Here's a little secret about me: I'm cheap. Very cheap. Friends giggle about it. Family members make jokes to my face about it. I'm OK with this, because I have another secret: I like shopping. The thrill of hunting down a bargain is a pretty powerful feeling, whether it is a stock, a piece of electronics, or even clothing. So when I find myself in the mall with my wife, and I don't have much of a choice, anyway, it's better to get along and see what I can learn while I'm there.
Bargain hunting skills come in very handy when hunting for investments. Right now I feel the world of retail is offering up some special discount opportunities, and I've pulled out three of my favorites. Yes, some of these companies have not had impressive same-store sales ("comps") in the first quarter, but they are strong brands with a history of growth, solid balance sheets, and quality management. When all of these traits travel together, it makes sense to pay attention to reasonably priced companies, regardless of the performance of the past few months.
Hit one into the gap
We'll start with the company that appears to be the most clear-cut value at today's prices. After wrestling with debt payments brought on by an overzealous expansion at the end of the '90s and into 2000, this company has really pulled itself together. The interesting thing is that the market isn't giving the company a good deal of credit for getting its fiscal house in order, because sales have been flat.
The company that has me so intrigued is none other than Motley Fool Stock Advisor pick Gap (NYSE:GPS). While pessimistic folks may point to Gap's mediocre sales performance of late and say that Gap's time has passed, I don't buy it. It's still a great place to go for basics -- and the company also has the Banana Republic and Old Navy brands under its canopy. Besides, it's the recent lukewarm performance that causes the market to discount the shares of this well-known collection of brands.
More important is the fact that after years of wrestling with the debt monkey, Gap now sits on close to $1 billion more in unrestricted cash than long-term debt, and it uses free cash flow to return more value to shareholders via net-share repurchases and a recent dividend increase.
A limited risk?
Our next retailer on sale is the Limited (NYSE:LTD). Before we go any further, I need to note that the chairman's letter to shareholders is very easy on the eyes. OK, back to more serious stuff. After a year that saw large share repurchases and a special dividend on top of regular dividends, Limited saw sales flatten out. Hence, our opportunity to pick up a company that churns out brands at what appears to be a reasonable price.
Let's be up front about the Limited of today. It's primarily the lingerie and health and beauty lines -- Victoria's Secret and Bath and Body Works, respectively -- that drive the company. The namesake Limited brand has not been performing well, nor has its sister line Express. The company is taking steps to get the entire business firing on all cylinders, but the jury is still out on whether it can turn things around by introducing new products in apparel and breaking the business into separately managed units.
That said, the lingerie and the health and beauty lines are experiencing very healthy growth, so much so that they have made up for the falloff in the apparel business over the past few years. As a guy who routinely has to stop at both stores anytime he is in the mall, I understand very well the pull that Bath and Body Works and Victoria's Secret have. Based on a couple of new-store formats and product lines that the company has tested in both of these divisions, it looks like there is plenty of room in the future for growth.
A small retailer that delivers
Kenneth Cole Productions (NYSE:KCP) is the smallest retailer on my bargain rack, but I happen to believe it is also the retailer with the most interesting long-term prospects, mainly because the firm is still quite small and expanding out of shoes and further into apparel.
The shoe business is extremely competitive, but Kenneth Cole has managed to cut out its niche by designing its shoes in-house and outsourcing the production. This helps limit the investment in fixed assets and fixed costs, but by controlling design and increasingly distribution, Kenneth Cole has maintained control over its brand. Sales are made via company owned stores or via large department store retailers such as Federated (NYSE:FD).
As an interesting side note on the Kenneth Cole brand, the company has found that sales at department stores improve when a company owned store is opened in the same vicinity. Normally the opposite is true, a company owned store would cannibalize sales from other stores. However, it seems that the company owned store has the effect of improving brand recognition and driving sales across the board.
Final thoughts.
As a group these three retailers are pretty diverse, but they do share a few things in common: strong brands, return on equity over 15%, and double-digit return on assets, to name a few. All three also pay dividends. On the valuation front, I ran a low and high estimated-discounted-cash-flow analysis on each company using the Inside Value DCF calculator. Overall, Gap came out as the best bargain of the three, but I think at today's prices, investors will do well by picking any two, and then sitting back and watching the fashion seasons change.
For more Foolish reading on the retail biz, check out these links:
- Think Like a Woman
- Snap the Gap Trap
- Credibility Gap
- Sock Away Some Kenneth Cole?
- A Showing of Limited Appeal
Interested in learning about more bargains out in the market? Each month Motley Fool Inside Value Analyst Philip Durell highlights two promising bargains. Want to see what he has on deck? Click here for a risk-free, 30-day trial to the newsletter. Or, for a limited time, take advantage of a 25% discount to our regular price.
Fool contributor Nathan Parmelee has no financial interest in any of the companies mentioned. The Fool has a disclosure policy.
