Nike (NKE) | Monday’s 3Q EPS Looks Good, But Beware of A Quad 4 Day Around The Guide. We’ll almost always defend Nike when bears start getting spooked ahead of an earnings release. This is a Best Idea Long, and the TAIL call here is that the company delivers 20% EBIT margins (vs 15% today) and $7+ in EPS power. Given that it is likely to be at 50-60% DTC to get to those numbers, the control the company has over the brand, product, and growth trajectory will arguably be the most powerful that Nike has had in its entire existence. That’s good for a 30x-40x PE on $7+ in EPS, or a stock pushing $250 vs $131 today. While we moved the name up on our Best Idea list when we entered Macro Quad 4 due to the fact that large cap quality names with stellar balance sheets like Nike outperform peers in Quad 4, the reality is that we need to get past the messaging in this 3Q print, as it’s highly likely that the company will throw out a big cautionary flag about growth over the next two-three quarters. Consider the following… 1) 25% of sales come from Europe, which is a disaster right now from a Macro perspective, and it has what we estimate to be a $1bn business in Russia – which goes away entirely effective next quarter 2) China is still squarely negative, though we think Nike is recovering on the margin it is spending more capital to edge out competition as it relates to building brand heat 3) Though every retailer in the US seemingly has a love affair with the Nike brand if you listen to the conference calls, it’s because they’re afraid Nike will cut them off. And that’s exactly what Nike is doing. It’s decimating marginal wholesale distribution, and while bullish for the brand, it’s bearish for the P&L – especially in the US 4) Supply chain is improving via output at factories in Asia, but we’re not out of the woods. The company is still chasing demand as it relates to product supply, and is leaning heavily on air freight. All in, we think it's incredibly unrealistic to expect Nike to maintain its guidance for the year (even though we think current guidance is doable). That fact that it can hit earnings will be irrelevant on the day if it issues a cautionary statement to the market. This name is down 21% since the last earnings release vs -6% for the S&P – so we think a LOT of the bad news is in the stock. But during Macro Quad 4 anything but a pristine print likely goes down on the day. And this won’t be pristine. It’s rare that Nike gives you a buying opportunity. We’d strongly recommend you be on the buying end if the market gets spooked on a Quad 4 day.
Guess? (GES) | Taking GES To The Top of Our Long Bias List. If we weren’t in Quad 4, this would be a Best Idea. While we have been vocal about the apparel space on slowing revenue and margin reversion risk due to normalization of markdown rates and inventory bloating, GES is an exception to that trend. In fact, we’re getting to $3.85 in EPS for this year vs the guide (and the Street) at $3.15. We think that the revenue guide set by the company is too low and will be raised throughout the year, and that the company side-steps the Gross Margin risks that we see broadly for the apparel space. The company has reduced its overall SKU count by 40%, raised AURs in Europe and North America by 15%, and created one global Guess? product line to improve the brand. Reducing SKU count helps eliminate markdown risk through not producing low velocity goods that would need to be cleared out. While AUR growth could shrink, the brand will still see AURs above 2019 levels driven by the outsized gains. The global line helps create pricing power and high brand recognition globally. Lastly, this ASR program is important. The company announced it will buy back $175mm worth of shares in an ASR program which equates to about 9mm shares at the current share price. Breaking down the float of 65mm shares, the Marciano Brothers and CEO Carlos Alberini own 26mm shares and ETFs own 11mm shares (insiders and ETFs own 57% of the float). So in the ASR the company is buying back about 1/3 of the tradeable shares. The CEO has a big payout target that triggers as early as mid-year if this is a $35 stock, and if we give this name even a 10x multiple on our estimate for this year, we think he gets paid. That’s good for a mid-high $30s stock over a year vs $21 today.
Victoria’s Secret (VSCO) | Removing VSCO from the Long Bias list. This name went lower on our Long list just after the LB separation, now it’s coming off. VSCO is one of the few consumer names trading higher than it was at Christmas. We remain negative on the apparel category in 2022. Since innerwear generally has less margin volatility, VSCO should have less margin risk than other apparel names, but it will still see risk to the downside in margins and the company’s guide on revenue suggests little to no growth in 2022 and slowing near term trends. Our catalyst into 2022 was cash return to shareholders, and the company fired that bullet with the $250mm ASR right around year end. We think you can get to earnings power of $7-$8 here, perhaps that’s beyond the industry margin reversion risk in fiscal 22. But if it’s not gaining share and margins are peaked, it’s hard to argue this business deserves a PE multiple beyond high single digits. If the downside number in 2022 is $5 in EPS, a 10x multiple is probably right, meaning the stock is fairly valued. Plus the CEO selling some stock a week and a half back in the mid 40s, the lowest the stock has been since just after the separation, doesn’t exactly create confidence that this is undervalued. You can still probably use VSCO as a long hedge to other apparel short exposure, but we’re losing conviction around absolute upside.
Dick’s Sporting Goods (DKS) | Taking off Best Ideas Short List – Thesis and EPS Change. If one thing is clear to us in our research on Nike and Deckers (HOKA), it’s that Dicks is turning itself into a higher-end and higher priced place to buy premium footwear at full price. We’ll call it the ‘premiumization’ of the footwear market. DKS is arguably the only retailer that is gaining support from Nike now as opposed to losing it, because Nike sees the strategic direction DKS is taking with its footwear and apparel business. This is a meaningful change vs pre-pandemic, which gives us a meaningful permanent lift to 40-50% of DKS business. We’re still assuming that the sporting goods business sees a mean-reversion in demand for the 50%+ of the business that’s NOT apparel and footwear, but the $8 per share that we previously modeled over a TAIL duration in DKS earnings is now looking to be closer to $10-$11. That’s still below consensus, hence DKS will reside on our Short Bias list, but nowhere near as far below the Street as we previously thought. We think the right multiple for DKS is probably in the high single digits until the market sees the real reversion level of the earnings base, which suggests downside to perhaps $90 – no where close to the delta we need to see to grant this name Best Idea status.
