We’re shorting the DDS rally. It delivered a decent quarter with comps flat YY, slightly ahead of consensus. But the model reversion is clearly underway from where we sit. Sure, EPS still grew YY with help of the share count being down 17% but EBIT is declining, down 12% YY in 2Q. Sales are no longer growing and gross margins are declining YY. Inventories are also building faster than sales, but admittedly still look lean relative to 2019. However we expect inventories to continue to build which will be a cash flow headwind into 2H. Cash flow is the key here as the core bull thesis is can the company buy back big chunks of the float before the margins and earnings revert hard. The company purchased $225.8 million (approximately 875k shares) of stock at an average price of ~$258. This is more repo dollars than last Q, but we think we are nearing the end of the large buyback rates, as CFFO was down 43% in 1H due to earnings starting to revert and working capital going back into the model. We think the risk in 2H is massive on sales and margins. DDS may be managing inventories relatively well (better than most), but the industry as a whole has a clear inventory problem. So competitors will clearing out product at the same time the consumer is weakening which will be applying pricing & margin pressure on DDS even if it isn’t yet choking on inventory. We see 2H cash flow compressing slowing the buyback, then 2023 EPS coming in over 20% below current consensus to around $12.50. DDS remains a Best Idea Short with 50% downside to $150 or lower vs current $300.
Takeaway: The decent qtr + repo made the bulls happy. We think the model will rapidly revert over 6 to 9 months and buyback will slow materially.
