Macro Outlook Remains Quad4. Our Hedgeye Macro team presented their mid-Quarter update this week. The outlook for the US economy remains a Quad4 environment with growth and inflation slowing. As a reminder, consumer discretionary underperforms in Quad4. This aligns with our net short view on retail/consumer as we think earnings estimates remain too high by a wide magnitude as the consumer is going to come under more pressure over the coming couple quarters – particularly hitting a wall in 1Q, which coincides with issuance of initial 2023 guidance. The better areas of retail to be in are more necessity based retail and discount channel (like off price). Style factors that tend to outperform are large cap, low beta, low leverage. Small cap, high beta, levered and growthy names tend to underperform. The names on our long list that fit the quad framework best are auto services (DRVN, VVV) and off price (OLLI, TJX). Still the exposure that makes the most sense in retail in Quad4 is on the short side, where our list of tickers is plentiful. The Macro team did give a glimmer of hope with a potential Quad 1 in 3Q23 – which would be very bullish for the group – but that is a lifetime away. We have to get past some VERY major downward revisions (greater than even most bears are thinking), which should take most stocks in the group much lower (remember when people thought Target was done guiding down three revisions ago? It’s STILL not done. Other companies will be worse).
Helen of Troy (HELE) | Moving to #2 Slot on Best Idea Short list (ahead of ULTA). Getting deeper on the research on this one, and we think its ultimately a $30 stock vs current $95. This is simply a bad/unownable company that’s egregiously overvalued on REAL earnings. HELE is a low-quality portfolio of brands spanning the Beauty, Home, and Outdoor segments. Major brands include Hydroflask, Osprey, Honeywell, Braun, Vick’s, and Beauty Brands Hot Tools and Drybar. It’s a hodge-podge of brands that don’t belong together that offer up very few synergies. 42% of its sales go through Amazon (19%), WalMart (11%) and Target (11%) – all of whom we expect to put increasing pressure on their suppliers. The brands are largely ‘stuck in the middle’ with higher end competition above them, and lower end competition below – it’s getting clipped at both ends. Let’s be clear about something here…this is not a management team that runs brands well. It is good at acquiring them, then using non-GAAP adjustments to manufacture earnings power 2x the REAL earnings number. The Street looks right through the accounting gimmicks, and underwrites the wrong earnings numbers. Unfortunately, the company is tapped out in financial leverage, and no longer is in a ‘free money’ environment to do deals given rising rates, and does not have the internally-generated cash flow to acquire. Without deals it runs out of accounting adjustments. That means that ‘adjusted earnings’ mean-revert to GAAP earnings, which we think are $3-4 per share, compared to the $12 the Street is looking at over a TAIL duration. This stock looks beaten up and cheap. But it’s headed a LOT lower. We think that a fair multiple on these brands is 10x at best. Next year our estimate is $6 vs the Street at $10. Over a TAIL duration, we have estimates coming in at sub $4 as the company runs out of ‘adjustments’ and is no longer able to fuel the growth engine with deals. 7x EBITDA on that number gets us to a stock at $30 vs it’s current $89. Don’t let the chart fool you – this name is NOT at the tail end of a bottoming process. It’s headed a LOT lower.
Moving Advance Auto Parts (AAP) Lower on Short List after 3Q Print Selloff. We flipped from bullish to bearish on AAP in late July with the stock around $190 as near term industry demand drivers were weakening and cost pressures continued to persist, which would put a hitch in the AAP margin expansion bull case. We got incrementally bearish in early October when data was suggesting AAP was losing share relative to ORLY. This week AAP confirmed our negative view with a big miss of 3Q earnings. Cost pressures caused deleverage on the P&L with sales weak, specifically citing store labor, medical, and fuel costs. AAP is stating it has to invest more heavily into inventory to win transactions, which is pressuring cash flow. Again the AAP margin expansion story might ‘work’ in a strong consumer demand environment (i.e. when we went long in 2021), but as the consumer comes under pressure, and demand drivers moderated in mid 2022, AAP shows its true color. The stock is down 22% since we went short. AAP is moving lower on our short list but not quite off yet as it is now hitting troughy multiples at 11x EPS and 9x EBITDA, though there are still some earnings and even multiple risk as we see 2023 estimates as ~10% too high.
Still Bearish Best Buy (BBY) Into Earnings. BBY reports Tuesday before the open. We remain bearish on BBY as we think earnings numbers are still headed lower despite the fact that the company has cut expectations a couple times already in 2022. Traffic trends from Placer remain weak, with the 5 week trend slowing from -8% in Aug to -17% as of last week. That matches the demand trends we heard from TGT this week, which noted electronics remain a challenging category. Confirming the slowing trend was US Retail sales for October which were reported this week. Electronics and appliance stores were a standout on the bear side with a slowdown to -12.1% in October, the worst rate seen all year. Both TGT and KSS were explicit in their commentary that the middle income consumer is slowing materially in recent weeks. We think there is high risk of another guide down here for BBY as demand weakens, margins see pressure from promotions, shrink, supply chain costs, and wage inflation. Remember that Best Buy recently took down margin guidance from 5.5% to 4% for the year, but at such low levels, we think that for the balance of the year we could see something closer to 3%, and then 2% in 2023 – which cuts earnings in half. BBY remains a Best Idea Short as we see downside into the $40s-$50s from its current $72.
DKS Reports Tuesday Before The Open. We think the quarter here looks decent, visit trends were good in 3Q, though slowing in just the last few weeks. Sporting goods has been one of the better Retail sales performers in the census data as well, with store sales up about 4% for retail 3Q. FL also reported a better than expected Q on Friday, which drove a late week rally. We would expect to see a 3Q beat, but tempering of 4Q on slowing trends since late 3Q. We remain bearish DKS, as we think the slowing consumer, and category reversion of sporting goods will mean comps and earnings disappoint here over the next 12 months. Is this a stock that will get cut in half? Perhaps not, given better operations, a good balance sheet, and buyback capability. We do think it is one that grinds lower on the hardlines demand reversion and apparel margin pressure to come. We think a fair value here is around $80 to $90, with downside risk to YTD lows in the low $70s as earnings come down, so comfortable being short with the stock around $110.
