Apparel brands are increasing their investments in company-owned retail, new product lines, e-commerce and international expansion. The S&P Apparel, Accessories & Luxury Goods Index advanced 23.4% year to date. So let's take a look at two companies in the apparel sector and see which one is doing better and thus stands as the best investment.
Abercrombie & Fitch Co. (NYSE:ANF) specializes in lifestyle branding and operates over 1,000 retail apparel stores across four brands. This apparel retailer focuses on improving sales via new brands, store expansion, comparable store sales increases and e-commerce. A company key driver is the ability to develop and grow casual luxury youth apparel/lifestyle brands in a difficult retail environment where the firm has little protection to its position. However, unemployment rates for teenagers are a factor to consider when assessing the business.
Abercrombie reports its sales under 2 segments: U.S. Stores and International Stores. The first segment contributed with approximately 70% to the company´s total revenue in Q2 2013. The International Stores segment, which includes operations in Canada, Europe and Asia, contributed with nearly 30% to the total revenue during the same quarter. Consequently, the company is pursuing international growth opportunities in those markets. The firm plans to open Abercrombie & Fitch flagship locations in Seoul and Shanghai, about 20 international Hollister stores, and also international outlet stores in the near future. Additionally, it is expected the close down of 40/50 U.S. stores and will be implementing a cost-cutting program in order to improve margins. This program is part of a strategic evaluation but it will take a year to implement it.
In terms of valuation, the stock sells at a trailing P/E of 12.9 x, trading at a discount compared to an average of 18.48 x for the industry. Analysts’ expectations imply a forward P/E of 11.61 x.
The Gap, Inc. (NYSE:GPS) is a leading apparel specialty retailer that sells casual apparel for men, women, and children under the Gap, Old Navy, Banana Republic, Piperlime, and Athleta brands. With a very broad spectrum of consumers, the company becomes the largest specialty apparel retailer in the U.S.
Net balance: Open
The company plans to reduce its dependency on North America and expects to open 160 stores (35 stores in China and 20 in Japan, for example). The firm also expects its franchise partners to open 75 Gap and Banana Republic stores in fiscal year 2014. Finally, the firm plans a reduction in weak-performing stores, approximately 80 stores in North America.
In order to improve productivity, the firm has transitioned to a new global brand structure where it has combined all the channels (specialty, outlet, online and franchise) and geographies under one global leader each for Gap, Banana Republic and Old Navy, establishing a clear message to drive its long-term growth.
Looking at the financials, the company has a strong balance sheet as well as good cash, which allow the company to pay out dividends to current shareholders. Dividend payments of $140 million during the first two quarters demonstrate this fact. In addition, Gap announced the increase of its dividend to $0.80 per share (from $0.60).
In terms of valuation, the next table shows two of the most used multiples:
|Company||Trailing P/E||Compared to Industry P/E Mean (=18.48)||Forward P/E|
Finally, I always like to see of one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: The return on equity.
|Company||ROE||Compared to Industry Mean (=9.1)|
Gap´s high ROE, compared to industry peers, is a great sign of operational efficiency. It is very important to understand this metric before investing in a high-growing company.
Amid the weak macroeconomic conditions in the international markets, the intense competition in the industry and unemployment rates higher than historical averages, I see in Gap a buying opportunity. Not so in the case of Abercrombie, where I see risks regarding the international focus where weak European spending could slow down profit potential.
In my point of view, the strong brand, strategic expansion, and healthy balance sheet (that generates strong free cash flow and allows it to grow earnings per share through large stock repurchases and consistently raise its dividends), makes of Gap the most attractive choice.
Hedge fund gurus like Ken Hebneer, Joel Greenblatt and Steven Cohen added Gap´s stock to their portfolios, and I would advice fundamental investors to consider adding it to theirs, too.
Disclosure: Victor Selva holds no position in any stocks mentioned.