Apparel retail industry in the U.S. has seen a resurgence with improvements in the economy. Large opportunities have arisen in emerging retail markets, such as the BRICs - Brazil, Russia, India and China - and CIVETs - Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa. A growing number of retailers are now using the Internet to enter a new market before establishing physical outlets. Forecasts are difficult to make in the retail apparel market due to rapidly changing trends and hence the customer preferences.
The following are the industry drivers for apparel retail:
- Economic situation of the countries they are operating in or are exposed to.
- Fashion shifts/cycles. Customers postpone purchases when they do not know what is going to be fashionable in coming times.
- Image/popularity of the brand determines the premium they are able to charge.
Below is a list of some of the players in the low end to luxury apparel retail industry with their respective valuation ratios:
Current year EPS est
Expected next year EPS est
Forward Dividend Yield
Growth rate per annum est. (5 year)
Free cash flow
Gap Inc. (GPS)
Gap is one company that has exploited the current fashion trends the most. From being termed as boring couple of years ago, the specialty retailer has revamped its image this year. The credit mainly goes to the colorful denim spring collection in stores. From thinking of closing 189 stores in October last year due to falling sales, the company has witnessed a turnaround and reported an increase of 9% in sales at stores open at least a year. This was primarily due to Gap identifying a trend and delivering it to the market faster than its competitors due to a shortened production cycle. The company has seen some restructuring as well. Almost a year ago, the company introduced an internal social network called Feedback that connects store managers with corporate sales personnel. The 2,000 people strong network helps in sharing customer comments, posting photos and sending details about products selling well or poorly. "We get immediate feedback," said Mark Breitbard.
But trends do not last forever. The company will face the same challenge as always of getting the mix right between being fashionable and being basic as well as pricing their products appropriately. This mix has gone wrong in the past leading to decline in sales.
Currently, Gap Inc., is one of the best performers in the market with an 8 percent increase in sales when the Wall Street was just expecting a 5.4 percent increase in revenue at stores open at least a year. As a result, Gap raised its first-quarter earnings outlook. By division, revenue at stores open at least a year rose 9 percent at Gap North America's division; 5 percent at Banana Republic's North America division; 11 percent at Old Navy's North American division; and 2 percent at locations overseas.
Gap has posted healthy financials in the first quarter and the future outlook is decent. For the first quarter ended April 28, the owner of the Gap, Old Navy and Banana Republic chains earned 47 cents a share, compared with 40 cents last year. It is trading at a forward P/E of 12.67 (a discount to its competitors). We are of the opinion that unless GPS proves that its current sales gains are sustainable in the future there is likely to be a resistance at the $28-$29 price range.
Ross Stores (ROST):
Ross Stores Inc. is a leading retailer of low-priced apparel. Ross Stores Inc. has shown some impressive performance lately. They said mild weather helped drive March sales in stores open at least a year up 10 percent, more than what the analysts had expected (4.6% for the month). Similarly, first-quarter sales grew 14 percent to $2.36 billion, with sales at stores open at least a year up 9 percent. ROST's profits rose to 93 cents a share, in the first quarter through April 28 as compared to 74 cents a share, a year earlier. These positive quarterly results have triggered the company to expect a conservative EPS of $3.26-$3.37, up from its previous forecast of $3.12 - $3.27. Analysts have estimated an average range of $3.4-$3.8 a share for the year.
In addition to very strong performance in the first quarter, the management is looking forward to double the company's size to 2,500 stores in the longer term (from 1,146 today). This would be done with 6-8% annual square footage growth. Management thinks that its micro merchandising tools that help in catering to local tastes and its inventory reduction strategy will result in better performance in the future.
It is trading at a P/E of 16.5x, slightly higher than the industry average but has a growth rate of 13.42%. We recommend buying ROST based on the demand from customers for low priced apparel that has continued from the recession and into the recovery.
Abercrombie and Fitch (ANF):
Abercrombie and Fitch is a specialty retailer of casual apparel for men, women, and kids. It is currently trading at a forward P/E of 8x which is one of the lowest in the industry and is roughly 56% off its 52-week highs. The financial position at the moment is not very impressive with a negative free cash flow and one of the lowest profit margins. This is because ANF is heavily exposed to sales from its Europe stores (30% of sales are derived from international markets with Europe having the largest number of international stores). Moreover, inventories are up 44% which lead some analysts to think that ANF might have to sell some items on discounts, which will hurt the margins. In spite of all the bad news, its future outlook is promising with a growth rate of 19.14% (one of the highest in the industry) and a higher expected EPS estimate for January 2014. A low EV/EBITDA also indicates that the company is undervalued.
Other reasons for buying ANF are:
- The free cash flow position would improve now that the international expansion is almost complete. Merrill Lynch sees free cash flow rising from $150 million in the current fiscal year to more than $300 million in fiscal 2014 and around $360 million in fiscal 2015.
- Improving European economic conditions would mean an upswing in sales.
- Margins are expected to improve according to the company. It has secured better product costs beginning in 2Q12 which enabled management to maintain F2012 EPS guidance even despite weaker international sales," according to analysts at Merrill Lynch, who rate shares a "buy" with a $54 price target (implying more than 75% upside)
- ANF promises a good stream of cash for the investors with its decent dividend yield of 2.1%. This could increase as the cash flows increase in the future.
- Now that expectations from this iconic retail stock have been set more realistically (adjusted for the weak sale trends), it is bound to deliver upon all its expectations.
Upcoming Catalysts for ANF:
- Economic conditions in Europe improve.
- If the U.S. slips into recession, this can mean trouble for ANF and other retail brands.