Why This Apparel Company Is Still a Great Investment

The apparel industry has been struggling a lot of late, but there are still a few enticing opportunities.

Marshall Hargrave
Marshall Hargrave
Apr 29, 2014 at 7:03AM
Consumer Goods

Gap (NYSE:GPS) continues to be an impressive apparel retailer, one that investors should take note of -- especially since shares are still flat year to date. The very cold winter has forced February and March same-store sales growth into negative territory. But given its potential growth opportunities, this could be a great chance to buy.

There are still plenty of growth opportunities available
Something investors should be excited about is online growth. Gap is turning to omnichannel sales to capture market share. Although Gap's annual revenue of $16 billion is more than impressive, there's still plenty of the apparel market to be captured. The global apparel market is worth more than $1.4 trillion.

Gap is also making China a bigger part of its future growth story. It'll be diffusing its Old Navy brand in China over the coming years (it currently only has one Old Navy store in China). This, and store growth of its Gap brand, should help China account for more than $1 billion of its sales in less than three years. All of Asia currently only comprises slightly more than $1 billion in Gap's annual revenue.

Gap is a growth story in an industry filled with turnarounds
Gap continues to win on a number of fronts. This includes being able to compete with lululemon athletica with its Athleta brand, with Guess? (NYSE:GES) thanks to its strong jean offering, and the various teen retailers, such as Abercrombie & Fitch (NYSE:ANF) and Aeropostale.

The problem with Abercrombie & Fitch is that its customer base is largely teens. And teens are fickle, especially when teen unemployment remains above decade highs. But one of the biggest issues for Abercrombie & Fitch has been the rise of fast-fashion retailers, such as Forever 21. However, a big positive for Abercrombie & Fitch investors is that the company is looking to tap into the fast-fashion market. There's talk that the company could be looking to turn its Hollister brand into a fast-fashion brand.

Thus, Abercrombie & Fitch could be the best investment among the teen retailers. It trades at a mere 13 P/E based on next year's earnings estimates. Something else you wouldn't expect from Abercrombie & Fitch is a 2.2% dividend yield. Its yield has been pushed up to attractive levels after the stock price has fallen by more than 20% within the past year.

Europe remains a tough operating environment
Guess? is still a dominant force in the jean market, but its shares have largely underperformed due to a weak January-ended quarter; shares are down more than 12% year to date. For the fiscal fourth quarter, Guess? managed to post earnings of $0.83 a share, which is well below the $0.95 for the same quarter last year.

However, it's worth noting that Guess? is heavily levered to Europe--it generates more than 35% of its revenue from Europe. Compare that to the 5% of revenue (as a percentage of total revenue) that Gap gets from Europe. And Europe has been a tough place to invest over the last couple years. Any rebound in the European economy over the next few years will be a big positive for Guess?. In addition, Guess? is looking to tap some newer, faster-growing markets, including Russia and Brazil.

Why Gap is the best bet
Gap continues to be one of the best investments from a valuation standpoint, trading at a 14 P/E. Meanwhile, Guess? trades at a P/E of 15, Abercrombie & Fitch at a 54 P/E, Urban Outfitters is at 19, and American Eagle's is 26. Don't forget that Gap pays a 2%-plus dividend yield. Gap also remains one of the largest and most geographically diverse apparel retailers on the market.

Its current P/E is slightly below its 10-year average of 15. However, its return on investment is at decade highs, coming in at 28%, which suggests that Gap should be trading at a higher valuation.

Bottom line
Gap is still one of the largest apparel retailers around. This is a big positive in an industry that's fairly fragmented. The other key to Gap is that it has three strong brands (Old Navy, Gap, and Banana Republic) that allow it to compete with nearly every fashion retailer. Its focus on China and e-commerce helps make the company a growth story. For investors who need a retailer in their portfolio, it's hard to go wrong with Gap.