TWST: Kimberly, as we look out at 2005, what's the outlook and what are
people thinking about?Ms. Greenberger: We're feeling near-term cautious about the group, its
record sales numbers during Q12004, and also about the record operating
margins for most retailers in 2004. Here in the near term, we're having
a difficult time finding a catalyst to drive the stocks higher,
particularly given that the sector is now trading at about a 5%-10%
multiple premium to the S&P 500 when it has historically traded for a
20%-25% discount multiple to the S&P 500. The valuations are feeling
sort of full, and as far as the near-term catalysts, we have some risk
that against the first quarter comparisons, comps could come in a little
on the light side. And against record-high margins, we're just not
seeing a lot of near-term upside to the earnings estimates. As we get
further into the year, we get far more constructive and certainly think
that, particularly given that retail started to slow down in the June
time frame last year with the ramp up in oil prices, the second half of
the year is looking much more interesting for the stocks.TWST: Gabrielle, how about your perspective as we look out at 2005?Ms. Kivitz: We're also maintaining a somewhat selective viewpoint with
respect to our recommendations. I really take a bottom-up approach. The
theme we've been talking about is sticking with names that are showing
strong pricing power. Pricing power comes from a combination of having
the right product and strong execution and should really lead to strong
top line and margin performance. But echoing what Kimberly just said,
valuations are not necessarily low. The PEG ratio for our group, based
on our estimates, is 1.2. Strong performers are getting premium
multiples, but companies that have had challenges are also trading at
premiums and, in some cases, even higher premiums than the strong
performers as the market is discounting some improvement in these
businesses. I do think there are some opportunities for second half of
the year turnarounds, but for now we're really sticking with that theme
of strong pricing power.TWST: Liz, how about your perspective as we look out?Ms. Pierce: It is fairly similar; one of the things I am most concerned
about is last year's difficult comparisons. As Kimberly mentioned, a lot
of companies are operating at or close to peak margins, and other than
Easter, there is not a strong spending catalyst. So the combination of
peak margins and difficult comparisons does make one wonder how much
higher stock prices can go. We have adopted a thesis fairly similar to
what Gabrielle mentioned in terms of sticking with companies that have
more or less been immune to some of the volatility in the economic
environment and the geopolitical environment. We do not really see light
at the end of the tunnel in terms of extending beyond that limited group
of companies until we get into the second half when comparisons get a
little easier.TWST: Neely, how about your take on what 2005 is going to look like?Ms. Tamminga: We also believe it's about stock selectivity right now.
Some of the things that we are focusing on include those brands that are
relevant and differentiated, as well as those brands that emanate
somewhat of a status within their respective demographic groups. That
said, we're coming up against very difficult comparisons, and nobody is
denying that. I think those that weather the storm best are those that
are levered toward the increasing price points, whether it's through
better status, better quality products or further differentiation from
the pack; that is how you maintain your pricing power in this
environment.TWST: What do these retailers have to do to set themselves apart?Ms. Tamminga: I think Urban Outfitters (URBN) is a good retailing
concept to point to. At Urban, they really house a portfolio of brands
instead of being their own brand. Right now in fashion, it's all about
having exactly that right brand, whether it's Diesel jeans or Citizens
of Humanity denim or a Modern Amusement shirt from Mossimo (MOSS). It's
about having something very unique and presenting it in a very boutique-
y environment. There are some retailers that play that trend better than
others, and I think Urban Outfitters is one of those.TWST: Gabrielle, in this crowded environment how do these specialty
merchants go about setting themselves apart from the pack from your
perspective?Ms. Kivitz: When I look at apparel retail companies, I evaluate the
brand, the competitive position and points of differentiation. In terms
of the fashion offering, I think they have to be trend relevant in a way
that is applicable to their customer or brand. That's always important
in terms of emulating whatever the trends are but to do it in a way
that's right for the customer or brand. I think Abercrombie & Fitch
(ANF) is a good example of a brand that is really offering
differentiated product. They're a fashion leader. They're trying to
become even more of a fashion leader now, and it's really all about the
product, the aspirational brand and the store environment in the total
package.TWST: It becomes harder and harder. Kimberly, what's your view on what
these retailers have to do to maintain and establish a position?Ms. Greenberger: In terms of differentiation, I would second the comment
that was made about Urban Outfitters being one of the retailers that has
shown an ability to differentiate its products. I think differentiation
comes in a number of different forms. For the Urban Outfitters and
Anthropologie divisions, I think their differentiation comes not only
from the product and the fashion point of view and the level of
freshness that they continually strive for in their assortment, but also
the shopping experience, which provides a mix of hard goods and soft
goods and a very uncharacteristically interesting environment (for a
mass retailer or a chain retailer) that's not easy to replicate. One of
the things they do have is a visual management team on staff at every
store. There's a lot of additional payroll that's required for that, but
we think that the payoff is there in terms of both sales and margins.
