Which Retail Name Is in Fashion?

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

Fashion-retail investors are having the time of their lives. Top- and bottom-line expansion has helped this space to outperform the market by leaps and bounds. A straightforward example has been fashion retailer Express (NYSE: EXPR), which has witnessed more than a 50% rise in its stock price since the start of the year, more than double the appreciation in the S&P 500 (21%). 

What has led to these superb gains? Is that the end, or is this just the beginning? Let’s have a look.

Investment thesis

Express notes a target audience of 20-to-30 year-old women and men (65%/35%, respectively), offering "an edited assortment of fashionable apparel and accessories,” including work, casual, jeans-wear, and going-out occasions. The test and reorder "go-to-market" strategy has been key for the company to grow its margins since Michael Weiss returned to the business in 2007—the same time Express accelerated its store-closing initiatives to combine Express and Structure under one dual-gender store format.

Having gone public in 2010, the company cannot point to a lengthy historical public performance. However, over the past several years it has implemented several business initiatives to help boost productivity and margins, focusing on its four pillars of growth: 1) increasing sales productivity and margins within its existing stores; 2) bringing the e-commerce penetration above 15% of sales from ~12.5% in FY 2012; 3) building out its new-store opportunities in North America; and 4) entering untapped international markets.

Increased penetration

At 625 stores at the end of FY 2012, Express appears 85% to 90% penetrated in North America relative to its target of 640 US stores and a 50 Canadian-store fleet. Management recently spoke of an additional growth opportunity coming from the outlet channel, which could be a 100-store or $500-million-revenue opportunity in their view. On a productivity basis, the company still sits below the FY 2011 peer average of ~$400/hired employee, which is the result of relatively larger stores and a presence in lighter-volume malls.

Improving valuations

At $0.66 per share, Express ended FY 2012 with a net-cash position, the first time it hasn’t been in a net-debt position since its IPO. As Express builds up its cash levels, one would expect to see a greater impact of share repurchases, which are not accounted for in management’s 2013 guidance. At the end of 2012, Express had roughly $35 million available under its prior authorization, and it won’t be surprising if this number increases over the course of the year. The company seeks to maintain a ~$100 million cash cushion. It is also interesting to note that Express is still paying roughly $20 million in annual interest expenses.

After a tough Q2/Q3 of 2012 on the merchandise side, the company has seen nice progress in the past six months and has generated a “softer landing” than most investors had been expecting. As investors look past near-term de-leveraging from the “flagships” and consider “kitchen-sink” guidance, assuming the top line continues to show sequential improvement (as compares ease materially), Express shares can outperform, perhaps even earning a multiple that's in line with the specialty SMID-cap mid-teens average. This as it returns to positive-comp territory and gross margins begin to expand again.

Peer analysis

For quite some time, Signet Jewelers (NYSE: SIG)) has been selling accessories, gifts and jewelry. Given the nature of its products, it is seen as a direct competitor to Express. The fashion retailer, just like its peer, has also seen some enormous gains since the start of the year (+40% year-to-date). However, the stock is a bit expensive as compared to Express. It trades at a forward multiple of 14x, as compared to 12.5x for Express.

However, the company has been an attractive one for investor. There are several long-term drivers to the story (more branding, domestic share gains and off-mall/outlet opportunities), and Signet could leverage its competitive strengths. These include its industry-leading marketing budget, proprietary in-house credit operations and growing exclusive product assortment, to fend off weaker competitors.

Are expensive valuations justified for this company?

An even more expensive stock is Urban Outfitters (NASDAQ: URBN), which has made a name for itself in the specialty retail space. The stock trades at a forward multiple of 20x. This multiple has come as a surprise given that the stock has appreciated only 7% since the start of the year.

Urban Outfitters has been able to manage its sales growth with its direct-to-customers channel and the re-positioned Anthroloplogie brand. It has focused on a better online experience and long-term relationships with customers, and has invested in online technology, people and processes.

It also follows a structured expansion strategy with a specialized site selection software package. It will continue to expand its stores across the brands with international expansion in China and Japan. Its DTC channel along with brands expansion in new markets will drive its sales growth. Given such growth prospects, expensive valuations seem to be justified.

Final word

The fashion retail space has seen some goods days in the past six-to-seven months. However, these were only good days--the wonderful times are still to come. In this space, Express seems to be the best shot given its ‘four pillars of growth,’ improving penetration and improving valuations. 

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Zain Abbas 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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