2 Consumer Brands To Buy, 1 To Avoid

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

If you are optimistic about consumer trends like I am, it is time to consider buying shares in apparel producers. Although the industry is subject to fickle demand, a full recovery is underway that will lift multiples of cheaper stocks closer to average levels. With a series of high multiple stocks out there, like Lululemon and Under Armour, there are easy comparisons for high momentum stocks to appreciate off of...

Lightly Buy Nike (NYSE: NKE) Despite Bearish Trends

Over the last six months, Nike's stock has precipitously lost 18.3% of its value while the S&P 500 was roughly flat. The poor performance is largely due to weak results in the fourth quarter, where profit fell for the first time in three years from overly high marketing that failed to drive volumes. Although shares are nearer to their 52-week low than their 52-week high, multiples are still elevated at 19.9x past earnings. With little debt and high gross margins of 43.2%, management has kept the business relatively sound financially. Analysts forecast 10.3% annual EPS growth over the next 5 years, which is virtually in-line with what was achieved over the past 5 years.

Assuming Nike meets expectations, 2016 EPS will come out to $8, which, at a multiple of 17x, translates to a future stock value of $136. Discounting backwards by 10% yields a present value of $84.45 - well below the current prevailing price. Accordingly, the stock is slightly overvalued, and analysts rate it a "hold".

To confront higher input costs that have eroded margins, management has increased prices. However, this has been ill timed for soft demand in Europe and slower-than-expected growth in China. Some have argued that management's decision to implement an $8 billion share repurchase program may also be ill timed due to how the stock is trending downwards. However, in my view, they help limit the downside against an uncertain economy. Moreover, I don't see multiples compressing any more in light of inflated peers.

I am especially optimistic about positive trends coming from Converse and NIKE Brand, which have seen double-digit growth drive revenues up 15% in the recent quarter. And although gross margins declined around 80 bps, profitability has been better than anticipated and even improved sequentially. Moreover, the overly high SG&A spent in this quarter went towards product innovation that will help to drive future free cash flow. Further awareness generated through the London Olympics, especially the greater participation by women, only add to the future growth story. It should also be noted the suppliers of Nike products, including Foot Locker, the Finish Line, and Dick's Sporting Goods have all delivered strong results of late and signal growing consumer confidence.

Buy American Eagle Outfitters (NYSE: AEO), Avoid The Gap (NYSE: GPS)

Given that shares in both retailer producers have approximately doubled from the 52-week low, investors are naturally wondering whether the peak is near or has passed. Ultimately, I recommend buying American Eagle over Gap. The former trades at a respective 21.5x and 13.6x past and forward earnings versus corresponding figures of 20x and 14.7x for the latter. Analysts, accordingly, rate American Eagle a "buy" and Gap more of a "sell". Fundamentally, however, there are several reasons for this preference.

First, while Gap has exceeded expectations more than American Eagle has, American Eagle has a cleaner balance sheet with no debt and a current ratio of 3.5x. This is particularly important, since it will enable the company to spend more on marketing during a full recovery in an effort to gain share. In addition, American Eagle is forecasted for 119 bps-greater annual EPS growth over the next 5 years (11.4%). It should be stressed that the company saw declining earnings over the last half decade and that this poor performance has resulted in multiples trading at a discount. However, since the past is no indicator for the future, it has overblown the value gap.

Moreover, American Eagle has seen margins hold up better than competitors’. If the company can achieve this during a weak economy, one can only imagine what it can achiever during a strong economy. ROA, ROE, and ROI have also outpaced peer levels while the outlook has come ahead of analyst expectations.


TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Nike. Motley Fool newsletter services recommend American Eagle Outfitters, Gap, and Nike. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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