Apparel: Dressed for Success

Sky-high gas prices haven't stopped consumers heading for the mall, making for a number of S&P buys

What consumers are putting on their backs bodes well for a number ofstocks in the apparel trades, says Standard & Poor's analyst Marie Driscoll, who covers companies in apparel manufacturing and retailing.

So far this year, the S&P 1500 index is up 0.7%, with the consumer discretionary sector down 2.9% -- but that's almost entirely because of a big drop in autos. The good news from Driscoll is that apparel retailing stocks are up 12.7%, even in the face of high gasoline prices.

LIZ AND CHICO.

  "The leading edge in fashion is lots of appliqué and embroidery, a bohemian flare, kind of a hippie influence, and a strong luxury trend that you can see with furs, leather, lace -- that kind of thing," says Driscoll. One of her favorite stocks is Coach (COH ), which is highly profitable and thus merits a buy ranking from S&P despite that it trades at a premium to its peers.

Although Driscoll sees no strong buys in her group, she has a number of buys in addition to Coach: Abercrombie & Fitch (ANF ), Aeropostale (ARO ), American Eagle Outfitters (AEOS ), Chico's FAS (CHS ), Liz Claiborne (LIZ ), Polo Ralph Lauren (RL ), Nike (NKE ), Reebok (RBK ), and Gap (GPS ).

These were some of the points Driscoll made in an investing chat presented July 12 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from Jack Dierdorff of BW Online. Following are edited excerpts from this chat. AOL subscribers can find a full transcript at aol.businessweek.com/chats.

(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 are consumer stocks doing -- and especially the ones you cover?

A:

Consumer stocks have been rallying, as the consumer just doesn't seem to be giving up, even in the face of high gas prices. Retail sales continue to be strong, with companies as varied as Wal-Mart (WMT ), Gap (GPS ), and Abercrombie & Fitch (ANF ) reporting better-than-expected June sales.

The latest data I have is through the end of last week, which shows the S&P 1500 up 0.7% year to date. Consumer discretionary is down 2.9%, but that is largely reflecting auto parts and equipment, which is down 14.1%. Apparel retail is up 12.7% year to date. Apparel, accessories, and luxury goods are up 7.4%. Footwear is down 0.3%.

Q: If there was one consumer stock to buy, which one of these would you pick: Bed, Bath & Beyond (BBBY ), Coach, Best Buy (BBY ), American Eagle Outfitters, or Abercrombie & Fitch?

A:

To begin with, I have buy recommendations on ANF, AEOS, and COH. All five of the companies are rated buy by S&P's STARS system [Stock Appreciation Ranking System].

I'm going to say that while Coach is trading at quite a premium to peers and the market, it continues to excel and has lots of international opportunities. We see potential for additional categories. It has a very strong brand name and a great management team.

And while it's expensive, Coach has the highest margins of these companies that you mention. So it's the most profitable company here. We expect continued above-average growth for the next few years. So if I'm going to single it out, I'm going to go with Coach. That said, all of the companies are excellent companies with great management teams.

Q: Kohl's (KSS ) -- buy, sell, hold?

A:

KSS was recently upgraded to a buy. We view KSS as a mature retail concept, playing catch-up with the competition. And we look for them to have more exclusive, higher-quality merchandise going forward. We have a 12-month price target of $64.

Q: Which would you consider the better buy, COH or Chico's FAS (CHS )?

A:

I like Chico's, too. I just raised my target price on CHS yesterday, to $45. CHS, too, has a lot of growth opportunity -- via White House Black Market, Soma by Chico's, and Chico's. We see 26%-plus growth for the next few years. Lots of growth potential.

Q: What do you think about Gap? It seems to be running sideways.

A:

Gap surprised last week with stronger-than-expected June sales. But given Gap's $16 billion retail presence, the competition is constantly going after Gap's market by targeting smaller consumer niches. Gap has a concept for multiple consumer segments. The Gap brand is targeted at the 20- to 30-year-olds. Old Navy is positioned at the mother as well as the teen audience, providing value-priced apparel for the family. And with its Banana Republic brand, Gap goes after the urban sophisticate and a contemporary 25- to 45-year-old.

This fall, Gap is launching a fourth concept called Forth & Towne, positioned at the 35-plus-year-old woman, a demographic that Chico's is doing very well with and that the department stores have seemingly abandoned in their pursuit of the younger contemporary shopper in their efforts to revive their business. Gap is set to open five Forth & Towne stores this year.

Q: Any stocks you recommend selling?

