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Retail | What's NOT In The Guides or Retail Stocks. Retailers remain too bullish on consumption in 2023. Credit availability and Labor to get worse, while student loan payments come back.
Three Key Macro Themes…
Credit Availability Drying Up: The consumer has levered up in a high rate interest environment at an unprecedented speed in terms of added credit balances. Then this is the first time in over a decade that it didn’t reduce credit card debt post-holiday. As delinquencies are spiking (direct P&L risk for retailers with private label card exposure), credit standards are tightening leading to a spike in rejections. This limited access is what HD was talking about on credit availability pressuring demand particularly in high ticket pro projects.
Labor Will Be Going From Less Good To Bad Fast: Per the slide below, when the YY change in continuing claims hits this level, it has always led to a subsequent recession. Corporate profits are going negative, layoffs are accelerating and the job market is going to get bad, which is likely to further pressure discretionary consumption. WARN Notices suggest an acceleration in initial claims, its no wonder the household expectations of financial conditions are hitting new lows.
Student Loans Payments = Real Consumption Headwind: Student loan payment deferrals arguably are contributing ~150bps to PCE. When loan payments come back (60 days starting June 30th) there we be yet another discretionary consumption headwind. For context on where these loans lie within the consumer demo… per educationdata.org “6.4% of federal student loan debt belongs to adults under the age of 25. Adults aged 25 to 34 years old hold 30.4% of the federal student loan debt; 38.7% belongs to 35- to 49-year-olds. 24.5% of federal student loan debt is from borrowers aged 50 years and older.” The headwind definitely isn’t isolated to recent 20 something grads, rather concentrated on the core spending demos of 25yo to 49yo. 
NKE…The Foot Locker Fallout. FL got absolutely shellacked on Friday, down almost 30% on a miss and huge guide down. I (McGough) am kicking myself, because on last week’s The Retail Show I commented that I was likely to add that back short side this weekend after the print. After all, how in the world could rock star CEO Mary Dillon tank the quarter and the guide just months after giving aggressive long term guidance expectations and then following that up in recent months with bullish commentary on the conference circuit? Answer, a) she’s either not the CEO we thought she was, b) even the worst businesses can’t be fixed by above average CEOs, and/or c) the consumer got much worse than the company expected over the past month. We think it’s a combination of the three. Everything Footwear-related traded down on Friday, and for good reason. The only name we’d be buying on the sell-off is Nike. Remember, one of the reasons traffic and conversion was down at FL is because it’s ‘Nike ratio’ of buys went from 70% at this time last year to 50% today. Despite the narrative that ‘ties are improving’ between the two, we don’t think that we’ll ever see over half of the store with a swoosh again. Not a shocker that CAL pushed back EPS date by a week, and moved its Investor Day from June to ‘Fall’. Business ain’t good in any segment other than the high-end limited edition sneakers that are dominated by Nike and the luxury brands. Nike also continues to mop the floor with Adidas market share, which we think is having a particularly tough go at it right now. Names like UAA and Puma have been beaten up as well, but we think justified given eroding market position. We’d still press ONON here despite the huge selloff last week. And though a Best Idea Long, we’re approaching ‘trim mode’ after a blistering run over the past year on DECK.
Dick’s Sporting Goods (DKS) | Reports Earnings Tuesday. DKS is on our Short Bias list. Traffic trends for DKS have look weak throughout 1Q with some of the worst trends seen over the last year. Both March and April were down just over 11%. When combined with the weak performance of FL this past week, it appears the sporting goods subcategory is starting to show signs of real slowdown. That was reflected in the Census Sporting Goods, Hobby, Toy and Music channel for retail sales as well, with yy growth slowing from 7.2% in January to -5.4% by April, with a big drop off in the 2 year trend in the last 2 months. Separately a DKS core category of golf, which has been very strong in recent quarters, is perhaps starting to show the first signs of cracking with MODG miss on the golf equipment side, while GOLF’s stock has also been falling the last couple weeks. With the stock selloff around FL putting pressure on sentiment for the retailers related to athletic footwear and apparel, the market looks to be expecting some earnings revision risk in around the event. DKS has been able to deliver better then most over the last year though, and we’re not sure it’s a press into the event, though we remain bearish on the stock here. Interestingly the short interest has come down significantly to a bit over 12% from over 27% last summer (perhaps increased the last few days not in our data). There will likely be some points for both bulls and bears on this print, but ultimately we have TAIL earnings around $9 vs street at $13, and think a fair price range for DKS is $80 to $105 vs current $127. 
