The SIGMA (Sales Inventory Gross Margin Analysis) triangulates the quarterly (or halves in case of certain international companies) sales to inventory growth spread with the EBIT margin change. This is a critical tool for us in monitoring the TREND directional rate of change in the P&L vs the Balance Sheet. Covid introduced unprecedented volatility into sales vs inventory spreads and margin change trends, so the charts observe abnormally large swings. Given the comparisons this most recent quarter, the vast majority of companies saw a bearish move downwards and to the lower left similar to the aggregate industry. When we use this as a screening tool, we’re looking at the latest quarter's quadrant, the direction and magnitude of the shift, and the upcoming comparisons to flag bullish and bearish moves. Generally, the most bearish move is a shift from Quad 2 down and to left into Quad 3 or 4, and the most bullish move is a shift up and to the right from Quad 4 into Quad 1 or 2. Bearish moves have a higher probability of margin risk in the coming quarters and bullish moves have higher probability of margin upside. This is a screening analysis, so a bullish or bearish move doesn’t automatically make for a good long or short, but it provides a list of ideas to vet further as it relates to the TREND investment opportunity long or short.
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Industry Trend: In 3Q22, the Retail Industry took a sharp move further into ‘Retail Quad 4’, which happened to coincide with Macro Quad 4 – yes, there is a difference. You need to be living under a rock to not know that Retail has an inventory problem, but the order of magnitude is rather startling. In effect, inventories are building aggressively vs last year, and margin pressure is stepping up. Yes, the stocks look cheap, but we think numbers are still too high, and the negative revision cycle is far from over. Cheap can always get cheaper. That’s not to say that there’s aren’t any standouts bull-side, but the bearish callouts outnumber the bulls by a massive margin – 36 positive SIGMAs (potential margin upside), and 100 negative SIGMAs (gross margin risk).
We highlight the notable positive and negative tickers below. But there are several that stood out to us as particularly severe or notable for further vetting. Thematically, if there’s any callout, ironically it’s that there are no major sub-sector callouts. Usually we can flag one category where inventories are out of whack relative to Sales. But this time around it is incredibly broad-based – from apparel, to electronics, sporting goods, guns and ammo, home furnishings, home improvement, to jewelry and beyond. There’s earnings risk across the board, which synchs with our top-down view that the $225bn+ EBIT estimate for retail in 2022-2024 is looking straight through a recession (which likely implies EBIT dollars closer to $125bn) and is well above the normalized EBIT rate of $150bn, which the industry earned like clockwork in the 7-years pre-pandemic.
KEY CALLOUTS
Most Bullish: AMZN, ANDPY (Anta), CHWY, CFR.SWX (Richemont), DUFRY, LVMUY, MONC, PRPL, PRTS, RMS.PAR (Hermes), VVV
Most Bearish: Retail in Aggregate, AAP, ADDYY, ATZ-TSE, BBBY, BGFV, BRBY.LN, CRI, CROX, CTC.A.CN, DOL.CA, FTCH, GCO, GIII, GOLF, HBI, HD, H&M, HOFT, HZO, KTB, LAD, LESL, LL, LOVE, LOW, LULU, MOV, OXM, PANDY, PMMAY, RH, RUSHA, RVLV, SFIX, SONO, VSTO, W, WSM, WWW
Bullish: AEO, BBWI, BBY, BOO.LN, CAL, CPRI, CPRT, CRMT, DBI, DECK, DDS, GPS, KMX, LEG, MELI, MUSA, OLLI, PSMT, RCKY, REAL, ROST, TCS, TGT, ULTA, WBA
Bearish: ABG, AN, ANF, ASO, AZO, BIG, BKE, BOOT, BOSS.GR, BURL, COLM, CONN, CVNA, CWH, DG, DKS, DLTH, DLTR, MODG, EXPR, FIVE, FL, FND, FOSL, GOOS, HIBB, IDEXF (Inditex), IPAR, JWN, KIRK, KSS, LE, LEVI, LZB, M, NKE, ODP, PAG, PLCE, PRTY, PVH, RGR, RL, SBH, SCVL, SIG, SNBR, SWK, SPWH, SWBI, TPR, TSCO, TTSH, UAA, URBN, VFC, VNCE, VSCO, WOOF, YETI
