2 Retail Stocks That Survived The Meltdown

By Markets Fool.com

Many U.S. retailers recently posted weaker-than-expected quarterly earnings, sparking concerns about a slowdown in consumer spending. But as I mentioned in a previous article, overall retail sales growth and consumer sentiment remain robust, and not all retailers were crushed. Let's take a look at two apparel retailers that survived that meltdown, and how their relative strength might help them outperform the broader retail sector.

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Image source: Pixabay.

American Eagle Outfitters

Many apparel retailers have fared poorly over the past few years due to the rise of "cheap chic" chains like H&M, Forever 21, and Zara. Running too many brick-and-mortar stores also increased expenses and throttled retailers' ability to compete effectively against e-tailers.

Yet American Eagle Outfitters bucked that slowdown last quarter. Sales rose 7% annually to $749.4 million, topping expectations by $18 million. Total comparable store sales improved 6%, thanks to 4% growth at the company's core AE stores and 32% comps growth at its Aerie lingerie and activewear stores. Digital traffic, which accounts for about a fifth of overall business, rose over 20% and offset a slowdown in mall traffic.

American Eagle Outfitters' app. Image source: iTunes.

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American Eagle's gross margin improved 170 basis points annually to 39.2%, thanks to favorable occupancy and product costs. Net income rose 39% to $40.5 million, or $0.22 per share, beating estimates by four cents. Looking ahead, American Eagle plans to reduce its overall store count by almost 2% by the end of the year. That move will slightly reduce its brick-and-mortar expenses and allow the company to rely more on its growing e-commerce business.

Analysts expect American Eagle to respectively grow its revenue and earnings by about 3% and 16% this year. The stock currently trades at just 11 times forward earnings, so shares are fairly cheap compared to AE's earnings growth potential. Furthermore, American Eagle pays a forward annual yield of 3.1%, which is much higher than the S&P 500's current yield of 2.1%.

Abercrombie & Fitch

For many years, Abercrombie & Fitch arguably embodied the worst qualities of the American apparel industry -- high prices, self-promoting logo designs, and oversexualized ads. The eccentric behavior and PR gaffes of former chairman and CEO Mike Jeffries antagonized younger shoppers, and its loud, cologne-filled namesake stores drove away shoppers, according to a Concordia University study.

Image source: Abercrombie & Fitch.

But after Jeffries' resignation at the end of 2014, the retailer finally turned over a new leaf. It reduced the music and scent levels at its stores, rearranged the lighting, props, and clothing to "simplify" the shopping experience, and sold less logo-based clothing. It also tested a "fully redesigned" store prototype for its Hollister brand, which will roll out in around 60 locations this year.

Shoppers have started to notice. During the fourth quarter, A&F's sales dipped 0.9% annually to $1.1 billion, butthat beat expectations by $10 million and represented a significant improvement from a 13.8% plunge a year earlier. Comparable store sales rose 1%, with a 2% decline at A&F being offset by 4% growth at Hollister. Like American Eagle, A&F is investing heavily in digital channels and closing brick-and-mortar stores. 60% of its online traffic and 40% of its direct-to-consumer sales now come from its mobile apps.

A&F's gross margin also improved 100 basis points annually on a constant currency basis to 60.7%. Non-GAAP net earnings slipped 6.1% to $1.08 per share (including a $0.23 currency impact), but still exceeded expectations by $0.09. Analysts expect A&F's sales to stay flat in 2016, but earnings could improve 7% thanks to margin improvements and potential share buybacks. A&F currently trades at 17 times forward earnings, indicating thatit's pricier relative to its earnings growth potential than AE, but it pays a beefier forward annual yield of 3.3%.

Which is a better contrarian bet?

Both AE and A&F have two moats which many of their peers lack -- popular secondary niche brands (Aerie and Hollister) which are growing at a faster rate than their namesake brands, and aggressive e-commerce initiatives which are resonating with customers. AE's stronger growth and lower valuations make it a better pick at current prices, but A&F could also become a worthy buy if its turnaround proves sustainable.

The article 2 Retail Stocks That Survived The Meltdown originally appeared on Fool.com.

Leo Sun has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.