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.
Deckers Outdoor (DECK) | Upping to Best Idea Short. We added this name just over a year ago to our Best Idea Long list at 255, calling for a double in the stock. Today it's at 622. We spot checked our multi-year sum-of-parts model at the time of our Best Idea call, and we called for a fair value of 600-700 over 3-4 years. We got that in just 15 months. Earnings have come in way ahead of consensus, but inline with our model, and the consensus is rapidly catching up to our estimates -- despite the company's best efforts to keep expectations low. Yeah, we could tweak our multiples higher in our SOP model -- but that's called 'deviating from the process' and we don't do that. So that explains why we're no longer Long DECK. So why Short? First off, we're convinced the running competitive landscape will intensify meaningfully in 2024, which we fully expect. One thing that tweaked us in the latest quarter is that the upside came from Ugg, not HOKA. Golf clap to DECK management there (we've repeatedly said they're second only to Nike as being the best brand managers in the business). But the reality is that no one will ever pay for Ugg in DECK's valuation. It's worth maybe 5-6x EBITDA as a cash cow annuity, and the combined entity is trading at an all time peak 18x EBITDA and 3.6x EV/Sales (the latter is even more stunning to us). Valuation is not a catalyst, but the reality is HOKA is slowing on the margin. Is it coming off a big growth base, yes. It's still putting up better numbers than 98% of retail. But we think that Nike is going to attack the running category with a vengeance in 2024 -- likely with a major platform launch around April/May ahead of the Olympics. Nike has spent several hundred million on this launch (and has kept it quiet) and will disrupt the running space next year. We're not saying that Nike succeeds, but simply that it will be disruptive. Someone's going to lose share, and most brands are likely to step up discounting due to excess product in the channel. We think that this will be most damaging for ONON (Best Idea Short) -- and the 'dummy math' is to slap a ONON multiple on HOKA and give Ugg its' 5-6x EBITDA multiple. What happens if ONON loses half its market cap in a single day when sales slow, margins crack, inventories bloat, and the company lowers guidance? Yes, we think that will happen, which poses risk for DECK. Simply put, at 622, too much can go wrong and not enough can go right. We remain SLIGHTLY ahead of the consensus for the year (we were 30% ahead before the Street caught up), but that won't be enough to generate outsized Alpha on the upside with DECK. At a minimum, if you own it, we'd be sellers. If you believe our thesis about an intensified running ecosystem in 2024, we'd initiate a short position in DECK here.
Gap Inc (GPS) | Elevating to Best Idea Short. After Friday's massive squeeze by 31% to 17.85, we think it's time to be outright short GPS. Fact, no-one knows what the real near-term earnings power is here -- even within a fair band of confidence relative to other retailers (which is a moving target in itself). That's why we need to look out over a TAIL duration and see what the real underlying earnings power is after the new CEO pulls all his cost and margin levers and 'refocuses the brands' (not sure how that's possible without the capital budget to sustain real topline growth). If the company invests in the brands accordingly, numbers are coming down before they go up. Let's also not forget the credit card risk at GPS, as credit EBIT -- and its customers are in the sweet spot of the elevated charge offs and delinquencies we're seeing at COF an SYF -- are pushing 50% of EBIT now. A credit event is looming here, like we saw with Macy's and Canadian Tire. We underwrite long term earnings power here below 1.00. Closer to 0.50-0.75. Let's be generous and give this a 10x multiple and you get to a mid single digit stock -- a far cry from the ~18 you're looking at today. Further cost cuts could get people (who have had a love affair with this name since the new CEO started) more bulled up about earnings power, but we think it needs to invest sustainably around its content, up the consumer experience, build better consumer connectivity, and solidify a real value proposition. Even its crown jewel Athleta just comped down in the high teens. That's more than just a product tweak that's needed -- the organization needs a full retooling. And the same can be said about GPS in its entirety. A company that's been in cost-cut mode for 20 years can't just pivot to growth, and can't magically find cost cuts when it's already understaffed. We're simply not believers in this model, and will press the short if it heads higher around unsustainably high cost-driven earnings. This is a head fake.
