The Hedgeye Macro team has been highlighting the inflation accelerating call since last fall. The inflation data in recent months has caught the attention of the Fed and the market as June CPI saw the biggest YY increase since 2008. We felt it was time for us to highlight the apparel specific inflation trends we track on a monthly basis. We specifically watch the apparel import costs and units that are reported by OTEXA in relation to the CPI changes at retail. Monitoring only consumer prices or import costs in isolation is meaningless. This symbiotic relationship helped to make bearish calls on apparel and related brick and mortar space in the past (2019 #RETAIL5.0 | NAVIGATING THE APPAREL DEPRESSION), the trending data now is anything but bearish. After apparel was clearly one of the worst retail categories in 2020, we think it's trending as perhaps the best in retail today. CPI is outpacing the import cost changes so the spread (or “net inflation” as we call it) over the last 6 months is running right around all time highs (or at least back to the turn of the century where our model starts). This immediate term (and through 2H21) trend is very bullish for margins in apparel. We think that we’re going to see GM beats across the whole supply chain – the Brands, Retailers, and OEMs (in Asia). It’s still too early to short this group. Period.
Historically the margins of the apparel retail and wholesale companies have tracked the net inflation/deflation trends. Below we match up an apparel ticker index average gross margin change vs the inflation moves. Perhaps bullish 1Q margins (which have of course been reported) is no shocker to the market given the reversal of Covid reserves and 2021 stimulus help, but the data remains positive in 2Q and we suspect the next few months will continue to see CPI outpacing the import trends. Demand is ramping on re-opening, a return work and socializing, and back-to-school. Raw materials inflation will be flowing through the supply chain at some point, but given the lag and hedging that could still be several months away and if supply chain transportation is still catching up, perhaps discounting remains absent and pricing simply rises more.
An important part of the margin opportunity to keep in mind beyond the inflation spread is the unit velocity. The absolute margin dollar opportunity will rely on the actual flow of units. Apparel imports have still not made up for losses last year. Recent months of have only seen March much above 2019 levels, we’re still undersupplied. This is of course good for full price selling even beyond the inflationary environment, again bullish for margins. The counter argument right now is given the recently worsening port issues, could there be a risk on having enough or the right inventory in place for BTS or holiday? Perhaps. But our take at the moment is that the margin environment remains very bullish for apparel retail and we could see big 2Q and 2H margin upside during earnings prints. This is why we still have several apparel longs on our list despite many of them running up, and it's why we’ve stayed patient on adding more B&M apparel retailers to our list of conviction shorts.
