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. Live Video Link CLICK HERE.
Macro Themes Read For Retail. The Hedgeye Macro Team Presented its Macro Themes call last week. While being bearish on the European continent (recessionary data there) the outlook for the US is Quad 3 (Stagflation, growth slowing with inflation accelerating) over the next 3 quarters, though with low conditional probabilities. Consumer discretionary can historically work in Quad3, though outperformance for equities is generally concentrated in secular growth, mid to higher cap, quality, and lower beta. Net net that is supportive of our top longs, RH, AMZN and perhaps NKE. With that said, the consumer environment as we see it is at risk of getting worse while expectations are far too high implying material rate of change improvements across the aggregate retail landscape. Add on the fact that the market signal on nearly all of retail is bearish. We remain net short of retail in 4Q23 and will update our full view of the TREND setup for the space in our quarterly Theme presentation in a couple of weeks.
From Hedgeye Macro:
USA #Quad3 Stagflation: Easy CPI comps are fully rearview, Headline & Supercore Inflation are reaccelerating, Demand growth is back to Trend deceleration following the countertrend bounce in July and the inimical margin-negative Quad 3 duo of Demand ↓, Prices ↑ has now defined the prevailing reality domestically since late July. Meanwhile, the global/local industrial-mfg recession remains entrenched, the consumer retrench continues to intensify and the list of income/discretionary consumption shocks in queue continues to layer as “the Convergence” thesis we promulgated in 2Q remains on time and on script. We’ll detail where we are on that Convergence timeline, how long we expect the Stagflationary mojo to persist and how we’ll risk manage & allocate inside the current, idiosyncratic version of Quad3.
LoveSac (LOVE) | Shifting Lower On Best Ideas Short List. The stock is starting to price in something resembling reality in terms of TAIL earnings power. Stock down 31% from when we moved it up to the Best Ideas Short list swapping with it with ARHS. It is also the worst performer on our short list over the last month (-22%), when we reiterated it short side after a silly rally on a preliminary result slightly better than its guide down when the company had to delay its report due to accounting issues, and said nothing about forward expectations. This is one of the companies with the biggest implied acceleration in the business in 2H, and it will end up being one of the last to communicate the risk to those expectations. We think the market is waking up to that fact. We think the street expectations here are ridiculous over the long term, with consensus (3 analysts) thinking EPS is headed to $4.50+ and margins into the low to mid-teens. Rather, we think you have earnings power of $1.00 to $1.50 and we’ll give this a low DD to mid-teens multiple meaning a stock worth around $15 to $18 vs currently just under $20 so another 15% to 25% downside risk. The risk reward just isn’t what it was a back in the spring/summer rallies. Keeping this on the BI list until we get the guide down, but risk managing the short here.
Tapestry (TPR) | Just a week after elevating this name on our Short Bias, we're taking it to a Best Idea Short. This call has been working for us since the low $30s, but we'd press it at $28. We outlined our full thesis on the name in our Black Book (CLICK HERE), but at $34 we said that this stock could see a low $20s price as we approach the deal closing date for the CPRI merger. We're beginning to think it could be far worse than that. This thing will be over 4x levered on what will likely be EBITDA cuts in the quarters immediately following the deal to clean up the sins of CPRI management as it acts unhealthily to keep numbers high (pushing the envelope just enough to not violate the merger agreement) as the deal closing date approaches in early 2024. On top of that, the category (mid-range luxury) is likely to be highly promotional, which won't help either business on a stand-alone basis. This stock looks cheap on earnings, but the EBITDA multiple and the leverage could take this stock to $10 if EBITDA gets cut enough and we're looking at a 5-6 EBITDA multiple on 4+x leverage. This market has no appetite for those dynamics. But to be clear, the cash flow characteristics of this business are simply astounding, and this company can be debt free over a 4-year time period. That will make for a VERY powerful long idea once this name finishes its bottoming process. But we think the upcoming quarter for both companies will come with a guarded outlook, especially given hot inflation, student loans coming back, a historically low personal savings rate, outsized consumer leverage, and tightening consumer credit standards. We think we'll have this name as a raging long on our Best Idea list sometime over the next 12 months. But we think that will be at a much better price than $28. Don't underestimate how low this name can go given the debt burden. Take the earnings multiple and throw it out the window. It's all about EV/EBITDA x Leverage and directional movements in cash flow, which are negative.
Helen of Troy (HELE) | Best Idea Short -- Not Expecting a Lot of Fireworks on Wednesday's EPS report. This heavily shorted name has squeezed by 18-19% on each of the last two earnings prints. Let's be clear, this 2Q report on Wed will be ugly. But the Street is expecting ugly -- net income down 27% yy, to be exact. And keep in mind that's a non-GAAP, non-cash number. GAAP earnings will be worse. But our sense is that where the business is tracking its primary categories, Beauty, Home and Outdoors have all decelerated, and we think the portfolio is broadly losing share in that context -- to higher end brand on one end, and lower-end/private label on the other. It's stuck in the middle with average brands, which is the root of the company's problems. It spent the past cycle in a zero interest rate environment levering up to build a mediocre portfolio -- and using special charges to obfuscate the real GAAP earnings power of the company. That game is over. That's why the CFO left earlier this year, and why the CEO is out in another quarter. The real problem comes in 3Q and 4Q, where the Street is expecting mid-teens growth in earnings. The CEO only has three months left on the job, and our sense is that he's going to pull every accounting gimmick in the book to hit elevated earnings expectations, even though it will likely be in the worst consumer spending environment on goods imaginable. He's going to leave a massive problem for his successor, who will have to grow, cut costs, and de-lever all at the same time -- something I (McGough) have not seen a company successfully do in my 30-year career. The punchline here is that this company is going to pull out all the stops between now and year end, and 2024 is likely to melt down, at a time the Street is expecting 15% earnings growth. Not gonna happen. Will this be the quarter you get paid short side? Probably not. But at $117 we think that even if the you believe the Street's numbers the stock is worth about $80. If you believe ours, you get to a stock closer to $40. The push back we get there is that for this to be a $40 stock, it would need to trade at a FCF Yield about 20%. Our answer there is 'exactly'. There's no reason this can't trade at that kind of yield. Just look at HBI...trading at 22% FCF Yield, and the characteristics between this model and HBI from five years ago are eerily similar. Same goes from Newell Rubbermaid from a decade ago, and Jones Apparel Group 15-years ago. These generational zero-interest rate 'free money' roll ups left with mediocre assets and too much debt are just doomed. Would we be against lightening up on some HELE short side while the CEO orchestrates his grand exit? No. Again, we think 2024 is where you really get paid in a BIG way on this one. We have EXTREMELY high conviction that this name plays out meaningfully to the downside over a TAIL duration.