VF Corp. (VFC) | Going Short Again. We took this name off our long bias list amidst the hype around two activists circling around the name and a 20% move higher several weeks back. The stock since gave up all its gains, and then an Old Wall upgrade (probably prepping to do some banking business -- which VFC needs) upgraded and gave another opportunity to step in short side at 17. This company is stuck between a rock and a hard place. The new CEO has a major problem. Brand heat is hurting...with core brands like Vans comping down 20%. Only one way to fix that -- invest more capital. But that brings me to the next, and bigger problem -- the balance sheet. Leverage is painfully high, and mind you that this company isn't looking at a balloon maturity 5-years out, but rather meaningful maturities that come up every year starting in 2024. Asset sales are a must. They won't drive the stock higher, but will simply fund debt service. But what to sell? Supreme and Dickies make the most sense, but they won't generate enough interest or proceeds to put a dent in the debt problem. In order to REALLY service its debt, it needs to sell Timberland, The North Face, or Vans -- the brands that will get the highest price tags, but also are the core part of the long term growth and cash generation portfolio here. Selling those makes this entity pseudo worthless. Regardless, the new CEO has a near impossible job -- driving brand heat while fixing an impaired balance sheet. We simply can't underwrite that long side -- no matter how cheap or beaten down this stock looks. It was built to be cheap. Hype around an activist case, which we think if implemented will lead to a failed strategic move -- will take anyway any brand recovery premium embedded in a still nosebleed 11x EBITDA multiple. If the activist case doesn't come to fruition this company struggles to generate cash and takes all excess capital and tries to satisfy its debt. This name could get a lot cheaper. Wouldn't shock us to see this as a 10 stock 12-18 months out while the rest of retail is in recovery mode.
Olaplex (OLPX) | Adding To Long Bias. Never thought this day would come, but we're adding Olaplex (OLPX), which has been a perennial pig for the past year, to our Long Bias List. This is a Bone, Bagger or Bust, but one with a rock solid balance sheet, stellar margins, and great cash flow generation -- and a call-option on being bought by a bigger beauty brand. Yes, this stock did lose 50% of its value on one day back in October 2022, and has continued to trend down since then (-94% from its peak). At the time the company had preliminary reported the quarter with a massive miss and guide down. Since then, the company has seen guide down after guide down, with revenue trends down substantially YY. This stock is now trading at about 1.90, a 7x EV/EBITDA and 10x PE. YTD revenues are down 40% and we don't expect that to materially improve in Q4, but next year the company is going to have incredibly easy comps. There are a few things we like about this company, the first being its balance sheet. The company has about $650mm in debt, due in 2029, but it also has about $450mm in cash right now and is 0.9x levered. This company is one that generates cash consistently, even in our bear case model, with revenues down out through FY27 and EBITDA margins falling to the low-30’s, the company still gets to negative net debt by 2026. The company is an innovator and has patented formulas for its products; it continues to invest there to bring new products to market, which will ultimately help growth in the coming years. Despite the hiccups that this company has faced with some negative viral stories, it still has a loyal customer base and consumers who are willing to give it a try. Ultimately, this stock just won’t be a bust…. Could it be a bone? Maybe, which is 50% downside from here today, but it is more likely to be a bagger. The upside potential here is really strong -- high single digits on our base-case scenario. And we aren’t counting out the possibility of another company buying it outright once revenue trends start to stabilize. It would be a great asset to a lot of different company portfolios in the beauty space. As with other 'bones' that we think will be 'baggers' we recommend buying a small position in several of these names collectively amounting to a full position -- REAL, PRPL, TCS, and now OLPX. You only need one to work -- we think all of these will get very respectable upside in the bundled position.
Williams-sonoma (WSM) | A Short At 179. This stock has simply ripped since Leonard Greene announced a 5% passive stake, and then the company followed up with a better than expected 3Q. Revenue trends looks abysmal, but margins were strong. Management boldly pushed an agenda that it would take both market share and margin in this operating environment, which is about as bad as it's been during this cycle. We took this off our Best Idea Short list (fortuitously) last month, but it sits at the very top of our Short Bias list, and teeters again on Best Idea Status -- especially at 179 when we think numbers will be heading lower. People are afraid to short this name because they're concerned about Leonard Greene's 'passive stake'. Mind you that LG took a passive stake in BBBY and look how that ended. We can't envision a NPV-positive scenario where a full takeout over 200 (which would have to be given a premium to the current trading price) would make sense for LG unless it held for an exceptionally long time, wiped out management, and completely redesigned the global growth profile of the company. We'll be tactical on this one, and even just a few dollars high from 179, this likely goes back to Best Idea status.
Dick’s Sporting Goods (DKS – Short Bias) | Reports Earnings Tuesday Before The Open. Our take on DKS has been that in order to want to own it at ~120+ you have to believe in margin sustainability, category sustainability, and an elevated valuation profile relative to pre-pandemic. Last quarter the sustainability of margins clearly came into question. We think the category demand still has risk as sub sectors like golf sit at peak consumption levels with some signs of slowing. Golf Galaxy visits growth has plummeted into negative territory (below) and we’re seeing more discounting on clubs with inventories appearing to build after a couple years of lean activity. We won’t get too carried away with the multiple debate, though we don’t think it deserves much above 10x at least until the EPS trajectory shows a bottom. Heck, if BBY can hold a low to mid-teens multiple as often as it does there is no reason DKS shouldn’t have it at some point. The core banner visits at DKS look weak as well trending down around mid to high teens since the mid-summer slowdown. Expectations of flattish EPS for 2H and then +2% comps in 1H24 look far too high for us, as we expect demand pressure over that full time period. Ultimately, we have TAIL earnings around 10 vs street at 13, and think a fair price range for DKS today is 85 to 105 vs current 118.