There are other ways to differentiate or to establish as a retailer. I
think Chico's FAS (CHS) is another good example of a retailer that's
differentiated. I think they do it on a couple of different metrics. One
is fit and fashion, and two is really what I think is the magic of the
business, which is their marketing and customer service point of
differentiation. This is a company that reaches out to its 5 million
plus frequent purchasers every month with a catalog that reminds them to
come back into the store because every catalog has a coupon in it that
gives them an incentive to do that. They also compensate their store
level employees on a commission basis. They're one of the few retailers
that does that today. Most retailers, at least in the universe that I
cover, have switched over to a regular hourly wage or a salary with
sales goals, but there is no real incentive to exceed those sales goals.
Chico's pays their employees on commission in order to deliver very
superior customer service, and I think superior customer service in this
day and age is absolutely a point of differentiation. There are a number
of different ways to either compete or differentiate or to establish as
a retail business, whether it's through the fashion point of view,
product quality and fashion, shopping experience or environment, or
level of customer service or marketing. There are a number of retailers
in this sector that excel at one or several of those dimensions.TWST: Liz, how about your view on this whole idea of differentiation?Ms. Pierce: I think it is particularly important because with lead times
changing as rapidly as they have been changing, it seems that a lot of
me-too or sameness develops very quickly, so retailers need to figure
out what else they can do to drive that traffic. I believe that Kimberly
and Neely both pointed out two companies that have great formulas, which
have been very effective at driving traffic. In today's retailing
environment where consumers have so many options, it is not just product
or price anymore; it is about great customer service, ambience and
marketing. If you look at some of the more successful retailers, there
is a common theme and that is tapping into what makes that customer shop
and what makes that customer commit money once they walk in the door.
For each company it may be a variety of attributes and each company has
to put these attributes, together into an equation to come up with their
specific winning formula.TWST: So it's not easy.Ms. Pierce: No, I doubt any of us would say it is easy.TWST: Gabrielle, as we look at the specialty segment, are they
continuing to gain market at the expense of the old-line department
stores, or is that balance beginning to come back?Ms. Kivitz: If you look at the overall market for apparel you'd see
pretty slow growth, so it really has become more a game of market share
gains. Dollars are still coming out of the department stores and going
to specialty retailers and to the discounters. What's unique, though, to
specialty retailers is that they do have that close contact with the
customer; they do have a brand that they can use to speak to that
customer, and they can really read their customer better and respond to
their customer faster than some of the other channels.TWST: Neely, is there any chance that as this consolidation goes on that
the department stores can come back and reestablish a position?Ms. Tamminga: We wouldn't count the department stores out, really,
because they are still the house of brands and multiple brands at that.
What we are seeing right now in terms of fashion is a status cycle in
bottoms, particularly with denim brands, and we haven't really seen this
cycle since the 1980s. We find it very interesting that the only place
to really play this in specialty retailing would be boutiques or Urban
on a national basis; otherwise you have to go to Nordstrom (JWN). So we
do believe that if this fashion cycle continues, department stores are
going to get that traffic back. As a matter of fact, national traffic
has actually been coming back here somewhat, and it's not from the
teens; it's from the parents. Looking back over the past three years,
national mall traffic has been on a downturn, but recently it has been
coming back. We think if you talk to the mall owners, they'll tell you
that teens never left, so it's the parents coming back. We even see this
in the proprietary teen research that we do in which we talk with about
700 teens every six months across the United States. We also talk to
some of their parents, and we noticed in our most recent survey this
past fall that the parents are talking more about department stores than
they have been before in the past. So we think that there could be a
trend here. Don't count the department stores out.TWST: Liz, are department stores dead or not?Ms. Pierce: I totally agree with Neely. I have been covering the retail
sector for a long time, and I have seen multiple waves of investor
sentiment ranging from the death of the discounters to the death of
departments or the specialty retailers. I do not think any sector ever
goes completely away; their popularity just seems to ebb and flow.
Although I do not cover any of the department stores at this point, they
have 'walked' many categories, i.e., kids, electronics and soft home to
a lot of the big box retailers. I do not believe they are going to let
apparel go that easily as evidenced by the emergence of several more
moderately priced high profile designer brands being showcased at
department stores. So I believe the department stores are going to put
up a tough fight. And Neely is right. The department stores historically
have always been the launch pad for brands, which is why consumers have
historically shopped there.TWST: Kimberly, are department stores going to continue to lose share,
or are they going to be able to stabilize things here?Ms. Greenberger: The most recent NPD data we have access to did show a
slight share loss in 2003. The 2004 numbers are still being finalized,
so we don't have those yet. But prior to the 2003 time frame, the
department stores had been losing share at a faster rate. So it looks
like, in line with what my colleagues are indicating, the flow has been
stemmed here, and the department stores do seem to be bouncing back.
