This Company Shows Why Diversification Is Important

This article features The Gap Inc, American Eagle Outfitters, and The Men's Wearhouse, Inc. The author has no positions in any of the stocks mentioned. The Motley Fool has no positions in any of the stocks mentioned.  

The recent results of the nation's largest mall-based clothing chain, Gap (NYSE: GPS  ) , contrasted sharply with the lackluster results posted by the heavyweights of the retail sector. The company operates through its diverse portfolio of brands like Gap, Banana Republic, Old Navy, Athleta, Piperlime and the newly acquired Intermix, providing apparel and accessories.

Robust results
The U.S. remains the country with the second-largest number of digital buyers, at 155.7 million this year. The retail landscape is undergoing a paradigm shift with the advent of e-commerce. As a result, Gap set out to build upon its online success by delivering an industry-leading omni-channel platform. These initiatives led to good growth in online sales during the second quarter.

The company reported that revenue from the online channel increased by around 27% from the same period a year ago to land at $466 million. During the quarter, Gap's online channel contributed about 12% to its total revenue.

The company reported that total revenue jumped 8.2% year over year to land at $3.9 billion. On the back of solid top line growth, earnings moved up 30.6% from the year-ago quarter to $0.64 per share.

One of the main advantages for Gap as compared to American Eagle Outfitters (NYSE: AEO  ) and The Men's Wearhouse (NYSE: MW  ) is that it caters to a wide customer base. This has kept Gap insulated against any changes in the behavior of a given age group so it has been able to perform better than its peers.

This, along with the initiatives that the company has been taking for improving its top line, has resulted in consistently positive comparable-store sales (comps) performance for the past four quarters. During the reported quarter, comps at Gap Global and Old Navy Global increased 6% each, while comps at Banana Republic Global dropped 1%.

Looking ahead
Going forward, the future of the company looks good. Over the next few years, the company will strengthen its online sales initiatives and also take the Old Navy brand to untapped markets.

It is introducing Old Navy in the Philippines as a part of its global expansion drive in order to gain market share in the $1.4 trillion global apparel retail industry. In all, four stores are slated to be operational in the Philippines by 2014.

Gap also has plans to launch Old Navy in China in 2014. In China, e-commerce is 6% of sales and is expected to grow in the future. More than three-quarters of online sales are in the apparel segment. In order to tap into this channel, Gap plans to launch an e-commerce site for China in the first half of 2014. Gap currently has more than 60 stores across 17 cities in China.

Gap is also planning to expand into Taiwan in 2014. The store will be located in Taipei and the company also plans to launch a dedicated e-commerce site for the market.

In fiscal 2013, the company intends to open 160 company-operated stores and close 80 existing stores. The company will be mainly focused on opening more Athleta, Gap China, Old Navy Japan, and global outlets. In fiscal 2013, the company expects net square footage to increase 1%.

Encouraged by an excellent quarterly performance, Gap raised its fiscal 2013 earnings guidance range from $2.52–$2.60 per share to $2.57–$2.65 per share.

Looking around
American Eagle Outfitters caters to the teen apparel sector so it is not as diversified as Gap in terms of the customers it serves. Any change in customer buying preferences can have a great impact on its operations. This is precisely what happened as American Eagle Outfitters lost favor with its target customers. Sales dropped 1.7%, comps declined 7%, and earnings declined 52.4% as compared to the year-ago quarter and the company expects a mid to high single-digit decline in comps going into the holiday season.

The reason behind this subdued performance isn't hard to find. As mentioned in a previous article, teens are spending money on electronic items. Hence, they look for cheaper options when it comes to clothing and the likes of Forever 21and H&M provide them just that, taking business away from American Eagle in the process.

The Men's Wearhouse is a men's only apparel retailer, so its problems are similar to American Eagle's problems. The company reported discouraging quarterly results recently and it also sees a weak quarter ahead. Sales dropped 2.3% and earnings fell 12.2% year-over-year as buyers are spending more money on big-ticket items. Going into the holiday season, it has reduced its expected comps growth by 2%.

Similar trends seem to be hurting Men's Wearhouse as well. Consumers seem to be spending their money on homes and cars to take advantage of the still-low interest rates and this has led to a drop in retail sales of late.

Conclusion
Gap has been through its own tough phase of declining comps and reduced profitability. However, on the back of excellent turnaround strategies, it is coming out of that phase as indicated by solid comps and sales performance in fiscal 2013 so far. In the long-term, it is reducing its dependency on the North American specialty business, while increasing its online presence and expanding its international operations. These moves make Gap a stock to watch out for.


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