After a fairly good start for the new year, the apparel business has sagged a bit in the last month or two, reports Marie Driscoll, the Standard & Poor's consumer-sector analyst who follows apparel makers and retailers.
Portions of the industry, however, are still faring better than the S&P composite index (off 3.3% year to date) and the consumer discretionary sector as a whole (down 8.8% so far). Apparel retailers are up 1% year to date, with apparel accessories and luxury goods off 4.2% and footwear down 9.5%.
GAP AND NIKE.
Driscoll views consolidation as a major factor influencing the industry. As for fashion trends, she sees "express yourself and create your own look" as the consumer's driving force. Marketing skill remains crucial, and she brands Chico's FAS stock (CHS ) as a buy because of its success at drawing repeat customers.
Among the other stocks Driscoll ranks as buys are Abercrombie & Fitch (ANF ), American Eagle Outfitters (AEOS ), Aeropostale (ARO ), Gap (GPS ), Coach (COH ), Liz Claiborne (LIZ ), Nike (NKE ), and Reebok (RBK ). Coach has had particularly notable success in dominating a broad swath of the luxury market for accessories.
These were a few of the points made by Driscoll in an investing chat presented May 10 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from Jack Dierdorff of BW Online. Edited excerpts from this chat follow. AOL subscribers can find a full transcript at keyword: BW Talk.
(Marie Driscoll is an S&P Equity Research analyst. She has no ownership interest in or affiliation with any of the companies under discussion in this chat. All of the views expressed in this chat accurately reflect the analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARS-ranked companies, go to spsecurities.com and click on "Investment Research" and then on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts.")
Q: Marie, how has this volatile and essentially flat market been treating consumer stocks, especially those you cover?
A:I cover specialty apparel retail and apparel and footwear companies -- wholesalers, for the most part. And basically, after a strong runup in January, February, and some of March, it has started to weaken. As a group, they're down 10%+ off their highs. For specialty apparel retail, they outperformed the index last year, up 16.8% in 2004, vs. a 10% gain for the S&P 1500.
For 2005, apparel retailers were up 1% year to date, vs. a 3.3% decline for the S&P composite. Apparel accessories and luxury goods are off 4.2%, vs. the same 3.3% decline. Footwear is down 9.5% year to date. Consumer discretionary in general is off 8.8% year to date. So while the companies I follow were up in the first few months of the year, they've more than lost their gains in the last month or two.
Q: How does China affect the apparel makers of the U.S.?
A:China is the low-cost provider, and through Dec. 31, 2004, we had quotas on apparel coming into the U.S. The quota has lifted. For some categories, some apparel industry participants would say the Chinese have flooded the market with shipments in the first three months almost equal to all of last year's total.
The companies I follow anticipate that some form of quota will be put back on Chinese products over the course of the year, though from our vantage point, this is just a stopgap measure because these safeguard measures really end in 2008, and we expect to see apparel wholesalers rationalizing their sourcing base over the next few years, and ultimately evolving working relationships that look more like strategic alliances with fewer manufacturers. For this year, we don't anticipate a lot of cost saving. The longer-term trend is that manufacturing would move to China, and the costs would decrease.
Q: What's your take on Limited Brands (LTD )?
A:We regard the company as a mature specialty retailer. They're trying to turn around their apparel retailing business of Limited and Express. They have very low margins there. However, we believe the brands are very mature and really don't expect a lot of improvement there.
On the other hand, Victoria's Secret is very strong and capable of being an umbrella brand for many other product offshoots. They recently launched Pink, which is a sub-brand. They're doing a lot of business in fragrances, cosmetics. And then there's Bath & Body Works, which is remerchandising the stores, making them into modern apothecaries. This is promising.
Limited is also testing the Bendel's model, the upscale department store, located here in New York City on Fifth Avenue. Perhaps they may grow that as a specialty retail concept. Right now, it's just in test mode in Ohio.... We have a hold on [LTD stock]. Basically, our outlook is neutral.
Q: Your thoughts on Chico's FAS (CHS )?
A:We recommend purchasing Chico's. Chico's is highly regarded for its in-depth knowledge of the consumer, incredible marketing expertise, and unique differentiated fashion that's appropriate for their target customer. They have some of the best margins in the industry. We regard management's acumen very highly.
Almost two years ago, Chico's purchased White House/Black Market, another retailer geared toward younger, fashionable women. They have a customer loyalty program called the "black book." We expect them to enjoy a lot of success. The customer enjoys these loyalty programs. If catalogs are sent out monthly, if coupons are included, these incentives work to draw the customers back to the store.
What Chico's has found is that Passport [the name of its loyalty program] customers spend considerably more than the average customer. These customers account for more than 75% of Chico's sales. So Chico's can grow by opening new stores and getting new customers into their Passport Club. They have more than a million permanent members in the Passport club now, and those customers are very loyal.
Q: With the current rise in interest rates and anticipated slowdown in personal spending, what are your thoughts on the retail sector -- more consolidation or a greater dichotomy between low-cost and luxury retailers?
