Too many value investors comfort themselves with past consistency. Selling clothing to people is not a steady business with the exception of men's dress clothing. Tastes can change rapidly - look at Crox. The clothing industry is not part of some broader cycle that allows any individual company to piggy back on the broader upswings like housing or steel. Marginal capacity remains just that even when clothing demand is strong. My scientific method for establishing that is looking at the stocks of steel and housing companies from 2000-2008 and 2000-2005 respectively compared to clothing retailers over the same periods. The former was correlated, the latter not at all.
To understand the differing economics a clothing retailer faces, it helps to put them against the backdrop of retailers in general, where there are many dominant players. Target is not likely to start carrying a small selection of lumber and Home Depot is not going to start offering fresh produce or 10 pairs of socks for $5. This allows for some modicum of a competitive advantage among certain retailers. The same competitive advantage is not available to clothing retailers. When skinny pencil jeans are all the rage, anyone that sells pants - i.e. any clothing retailer - is more or less free to jump on that band wagon regardless of what is perceived as their core focus. Even though this implies that a "brand" plays a key role, there are very few enduring clothing brands based on specialty retailers. Brooks Brothers is the only one I can think of off the top of my head, but men's dress clothing is the exception to the rule.
The LBO of J. Crew centered less on the stores, logistics, etc than the presence of CEO Mickey Drexler, who is credited with J. Crew's success in recent years and Gap's success in the 1990s. Gap suffered in the year or two leading up to his departure though, so even the most skilled merchandisers run out of steam every so often.
The limited focus of some clothing retailers - Aeropostale, American Eagle, Gap, etc - makes it hard to rapidly adjust to changing preferences. The existence of retailers built on a model of rapid turnover and super short lead times makes the job of some of the more traditional retailers mentioned above a lot harder. H&M and Inditex don't "miss" a fashion cycle because they focus on rapidly duplicating current fashion and putting it on their shelves. This model rests less on a maestro merchandiser and more on a system focused towards a specific end. H&M and Zara don't stand for anything, they simply mirror whatever is fashionable at the moment.
Aeropostale is a name that keeps popping up in portfolios of many value investors, but I find that it has more traits that don't make it a value investment. The company caters to the 14-17 crowd and is suffering right now. People seem to be focusing on the broader economy leading to more intense discounting and higher cotton prices squeezing the company. While these seem transient at first blush, I don't know how accurately this portrays what is really hurting the company.
There is nothing fundamentally dishonest about such an interpretation, but it is narrow in focus. More broadly speaking, it is that their key demographic is suffering disproportionately to the rest of the economy. Cotton is a marginal issue in comparison to this. Every clothing company has to deal with cotton costs and a weak economy. Why have Aeropostale's recent results been so relatively weak?
I'd like to think that Aeropostale's weak results in recent quarters stem from the fact that teenagers by and large are a mindless and fickle group. When I think back to myself at this age, once some brand or style became uncool in my opinion, it was done. I never gave something a second chance. I moved on. There is such a variety when it comes to arraying oneself in fabric.
Maybe Aeropostale is just in a fashion funk and their clothes are no longer selling well. That seems hard to judge in the near term. I view fashion as practically random, in that in practice it is difficult to really know what items will be a hit. The issue of fashion applies to more than just the special focus retailers, except that they have their own distribution which leverages the business model. I have a hard time figuring out how one could have knocked one out of the park with Uggz or "luxury denim", survived the rollercoaster of Crox or recognize that Heely's now trades for below cash. The monstrous successes and failure would not have been apparent in SEC filings - perhaps incremental successes of sales growth outpacing inventory - and personally I would have scoffed at the idea of anyone buying any of these products before the fact.
You can't tell me that you would believe that these fabulous moon boots get sold in stores, except that they do:
Back to Aeropostale. It's the end of summer right now, when most 14-17 year olds should have gotten summer jobs that allow them to support their spending habits in lieu of the parental payroll. Except that according to the July BLS data on youth employment, 16-24 year olds, the labor force participation rate for all youth in July was the lowest on record. So when your store is targeting that specific demographic, it should come as no shock that same store sales are down and merchandise needs to be heavily discounted to sell it. My inclination is to believe that this is the major factor driving Aeropostale's results and that this is going to obscure whether or not Aeropostale is remaining relevant, since other teen retailers are not seeing as much gross margin or sales pressure.
Sentiment is clearly at an all time low with Aeropostale, but that is not a reason to buy a stock. How can you extricate the effect of cotton, youth unemployment, and a weak economy from a retailer losing its merchandising touch or its appeal to teenagers? That is, how can you establish the difference between a permanent impairment in the business and a temporary blip? At 2.4x book value, there is no downside protection in the form of hard assets backing the valuation and I am skeptical of trying to peg their earnings power going forward with the potential for a fundamental change in Aeropostale's prospects.
I chose Aeropostale because it seems to be the most extreme of the bunch right now in terms of share price. Plenty of people have opinions about the company and its prospects. It just demonstrates why I don't like clothing retailers. It's a hard business with prospects that are difficult to evaluate. Talbot's, bebe, Wet Seal, or Cache are some other examples one might look to for evidence that reversion to the mean is a hard thesis to put forth for a retailer.
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