Conclusion: Macro and Micro are converging in a way that contextualizes a simple, yet powerful story about the state of retail. Hindsight positives plus deteriorating inventory spreads being led by high-end retail is not what bulls want to see.
Shorts: CRI, HBI, GIL, BBBY, KSS, GPS, M, JCP, GES, HIBB
Longs: FNP, NKE, RL, URBN, UA, DKS, DECK, AMZN, FINL
Let’s step back and put some of the bigger picture datapoints in retail into context. They all point to complacency today, and a good element of hope built into financial models in 2H. Consider the following…
1) This morning’s CPI report showed that apparel/accessories CPI accelerated by 20 basis points on both a 1 and 2-year basis.
- The absolute change of 5.12% is the highest reading on record since December 1990. At face value, this comes across as extremely bullish.
- But consider this…in 1990 roughly 70% of Apparel you put on your body was made in the US. Costs were high, elasticity of demand was a big issue, pricing was critical, ‘the era of the mall’ kept supply in check, and ultimately, competition was rational. When costs went up, consumer prices followed. In fact, for the 30-years leading up to 1990, average price increases clocked in at 3.5%.
- Then we went through a massive outsourcinig wave thanks to changes in the US Government’s arcane import regulations geared toward protecting dying US textile mills. Now only 5% of what we wear is made in the US.
- Over this 22 year time period, per capita unit consumption of apparel went up by roughly 50% (from 40 units/yr to 60). In other words, the industry drove prices lower and stimulated additional unit purchases. This took industry margins about 500-600bps higher, despite lower prices.
- Today, there is almost no more room to outsource. But simply to get more efficient in how outsourcing is being handled. Retailers can’t drive increased unit demand AND margins by lowering price anymore. Finally, with 'the era of the mall' has transformed to 'the era of selling to the consumer at a transparent price -- mall or no mall.' Translation, they NEED higher prices to stick, or simply need to be very conservative with inventory buys.
Apparel CPI (yy chg).
Source: Bloomberg
2) The CPI readings are definitely positive, but we can’t exactly call them bullish. Keep in mind that we’re looking at April data. This is very much a lagging indicator. It mirrors any pricing success that the industry is seeing TODAY in its reported 1Q results.
3) But with these results, we’re also seeing inventories rise. KSS, SKS, JWM, M…all of them have an eroding sales/inventory position. This is how it starts, folks. Each retailer has a slight erosion on the margin, but assures people that it is manageable. The reality, however, is that they are powerless over what the competition will do as their respective inventories get too high.
4) The biggest concern for us is that the two retailers with the worst sales/inventory deltas are Saks and Nordstrom. It’s way too premature to call for the death of the high end consumer – people have been calling for that for the better part of a decade. But this has been a ‘safe haven’ in the midst of KSS blindly fighting JCP in the mid-tier (collectively KSS and JCP account for about 15% of the industry). Our call all along has been that these factors would start to bleed in to 2H, and put estimates at risk.
Shorts: CRI, HBI, GIL, BBBY, KSS, GPS, M, JCP, GES, HIBB
Longs: FNP, NKE, RL, URBN, UA, DKS, DECK, AMZN, FINL
