The advent of videoconferencing this year due to the coronavirus pandemic has led to "business up top but party below" becoming an official fashion trend, but it's also a trend that spells disaster for many apparel companies. According to the U.S. Census Bureau, clothing and apparel retail sales are down 35% and department store sales are down 19% in 2020 compared to 2019.
But not all apparel companies are facing an existential threat due to COVID-19. Three that are worth buying right now are Skechers (SKX 4.46%), lululemon athletica (LULU 4.68%), and Target (TGT 0.42%).
1. Skechers: A scrappy shoe company for a long-term value
Skechers has been a serious test of investor patience over the years. The small shoemaker's stock has given investors a volatile ride as spending on overseas expansion has moved in fits and starts and created highly variable profitability. However, what many have missed is the resulting global style powerhouse that has emerged as a result of the company's efforts over the years.
Some 60% of Skechers sales come from outside the U.S., and the company reported that many of these markets have returned to year-over-year breakeven or (in the case of China) year-over-year growth as of July. The company's direct-to-consumer e-commerce business also increased over 400% during the second quarter of 2020, going a long way toward offsetting the temporary closure of all of its stores during the spring months. As was the case with many apparel companies, Q2 was ugly for Skechers, with an overall drop in sales of 42%, but all signs are pointing toward a very quick recovery for this shoe company.
Also promising is that, despite the massive disruption COVID-19 has been, Skechers still had positive free cash flow (revenue less cash operating and capital expenses, and excluding non-cash expenses like depreciation) through the first half of 2020. The total sum was a meager $26 million through the end of June, but it nevertheless underscores the strength of the business, as it is able to still operate in the black during times of crisis.
Skechers trades for 50 times trailing 12-month free cash flow (or 34 times trailing 12-month earnings per share), valuation metrics that are skewed because of financial results during the pandemic. However, a price-to-book value of just 2.2 -- significantly lower than those of its rivals in the shoe business -- and a positive return on invested capital over the long term make this stock look like a real value right now.
2. Lululemon: From yoga pants to everyday clothing essentials
Lululemon also experienced a big drop in activity during the first half of the year. Sales are down 7% to $1.55 billion through the first half of the company's 2020 fiscal year, a big fall from the 21% pace of growth notched in 2019. However, while the picture isn't pretty at the moment, Lululemon's declines are much less than those of its peers -- implying it continues to quickly gobble up market share.
These days, Lululemon has leveraged its early success making athletic wear for women into a full-fledged line of athletic-inspired clothing and accessories for everyone. More than that, though, the company started betting heavily on e-commerce years ago, a prescient decision considering the current world situation. As a result, digital sales grew 155% in Q2, compounding the impressive pre-crisis era 41% rate reported in the final quarter of 2019. This isn't just a high-end athletic line, this is a clothier built for a new digital era.
Of course, such strong positioning in an industry obliterated by the pandemic isn't going to come cheap. Lululemon stock is valued at over 100 times 12-month free cash flow (and nearly 90 times earnings). This sky-high valuation implies expectations this company will return to growth before too long and will remain in expansion mode for the foreseeable future. Such expectations already priced in may not sit well with all investors, so Stitch Fix (SFIX 5.76%) is worth mentioning for those looking for a growing online clothing retailer trading for a relative value.
Nevertheless, Lululemon is a story worth considering. Consumers of all kinds are flocking to the brand, and even in a rough year, the company remains highly profitable, with an adjusted operating profit margin of 15% in Q2. Paired with a balance sheet that has $523 million in cash and equivalents and zero debt, this stock looks like a buy for the long-haul.
3. Target: A top-notch apparel stock masquerading as a big-box store
If Skechers is a bet on rebounding global shoe sales and Lululemon a play on the enduring popularity of athletic-inspired clothing, Target is an investment in apparel and accessory basics at a reasonable price point. While the retailer has primarily received attention this year because of its booming digital commerce business, Target is much more than your typical big-box store.
The key to its success has been management's decision a few years ago to increase its in-house brands. Specifically, Target's apparel and accessories for adults, kids, and babies have been in growth mode this year -- bucking industry trends and hastening the decline of department stores. Some categories grew by double-digit percentages compared to a year ago in Q2. Besides changing styles favoring the likes of Lululemon and other athletic brands, consumers demand convenience. And Target's household basics, paired with an assortment of clothing, make it an ideal one-stop-shop in a highly competitive retail environment.
Granted, the 25% year-over-year rate of growth to $23 billion in revenue reported in Q2 isn't going to last forever. As the effects of the pandemic wear off, Target will likely return to single-digit-percentage growth per year. However, with the department store and shopping mall model struggling to rekindle upward momentum, Target looks to me to have the most to gain in the years ahead. Thus, shares trading for 13.2 times 12-month free cash flow (23.9 times earnings) looks like a reasonable price tag. Throw in a stable dividend currently yielding 1.7% and this looks like a solid investment in the future of clothing and apparel set to benefit from growth in e-commerce and consolidation in the industry overall.