Best Buy (BBY) | Reports Earnings Thursday. Best Buy’s core offering of home electronics and appliances remains significantly under pressure. Traffic looks have deteriorated throughout 1Q with some volatility around the holiday (Easter and Mother’s Day) shifts. To put it in context April put up -13% on top of down 12% last year. Sales trends are unlikely to be much different than traffic, as we had negative commentary around discretionary categories like electronics from the likes of Target and Walmart. The Electronic/Appliance stores channel in Census retail sales also saw sales growth slow from +4.1% in January to -7.3% in April. We think BBY will continue to face demand pressure in the coming quarters, while credit quality deterioration will pressure credit card net revenue, and margins will de-lever with continued low income labor inflation. Short interest is only at 6%, we think BBY’s stock can head below the lows of last year (downside to sub $60). Best Idea Short.
Lowe’s (LOW) | Reports Earnings On Tuesday. The Home Depot print gave us a good read as to what to expect at LOW this quarter. 1Q perhaps will meet expectations, but there is risk to the outlook, even as LOW expectations have been trending down in recent months. The demand environment is weak, as HD signaled with its downward comp guide for 2023, which we think is still not low enough. LOW will have similar risk to demand, though it looks like LOW also stepped up the promotional email cadence since late fall and continuing through 1Q (chart below). HD management talked about DIY and Pro being down this Q, and that Pro is seeing customers shifting to smaller ticket projects with some pressure from credit/financing of those projects. Pro backlogs still exist but are shrinking, meaning there is further risk for comps to trend down toward underlying end demand. And ticket this Q was up just 0.2% vs +5.8% last Q, while the company is noting like-for-like SKU inflation is still being observed. So comps are down 4.5% and ticket flat while pricing hasn’t actually cracked yet... what if we get a moment of actual deflation given the consumer pressure and competitive intensity? Relevant PCE Category prices are still up ~20% from pre-pandemic, and after a period of significant over consumption, there remains significant unit consumption reversion risk. So factor in compressing backlogs, price/ticket risk, and continued consumption reversion, we think you have a high probability that comps are going to get worse from here. Add on the fact that LOW saw gross margins expand with ~300bps purely from pricing / cost relationship, which presents real margin risk as consumer wallets continue to tighten. We see LOW EPS risk to $9 to $9.50 and stock downside to $120 to $150. LOW is a Best Idea Short and our favorite short in Home Improvement.
Here is our full note on the HD print: HD | Not Good, And Why It Will Get Worse 
Dillard’s (DDS) | Removing From Best Idea Short List. This one just hasn’t worked out for us. The company is over-earning, arguably by 2x, but there’s a duration mismatch as the company is buying back so much stock -- an uphill battle we don’t want to continue to fight and be wrong. The company announced another $500mm authorization over the weekend. Even though the stock is overvalued on unsustainably high earnings numbers, the reality is that if the company wants to buy up here, it’s going to. The stock is down 33% from the highs. With such limited float dynamics, we don’t want to continue to get burned by a share count that’s shrinking faster than EBIT. There are better places to deploy short capital for us in retail. We’ll take a small loss on this one and move on.
Kohl’s (KSS) | After the credit shoe drops, we’re inclined to get bullish on Kohl’s. For me that sounds like a blasphemy – as I’ve been nothing but short it for much of my career. Painful at times, but right in the end. We think that that a few things are at play here…1) Earnings expectations at KSS are the closest to being right-sized out of any department store. Expectations went from $9ps at the time of the (fake) rumored buy out. And now stand at -$0.15 for FY23, and $2.32 for FY24. Of that FY24 number, roughly 100% of the EBIT is coming from credit income, which we think is the next shoe to drop – especially in noting higher delinquencies at Synchrony, Capital One, and Canadian Tire. In other words, we see at least one more guide down to come, which likely happens this week. On the plus side, this Kohl’s/Sephora rebranding/partnership has teeth. The data clearly shows that the KSS stores that open a Sephora are getting a comp lift at the expense of ULTA, and 80% of that initiative will be done by the end of this year (the build outs of which have been very disruptive to the shopping experience at KSS). DO we think KSS has too many stores? Yes. Are the stores too big? Yes. But normalized margins here are likely in the 4-5% range, which is double where the Street is over a TAIL duration. Never thought I’d say this, but KSS is starting to look interesting to me long-side. But we’ll wait for the credit crack before getting involved.
