4 Fashion Stocks to Watch During the Back-to-School Shopping Season

Sometimes, investing in fashion stocks can feel a bit like owning shares of junior mining companies. If you buy into a chain that happens upon the next hot trend (the fashion world’s equivalent of a big resource find), the shares can explode. But if fashion stocks are late to the party or fail to adapt with the times, their young customers are quick to turn up their noses.

Take the case of Abercrombie & Fitch (NYSE: ANF), whose racy catalogs featuring half-naked models once got teens talking. Now, however, it seems young shoppers are more interested in the clothing than the models—and more of them are giving the stores a miss. The fashion stock’s share price is off 35% over the past year. In the second quarter, Abercrombie’s profits slumped 52%, and same-store sales declined 10% across the chain.

“Abercrombie is still running an offense which is a huge banner of a bare-chested guy with a cute girl who’s not wearing enough clothing,” said David Maddocks, a former chief marketing officer for Nike, in a Bloomberg Businessweek article. “It’s vacuous, there’s no core idea there anymore and people want the richness that comes with real authenticity.”

Now, with the crucial back-to school shopping season upon us, many fashion stocks are upping their games. Here are three others to keep an eye on:

This Fashion Stock’s Looking to Make a Big Turnaround

Aeropostale (NYSE: ARO) fit the tenor of the times back in 2008 with its highly fashionable yet budget-conscious clothing. The company, which mainly targets 14- to 17-year-olds, was selling its apparel for an average of 30% to 50% less than competitors, American Eagle (see below) and Abercrombie and Fitch.

The stock went on an extended run as a result, starting at $9.33 a share in November 2008 and peaking at $29 in September 2009—for a total gain of over 210%.

The shares broke through that ceiling again in April 2010, but they’ve mostly drifted lower since, including a 32% decline on August 2, 2012, after the company cut its second-quarter earnings forecast to $0.00 per share from its previously estimated $0.03 to $0.05. When it reported its full results two weeks later, it had only managed to eke out a profit of $0.1 million in the quarter on a 4% overall sales gain and flat same-store sales.

The reason? The fashion stock’s summer lineup consisted of too many basics and too few eye-catching new clothes. As a result, it lost out to more fashion-focused chains like American Eagle (see below).

“Our core basics business experienced significant pricing pressure due to the highly promotional and competitive retail landscape,” said CEO Thomas P. Johnson. “As a result, we promoted these businesses more aggressively than initially expected to end the quarter with inventories in line with our plan.”

Aeropostale is now racing to inject more edge into its clothing lineup. Whether it will be able to turn things around—and how quickly—remains uncertain.

American Eagle Moves to the Head of the Class

Many of the customers that have gone missing from Aeropostale’s stores appear to have surfaced at American Eagle Outfitters (NYSE: AEO). According to CEO Robert Hanson, the chain saw a 33% increase in active customers in the second quarter despite the fact that, unlike Aeropostale, it had cut back on promotions.

American Eagle’s customer count rose because it hit a home run with its summer lineup, particularly jeans and other denim clothes. As a result, its sales rose 11% in the second quarter, to $740 million from $669 million a year ago. Same-store sales jumped 9%. Profits slipped 3.3%, but that was largely due to the sale of its money-losing 77kids division. Income from continuing operations, however, rose 21%, to $0.21 from $0.13, meeting consensus estimates.

Based on its strong performance, the company sharply increased its per-share profit guidance to $1.33 to $1.36, up from its previous forecast of $1.16 to $1.22.

The stock has risen 42% this year, and with a promising back-to-school season ahead, it looks ready to head.

In a note to clients quoted on Reuters.com, analyst Jennifer Davis of Lazard Capital Markets wrote that the increased guidance “reinforces our belief that American Eagle is taking [market] share this back-to-school season.”

Return of The Gap

If Aeropostale needs any encouragement that a turnaround is possible, it only needs to look to The Gap (NYSE: GPS). The company operates a number of chains other than its namesake, including Old Navy and Banana Republic.

After struggling for years to find its place on the retail landscape, the company looks like it could be starting to hit its stride. Like American Eagle, The Gap boosted its full-year profit forecast following strong second-quarter results: Profits rose 28.6% year over year, to $243 million, or $0.49 a share. Sales were up 5.6%, to $3.58 billion. Both figures beat the consensus estimate: Wall Street was expecting $0.37 a share in profits on $3.46 billion of revenue. Same-store sales rose 4%.

It was the fourth straight quarter that the company had beaten expectations.

Also like American Eagle, the company’s new clothing is finding an audience, particularly the brightly colored jeans it rolled out this summer.

But that’s not the whole story: The Gap is also keeping a tight lid on its costs and firm control of its inventory levels. That reduces the need for costly clearance sales and boosts profit margins: after two straight quarters of declines, The Gap’s profit margins rose in the last quarter, jumping three points from a year earlier, to 39.9%.

The company hopes to build on this success by adding to its design and management talent. It recently rehired Tracy Gardner, formerly of J. Crew, who is expected to have a strong influence on The Gap’s fashions for the holiday season. In addition, well-respected women’s clothing designer Narcisco Rodriguez will serve as an adviser to the Banana Republic brand starting this fall.

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