Specialty Retail

A select group of niche clothiers is looking spiffy

Attention, bargain stock shoppers. Before you give up completely on the sagging retail sector, take some time to poke through the racks in a few specialty clothing stores. At a time when the big chains have already exhausted the pop they usually get early in a recovery, the small guys are outperforming them.

It's no big mystery why: Discretionary spending, which the specialty niche depends on far more than big stores do, tends to catch fire late in a recovery. As a result, the Standard & Poor's specialty-apparel index is up 8.9% for the year, while the S&P's broad retail index is down 5.2%.

It's important to be selective. The sector, like its underlying business, is volatile. But the best niche players should continue to do well, especially the smaller companies. They're benefiting from the woes of the Gap (GPS ), the largest of the specialty players. Its comparable-store sales have declined for 25 straight months, allowing up-and-coming players to steal market share. Besides, a modest improvement in dollar sales at a small company can produce a bigger earnings jump in percentage terms than it can for large players.

That's why institutional investors like Abercrombie & Fitch (ANF ) as a strong near-term play, even though its share price has bounced around wildly between $46 and $8 in the past two years. It's now trading at $25.50. Even with sales down at stores that have been open at least a year, Abercrombie's fiscal first-quarter profits rose 13%, thanks to tight inventory and expense controls. With that discipline, Dreyfus analyst Elaine Rees expects pleasant surprises from Abercrombie's earnings this summer as teens start loading up on the company's popular surfer-style beachwear. "When the sales turn, there is a lot of money to be made," says Rees.

Timing is everything with specialty retailers, because they fall in and out of favor quickly. American Eagle Outfitters (AEOS ), for example, is paying the penalty for its fashion faux pas in the first half of the year, when it missed the bohemian and peasant styles. Second-quarter profits are expected to be down, continuing a fall that started late last year. But American Eagle is now picking up on the folksy styles, which could pay off in the second half. Lazard Freres analyst Todd Slater expects second-half earnings to be up 20% year-on-year, after falling an estimated 13% in the first half. Now priced at about $22 a share, "this will be a $30 stock by yearend," he says.

Another promising second-half prospect, say analysts, is Talbots (TLB ), the classic women's clothing retailer. Through spring, it bet too heavily on structured clothing, such as suits, when women wanted less fitted items. But Talbots' management is considered among the best in retail, and many analysts expect the company to get back on track for the remainder of the year, when its mix typically includes more casual clothing. May sales fell only 3%, when most analysts braced for a decline near the mid-teens. Talbots says virtually all merchandise sold at regular prices.

Two small casual chains, Chico's FAS (CHS ) in Fort Myers, Fla., and J. Jill Group (JILL ) in Quincy, Mass., offer some of best growth prospects in the sector. Analysts expect earnings-per-share gains of 42% and 30%, respectively, in their current fiscal years. Both sell casual clothes targeting women 35 and older. Although they have had good runs this year, they're still trading at lower price-earnings ratios than many fast-growing retailers.

Even slightly better-than-expected earnings could drive shares higher. J. Jill could post the biggest near-term gain, argues Jeffrey Klinefelter, an analyst at U.S. Bancorp Piper Jaffray. With 55 stores, vs. Chico's 319, "they are just at the start of their growth curve."

Despite the perpetual worries that consumers will sit on their wallets, they're still spending. But investors, like fashionistas, are always a season ahead of the economy. And they've already gotten a fair bit of wear out of the specialty-sector play. Still, there could be some finds left for picky shoppers.

By Robert Berner

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