What is interesting today and what may be helping the department stores
is that a lot of small emerging brands are capturing a tremendous amount
of buzz, especially among the celebrity community, and because of our
fascination in this country with all things celebrity, it's being
quickly disseminated to the masses through publications like InStyle
magazine and other celebrity-watch magazines. Many of those brands seem
to be housed in department stores. So I would say unlike years past
where department stores had a fashion cycle that they could capture and
then subsequently potentially lose share, now it seems that there is
actually a return of buzz around many of the brands that department
stores are carrying. But I would absolutely agree that it's much more
among the young contemporary brands rather than the more 'missy'
oriented brands. But department stores are secondarily making strides
with their private label programs, and many of them have decided that
they need to increase their commitment to the private label in a way
that makes them greater head-to-head competitors with the specialty
segment. And we'll see if they can execute the task of vertical
integration as well as the specialty sector has. The jury is still out.
The retailer that seems to be doing the best job at a private label
business, according to Deb Weinswig, our broad lines analyst, is J.C.
Penney (JCP), so she thinks that they're ahead as it relates to that. I
think that is a point of differentiation for department stores, whereas
in the past they've really not had much of a point of differentiation,
at least among one another if you looked at department stores of the
same price point.TWST: Gabrielle, as we look out this year and next, are these specialty
retailers going to continue to open stores aggressively, or is the
slowdown in mall construction going to constrain them?Ms. Kivitz: We are expecting most of these retailers to continue to open
stores. There still is a lot of growth opportunity for a number of
companies. However, over the last few years we have seen a slowdown in
growth rates as it becomes increasingly difficult for these companies to
sustain high growth rates on larger store bases. We are also in an over-
stored environment, which is something that has been talked about for a
long time, but I do think that there are still demographic opportunities
where the market is under-stored. One untapped demographic opportunity
is men and women in their 20s. That demographic is growing as the older
segment of Generation Y has graduated from college, and these
individuals are moving to cities and starting their first jobs.
Retailers capitalized on this generation when they were teenagers, and
now the lifestyles and needs of these customers are changing. There
aren't a whole lot of retailers that focus on that segment or do so in a
way that's relevant to the preferences and or tastes of this generation
or to their new lifestyles. I also think the baby boomer customer has
been under-served or maybe misunderstood, and there could be room for
retailers to expand in this segment and really appropriately address
that customer as well. So although we will probably continue to see a
slowdown in growth rates, there's room for brands that have strong
competitive positions, particularly those that serve untapped
demographic opportunities. Gap (GPS) and Limited Brands (LTD) were
historically the pioneers in this industry and have set standards in a
lot of ways as well. Both of these companies now are really looking at
more or less flattish square footage growth. There are still some growth
opportunities, but overall it's really flattish. The focus at both of
these companies, in addition to finding new growth opportunities, is
really about how to maximize the existing brands and improve sales-per-
square-foot productivity and profitability.TWST: Liz, what's your take on expansion potential for this space?Ms. Pierce: Depending on the retailer's target audience, I would
actually use the word selective when describing expansion. But the
interesting thing about retail is the very low barriers to entry. The
retail sector is always evolving. So even though we may think square
footage growth is limited right now, new concepts seem to be born when
we least expect it. Another thing that is happening right now is older
companies are closing stores and retrenching while they look for new
ways to drive growth. Thus, I believe it is hard to look beyond the next
couple of years and determine how much square footage growth is really
legitimate.TWST: Neely, are expansion opportunities still available?Ms. Tamminga: Absolutely. Though it's not so much whether expansion is
there or not, it's where it is going. If you look at where the real
estate developers are building right now, the focus is less about the
traditional regional enclosed mall and more about the off-mall lifestyle
center (of course, lifestyle centers here meaning a strip center with a
lot of shrubbery and good parking). That's certainly where the trend
seems to be going. The attraction is about focusing on the right age and
income demographics. So you have a baby boomer customer who might prefer
to shop off-mall, so opening more deals toward the off-mall kind of
