The Gap, Inc. (GPS) and American Eagle Outfitters, Inc. (AEO) are two of the most popular retail apparel manufacturers based in the United States. With an international market presence, both companies are known for their distinctive products and garments, which they sell through retail stores and e-commerce platforms.

To remain profitable amid a pandemic, the global apparel industry has been adapting to shifting industry trends over the past year. E-commerce sales accounted for most of the revenues generated by companies last year, given the social distancing protocols. However, traditional brick-and-mortar apparel stores are witnessing a gradual rise in foot  traffic lately as the mass vaccination drive and gradual easing of social distancing restrictions drive increasing demand for trendy outdoor apparel. Furthermore, with people engaging in more social activities this summer given the high pent-up demand for such pursuits, sales of trendy garments are increasing. Consequently, the global apparel market is expected to grow at a rate of 20.5% year-over-year to $635.17 billion in fiscal 2021.

AEO has gained 271.4% over the past year, while GPS returned 248.8%. In terms of year-to-date performance, AEO is the clear winner with 76.5% gains vs GPS’ 65.7% returns. AEO gained 91.5% over the past six months, compared to GPS’ 53.8% gains.

Click here to checkout our Retail Industry Report for 2021

But which stock is a better buy now? Let’s find out.

Latest Developments

On May 27, GPS entered a long-term partnership with Walmart, Inc. (WMT) to launch ‘Gap Home’, its first ever home wear collection under a casual lifestyle brand. The new GPS brand is scheduled to be launched on June 24 exclusively on the Walmart website, as per the agreement. GPS is expected to see a  substantial rise in revenues in the coming months, thanks to the rising adoption of hybrid work models and WMT’s immense market presence.

Moreover, GPS is scheduled to buy back approximately $200 million shares this year, as part of its multi-year share repurchase program. This should allow investors to realize higher earnings per share in the coming quarters.

In  April, GPS’ brand Athleta announced its plans to expand to the Canadian markets through e-commerce and retail stores in 2021. This should allow the company’s revenues and earnings to increase substantially in the near term.

AEO has strengthened its sustainability commitment by launching a limited American Eagle jeans collection, which uses sustainable raw materials and production techniques. The rising awareness regarding climate change and other environmental challenges have sparked  the demand for sustainable products. This, coupled with the rising popularity of ESG investing, should allow AEO to grow significantly in the coming months.

And in January, AEO released its “Real Power. Real Growth” strategy, which highlighted its growth strategy and long-term outlook. The company plans to generate approximately $5.50 billion in annual revenues in 2023. And it  expects its operating profit to increase at 15% CAGR over the next two years to reach $550 million in 2023.

Recent Financial Results

GPS’ net sales  increased 89.4% year-over-year to $3.99 billion for the fiscal first quarter, ended May 1, 2021. Its Gross profit improved 508.2% from the same period last year to $1.63 billion. Its net income and EPS were $166 million and $0.43, respectively, representing a substantial rise from their negative year-ago values. Its cash flow from operating activities stood at $340 million, up 136.2% from the prior year quarter.

AEO’s revenues came in at $1.03 billion for the fiscal first quarter ended May 1, 2021, indicating an 87.5% improvement year-over-year. Its gross profit and net income increased 1441% and 137.1%, respectively,  to $436.19 million and $95.46 million from the same period last year. Its EPS stood at $0.46, representing a substantial rise from its  negative year-ago value.

Past and Expected Financial Performance

GPS’ revenues increased 6.1% year-over-year, while its EBITDA rose 35.2% over the past year. The company’s total assets increased at a 21.5% CAGR over the past three years. Comparatively, AEO’s revenue and EBITDA improved 6.8% and 110.4%, respectively, year-over-year. Its total assets increased at a 25.3% CAGR over the past three years.

Analysts expect GPS’ EPS to rise 341.2% in the current quarter (ending July 2021), 178.2% in the current year, 29.1% next year, and at a rate of 4.9% per annum over the next five years. The company’s revenue is expected to increase 22.5% in the current year and 3.5% next year.

The Street expects AEO’s EPS to rise 1,800% in the fiscal second quarter ending July 2021, 5,175% in the current year, 8.5% next year, and at a 7.7% CAGR over the next five years. Consensus revenue estimates indicate a 31.6% rise year-over-year in the current year, and a 7.8% improvement next year.

Profitability

GPS’ trailing-12-month revenue is 3.70 times AEO’s. GPS is also more profitable, with a 47.45% gross profit margin, compared to AEO’s 36.68%. Moreover, GPS’ 16.9% ROE  is 3,700 basis points higher than AEO’s 13.2%.

However, AEO’s 3.38% net income margin is slightly higher than GPS’ 2.76%.

Valuation

In terms of non-GAAP forward P/E, GPS is currently trading at 19.08x, 14% higher than AEO, which is currently trading at 16.73x. GPS is also more expensive in terms of non-GAAP forward PEG (0.80x vs 0.05x).

However, GPS’ trailing-12-month Price/Sales and Price/Cash Flow ratios of 0.80 and 8.33, respectively, compare with AEO’s 1.39 and 29.26.

POWR Ratings

GPS has an overall A rating, which equates to Strong Buy in our proprietary POWR Ratings system. AEO, in comparison,  has an overall C rating, which translates to Neutral. The POWR Ratings are calculated considering 118 different factors, with each factor weighted to an optimal degree.

Both GPS and AEO have a grade of B for Quality, consistent with their higher-than-industry profitability ratios.

GPS has a Sentiment grade of B. This is justified because  JPMorgan and Barclays analysts have rated the stock Strong Buy. AEO, on the other hand, has a Sentiment grade of D, in sync with multiple analysts’ Hold rating for the stock.

Of the 65 stocks in the A-rated Fashion & Luxury industry, GPS is ranked #8 while AEO is ranked #37. In addition to the grades we’ve highlighted, we have also rated GPS and AEO for Momentum, Value, Growth and Stability.

Click here to view all GPS Ratings. Get all AEO Ratings here.

The Winner

AEO is known for its specialty products, such as jeans and T-shirts, while GPS’ diversified products make it one of the biggest specialty retailers in the country. GPS’ latest movements to establish its industry dominance and strengthen its market share are expected to drive its financials significantly in the near term. This, coupled with GPS’ higher profitability, make it a better investment bet now.

Our research shows that the odds of success increase if one bets on stocks with an Overall POWR Rating of Strong Buy or Buy. Get all the top-rated stocks in the Fashion & Luxury industry here.

Click here to checkout our Retail Industry Report for 2021

GPS shares were trading at $32.57 per share on Tuesday afternoon, down $0.88 (-2.63%). Year-to-date, GPS has gained 62.62%, versus a 12.62% rise in the benchmark S&P 500 index during the same period.

About the Author: Aditi Ganguly

Aditi is an experienced content developer and financial writer who is passionate about helping investors understand the do’s and don'ts of investing. She has a keen interest in the stock market and has a fundamental approach when analyzing equities. More...

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