A:

I do have two sells: AnnTaylor Stores (ANN ) and Tommy Hilfiger (TOM ). We see a lot of work ahead for ANN as [Katherine Lawther] Krill has been made president of AnnTaylor Corp., following her success at AnnTaylor Loft. I'm worried that Loft will flounder as she focuses her energies on Loft's older sibling. I think that both concepts are really appealing often to the same woman.

And at TOM, I'm concerned about the brand domestically, as well as the attorney general's investigation into its accounting practices.

Q: What are your thoughts on Fortune Brands (FO ) and Constellation Brands (STZ )?

A:

We have a strong buy on FO. This is based on total potential return, a high-growth profile for the company, and an attractive valuation. Howard Choe believes consumers will continue to invest in new homes and remodel existing homes, aiding FO's home and hardware division. Additionally, we believe the company's other operating segments provide diversification.

We have a strong buy on STZ as well. We believe the recent Robert Mondavi (MOND ) acquisition will support strong growth in the long term. We are seeing healthy, strong demand for premium wine continuing. We see margin recovery in fiscal year '06 and beyond as heavy marketing costs likely ease. The 12-month price target on STZ is $36.

Q: What about retailers such as Nordstrom (JWN ) and Neiman-Marcus (NMG )?

A:

We have a hold rating on JWN. It recently was lowered to hold, based on valuation. Our analyst does really like the company. We look for the company to benefit from same-store sale comparisons and to sustain strong sales and earnings momentum and potentially increase market share over the balance of the year. The company is better than peers at anticipating and responding to customer needs. So it's a valuation call; that's why it's a hold.

Now, for NMG, that company is going private, purchased by Texas Pacific Group and Warburg Pincus LLC for $100 a share. That's expected to close Nov. 1, subject to the necessary approvals.

Q: Do any department stores get a favorable rating?

A:

Well, Kohl's does [buy]. J.C. Penney (JCP ) has a hold rating. Federated (FD ) carries a hold recommendation. Sears Holdings (SHLD ) has a hold rating as well. Saks (SKS ) carries a sell rating.

Q: What's your opinion on Columbia Sportswear (COLM )?

A:

I don't cover Columbia Sportswear. I follow VF (VFC ), and I have a hold rating on that. They participate in the sportswear/lifestyles categories. And Nike (NKE ), of course, which I have a buy on. I also have a buy on Reebok (RBK ).

Q: What do you see as the leading edge in apparel these days? How much does the latest in fashion affect stocks?

A:

The leading edge in fashion is lots of appliqué and embroidery, a bohemian flare, kind of a hippie influence, and a strong luxury trend, which you can see with furs, leather, lace -- that kind of thing. If you can isolate the trends and see what wholesaler or retailer is best delivering them, you can try to invest in it. Many wholesalers are broadly diversified by brand and channel, so that you can't necessarily capture the trend.

Companies that are very trendy right now would be Bebe Stores (BEBE ), which we have a hold rating on, and Urban Outfitters (URBN ), which we also have a hold rating on. The secret to Chico's success is not trends, but knowing their customer and interpreting the trends for their customer.

Q: How about menswear? You've mentioned some companies also into that.

A:

Menswear enjoyed sales growth last year as men finally got out and saw that they needed to replace their apparel, either because it was so out of fashion or they didn't fit into their clothes anymore! But men's apparel brands have been meeting a new set of needs -- there's more dressy casual (a real oxymoron).

But, that said, there's a lot of interest in the department stores for a contemporary male. Banana Republic is doing well dressing this male as well. Men's Wearhouse (MW ) has seen its business increase dramatically with suit sales up, as well as various other products -- woven shirts, etc. And Polo Ralph Lauren (RL ), which we have a buy on (we raised it to a buy last Friday), has a very strong men's business.

Q: Does S&P expect consumers to be able to keep spending even if gasoline prices remain high, or go higher?

A:

You know, a year ago we thought that $50 a barrel would crimp spending, but it really isn't. As I said, June retail sales were better than expected. And the American consumer just seems to spend more and more of her disposable income as long as the job picture is good. And the job picture is good: Unemployment declined to 5%. And when you fill up your tank you notice it, but people are still buying Starbucks coffee (SBUX ) and $100 jeans. So the American consumer is still going strong.

Q: Could you remind us of the stocks you list as buys?

A:

Among the companies that I cover, my buy ratings are on ANF, AEOF, Aeropostale (ARO ), CHS, COH, Liz Claiborne (LIZ ), RL, NKE, RBK, and GPS. We did talk about other buys that my colleagues cover -- BBY, BBBY, and FO are among those. STZ is another buy.

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