Once-Popular Teen Retailer Looks Set to Take a Double-Digit Dive

StreetAuthority Network

The S&P 500 continues to trade below its downtrend line off the early August all-time high near 1,710. As a result, as I stated last week, I continue to hunt for candidates to sell short.

One sector that looks particularly vulnerable is retail stores catering to teens. Many of these chains, including Abercrombie & Fitch (ANF), American Eagle Outfitters (AEO) and Aeropostale (ARO), posted a decrease in second-quarter same-store-sales. They also revised their earnings outlooks downward.

Of the three, the hardest hit was Abercrombie & Fitch. Of the 500 stocks in the S&P, it was August's worst performer. ANF plummeted 29% for the month, losing nearly 18% in just one day after it reported dismal second-quarter results.

Abercrombie's same-store sales -- a key measure of retail success -- tanked 10% in the second quarter. With its clothing having less appeal in the key market of teen girls, net income fell by a third to $11.4 million from $17.1 million in the year-ago period.

The retailer doesn't seem to believe things will pick up anytime soon. For the upcoming third quarter, management expects comparable same-store sales will be "down slightly more than second quarter," while earnings are expected to drop about 50% from the year-earlier period.

Because the outlook is so weak, the company won't even estimate how it will perform for the full year. It blames its inability to project results on a "lack of visibility given recent traffic trends."

The negative outlook is weighing heavily on the stock, creating a highly vulnerable chart pattern and providing a potentially profitable opportunity for traders who sell short.

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ANF Stock Chart

Falling from a high near $75 in October 2011, ANF formed a major downtrend line. In the summer of 2012, shares hit a multi-year low near $28. The stock recovered from there, reaching the $36 level in August 2012, before falling again to $28.

On reaching this low, ANF rebounded to the $38 range in September. Shares fell again, finding support near $30. These three bottoms suggest there is good buying interest for ANF in the $28 to $29 range.

Rebounding strongly from the third bottom, shares rocketed through $36 resistance, breaking the major downtrend line in the process. The stock rose to a high around $49 in December 2012 and edged its way up to over $55 in May 2013.

Meanwhile, on pullbacks ANF twice found support near $43, once in February and again in June. However, in early August, when the company reported bleak second-quarter results, it fell dramatically through $43 support on high volume.

While ANF has temporarily stabilized near $36 in the last two weeks, it still appears technically vulnerable.

First, the declining 30-week moving average (MA) has bearishly crossed down through the falling 10-week MA, a signal akin to the "death cross" when the 40-week MA drops through the 10-week MA.

Second, the Moving Average Convergence/Divergence (MACD) indicator has just entered bearish territory and is well above levels at which the stock previously bottomed.

The next major support is the 2012 lows near $28. At current levels, this drop would mean 23% potential gains for traders who sell short.

The bearish technical outlook is supported by weak fundamentals. Analysts anticipate upcoming third-quarter revenue will fall 6.8% to $1.09 billion from $1.17 billion in the comparable year-earlier quarter. For the full 2013 year, analysts expect revenue to drop 4.9% to $4.29 billion from $4.51 billion last year.

The earnings outlook is equally soft. Based on decreased consumer demand, coupled with store expansion costs, analysts project third-quarter earnings will fall about 57% to $0.44 per share from $1.02 in the comparable year-ago period. For the full 2013 year, analysts predict earnings will drop 29% to $2.06 per share compared to $2.91 last year.

Based on the company's weak technical and fundamental outlook, I plan to sell short the former favorite of fickle teen shoppers.

Risks to consider: Abercrombie is attempting to win over teens in other parts of the world. The company plans to open a new flagship store in Seoul, Korea, this year, as well as 20 international outlets under the Hollister brand. However, even if the expansion is successful, it will take time for sales in those markets to have an effect on the bottom line. 

Recommended Trade Setup:

-- Sell ANF short at the market price
-- Set stop-loss at $40.15, just above $40 round number resistance
-- Set initial price target at $28.05 for a potential 23% gain by early 2014

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