Ulta Beauty (ULTA) | Adding to Best Idea Short List. We think that the recent quarter is as good as it gets for ULTA. Any way you cut it, despite re-opening tailwinds in beauty, growth is slowing in the core business, the company is starting to acknowledge specific competitive pressures such as Sephora/Kohl’s and Amazon (after a generation of taking share from department stores), noted that promotions are likely to step up in 2022, and is being dinged (along with the rest of consumer discretionary) by higher labor costs. In other words, the 15% margin that ULTA just put up in 2021 is the best we’re likely to see – ever – with reversion on a slower top line to 12%-13% over the next two years. That syncs with the company’s guidance, which implies about 2% EPS growth – EBIT down, offset by lower share count. Even if it’s a sandbag (which we’re not convinced it is), we’re still looking at well below 10% EPS growth for what was once one of the preeminent growth stories in retail. Unit/store growth is slowing, it’s cannibalizing its own growth with the Target partnership, and still carries a 13.5x EBITDA multiple when business with far superior growth algorithms are trading closer to 5x EBITDA. The biggest saving grace is the stock repo – as ULTA massively accelerated its share repurchase to $750mm in the latest quarter. But this is a warning sign to us if anything – we’d rather see it deploy the capital into the business to accelerate growth as opposed to buying stock near (what will likely prove to be) the top. This has been a good Quad4 stock in the past, but the business model is changing structurally to having a shallower competitive moat, less impressive management, lower growth, and declining financial returns. Not a recipe for multiple expansion. In fact, on our lower EBITDA numbers, we think valuation sets a new trough multiple of 8-10x EBITDA – or a price at least $100 lower (which would be 10x – each multiple turn is ~$30 in stock price). We wouldn’t touch this stock long-side until it started with a 1-handle, or 50%+ lower than current levels.
On Holdings (ONON) | New Short Idea. Since adding Deckers Outdoor (DECK) to our Best Idea Long list, we’ve gone heavy in researching brand awareness and consumer value proposition for HOKA, and its closest peer, ONON. The reality is that ONON carries an egregious multiple of 50x EBITDA, but the sustainability of growth is arguably less than what we see at HOKA (which is firmly rooted in performance). ONON might nab a couple of slots on the wall at Foot Locker as Nike tightens allocations (which is the best bull case we can paint), but we think it has an inferior consumer value proposition to HOKA in almost every way. At a minimum, we think that ONON is a great pair against our DECK long (which we’ll be presenting this Wednesday at 11:30am EST), and even if we give HOKA half of ONON’s multiple, it suggests that you get the Ugg brand for free. But with a $6.8bn EV, ONON is likely a solid standalone short. To put the EV into perspective, it’s currently 15% higher than UnderArmour, which is a far superior brand in apparel, and has 3x+ the market share in Footwear. The valuation for ONON at current levels just makes no intuitive sense given the lackluster channel checks we’re coming up with as it relates to the customer connectivity of the brand.
Crocs (CROX) | Removing from Short Bias List. This stock is down 43% since we shorted it two months ago. We shorted it because we think that the growth is slowing, margins are over-earning, and that happened at the same time the company went out and paid $2.5bn for Hey Dude – which can’t speak positively about the sustainability of the core. But unlike apparel, where margins can change at lightning speed, mean-reversions in footwear models take years, not months. At the moment, the core Crocs brand is still hot – slowing – but hot. And we think that Hey Dude will prove to be margin accretive for 2-3 quarters until management reinvests in manufacturing capacity and takes down margins. In other words, we got paid with the multiple going from 12x to 6x, and the earnings datapoints are likely to be positive for at least a few more quarters. We wouldn’t be long CROX here, as we think the ‘troughy’ multiple is a permanent change while growth in the core is decelerating. Also note that peaking oil prices is very bearish for COGS as 100% of Crocs inputs are oil-based. But we think earnings look fine, and this name is highly unlikely to slide further to 3-4x earnings. We’ll come back to this one when the time is right, and earnings begin to break down. But for now we’ll take the win and move on.
