Arhaus (ARHS) | New Best Idea Short. ARHS is a relatively high-end home furnishing retailer, and is likely the only brand out there that could MAYBE give RH a run for its money on the lower-end assortment. But the problem is that ARHS hugely benefitted from the pandemic – which caused it to subsequently go public, and we think it will see a big demand slowdown over the next three quarters. In attrition, while ARHS has 80% of the locations as RH, it has only 25% of the square footage. It’s stores are simply too small, and lack the scale/size to churn out high-end margins. In the latest quarter this company put up a 16% margin, which is well above where RH topped out when it was operating small scale stores like ARHS. The common view is that ‘ARHS is eating RH’s lunch’ bc it put up a ~60% comp last quarter. But ARHS is VERY promotional when demand ebbs, and we’re seeing that right now. Check out the interaction I had with an online representative at ARHS just yesterday about where I could ‘find a deal’. The answer was stunning – EVERYTHING in the store is on sale – by an average of 30%. Could RH have put up a monster comp this past quarter? Yes. But it DOES NOT DISCOUNT its product. ARHS does. That becomes very dangerous when we enter a downcycle for home furnishings, like we are currently in right now. Sales growth slows, gross margins erode, SG&A de-levers, and margins crash. That’s what we think is in the cards for ARHS in the coming quarters. Is the stock expensive at 11.6x forward earnings? No. But on a downward revision with such little short interest there’s no reason this name can’t trade at 6-8x earnings on lower numbers. The street has EPS marching up to $1.00 per share over a TAIL duration, but we think that the $0.70 we saw over the past 12 months is peak for ARHS. This company went public when it did for a reason. Ultimately we think this is a $4-$5 stock (where it loses Institutional sponsorship), vs $9.06 today.
INTERACTION WITH ARHS ONLINE
H&M Hennes & Mauritz (HNNMY/ADR) | New Best Idea Short. This stock is down 20% since we first went short in May, in a +4% tape. We still think there’s another 40-50% to go – likely sooner than later. This is a solid structural short in apparel that still carries a hefty 16x p/e multiple – should be closer to 10-12x given existential threats. H&M was once the dominant model in apparel for disintermediating the traditional fashion retailers with inexpensive fast-turning sales of trend-right apparel. While it grew up over the past decade, the company got way too big to remain at the top of the fast-fashion food chain, amassing a fleet of ~4,800 stores globally – a number that’s both staggering and unsustainable. Aside from the traditional retailers ‘catching up’ and getting faster and more relevant to the end customer, the explosive growth of SHEIN poses the biggest existential threat that H&M has seen since Primark – but much worse given SHEIN’s online-only model (Primark is store-only and hurts the most in Europe). The consensus has sales climbing over a TREND and TAIL duration, with margins going up from 2021 levels despite what should be a major negative inflection in margins as apparel inflation spreads go negative in 2H as inventories build in the channel in the face of inflating product costs and slowing global consumer demand. Over a TAIL duration, the Street has EPS going from SK6.53 in ’21 to SK8.23 by FY24. That couldn’t be more wrong. The store count is shrinking – which alone should put this name in valuation purgatory – online sales are slowing, gross margins should be under pressure primarily due to the growth of SHEIN – which undercuts H&M price points by more than 50% on like for like items. Ultimately, we’re coming in at TAIL earnings of between SK4.00-5.00 per share. We think that historical average valuations are absolutely meaningless, as this used to be a growth company, and now is turning into the opposite. Today we’re looking at 16x earnings on the Street’s numbers, and we think that the Street is too high. It’s actually trading at closer to 25x our TAIL earnings estimate – which is egregiously too high. This name is levered and if our model is right over a tail duration, it will need to tap capital markets and likely cut its dividend. In the end, we’re likely looking at 10-12x our estimate (or about 4-5x EBITDA), which is about a SK50 stock – or ~50% downside from current levels. This is one of the few apparel names out there with big earnings downside where you also get paid on the multiple.