makes sense. For the retailer it's advantageous because the lease deals
are better. So we think it's going to be more about these off-mall
lifestyle centers in terms of near-term development.TWST: Neely, whom are these off-mall centers catering to? Is this the
big box discount side or more the up-scale?Mr. Tamminga: I think you're seeing a little of both. A good example
would be a development very close to me where they have Bed Bath &
Beyond (BBBY) and a Kirklands (KIRK) and a J. Jill (JILL) and a
Coldwater Creek (CWTR), so the mall is focusing on a variety of price
points and demographics as well as shopping patterns. If anything, it
just helps protect them in terms of making sure there's a traffic flow
to those centers.TWST: Kimberly, how about your views on expansion opportunities for the
group?Ms. Greenberger: I would definitely concur with the prior comments in
terms of square footage growth now being promising among a few select
companies. But by and large the sector-wide square footage growth has
decelerated dramatically from where it was back in the late 1990s. At
that point you had Gap putting up double-digit square footage growth
along with Abercrombie, American Eagle Outfitters (AEOS), Pacific
Sunwear of California (PSUN), and a number of the other retailers in the
sector. What we're finding now is the evolution of this specialty
retailer as their original concept or their core concept reaches the
point of saturation. Many of the management teams are hatching a second
concept and, in some cases, a third concept in order to provide
additional opportunities for square footage growth. So in the sector
we're seeing a certain metamorphosis among the management teams from a
single-brand management or a single-regional concept management
structure to one that is multi-branded or multi-concept. That is
probably an indication better than any that I can point to that would
say that the core businesses of many of these retailers are reaching the
point of saturation.TWST: When they reach saturation as we saw with Gap and Limited, what do
they do?Ms. Greenberger: As Liz pointed out, they retrench and right-size their
real estate portfolios. Generally speaking, during the go-go growth
years, most of these retailers over-expand and occasionally sign lease
deals that they might later regret, so they have an opportunity to
rationalize their store base and get a little smarter about their
existing real estate portfolio. Many of them also look to remodel their
existing concepts to maximize the efficiency of their existing square
footage, and Limited Brands is in the process of doing that,
particularly in the Victoria's Secret business. But once you reach that
point of saturation and maximize your existing real estate portfolio,
really the opportunity would be to develop a second concept.
Occasionally retailers have looked toward acquisitions as an additional
way to grow. Children's Place Retail Stores (PLCE) just acquired the
Disney Stores recently, and about a year and a half ago Chico's acquired
the White House/Black Market business, both of which we think can
provide each of those retailers with some very solid square footage
growth.TWST: Liz, we've been talking about expansion here. How about the other
side with consolidation? We've seen some specialty retailers fail. Are
we going to see more?Ms. Pierce: I think so because consumer preferences change and things go
in and out of style. If retailers do not adapt quickly to changing
consumer preferences, it sets the stage for consolidation. For example,
just recently Forever 21 announced that it is acquiring Gadzooks
(GADZQ). We believe the junior customer has changed and the retailers
that traditionally catered to this customer have not adapted quickly
enough to these changes. Two other junior retailers that continue to be
under a lot of pressure are Wet Seal (WTSLA) and Charlotte Russe (CHIC).
If history serves as an example, adaptation is a necessary survival
tactic. Just look at what happened to Merry-Go-Round. In addition to
expanding too rapidly, another reason the company did not survive is
because it did not pay enough attention to the changing environment and
what its customers wanted. So I would not be a bit surprised to see
further consolidation and/or contraction of space; I believe
rationalization of retail estate is a healthy thing.TWST: Gabrielle, are we going to see a further shakeout in this market
space?Ms. Kivitz: I think we could. I have to agree. I think what gives
longevity to a retailer is having points of differentiation. This is an
industry where the barriers to entry are very low, but the barriers to
success are high, so it's all about points of differentiation and
establishing a strong competitive position, and then it's about a
combination of product and execution. I think companies that do have
that probably don't have the threat of going away. For the most part,
the companies on my coverage list do have those points of
differentiation and strong competitive positions, but I do think that we
could see failures of smaller retailers that are falling short either on
execution or on establishing a competitive position for the brand.TWST: Neely, is a consolidation or shakeout in the space coming along?Ms. Tamminga: Yes, I think that that's always a possibility every year.
