When you think of teen apparel you probably think of names like The Gap Inc. (NYSE:GPS), perhaps Victoria’s Secret, or maybe even Ralph Lauren Corp (NYSE:RL). Somehow retail continues to do an extremely impressive job of generating yields. Let me illustrate this for you.
Economics of retail
After the 50% decline in the valuation of the SPDR S&P Retail ETF, along with a 50% decline in the SPDRs S&P 500 Trust Series ETF, both the broader stock market and the retail ETF recovered. The gray period on the chart is the recession. During economic recessions, both the broad market and retail indices pulled back by the same amount. But when the economy recovered the S&P Retail ETF was able to grow by 106% over a 5-year period, versus the S&P 500 Trust Series ETF growth of 32.13% in the same period.
The retail sector has been able to generate higher returns on investment than the broader stock market because disposable personal income has been able to recover to new all-time highs since the bottom of the economic recession. Believe it or not, Americans earn more now than they did prior to the great recession.
Clothing purchases are extremely sensitive to income. When income rises the amount of spending on non-durable goods, like clothing, rapidly increases; but when income declines spending on non-durable goods rapidly declines.
Non-cyclical goods (necessities) aren’t as negatively affected by changing income.
Investors should attempt to buy the cyclicals during periods of economic growth and buy the non-cyclicals during periods of economic contraction. Of course timing this is difficult. But I believe that over the next five-years the economy should experience steady growth as the inflationary monetary policy by the Federal Reserve seems to be working.
Three clothing retailers to watch out for
Abercrombie & Fitch Co. (NYSE:ANF) the teen apparel retailer known for its Hollister Co, Abercrombie & Fitch Co. (NYSE:ANF), along with its Abercrombie stores, continues to grow. The growth is driven by a mix of store expansion, higher gross margins, and the improving economy. Analysts on a consensus basis anticipate this company to grow earnings by 20.30% in fiscal year 2013. The company is projected to grow earnings by 17.06% for the next five years, making the 18.5 earnings multiple reasonable in light of the potential growth. The company also comes with a 1.49% dividend yield (for all of you dividend reinvestment planning folks out there, this is for you).
Clothing retail tends to out-perform the broader stock market during periods of economic growth. Assuming the economy continues to grow, and Abercrombie & Fitch Co. (NYSE:ANF) continues to expand its store line-up the company should be able to meet analyst estimates.
L Brands Inc (NYSE:LTD) is a clothing retail company that operates in two segments. The company operates Victoria’s Secret and Bath & Body Works.
Similar to Abercrombie & Fitch Co. (NYSE:ANF), L Brands Inc (NYSE:LTD) is a vertically integrated clothing company that designs, markets, and retails its clothing at its own retail locations. The company primarily markets its products in the up-scale mall locations with the exception of New York City (downtown Manhattan is low hanging fruit). That being the case, L Brands Inc (NYSE:LTD) is heavily focused on expanding its retail store foot print into international markets. Its primary growth initiative is Europe.
Analysts on a consensus basis anticipate the company to grow earnings by 11% on average over the next 5-years. The company currently trades at an 18.4 earnings multiple. The company has a bit of a premium priced into it as the earnings multiple is higher than the projected growth. This premium is driven by the high rates of historical growth (the company earnings grew by 50.42% on average over the past 5-years). The company also offers a 2.32% dividend yield. In the 2012 holiday quarter, (fourth quarter) the company was able to beat earnings estimates.
Lululemon Athletica inc. (NASDAQ:LULU) is a company that specializes in selling high-performance yoga-clothing. The spandex they sell is supposedly made of superior fabric. The company markets its products in the high-end mall locations. In its fourth quarter 2012 earnings release, the company was able to report $2,058 in sales per square feet (extremely good, Abercrombie & Fitch Co. (NYSE:ANF) reports in the $500 per square feet range). The high-end yoga concept seems to be working, as investors are highly optimistic about the company’s forward growth.
Analysts on a consensus basis anticipate that the company will grow earnings by 23.20% on average over the next 5 years. This high rate of growth will be driven by store openings in affluent markets all over the world. The management team believes that it can sustain its growth through international expansion. For now markets like Paris and Hong Kong are the company’s best bet. Lululemon Athletica inc. (NASDAQ:LULU) has a proven business model that appeals to the super affluent. The company currently has a 43.3 earnings multiple. The high earnings multiple puts it at a bit of premium relative to forecasted growth. But on the plus side, the company could surprise analyst estimates for the current fiscal year.
Conclusion
Fashion retail out-performs during periods of economic growth. Lingerie, teen apparel, and high-end spandex seem to be the most prolific growth opportunities in the space. The combination seems like a ridiculous way to generate investment yields, but then again it is never good to judge a book by its cover.
The article The Retail Sector Sports Some Great Returns originally appeared on Fool.com and is written by Alexander Cho.
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