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The multi-year cycle is clear. ’03-’06 = organic revs and ‘free money’ gross margins. 1Q07-3Q08 = inventory draw down and capex reduction. 2009 = cut SG&A, and where no fat remains kill the muscle.

We all know that margins drive stock prices in this space. But visualizing the derivation of the change in margin over the past five years for the apparel and footwear retail space puts the current situation into a much clearer perspective. The punchline is that there will be some questionable head fakes by companies that should not cut costs, but will anyway. Others can genuinely afford it -- like LIZ, ZQK, and HBI.

Cycle considerations:

’03-’06: Revenue consistently ran ahead of inventory growth, the rate of gross margin improvement trumped SG&A margin changes, money increasingly flowed through the acquisition landscape, and capex was coming off a cyclical low and slowly building. This was a multiple-enhancing environment that allowed less severe competition allowed average brands and management teams to exist.

1Q07-3Q08: Revenue growth slowed by about 1,000bp nearly spot on with the inventory growth slowdown. But weaker pricing dynamics took gross margins down steadily while SG&A margin went the complete opposite direction as the retailers were (as usual) 9-12 months behind in aligning costs.

Interestingly, capex growth came down before SG&A – which is a departure from past cycles. We’re already benefitting from slower capex growth in 2009, but the big theme for the year will be SG&A. Think about it – more than half of companies in this industry have announced layoffs. With slower capex growth and even the slightest (even if temporary) reprieve in top line pressure, SG&A cuts could spur some meaningful EBIT growth pops this year.

I’ll never pay up for SG&A cuts as opposed to real organic growth. But for companies that have been left for dead like Liz Claiborne, Quiksilver, Hanesbrands and even Macy’s – a directional change in EBIT growth at current valuations can’t be ignored.