Lowe’s (LOW – Best Idea Short) | Reports Earnings Tuesday Before The Open. We remain bearish LOW and home improvement into this weeks print. The near term trends are mostly known post the HD and FND print. Though we think LOW might have some greater demand risk given the lower Pro penetration, and commentary from Toro around weakening demand with homeowners. We think the consensus view is still too bullish on home improvement sales performance over the next 12 months as we expect reduced home turnover and pressure on the consumer wallet to continue to drag on demand levels in the home improvement channel. LOW is our favorite short in the home improvement space as we think you have greater margin deleverage risk on weakening demand given the gross margin expansion the company saw in the pandemic’s opportunistic pricing environment. Store visit trends (below), have gotten a little less bad vs the down mid-teens trends seen in September, but are still trending down double digits in the latest week. We think there is potential for risk to 4Q sales, and the ‘barely negative’ expectations of 1H 2024 look hard to hit. We see ~25% downside risk to 2024 EPS estimates, and think multiple pressure along with that, meaning downside of 30% to 40% for the stock.
For the replay of our call on the home improvement demand risk and scenario analysis, see our Home Improvement Deep Dive Video Replay and Slide Deck Link CLICK HERE
Nordstrom (JWN – Best Idea Short) | Reports Earnings Tuesday After The Close. We remain bearish JWN into this week’s print, though the market appears to expect some weakness on the print itself with the stock sitting a buck or two off its year to date lows and the short interest back up around 22%. Visits trends have gotten a little less bad at both Nordstrom and Rack over the last month and a half, but the trends are still down about 20% at the core banner, and negative at Rack despite an excellent off price shopping environment. Rack continues to lose share big time relative to the other off price players, below you can see that visits to TJ Maxx are out performing Rack by about 20% over the last couple of quarters. Rack probably improves, but it’s still ceding share. Meanwhile JWN has some of the biggest ‘hockey stick’ expectations for 4Q, as comps are expected to inflect to +1% in 4Q vs down HSD in 1H and EPS growth is supposed to go from -38% in 3Q (low bar) to +31% in 4Q (high bar). An important data point this quarter will be credit. Credit income makes up the majority of EBIT here, and the direction of delinquencies and charge offs in the credit card space is clear: getting worse faster (see delinquencies table below). Even with JWN having a higher credit quality portfolio than other retailers, the bad debt risk is still building. The timing of when that risk hits the P&L is hard to know, as we don’t know the exact accounting and internal reserving processes of each retailer. Macy’s is always the first to make an adjustment, and we saw it take the hit there in 2Q, still down 31% this Q just reported… the others tend to take their hits later on. But we think the reversion in portfolio profits is definitely coming in the next 6 to 12 months. We think earnings power is around 1.30 here vs the street at 2+ and the stock is going sub 10 vs current 15.
30+ Day Credit Card Delinquencies By Month Nov 2022 to Oct 2023:
Best Buy (Best Buy – Best Idea Short) | Reports Earnings Tuesday Before The Open. We remain bearish BBY as we think the company still has sales and margin risk to come. Best Buy has been a Best Idea Short since fall 2020, and it remains a top short. Traffic continues to be weak, with visits down into the mid-teens, online interest trends don’t look much better despite the early start to Black Friday across the industry. We think the continued pressure on discretionary spending will be a problem here, as is the replacement rate of long-lived goods that BBY carries that were over consumed during the pandemic. Additionally, the depressed home turnover environment will be a drag on big ticket home durables that BBY carries like appliances and home entertainment. Lastly, and perhaps most important is BBY’s material but ‘quiet’ credit portfolio risk. As the company disclosed a couple quarters back, when balances went up and credit quality went to peak, credit ADDED 50bps of margin. But now credit is going from tailwind to headwind, meaning there is arguably at least 50bps of incremental margin risk from credit alone, and the potential for much more if we see a truly weak consumer credit environment with recessionary levels of delinquencies and bad debt expense. Given the rapidly rising trends we are seeing in credit card delinquency rates we think you have 75 to 100bps of margin risk here just from credit, when this is only a 4% operating margin business. We expect the retail business to see margin pressure as well in the depressed demand environment. We think you have earnings downside to 5 to 5.50 and stock downside to the low to mid 50s vs current 68.