It's becoming far more costly these days to be a publicly traded
company. Some of these guys are spending $1 million to $2 million this
year just on Sarbanes-Oxley compliance. But I think that we'll probably
see a couple of major merger/acquisition announcements in 2005 in the
women's apparel space, and you could probably see some consolidation
still at the core brand level if you look at the apparel brands in terms
of the manufacturers.TWST: Are we going to see more failures as well?Ms. Tamminga: I think that's usually what happens before you come to the
table for an acquisition. So yes, absolutely, I think that you could
have more bankruptcies.TWST: Kimberly, consolidation and shakeout in the space?Ms. Greenberger: Absolutely. I do think we'll see some rationalization
and failures, and consolidation to the extent that we're seeing what I
would call bargain hunting-driven consolidation. This appears to me to
be more reasonable than paying up for a healthy retailer, because at the
end of the day there's very little asset value associated with most of
these retailers. There is a tremendous amount of brand value held by
some of them but obviously not all. What's interesting historically as
you look at the bankruptcy trends is that every 10 or 15 years we seem
to have a shakeout and it's hard to know whether that is driven by a
change in fashion, a change in the retailing landscape, or exactly what
it's driven by. But the last good round of bankruptcies that we had was
in the 1994-1995 time frame. We had Merry-Go-Round and County Seat and a
number of other retailers really struggling and shutting a lot of stores
at that point. We haven't had a good cleansing in the sector since then
and it certainly feels like we've had enough of a change in the
landscape over the last 10 years to lead potentially to an acceleration
in the cleansing or a fallout in the sector, if you will, over the next
year or two.Ms. Tamminga: I'd love to share my favorite quote from Les Wexner, the
Chairman and CEO of Limited Brands. He's always said, 'Bad inventory
will only give you indigestion; it's bad real estate that will kill
you.' So I think if you look at who has the real estate problems, that's
where you'll see the most shakeouts.TWST: Neely, following up on that, bad real estate sounds like bad
management. Is there a shortage of good management in this specialty
retail space?Ms. Tamminga: Yes, I think there's a paucity of talent, and that's
mainly because of the tech boom. Wooed by bigger paychecks, people
shifted their focus away from retailing as a career during the tech boom
in the 1990s. So we have this great crop of old-school guys running
retailers, but we're lacking some bench strength in the ranks.TWST: Gabrielle, is there a shortage of good management in the specialty
retail area?Ms. Kivitz: I think what's going on with management in the specialty
retail area is actually quite interesting. Specialty retailers
historically were single-concept companies that then came out with
second, third and fourth concepts to sustain growth, and they now have
found themselves as quite large organizations in many cases. Some of the
merchants that did a commendable job of building and growing brands may
not want to run large, multi-division organizations. So now some of the
larger retailers are going outside of the retail area to bring in
executives who have experience running large, multi-division
organizations or who can bring new expertise to the organization. Gap
is one example. Mickey Drexler retired a few years ago after a very long
tenure at the company. When he retired from the company, he expressed
his passion for creativity, customer connection and merchandising, and
said that his passions had been upstaged by the demands of running a
global $14 billion company. The company then hired a CEO and CFO from
outside the apparel retail area ' two individuals from Disney. Limited
has gone even more the academic route and more the consulting route, and
I think we may see that increasingly from other specialty retailers as
their businesses grow.TWST: Kimberly, is there a shortage of talent here?Ms. Greenberger: If you ask retail management whether there is, for
example, a shortage of merchant talent, I think they would say, 'Yes,
there is a shortage.' My view is that there is something of a shortage
of very solid retail talent, in part because the traditional training
ground for merchant talent was the department store training program,
and because of the consolidation in the industry and the problems the
department stores have had, or at least the financial problems
department stores have struggled with over the last 10 or 15 years, many
of those programs have been downsized and/or eliminated. So there is no
place now other than on-the-job training for merchants to get really
terrific, well-rounded experience in the different aspects of the
business. I think that is leading to a dearth of new, emerging talent.
However, even the very, very, very best merchants out there, even the
talent that we've got in the industry, those people can't be 100% all
the time. And because the fashion business is somewhat cyclical and
there's a lot of competition out there, the margin for error is quite
slim. So if you're not 100% all the time, I think even the smartest,
most talented merchant can look somewhat less stellar on a regular
basis. And it's not because they're not incredibly talented people; it's
that it is very, very difficult to execute six, seven, eight or nine or
10 lines flawlessly every year, year in, year out, without making any
mistakes.TWST: I guess we could ask Mickey Drexler about that. Liz, how about
your take on the management in the industry?Ms. Pierce: I would echo all three of my colleagues' comments. There
seems to be a shortage of skilled merchants and, as Kimberly pointed
out, it is likely a function of industry consolidation, especially at
the department store level. Unfortunately, an additional byproduct of
consolidation and the corresponding expense cutting has been the
elimination of many of the buyer-training programs; programs that helped
many of today's successful merchants develop their skill sets. I also
believe managers struggle today because it is difficult to blend the
'art' and 'science' of retailing. Historically, retail has been thought
of as more of an art, and today with so many tools at a retailer's
disposal, it has also become a science and I believe the best managers
find some type of happy medium between the two. If a manager has not
developed the scientific skills to better understand the art, it becomes
difficult to apply the science. I further worry that retailers are
becoming too regimented or too automated in terms of buying and
