Critical Bearish Retail Theme: Guidance – It’s Simply Not Believable. I (McGough) have been doing this job for 29-years. Yeah, maybe that makes me the old guy in the room. But I’ve seen my fair share of economic, market, Quad, and most importantly RETAIL cycles. By my math, I’ve been through ~15,000 earnings reports, and management guiding throughout those reports. I can say with 100% confidence that the guidance I’m seeing out of management teams – over the past three weeks, in particular – is the least believable of any time in my career. The Pods and The Quads were built to front-run management team guidance -- to predict today what they’ll be telling us in another 3, 6, 9 months down the road. We seen some realistic cuts for 2H of this year – which might be good for an occasional bear-market bounce on a given reporting day or as the real time credit card data shows trends better than management guided. Other companies (like WSM) are ‘extending the trend’ and just because things are stable today, they will not remain that way. Good luck with that strategy. But no one, and I mean NO ONE is talking about 2023 – and the consensus is looking for massive ramps in earnings in ’23 thinking that the margin hit we’re seeing today is ‘transitory’. Well guess what…it’s not ‘transitory’ if it happens four quarters in a row. My prediction… retailers will have an absolutely abysmal holiday season as consumer confidence crashes, inflation soars (booting the price of necessities – like at WMT), the personal saving rate tests new troughs, and consumers lever up at generationally high interest rates. Holiday is going to be a dog fight, and we’re just getting a taste of this during back-to-school. After getting their teeth kicked in in 4Q, I think retail management teams will actually take an overly cautious approach to guiding FY23 by the end of 1Q, and come April/May, we’ll likely begin to see beatable numbers out there – on much lower stock prices. Remember that spending could fall off a cliff in 1Q23 -- we still face tough compares and the consumer will just have stretched to spend around holiday. Don't be tempted to be long retail before then. But after the April/May time frame that’s approaching the point where we get out of Quad 4, which is a double whammy to the upside. I currently have 44 shorts, and 21 longs (some with waning conviction), which is as short as I’ve been in the 15 years since we started Hedgeye. Recall that Retail EBIT ran +/- 3% of $150bn for seven years in a row this cycle (see table below), and now the consensus is closer to $200bn in 2022, and has that growing to $230bn in 2023. If we’re in fact in a recession, there’s no reason we can’t see $100bn in EBIT. That’s a LONG way from current estimates. That is beyond unreasonable given the current economic climate, with top and bottom line pressures on cycle-high inventory levels. Needless to say, I remain short retail. Sell the lower highs, and buy the quality businesses with asymmetric growth drivers on the red days (see Position Monitor at the bottom of this note for idea ranking).
"Short Retail" Video Replay Link CLICK HERE
Target (TGT) | Tar-Jay -- New Best Idea Short. Something just is not right here at Target. The company has a massive inventory problem, as do its competitors. To its credit, TGT cut guidance twice in three weeks this summer to be more offensive in clearing excess product. In effect, it’s given back nearly all of the margins gains that it won during the pandemic. Bulls think the company kitchen-sinked the guide, threw in the towel on margins, and only good news on the margin from here. But we have two problems with this story. 1) It gained $30BILLION in sales during the pandemic – off a base of $78bn. That is simply massive. To its credit, the company was in the right place at the right time with the right strategy that aligned with how the customer wanted to shop. But these massive and compressed market share gains are unlike anything we’re ever seen for such a ‘stable’ big box retailer in decades. That leads us to problem #2. The Street is following TGT’s guide on margins for the next quarter – sort of. But the ramp in EPS growth and positive rate of change is very difficult to stomach. EPS was down 89% in the latest quarter. Street has that sequentially improving to -29% in 3Q, and then +4% in 4! To cap it off, the consensus is looking for 47% growth next year. 47%!!! To be abundantly clear, there is no reason why the top line can't be down next year. We’ll be going through 4 Quad4s – and I don’t think Cornell (CEO) gets this -- will be surprised to see him still there in a year. And as stated above -- industry EBIT growth expectations for 2023 as being way too high – both sales and margins – TGT is sitting right in the bullseye of competitive pressure from the 80-90% of retailers that will be aggressively clearing product. Bottom line is that going from ~$8 this year to $12 next year in EPS is a herculean feat that we don’t think TGT will pull off. Not hugely expensive at 10x EBITDA, but what’s the real EBITDA rate? That’s the part of the equation that the market has wrong. No reason why TGT can’t revisit $100-$120 vs current $165 – a big return on a beta-adjusted basis for a big cap ‘stable’ name like target. This is one of the few times where we should see a meaningful price divergence between TGT (lower) and WMT (which our Staples team Biolsi/Penny have as a Best Idea Long). We’re hosting a Black Book on our Target call on Friday September 16th at 10am. Details to follow.
