We’re hosting our weekly “The Retail Show” tomorrow, Monday at 10am (NOTE: 1 Hour EARLIER than our usual time...this week only). 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. Video Link CLICK HERE
Beware Apparel Inflation Spreads – Bearish For ANYONE Without Pricing Power. Short HNNMY (H&M), GPS, OXM KSS, RL, AEO, ANF, and anyone else lacking or anniversarying pricing power.
We've spent a lot of time on the road over the past month since we presented our SHEIN deck (for replay CLICK HERE). Slide 55 has gotten a remarkable level of interest, as it should. The reality is that even the most sophisticated management teams in Apparel don't think of the world this way – and the fact that they don't see their businesses as being impacted by these trends is pretty mind-boggling. Our analysis looks at the unit economics in selling apparel. Specifically, we track the pennies in the cost of selling at the consumer level, and track that against the corresponding change in the import cost. We might be only talking $0.05-$0.10 per garment, which might not seem like much. But multiple that by the 22 BILLION garments we consume in the US every year (yes, that's about 70 units per capita – a staggering number) and those pennies add up FAST. Our math suggests that about a THIRD of Total Apparel Supply Chain Gross Margin dollars (or about $50bn of about $150bn annually) can be explained away by changes in these 'Inflation Spreads'.
People – especially management teams, have very poor long-term memory as to what drives these spreads, and how quickly they can change. To be clear, despite what the past four years told us, Apparel is a deflationary industry, and has been since import quotas were removed in the early 1990s. (These ancient protectionist measures limited US imports of apparel by category, and were lifted ahead of China joining the WTO in 2001). Since then, both cost and price came down, and the US stayed steady at $1,200 per year in per-capita apparel spend. We simply bought more units at a lower price. But then covid hit, and brands and retailers started taking up price, and management teams (and too many investors) think that this is the 'new normal'. We call fowl on that. In fact, over the last 3-months, Apparel CPI decelerated from 4.6% to flat, and our bet is that it is once again negative within a 3-month time period. That'd be fine if costs were coming down, but they're not. We're going into a period where consumer prices are being driven down (while the broader economy inflates), and costs are grinding higher.
This is very negative for inflation spreads how we're doing the math, and the correlation between these spreads and the industry's Gross Margins (this is a bottom-up GM build of all public companies in apparel) is massively obvious. (And yes, the GM rate is highly correlated to stock price).
The punchline is that our historical math can't be argued with. It's fact. Our assumptions on a go-forward basis are open to debate. We're assuming that input costs continue to grind higher with broader inflation in the economy and with commodity prices (ripping) and labor rates. We're also assuming – as has been partially proven over the past 3-months with the deceleration in the Apparel CPI – that the pricing environment will mean-revert from the aberrational period we've seen over the past four years. Prices down at an accelerating rate, and costs up = margins down.
Conclusion: We'd express this thesis in being short a basket of apparel companies that either have no pricing power, or have had temporary pricing power over the past four years. We'd include H&M (HNNMY, HMB), Gap (GPS), Oxford Industries (OXM), Kohl's (KSS), Ralph Lauren (RL), American Eagle (AEO), and Abercrombie (ANF).
RH...Be Patient. Don't Be Afraid To Buy It Higher. Check out our note from last Wednesday night (CLICK HERE) where we go through our thoughts on this RH quarter. The good news is that with Thursday's $50 rip in the stock (a week ago we said it could be +/- $50 on this print) RH made it onto Hedgeye's Signal Strength Long list. The fact that RH finally made it there is kind of a sign of the apocalypse. Friedman's tone on the call was super bullish in the face of puking on almost every metric this quarter. And expectations are now clearly set for a rebound in demand, and that estimates are washed out. We actually agree with this. In fact, we don't think estimates are high enough over a TREND and TAIL duration. But we're troubled by the strength we've seen in Existing Home Sales over $1mm, and the lack of pickup in RH demand (see below). We come back to the 40% price increase RH took over the course of the pandemic. We've gotta put our cynic hat on given how high profile this name is for us, and we need to keep it real. We still think that there's a VERY high chance that – to get volume growing again – management takes down price on it's new assortment such that the price/value equation is sharp enough to actually get volume moving in the right direction. That event carries with it some headline risk. Yes, we like the fact the name broke out and has Signal Strength. But we'd rather add to positions either a) lower on a merchandise price cut, or b) higher (call it $400) when the risk of a price cut is de-risked. RH remains a core holding for anyone interested in a huge TAIL call.
Hibbett Sports (HIBB) – Going Long. Initial Work Suggests 30-40% Upside, With Take-Out Optionality. We had been short HIBB for most of the past two years – since it was pushing $100 with the Street underwriting long term earnings power in the $12 range. We covered our short two weeks ago, and now at $76 are bullishly inclined, for several reasons.
- We think that earnings expectations have finally bottomed, with the Street now looking for about $8 in EPS power vs previous nose-bleed expectations for $12.
- HIBB has massive (73%) Nike exposure and will be one of the big beneficiaries of Nike turning the corner in its product cycle. To be clear, this heavy reliance is NOT healthy, and should be represented in the stock's multiple/discount rate. But as earnings head higher, the stock is likely to get something above 10x earnings (even though we'd argue that it shouldn't).
- This is one of the rare environments where multiple brands are competing on product instead of just price. Brands like Nike are paying for fixturing, which opens the door for other brands to open up their wallets. We could only point to a handful (2 or 3) of these environments over the past 30 years. It's one of the rare times where you want to be long retailers like HIBB (and FL and JD Sports).
- We wouldn't be surprised in the least if HIBB was acquired at a much higher price. This is arguably the best off-mall asset in the US (with dominance in the bible belt) and would make an ideal add-on to the portfolio at JD Sports (which already bought the former Finish Line) and wants more US exposure in its portfolio. The overlap with its existing store base is very low, and a deal flat out just makes strategic sense. We wouldn't completely take FL out of the running, either, to buy HIBB. But think that JD is a much more logical choice. With M&A, the timing is always an unknown, but we wouldn't be surprised in the least to see a deal sooner than later. When the balance of power shifts over to the retailers like we're seeing today, that's the time we've seen big moves as it relates to IPOs and M&A in the past. HIBB really shouldn't be a publicly traded company, and we don't think it will be over the long term.
Caleres (CAL) | Adding to Short List. This is a retailer that did mid single digit (4%-5%) operating margins for a nearly a decade post the GFC, now all of a sudden the street is expecting margins to hold elevated levels and eclipse 8% over a TAIL duration on higher gross margins. The stock is at all-time highs, and though it looks reasonably cheap on P/E at 9.2x the consensus numbers, it is back to an all time high EV/sales multiple matching what was seen in the 2021 peak. Famous Footwear was a net winner on the Nike wholesale pullback, as it was a low to mid price player that didn’t really lose product flow as some others had allocations cut at those price levels. Nike’s shift back to wholesale is more focused on giving desirable traffic driving higher priced exclusives to certain retail partners, but flowing mid-tier product as well within those orders. As a family value footwear store, Famous Footwear doesn’t carry the high priced items, and will now have more competition in the mid-tier like at DSW which is getting Nike back, and will potentially lose share on competitors capitalizing on mid to low priced attachment with the incremental traffic from Nike exclusives. We don’t have the clear catalyst yet to make this a high conviction short, but as we get incrementally positive on retail, this is one where the earnings upside this year is minimal, and over the long term look estimates look like a big stretch, while the stock looks to believe those TAIL numbers.
Here's our Elevator Pitch for Best Idea Long Bath and Body Works (BBWI)
