Key Theme From Institutional Client Meetings This Week. People ‘get it’ that 4Q numbers are probably too high, which leads me to think that we could see a dead cat bounce on 3Q earnings reports (which are doable) and then see nickel/dime guide-downs for 4Q (which won’t be enough). But people seem to be seriously underestimating the magnitude of the guide-downs that we’re likely to see in Jan-April of 2023 when companies provide FY guidance. Need to be nimble over these next few months, and respect the trading/risk ranges. Still stay net short retail, sell the bounces, and get ready for a BIG selloff in the group in early 2023. We’re likely to go massively bullish in Retail – but my best read on the timeline is that it’s not till April or May when the rate of change on fundamentals turn and square with newly set ‘kitchen sink’ expectations. Also should be when we get line of sight to getting out of Quad4.
The Move I Contemplated, But Didn’t Make This Week. I was on the verge of swapping GOOS (#1 Best Idea Short) with ULTA (#2). The reality is that ULTA is viewed as the ultimate ‘safety stock’ in retail right now. Completely over-owned, and severely under shorted. And I think that the P&L breaks down severely over 6-9 months, at the PRECISE time people will move away from safety and toward the 80% of retail that the Street currently deems uninvestable. That’s when we see numbers come down for ULTA over a TREND and TAIL duration AND see meaningful multiple compression. I have a very high degree of confidence in this short idea. GOOS has been a great short for us, and now sits at just $16.58 (we went short at $30). We see downside to $10-$12 from here, which is not as much as ULTA. But if we’re right on GOOS, this name will break SOON. Sooner than ULTA. Bottom line, this is about duration, and I think you get paid on Canada Goose this calendar year, while you need to wait to Spring 2023 for the big move in ULTA. I nearly started typing the position change, but changed my mind – I’m not going to take GOOS down a notch when the story is just about to play out.
Fast Retailing (9983-JP, FRCOY ADR) | New Short Idea. Fast retailing owns UNIQLO, Theory, Comptoir des Cotonniers, PLST, GU, and Princesse Tam.Tam. But all you really need to know is that UNIQLO accounts for 85% of sales and 92% of EBIT. The other brands are a rounding error. UNIQLO Japan accounts for a little over 40% of the entire business, which is a definite risk being so reliant on one (toxic) geography for such a large portion of revenue. The remainder is in the US, China and Europe, which are squarely in the wrong place to be for mid-priced apparel ahead of multiple Quad4s. UNIQLO is known for its inexpensive, basic clothing. Its main competitors are H&M and Zara – which is a dangerous competitive set. But to its credit, UNIQLO has held its own. The problem is that all three face an existential risk in SHEIN, which is offering a similar (plus far more extensive) product offering at literally 75% off the price points you find at those retailers (basically, everywhere outside China). We’re already short H&M (HNNMY), and that call has been working nicely. But FRCOY has traded up 27% since the May low, while the stock in local currency is up near 50%. There’s a lot going on here with currency and IFRS accounting rules, but the reality is that this company has $58bn in market cap (almost equal to the entire US department store space), 500bp of TAIL margin risk, and trades at a mind-numbing 36x NTM earnings, and 13x EBITDA – for an apparel company that is facing its biggest existential threat in its lifetime (SHEIN, and a more desperate H&M, Zara and Gap/Old Navy). We get it – Japanese equities tend to defy gravity as it relates to valuation for several reasons – not least of which are exchange rates and close to zero cost of borrowing. But based on our backtests…the PODs (revenue, margins, cash flow) are ‘geography-agnostic’. If we’re right on the rate of change in its sales and margins in Japan, China, Europe and the US, then this company will disappoint – again. To the Street’s credit, it is already looking for 2023 (Aug) EPS to be down 10%. But there’s no reason it can’t be down 30%. No way a 36x multiple holds if we’re right – and even if something closer to consensus numbers play out, this stock could STILL lose 30%+ of its value – multiples don’t expand when earnings and cash flow decline – and both of those are likely to decline deeper and for far longer than most people think. This name is going on our Short Bias list (as is usually our process for new ideas) and is likely to go higher (Best Idea potential written all over it) as we get deeper in the research.
Burlington Stores (BURL) | New Short Idea. It’s VERY rare for us to add a stock short side when it’s on its lows. But we’ve grown increasingly concerned about the off-price retail space in recent weeks (including taking TJX lower on our Best Idea Long list last week). The reality is that apparel inventories industry-wide are up 30-40% vs last year, and imports are tracking up close to 20%. This should be a dream environment for an off price retailer that relies on buying inventory on the cheap, packing it away, and selling a year later driving both comp and margins. But to be 100% clear, the hand-off between retailers with excess inventory and finding a home in off price channels is an ugly hand-off. It takes pristine execution, a seasoned management team and a best in class buying/sourcing organization. BURL has none of those. It’s the inverse of TJX in that regard. In the meantime, BURL will have to compete through holiday with existing inventory, in an environment which should show the biggest apparel gross margin declines in a generation as in-line retailers discount to a far greater extent than they’re currently planning. Then we think the US consumer (100% of sales for BURL are US) dries up in 1Q23 – leading to ‘kitchen sink’ guides for the year. THAT’s when we think that retail will finally be investable, and we’re likely to shift to being net long in a big way (also as we start to eye an end to Macro Quad4). Until then, you’ve got earnings risk at BURL, a highly likely downward earnings revision, and the stock trades at 22x EPS, 15x EBITDA and has only 5% of the float short. Sometimes new lows beget new lows, and that’s what we think is likely with BURL. This should be a $70-$80 stock, and it’s currently at $125.
