Abercrombie & Fitch Co. (ANF), L Brands Inc (LTD): Economics Of Retail

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When you think of teen apparel you probably think of names like The Gap Inc. (NYSE:GPS), perhaps Victoria’s Secret, or maybe even Ralph Lauren Corp (NYSE:RL). Somehow retail continues to do an extremely impressive job of generating yields. Let me illustrate this for you.

Economics of retail

After the 50% decline in the valuation of the SPDR S&P Retail ETF, along with a 50% decline in the SPDRs S&P 500 Trust Series ETF, both the broader stock market and the retail ETF recovered. The gray period on the chart is the recession. During economic recessions, both the broad market and retail indices pulled back by the same amount. But when the economy recovered the S&P Retail ETF was able to grow by 106% over a 5-year period, versus the S&P 500 Trust Series ETF growth of 32.13% in the same period.

The retail sector has been able to generate higher returns on investment than the broader stock market because disposable personal income has been able to recover to new all-time highs since the bottom of the economic recession. Believe it or not, Americans earn more now than they did prior to the great recession.

Clothing purchases are extremely sensitive to income. When income rises the amount of spending on non-durable goods, like clothing, rapidly increases; but when income declines spending on non-durable goods rapidly declines.

Non-cyclical goods (necessities) aren’t as negatively affected by changing income.

Investors should attempt to buy the cyclicals during periods of economic growth and buy the non-cyclicals during periods of economic contraction. Of course timing this is difficult. But I believe that over the next five-years the economy should experience steady growth as the inflationary monetary policy by the Federal Reserve seems to be working.

Three clothing retailers to watch out for

Abercrombie & Fitch Co. (NYSE:ANF) the teen apparel retailer known for its Hollister Co, Abercrombie & Fitch Co. (NYSE:ANF), along with its Abercrombie stores, continues to grow. The growth is driven by a mix of store expansion, higher gross margins, and the improving economy. Analysts on a consensus basis anticipate this company to grow earnings by 20.30% in fiscal year 2013. The company is projected to grow earnings by 17.06% for the next five years, making the 18.5 earnings multiple reasonable in light of the potential growth. The company also comes with a 1.49% dividend yield (for all of you dividend reinvestment planning folks out there, this is for you).

Clothing retail tends to out-perform the broader stock market during periods of economic growth. Assuming the economy continues to grow, and Abercrombie & Fitch Co. (NYSE:ANF) continues to expand its store line-up the company should be able to meet analyst estimates.

L Brands Inc (NYSE:LTD) is a clothing retail company that operates in two segments. The company operates Victoria’s Secret and Bath & Body Works.

Similar to Abercrombie & Fitch Co. (NYSE:ANF), L Brands Inc (NYSE:LTD) is a vertically integrated clothing company that designs, markets, and retails its clothing at its own retail locations. The company primarily markets its products in the up-scale mall locations with the exception of New York City (downtown Manhattan is low hanging fruit). That being the case, L Brands Inc (NYSE:LTD) is heavily focused on expanding its retail store foot print into international markets. Its primary growth initiative is Europe.

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