Specialty Retail Analysts: Ike Boruchow / Tom Nikic, CFA For Specialty Apparel Exposure, Highlighting URBN/GPS Pair Trade
By Mel Fabrikant Thursday, October 03, 2013, 03:09 PM EDT
Investors looking for long/short exposure in the specialty apparel space should consider a pair trade, long URBN and short GPS. Digging deeper into our thought process, we highlight several key factors (including merchandising, inventory, valuation spread and sentiment) that all favor URBN over GPS, in our view. We remain at Buy with $45 PT on URBN and Underperform with $38 PT on GPS.
#1 Merchandising: "Broad and Shallow" > "Narrow and Deep." In 2012, the apparel industry was dominated by the colored denim trend, which was beneficial to retailers such as Gap, which cater their assortments to a specific theme and invest heavily in those styles ("narrow and deep"). However, this year there is no big trend in apparel, and the industry is currently being driven by several smaller trends. Thus, retailers with broader assortments, such as URBN, can have exposure to these multiple mini-trends, without being overexposed to less favorable styles (thanks to their "shallow" merchandising). Also, GPS has very long lead times (~9 months), making it difficult to respond and react to changing trends, whereas URBN is more nimble and has more open-to-buy available for the upcoming holiday season.
#2 Inventory: Look at the Inv-to-Sales Spreads. Inventories were up 8% at URBN entering Q3, and we are projecting 10-11% sales growth for the quarter, resulting in a favorable inventory-sales spread. GPS, on the other hand, came into the quarter with inventories up 10%, and we expect sales growth of only 4%, resulting in a very unfavorable inventory-sales spread. As a result, we believe there is much more margin risk at GPS in a slowing sales environment.
#3 Valuation Spread: Narrow vs. History. Historically, URBN has traded at a 6-turn premium to GPS. Prior to URBN's 10-Q release in early September, the spread was in the normal 6-turn range, but the premium has now narrowed to < 4 turns. YTD GPS is up ~30%, whereas URBN is down 7%, despite URBN owning the hottest brand in apparel today (Anthropologie). We see meaningful multiple expansion potential for URBN (both on an absolute basis and relative to GPS), whereas GPS is already trading two turns above its 3- and 5-year averages, with Street numbers that are likely overly optimistic.
#4 Sentiment: Much More Bullish on GPS. Following the 10-Q release, URBN fell toward the bottom of our Sterney Sentiment Index, as numbers were cut and expectations lowered. For GPS, sentiment remains very favorable, which could easily change as comps have slowed, product margins are contracting and Street numbers now appear too high.