Investing in apparel stocks is much tougher than simply buying shares of your favorite retailer. The retail apparel sector is shaped by plunging price expectations, fickle consumer tastes, the rise of e-commerce, and currency fluctuations. Let's discuss where these trends are headed, and which stocks investors should watch to gauge the industry's health.
Source: YCharts .
Gap traditionally fared better than A&F and Aeropostale because it used a tiered pricing strategy -- Old Navy was its low-end play, its namesake stores catered to mid-range consumers, and Banana Republic was its premium play. As a result, Old Navy sales would generally rise during economic slowdowns, while Banana Republic benefited from increasing disposable income.
To shore up its defenses against "cheap chic" players such as H&M and Forever 21, Gap hired former H&M designer Rebekka Bay in late 2012 to launch new styles. But Gap disapproved of Bay's minimalist styles and fired her earlier this year. The entire effort was fairly futile, since Gap continued to lose customers to those low-end rivals.
Last quarter, Gap reported a 10% year over year drop in same-store sales and an 8% decline in earnings. Old Navy was the only business segment to report positive comp growth, reflecting declining price expectations across the market. Shortly afterward, Gap announced that it would close 175 of its 675 Gap stores in North America.
E-commerce and currency impacts
Gap shuttered those stores to increase its focus on online sales, which haven't been hit as hard as its companywide comps. Last quarter, Gap's online sales declined 2% annually and accounted for 43% of its top line. This shift toward e-commerce is occurring across the retail apparel sector: According to eMarketer, online sales of apparel and accessories in the U.S. will likely surge from $52 billion in 2014 to $86 billion in 2018.
In addition to nurturing e-commerce growth, apparel retailers must be wary of a strong dollar. For retailers with international operations, s ales generated by foreign stores now aren't worth as much when translated back into dollars. That's bad news for companies such as Gap and Abercrombie & Fitch, which are expanding into Asia and other growing markets.
Finding the green shoots
Faced with all those challenges, investors might be discouraged from investing in apparel stocks altogether. However, there are a few solid stocks in this sector which shouldn't be ignored. I would recommend that investors keep an eye on (but not necessarily buy) Urban Outfitters .
Urban Outfitters' dresses. Source: Urban Outfitters.
Urban Outfitters, which also owns Anthropologie and Free People, has carved out three defined niches in the market. Its namesake stores sell kitschy, ironic, and humorous apparel. Anthropologie is a trendier female brand that also sells gifts and beauty products, while Free People sells apparel aimed at younger female shoppers. Last quarter, Urban posted 5% comp growth, Anthropologie logged 1% growth, and Free People reported a 17% gain.
The downside is that gross margin came in at just 33.3%, down from 34.8% a year earlier, causing net income to slip 12.5%. The company certainly isn't immune to the pricing pressures weighing down the sector, but at least it's keeping its comps positive.
Takeaway time
Looking ahead, Moody's expects a few positive catalysts to get apparel stocks back on track. Declining cotton prices and ramped-up online operations are expected to lift some retailers' bottom lines. However, investors should be aware that the "cheap chic" effect and a strong dollar could nullify those benefits, so do your due diligence before investing in the retail apparel sector.
Ready to learn more about investing?
The Motley Fool's mission is to help the world invest, better. We have done this over the past 20 years by thinking long term and outside the box -- even if that means turning Wall Street on its head. To learn more about what The Motley Fool thinks about current investment trends, and receive a special free report about what might be the next big industry to come out of Silicon Valley, just click here now .
The article Stocks To Watch in Apparel: Abercrombie & Fitch Co., Gap Inc., and More originally appeared on Fool.com.
Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Urban Outfitters. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .
Copyright © 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy .
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
