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Time Is Right for Retail Stocks

Now is the time for investors to dabble in retail, according to analysts and industry consultants who say current stock valuations are attractive.

Now is the time for investors to dabble in retail, according to analysts and industry consultants who say current stock valuations are attractive.

Shares of many apparel retailers have taken a beating over the past two months, trading at 52-week lows. And coming off weak January same-store sales means investors might be able to pick up “solid companies” at bargain-bin prices.

“We believe investors should start looking at the retail sector as a value play and hence should start accumulating shares in well-managed companies with growth opportunities in terms of store growth and operating margin expansion,” said Liz Pierce, retail analyst at Roth Capital Partners.

The key to hand-picking value stocks is to look for companies that have a historically low price-to-earnings ratio, or P/E, which is the current stock price divided by trailing annual earnings. And a prospective earnings growth, or PEG, ratio below 1 is also a key metric.

Out of 33 specialty retailers tracked by WWD, 17 have P/E ratios below the industry standard of 17.2, while 12 have a higher ratio. Four of the companies posted losses so have no P/E data.

“There are hordes of stocks currently at historic lows in P/E and PEG ratios. The trick to investing is buying a good company that’s a bad stock. Currently there are whole sectors, not just a few companies, out of favor,” said Craig Johnson, president at Consumer Growth Partners, a consulting firm.

Teen retailers in particular could be attractive to long-term investors.

Aéropostale Inc., which has a P/E of 17.1, PEG ratio of 0.98 and a 13.1 percent operating profit margin, has spent the past year reshaping its merchandise and brand image. With the appointment of Mindy Meads as chief merchandising officer in May, the company has moved away from just basics, adding some fashion-forward and veneer items to its mix. For the spring it will incorporate dresses and swimwear to its assortment.

The company was also one of the only apparel retailers that delivered double-digit comp growth during the holiday season and it was the only teen retailer with positive January results.

“We believe Aéropostale remains ideally positioned to capture more ‘trade down’ from its competitors in 2008 and achieve further top- and bottom-line upside, despite the weary economy,” said Eric Beder, retail analyst at Brean Murray, Carret & Co. “With management’s focus on further improving inventory turns and driving fashion newness, we believe 2008 will be another year of demonstrating the strength of the company’s business model.”

Despite softness during the holidays and in January, American Eagle Outfitters Inc. is poised for a comeback. With shares down 34 percent for the year, a P/E of 11.9 and PEG of 0.87, it’s on the cheaper end of the specialty retailers.

The company recently announced a share buyback program, signaling a strong balance sheet. According to analysts at Oppenheimer, the teen retailer will most likely end the year with $500 million in cash even after spending $438 million buying back stock.

While the pending launch of its third concept, 77kids, may not be the best use of excess cash, as the company still needs to get a handle on its second concept Martin + Osa, analysts expect American Eagle to rebound.

Abercrombie & Fitch is also a solid brand that continues to expand both domestically and internationally. Richard Jaffe, retail analyst at Stifel Nicolaus, anticipates the retailer posting 12 to 18 percent earnings per share growth for the next several years. He said this growth will be fueled by the expansion of the existing business, new concepts and modest positive sales momentum generated by the appeal of the brand and leverage on expenses achieved from both new store sales and operational improvements.

Abercrombie & Fitch, which feeds off its aspirational image, recently launched its first lingerie store, Gilly Hicks. The new concept was opened at the Natick Collection outside Boston, and the company said it would add about 15 stores this year. Management also has plans to open additional flagships overseas.

Charlotte Russe Holding Corp. recently reported a decent first quarter despite the tough macroenvironment. For the three months ended Dec. 29, net income increased 0.7 percent to $14 million, or 56 cents a diluted share, while sales jumped 13.9 percent to $238.2 million.

On a call to Wall Street, management said it hired a consultant to determine how to drive profitability at the core business while making plans to roll out a second concept. The company has a P/E of 12.3, a PEG of 0.77 and it’s stock is down 42 percent for the year. Charlotte Russe has a stronger balance sheet with $4.5 million in cash and $17 million remaining in its share repurchase program.

“Based on the positive changes being made at [Charlotte Russe], including merchandising, presentation and various systemwide enhancements that should drive productivity, as well as its impressive and continuous fresh fast-fashion merchandise, we believe that any material weakness in the stock price should be viewed as a buying opportunity,” Pierce stated in a report.

In the misses’ sector, AnnTaylor Stores Corp. and Dress Barn Inc. may have some potential. While Ann Taylor posted a 9.4 percent drop in December same-store sales, has seen shares decline 32 percent for the year and has experienced weak traffic, there are some positives. January comps were flat, which is better than its Baby Boomer competitors; operating profit margins, which are currently at 8.2 percent, have increased, and merchandise has improved slightly at Loft. Though it is unlikely women will shop for themselves during an economic downturn, when the economy picks up there could be pent-up demand.

The company also recently announced it would delay new store openings and reduce capital expenditures on less productive stores, which should enhance cash flow. Ann Taylor has no debt and more than $100 million in cash.

Dress Barn’s P/E of 9.2 is well below the industry average and the stock is down 46 percent for the year.

“We believe the well-known balance sheet strength and cash-generating capabilities of Dress Barn merit an investment in the stock with the opportunity of the company completing an acquisition and failing that commencing a buyback of shares,” said Mark Montagna, retail analyst at C.L. King & Associates, in a research note.

Meanwhile, the men’s sector has been notably more resilient than women’s. While women’s apparel has been strewn with fashion misses and accused of not knowing its demographic, men’s has seen a drastic improvement, becoming more fashion-forward.

Jos. A. Bank Clothiers has a P/E of 9.3 and a 0.65 PEG ratio, while Men’s Wearhouse has a PEG of 0.57 and P/E of 7.2, its lowest point in more than five years.

“Women’s underperformance versus men’s now stands at 20 percent. A year ago comps were running in unison and six months ago the gap was at 10 percent,” said Brad Stephens, analyst at Morgan Keegan & Co.

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