Ralph Lauren (RL) | This has been a frustrating short for us…but it just won’t go down. It’s been rangebound between $110-$120 for most of the year. The company is out with earnings on Thursday, and we’re expecting a guide down consistent with what we’ve seen with much of the rest of retail. Clothing store traffic has been abysmal in the US, which is 60% of RL sales. And keep in mind that 100% of any revenue growth the company has generated in recent quarters has come from Average Unit Retail, or pricing. Net new customers has been squarely negative. Apparel CPI is still positive, but clearly decelerating, and department store traffic, which is still a third of RL US business, has been horrible. Street expectations has RL marching up to $14 per share (vs $8 this year) over a TAIL duration, which is simply way to high for a company that is having a net migration of customers of the brand away from the brand in its core market. To its credit, Europe and Asia have been doing quite well for Ralph, but still its been driven in large part by price increases that we don’t think will stick. We think fair value for RL is closer to about $80 vs its current $110. And we’ll likely be quick to cover on a big sell off and/or big earnings guide down. The reality is that this company has virtually no exit strategy, and Mr. Lauren is 83 years old and is still intimately involved in product design and merchandising. There’s no logical US buyer (PE would be foolish to), but we could see the likes of LVHM, Kering or even Richemont (which owns Peter Millar) stepping up and buying RL at a better price. To be clear, we think its headed lower, but once the expectations and price come down to realistic levels, we don’t want to be there in the event of a take-out.
Petco Health & Wellness (WOOF) | Reports Wednesday. This stock is starting to look interesting to us again on the long side. As a reminder, this company is undergoing a shift to convert 75% of its 1,400 stores into full service vet clinics, which increases customer loyalty, gets them into med meds, and increases conversion in food and accessories at the front of the store. Traffic trends haven’t been great by any means, but haven’t fared as poorly as more discretionary retail categories overall. The company has been having a hard time staffing its stores with qualified labor for the vet clinics, which has come at a cost. But we think its made progress in that regard over the past quarter. Forward expectations here look rather anemic, with the Street coming in below our model. But we think that, like most of the rest of retail, this business has one more guide down ahead of it. We’re getting more interested here under $10, but will be patient on this one. 
American Eagle (AEO) reporting Wednesday. We have no skin in the game on this one, but wouldn’t be long this into the print. We think a guide down is coming – even though it might well hit the quarter. This brand has been working to grow Arie with new brick-and-mortar stores popping up in key markets. The past two quarters sales have been down, although sequentially improved from Q3 to Q4, and expectations are such that Q1 puts up 1.4% growth. That shouldn’t be too hard for the company to hit, since last year Q1 was up only 2%. Gross margins are expected to be up about 50bps, sequentially lower than Q4 up 150bps. Promo activity and discounting is a big part of the model at this company. Inventory is moderating though, up 5% in Q4 lower than up 8% in Q3. Seeing an increase in inventory here isn’t very concerning to us, given that its relatively small and the company is opening new stores and needs to stock those stores accordingly. Should be a relatively inline print, but with downside to the guide.
Best Idea Short VFC reporting Tuesday. We’re getting close to covering this one – just not yet. Over the years this company has gone from Great, to Good, to Below average. Key brands like Vans, Timberland, The North Face, and Supreme (recent failed acquisition) are all declining. Management should be investing more in R&D and marketing to reignite brand head across the portfolio but it isn’t. This company also has about $7bn in debt including leases, and about $3bn of that comes due in the next 2 years. Expectations have revenue down 3.5% this quarter, sequentially worse than last Q down +2.6%, but that seems too high to us. Maybe the company beats top line given that it sat on 101% inventory growth at the end of last quarter and has to push product through the pipe. In fairness, the street is expecting margins to be down this quarter and sequentially worse than they were last quarter. We went short this name 50% higher, and have seen numerous upgrades over the past few weeks. We think things are going to continue to deteriorate for the company fundamentally. It’s headed down the wrong path. Is it coming to an end of the negative revision cycle – probably, and we struggle if this still deserves Best Idea Short status (which is about a 40% move). We likely cover somewhere in the mid-teens, not too far off from its current $19.
