Takeaway: Lot's of movement long and short -- CPRI, RL, PANDY, ADDYY, UAA, Quads, LESL, POOL, CROX, VFC, CTC, GIL, CROX, RCII, KER

We’re hosting our weekly “The Retail Show” tomorrow, Monday at 11am. We’ll ‘speed date’ through our Position Monitor changes, upcoming earnings for the week, and any other questions that viewers (including you) put into the queue.

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Capri (CPRI) | Moving Higher on Best Idea Long list – back to the #2 position above Nike (even though we think Nike is going to smoke the February quarter). I (McGough) got the CPRI quarter wrong last week, the stock got shellacked, and I had egg all over my face. What I got wrong was underestimating the amount of product the company shipped to lower tier department store doors in the preceding quarters. It didn’t outright stuff the channel, but it definitely filled orders where it otherwise should have said “No”. But the company is rebasing wholesale exposure – keeping the Kors brand intact (if there was a brand problem I’d be concerned, but that’s not the case), and mitigating the amount of excess inventory in the channel. It was 40%-50% of sales pre-pandemic, is about 35% today, and should be down to 23% by the end of next fiscal year (March) – limited only to top tier wholesale doors. The Versace and Jimmy Choo brands remain healthy, as does our thesis that over a TAIL duration they will account for upwards of half of EBITDA. Importantly, we think this debacle accelerates John Idol stepping away from the CEO role. I’d peg a 90% chance of a press release naming a new CEO within 6-12 months – which is probably good for a 20% stock move on the day. As outlined in our note -- CPRI | Shock Value – we think the company prints close to $6.50 this year, setting up for $7.50 next year. Implying a sizable earnings beat in the upcoming quarter when it is trading at just 7x NTM estimates (which are too low). We think we’re looking low teens multiple on $10 per share over a TAIL duration, implying a 2-3 bagger from current levels – after a major earnings reset with strong downside support.

Adidas (ADDYY) | Moving lower on short list after earnings blow up, but staying short the name. The company came out with results for 4Q and full year, and they were simply horrendous. Q4 GM down 1,040bps from last year. Guided to Fy2023 operating loss of 700mm euros compared to the street operating income estimates ranging around positive 500mm euros to 1.5bn euros, FY23 currency neutral sales down HSD. The shutdown of Yeezy is expected to lower revenues by around €1.2 billion and operating profit by around €500 million this year.  That’s after Adidas only did 670mm euros in EBIT this year.  Stock was down about 12% on the news.  So good for our short positioning on the stock, though notable that we have been getting less bearish post the new CEO announcement, and this guide was an important catalyst on the short side.  It’s going to be 2 or 3 years at least before Adidas has the potential for the brand to get moving again, CEO needs to assess the business state, formulate a strategy, then hire/spend to execute that strategy. Though we’ll now have significantly lowered expectations around growth and earnings over the next couple years, we think the stock is flat-out expensive on next two-three years of earnings with literally no catalyst on the brand heat side. Could the company beat a quarter or two? Yeah, it probably added some cushion into the massive profit erosion forecast. But this name is just egregiously expensive for what you get. We’re going to present a Deep Dive Black Book next month on whether the 50-year duopoly in athletic footwear is officially dead – and the punchline is yes. But we’re going to go through market share and inventory dynamics as well as go deep on emerging brands and changes in the barriers to entry in this business, which pose an existential threat to Adidas. Stay tuned for more details.

UnderArmour (UAA) | Moving higher short side. I was underwhelmed by last week’s UAA print, and yet the stock rallied. UAA reminds me of Reebok from the 1990s and early 2000s – except unlike Reebok, there ZERO chance of a take-out here. The brand has simply died. Management has been focused for four years on cutting costs, and making it a smaller but more profitable company. They failed – both in logic and execution. They cut way past the fat and squarely through muscle and into bone. R&D and marketing/endorsements both suffered tremendously, and so the product pipe has dried up. Nike is eating its lunch. The only way out from here to make this a BIG stock idea long side is for management to come out, say they’re materially reinvesting in the IP and take up endorsements, R&D, and digital marketing. That would mean earnings get cut in half (meaning you want to be short into the event), and then buy the stock all day at $5-$6. But no way I’d touch it long side here. This should be a mid-single digit stock vs current $11 and 17x multiple. I wouldn’t touch this long side unless we see a big Adidas-esque business model reset and a commensurate stock collapse.

