oriented brand embodying a laid-back lifestyle.

"Hollister is one of the hottest mall-based retailers," Hess said. "They are continually flowing new product in, but their shelves are always light in certain styles of fashion denim."

He also likes American Eagle, whose shares got hit last week when its second-half guidance, though in line with estimates, proved not aggressive enough for Wall Street's liking. Still, the Warrendale, Pa., seller of jeans, plaid shirts and cargo shorts said both second-quarter total revenue and same-store sales rose more than 20%, and its earnings beat expectations.

American Eagle "has maintained a relatively moderate level of promotion throughout the entire month of August, and this indicates to us that they are pleased with how their products are retailing," Hess said. "They did put their denim on sale three weeks ago, but it was a planned promotion. They have not felt the need to increase that promotion more recently, unlike

Aeropostale

(ARO)

and

Pacific Sunwear

(PSUN)

, where increasing promotion levels are troubling."

Pacific Sunwear could run into trouble, he noted, because its customers have not viewed it as a destination for denim wear.

As for other retailers that look poised for denim overload, Hess named the Express, a unit of

Limited Brands

(LTD)

that has been a longtime underperformer.

Image placeholder title

"They abandoned denim last year, and it appears they're looking to correct for that mistake by building up inventories too fast for this fall," he said. "That could be another mistake."