CONCLUSION: 2022 is going to be one hell of a wild ride in Retail – we’ve already gotten a taste in the first two weeks of trading. If there is any one key critical uncertainty to master in Retail today, it is understanding the net puts and takes in the consumer’s wallet (and savings account) and the consumer’s propensity to spend by year and by quarter throughout the pandemic, as well as which Retail sub-sectors and companies benefitted the most/least from a generational (and unsustainable) peak in spending/sales, margins, profitability, and returns. Then, ultimately, we need to drill down where consensus expectations offer up the biggest variance for meaningful deviation (up and down) vs economic/financial reality. Couple that bottom-up approach with a dynamic Macro climate – most notably Quad 4 (growth and inflation slowing) in the same quarter (Q2) that is perhaps the most ‘uncompable’ quarter in the history of retail, and you need to be extraordinarily careful what you own, and importantly, when you own it. If you can’t short stocks, you’re going to be in a world of hurt – particularly as the market discounts the Retail earnings misses we’re likely to see from April through November. We outline the big picture TREND and TAIL Consumer (wallet change) and Retail puts and takes in this note. But we’ll have a detailed deck on Wednesday January 19th where we’ll go through these trends in detail, including our favorite investment ideas – both long and short.
DETAILS
We got a lot of positive feedback on our deep dive into the Retail P&L on our 1Q22 Retail Themes & Idea Hunt Black Book. There we highlighted retail the stellar year retail had in 2021, and the mismatched TAIL consensus expectations by subsector vs what would likely be reality in the coming years on normalization.
After several recent conversations about the consumer setup into 2022 where investors had extremely differing viewpoints, we decided to take our analysis a step further and dive into consumer income and outflow trends over a TAIL and TREND duration to match up the setup for retail in aggregate and the retail subcategories. We'll go through the data in detail in a presentation on Wednesday, January 19th at 10AM EST.
Call Details
Date/Time: Wednesday, January 19th at 10am EST Add to Calendar: CLICK HERE
Live Video Link: CLICK HERE
Here is tasty sample of what we will be presenting on Wednesday.
The Retail Industry P&L
Everyone knows that 2021 was a big year, but we don’t think people appreciate just how big it was. Retail sales were up 17.2% to $3.6 trillion, with EBIT clocking in at ~$232 billion, or 51% higher than any single year in history. Catch-up from 2020 + a consumer flush with cash drove the outsized top line. Gross margins ‘over earned’ by ~150bps (big given total EBIT margin of ~6%) due to strong demand, tight supply, and minimal promotions in the face of a generational surge in freight costs. SG&A showed surprisingly little leverage due to higher labor costs and e-commerce investment. Balance sheets improved to the healthiest levels on record for modern-day retail. All in, we can make the case that profitability and return on capital in 2021 is not only the highest it's ever been, but is the highest level we’ll see over the next decade, which is a pretty massive statement in itself.
The Annual Consumer P&L View
When we look at the Annual Consumer P&L it paints the picture as to how we got to such a great year for Retail. The last 2 years saw a build in income per capita of $7,300, which is a major surge in the Consumer’s top line and capacity to spend relative to any historical norms. That increase was driven by the $5,200 increase in Personal Transfer Payments (made up mostly by government social benefits/stimulus). The savings rate in 2020 also spiked, meaning a full kitty (to spend in 2021) on top of the incremental 2021 transfer payments and rising wages amidst inflation. All together these factors meant that despite the inflationary cost pressures, the consumer was able to take up discretionary Goods PCE spending up 20% YY in 2021 for total Goods PCE increase of $2,500 per capita.
The risk now, looking at the trend in government help vs inflationary pressures, is if we assume relatively consistent 2-year price trends on necessities (with theoretically constant volumes) and a reduction in transfer payments equivalent to 2021 stimulus and enhanced UI, the large spending tailwind becomes a large spending headwind. There’s a $2,800 per capita pressure in spending that would have to be made up by wages/salary growth and/or tapping into savings. For context, wage and salary growth would have to exceed what we saw in 2021 per capita dollar growth, and 2021 was more than 2x the dollar growth of the best year seen in this entire economic cycle. In other words, barring the personal savings rate going to zero, we’re going to see a major snap back in spending in some key retail categories -- which is a supremely bearish setup for retail in aggregate.
The TREND Consumer P&L View
Here is the quarterly setup. The key callouts are how the elevated savings rate (pre-funded spending capacity) and the 1Q21 stimulus payments drove the ability for a multi-quarter step up in Goods PCE at the same time Services PCE was normalizing. Calendar 2Q21 was the highest spend period and the hardest upcoming comp, though 2H isn’t much easier. Wage/salary income growth is facing harder compares and the savings rate has fallen to below pre-COVID levels. This makes for a very challenged discretionary spending setup for the majority of 2022, but especially in the March to November time frame.
The likely pushback to the bearish setup is the opportunity for wage and salary growth and tapping into savings to offset the other income headwinds. This argument has some merit, and we'll dive deeper into it on Wednesday's call, but our early indications are that a significant majority of savings has been concentrated with the top 10-20% of households. This analysis is the average of things, while the median tailwind to headwind inflection likely looks worse, and the lower-end consumer worse still.
TAIL & TREND Category Detail
To help with the hunt for the companies with the most risk, here are some breakdowns of relevant retail related PCE categories over both a TAIL and TREND duration. Nearly every category has a tough compare. Some outsized consumption category standouts for 2021 vs 2019 include RVs, Jewelry & Watches, Pleasure Boats, Sporting Goods, PCs, and Home Tools/Equipment. Though we'd also flag categories where repeated consumption is uncommon, like household appliances, video and audio equipment. You can gradually furnish, update, redo a multiroom house, but once you buy a new fridge, oven, TV, computer, etc. you are not likely to be in the market again a year later, especially when we think how/why people bought during the pandemic. Like extra food stocking, home office, home learning etc.
The TREND duration compares are similar, a lot of tough category comparisons starting in 1Q and building. Cosmetics/beauty, new vehicles, and motor vehicle parts/accessories/service probably has the easiest growth comparison setup. Clothing (garments) looks relatively easy, but that’s where the gross margin reversion risk is greatest, so it won’t take much in the way of demand drop to punish EPS YY.
Macro #Quad4
Our Macro team highlighted the impending Quad4 (growth and inflation slowing) in 2Q22 on its 1Q22 Macro Themes call a couple weeks back. They have also just recently flagged the rising Quad4 risk from the market signal and a potential pull-forward of the market pricing in the ultimate deflation event. Our analysis of the consumer P&L setup very much echoes that Quad4 view given the importance of the consumer in US GDP.
In Quad4 Retail underperforms in aggregate. The best subsectors to own are those that deal with as little discretionary as possible. That means staple like retail like Dollar Stores, Warehouse Clubs, Walmart, and even beauty (though less so) like ULTA or BBWI. Also, Auto Parts and Auto Maintenance have been strong outperformers in historical Quad4s.
On style factors stay with quality, lower beta, and higher cap. The worst areas to be are high beta, momentum, mid to small cap, lower quality.
Here are some other good charts from our macro team that also help frame up the Quad4 risk.