merchandising, which is unfortunate because I believe we will lose so
much of the uniqueness that inspires customers to spend. So I do not
want to label it bad management, I just think we have limited the
development of the skill set for what it really takes to be a good
merchant in today's very competitive retail arena. It needs to return to
a better balance between art and science, if you will.TWST: Regarding the science side, how are they doing at using technology
to better their businesses?Ms. Pierce: It has always been something of a joke that retailers are
the last to adopt technology, because the 'old school' management style
was basing buying decisions partly on past performance and partly on a
belief that the retailer knew better than the customer what the customer
wanted, and it was difficult to ever challenge that creative side. But
the beauty of all the science is being able to focus, down to the SKU
per store, to see what is or is not working. I believe the best
merchants will try to tap into the science part of the equation that
technology provides and combine their own instinct, their own perception
and their own take ' i.e., the art ' to the buying and merchandising
process.TWST: Kimberly, are these specialty merchants good at utilizing
technology at this point?Ms. Greenberger: I would say that the specialty retailers are utilizing
IT more now than ever, exactly as Liz had said. We are still seeing many
retailers implement new IT programs, including more robust planning and
allocation programs; customer relationship management programs that will
help their stores target their customers a little better; and mark-down
optimization programs that will help companies decide when and if to
take mark-downs and how drastically to mark down items. But all of
these, in particular mark-down optimization, really have just been
adopted here for the last year or two. Retailers in the softlines sector
were not particularly early to adopt technology relative to other parts
of the economy. But now that the interest is there, they seem incredibly
willing to take a look at these new technologies and then really use
them to maximize their profit and loss.TWST: Neely, are we seeing good use of IT here?Ms. Tamminga: It's definitely improving. But I think it's tied very
closely to the fact that the decision makers in the IT process, pretty
much up until very recently, have come from the old school. The
improvements have almost been pure systems updates (for example,
purchasing new computers from the last time they had to upgrade, which
was probably around Y2K issues). Necessity has been the genesis of them
implementing some of these new software programs and getting all their
systems up to speed. Retailers themselves will admit, with some laughter
under their breath, what late adopters to the technology they have been.
So I would just say that it will come. It has come slowly, but it will
come with improvements. Systems improvements, we believe, could actually
take the margins a little higher, past the peak that they are now
seeing. Circling back to the initial comments my peers have made, we
agree that we're at peak margins and we believe it's systems that can
take it higher beyond peak.TWST: Gabrielle, is IT usage going to help as we look forward?Ms. Kivitz: Apparel retailers have higher operating margins than other
retail segments, and some of this is due to the emotional impact that a
brand, lifestyle, store experience or product offering can have on a
consumer. Consumers are willing to pay up for fashion or for an
inspirational look. Apparel retailers are able to charge a significant
markup for differentiation and creativity, and because operating margins
were already strong, I don't think they felt the pressing need to be
innovative or proactive with systems ' compared to supermarkets, for
instance. That's my take on why this group has historically been late to
innovate with systems. They really didn't have to do so in order to
maintain strong margins. With recent systems initiatives like the
planning and allocation, markdown optimization and distribution
initiatives that Kimberly, Liz and Neely mentioned, we're already seeing
some benefits, and some companies have even been able to quantify the
benefits to margins. I'll also mention customer loyalty programs. I
think companies are realizing more and more how much they can get out of
better connecting with their customer by doing a better job of tracking
customer data and really being able to maximize customer loyalty
programs using technology to help drive more top-line opportunities. So
I do think companies are realizing more and more how helpful these
improved systems can be and how they can help them reach new levels of
profitability.TWST: Neely, when you go out and talk to institutional investors at this
point, what's the key question or concern you hear from them?Ms. Tamminga: I think they're really trying to figure out where to place
their money. It's really a balance between going for the growth names '
and growth has been decelerating, as we've discussed ' or just paying
premium multiples for the names that have been good in terms of
consistent performance.TWST: Kimberly, what are you being asked when you go out and talk to
investors?Ms. Greenberger: Most investors, at this point, appear very interested
in the turnaround stories in the sector. I would say that nine times out
of 10, in meetings or in conversation, 'What's the next turnaround
story?' is absolutely one of the first questions investors ask. In this
sector, these retailers tend to occasionally get themselves into
trouble, but the nice thing is that with every season there's a new
opportunity to emerge as a better business with a more appropriate
assortment. So it's sort of a revolving door of turnarounds. Last year,
the really phenomenal turnaround stories were American Eagle Outfitters
and Children's Place, and Abercrombie & Fitch toward the second half of
last year and the beginning of this year had tremendous stock price
performance, based, in part, on a turnaround in its business. So the
investment community today ' particularly because of valuations ' seems
to be very interested in playing the turnarounds, those retailers that
are not operating at peak margins, those that have easier sales
comparisons. That really seems to be where the interest lies in my
conversations.TWST: Liz, give us your perspective. When you talk to these investors,
what are they asking you?Ms. Pierce: I would say it has been a very bipolar response. As both
Kimberly and Neely have pointed out, there has been a lot of interest in
'turnarounds' or 'surprises,' but I have also had several discussions
about the viability of paying premium prices for a successful company.
