On June 26, clothing retailer Gap (GPS +0.31%) announced a collaboration with famed musician Kanye West. The deal creates an apparel line under West's popular Yeezy brand.
This sparked an interesting reaction from the investing world. Robinhood is a popular investing app. According to information from Robintrack, Robinhood users holding Gap stock increased tenfold in the days following the Yeezy announcement. Clearly, these investors are betting big on Gap's future growth prospects.
However, I believe investors are picking the wrong company. If you're looking for an investment in apparel retail, Stitch Fix (SFIX 0.97%) is the better growth stock.
Image source: Getty Images.
The good and bad for Gap
Keeping up with fashion trends is a constant challenge. However, West is an influential person married into the trendy Kardashian family. With the Yeezy deal, maybe Gap can set fashion trends instead of chasing them. That's certainly worth something.
But how valuable is it really? Let's assume revenue for Yeezy Gap grows without detracting from the rest of Gap's business over the next five years. According to The New York Times, Gap hopes Yeezy Gap will generate $1 billion in annual sales by then. The company had $16.4 billion in sales in fiscal 2019 across its portfolio of brands. Therefore, Yeezy Gap will add about 6% to the company's top line in five years, if everything goes according to plan.
Even 6% growth would be refreshing for Gap shareholders. The company has struggled with growth over the past decade as the chart shows.
Data by YCharts.
However, Gap is facing headwinds, and the Yeezy deal doesn't address any of them. The COVID-19 pandemic is profoundly impacting the retailer with all company-owned stores forced to close, leading to a 43% drop in first-quarter sales.
To its credit, Gap already does well online. It had $4 billion in annual e-commerce sales prior to the pandemic, and its online operations have surged during the outbreak -- up over 100% year over year in May. There's only one problem: Gap wasn't built to be an entirely e-commerce business. It still employs thousands of people at thousands of brick-and-mortar locations, and both cost the company money.
Moreover, Gap's inventory will be an ongoing issue. In the fiscal first quarter, it took a $235 million impairment charge on inventory. Other items are being stored until next year to keep them out of what management calls a "highly promotional environment." But overall inventory will only be down modestly for the rest of 2020. If the pandemic causes additional rounds of store closures, it'll only get harder to move merchandise.
Image source: Stitch Fix.
Stitch Fix is built for this moment
Ont the other hand, Stitch Fix is an e-commerce company. Its digital model mitigates the pandemic's impact. Revenue was down 9% year over year in the fiscal third quarter, but consider its timing. The quarter ended May 2, putting the worst weeks for retail in the middle of the period. For perspective, clothing retail overall was down 87% year over year in April, according to the U.S. Census Bureau. The company's single-digit decline looks pretty good in that context.
The company had to close its physical distribution centers, resulting in an inability to fulfill orders. But the demand was there as Stitch Fix's active clients grew 9.1% year over year, and net revenue per active client was up 6.5%. In other words, even in a pandemic, Stitch Fix increased adoption of its model.
On top of that, the company's commitment to data prevents inventory problems like Gap's. It primarily ships five-item "fixes" to clients largely based on what the data says the customer will want. As items are kept or returned, the predictive algorithms improve. This insight allows Stitch Fix to clear out inventory quickly and avoid profit-killing discounts later.
Stitch Fix's auto-ship service also helps with inventory management. Most clients automatically receive shipments on a schedule. Therefore, the company knows exactly when it needs to have items in stock. No brick-and-mortar retailer can say this.
Not without risk
Stitch Fix is a top clothing retail growth stock, but there are still risks. Specifically, the COVID-19 pandemic caused the company to rethink its real estate footprint, even though it's relatively small. It's reportedly laying off 1,400 stylists in high-priced California and opening styling hubs around the country in cheaper spaces.
Stitch Fix is set to hire 2,000 stylists to fill these spaces. That's a net increase in employees, suggesting the company anticipates continued growth. However, that's a lot of new faces, and the transition might not be smooth. Furthermore, the change could result in one-time charges, which won't look good on quarterly results.
While I believe in Stitch Fix's long-term growth opportunity, results might be messy in the short term.
