Several key data points we are watching in apparel suggest the margin risk is building. We're not to the point of imminent markdown risk, but we think the trend over the next 3-6 months could easily bring us to that point – and that’s not represented in consensus expectations or management guidance. Apparel names are largely our go-to names to short into this trend, especially JWN, M, DDS, RVLV, RL, OXM, KSS, GOOS, HBI and BOOT. We’d look to the off-price names long-side – especially TJX – which should benefit as inventories build in the channel and promotional activity returns.
A quick review of what has happened over the last year or so. Apparel was pretty much the worst consumer goods category in 2020. Clothing stores retail sales were down 29%. Unit imports were down 17% and CPI was down 5.5%. 2021 saw some pent up demand and a healthy consumer flush with cash from stimulus. Coupled with slow supply chains and retailers chasing demand, discounting was almost nonexistent, and the category saw a rare inflationary moment up 2.5%. That might not sound like a lot, but given that import prices were trending negative, the margin opportunity was immense when spread across the ~29bn annual units we import/consume.
Looking at Retail 2Q and 3Q of 2021 (May to Oct), the average import price started to march up at +2.4%, and the retail price was +3.8%. A small spread, but when you consider the average import price is about $3, and the average retail price is closer to $12, that price change variance becomes nearly 40 cents in profit per unit. Multiply that by the ~15bn units imported in those quarters and it puts the rough apparel margin tailwind at $6bn in the middle of 2021. That’s a $7 billion tailwind for a $280 billion category that operates at a 7-8% EBIT margin. In other words – the industry cranks out about $20-$22bn EBIT dollars a year – and in mid-’21 we saw that profitability spike by over a third.
January OTEXA data was released yesterday and we wanted to highlight a few things are changing in the data over the last few months. Import prices are accelerating as materials inflation flows through the supply chain. The last 3 months saw average imports up 12%. Meanwhile apparel inflation looks to be starting to rollover as January slowed 90bps to +5.2%. That still makes for a margin tailwind in backward looking retail 4Q, but a compressing one.
Unit imports are catching up with the last few months up over 20% YY and trending above 2019. January saw a slowdown, but that might be related to Omicron port capacity issues. Then we are seeing inventories building on the margin for retailers at the same time consumer demand is weakening with rapidly compressing discretionary income. Below is a sample of larger scale apparel retailers. Compared to 2019 inventories are up an average of 18% vs up 5% last quarter. That is with sales going from +10% last Q compared to 2019 to +9% this Q. So that spread has inflected from +6% to -9%. With more units coming and likely further consumption pressure in the months ahead, it's a clear recipe for discounting to start to return at a rapid rate. Again, we are not to a critical level yet, but the data points are trending in the wrong direction for the apparel margin outlook in 2022. This while consensus expectations are for minimal margin reversion from the unprecedented merchandise margins seen in 2021.
We’ve been adding apparel tickers to the short side of our position monitor, and recently those names are also moving higher on the list.
If things play out as we expect, the excess inventory seen in mid to late 2022 will mean great product flow for the off price channel, which is bullish for Best Ideas Long TJX.