Even if the company has a good track record and significant organic
growth, it is a challenge to convince investors to pay up for these
attributes. Two examples are Chico's and Urban Outfitters. Based on
their fairly pristine track records, unique merchandising strategies and
legitimate organic growth, we believe they are core retail holdings and,
therefore, deserve premium multiples.TWST: Gabrielle, when you talk to institutions, what are the issues?Ms. Kivitz: Investors always seem to be concerned about the volatility
in comp performance in this group and really getting comfortable,
particularly when comparisons get more difficult. If momentum is strong,
can it continue? I think it leads back to what Kimberly and Liz
mentioned; it does prompt a number of investors to actually focus on the
potential turnaround stories where comparisons are easier and the chance
of a miss is not as great, considering the business momentum is already
weak. I think the second concern that investors have is actually one
that you asked earlier ' people wondering if there are too many stores
and how much real growth opportunity there is. Are the potential store
bases that we talk about realistic or are they too high?TWST: Gabrielle, what are you telling investors to do at this point?Ms. Kivitz: As I said before, we're still very selective. Our theme is
sticking with retailers that are showing very strong pricing power, and
we think those companies will continue to show strong top-line and
margin performance. So that's really what we're recommending.
Abercrombie & Fitch and Urban Outfitters are our top picks, and we're
sticking by those names. We are also recommending Aeropostale (ARO).TWST: Liz, how about you? What's your advice to investors at this
juncture?Ms. Pierce: I have been pretty firm about sticking with companies that
have had consistent execution and companies that we believe still have
an opportunity for margin expansion and legitimate organic growth. But I
also have been intrigued and have been pushing some ideas that I would
call early-stage turnarounds. While it is a riskier strategy, there are
obviously clients out there who have a high tolerance for greater risk.TWST: What are some of the names that you like?Ms. Pierce: We call these companies 'our best-of-breed companies,' which
include American Eagle, bebe (BEBE), Chico's and Urban. The emerging
turnarounds are Limited Too (TOO) and Talbots (TLB).TWST: Kimberly, what are you telling investors to do, and what do you
like?Ms. Greenberger: Two of our favorites are Chico's and Children's Place.
We like Chico's because we still like the very solid organic growth as
mentioned by Liz and others on the call. The consistent execution there
has also been quite good. Moreover, as you get beyond the spring,
Chico's actually has easier comparisons relative to their historical
comparisons the rest of the year than they've typically been up against
because of things like the hurricanes in the third quarter of last year
that hurt their business somewhat. We like Children's Place as a margin-
expansion story. For investors who are looking for a retailer that
doesn't have a peak margin with excruciatingly difficult sales
comparisons, we think the acquisition integration and continued
operating-margin opportunities in their core business provide for very
attractive earnings growth.TWST: Neely, how about you? What are you telling people to do, and what
are your favorite names?Ms. Tamminga: Similarly, we are telling investors who own stocks like
Chico's to sit nice and tight, 'Don't sell those great retailers.' But
we're not recommending that people put new money to work in those names,
given the valuations and the very difficult comparisons that they're up
against. That being said, on the longer-term side, for people who maybe
have a longer time horizon for a couple of turnaround stories, we do
believe that J. Jill and AnnTaylor (ANN) are two stocks worth investing
in. Simply put, these are very relevant brands that are top of mind for
their core consumers. These companies are just dealing with near-term
execution or inventory issues ' it's not a real estate issue for them,
it's an inventory issue ' and we believe they will overcome these near-
term issues and really provide some upside to margin and earnings
growth, looking long term.TWST: What should investors look for in those two in terms of signposts
that things are getting better? Comps?Ms. Tamminga: Of course, same-store sales are the blood pressure to all
of retailing, and that's something to look for ' but some of the
turnaround you really won't even see until probably September of next
year for AnnTaylor in terms of their core business. In the meantime, we
recommend that people actually be out in stores checking out the
assortment, seeing how people are responding to the product, because
these are the types of brands that fly when they do work. They are
getting the traffic across their lease line; that's not the problem.
