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Two Globally Expanding Apparel Manufacturers
Posted by: Patricio Kehoe (IP Logged)
Date: October 9, 2013 11:16AM

A look at specialty retail giants Gap Inc. (GPS) and Guess? Inc. (GES) will depict the importance of global expansion in the apparel industry. However, what sets these two firms apart is another issue. Specifically, the advantages of early global expansion might be coming to an end for Guess. And a new merchandising strategy, coupled with increasing international sales, can be the key for Gap’s future success.

Improved Merchandising Strategy

The specialty retailer Gap sells affordable apparel for a very broad audience at its more than 3,000 corporate-owned stores. Despite its long history as a specialty retail store, the firm is currently undergoing a reinvention directed at increasing sales. The company has already put a new merchandising strategy in place, which enhanced performance, and is seeking to expand globally in order to capitalize on its recent success.

Faced with increased competition from new retail chains, Gap has been able to correct its merchandising mishaps and see sales rise. Last quarter, the company saw an 8% jump in sales, and 40.5% increment in gross profit margins. A reduction in poorly-performing stores and a revamped merchandising strategy, which resonated with customers, resulted in a drastic improvement in productivity and profits. The new merchandise is now expected to increase sales globally, as expansion at both global locations and outlet channels will help the company optimize its operating margins. Additionally, e-commerce continues to represent a great opportunity, particularly overseas, where the firm has not yet achieve the degree of penetration it has in the U.S.

The new merchandising strategy and continued expansion abroad are paying off, and are expected to continue driving Gap’s revenue upwards. Jean-Marie Eveillard of First Eagle Investment Management recently added this stock to his portfolio, which is always a good sign. Also, the company is known to be a good allocator of shareholder capital, with annual dividend per share set to rise from $0.60 to $0.80 beginning next quarter. Gap is currently trading at 14.2 times its earnings, so it even comes at a price discount to the industry average. Due to the firm’s tremendous distribution and purchasing power and the bright outlook it faces, I feel bullish about this stock.

Early Expansion and Fashion Products

Guess was originally a denim jean design firm, but it has transformed into an apparel retailer with over 15,000 employees. The company, which proffers trendy merchandise to young and fashion-aware consumers, has been achieving double-digit annual increases in profits for over 10 years. Much of this success is due to a transition from a U.S.-based apparel manufacturer to a global enterprise. Today, international revenue makes up 50% of the firm’s sales. However, Joel Greenblatt recently sold a large portion of his share of Guess, raising questions regarding the retailer's future.

Unlike Gap, Guess’ success is not U.S. based, but rather stems from its global operations. The company expanded overseas early on, and has remained a priority ever since. The new round of overseas investments is set to target Central and Eastern Europe, Asia and Latin America. These markets have great growth potential and could rally Guess’ sales in the retail and wholesale channels. Yet the recovering U.S. market also offers possibilities, which the firm seeks to benefit from. In order to do so, the retailer seeks to expand its assortment mix and lower price points, thus creating a broader customer base.

A long growth trajectory such as the one Guess has enjoyed is hard to sustain over a long period of time. New competition in the global apparel market and high uncertainty in regards to the company’s ability to deliver fashionable products are two important risk factors.

Particularly worrying is the firm’s reliance on fashion-relevant offerings, since falling out of favor with customers has a huge impact on sales and profitability. Additionally, Greenblatt might have noticed that exposure to European macro uncertainties could frustrate Guess’ expansion plans. While currently trading at 15.2 times its trailing earnings, the stock is available at a price discount. Although Guess has interesting growth prospects, there are some unfavorable risk factors present that make me feel bearish about this stock.

Brand Recognition Remains, Fashion Trends Dissipate

Gap’s customers seem to be more forgiving towards the popular apparel retailer, and prefer to forgive the firm for previous merchandising missteps. A new strategy and emphasis on global expansion are bound to continue driving sales, while shareholders can benefit from prudent management and increasing dividends. Also, I think the speciality retailer is a better investment option than Guess, since it doesn’t rely so heavily on fashion-relevant offerings.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned.

Guru Discussed: Jean-Marie Eveillard: Current Portfolio, Stock Picks
Stocks Discussed: GPS, GES,
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