Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

The Gap Inc. (GPS), Limited Brands, Inc. (LTD): Efficiency Is King in Fashion Retail

Fashion retailers operate in one of the most difficult competitive environments in the entire economy. With no sustainable competitive advantages, companies in this industry must design new products to stay ahead of fashion trends while keeping an eye on efficiency of production. This is a difficult balancing act, but a few retailers have been able to achieve it.

The Gap Inc. (GPS)

For instance, The Gap Inc. (NYSE:GPS) is known for its prudent inventory management despite some merchandising missteps in the past. At the same time, Limited Brands, Inc. (NYSE:LTD) has been able to generate good returns from its signature Victoria’s Secret and Bath & Body Works brands, while keeping expenses low. Meanwhile, Abercrombie & Fitch Co. (NYSE:ANF) has carved out a niche that allows it to thrive.

Measuring efficiency

The long-term success of each of these companies ultimately comes down to efficiency. As part of its effort to achieve efficiency, Abercrombie sells its products at a higher price point than The Gap Inc. (NYSE:GPS) and Limited Brands, Inc. (NYSE:LTD).

Abercrombie’s higher price point allows it to earn higher profits during good times, but lower profits during bad times. This is because price-conscious consumers often favor lower-priced apparel when their income is down. As a result, of operating leverage — a cost structure that mainly consists of fixed costs — Abercrombie’s net income is extremely sensitive to consumer income levels.

Meanwhile, Limited Brands, Inc. (NYSE:LTD) and The Gap Inc. (NYSE:GPS) have broader consumer appeal due to a greater mix of price points. This allows them to earn more consistent operating profits.

Another crucial metric of a retailer’s efficiency is inventory turnover. A high turnover ratio indicates that the retailer is able to replenish its inventory several times per year. Good inventory management limits a retailer’s downside in the event that the wrong trend is stocked in stores.

Limited Brands, Inc. (NYSE:LTD) and The Gap Inc. (NYSE:GPS) manage their inventory better than Abercrombie. This is because the two companies have worked to shorten lead times on ordered merchandise and maximize sales per square foot. Both companies have had merchandising mishaps, but neither were severely affected due to prudent inventory management.

Finally, investors should always consider a retailer’s cash conversion cycle. The cash conversion cycle measures how long it takes the company to acquire and sell inventory, collect accounts receivable, and pay accounts payable. A lower number indicates that the business quickly turns inventory purchases back into cash, whereas a higher number indicates a longer time between initial inventory purchase and re-conversion to cash.

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.