In light of the ongoing consumer recovery, fashion retail sounds like the perfect place for investors' money. And yet, even as wages recover and consumer spending shows further signs of uplift, a shadow of doubt lingers over the apparel sector as changing modes of consumption create anxieties both in the high street and the boardroom.
Nonetheless, John Stevenson, retail analyst at broker Peel Hunt, suggests that several stocks in the space are primed for a re-rating as weak comparatives from last autumn/winter (one of the worst seasons on record due to mild weather) make year-on-year growth far likelier. However, we think the best way to identify the standout performers is to break the sector down into the online, high street and luxury retail segments.
A disruptive presence in the market
It's no secret that the internet has changed the way consumers shop - and that's been particularly true in the case of apparel. With the advent of video modelling, detailed size charts and free delivery, the appeal of shopping for clothes from the sofa has grown. This has obviously caused major problems for some traditional bricks-and-mortar retailers with no prior online presence.
The most widely cited online fashion retailer is Asos (ASC), which first joined Aim back in 2001. From admission through to the early part of last year, the retailer's shares gained a phenomenal 216,823 per cent. Put another way, an initial capital outlay of £1,000 at IPO would have garnered well in excess of £200,000 over the period.
Lately, however, Asos has come under fire. The share price has fallen from a peak of 7,050p in February 2014 to its current level of 2,994p as the group's performance has been marred by heavy capital expenditure, squeezed margins and profit warnings. There are still obstacles ahead as Asos invests heavily in its warehousing capacity, while industry-wide pressure to slash prices is intensifying. What's more, it's only been a matter of days since the group's founder and long-standing chief executive Nick Robertson announced he would hand the role over to chief operating officer Nick Beighton. Mr Robertson set up the business fifteen years ago and has been credited with much of the company's long-term success. He will remain on the board as a non-executive director for the foreseeable future, but a management change like this usually causes a wobble in the share price as investors get used to new hands on the reins. That said, over the long term, some analysts are convinced Asos still has a stronghold on the online market - and a forward PE ratio of 84 is actually the cheapest rating for some time.
One of Asos's closest competitors is relative London-newcomer Boohoo (BOO). The online retailer and family-owned group joined the market early in 2014. Although the IPO was deemed a success, a wider downturn in e-commerce stocks hurt the share price, as did an unexpected profit warning in January. The Peel Hunt analyst said that investors are "absolutely right" to have trust issues with Boohoo, but he also believes that the warning amounts to "a blip" and that Boohoo's shares are more likely to re-rate than those of Asos. Margins are solid, and the group is up against seriously weak comparative figures after the disastrous autumn/winter 2014 season. On a six-to-12 month view, Mr Stevenson says Boohoo is the stock to pick "purely on valuation grounds". A forward PE ratio of 34 might not sound cheap, but it's at a time when e-commerce ratings are at an all-time high.
Brand is everything
The success of online retail has thrown some traditional high-street chains into turmoil. So it's interesting to evaluate why some have been more successful at weathering the storm than others. What makes propositions such as Next (NXT), SuperGroup (SGP) or Ted Baker (TED) more compelling than, say, Marks & Spencer (MKS) or French Connection (FCCN)?
It seems there are two answers. The first is specific to Next, whose traditional catalogue business has enabled it to rapidly adapt to an online business. Most of the necessary infrastructure to serve an online customer base was already in place, and there wasn't the need to win over a different kind of customer.
The second factor relates to the product offering. What keeps customers going to Ted Baker - either online or on the high street - is brand identification. Labels like Ted Baker and Hackett are not synonymous with fashion trends; instead, they make a statement about the consumer. As a consequence, the outlet has established a mature customer base, complete with a high rate of discretionary spending power. And Ted Baker has been able to use the internet to its own advantage. By setting up overseas websites, the group has been able to tell where international demand is strongest, and where opening stores overseas would offer the best returns.
In the eyes of the market, French Connection simply made the mistake of alienating its customer base. French Connection veered away from its original roots towards a brand unduly influenced by fashion trends. This, according to some City analysts, demands a cheaper price point which French Connection failed to offer.
Another example of customer alienation - and why 'brand is everything' in this space - is luxury retailer Mulberry (MUL). The luxury sector isn't as reliant on online trading - its core customer has no issue travelling to a store and is often seeking personalised service anyway. With luxury, the product speaks, as does the price point, and Mulberry's decision to close access to the brand by hiking its prices backfired horribly. Now the company is suffering significant price deflation as it corrects the work of previous chief executive Bruno Guillon. Its wholesale division has also been injured in the process, with sales there down nearly a third to £38.8m in the year ended March.
Marks & Spencer's mistake was its seeming inability to produce a retail website that is user friendly. Having relaunched the site in 2014, online sales fell more than 8 per cent in the following quarter. These miss-steps make it harder for retailers to mitigate weather-related sales slumps; rain or shine can be a key factor in driving customers into the shops.
IC VIEW:
It's clear that embracing an online business model has been crucial for the apparel sector and most companies have endured different levels of success. It's also clear that being an online-only business model doesn't guarantee smooth sailing. There are still challenges ahead: the concept of free delivery is one City analysts suspect is "fundamentally unsustainable" and recent moves by companies such as John Lewis to curb its free delivery orders suggest this might be true. Ratings are also at an all-time high (particularly for e-commerce plays), so identifying which stocks have re-rating potential will be key for investment success this year.
Favourites:
Despite having placed Boohoo on a sell recommendation we now appreciate it has a more significant opportunity to re-rate than Asos. Crucially, margins there seem more robust than Asos and its rating offers better value. Other recovery plays include SuperGroup, which has taken back control of its US expansion and has made conscientious efforts to evolve its products. Finally, quality core holdings should include Next (for the track record of shareholder returns in particular), and Ted Baker, which has managed to grow with its customers in ways not seen elsewhere on the high street.
Outsiders:
For now our outsiders have to include Marks & Spencer, French Connection and Debenhams (DEB). The last of which reported half-year figures ahead of expectations but the competitive rating reflects how much cash management is pouring into bringing its sales systems up to scratch. Deciding whether the group has truly turned a (permanent) corner in terms of positive like-for-like sales growth is anyone's guess. Finally, we are concerned about Burberry (BRBY). The luxury apparel group's share price is flat year on year despite climbing to a peak of 1,929p in February. The majority of group sales come from outside the UK, but a deceleration in Hong Kong has caused a recent sales slide in Asia Pacific - a crucial market for Burberry. While sales growth remains positive at the group level, and as the Chinese growth issue looms large, we don't see a near-term catalyst to perk up the share price.
