Urban Outfitters, Inc. (URBN), American Eagle Outfitters (AEO), Williams-Sonoma, Inc. (WSM): How to Play the Retail Sector in the Second Half of 2013

It’s been a turbulent couple of months for the retail sector, as investors are digesting a mixed bag of consumer data and earnings reports.

Consumer confidence and consumer spending have largely risen year-to-date, with Americans seeing an improved employment outlook, higher stock prices, and a resurgent housing market. However, the recovery may be short-lived, as stock prices have turned lower in recent weeks. Markets closed the month of August with the worst monthly performance since May 2012. And home prices, which traditionally lag the market, unexpectedly plunged 13.4% in July.

Given the above, is it time to be bullish or bearish on consumer-related stocks? Let’s take a look at the following consumer “report cards” before making a decision.

Urban Outfitters, Inc. (NASDAQ:URBN)

The winners
Underlying fundamentals at Urban Outfitters, Inc. (NASDAQ:URBN) have exceeded actual gains in the stock price, which may present a compelling opportunity for readers.

Back on Aug. 19, Urban Outfitters, Inc. (NASDAQ:URBN) reported record Q2 sales and earnings on the back of new product offerings, higher merchandise margins, and new store openings. Earnings per share came in higher than expected at $0.51 compared to $0.48 consensus, on a record $759 million in revenue. Comparable-store sales also rose 9% during the May 1 through July 31, adding to the company’s impressive quarter.

While Urban Outfitters, Inc. (NASDAQ:URBN) trades at a premium 24 times price-to-earnings ratio, the valuation is justified when considering that management continues to deliver outstanding results. Revenue at Urban Outfitters, Inc. (NASDAQ:URBN) has grown 14.3% in the last 12 months, while earnings have increased an impressive 42.6%.

The company’s board of directors is voting with their pocketbooks that shares remain inexpensive, announcing a 10 million share-repurchase plan on Aug. 28. The new plan will allow Urban Outfitters, Inc. (NASDAQ:URBN) to repurchase 6.7% of outstanding shares, putting a floor under the current stock price.

Readers might consider Urban Outfitters, Inc. (NASDAQ:URBN) with a 12-month investment horizon. The Philadelphia-headquartered company operates under the Urban Outfitters, Anthropologie, Free People, Terrain, and BHLDN brands.

The losers
As I hinted in the introduction, not all of the retail sector is cheerful and sanguine, as evidenced by results at teen retailers such as American Eagle Outfitters (NYSE:AEO), Aeropostale, and Abercrombie & Fitch.

Shares of American Eagle Outfitters (NYSE:AEO) are reaching an 18-month low as the company reported Q2 earnings and cut its Q3 guidance in half. Second-quarter results came inline with expectations, as the company reported $0.10 EPS on $727 million in revenue. However, third-quarter guidance was sharply reduced to a $0.14–$0.16 range, a huge shortfall compared to the $0.35 consensus.

My research indicates that ‘AAA’ retailers–a term I coined for American Eagle Outfitters (NYSE:AEO), Aeropostale, and Abercrombie & Fitch– have fallen out of favor with U.S. teen shoppers in favor of newer, trendier stores such as H&M, Forever 21, and Zara. Ironically, the parent company of Zara is the largest global specialty retailer, followed by Swedish-based H&M in second place. U.S.-headquartered Gap is the third largest specialty retailer.

Readers might consider exiting their position in the AAA retailers, as these companies appeal to a narrow range of consumer. In contrast, Urban Outfitters appeals to shoppers of all ages, and the company has momentum going into 2H 2013.

And the undecided
On Aug. 28, Williams-Sonoma, Inc. (NYSE:WSM) reported better-than-expected second quarter 2013 results. The company provided investors with the “trifecta”–beating earnings and revenue estimates while raising its financial guidance for the second half of 2013.