Urban Outfitters (URBN) | reporting Tuesday – still on our Short Bias. For the year-to-date, this stock has been extremely resilient. People are looking forward to ‘easy comps’ at the Urban concept throughout this year and are net bullish. Over the past couple of quarters inventories have been elevated, as management said it did not have the right inventory at Urban Outfitters, but last Q inventory ended down 1.5%, so trending in the right direction. The Anthro and Free People brands have been driving the company’s growth, while Urban has been down YY for the last three quarters. We’re concerned about wo things here…1) That just bc comps get easy at Urban, it doesn’t mean the company will comp up profitably, and 2) That Anthropologie will be the next shoe to drop. We’ve said before we like this company and that we would like to own it at a price closer to $20. Well its trading at about $27 right now and we still aren’t ready to flip on it yet. Revenue growth for the quarter is expected to come in at 3.5%, with GM are up 110bps while it was down 70bps last Q and operating margins down 20bps vs down 130bps last Q. While we think the sales growth is possible, the margin improvements don’t seem realistic. We have not seen a significant decrease in the promotions the company is running so we expect that pressure to remain and flow through.
e.l.f Beauty (ELF) | Reporting Earnings on Wednesday. We have no call here, but this stock has been a monster year-to-date -- up 60% from the beginning of the year. This company has put up impressive growth rates over the last few quarters, with 3Q23 sales up 80% from 3Q20 (month ending December 2019). Expectations have Q4 coming in at +48.5%. Now yes, we’re short beauty, but given the brand heat and the price point of this brand, not to mention it’s on an easier comp, we can get behind that level of growth. Gross margins have improved around 200bps compared to pre-pandemic, while operating margins are still variable with some quarters ahead and some below. While we think this is good product, we still think the beauty space is going to crack in the upcoming quarters (and will have a Black Book to back that up on June 13th). At some point, we think ELF will be a short, as it is trading at 34x peaky cash flow – neither of which are sustainable long term. But with the consumer in trade-mode ELF continues to be a wallet share winner.
Gap Inc (GPS) | This is the mother of all low expectations retail stocks. No permanent CEO, most businesses (most notably Old Navy and Athleta – where the value is) underperforming, and the stock sitting around Mar 2020 pandemic lows. Short interest sitting at 15% of the float, only 3 of the 20 analysts covering it with Buy ratings. How much worse can things really get here? The company is staying away from the quarterly guidance game, which we think is smart. So expectations are all over the place this quarter. The Street looking for a loss of ($0.16) this quarter, vs a loss of $0.44 last year. Ambitious swing. The numbers don’t look like a lay up. Traffic trends looked better in 4Q – especially at Old Navy and Banana – and the company still didn’t comp in either concept. We’re short this name, but given the overwhelmingly negative sentiment, are looking at every angle to get constructive. But with nobody steering the ship, and the company in cost-cutting mode when it should be hiring talent into the organization, that’s tough to pinpoint right now. In reality there’s no reason why this can’t be a $5 stock. We’ll outline the name on our Bone, Bagger or Bust 2.0 deck on Wednesday.
RH (RH) | Announced Grand Opening on RH England on June 3. This puts to rest rumors that it will be pushed out. We still think this is the tip of the iceberg of a MAJOR leg of growth for RH. Yet, we still get plenty of pushback that ‘The American RH aesthetic won’t work in Europe’. What people don’t realize is that 80% of RH product designers are European. Its not them adopting our ‘look’, we’ve been adopting theirs. The company is merchandising each store locally due to the different consumer tastes throughout Europe, as it’s been studying the market for the better part of a decade. Will there be hiccups? Of course, but the company is coming off a base of ZERO. Anything is incremental to growth. Next up is RH Paris, where it opens the whole country through one Design Gallery, much like it’s doing in England (though RH London set to open in 2024). We still get to TAIL estimates of near $60 with the Street at about $20. Best Idea Long.
