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

It is calculated by adding the number of days it takes to collect receivables to the number of days it takes to sell inventory and subtracting how long until the company has to pay its payables.

While The Gap Inc. (NYSE:GPS) and Limited Brands, Inc. (NYSE:LTD) have cash conversion cycles lasting about one month, Abercrombie’s stretches to 75 days.

A company that operates in a fast-changing industry cannot create consistent shareholder value if it cannot turn its inventory into cash at least as quickly as its competitors. This is a major reason why Abercrombie’s free cash flow has fallen off a cliff in recent years, while Limited and Gap continue to produce ample free cash flow.

Bottom line

There are no sustainable competitive advantages in fashion retail; investors have to believe that companies will continue to maintain historical efficiencies — or improve historically poor efficiencies.

Limited, Gap, and Abercrombie each trade at around 14 to 15 times earnings, but Limited Brands, Inc. (NYSE:LTD) and The Gap Inc. (NYSE:GPS) are more attractive due to their superior efficiencies. If they can continue to be efficient retailers, their stock prices will reward investors more than Abercrombie’s stock rewards its investors.

The article Efficiency Is King in Fashion Retail originally appeared on Fool.com and is written by Ted Cooper.

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