Express Dives Into the Business of Outlet Stores

In a move that reflects a major shift from its traditional business model, Express (EXPR) has recently announced that it will open the first of many factory outlet stores. The first store, which will open at the Tanger Outlets National Harbor in Washington, D.C., will be just one of thirty Express outlet stores the company expects to open throughout the year. Given that the move represents a big change from its long-established business of selling full-priced fashionable clothing and accessory items, what are the implications for investors in the company? 

Impacting the brand
One of the first rules of fashion is to always have a new product for your customers to desire. Express has always excelled at this as it regularly rolls out new lines of clothing every season. While the company often does run coupon-based promotions from time to time with the occasional sale, the extent of the discounts it makes available to customers largely remain controlled for its highly desirable products.

By opening a factory outlet store, the company is departing from its traditional business model by selling slightly dated products at factory-discount prices, all under the "Express Factory Outlet" banner. According to its website, Express plans on opening 30 more factory-outlet stores across the country throughout the year. While the move may very well increase its overall sales, it is possible that the move will begin to take sales away from its traditional stores. In order to get a glimpse into what might happen, we need to look at what has happened to competitors that have also made the move toward opening factory-outlet stores.

Competitor outlet stores
The first of Express' competitors that has operated outlet stores is The Gap (GPS -2.76%), particularly through its Gap and Banana Republic brand stores. Both brands have a number of outlet stores nationwide and have seen decent results. While the company doesn't provide financial results for its outlet-store division, we can get a sense of how its brands are performing. According to the company's latest 10-K Annual Filing:

As we transitioned to a global brand structure to drive long-term global growth, we opened 190 Company-operated stores, primarily through expansion in Asia, growth of our global outlets, and Athleta stores in the United States. Specifically, we expanded our Gap store base in China, opening 34 stores for a total of 81 specialty and outlet stores, and opened an additional 17 Old Navy stores in Japan for a total of 18 stores. We opened 58 global outlets for a total of 532 outlet stores. We also opened 30 Athleta stores, ending fiscal 2013 with 65 Athleta stores. Our franchisees added 72 new stores and five new markets.

Clearly the opening of outlet stores is a major part of The Gap's growth strategy in the years ahead in addition to international growth. This makes sense given the company's presence throughout the U.S.

Even more useful in assessing Express' move into the outlet-store market is the recent performance of H&M. H&M's entire business model revolves around an outlet-store model of sorts with a majority of its store products usually priced much lower than competitor Express' products. This business strategy has yielded strong results for H&M. In fact, the company has grown to just under 3,000 H&M brand stores at the end of fiscal 2013.

H&M's comparable-store sales were unchanged for the year, which is impressive given that the company opened 356 new units, an increase of more than 10% for the year. This is all the more impressive given that Express saw a 1% same-store sales decline in fiscal 2013 and a 3% sales decline in fiscal 2012, when e-commerce sales were excluded from the results. 

Express' move to open outlet stores makes even more sense considering the fact that its major competitors in the discount-fashion space, TJX (TJX -1.52%) and Ross (ROST -1.72%), continue to grow their profits and comparable-store sales by leaps and bounds. Both companies excel at selling fashionable clothes at highly discounted prices, months after they originally hit the market. The results of these companies have been excellent in recent years.

Clearly the results of TJX and Ross give Express good reason to get into the outlet-store business. It is unfortunate that the company didn't make the move sooner.

Foolish takeaway
Express has a strong incentive to start selling under the outlet store business model. Fantastic results from TJX and Ross, plus the fact that its competitors at The Gap and H&M are making the same move, show that Express needs to at least have a presence as an outlet-store retailer. It will need to do so in a way that does not harm its traditional stores, however, since that is and will remain its major business for many years in the future. Foolish investors should keep an eye on any changes in Express' store sales as its outlet stores open their doors for business.