Lululemon Athletica inc. (LULU), DSW Inc. (DSW), The Wet Seal, Inc. (WTSL): Are There Still Opportunities in Apparel?

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Many argue that the apparel business doesn’t offer good long-term investment prospects because low barriers to entry and fashion variations make the companies in the industry highly unstable. However, some firms have proven successful in continually adapting to a changing environment and attracting clients, even through tough economic patches. Lululemon Athletica inc. (NASDAQ:LULU), DSW Inc. (NYSE:DSW) and The Wet Seal, Inc. (NASDAQ:WTSL) are three of these companies. Having performed well in the past, what lies ahead? Are they worthy investments?

In the athletics business

Lululemon Athletica operates in a niche within the athletic apparel business, mainly focused on yoga and other healthy and fun products, aimed to enhancing its customers’ quality of life. Growth prospects are strong for this firm, principally due to its client base’s discretionary spending power. Analysts expect annual EPS growth rates around 22%-26% for the years ahead. However, most of this optimism seems to be priced into its stock, which trades at 44.1 times earnings, more than double the industry average valuation. Same goes for its price-to-book and price-to-sales ratios. So, are these shares a buy? Well, I’d say they are.

Lululemon Athletica inc. (NASDAQ:LULU)Although fundamental investing is not only about financial performance, taking a look at Lululemon Athletica inc. (NASDAQ:LULU)’s figures seems pretty important, given that it leads the industry in almost every metric. Its results look somewhat moated by the firm’s strong brand name, “which will likely make it more resilient through fashion and economic cycles (…) [Furthermore], the company stands to benefit from improving productivity, increased store count and focused merchandising in its trendy and quality-focused apparel in the near term.”

After a few months of problems and complaints about the quality of its popular black yoga pants that had to be pulled out of the market for a while, the company has now restocked them and seems poised to grow. Last quarter’s results, reported on May 10, seem to confirm this. Revenue rose by 21% to $345.8 million from the $285.7 million in the first quarter of 2012, mainly on the back of a 7% increase in comparable-store sales. Additional growth should be provided by a recuperating economy and the incursion into new categories including men’s and teens’ clothing.

In the footwear industry

DSW Inc. (NYSE:DSW) is a footwear retailer that has been catching investors’ eyes for some time now. The company’s strategy of offering a hard-to-match array of high-end brands at attractive prices has lured many customers over the last years, when discretionary spending was limited but many people still wanted to wear branded footwear. As a result, DSW delivered an average annual EPS growth rate of 36.86% over the last five years, and is expected to deliver an extra 13%-15% over the next five.

Its low fixed-cost business model, which reduces labor expenses by operating self-service stores, has procured the firm above-average operating and net margins, of 10.5% and 6.5%, respectively. The management’s track record suggests that the company will be able to continue to widen those margins in the coming years (although it could feel some pressure in the short term).

Despite weak results in the last reported quarter due to bad weather, sales started to rise as it got warmer. Management’s projections for the full year are still positive but limit same-store sales growth to 0%-2%, and EPS growth between 1.5% and 7.5%. Going forward, the company expects to continue expanding its store base at mid-to-high single-digit rates. Further growth should be delivered by its web sales, which have been pretty successful lately.

However, DSW’s future is pretty uncertain; with a replicable model, low barriers for new industry entrants as the economy recuperates and increased competition from companies like Zappos, the firm holds few weapons to defend its ground. Trading slightly above average industry valuations, at 22.8 times its earnings, this stock looks a little expensive for the security it offers (not much).

Targeting teenagers

The Wet Seal, Inc. (NASDAQ:WTSL) is an apparel retailer that targets young and active customers, through fashionable and comfortable products. By offering low-priced products, it has lured many low- and mid-income clients that have developed a certain degree of brand loyalty.

After a weak 2012, the renewal of several management positions and strong merchandising initiatives could serve to turn around the story – last quarter’s results certainly back this theory. With several growth and cost-cutting initiatives running, the outlook seems favorable; analysts expect the firm to deliver an annual EPS growth rate of 48% over the next five years. Trading at 3.4 times its book values and 0.8 times its sales, versus the 4.9 and 1.2 respective industry means, this stock looks like a buy to hold.

The company operates two retail channels, stores and e-commerce websites, and is set to revamp both. This is one of the main factors behind the confidence put in the firm’s future. On the e-commerce front, the company has been investing in overhauling the shopping experience in both computers and smartphones, while expanding its product offerings to draw more web traffic. Regarding stores, the makeover has been even bigger. By hefty investments on advertising, store remodels, visual merchandising and corporate image, The Wet Seal, Inc. (NASDAQ:WTSL) expects to attract more customers, especially young women.

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