Fashion or Fitness – What’s a Portfolio Manager To Do?
Apparel is considered a discretionary purchase. Really? Most would agree we have little choice as to whether or not we purchase and wear clothing, and it’s considered ‘de rigueur’ in most social settings. The array of apparel choices is truly mind-numbing and drives a $1.7 trillion global market. Options span the most basic Gildan Activewear cotton t-shirt sold by the gross to vendors for silk-screening early in the supply chain, to non-branded apparel at Walmart, to national and specialty retail brands, all the way to the rarified luxury world of a Chanel tweed jacket priced at $10,000. There is something for everyone.
Branded apparel companies (both wholesalers and specialty retailers) such as Ralph Lauren, PVH (Calvin Klein, Tommy Hilfiger, Lacoste et al.), JCrew, and Gap differentiate themselves in the market by appealing to targeted consumer segments based on age, lifestyle, and income, as well as their interpretations of prevailing fashion trends for their demographic segment. Therein lies the rub! Fashion is fleeting and supply chains are inconsistent. Balancing the tightrope of enough fashion to be relevant, while not too trendy to incur speedy obsolescence, is the fashion merchant’s Gordian knot. Imagine doing this for two to four seasons a year!
Fashion may be a glamorous business, but as it scales, by its very nature, it becomes less desirable. What woman is pleased to discover she’s wearing the same dress as her hostess? As Dick Haynes, founder and CEO of Urban Outfitter so aptly phrased, “big is the enemy of cool.” Contrast this with the sports apparel business, where rather than focusing on the next big thing/trend in fashion, attention is on iterative innovation with technically-based improvements. Performance breakthroughs create a bond with the consumer while the brand itself becomes synonymous with technological innovation driving superior performance—along with sales and healthy merchandise margins at the corporate level. And it does scale, so that “bigger is cooler.”
Sports apparel is a very lucrative subset of the apparel industry; less of a fashion risk, and ubiquity is a plus, benefiting from a tribal recognition of lifestyle attributes. Wearing the same jersey or jacket is not a fashion faux pas. This translates into a considerably larger market opportunity. Team sponsorships—spanning middle schools to national teams—create brand loyalty at an early age that potentially lasts a lifetime. Sports celebrity endorsements are another marketing tool that drive engagement and loyalty. Endorsements, combined with frequent product performance enhancements, create the marketing buzz for sports apparel to maintain street cred, plus provide consumers with high-performance products with a high cool factor. VF Corp. was a pioneer in technologically-advanced products for the professional and enthusiast alike, along with Patagonia, Nike and UnderArmour.
Leading companies differentiate themselves comparable to best-of-class CPG (consumer product goods) companies by iterative innovation and marketing. In 1995, UnderArmour virtually invented compression apparel for serious athletes to regulate body temperature by wicking away perspiration and thus enhancing comfort, mobility and performance. At VF’s North Face, best-of-class mountain climbing equipment has been grounded in performance since its founding in 1966 with a commitment to research design and development that birthed the rucksack with lighter suspension features than traditional frame packs. At Patagonia, climber Yvon Chouinard founded the company on handmade re-usable chrome-molybdenum steel pitons in the early 1960s, and by 1970, Chouinard Equipment was the largest supplier of climbing hardware in the US. Because of damage to the environment, the business was phased out replaced by manufactured aluminum chocks (that could be wedged into the mountain rather than hammered) that sold faster than Chouinard could make them and marked the company’s emblematic dedication to caring for the planet. The coolness of high-performance brands resonates with a sophisticated, yet aspirational, New York urban shopper wearing serious performance gear to fight a two-foot snow bank on the corner of 42nd and 5th. She only dreams of sheer face mountain climbs in British Colombia.
Today’s purchasing behavior reflects a heightened value equation driving apparel sales since the 2008-2009 recession, which led to systematic markdowns at retail, undermining brand equity. Sales continue to be challenged by the destruction of too many apparel brands to name, as well as the consolidation of the department store channel and the price transparency ecommerce provides. Apparel has become less of a vehicle of prestige and self-expression (and increasingly more commodity-like); accessories, such as footwear (the infamous red-soled shoe), handbags, sunglasses, and watches are today’s status builders.
Health and wellness are growing trends in developed countries, spanning multiple age groups. Sports apparel easily addresses these behavioral shifts. According to the Outdoor Foundation, 141.9 million Americans participated in outdoor recreation in 2012, taking an average of 87.4 outings for an overall total of 12.4 billion. Hiking, running, and jogging are among the top five activities among youth (6-24 year olds) and adults (25+). A solid growth strategy for sports apparel and outdoor brands is the ability to extend their brand equity to footwear and other sports, following the lead of North Face and UnderArmour.
Where’s the Love?
February 14th, 2014, wasn’t a very loving day for sportswear leaders, VFC and UnderArmour. The former reported weaker than expected Q4 sales and provided 2014 guidance modestly below market expectations (VFC shares closed down 5.1% on the day). The latter got called out for losses of the US speed skating team at Sochi (and UA shares dropped 2.4%). We think investors will recover and get over it.
Meanwhile, VFC shares in February were trading at a 18.5 forward P/E multiple, and a 33% discount to its sports apparel peers, a real buying opportunity in our view given the strong momentum for its Outdoor & Action Sports Brands and its lobal growth opportunities. Last June VFC articulated its five-year growth plan with an objective of $17.3 billion in revenues by 2017, for a 10% CAGR with acquisitions supporting 200 basis points of growth. The North Face just surpassed $2 billion and Van’s, $1.7 billion. A 16% operating profit margin and EPS of $4.50 are 2017 goals, up from 2013’s 14.5% and $2.71 respectively are doable in light of VFC’s strong brand portfolio and management acumen.
Competition Heightens with New Entrants
That said, given the favorable demographics, lifestyle and purchasing trends, competition is heating up from traditional apparel companies as well as health and fitness companies. In addition to Gap’s Athleta and Lululemon, L Brand’s Victoria’s Secret Sport, Curves International, a chain of fitness centers for women, recently launched a performance and lifestyle apparel line of 20 pieces designed to be functional and flattering, many with breathable wicking material, comfortable compression and gel cushioned straps. Another recent entry is H&M, which dressed Swedish Olympic teams in Sochi (and will clothe the Swedes for the 2016 Rio de Janeiro Summer Olympics). The Swedish Olympic team provided input and inspiration for the special capsule collection of functional sports garments, named Go Gold. This line has been available at select locations in the US since January 2014. We applaud the creativity of fashion and function at H&M, but constant attention to performance improvements are necessary for continued success in the sports apparel business as VF and Patagonia can attest. Time will tell whether H&M has the stamina for this business marathon.