Leading clothing retailers like Gap Inc. and American Eagle Outfitters are expected to report larger fourth-quarter profits in the coming weeks, the latest evidence that smart inventory management and lower costs helped overcome sluggish holiday sales for most in the industry.
For calendar 2013, clothes retailers are expected to see margins improve due to better control of when their products arrive in stores, lower manufacturing costs and smarter use of technology for online sales and price comparisons.
Ken Perkins, president of data-monitoring firm Retail Metrics, expects fourth quarter net earnings at 18 U.S. apparel companies he follows to increase by 18 percent on average. Ten other retailers that sell clothes to teenagers are expected to see a 37 percent average increase in net profit, while the broader group of 120 retailers should see earnings rise 9.5 percent.
Lower product costs, investments in a smarter supply chain that helps manage inventories better, and controlled discounts are what analysts are banking their estimates on.
"Apparel retailers have lower product costs year over year, and most companies came into this quarter clinging on inventory. So even though top-line trends may not have been strong, margins should grow," said Betty Chen, retail analyst with Wedbush Securities.
According to Thomson Reuters estimates, Gap's profit is expected to rise about 34 percent over last year, while margins expand about 3 percentage points. Nike's profits are expected to be up about 8 percent. Abercrombie & Fitch Co., American Eagle and Lululemon Athletica Inc. are all expected to post better profits and margins as well. Many others raised profit expectations on Thursday.
"The fact that input prices were significantly lower than last year because of the dramatic drop in cotton prices, and the post Christmas enthusiasm helped on markdowns," said retail analyst Jan Kniffen. "So, despite the only OK Christmas selling season, margins are better than otherwise."
Kniffen said costs of manufacturing were down by about 8 percent this year, while Michael Niemira of the International Council of Shopping Centers pegs the decline at 10 percent to 12 percent.
Analysts also said apparel retailers are getting "smarter", and more technology savvy by the day, helping them better manage inventory and invest in suitable fashions and markets. That, coupled with fledgling signs of an economic recovery seem to have raised Wall Street's expectations from the group.
"The companies are working to become more efficient and one contributing factor (for gross margin expansion) is online sales," said Helena Song, credit ratings analyst with S&P.
"Every single clothes retailer is investing in and working hard to improve online sales... which contributes to margins. It is a profitable way of selling things and contributing a greater and greater percentage of the total sales," she said.
Retailers have also raised prices on products over last year, another reason margins are looking up. While retailers push up price tags when manufacturing costs go up, they seldom bring prices down when costs go down. When cotton, which is the clothing sector's most used raw material, rose sharply in the past few years, almost all of the retailers and manufacturers had to push up prices. Cotton futures have fallen off their peak and are trading down 15 percent from this time last year.
Most analysts stuck to their top picks like American Eagle and Gap, and Jefferies' Randal Konik said he also expects Ugg maker Deckers Outdoor Corp to do well.
"UGG brand remains a cold weather staple and our checks indicate that sales have picked up after the recent drop in temperatures across much of country. After fourth quarter results, we expect the business to stabilize ... due to lower sheepskin costs and cleaner inventory levels," he said.
Gap, the standard favorite among analysts is trading at about 14 times forward multiples, according to Thomson Reuters data, while the broader S&P Apparel Retail Index is trading at 15.5 times.
The S&P 500 has risen about 8.49 percent over the past quarter. In contrast, the S&P Apparel Retail Index has risen 9.73 over the same time.
Jaime Katz, retail analyst with Morningstar, said though the stocks are "fairly overvalued", they could still rise in the next few months.
"People are really hesitant to put their funds in the fixed income markets and they would prefer to put them in equities. There could be some support to domestic apparel retailers in the near term," she said, adding that while international markets are not doing as well as expected, domestic clothes retailers could still have the advantage of a somewhat improving consumer confidence levels.
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