Why savvy investors are eyeing apparel retailers

Despite an ongoing pandemic, consumers are eager to spend on goods and services.

  • By Andrew Graham,
  • U.S. News & World Report
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Consumers tended to forgo flashy fashion statements during the darkest days of the coronavirus pandemic, favoring worn-in sweatpants and T-shirts over fresh jeans and blazers. But now that families and individuals are returning to schools, restaurants and travel destinations, savvy investors should take note: The apparel industry is poised to benefit.

Until recently, Wall Street tended to underestimate the resiliency of clothing retailers. During the height of pandemic shutdowns, the chances of a prolonged recession seemed high, and many investors believed personal balance sheets would take a beating.

That's not exactly what happened. While not everyone got by unscathed, personal savings rates remain above pre-pandemic levels. Moreover, consumer sentiment remains elevated from early 2020, thanks to multiple rounds of stimulus, the rollout of vaccines and businesses opening without restrictions.

Although concern about the COVID-19 delta variant is warranted, the likelihood of negative lasting economic impact may be overblown. Nearly all emerging policy changes are focused on ramping up vaccinations and encouraging masks, not forcing businesses to close. As long as that doesn't change, strong consumer demand and easing supply chain pressures will continue to fuel a recovery.

Keep an eye on apparel retailers

The apparel industry may be one of the chief beneficiaries of a reopening economy. But lately, Wall Street has underrated the strength of apparel companies, with much of the industry easily overshooting earnings forecasts in the first and second quarters of 2021.

Aside from improving economic conditions, the overperformance has been due, in part, to firms shedding real estate expenses and slashing head count during the pandemic, resulting in bigger margins. And the recent momentum should continue into the latter stages of 2021.

That's because, while the lockdowns were an event, the reopening will unfold in different phases. And Americans are only in the early stages of that process. People are just now beginning to travel again, attend events and head back to the office.

Millions of kids are returning to school, and the holiday shopping season will arrive in a few short months. Along with child tax credits hitting bank accounts, these developments should lead to further spending in this area.

Meanwhile, another boost to apparel companies is the emergence of a new denim cycle. About once per decade, jean fashion undergoes an evolution. For years, the preference – especially among young people – was for a skinnier, formfitting cut. That's beginning to change, with a looser, more high-waisted style beginning to take hold.

This type of phenomenon typically sparks a chain reaction. Indeed, shoes, tops and accessories that are a good match with one pant style often don't go well with another. As a result, people spend money to update their wardrobe.

Retail stocks to watch

In this environment, investors should eye a couple of apparel companies poised to do well:

  • American Eagle Outfitters Inc. (AEO).
  • Tapestry Inc. (TPR).

Read on for more details about why each apparel company is set to take flight.

American Eagle Outfitters. Though the company's most recent earnings report disappointed, with revenue growth coming up short of expectations, management raised guidance for operating income for the fiscal year. What's more, roughly half of the company's store leases are set to expire soon, providing an opportunity to capture additional profit based on lower rental payments.

Meanwhile, AEO should benefit more than other apparel retailers from child tax credits, the back-to-school season and the emerging denim cycle. Over the last year, executives have also cut the company's once-sprawling brick-and-mortar footprint, improving its cash-flow model. If anything, the recent pullback in American Eagle's stock price could give investors a better entry point.

Tapestry. With flagship brands Coach, Kate Spade and Stuart Weitzman, Tapestry's top line should benefit into the holiday season and well into 2022 as global tourism returns to form.

Look for margins to improve as executives continue to streamline operations and focus more on its better-performing e-commerce business. Trading at roughly $40 per share, the stock could easily approach $60 by year-end.

Takeaway

Businesses and consumers continue to adapt to an uncertain reality. But with spending making a stunning comeback and a national personal savings rate remaining high, the latest indicators show that the country is ready for change compatible with growth.

Whether it is a new denim style that could drum up sales or the rise of hybrid clothing and elevated casual for the return to the office, the power of dress is back. For the right apparel retailers, the future looks bright.

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