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    MARKET EDGES

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Capital deployment is like feast or famine in the apparel industry, and the supply chain starved.

If there's one thing I am convinced of it's that for a company to thrive in what will be a dramatically different operating environment for the next 3-5 years, the brand/retailer needs to invest in its content - big time. Whether it manifests itself in capex or SG&A depends on the specific business model (retailers need more capex while 'brands' need more SG&A).

Another key backdrop for me is that a company in this space could literally earn whatever it wants to for a few quarters. Maybe even a few years. Not tough to defer lease liabilities, and take down opex to boost margins today and borrow from 2-3 years out. EPS does not equal economic reality.

Consider the following...
  • The first exhibit shows the year/year change in gross margin for the apparel supply chain versus its SG&A ratio. In other words, it shows how much the industry is reinvesting back into sales, marketing, product, and the retail experience in different gross margin cycles. Noticing anything?
  • First off, it's pretty tough to miss that gross margins were up pretty massively over 7 years. That's right in line with my industry call (i.e. this tailwind will reverse).
  • Second, is it just me or has the yy change in the SG&A ratio consistently coming down? I don't know about you, but when I look for a good business, I like to find one that takes gross margin improvement and reinvests a fair share into SG&A to drive future growth. This industry has done the polar opposite.