3 Apparel Retail Stocks that May Catch Your Attention

Damian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Although the apparel retail segment is not expected to outperform the market, some companies have survived and even benefited from the last economic crisis and now stand in considerably strong positions to benefit from various expansion opportunities. In this article I will look at TJX Companies (NYSE: TJX), Ross Stores (NASDAQ: ROST) and L Brands (NYSE: LTD), three firms in the industry that offer compelling and sustainable growth prospects for years to come.

TJX Companies: Takes advantage of economic crisis 

TJX is the leader in the U.S. low-price apparel retail segment and runs over 3,000 stores worldwide. One of its main competitive advantages stems from its partnerships with manufacturers such as Ralph Lauren, allowing it to purchase excess inventory at a fraction of the original price. With central economies hit by the economic crisis and a slow recovery following, consumer trends shifting to lower priced products largely benefited TJX. This trend is expected to continue in the upcoming years; consensus estimates project an 11% annual earnings-per-share growth rate for the next five years. Although not poised to outperform the market, the company does deserve a closer look due to its established position in the market and its scale, which provides a considerable moat and keeps competitors lagging.

One of the main growth drivers for the company in the long-term is its expansion initiatives. While results are already outstanding in the U.S. and Europe, store base expansion should heavily contribute to revenue and earnings increases. The company targets a 5% growth in its store count by the end of 2014. The incursion into the e-commerce sector, boosted by the Sierra Trading Post acquisition last December, is also expected to deliver positive results and boost earnings by the end of the next fiscal year.

None of its close competitors seem capable of matching TJX’s operations or revenue (which is almost triple that of Ross Stores). Meanwhile, its prospects look promising and its margins are pretty shielded since when prices rise elsewhere, TJX can do so as well without losing the competitive advantage provided by its offering of discount prices. Consequently, the company's margins have reflected this pricing and margin generation power, reaching 12% for the operational margin and 7.4% for the net margin, which are considerably above the industry averages of 9.3% and 5.5%, respectively. Returns on capital and equity should also be highlighted as they comfortably double the industry means. With such compelling financials and profitability figures and a balanced debt/equity ratio while trading slightly below average valuations at 20 times its earnings, I would recommend buying this stock.

Ross Stores: Discount price strategy

Ross Stores is widely recognized for offering established apparel brands at discount prices. Everything in its stores, from the location to merchandising, is consciously aimed at its customer base. Due to its scale and its trend to overstock, the company can leverage over providers and obtain low prices that it can then transfer to its clients. However, it remains a laggard compared to TJX in terms of revenue. You might wonder why you should look at Ross then. Well, for starters it seems more profitable. Its operating margin stands at 13.1% and its net margin is at 8.1%, both of which are better than TJX´s. The company trades at 18.7 times its price-to-earnings ratio, a 6.5% discount compared to TJX, while offering wider margins and lower debt leverage –a 0.1 debt to equity ratio, which is half of its competitor’s rate. I would recommend adding this stock to your portfolio as well.

Its store base expansion plan targets to double its number in the long term, by adding 900 Ross and 500 dd's locations to the existing 1,100 and 110, respectively. The expansion project looks feasible, and both profits and margins should increase hand-in-hand.

So if Ross looks better than TJX, has a similar retail model and is expected to deliver a higher average annual growth rate (about 12% per annum over the next 5 years), why buy both? The thing is that their overlap is not much. These firms target different client bases. While TJX focuses on higher-end consumers, Ross points to a lower-income segment that still holds some discretionary spending power.

With a history of returning value to shareholders through aggressive share repurchases and a 0.9% dividend yield, while trading at 18.7 times its earnings, below the 21.5 times price-to-earnings industry average, this is definitely a stock to add to your watchlist, or even better to add your share portfolio.

L Brands: Low prices and mainly two brands 

L Brands is yet another apparel retailer with a market cap very close to Ross Stores'. Once a diversified business, now it has become focused on two specialty retail store chains: Victoria's Secret and Bath & Body Works. One might believe that this is not so good, but it actually reduces the company's dependence on fashion and disposable income fluctuations while providing wider margins. Holding a leading market share in the beauty, fragrance, and lingerie segments, the firm is poised to deliver strong and consistent results in the years to come. Analysts expect the firm to deliver an average annual growth rate of 12% for the next five years. Trading at 19.6 times its earnings, below the industry mean, offering strong returns - especially on capital - and expanding revenues and margins, a 2.41% dividend yield and a history of active management of cash flows and consequent share repurchases, I would recommend getting a hold of these shares.

One of the main advantages in this company is its franchise model, which “allows it to exert control over its partners, dictating assortment, pricing, store designing and promotions, which we believe will prevent the brand from being diluted by poor management outside of the firm” according to Morningstar. Furthermore, its scale permits the company to reduce costs by leveraging over suppliers, control other costs and manage inventories efficiently.

Growth in the long-term is expected to derive from brand extensions such as PINK, Henri Bendel and VSX and from international expansion since a strong brand name provides plenty of opportunities in underpenetrated markets, especially in Canada. A cautious approach toward store base widening might make development slower but it has proven to return good results and avoid bad investments.

Bottom line

Above I have succinctly analyzed three firms in the apparel retail segment that provide compelling growth opportunities and sustainable projected rates. All three of them comprise, in my opinion, good options to add to your share portfolio. Since they don't overlap, but rather target different demographics, their compound growth rates and future earnings could add considerable value to your collection. Consider investing.

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Damian Illia has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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