Is Traditional Apparel Retailing Dead?
No, says analyst Bridget Weishaar, but it will look much different in the future.
Given the recent negative performance of many apparel retailers and some calls that traditional apparel retailing is dead, we are addressing our thoughts on these issues and discussing which subsectors and companies we see as positioned best for long-term success. In our opinion, there has been a secular shift in apparel retailing that is a persistent force. We believe the current trend toward value over brand is here to stay. Unless a product can perform notably better than the competition (keep you warmer, keep you drier, perform better in athletic situations), consumers appear unwilling to pay a premium simply to own a brand. We also think that shifts in wallet share are here to stay, with experience (travel, restaurants) valued over apparel, and other costs--including healthcare, education, and housing--rising in share. Finally, we think the shift in distribution channel toward digital will persist. As a result, we agree that apparel retail growth is not likely to return to historical levels.
Having acknowledged that, we do believe that we are at a low point in the apparel retail cycle and there is future upside. We do not believe brick-and-mortar apparel retailing is dead; however, it will look much different in the future. We think there is a place for stores where consumers can touch fabrics, try sizes, and see fit. However, the apparel industry has experienced much self-inflicted near-term malaise. Many management teams have been overly optimistic regarding inventory levels and have not converted to more modern, responsive supply chains. This has resulted in a highly promotional retail environment that has forced even well-run companies to discount to remain competitive. Also, we think we are nearing the end of the athleisure fashion trend. With consumers having enough skinny and yoga pants to clothe themselves for a while and no new fashion must-haves, nothing is driving discretionary purchases.
Therefore, in the near term, we see downside risk to many names in our coverage universe as company guidance in the fourth quarter of 2015 may not have accurately reflected the unexpected decline in consumer demand for apparel that played out over the first quarter of 2016. We think these issues will take time to correct, and we're cautious on the space in 2016. That being said, we think there is long-term upside as both inventory management and fashion newness can be corrected. When we look at our coverage universe, we think the off-price, replenishment, and apparel manufacturers are best positioned for success. We think traditional retailers and department stores are most at risk.
Off-price retailers are uniquely positioned to capitalize on both consumer demand for value and a very responsive inventory management system. This enables the companies to respond quite quickly to what the consumer wants no matter how volatile the demand. Their buying system enables them to capitalize on overstock situations and maintain their margins no matter how promotional the environment. As a result of this and the benefit of scale in buying, we think these players are somewhat insulated to new competitors. In our coverage universe, T.J. Maxx (TJX), Ross (ROST), and Nordstrom Rack (JWN) fall into this category.
We also favor products that are replenishment in nature and where brand is valued more than price. The innerwear category falls into this camp. Price is actually the fifth decision point for consumers in this category, making the customer much more brand loyal than the general apparel universe. In excess inventory situations, basic undergarments can often be stored and sold later at full price. Finally, consumers tend to replace these products as they wear out, making them slightly less discretionary in nature. We highlight Hanesbrands (HBI), Gildan (GIL), and L Brands (LB) from our coverage universe as in this camp.
Finally, we think that apparel manufacturers can be strong performers, provided that there is solid management execution. Although apparel manufacturers are more exposed to the cyclicality of the industry than the aforementioned subsectors, they are channel agnostic, which provides defense to online trends. In fact, we think many will benefit from this as they can now do business directly with consumers instead of relying on other retailers' merchandising and foot traffic. For example, we note that VF's (VFC) channel exposure is only 4% department stores, 4% midtier, 12% mass, 25% direct to consumer, and 55% specialty stores. Ralph Lauren (RL), in contrast, is more than 50% direct, but also nearly 25% of wholesale is Macy's (M).
Therefore, we think well-positioned brands that deliver either value or technological innovations that outperform competitive offerings will survive and grow. From our coverage universe, we highlight Gildan, Hanesbrands, and VF in this category. Our thesis on Ralph Lauren is that longer-term growth in international, particularly Asia, and growth in accessories and its own stores can offset the department store issues.
We think department stores are most at risk in the long term. As these retailers carry many of the same goods as online retailers, we think they are often forced to compete on price, which puts margins at risk. Furthermore, the sector continues to underperform the general apparel retail environment, and we think it is in a state of secular decline as the format has become tired compared with new retailers. Of our coverage (Macy's, Kohl's (KSS) and Nordstrom), we think Nordstrom is best positioned in the long term because it carries many smaller brands that cannot move direct to consumer and it provides real value in carefully curating a selection of products for a very defined niche consumer, almost like a large boutique.
Bridget Weishaar does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.