The Best Apparel Retailer Is....

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Its stock is up 55% in the last year. It beat sales expectations and has announced plans to expand globally. What company am I talking about? No, it’s not a tech anomaly, it’s The Gap (NYSE: GPS). A model of a clothing retailer turnaround, the Boston Globe reported that Gap continued to sell above expectations in May and only 2 weeks ago, the company announced plans to have a presence in eight latin American countries by the end of 2013.

Gap, however, is an anomaly. Apparel Retailers are in an extremely competitive environment. Selling a commodity, companies like American Eagle Outfitters(NYSE: AEO) or Urban Outfitters (NASDAQ: URBN) are at the mercy of constantly changing fashion trends and material prices that threaten to squeeze them out of a profit through both revenue and costs. Unlike The Gap, American Eagle is facing problems keeping its sales up as sales from stores open at least one year fell 5% in the most recent quarter due to what CEO Robert Hanson called “a tough macro environment.” Urban Outfitters, on the other hand, is only making the news for having to pull a line of coffee mugs from shelves because they could easily be confused with prescription drug bottles.

Luxury apparel is no different

One might think that in this environment higher end clothing retailers might spin a different, more positive tale. Jos A Bank Clothiers(NASDAQ: JOSB)’s most recent quarter’s EPS was in line with expectations, but same store sales were down 8.5%. Their gross margin has decreased in the last year, and their net profit margin, according to, is trailing the industry average. The Men’s Wearhouse (NYSE: MW), which trades at a slightly lower earnings multiple than Jos A Bank Clothiers grew earnings per share and gross margins; however, the company is plagued by new management troubles as they’ve fired Founder and Executive Chairman George Zimmer, who owns 3.5% of the company.

The truth is in the numbers

With the tough macro environment and the troubles these retailers are going through, it may seem daft to be looking at retail for investments at all. However, contrarian battlegrounds like these can often be the areas of the most impressive market mispricings. While, The Gap's performance is certainly remarkable, I believe the numbers show that American Eagle is truly the more impressive company and is currently being fundamentally mispriced.

<table> <thead> <tr><th> </th><th> <p>Gross Margin</p> </th><th> <p>Net Profit Margin</p> </th><th> <p>Inventory Turnover</p> </th><th> <p>Return on Equity</p> </th></tr> </thead> <tbody> <tr> <td> <p>The Gap</p> </td> <td> <p>42.9%</p> </td> <td> <p>7.77%</p> </td> <td> <p>5.5</p> </td> <td> <p>39.98%</p> </td> </tr> <tr> <td> <p>American Eagle Outfitters</p> </td> <td> <p>40%</p> </td> <td> <p>6.39%</p> </td> <td> <p>5.8</p> </td> <td> <p>18.53%</p> </td> </tr> <tr> <td> <p>Urban Outfitters</p> </td> <td> <p>41.4%</p> </td> <td> <p>8.71%</p> </td> <td> <p>5.4</p> </td> <td> <p>19.73%</p> </td> </tr> <tr> <td> <p>Jos A Bank Clothiers</p> </td> <td> <p>60.6%</p> </td> <td> <p>6.99%</p> </td> <td> <p>1.2</p> </td> <td> <p>11.44%</p> </td> </tr> <tr> <td> <p>The Men’s Wearhouse</p> </td> <td> <p>49.5%</p> </td> <td> <p>5.48%</p> </td> <td> <p>2.1</p> </td> <td> <p>13.01%</p> </td> </tr> </tbody> </table>

Source: Yahoo Finance and The Motley Fool

Based on Return on Equity, The Gap is clearly far into its turnaround, achieving high returns on its equity. Of the three casual apparel retailers, it has the highest gross margin as well. However, American Eagle Outfitters has a higher inventory turnover, and Urban Outfitters has a higher net profit margin, even if only by a percentage point.

The difference in business models between these three casual clothing stores and the more upscale Men’s Wearhouse and Jos A Bank Clothiers is made extremely clear, however, in these numbers. Their gross margins of the are significantly higher and their inventory turnover is higher as well, which makes sense. Interestingly even within the luxury segment, Men’s Wearhouse’s lower margins compared to Jos A Bank is accompanied by higher turnover than Jos A Bank Clothiers. However, even with these significant business model changes, all of these net profit margins end up at around the same 5.5%-8.5% range.

To truly compare these companies we need to go further than those generic quantitative metrics. Instead, we should use more industry specific metrics like Revenue per Employee and Sales per Square Foot. I’ll also use Gross Profit/Total Assets to see how well, net of pricing, these companies are using their assets. These metrics reveal more insight into these companies and their efficiency, which is important in such a competitive industry.

<table> <thead> <tr><th> </th><th> <p>Gross Profit/Total Assets</p> </th><th> <p>Revenue/Employee</p> </th><th> <p>Sales/Square Ft.</p> </th></tr> </thead> <tbody> <tr> <td> <p>The Gap</p> </td> <td> <p>.826</p> </td> <td> <p>116,860</p> </td> <td> <p>$424</p> </td> </tr> <tr> <td> <p>American Eagle Outfitters</p> </td> <td> <p>.792</p> </td> <td> <p>492,369</p> </td> <td> <p>$489</p> </td> </tr> <tr> <td> <p>Urban Outfitters</p> </td> <td> <p>.570</p> </td> <td> <p>357,751</p> </td> <td> <p>NA</p> </td> </tr> <tr> <td> <p>Jos A Bank Clothiers</p> </td> <td> <p>.680</p> </td> <td> <p>225,197</p> </td> <td> <p>$388</p> </td> </tr> <tr> <td> <p>The Men’s Wearhouse</p> </td> <td> <p>.741</p> </td> <td> <p>203,084</p> </td> <td> <p>$415*</p> </td> </tr> </tbody> </table>

SOURCE: The Motley Fool, Personal Calculations, Company 10-K Filings

*Weighted average of 3 store brands (Men’s Warehouse, Moores, K&G)

Currently beating all expectations and at the peak of its turnaround, Gap is using its assets most effectively of all of these companies. However, American Eagle Outfitters and The Men’s Wearhouse, even with different core customers, are very close. Men’s Wearhouse keeps up in Sales/square ft. and beats Gap on Revenue/Employee as well. American Eagle Outfitters, though, is much more efficient, selling 15% more per square ft. than The Gap and achieving 4.24x more sales per employee.

American Eagle deserves a higher valuation

Even so, The Gap is selling for 16.27 times earnings and American Eagle Outfitters is selling for 15.15 times earnings, likely because The Gap is on such a run with its current turnaround. Momentum is fickly. Ultimately, remember that while the Gap is currently more profitable, American Eagle Outfitters seems to be a more efficiently run organization in the long run. It’s more efficient with its employees, its space, and its inventory, so while in the short-term The Gap is getting a lot of attention, it might be worthwhile to take a closer look at American Eagle Outfitters as potentially the true best clothing retailer.

Nikhil Shamapant 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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