Danger Zone

With earnings season about halfway done (brands reported, but retailers have not) we've got a pretty good sense as to where the industry stands. It's not pretty. Sales are off, inventories and high, and margins are down. (Thanks McGough, tell me something I don't know). We know this is painfully obvious to just about everyone that watches the tape, but what might not be as obvious is how bad the industry is on top of increasingly easy compares.

The chart below show shows the spread between sales growth and inventory growth on the vertical axis, and the yy change in Gross Margin on the horizontal axis. The sample includes every publicly-traded company that makes, designs or sells apparel. The place to be is in the upper right-hand quadrant, where sales are growing faster than inventories, and margins are up. On the flip side, retailers never want to be in the lower left quadrant -- inventories growing too fast relative to sales and Gross Margins down.

Unfortunately, we're in that lower left quadrant today. Even more unfortunate is that 1Q is the first quarter of easy compares vs last year in the current cycle. Bulls might argue (correctly) that any move out of the lower left quadrant is a positive stock move. We'd note that K Mart was there in almost every quarter for the 5 years before it went under. Sears and Foot Locker are there perennially.

Importantly, over the past 5 years, the apparel industry was to the right of the vertical line (margins up) almost 90% of the time. This was the tail end of the multi-year margin tailwind we think is going away. We have no reason to think that the current quarter is an aberration in any way vis/vis what is yet to come in this industry.