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|  | JULY 19, 2004
Clothes Retailers That Look Good S&P's Marie Driscoll says those riding hot trends are enjoying firming prices. Two she favors: Pacific Sunwear and Liz Claiborne Some major retailers, such as Wal-Mart (WMT ) and Target (TGT ), recently reported disappointing June sales. And the government's latest reading of overall retail sales for June fell 1.1%, much weaker than economists expected, sparking concern about consumer spending's strength. Despite the negative news, the outlook for a few apparel retailers and manufacturers is still fairly bright, says Marie Driscoll, who follows the group for Standard & Poor's. She sees firming prices for the chains and makers that are following the right fashion trends. The hot things are footwear and accessories, as well as unique products. Plus, consumers may continue to spend, thanks to improving employment, income, and confidence, she says. With interest rates rising, investors should select retailers with strong fundamentals, Driscoll says. Companies that fit this bill include Ann Taylor (ANN ), Chicos (CHS ), Coach (COH ), and Gap (GPS ). Pacific Sunwear (PSUN ) is her favorite apparel retailer, while Liz Claiborne (LIZ ) stands out as the manufacturer with some of the most popular clothing brands. These were a few of the points Driscoll made in an investing chat presented July 13 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Karyn McCormack. Edited excerpts follow. A full transcript is available from BW Online on AOL, at keyword: BW Talk. Note: Marie Driscoll is a Standard & Poor's Equity Analyst. She has no ownership interest in or affiliation with any of the companies under discussion in this chat. All of the views expressed in this chat accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARSS-ranked companies, go to spsecurities.com and click on "Investment Research," then click on "Required Disclosures & Standard & Poor's STARSS vs. Closing Prices Charts." Q: Do you expect sales to slow down among apparel retail and manufacturers? We saw some disappointing sales reports for June last week. A: Actually, I don't. We're in the middle of a fashion trend that's firming prices and creating demand. The consumer looks pretty good in terms of employment, income, and confidence. That, with firming prices and lean inventory levels, bodes well for solid sales growth. Regarding June's softer sales, part of that was weather -- we also see it as a function of consumers shopping early in spring for fashion apparel. June, July, and August are soft clearance months. July and August are transitioning into back-to-school and fall merchandise. We believe retaliers with trends-right apparel merchandise will enjoy strong sales growth. Q: What are your favorite apparel retail stocks? A: Pacific Sunwear (PSUN ). We have a 5-STARS (buy) rating on PSUN. Then we have a few 4-STARS (accumulate) stocks, including Abercrombie & Fitch (ANF ), Ann Taylor (ANN ), Aeropostale (ARO ), Chicos (CHS ), Coach (COH ), and Gap (GPS ). To give you a little flavor for them, our target price for PSUN is $29 -- that would be up about 30% from today's close of $19.86. The company's year-to-date comps [comparable store sales] are double-digit. They operate two chains, Pacific Sunwear, a surf-and-skate lifestyle apparel store, and Demo, an urban hip-hop apparel store. Both chains carry multiple national and private-label brands, which limits fashion and inventory risks and enables the company to nimbly catch the latest trends for the teen or young adult market. At Pacific Sunwear, 41% of the stores are less than three years old. They expect to grow square footage 13% to 15% for the next three to five years, and revenues should double over the same period, with modest margin expansion as well. We estimate PSUN will earn $1.35 this year and $1.60 next year -- that's up from $1.02 last year. The stock is trading at a discount to the market and its peer group. So we think it's very attractive. Regarding my 4-STARS, a few of them are teen-apparel retailers competing with PSUN -- that would be Abercrombie & Fitch and Aeropostale. The others are targeted toward women -- Ann Taylor and Chicos. Q: What are the hot products in the current fashion cycle? Who else is benefiting from the trends, besides Pac Sun, as you mentioned? A: Very hot are accessories and footwear. Most of the retaliers we follow, Pac Sun included, are growing their accessories and footware business. This [leads me to] Coach -- which is a beneficiary of this trend. The fashion trend is unique, differentiated product, and Urban Outfitter (URBN ) is benefiting from this with its Urban Outfitters and Anthropology stores. We have a hold recommendation on URBN, with a $30 target price. URBN is up 60% year-to-date, following last year's 200% rise. So on a valuation basis, this is one of the highest-priced stocks we follow. It's trading at 26 times next year's earnings estimates, which represents a 70% premium to the market (vis-a-vis the S&P 500-stock index). Q: How about American Eagle (AEOS )? A: It's in the midst of a turnaround [and has] very impressive margin expansion. Still, we're concerned with the growth opportunities going forward. Its operating metrics are substantially below Pac Sun, and yet it's trading at about a 15% premium to Pac Sun. So we think it's fairly priced.
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