Petco Health and Wellness (WOOF) | Taking lower on Best Idea Long list. Nothing wrong with this story – the latest quarter was spot-on with our model (which was 10% ahead of consensus). But the company guided meaningfully higher for the year – to right where our model sits. Now we think upside on a TREND duration is much more muted. We still like the TAIL call, where we’re a full dollar ahead of the Street (or about 40%) due to stronger revenue and margins as the vet clinic rollout to 900 of its 1500 stores makes for a stickier customer experience and not only boosts sales in services, but also in consumables and higher margin impulse purchases like toys, treats, etc… The de-levering story here is alive, well, and underappreciated. We still think this stock is headed to $30 (from $18) over a 2-year time frame.
Dollar Tree (DLTR) | Moving to the bottom of our Long Bias list. To be clear, the fact that this is a good Quad 4 stock is the ONLY reason we’re hanging onto this name with the stock up 72% since Sept lows and pushing $150. We took this name off our Best Idea Long list last month as the risk/reward was getting too thin for us in light of the Dollar Plus (break the buck) initiative, as initial datapoints came back mixed at best, and we got to near-term upside of $140-$160. At the same time, let’s not forget that this company meaningfully benefitted from stimulus dollars last year, which becomes particularly challenging in the coming weeks. We like the recent Board reorganization, as it infuses some well-needed talent and leadership into an otherwise sub-par management team. So near-term, bias is still to the upside, but were it not for Quad 4, we’d be giving this name the boot at current prices.
Academy Sports and Outdoors (ASO) | Taking higher on our Long Bias list. Kind of stunning to see this stock trading at $32 – it’s definitely been ‘Quad 4’d’. While we’re net bearish on the sporting goods space, we think that the risk to the downside here is getting extremely low. We like pairing up ASO long vs DKS and BGFV short. Management is buying stock, we’re about 2 quarters away from the emergence of a unit growth story, the company didn’t ‘over-earn’ during the pandemic to the extent that DKS did, and the name is trading at just 5x what we think is a very achievable EPS and EBITDA number. Even if earnings got cut in half from here – which will almost certainly not happen – its still at just 10x earnings at the time unit growth is accelerating. Makes no sense to us. Only reason it’s not a Best Idea is because of our caution around the sporting goods space, and the fact that we still have plenty of Quad 4 ahead of us. But the risk reward on this one starting to look really tasty.
Dick’s Sporting Goods (DKS) | No Change -- Remains at the Bottom of Best Idea Short list. DKS put up a decent 4Q his week. A moderate EPS beat on sales ahead. Sales momentum and merch margin are driving the upside. Management guiding full year up with comps of -2% and adjusted EPS to $11.70-13.10 ex-items vs consensus at $11.42. It’s definitely executed well in the pandemic to gain share at high margins in booming categories, the only real misstep with 20/20 hindsight being a very poorly timed convertible bond offering. On the earnings call this week, and at a consumer conference, management was consistent about its view of structurally higher gross margins. The team cites less markdown risk, but also that the product assortment has been improved. We’ll agree with that in the sneaker section. More/better Nike, new Hoka offering, these are low markdown risk assortments. The rest of the store however we think has plenty of markdown risk. The trade here is definitely tied to how sporting goods and athletic apparel plays out in 2022. Demand and margin reversion has to come at some point. We’re modeling comps below consensus at -4.5% as we think the consumer and the category are going to see more pressure than management expects in 2022. Merch margin reversion and some cost deleverage means operating margin ~50bps below consensus. The company will no doubt execute some sizeable stock buyback, we’re estimating a nearly 10mm drop in diluted shares. That gets us to $12.55 in EPS this year slightly ahead of the consensus (which isnt baking in the full repo potential), we have another drop in 2023 expecting further merch margin pressure to $10.40 vs consensus of $13.26. We think long term operating margin settles around 10%. The question is where should DKS trade on a PE multiple. It’s performance during the pandemic has taken it from so so operator status to strong operator status. Though the recent Nike distribution changes perhaps suggests any material seller of Nike needs a big multiple discount. There is not near term risk for DKS Nike product, but longer term nobody is safe. In Quad 4 with slowing trends and margin pressure, we think this trades in the 6-8x range. That would put downside to the mid 80s with a fair value more in the low 90s. Whenever we transition out of this Macro environment a more fair “steady state” multiple here is probably 8-10x. DKS is not a name that is going to crash, but one where we struggle to see what gets incremental investors interested long side and see Trend downside risk. We like ASO Long against DKS as it is carries a lower multiple yet is about to go into unit growth mode with similar category risks/opportunities. Our net view near timer remains bearish sporting goods.
