In recent weeks we’re gotten increasingly bullish on apparel and footwear stocks as it relates to the frequency and magnitude of likely earnings beats in 2H due to inflation spreads blowing out to levels not seen before in this millennium. To be clear, by ‘inflation spreads’ we’re referring to the change in the prices consumers are paying for apparel and footwear (which are up msd), vs the cost of the goods for the brands and retailers that are selling the goods – and those input costs are tracking down in the low single digits. In other words, we’re seeing ~1,000bp spread between cost and price for the companies, which has extremely bullish gross margin implications – and nearly across the board, that’s not represented in the consensus earnings expectations.
Accordingly, we’re tightening up apparel exposure on the short side of our Position Monitor. Most notably…
Kohl’s (KSS): Removing from our Best Idea Short list, as our back half earnings are roughly 20% ahead of the consensus. We still think that the TAIL call here is extremely bearish – as management’s margin targets (which the consensus believes) are a pipe dream, credit exposure is long-term bearish, and the company has about 40% more square footage than the consumer needs – with very limited optionality around its real estate due to egregiously long-dated leases. We’ll likely come back to the well on this one after we de-risk 2H earnings beats.
Kontoor Brands (KTB): Removing from Short Bias list. The company (Lee and Wrangler), which owns much of its own denim manufacturing, is likely to capture an outsized gross margin due to vertical integration. Also a beneficiary of the denim cycle (which also helps BKE Long Side). Lousy short in this environment.
Gap Inc. (GPS). Like KSS, we’re about 20% ahead of consensus for GPS in 2H. One we’re likely to come back to after a margin pop.
Our remaining apparel short exposure is represented in Stitch Fix (SFIX – Best Idea Short), which already operates a full price model, so it captures less of the CPI upside than other brands. We think that the SFIX model is structurally broken as the company has run out of TAM too many times, and way too quickly. Now its key initiative is to circumvent its proprietary AI and Stylist model and put the buying decision in the consumer’s hands. Sounds like a good idea, but it destroys the financial aspects of the model, requiring materially more working capital, a discounting mechanism, significantly lower operating asset turns (inventory) and far lower profitability than the consensus thinks across durations. If SFIX benefits from the environment we’re describing in 2H, we’d lean much heavier on the short. Ultimately, we think that SFIX is headed back to the mid-teens IPO price.
CarParts.com (PRTS): Though not subject to the apparel trends noted above, we’re also taking PRTS off our Short Bias list, as the cyclical and secular drivers to the auto aftermarket space are in full gear right now. Long side we like AAP and ORLY. But despite the tough comps up and down the P&L, we think that PRTS will likely ‘comp the comp’ in its business model.