A:Both. More consolidation for sure, and we're seeing that. We just saw Kmart and Sears (S ) last year. Saks (SKS ) just sold off some department stores, and Neiman-Marcus (NMG ) was bought out by a private equity group. So we're seeing consolidation, but we're also seeing further bifurcation of the market.
The department stores that are left are trying to go more upscale in terms of product quality, to differentiate themselves from the mass merchants such as Wal-Mart (WMT ) and Target (TGT ). And the national chains such as Sears and J.C. Penney (JCP ) department stores have to elevate product offerings -- their market share has contracted. Share has gone to the Kohl's, the Wal-Marts of the world, and the specialty apparel retailers.
Q: You named CHS as a buy. Any other buys or strong buys in your coverage?
A:Right now I have no strong buys. But my buys include Abercrombie & Fitch (ANF ), American Eagle Outfitters (AEOS ), and Aeropostale (ARO ) [all youth apparel retailers]. I also have Gap and Coach. I also have Liz Claiborne, Nike (NKE ), and Reebok (RBK ) as buys in footwear and apparel brands. And that's it.
Q: Is there one company that you foresee leading the field this year? Why?
A:I would say a very hot brand is Coach, with their affordable luxury positioning in designer handbags. They're growing at twice the rate of the handbag market and driving the growth of that sector. So it's a hot brand but not necessarily "the" hot brand of the year.
Q: What are the leading-edge trends in fashion now?
A:We're in a fairly strong fashion cycle, led by color and a slimming of silhouettes. At the same time, what's happening, though, is that the department stores, in an effort to wean themselves from competing only on price, are trying to have exclusive and/or proprietary brands in the store, so they can compete on merchandise, not just price.
What's going on in fashion is very much "express yourself and create your own look," with individuals looking to designers to teach them how to dress. There's a mixing of classic and designer looks -- jackets with jeans, for example. Jeans are very hot -- the department stores are asking manufacturers for $150, $175, $250 jeans, and they're selling them. This is a very strong trend.
Q: Do you have any favorite stocks in the accessory business, besides Coach?
A:Coach is the only pure-play accessory company I follow. I have the apparel companies, like Liz Claiborne. Most brands have drawn their businesses out from just apparel to accessories as well, because they're high-margin and increase the overall purchase. You buy a pair of pants, you buy a belt to go with it.
Q: How much apparel is actually manufactured in the U.S. these days? There are lots of countries besides China for outsourcing.
A:Not a lot. Probably less than 5%. What's still done domestically is some textile manufacturing and also accessories manufacturing. But most manufacturing has moved offshore in search of cheaper labor costs.
Q: Do you cover any stocks you recommend selling?
A:I have a sell on AnnTaylor Stores (ANN ). While I have a very high regard for the CEO, we see the AnnTaylor chain as being mature. Brand equity is eroding, given the frequent promotions, which in turn are straining margins, and some cannibalization has occurred with Loft. Loft has had two very strong years, and as they come into this year, it will be very difficult to duplicate results.
Q: What's your outlook for consumer spending, in light of energy prices and higher interest rates?
A:S&P's predicting about a 5% increase in personal income for this year. So interest rates are going up, but the consumer will be healthy. Higher interest rates could cool the housing sector, but I think in the apparel area more industry-specific issues are taking control. The consumer's out there and still wants newness, so we see continued demand. It's more consolidation that's affecting this industry.
Q: To what extent do your companies have to wait for the holiday shopping season toward yearend to make or break their year?
A:It's certainly a big part of their earnings, but the companies I follow are earning money all through the year. Chico's, noticeably, does not have a seasonal earnings pattern. There are shoppers in the store every month. That's the logic of the monthly catalog mailings. They draw customers to the stores, but it's also the demographic. That woman, 35+, shops frequently.
The traditional department store sees more of the seasonal pattern. Wal-Mart, with their supercenters, has the shopper in the store every week buying food, so they don't have the same fourth-quarter dependence that they had 15 years ago.
Q: Who's the crucial consumer for apparel companies these days? Are teens the fashion leaders?
A:Teens are important because they spend a lot of their disposable income on apparel. However, one demographic that's garnering a lot of attention is the 35+ woman. Gap is bringing out a new retail brand later this year that targets the over-35-year-old woman.
Certainly, Chico's has gotten much success by catering to this woman. The department stores, where this woman traditionally shopped, have just not been doing as good a job as they should be doing. Baby boomers are the biggest demographic -- they have the most disposable income, and they're starting to retire so they have the time.
The apparel brands have started to try to design for this woman, who's different from the 40-year-old of 20 years ago. She's in better shape and wants form-fitting clothes, but age-appropriate clothes. Stylish and contemporary, but clothes that fit.
We expect to see a lot of companies going after this demographic. Chico's will continue to be there, and Gap is going after it. Among the apparel brands, Liz Claiborne and Polo Ralph Lauren (RL ) are going after it as well.