Apparel brands are increasing their focus on new product lines, e-commerce, investments in company-owned retail, as well as international expansion. In this article, let's take a look at one apparel retailer in a better consumer spending environment in most major markets.
Margin expansion
The Gap, Inc. (GPS, Financial) is one of the most popular brands in the U.S. apparel sub-industry. This specialty apparel retailer operates Gap, Banana Republic and Old Navy stores, offering casual clothing for the moderate, upscale and value-oriented markets.
We believe a margin expansion could happen due to the firm´s strategies and investments in seamless inventory, omni-channel and responsive supply chain development. Gap´s operating margin is ranked higher than 91% of the 1166 companies in the apparel stores industry and is at 12.93%. Perhaps next year we can start seeing the results.
Opening stores
The company plans to benefit from its international expansion strategy, reducing its dependency on North America and opening stores abroad. New markets in Asia offer a new audience and could help leverage operating expenses, which are also in plans to be reduced. In fiscal 2015, the retailer expects to open about 185 company-operated stores, focused on China, Navy Japan, Athleta and global outlet stores, while closing some others.
Dividend yield
The company will generate $6 billion in free cash flow over the next five years, and this will probably be returned to shareholders via dividends and share buybacks. The current dividend yield is 2.29% and it has paid dividends since 1976.
Revenues, margins and profitability
The retailer reported an increase in revenues by 2.92% that led earnings per share increased by 17.2% to $0.75 for the second quarter from $0.64 for the same quarter the previous year. During the past fiscal year, the company increased its bottom line. It earned $2.75 versus $2.32 in the previous year. This year, Wall Street expects an improvement in earnings ($2.76 versus $2.75).
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| GPS | The Gap | 39.98 |
| AEO | American Eagle Outfitters, Inc. | 3.86 |
| TJX | The TJX Companies, Inc. | 52.42 |
| Â | Industry Median | 8.84 |
The company has a current ratio of 39.98% which is higher than the one exhibit by American Eagle Outfitters (AEO, Financial). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment, so the ROE of The Gap, Inc. (GPS, Financial) looks very attractive. For investors looking for a higher ratio, The TJX Companies Inc. (TJX, Financial) could be the option. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 13.8x, trading at a discount compared to an average of 22.4x for the industry. To use another metric, its price-to-book ratio of 5.62x indicates a premium versus the industry average of 1.98x while the price-to-sales ratio of 1.05x is above the industry average of 0.79x. Two metrics indicate that the stock is relatively undervalued and seems to be an attractive investment relative to its peers.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $17.168, which represents a 11.4% compound annual growth rate (CAGR).
The company has demonstrated a pattern of positive earnings per share growth over the past two years.
Final comment
Gap is one of theworld's largest apparel retailers and offers its products to a wide range of people of any age. It faces a strong competition that affects its revenue growth. One important competitor is Inditex, which is one of the largest fashion retail groups in the world with eight brands and more than 6,300 stores in 87 markets. However I continue to feel confident in my bullish sentiment. Moreover, the relative valuation and the return on equity that significantly exceeds the industry median look very attractive for investors.
Hedge fund gurus James Barrow (Trades, Portfolio), Ray Dalio (Trades, Portfolio) and Chuck Royce (Trades, Portfolio) added this stock to his portfolio company in the second quarter of 2014, and I would advise fundamental investors to consider adding this stock to theirs as well.
Disclosure: Omar Venerio holds no position in any stocks mentioned.