Pandora (PANDY) | Upping to Best Idea Short list. The jewelry category has outperformed virtually every other consumer category over the past three years, and PANDY has trailed category growth – hence it’s lost share. Yet since Oct lows the ADR has rallied by a mind-numbing 90%. This isn’t a bad company, but margins actually went down by 1,000bp during the pandemic – in the best jewelry environment in a generation. The bull case is that it recaptures its highs, but we don’t buy it. We think the category will come under pressure in 2023, and at a minimum mean-revert – taking margins from 26% to 20% or below. There’s no way that’s in the price with the ADR at $23. We’re 40% below consensus next year, and think we see multiple compression on top of that. That’s good for 40-50% downside in the stock.

Mid Quarter Macro Update.  Our Hedgeye Macro team held its mid Quarter Themes Update this week.  The data continues to support Macro Quad4 in 1Q23 and 2Q23, with a high conditional probability for both quarter.  The 2H outlook is currently both Quad 1s for 3Q and 4Q, but the probability of that outcome lower as of now, while 4Q has almost every quadrant still in play.  So the macro Quad framework continues to read negative for retail over the next couple quarters, and although the outlook looks better in 2H, there is a lot of time between now and then where we have to see retail experience and then report a Quad 4 reality.  We’re in the early stages of reporting of the US corporate profit recession.  We suspect to see more earning reductions and labor cuts across corporate America.  As it relates to consumer the most alarming info is around rapid tightening of lending standards from the recent Senior Loan Officer survey (chart below).  Tightening perpetuates the down cycle until you hit the bottom when generally the fed step in, and we are very far from the consumer bottom.   Labor data, which is a late-cycle lagging indicator, continues to look good, wages continue to inflate, though struggle to keep up with CPI mean real wages remain negative.  Disinflation has become the narrative, the Fed is likely to have to stay hawkish for longer to keep fighting inflation.  That will continue to put pressure on the consumer that is already slowing and reducing discretionary spending.
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Canadian Tire (CTC-CA) Reporting Thursday.  Our short call on CTC is around the sales per sqft ramp the company saw during the pandemic, and the reversion risk on sales, margins and earnings particularly in the context of a rapidly deteriorating consumer environment up north.  Sales per SQFT pre-pandemic was C$336, with a cycle average sitting right at $300. Today it is trending to ~C$402.  Margins have reverted some from the pandemic peak, but are still about 200bps above mid cycle and 400bps above recessionary.   We continue to get negative data points around housing and consumer health in Canada.  Despite the recent stock rally from ~$140 to $160, we think this quarter will show the pressure on the Canadian consumer, leading to a miss and or guide down of 2023.  The street is looking for earnings to be about flat YY in 2023, which we think is a pipe dream for a retailer with such broad exposure to the Canadian consumer.  The stock is somewhat cheap, trading at 9.5x PE and ~7.5x EBITDA, but it is a name built to be cheap and one that will get cheaper on lower numbers as we head further into recession.  Mind the credit exposure here, which remains about a third of total EBIT and is eroding quickly. We see downside risk to ~C$100 vs $160 today.

Rent-A-Center (RCII) Moving Higher On Short Bias List.  The data points relating to RCII’s core business remain bearish. RCII is a combo durables retailer and low income lender (via rent to own).  This week the Senior Loan Officer survey showed rapid net tightening in lending standards across consumer borrowing categories suggesting that consumer credit quality is falling rapidly.  In a normal environment, that could be read as bullish for RCII, as it could mean incremental customers that can’t find credit elsewhere.  But we are coming off of significantly elevated sales in the core RCII categories of consumer home durables.  The consumption will remain depressed and there won’t be much marginal share for RCII to win.  Meanwhile, a large portion of RCII’s earnings is directly exposed to the deteriorating credit environment.  Consumers won’t be able to pay their leases, creating incremental costs for RCII.  RCII also owns Acima, a buy now pay later lender much like Affirm. Affirm reported an ugly quarter and guide this past week with deteriorating credit metrics making up a big part of the earnings miss.  Despite having easier compares in 2H than most retailers given it started missing and guiding down the earliest a year ago, we think RCII has another 20% downside to earnings expectations and a couple turns in multiple risk vs the current 11x PE. All in there’s 30-40% downside to the stock.

