Apparel Stores Industry Analysis

1. Apparel Stores Industry Analysis By: Nick Cecero, Andrew DePalma, Vernon Gair, Sherry Xu

2. Industry overview

3. Overall Industry Recommendation • The overall recommendation for the Apparel Stores Industry is a sell. • Investment Thesis: Due to decreasing EPAT margins across the three comparable companies we will show through our analysis and valuations that our sell recommendation of the industry is justified.

4. Market Performance versus S&P 500 Retail Index SPDR ETF

5. SWOT Analysis

6. Discovery • What We Learned: • Customer Base: All seemed relatively similar of except for GAP. • Instead it was primarily older people, and it seems as though “Baby Gap” is a substantial revenue generator for them and this is something the other three companies do not have. • Stores are closing up in an effort to expand e-commerce business as well as focus on more outlet centers. • Foot Traffic was really slow, and there also seemed to be a lot of people returning merchandise. • Big markdowns (although expected post holiday season) conference calls were all pretty negative regarding this past holiday season, and if most of the companies are having markdowns after a bad holiday season this is bad forward looking guidance.

7. Industry Assumptions • Expected same stores sales growth is expected to grow at 2%-3% year over year for the apparel stores industry. • PPI Index (which measures the average change in selling price received by domestic producers for their output) Jump of almost .5% in March and we expect this trend to continue here on in resulting in the extra costs being passed on to the customers. • Consumer Sentiment although according to the University of Michigan increased to 82.6 in April from 80 in March we believe this trend upward is misleading. This sentiment takes into account gasoline prices, changes in equity markets, and unemployment. Gasoline prices will increase especially with the current geopolitical factors taking place in Ukraine. The real unemployment rate is higher since the number has been dropping due to workers dropping out of the labor force. • Although consumer spending has been rising we believe it will be spent on more durable goods.

8. Market Multiples

9. Valuation Methodology • We decided to utilize the Residual Enterprise Income Growth model since we felt as though the three companies we choose going forward since we believe

10. REI Model AEO

11. REI Model ANF

12. REI Model ARO

13. Aeropostale

14. Underperforming Stock Example • ARO’s stock has declined 37.5% since 1/1/14 • Its Net Income for FY was $-141,831 • Analysts expect losses and decreases in sales for the next two fiscal years

15. Assumptions

16. Sensitivity

17. Gap

18. BusinessOverview • Multi-brand • Gap (39%): casual wear, accessible price pts • Old Navy (39%): family clothing, accessible price pts • Banana Republic (18%): work wear, higher price pts • Piperlime: private-label and trendy • Athleta: Acquired in 2008, premier active apparel • Intermix: Acquired in 2012, luxury and contemporary • Wide age range • GapKids, babyGap, maternity apparel • Different customer base: excluded from comparable analysis

19. Key messages from CFO presentation at 2014 investor meeting: • Industry leader in domestic market

20. Key messages from CFO presentation at 2014 investor meeting: • Gaining progress at globalcompetition

21. Key messages from CFO presentation at 2014 investor meeting: • International expansion • 22% of FY13 total revenue • Speed up Asia operations, esp. China • Treble rev. over next 3 yrs from FY13’s $300m (2% of FY13 total revenue) and increase store count of 80 (FY13) to 110 (FY14) • Omni-channel retailing • Specialty: 81% of FY08 revenue  69% of FY13 revenue • Online, franchise & outlet: 19%  31% • Lowercapitalchannel • Brick-and-mortar retailing concept fading in US • Operation efficiency • Build efficient inventory model • Streamline supply chain • Prioritize revenue growth & maintain healthy margins

22. Implications  Val. Assumptions • Sales growth: steady, 4% perpetuity • Different growth prospects for different brands • Growth by international expansion but faces competition from existing global retailers • EPM: incr., 10% perpetuity • Strategic shift to product mix of higher price pts Incr. • Improved operation efficiency Incr. • Expand store count to regions with higher rent, occupancy and depreciation cost (eg. China) Decr. • EATO: incr., 1.81 perpetuity • Inventory: decr.-improved operation efficiency • CapEx: decr.-incr. in absolute amount to support international store growth and building of omni-channel retailing, but decr. as % of sales (shift to lower capital channels)

23. Valuation: REIModel & Recommendation : HOLD

24. Conclusion

25. Porter’s Five Forces • Existing Competition • Consumer preference has shifted from the “3As” logos, to more traditional styles • Off-price retailers, department & big box stores (TJX, M,Target) • Threats of New Entrants • International Apparel Stores are entering the US and capturing market share. (H&M, Uniqlo) • Substitute Products • Consumers are spending more of their discretionary income on durable goods instead of apparel • Bargain Power of Consumers • Consumers benefit from the increased competition in the market and can price shop

26. Contracting Middle Class • Consumer demand is shift to bimodal demand at higher and lower price points for apparel. • Elasticity of demand of teen apparel customers IBISWorld DI per Capita

27. Brand Risk • Our three firms are not as diversified in their offerings as larger stores • Greater susceptibility to changes in consumer preference

28. Questions???