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Express, Inc. (EXPR), Urban Outfitters, Inc. (URBN): Specialty Retailer Selling For A Bargain

I focus on merchandising strategy and inventory control when I evaluate a specialty apparel retailer for investment, and Express, Inc. (NYSE:EXPR) scores well on both points. Express adopts a cautious customer-focused approach to reduce fashion risk , and is able to optimize its supply chain to enhance margins. In addition, Peter Lynch would call this stock cheap at a PEG of 0.63, and I agree with him.

Not leaving fashion to chance

Express Inc (EXPR)Like any other apparel retailer, Express, Inc. (NYSE:EXPR) tracks sales data and all forms of fashion media, and also sends its people overseas regularly to fashion fairs and exhibitions to monitor current fashion trends. However, Express’ prudent customer-focused approach to merchandising sets it apart from its competitors. Express minimizes the risks of selling unwanted merchandise by avoiding being ahead of fashion trends.

While some of its competitors make big bets on fashion trends by selling to the early adopters, Express, Inc. (NYSE:EXPR) focuses on selling apparel that is already currently in fashion and accepted by the vast majority of its targeted customer base. This is reflected in Express’ conservative merchandising strategy of testing a high proportion of new products before mass ordering. According to its analyst day presentation, Express currently places close to 75% of new products in selected stores to gauge customer feedback before making company-wide orders, which is a far cry from the 20% of products tested prior to mass order before 2007.

Disciplined inventory control drives margins

Express, Inc. (NYSE:EXPR) outsources all of its manufacturing to third party suppliers. In addition to lowering costs of goods sold and minimizing inventory write-downs, this flexible supply chain strategy also allows Express to easily shift merchandise budget from planned products not ordered yet to trending products in demand quickly. Margin enhancement provides further evidence of such disciplined inventory control. Express’ average gross margin of 35.5% for the past three fiscal years represented a huge improvement from the 2008-2010 average gross margin of 27.8%. For the past six years, inventory days have been maintained at less than two months.

Growth drivers

Among the growth opportunities available to Express, e-commerce appears to be the most promising. Express, Inc. (NYSE:EXPR) grew e-commerce as a proportion of total sales from 5% in fiscal 2009 to 13% in fiscal 2013. Management commented at its most recent earnings conference call, that apparel with the highest price points have been among the best-selling items, which bodes well for improved margins. Also, Express manages its e-commerce platform in-house, which speaks volumes since you only keep what is core within the company.

Peer comparison

Express’ peers include Guess?, Inc. (NYSE:GES) and Urban Outfitters, Inc. (NASDAQ:URBN). Express, Inc. (NYSE:EXPR) is undervalued relative to its peers with a forward P/E of 10.8; in comparison, Guess and Urban Outfitters trade at 13.1 and 18.5 times their respective forward P/E ratios.

Guess has transformed itself in the past decade from a domestic-focused player to a global retailer with more than 1,600 stores in 88 countries. While Europe used to account for 1% of Guess’ sales and Asia was non-existent in its portfolio ten years ago, Guess now derives close to half of its revenues from Europe and Asia, which also deliver higher operating margins than its domestic operations. Guess?, Inc. (NYSE:GES) recently scored a victory in Milan, successfully defending itself against trademark infringement claims brought by Gucci. The words used by the Italian court in the judgment “the remarkable notoriety of the GUESS trademarks” bears testimony to the branding power of Guess.

With customers of specialty retailers are known for being fickle-minded, Urban Outfitters, Inc. (NASDAQ:URBN) customers seems to be of a different breed. According to its analyst day presentation, more than half of Urban Outfitters’ active customers are enrolled in its loyalty program, which drives impressive repeat purchase numbers. The top 10% of its customer makes an average of 12 purchases annually, while the top quartile buy its products 7.5 times per year. Strong customer loyalty, coupled with growth in its direct to consumer sales channels such as mobile have resulted in record sales for Urban Outfitters, Inc. (NASDAQ:URBN).

Conclusion

Express, Inc. (NYSE:EXPR) is cheap with a forward P/E and PEG of 10.8 and 0.63, respectively. I particularly like its prudent customer focused approach to merchandising , which helps to reduce the risk of filling up the stores with unwanted products.

The article Specialty Retailer Selling For A Bargain originally appeared on Fool.com and is written by Mark Lin.

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