On Holding (ONON) | New Best Idea Short – This Brand is Gonna Crash. We added back ONON last week to our Short Bias list, due to our anecdotal concern that the brand was becoming overdistributed – and simply growing in an uncontrolled manner way too quickly. Over the past week, my analyst Arianna did some great work and went deep into the different SKUs available at a host of different retailers, and I was quite frankly floored with the results. Over 60 SKUs of product, with EXTREME overlap in high end vs mid-tier retailers. To the brand’s credit, price point was consistent, but all it takes is one retailer to break rank in an over-inventoried Quad 4 environment and this brand will be in a world of hurt. Order cancellations, markdown money (shared discounts with retailers), and negative earnings revisions. This is a rookie management team, and it’s never lived through a brand cycle like this (like DECK has), and certainly has not managed the company through multiple Quad 4s. We’re also getting concerned about the European consumer as it relates to discretionary goods, and Europe represents 30% of ONON’s top line. This stock trades at 55x earnings and 28x EBITDA, and if we’re right and growth hits a wall and takes profitability (via discounts) with it, multiple can get cut in half here on lower numbers. This stock could easily fall 50-70%. Timing here is key…as it might take more than a few quarters for this to play out. But we’ll be patient, and will move up our Best Idea List as our research call grows in conviction, or in the less likely scenario that price goes against us. We’d pair against Best Idea Longs NKE, DECK and BIRD.
PLBY Group (PLBY) | It’s game time for PLBY. I ‘get it’ that this company and management team is hated. In 29 years, I don’t think I’ve ever seen such hatred towards a name – yes, including Radio Shack and JC Penney. But like it or not, this is one of the companies that’s proactively preparing for multiple Quad 4s. Pulled guidance, layoffs at corporate, sold the corporate jet, and just Friday PLBY filed a $250mm mixed shelf (which has a 3-year duration). Generally it tells us what we already know, the company is managing the business for cash, as liquidity risk is the only factor we can point to that can cut the stock in half and make it an official ‘bone’. We’ve had feedback from investors over the past two weeks that there are two factors that can double the stock overnight. 1) CEO Ben Kohn stepping down, and 2) Hedgeye pulling support for the stock – i.e. capitulating. #1 is highly more probably than #2, because the growth drivers are still in place, we just need the confidence that management is a) open to making changes in the C-Suite, and b) continuing to channel capital towards driving brand heat – especially in Honey Birdette and the core Playboy brand, and growth drivers like Lingerie, Cosmetics and Spirits. One can make an argument that CENTERFOLD needs to be shut down and restarted all over again. I think there’s a sub 1% change of that happening. What’s more likely is this name going private in the high single digits – and royally pissing off the shareholders (and me) who are in it for the turnaround and realization of all the growth drivers this company has at its fingertips. The consensus view on this company is that it is ‘unsalvagable’, but how we’re doing the math, the NPV of the future guaranteed licensing stream is worth alone where the stock is trading today. It’s currently got ALL the factors that don’t work…horrible sentiment, growth narrative (growth narratives hate Quad 4), small cap, levered, no GAAP earnings, and minimal ‘traditional’ valuation support (PE, EV/EBITDA). Though worth noting that it’s trading at 0.1-0.2x underlying sales, which is ridiculously troughy – as is the fact that its trading ~30% below liquidation value. Let’s be clear about one thing…I am not wed to this name. I’ll accept defeat and boot if I lose confidence in the research call (though I’ve already been #transparent and #accountable for riding the stock from $25 to $4 – one of the worst calls of my career). But I’ll walk away if, and ONLY if, the research call changes. Fortuitously, I have a meeting in LA with CEO Kohn and CFO Barton next week. I’m going armed with the tough questions. And I’m not holding back. Expect a detailed update on the name, and what I learned, and changes to my thinking going forward shortly thereafter. Again, it’s game time here. And I’m fully ready to play.
Best Buy (BBY) | Lower on Best Idea Short list. We moved this higher a few weeks back when the stock rallied and we made our ‘short the rally’ in retail call. The stock then was in the low $80s, but it’s corrected back close to $70. Category demand is weak, inventories high, and we think the US consumer will continue to weaken as we face multiple Quad4s. Still think you have downside here to around $55 to $60 on 2H revenue and margin risk, but the risk/reward after the drop suggests other shorts are higher conviction.
Kohl’s (KSS) | Removing from Short List. This is a first for me – kind of a sign of the apocalypse. I’m simply not a believer in the Kohl’s model, or the earnings power of the company. When activists were calling for $8-$9 in EPS power and pushing for a sale at $65, we said all along that a deal would absolutely not happen, and that the real earnings power is $4m. Lo and behold, the company guided down to $2.80-$3.20 – and any semblance of a deal was DOA. But dare I say that KSS is one of the very few companies with a believable guide out there. The company didn’t even include the $500mm ASR in its guidance. We’re seeing directors (including chairman Peter Boneparth who I don’t trust as far as I can punt him – but he’s great at managing the good ‘ol PA) buying stock here, which is a big tell. Also, fundamentally I’m bullish on the Sephora roll-out. KSS is launching in all 1,150 stores and is rebranding the banners as Kohl’s/Sephora. In effect, it’s going all-in on this initiative, which will create a world of pain for ULTA given that the stores operate in the same strip centers. We’re monitoring the progress there weekly, but it has the potential to change the fundamental narrative around the story. To be clear, we’re not going long KSS – not in Quad 4 and not with such massive mid-tier pricing exposure in a category like apparel. But we simply think its in the guide/consensus. As we exit Quad 4, based on what we know today, we’d consider going long this name with a price close to $25.