VF Corp (VFC) | Taking higher on our short list. We were right to go short in the face of a dividend cut, which played out last week. But the company actually beat the quarter and put up a respectable guide. We think the question to ask is WHY the company cut its dividend – and we think because it knows it has brand problems across the board on a levered balance sheet. We’re particularly concerned about the Vans brand, not to mention The North Face, Timberland and Supreme – all of which are in a decline. It costs capital – lots of R&D and marketing – to turn brands around, and VFC is being to stingy on the cost line. Its trying to protect margin instead of focusing on driving the top line on a SUSTAINABLE basis. We think that TAIL earnings here are closer to $2 than the consensus at $3, which is probably good for a high single digit multiple, and a stock about 30% below where it sits today. Not enough downside for ‘Best Idea’ status. But a short nonetheless.

Ralph Lauren (RL) | Reiterating Best Idea short. RL | Pricing Works, Until it Doesn’t Our short position in RL is predicated upon on the fact, and it is a fact, that the company is relying on AUR (average unit retail – or mix/price) to drive its top line at the exact time the consumer is getting more cautious towards higher prices (we’re seeing this trend emerge across nearly every segment of retail). The chart below speaks volumes. In the quarter reported Thursday, we saw 10% AUR growth, but only 7% constant currency revenue growth. Ditto for the preceding quarter, where more than 100% of revenue growth came from AUR. The company talked about drawing 1.6mm new consumers to the brand this quarter, up from 1.3mm last quarter. But this is a gross number. If the net consumer count was growing, we’d see total revenue growing faster than AUR, and that’s simply not the case. We’re coming in slightly below the consensus/guide for the upcoming quarter because we think either AUR will crack, or net customer migration will increase (churn). But over a TAIL duration we’re maxing out at $10 in EPS power with the Street pushing $14. The stock is admittedly fairly valued on the Street’s numbers, so we have to be right on our revenue decline/deleverage thesis for this to work on the short side with the stock at $118. But we think the pricing and net customer migration trends will bite this P&L over the next 3-6 months, and we think it takes the stock well below $100.
Retail Position Monitor | 14 Ticker Callouts Tonight - RL

Gildan Activewear (GIL) Higher On Short Bias List.  The data points out of low priced basic apparel continue to be very ugly.  HBI a couple weeks back guided down 2023 earnings by over 60% with gross margin pressure from clearing high cost inventory being a core catalyst.  PLCE preannounced 4Q earnings to be a loss of ~$4.40 while consensus was expecting around 50 cents in earnings.  Again, clearing inventory in the face of rising cotton/materials costs was a big driver of the massive miss.  GIL is a better company with a better competitive moat than the others mentioned, but it is not immune to the margin risk around rising input costs, slowing demand, and excess inventory.  GIL inventories were up 53% last Q.  Demand is slowing with excess inventories out in the channel, so we’ll likely see reduced orders from the screen-print distributors.  On the retail channel side, news hit recently that Walmart is pushing back hard on vendors saying they better have very good reasons to try to implement price increases.  WMT is looking out for the consumer instead of worrying about vendors that have margins widely above pre-pandemic, and also listening to a Fed that says it is keeping an eye on elevated retail margins.  GIL is trading below it’s ‘normal’ PE at 9x, but earnings expectations are too high, and in the last recession this got a low as 7x.  We think GIL has downside risk into the low 20s on a negative earnings print vs current $29.

Pool Corporation (POOL) and Leslie’s (LESL) | Elevating both on our short list. 

