What Makes Gap a Solid Pick in Apparel Retail?

Gap has outperformed American Eagle and Urban Outfitters, and the trend looks set to continue. Here's why.

Mar 27, 2014 at 1:56PM

Apparel retailer Gap (NYSE:GPS) recently announced its fourth-quarter financial results and the company achieved double-digit growth in earnings per share once again. Drivers included sales gains in January, growth across different brands, and e-commerce.  Also, Gap's cost-cutting initiatives further helped the company post earnings growth at a time when many apparel retailers struggled due to severe weather conditions in the U.S. For example, both American Eagle (NYSE:AEO) and Urban Outfitters (NASDAQ:URBN) were hurt by the cold weather, but Gap sailed through.

A better relative performance
Analysts expected Gap to earn $0.66 per share so it beat expectations with a result of $0.68 per share. However, revenue came in below the consensus estimate of $4.6 billion as Gap reported revenue of $4.58 billion in the fourth quarter. The revenue drop occurred because of foreign exchange headwinds and heavy discounting in the festive season.

The company has opened 500 stores globally so far and this was another reason behind the solid performance. Gap has been opening new stores globally while it integrates its physical and digital segments. In addition, Gap will invest in marketing initiatives to increase global awareness for its brands as well as omni-channel growth. 

Gap gained market share in North America because of its flexible growth model. Its business has also moved toward digital operations. Gap's business model has helped the company reduce costs and enhance its efficiency and productivity. The company posted remarkable results, considering that other established North American apparel retailers such as Urban Outfitters and American Eagle struggled.

American Eagle recently reported its fourth-quarter results, and the cold winter hurt the company. In addition, American Eagle faces pressure from fast fashion brands such as H&M and Forever 21. These factors led American Eagle to reduce its outlook for the current year. Even though American Eagle has been working to bring new and exciting products to consumers and improving its customer engagement, I think investors would be better off investing in Gap as it offers better prospects and solidity.

Similarly, Urban Outfitters struggled in the previous quarter as young customers explored other options. Revenue from Urban Outfitters' namesake brand, which makes up its largest source of revenue, dropped 9% in the fourth quarter. While Urban Outfitters' revenue received help from its other two brands -- Anthropologie and Free People -- the company expects weakness in the flagship brand to weigh on its results. Gap's huge number of stores and wide product assortment enable the company to distribute its risks effectively.

Growth strategies
Gap has about 3,600 stores, including franchises. The company has also made significant digital investments. Gap has launched reserve-in-store and find-in-store initiatives. These two elements help customers find products they like and pick them up from nearby Gap stores.

On the international front, Gap has done pretty well. Gap has made aggressive moves in China. Recently, the company opened more than 30 stores in the country and expanded its presence to 21 cities. Gap sees strong opportunity in China as 50 cities in the nation each have a population of more than 5 million. Gap has also made investments to improve long-term brand awareness in the Chinese market through marketing moves.

The company has also invested heavily in promotional activities to create market and brand awareness in the country. Gap also has approximately 20 stores in Japan, and it has grown the Athleta brand by opening 30 stores globally. With the structure and processes for the international business built, Gap has made a smart move because sooner or later these stores will start to contribute to its top and bottom lines.

Gap is focusing on four global strategic priorities. First, the company wants to recreate everything that it has done domestically on an international level. Gap looks forward to opening specialty stores and outlet stores abroad. Second, the company targets an omni-channel presence through its reserve-in-store and find-in-store initiatives. Third, Gap plans to create a better image and offer faster processing times online through all devices.

Bottom line
Gap looks like a better investment than its peers as the company has consistently performed well. The strategic priorities will help Gap capture market share and create brand awareness globally. Moreover, the company appears cheap relative to its growth. At a trailing P/E of 15.3, a forward P/E of 12.6, and with an expected earnings compound annual growth rate for the next five years of 13%, Gap looks like a good investment. In addition, Gap also pays a handsome dividend with a yield of 2.10%. Gap looks like a solid investment from all angles.

 

Meetu Anand has no position in any stocks mentioned. The Motley Fool recommends Urban Outfitters. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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