Why The Gap Is Not The Best Investment

Investors in The Gap believe that the company offers a compelling bullish story that warrants a long-term investment. Bulls believe that the company is on track to break out of its mature specialty retail mold which is characterized by limited growth and high execution risk season to season.

Tough road ahead internationally
The company recently reorganized itself to facilitate an international expansion. Even with the infrastructure in place, there is a long road ahead before these efforts deliver shareholder value. Investors need to be concerned with the fact that US apparel retailers historically have had little success in building strong businesses overseas, especially in Europe where Gap still struggles with its 198 stores. During the company's first quarter 2013 conference call from May 23, CEO Glenn Murphy hinted that its international expansion especially in Europe has a long way to go and faces stiff competition:

I think a lot of the omni-channel work and I travel around the world a lot, seems to be coming out of North America, particularly United States. In Europe, we'd like to get it in there. There are some very good retailers in Europe and they're very innovative. And I think some of the -- they're already advanced in some of these areas, not necessarily in our sector, but in some other sectors. So I think that the sooner we can get some parts of our omni-channel total package into the European business, I think that will help our European brands compete and also allow them to gain some market share.

Not the leader in e-commerce
Urban Outfitters 
holds one advantage over Gap, and that is its online offering. The company's website offers a significant amount of products that are not available in stores, which includes vintage items and extended sizes. This assortment coupled with lifestyle content such as blogs, music videos, style guides, and feature articles, encourages its customers to spend more time and money on the website.

By interacting with the site and making purchases, customers share information that can help the company better predict trends and drive sales. Not only does its broad assortment of goods help drive revenues, it also diversifies the company's inventory investment across many product lines, which limits the company's exposure to potential markdowns from any one specific style.

Urban Outfitters is currently exploring options to develop a one million square foot distribution center which is needed to keep up with increasing demand. The new facility would feature high-tech automation and begin with 500 employees when the facility opens in 2015, with this number reaching 1,500 a decade later.

Recently, analysts at Sterne, Agee & Leach disclosed that they are favoring Urban Outfitters going into the holiday season and are cautious about Gap.

eMarketer released a study that predicts annual online apparel sales will increase from $45 billion in 2012 to almost $90 billion in 2016. As it stands today, Urban Outfitters is set to maintain a leadership position in the online retail industry.

The Gap is soooooo 2012
Colored bottoms were a major benefit to the fashion industry in 2012. However, as we are about to enter 2014, past trends will become irrelevant and new trends will set the shopping tone.

Retailers such as Gap began aggressive marketing campaigns around the colored bottoms fad, such as Gap's "Be Bright" ad campaign. This was a major trend that gave customers a reason to update their wardrobes (blame peer pressure if you must), and it was easy for retailers to execute on this new trend. No new fits, details, or patterns were necessary; just make existing pants in new colors.

Express is better suited than most specialty retailers for a quickly evolving fashion environment. Express's core aesthetic is a little more urban and edgy than some of the more classic, traditional retailers like Gap. This means Express may find it easier to satisfy consumer demands for trends that emphasize dark colors and leather more easily than others. Management is optimistic that it is at the forefront of new fashion trends, and had the following comment during its most recent conference call on Aug. 28:

We are seeing a great response to our below-the-knee looks, our pencil skirt is one example, as fashion shifts in that direction. Having said that, the newer shorter look, including our holiday [ph] party skirt are also doing well. They create a really fresh pairing with either crop tops or chunky sweaters. I'm optimistic that this assortment will bring some progress to a category where we haven't been at our best over the last few quarters. We are certainly seeing some positive signs.

This directly contrasts with Gap, which is lacking a certain degree of "spark" and is less compelling than it was during last year's color trend, according to a BMO consumer research report.

Mind the Gap
Analysts at Goldman Sachs recently downgraded Gap with a $40 price target. The analysts expect that near-term demand headwinds will hamper comp sales and gross margin. The analysts also believe that the company faces many headwinds and weakness which won't be improved on between now and the holiday season.

Shares of Express are up over 100% in the past year, and this company stands out as the true winner in the group. While Urban Outfitters and Gap are both relatively flat year over year, Urban Outfitters appears to be a better fit based on its e-commerce position and infrastructure investments.

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The article Why The Gap Is Not The Best Investment originally appeared on Fool.com.

Jayson Derrick has no position in any stocks mentioned. The Motley Fool recommends Urban Outfitters. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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