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Apparel manufacturers are solidifying their brand identities and cost efficiencies to build moats.

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We think apparel manufacturers have experienced a resurgence in revenue-generating opportunities with the advent of innovative fabrics and designs, the ability to interact directly with consumers, and the chance to expand in growing global markets. Furthermore, additional pricing power through strong brands and a faster, more flexible, and lean manufacturing system has yielded margin expansion possibilities. We think the apparel manufacturing industry is dynamic, quickly growing, and one to watch over the next couple of years.

Given the sectorwide disruptive forces of e-commerce and fast-fashion retailing on apparel manufacturing, we have revisited the attributes that we believe lead apparel manufacturers to garner economic moats. We think modern technologies and consumer preferences demand an entirely different skill set from companies than in the past. In fact, we think current innovations have given companies an unprecedented opportunity to develop direct relationships with their customers to solidify their intangible brand asset, as well as be creative in managing the supply chain to develop unrealized cost efficiencies, both of which are critical to developing an economic moat in this category. In an effort to quantify the opportunity and positioning of our apparel manufacturing universe in regards to economic moats, we have developed a framework with which to view the firms. We look for leadership in five categories when analyzing competitive advantage: product differentiation, direct-to-consumer penetration, geographic reach of the distribution system, manufacturing efficiencies, and an ability to defend against rising costs. Those companies with narrow Morningstar Economic Moat Ratings-- Hanesbrands (HBI),  PVH (PVH), and  VF (VFC)--tend to outperform competition across all categories considered, leading to outsize revenue growth, operating margins, and overall returns on invested capital, while no-moat  Gildan Activewear (GIL) and  Guess (GES) trail in a couple of categories.

Bridget Weishaar 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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