Who Is Losing In The Decelerating Apparel Market?

The U.S. apparel market stands big at close to $250 billion, but its growth has decelerated in recent years, as buyers have scaled back their discretionary spending in the aftermath of the economic downturn. The market grew by 5.2% in 2012, 3.4% in 2013 and just 1.7% in the first 11 months of 2014. ^[1] While the market growth is already slow, most of it is attributable to rapid growth of fast-fashion players and online retailers. Casual apparel retailers, who rely on basic logo products and physical stores for a bulk of their revenues, have lagged far behind the industry. The biggest strugglers of the past year have been Aeropostale (NYSE:ARO), American Eagle Outfitters (NYSE:AEO) and Abercrombie & Fitch (NYSE:ANF), who have comparable presence in the U.S. and a product portfolio that mostly comprises of logo products. All the three retailers have lost considerable market share over the past year, on account of a decline in foot traffic, resulting from fickle consumer behavior and gradual online shift.

Over the last couple of years, U.S. buyers in numbers have excluded basic products from their wardrobes and switched to fashion-forward merchandise. Moreover, they are making more purchases online and subsequently, visiting fewer stores. Both these factors have resulted in tremendous revenue decline for the aforementioned retailers, as their respective online channels don’t contribute much to overall revenues. Even if these retailers revamp their product mix and aggressively expand their online business, a significant improvement in market share is unlikely, given that the industry is highly competitive and saturated. This is evident from the fact that Aeropostale, American Eagle and Abercrombie have their market shares at around just 1% and yet, their further expansion in the country is unrealistic, given that they already have a large store network. In fact, Aeropostale and American Eagle are consolidating their networks, in an attempt to shield their bottomline growth.

Our price estimate for Aeroposatle is at $6.38, implying a premium of over 180% to the current market price.

Our price estimate for American Eagle Outfitters at $13.02, is just below the current market price.

Our price estimate for Abercrombie & Fitch at $37.30, is more than 35% ahead of the current market price.

See our complete analysis for Aeropostale

Aeropostale

Aeropostale was one of the more popular apparel brands in the U.S. during the recession of 2008-2009, as it offered basic products at affordable prices, when buyers had cut back on their spending. With the gradual economic recovery, buyers started switching to brands that were relatively expensive and comparatively more fashionable. However, Aeropostale remained focused on basic apparel and lost a number of its customers to other brands in the process. The company tried a few fashion launches in between, but they failed to entice customers. Aeropostale’s struggle continues to date, as it is still offering heavy discounts to attract customers and compensate for its lack of fashion content and a small online channel. Since the start of the year, the company’s stock has declined by almost 75% on account of poor financial performance.

Aeropostale’s U.S. revenues fell 14% in the first quarter of 2014 and 13% in the subsequent quarters. Its share in the U.S. apparel market declined 11 basis points from 0.73% in Q1 2013 to 0.62% in the same quarter this year. In Q2 and Q3, the company’s market share was 11 and 12 basis points below what it was in the year ago period. Considering that Aeropostale’s market share is below 1%, this decline looks alarming. The company needs to find a way to win back customers or otherwise, its share will continue to shrink.

In fact, after its Q3 fiscal 2014 results, Aeropostale decided to ramp up its store closures. In its earnings call, the company stated that it is planning to close 75 of its stores during the fourth quarter, which is significantly more than its earlier plan for the entire year. With the closure of these 75 stores, Aeropostale’s total closed stores for the fiscal year 2014 would stand at 120, a long way ahead of its initial guidance of 40-50 stores. Next year, the company plans to shut another 50-75 Aeropostale stores along with 126 mall-based P.S. from Aeropostale outlets, which will reduce the retailer’s store base considerably. ^[2] This is not painting a pleasing picture for Aeropostale’s market share.

See our complete analysis for American Eagle Outfitters

American Eagle Outfitters

American Eagle has been struggling for the past couple of years due to a fall in foot traffic on account of limited fashion variety. From $3.48 billion in 2012, the retailer’s revenues declined 5% to $3.31 billion in 2013. Buyers moved from American Eagle to affordable fast-fashion brands such as Zara, Forever 21 and H&M, and subsequently developed a perception that the brand isn’t “cool” anymore. Although the company has a limited fashion variety, which is doing well, its major revenue source remains basic logo products that customers only buy for heavy discounts. The company’s shares fell by more than 30% from January to August, but rallied thereafter as American Eagle showed certain signs of recovery.

American Eagle’s revenues fell 4.5% year over year in the first quarter of fiscal 2014, 2.3% in the second quarter and 0.4% in the third. Its market share fell 6 basis points from 1.10% in Q1 fiscal 2013 to 1.04% in the same quarter this year. In subsequent quarters, the retailers margins shrunk by 5 basis points and 3 basis points (year over year), respectively. These metrics clearly indicate that American Eagle’s performance is gradually improving, which provides hope for the future. Also, it must be noted that the intensity of revenue decline for the retailer is much weaker as compared to its counterparts, Aeropostale and Abercrombie. This implies that despite the recent slump, American Eagle is at a relatively better position than Abercrombie and Aeropostale. However, since American Eagle is looking to shut a number of locations that do not account for sufficient traffic, its topline recovery and market share improvement will be arduous in the near future.

See our complete analysis for Abercrombie & Fitch

Abercrombie & Fitch

Abercrombie has had a number of problems including inventory mismanagement, lack of fashion depth, failed brands, overgrown store base and controversial brand image. Once one of  the most sought after brands in the country, Abercrombie lost its essence a couple of years back after off-pitch fashion calls and merchandise stocking issues (both shortages and surpluses) drove customers to other retailers. Just like its peers Aeropostale and American Eagle, Abercrombie was also focused on selling logo products. However, with buyers losing interest in basic products, Abercrombie was unable to hold onto its customer base with a limited fashion variety. The retailer’s U.S. revenues fell by 3.5% in 2012 and 17.4% in 2013. Abercrombie’s stock has been down more than 35% since July, as the company decided to aggressively phase out its logo merchandise, that impacted its growth.

Abercrombie’s revenues fell 11% in the first two quarters of fiscal 2014 and 15% in the third quarter. Much of the loss can be attributed to the substantial reduction in logo inventory at the retailer’s stores and websites. The company’s market share shrunk 9 basis points year over year to 0.64% in Q1 fiscal 2014 and 10 basis points and 15 basis points (year over year) respectively, in the subsequent quarters. The metrics clearly indicate that Q3 fiscal 2014 was particularly weak for the company. Even the near term is not looking good for Abercrombie since it is aggressively pursuing its strategy to reduce logo business to “almost nothing”.

While the retailer is doing this to reposition its brand in the market, it needs to be at a pace that buyers are comfortable with. Such product overhauls haven’t been too successful in the past, which is evident from Aeropostale’s misfired fashion launches last year. Moreover, as logo products go out and fashion keeps increasing, Abercrombie’s average unit retail will go up, that might prompt buyers to switch to other casual apparel brands. We believe that the retailer’s product portfolio needs to have an optimum proportion of basic as well as fashion products. Letting customers shift to competitors in search of unavailable affordable basic products would be a mistake. We believe that the company would do best to manage the transition, even as it fosters strong sales in relatively newer and more expensive fashion categories.

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1. Clothing and Clothing Accessories Stores, U.S. Census Bureau [↩]
2. Aeropostale’s Q3 fiscal 2014 earnings transcript, Dec 3 2014 [↩]