Making Money From Vertically Integrated Apparel

Most investors and consumers know brands like The North Face, Calvin Klein or Tommy Hilfiger. These brands belong to either VF Corp (NYSE: VFC  ) or Phillips-Van Heusen (NYSE: PVH  ) . However, what many investors don't know is that these companies are vertically integrated, meaning that they also operate retail stores. Another major vertically-integrated apparel manufacturer is Polo Ralph Lauren (NYSE: RL  )

VF's key brands include Wrangler, Lee Jeans, Timberland, Nautica, Vans and The North Face.  Phillips-Van Heusen brands include Calvin Klein, Van Heusen, IZOD, Tommy Hilfiger and Speedo. As mentioned, most people don't realize it, but both VF and Phillips-Van Heusen not only manufacture clothing but also operate retail locations. VF has 1,100 retail stores, while Phillips-Van Heusen has 1,200. 

More specifically, VF has around 1,050 "mono" brand stores, with about half of those located in the U.S. As a result, it gets around 60% of revenue from the U.S. The company's direct-to-consumer channel (mono retail locations and e-commerce) makes up around 20% of revenue, but is expected to jump to around 25% by the end of 2017. In 2012, VF manufactured about 28% of its merchandise units. 

As far as performance, the weather, specifically a warm winter, has put a strain on VF's key businesses. Also, weakness in Europe continues to be an overhang for the company. The winter had a slightly bigger impact on VF, compared to some of the other apparel companies, given that its The North Face and Timberland brands are cold-weather focused. Yet these outdoor brands will play a key role in VF's strategy to gain more exposure to the active-wear market.. 

Acquisition won't be enough
Some of the biggest news of late in the apparel space includes Phillips-Van Heusen's purchase of Warnaco Group, bringing the Calvin Klein brand entirely under the Phillips-Van Heusen name. Warnaco had been licensing the jeanswear and underwear businesses of Calvin Klein.

However, one of the real beauties is that Phillips-Van Heusen is gaining impressive exposure to the fast-growing Asian and Latin American markets. However, I think the company is a bit over-reliant on its Tommy Hilfiger line. Tommy Hilfiger accounts for more than 50% of revenue. Tommy Hilfiger International accounted for around 30% of 2012 revenue and Tommy Hilfiger North America accounted for 23%.

The company also continues to see struggles in its Heritage Brand, with respect to sales. This is a negative, as the brand still accounts for 16% of total sales.

Investor's best bet
Ralph Lauren sells its apparel via 11,000 locations, including key deals with top department stores. Macy's is its top wholesale client, accounting for 27% of wholesale sales. Its other venues include nearly 380 specialty retail locations and 500 shop-in-a-shops. The company also has more than 100 Ralph Lauren stores and more than 200 factory stores.

What's more, Ralph Lauren plans to open 30 new retail stores during fiscal 2013, with a focus on international markets. The other reason I like Ralph Lauren is that it has a solid blend of revenue, with wholesale making up 45% of revenue and retail 52%.

Back in August, Ralph Lauren managed to post fiscal 1Q earnings per share below the same quarter last year, which came on the back of higher operating expenses, namely due to expansion costs and infrastructure buildout. But this has provided investors with a buying opportunity, as the stock is down some 20% over the last 45 days.

And over the longer term, Ralph Lauren has under-performed the major apparel peers.

VFC Chart

VFC Corp data by YCharts

But let's look at some key metrics. While Ralph Lauren has the highest days of inventory, it does enjoy the highest return on invested capital and has no debt.

 

Ralph Lauren

VF Corp

Phillips-Van Heusen

Return on invested capital

18.6%

15%

1.2%

Days of inventory

130 days

98 days

120 days

Debt to equity

n/a

28%

104%

I believe Ralph Lauren is offering investors the best value. The stock is trading at 16.5 times forward earnings, and it's only trading at a 10.3  enterprise value-to-earnings before interest, taxes, depreciation, and amortization multiple, which is well below the likes of VF at 13.1 and Phillips-Van Heusen at 12.2.

Bottom line
All in all, these three companies are interesting plays in the apparel industry. They give investors access to a slightly more diversified business model compared to conventional apparel retailers. Of the three, the best play is Ralph Lauren, as the company has one of the broadest reaches with 11,000 retail locations. And although it's sometimes considered a higher-end brand, the company should perform nicely on the back of a rebounding economy.

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