ETSY | Moving ETSY back up to Best Idea Short list. Alongside a 53% rip off the bottom (in a +10% tape), we’re getting incrementally negative on ecommerce, after being more bullish around the spring potential for acceleration, we think with rising promotional intensity and a deteriorating consumer, growth in e-comm could disappoint in over the next 2-3 quarters. In that context, ETSY stands out as a short alongside W (balance sheet problem). ETSY has high discretionary exposure with top categories being homewares and home furnishings, jewelry and personal accessories, and apparel, all of which we think will be under pressure until at least mid-2023. Customer churn levels have remained elevated while still adding new customers, so churn risk remains high while at the same time spending per customer is falling. So the trend is buyers declining, sellers declining, spending per seller declining. The only top line drivers are from expensive (and seemingly struggling) international acquisitions (which are lapped here in 3Q) and raising fees on the sellers which already being squeezed. ETSY has some of toughest compares in ecommerce in 2H, yet weak recent trends, and carries the highest relative multiple (EV/Gross Profit) in the space on both an absolute and growth adjusted basis. It’s simply too expensive compared to what we think growth will look like in the coming 2-3 quarters. This should not carry an EBITDA multiple 25% higher than AMZN. The biggest risk to short ETSY is the company continuing to hit adj EBITDA numbers as it has in recent quarters with lower S&M spend and higher SBC being added back. Insiders keep selling huge amount of stock, with the CEO’s 10b5-1 selling about $2mm every couple weeks all summer. We think a fair price for this stock is in the $50 to $75 range, or 30% to 50% downside.
Hibbett (HIBB) |Moving HIBB higher on Short Bias list. As evidenced by 2Q results, sporting goods has held in as one of the best performing ‘covid winner’ categories in 2022. HIBB is trading more than 2x the price it was pre-pandemic. To be fair, we think this company probably deserves a higher value than 3 or 4 years ago. It now has a real online business, it has taken up the quality of assortment by improving its Nike relationship and increasing its Nike penetration, and it bought back a quarter of the float while carrying a solid balance sheet. But the problem for HIBB is it’s becoming an off-mall Foot Locker of circa 2016. Nike controls its destiny with both the amount and quality of product flow. That means it needs a big multiple discount, and it is over earning. The EBIT margin potential is likely about where FL has been able to hold trends historically…in the 6-8% range (currently ~10%). So earnings are likely still heading lower, and there is definitely demand reversion risk for apparel and hardgoods. We’d put TAIL earnings power around $6-$7, with an HSD multiple being right, meaning a stock worth $45 to $50 vs current $65.
Rent-A-Center (RCII) | Moving RCII higher on our Short Bias list. We’re getting increasingly bearish data points around low end credit quality. Delinquencies on the rise, our financials team went Best Idea short CACC (Credit Acceptance Corp) this week, as that company clearly took advantage of the all time high consumer credit quality and collateral (used autos) value boom. Talking about the name on Hedgeye’s The Call on Friday, our CEO shared anecdotes around private subprime lenders seeing metrics falling off a cliff in recent weeks. The low-income consumer is getting worse, and likely continues to get worse, even in the face of some states deploying stimulus dollars. There are many ways to short the low income consumer. We like RCII as it is kind of triple levered to the low income consumer as it has exposure on the discretionary durables consumption, it has very high and direct exposure to bad debt (categorized as stolen merch as lease to own customers can’t pay for product), and it has high financial leverage having done the Acima deal during the pandemic. $1.3bn in debt putting trailing EBITDA leverage at ~2x while forward EBITDA is in ‘crash mode’ and we are heading into a deep “Main Street” recession. Short interest has come down to 7.5% from 15% just 5 months ago. 6x EBITDA isn’t cheap enough with the earnings and leverage risk. Downside to the mid-teens from it’s current $26.
