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Stock Strategist Industry Reports

Which Apparel Brands Will Stay on the Shelves?

Apparel makers will have to fight hard to keep their brands relevant to consumers.

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Apparel makers have had a rough year, as deterioration in consumer spending on discretionary goods exacerbated issues stemming from already-tough industry dynamics. Despite a difficult retail environment, these stocks have performed quite well, fueled by increased consumer confidence and a more optimistic outlook for 2010. The stock prices of apparel manufacturers rated by Morningstar have increased more than 40% on average over the past 12 months, outperforming the S&P 500, which is up approximately 13% during the same period. While we believe the worst is over for most of these firms, we don't expect a significant rebound in results and project modest growth levels going forward. Currently, we believe most of these firms are moderately overvalued, with a median price to fair value ratio of 1.3. Over the longer term, however, we think the firms with the most potential are the ones that have kept their brands relevant and consumers engaged during the downturn. Additionally, we think manufacturers that possess a diversified portfolio of strong brands, as well as an extensive distribution channel with a broad geographic reach, will have a leg up and are likely to outperform their peers over the long run.

Top- and Bottom-Line Pressures
Several changes have occurred in the apparel industry in recent years that have negatively affected the manufacturers. National brands that are typically sold through department stores began to feel the pinch in the mid-2000s as a wave of department store consolidation resulted in a number of store closures and increased buying power from remaining chains like  Macy's (M), which is a big buyer of branded apparel. In an effort to differentiate products from competitors, department stores also pushed branded apparel aside in favor of private or exclusive label merchandise. Additionally, we believe the increased popularity of specialty retailers among shoppers also negatively affected sales at department stores and apparel manufacturers in turn. As apparel manufacturers were adapting to these changes in the retail sector, the macroeconomic environment began to deteriorate. Retailers cut orders sharply as demand for discretionary products waned amid the downturn, creating added top-line pressure for apparel manufacturer's sales. Retail bankruptcies, like Goody's and Mervyn's, also hurt revenues for some apparel manufacturers. On a different playing field, manufacturers that make basic apparel such as  Hanesbrands (HBI) and  Gildan Activewear (GIL) were also faced with steep revenue declines, thanks to reduced orders from wholesalers and mass merchants like  Wal-Mart (WMT).

Zoe Tan does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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