  • POOL reports this week. The company is guiding to an acceleration in revenue in the quarter – 5% due to an acquisition, and 10% due to inflation. We think that’s pushing it. Guided to a 150-200bp hit to Gross margins, a sequential erosion from flattish last quarter. Approximately 40% of the company’s revenue is tied to new pool construction, which we think is in a steep downcycle. Another 80% is lighting, grills, patio sets and other things you buy when installing a pool and don’t need again for another 5-10 years. We think this is a strong candidate for another earnings guide-down, and yet the stock still carries (what we think is a steep) 22x p/e in the wake of a 23% rally YTD. We think it can give up its YTD gains in a heartbeat on a guide-down.
  • LESL is interesting here. Not quite as expensive as POOL (but still at 16x earnings) , but has a far less defendable moat. Competing this year against WMT, which was largely out of stock with pool chemicals last year, and for some reason we have yet to understand, its leaning into inventory more heavily into the Spring. Yes, there’s a higher installed base of pools – but only 5% pre-pandemic, and we think banking on passing through inflation is a risky proposition here, especially with the inventory build. We like this short down from $14 to about $8-$9.

Crocs (CROX) | Reports EPS this Thursday.
We added this one as a Best Idea Short two weeks ago. We went Short CROX initially at ~$120 a year ago in January, and rode it down to $75 when we covered in March. We were a bit early in covering, as the stock subsequently went all the way down to $48.  But the stock has since ripped – up 150% off the lows and is back over $115 (our entry price is $120). We don’t get it. The fundamentals aren’t matching up with the price rip. North America growth in the core Crocs brand is slowing, Hey Dude has been on fire, but we think will slow in 2023, and most importantly, this company is pushing a 30% operating margin. There’s no way a footwear brand should be putting up that kind of margin, especially with growth slowing in its two brands. To its credit, it’s investing more in Hey Dude (which it acquired last year and is on track to be a $1bn brand in ’23) but the 40% margin we’re seeing there will come down by at least 1,000bps. It’s tough to call footwear cycles (as it relates to the core Crocs brand) but this brand, we think, is in the latter innings of a multi-year rip in growth and profitability. The company sold 110mm pairs of Crocs over the past year, which is a simply staggering number. We can’t see it getting to 130mm, which is what you have to believe to own this stock. The Street has revenue going from $3.5bn in this year to $5.8bn over a TAIL duration, with virtually no margin degradation. We think you’ve got to pick one or the other. After earnings ~$2 per share pre pandemic, we’re looking at ~$10ps in earnings this year. We’re giving the company the benefit of the doubt on the operating margin line, but are dinging the model on growth. Ultimately we’re coming in with a $10-$12ps earnings annuity while the Street is building to $17-$18 over a TAIL duration. If growth continues to slow, there’s no reason why we can’t see this stock trade at 5x earnings. It’s been there before (recently) and no reason it can’t get there again. That’s good for 50% downside, with the potential for earnings downside as a kicker. The Street is ahead of the high end of the guide for this quarter, which why we think it sold off ahead of this print. Footwear cycles take notoriously long to play out, data trends look good this quarter. In the end, we think the event will be a push. But if you’ve got duration we like this short a lot here.
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Kering (KER) | reports on Wednesday this week. Consensus estimates have EPS at about 15 euros for 2H and revenue growth of approx. 11%. The Street is estimating full year revenue growth of approx 17% while we are modeling about 18%. So we’re not wildly off. About two weeks ago Gucci announced the new creative director, Sabato De Sarno, who was previous at Valentino. The prior creative director, Alessandro Michele, left after creative differences with the Gucci and Kering Presidents. While under his direction the brand did grow and revive iconic pieces, it also became overextended with the various collaborations it did (i.e. The North Face, Xbox, Adidas). We believe the new creative director will come in and streamline the offerings and cut the collaborations. Simultaneously Gucci will continue to take up price. While Kering is majority Gucci, the other brands like Saint Laurent and Bottega Veneta hold their own in the luxury space. Seeing price increases and maintaining growth and market share. Especially, as the situation in China begins to normalize, we expect to see continued growth from Kering. Kering is our favorite Luxury name right now, and we think with a successful pivot in the Gucci strategy, this stock could re-rate from 17x earnings to 25x+ on higher numbers (we added the name long side at 14x EPS). Still a best idea long candidate. And we think if Gucci is weak on the print, it will get a pass due to the new creative head and major changes that are on the come.

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