Tapestry (TPR) | New Long Idea. Yes, we’re actually adding a Long in retail. The reality is that 90% of the profits here are with the Coach brand. We’ve been skeptics for some time on this one because so much of the investment thesis rested on one singular mature brand (it also owns Kate Spade and Stuart Weitzman). But Coach has accomplished something that we see once a decade in retail – it succeeded in taking the average age of the target customer down by 10+ years. To be clear, customers age with a brand, like we see with Ralph Lauren and Oxford Industries. Attracting Gen Z and Millennials without impairing the ‘cash cow’ older customer relationship is near impossible to do. And to Coach’s credit, it’s succeeded. The bottom line is that we think that the top line trajectory, AUR (price/mix) increase is sustainable for far longer than we have in the past. On the flip side, we absolutely don’t believe the ‘turnaround’ at Kate Spade. This has been $1.3-$1.4bn brand for 7 years, and operated at a paltry hsd fully allocated margin. The company is targeting a $2bn footprint at higher margins, which we’re unlikely to see. So if that’s part of the bull case, we think you’ll be disappointed. But at less than 8x earnings it’s trading at a 20% discount to brands like RL that are trying the same strategy – and we think will fail. In addition, let’s keep in mind that the handbag/accessory is far more defendable than apparel in a downturn (and otherwise). Higher margin, more predictable unit demand, less discounting, and better price integrity. For those who have to have names in their book long side – even if net short – we think TPR is a good one. With TPR braking into the high $20s last week (barely) and trading at just 7.5x earnings, we’re on board. We still like CPRI far better, even though the Coach brand is probably a notch ahead of the Kors brand right now in consumer relevance. But CPRI offers massive sales and margin upside over a TAIL duration with Versace and Jimmy Choo – something TPR lacks.
ETSY (ETSY) | Moving ETSY Higher on Best Idea Short list, swapping with BBY. The stock is down about 15% since we re-added it to our Best Ideas Short list a couple weeks back. We’re getting incrementally negative on ecommerce, as we think with rising promotional intensity and a deteriorating consumer will mean 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 are already being squeezed by inflation. ETSY has some of toughest compares in ecommerce in 2H, 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. But this Quad4 market looks to be punishing high multiples and ‘growth’ companies that are seeing low to no growth. Meanwhile insiders keep selling huge amount of stock, with the CEO’s 10b5-1 selling about $2mm every couple weeks all summer including a block this week. We think a fair price for this stock is in the $50 to $75 range, or another 20% to 40% downside.
Best Buy (BBY) | Moving BBY Lower on Best Idea Short list, swapping with ETSY. The stock has traded down into the $60s. We see earnings downside risk to ~$5.50 and a stock closer to $55 to $60. That leaves about 10 to 20% more downside. Core durables categories continue to see weakening demand, with inventories high, and we think the US consumer will continue to weaken as we face multiple Quad4s. Expectations are not at recessionary levels. Staying with the short here as we think there is another downward guidance revision to come, but adjusting lower again on risk reward.
Nordstrom (JWN) | Moving JWN lower on the Best Idea Short List. The stock corrected about 10% following the spike after the news of El Puerto De Liverpool taking a near 10% stake in the company. We think next year we see earnings settle in around $2.00 per share vs the Street at $2.40. Note that of that $2.00, about $1.60 is credit card income. Basically, the model is evolving into the retail operations selling product at break-even to generate credit card income. But the way we see it, a zero-growth credit book deserves a mid-single digit multiple (note Synchrony trades at 7x earnings), which suggests a core value per share to JWN’s earnings stream of about $11-$12 – and then about 10x on the retail operation earnings – which gets us to another $4 per share in value. Fundamentally the stock is worth something in the low to mid teens, with the stock sub $18 and with the potential headline risk around Liverpool’s stake we’re moving this lower on the short list.
Lovesac (LOVE) | Moving LOVE lower on out Short List. Short interest sits in the high teens, with the stock at 6x consensus earnings. This is a single product company with a core offering in the home/durables segment that should see pressure in a recession. We went short in June of 2021 with the stock around $91. Back then we said we think this name ultimately is worth a mid-teens multiple on $1.25 in TAIL earnings, that’s about $18 to $20. The stock is now at $20.58. Note that $20 is still 50% above where it was pre-pandemic, so we’ll give some credit for the store/customer growth of the last couple years. This is staying on the short list, as TREND and TAIL numbers are still way too high, and the business is likely to slow in the coming quarters, but with the risk/reward we see suggests moving the lower on the list.
Hanesbrands (HBI) | Moving Lower on the Short Bias list. The stock is now showing about an 8% dividend yield and 10% short interest. There’s probably about $0.75 to $1.00 in TAIL EPS power here, while the street is looking for around $1.40. With the stock at $7.64, it is now trading at 8x to 10x our number. HBI is about as close as you can get to a secular perma short. We’ve been short it since 2016 in the low 30s, but the core underwear offering here is somewhat ‘staple-like’ and would benefit from trade down as a low priced offering in the mass channel. Given recession risk and the financial leverage (~4.5x Net Debt to EBITDA) in the model it stays as a short, but at this price when the macro turns we’d be getting off the HBI short.