It's the conversion rate that can lead to upside surprises in any given
month. Buy them opportunistically, and we think it will reap good
rewards by year-end.TWST: Any names to stay away from at this point, Neely?Ms. Tamminga: I'm going to pass on that question. Some of the names that
I think you would not necessarily want to own are names that we don't
currently cover, so I probably can't speak to them.TWST: Kimberly, any names to avoid or worry about?Ms. Greenberger: I think I'm going to take the Fifth on that one.TWST: Gabrielle?Ms. Kivitz: I'll try one out. I do have a sell rating on Charlotte
Russe. I've had a sell on it since last fall. I get concerned here
because I think that company at this point lacks a strong competitive
position in a segment ' fashion at value price points ' that's become
increasingly competitive. This has been a potential turnaround with
starts and stops, but I'm not really seeing the improved product or
execution quite yet. They've had some management transition recently,
too. As the company comes up against tougher comparisons in the next
quarter, I think things could get somewhat challenging. I think some
investors have been interested in the name partly because the comp
comparisons are so very easy, and operating margins have eroded so much,
and people are looking at the opportunity and thinking that maybe
there's a bottom here for the stock. But what's of concern is this is
probably the only name on my coverage list where the competitive
position is not strong enough, and there really isn't enough of a point
of differentiation to garner any kind of longevity, which means that
Charlotte Russe may not turn around. If things get really bad, it could
ultimately turn into a Wet Seal or Gadzooks situation.TWST: Liz, any names to worry about?Ms. Pierce: I do not have sell ratings on any companies, so I suppose in
the technical sense, I do not have any avoids. But I would echo
Gabrielle's comments and the concerns I mentioned earlier about the
state of the junior market and the players that operate in that space. I
think the junior customer has changed, which begs the question of the
viability of those companies operating in that space and whether they
can adopt a formula to meet those changing needs.TWST: So it's a space to worry about.Ms. Pierce: Exactly, I think it's a space to worry about.TWST: Gabrielle, any closing comments you'd like to make?Ms. Kivitz: One thing we didn't talk about that's important is the
strong balance sheets of the companies. Most of them have very large and
growing cash positions with, essentially, no debt. They've been using
their large and growing cash balances to aggressively buy back shares,
and we expect that activity to continue. I think that's a really new,
big thing going on with these companies: while the growth rates are
slowing, the cash balances are growing, so investors are being rewarded
in new ways.TWST: Forgive me for not asking that. I hadn't thought of good balance
sheets as going along with retail.Ms. Kivitz: Actually, the specialty retailers do have very strong
balance sheets, given the high operating margins, strong cash generation
and lack of debt. We've even started to see new dividends ' Abercrombie
& Fitch initiated a dividend last year ' and I think that too could
continue as the cash balances grow.TWST: Liz, any balance sheet comments to make?Ms. Pierce: That is a great point Gabrielle mentioned, because it is the
balance sheet being so healthy for a lot of these specialty retailers
that gives them the ability to come up with another concept ' to do
their R&D and to see what is next to ignite the square footage growth.
It is one of the reasons I really enjoy the specialty retail space,
because it is always evolving and there is always something new
happening.TWST: Kimberly, what's your take on balance sheet positions here?Ms. Greenberger: I would echo my colleagues here. We've always had
fairly good balance sheets in the sector. We may have never had cash
balances as high as those we're seeing today. In part, we think, because
the sector is more mature today than it was five years ago, the internal
need, or the internal opportunity, to redeploy that cash has diminished
somewhat and, as a result of that, given the strong free cash flow
nature of these businesses, we've seen a steady cash build over the last
two, three or four years ' and finally, shareholders are encouraging
managements to take a look at using that cash for more productive uses
than putting it in the bank at 1% or 2% interest!TWST: Things like dividends and stock buybacks?Ms. Greenberger: Exactly.TWST: Neely, how about your take?Ms. Tamminga: It's the same. Obviously, Limited's actions in 2004
(buying back their stock and offering a special one-time dividend) were
significant. Clearly, that was pointing in the right direction for
anybody else who's amassing significant increases in cash. Shareholders
will encourage companies to return that or use that cash. Secondarily, I
think you'll see the companies spending more on technology.TWST: Thank you. (TJM)Note: Opinions and recommendations are as of 03/07/05.KIMBERLY GREENBERGER
Citigroup Global Markets, Inc.
388-390 Greenwich Street
New York, NY 10013
(212) 816-6409GABRIELLE KIVITZ
Deutsche Bank Securities
60 Wall Street
16th Floor
New York, NY 10005
(212) 250-6311ELIZABETH O. PIERCE
Sanders Morris Harris
333 South Hope Street
Suite 264
Los Angeles, CA 90071
(213) 253-2241NEELY TAMMINGA
Piper Jaffray & Co.
800 Nicollet Mall
Suite 800
Minneapolis, MN 55402For disclosure information, see www.twst.com.Copyright 2005 The Wall Street Transcript Corporation
All Rights Reserved
Apparel Stores >> Roundtable >> March 14, 2005
ROUNDTABLE FORUM: SOFTLINES & BROADLINES RETAIL
KIMBERLY GREENBERGER, Director and Senior Retail Analyst covering the
specialty apparel retailers, joined Smith Barney in July 2004. Prior to
joining Smith Barney, she spent nearly five years covering apparel
retailers at Lehman Brothers and Credit Suisse First Boston. Ms.
Greenberger has leveraged her industry experience successfully, having
worked for bebe stores, inc... More










