Why Are These Retailers Set To Post Fabulous Returns?

 |  Includes: GPS, LB, ROST
by: Fusion Research

Apparel companies operate in a highly competitive and a fragmented market. The industry operates under stiff competition due to presence of a large number of players ranging from large sized companies to private label or niche segment companies. As fashion trends change frequently, apparel companies have to adapt to this dynamic environment on a continuous basis. Rising population and an increase in consumer disposable income has resulted in a positive outlook for revenue growth in this industry. This can be substantiated from Moody's report, which expects that U.S. apparel sales could increase around 2% in the next 12 months, while emerging markets apparel sales can achieve 5%-9% growth during the same period.

We have selected three stocks that pose interesting investing opportunities in such a scenario. These three apparel companies are taking various initiatives like expansion of stores and consolidation of existing business to achieve revenue growth in the coming years.

Good revenue growth expected from global expansion and online business

Since 2011, Gap Inc (GPS) has been expanding its presence in China. With high population growth and rising disposable income, China is the second largest apparel market in the world. Total apparel sales in China are expected to reach $200 billion by 2014 from $110 billion in 2009. The company has opened 8 stores during first half of the current fiscal year, and it plans to open 28 more stores in the remaining part of the year, reaching 82 stores in China.

Its expansion initiative in China provides an opportunity for the company to increase revenue from the international market. The company has been taking international expansion initiatives to reduce its dependence on the maturing U.S. market. This has resulted in a decline in the percentage of U.S. revenue in total net sales from 74% in fiscal year 2009 to 67% of revenue in fiscal year 2013.

Apart from expanding globally, the company is focusing on generating revenue growth from online sales. According to yStats.com, over one-third of internet users worldwide made or intended to make apparel purchases online. Gap has launched various initiatives such as an iPad app to enhance customer experience and establishing an ecommerce website in Japan last year. It also started a "ship from store service" for its Old Navy stores, where customers can make purchases from their local stores online, and is starting an in-store service, which will allow the customer to reserve their products online and buy them at stores. Recently, the company announced launching of an ecommerce website in Taiwan by the first half of 2014, which is aimed at Taiwan's growing economy.

These initiatives are aimed at capitalizing on the growth in the ecommerce market. Due to its strategy of multichannel retailing, the company reported 27% year-over-year growth in ecommerce sales in second quarter of this year.

The company currently has a forward PE of 13.3 for next fiscal year, down from the current 12 months trailing PE of 15. Therefore, investors can expect earnings growth from the company. Gap's PE is currently below its industry average of 19.1, indicating this stock has still upside potential left to woo investors.

Increasing U.S. footprint and maintaining cash return to shareholders

Ross Stores (ROST), the third largest off-price retailer in the U.S., announced opening of 88 new stores in the U.S. in 2013. Up until now, the company opened 54 stores in first half of this fiscal year, and plans to open the rest in the remaining part of the year. Off price retail is a different segment which attracts customers due to their deep discounts on the merchandise. Most of the stores are expected to open in cities where the company has low presence. Looking at the demand in the U.S. off price retail market and presence in only 33 states, the company has set a goal to double its U.S. store count to 2,500 stores from the current 1,277 stores. The U.S. is the largest branded apparel market in the world and provides ample opportunity for Ross Stores to sustain revenue growth from its expansion initiatives.

Apart from opening stores in the U.S. market, Ross Stores has followed its strategy to return cash to shareholders with the repurchase of 4.4 million shares for $277 million in the first half of this year. The company expects to purchase $273 million worth of shares in the remaining part of this fiscal year.

Apart from share repurchases, the company also announced a quarterly dividend payment of $0.17 per share, up 20% year over year.

The company currently has 217 million outstanding shares, and with an expected $273 million share repurchase program, it will retire an expected 4 million shares at the current stock price. If we assume second half earnings of 396 million for fiscal year 2012 as base, than this repurchase of 4 million would result in accretive diluted EPS of $0.35 for the fiscal year 2013.

Ross stores compete in a completely different segment of apparel industry, so it won't be conclusive to directly compare this company on the price-earnings metric with apparel giant Gap. It currently trades at a 12 month trailing PE of 17.62, which is in line with industry standard PE. Its forward PE for the next the fiscal year is expected to decline to 15.34, thus investors can expect growth in the company's earnings, resulting in return on their investment.

Expansion in domestic and international markets

L Brands (LTD), the largest lingerie retailer in the U.S., has been restructuring its U.S. operations. This involves closure of 18 underperforming U.S. Victoria's Secret, or VS, stores this year and expansion of its PINK line of stores. PINK is a niche segment of VS's lingerie products and caters to college girls. Due its low market penetration in this customer segment, the company is expecting revenue growth potential from its expansion initiative, which involves opening 50 PINK stores in 2013, up from the 19 PINK stores opened in 2012.

L Brands, being the largest lingerie retailer, has been suffering from underperformance of its VS stores due to demand-supply mismatch stemming from growth in the number of VS stores that went beyond the demand growth. PINK store expansion provides an opportunity for the company to sustain its revenue per square foot from its U.S. stores. Therefore, all these restructuring initiatives are expected to improve VS's U.S. revenue per square foot from $817 in 2012 to $870 in 2013, as per Trefis estimates.

Apart from its domestic expansion, the company is also increasing its international footprint. Due to its limited presence on the international front, L Brands has ramped up its expansion initiatives. These includes opening of 16 new stores in Canada and three new stores in the U.K. in 2013. Apart from opening new stores, the company has expanded its product offering from core lingerie products to swimwear, sportswear, lounge wear and other accessories. Thus, customers will now have more options available with them, which is expected to enhance shopping experience. International expansion provides a platform for the company to offset a slowdown in the maturing domestic market. Therefore, analysts expect that the company will generate 10% year-over-year growth in international revenue this year.

Both initiatives are aimed at generating earnings growth for investors. The company currently trades at 12 months trailing PE of 21.02, which is more than the industry average PE of 19.1. This indicates that L Brands stock is overvalued, but with a low forward PE of 15.96 for the next fiscal year, investors can expect earnings growth in the coming year.


All three companies are expected to benefit from their expansion plans. L Brands and Gap are expanding globally, and Ross Stores is expanding in its domestic U.S. market. In addition to expansion, online business is expected to contribute to Gap's revenue growth. L Brands expects to benefit from consolidation of its U.S. operations and international expansion, while Ross Stores is providing value to its investors by its expansion program and cash return initiatives.

From a valuation standpoint, all three companies have a forward PE lower than their trailing 12 month PE, which reflects the earnings growth potential of these three stocks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.