The makers, designers and retailers of apparel have provided one of the brighter patches in a gradually mending U.S. economy.
Consumers flocked to uber-trendy clothing such as brightly colored skinny jeans and printed tops over the spring and summer, according to Retail Metrics, an industry analyst.
The group reported overall apparel same-store sales in August grew 7.8% vs. 2011, beating estimates for 5.3% growth.
IBD 50 stock Michael Kors' (KORS) earnings smashed analyst views when it reported Q4 earnings in August. TJX Cos. (TJX), also on the IBD 50 list, topped EPS expectations when it announced earnings last month.
IBD tracks apparel markets in two separate industry groups. The Retail-Apparel/Shoes/Accessories group ranked No. 8 Friday among IBD's 197 industry groups. Apparel manufacturers ranked No. 40. Manufacturers tend to be designer brands tightly tied to their own manufacturing, and which have a large portion of their business in wholesale channels such as department stores. Some retailers also manage their own manufacturing, but focus on their store chains rather than on wholesale sales.
As the economy has gradually recovered off its recession lows, data from both groups have formed a barbell pattern as high-end luxury brands such as Kors and discounters such as Ross Stores (ROST) have outperformed mid-range apparel players such as American Eagle (AEO) and Pacific Sunwear (PSUN).
1.BusinessThe entire apparel sector can be brutally competitive. Companies need clearly differentiated brands and product lines in order to draw shoppers to stores and websites, according to Ken Perkins, a research analyst at Retail Metrics.
Luxury brands like Kors, Ralph Lauren (RL) and Coach (COH) distinguish themselves via high-quality products and services for their customers. Coach leather handbags retail for nearly $400 each. Sales rose a steady 15% over the past two years as customers paid up for the signature "C" prestige. Analysts expect a slowdown to 12% sales growth this year.
Discount apparel retailers like Ross and T.J. Maxx map out the low end of the fashion market by acquiring brand-name fashions from department stores and other larger retailers who overbought inventory. Customers scour their racks to find cheap deals.
The middle ground is more rocky.
"The midtier has been in a tough spot as it's a highly competitive space," Perkins said. "They can't provide the services of luxury brands and have difficulty competing with discounters without ruining margins.
Apparel retailer Pacific Sunwear, for example, reported an eight-cent loss per share for Q2. Express (EXPR) reported second-quarter earnings above views; it gave cautious guidance for the rest of the year.
Not all mid-range retailers are doing poorly. Limited Brands (LTD) reported a 4.7% jump in August same store sales, or sales in stores open at least one year according to Retail Metrics. Francesca's (FRAN) reported strong Q2 earnings and raised guidance earlier this month. Shares suffered a sharp sell-off the week of Sept. 7 on news that co-founder and Chief Executive John De Meritt was retiring. The unexpected news followed the firing of the company's chief financial officer in May.
One key to Limited's and Francesca's fundamental success is a mastery of niche markets.
"Limited Brands owns the undergarment space with Victoria's Secret," said Jamie Katz, an equity analyst for Morningstar. "There is no one that specializes in it the way they do. American Eagle has its Aerie segment, but Limited has the ability to drill down into core items.
Francesca's strategy includes limiting inventory at its small boutique-style stores. Smaller supplies encourage customers to buy that dress or top now, or miss out on it later. The company orders merchandise for delivery no more than 90 days in advance to ensure the styles are en vogue.
2.MarketThe recent economic slowdown largely skipped over the core luxury customer. High-end retailers rebounded quickly after the recession because their core long-term customers were the last to retreat into a "spending cocoon," and the first to emerge, according to Marshal Cohen, chief retail analyst at the NPD Group.
Now luxury brands are trying to reach beyond those core customers in order to drive additional growth.
To jump-start auto sales after the recession, some upscale carmakers like Volkswagen (OTCPK:VLKAY) made cheaper models of their popular cars to attract customers in a wider range of income levels to the brand. Cohen explains that luxury apparel retailers are following a similar tack by blurring the lines between their distribution channels.
Neiman Marcus is teaming up with big-box discounter Target (TGT) to offer a limited holiday collection. Jimmy Choo is selling a line of shoes through bargain fashion chain H&M.
"While this might lower the brand a bit, it is a way to get aspiring customers back that used to shop at the luxury shops before the recession," Cohen said.
3.ClimateWhile the upper class emerged from the recession largely intact, the middle class remains in duck-and-cover mode. Many were forced to change spending habits and turn from mid-range stores to discounters. Those changes proved to be stubborn.
"Even with some stability in domestic economic environment, there has been more of a permanent shift," said Katz. "People don't feel like we are out of the woods yet.
As a result, off-price retailers saw a 6% gain from August 2011 to July 2012 vs. the previous year, according to NPD. And consumers continue to see the economy as a pressing concern.
"The consumer still has the price value equation at the top of their mind," Cohen said.
On the upside, cotton prices have declined and should help margins this fall and winter, according to Perkins.
4. TechnologyE-commerce sales topped $200 billion last year as consumers become more comfortable shopping online. Online sales are seen growing from 7% of total retail sales last year to nearly 9% by 2016 according to Forrester, a global research firm.
"E-commerce reaches a whole new audience where there is no brick and mortar store," said Katz. "Retailers get clear data on what people are interested in and what people are clicking on which can be an extremely helpful marketing tool.
Getting a grasp on what consumers are interested in can help retailers manage inventory better and reduce the need for sales and clearances to offload unwanted merchandise.
5.OutlookAnalysts are generally positive that apparel groups will see continued strength as they move into this year's holiday season. Cohen expects women's wear to gain momentum in the next six months and the men's market to remain strong.
Katz sees apparel retailers managing inventory better and remains confident in the domestic part of the businesses.
Citigroup analyst Oliver Chen launched coverage on a dozen luxury and specialty retail stocks Thursday. Accessories have the advantage, Chen wrote, with consumers craving "multiple watches, layers of jewelry and handbags for different occasions.
Michael Kors, Limited Brands, Ross Stores and TJX were among those that received buy ratings. Abercrombie & Fitch (ANF) earned a sell rating, with a neutral outlook going to Urban Outfitters (URBN) and Coach.
• Upside: Apparel makers who offer unique products, discounted but trendy clothing or high-quality goods with excellent customer service will keep customers flocking to their stores.
• Risks: Consumer spending could drop if unemployment rises. Mid-market apparel chains could disappear if they aren't unique enough to entice customers. A new iPhone or other gadget could shift spending back to electronics from apparel.
- Michael Kors
- Limited Brands
- Limited Brands
- Ross Stores