I'm getting conflicting factors on whether to own this group. Near-term, the market is discounting that more downward revisions will come on either sales day or EPS season. Add that to trough valuation/ growth expectations and easy 2H margin compares, and this group might look like a nice trade. I remain concerned, however, that the consensus is not bearish enough for 2009, as the Street's 'trough' NTM earnings growth still appears over 1,000bp too high. Be selective.
In analyzing where the US apparel industry is in its earnings cycle, I come up with the view that NTM earnings growth will go negative. While there are trade-offs between sales and margins, the end result is the same. Down earnings. Consider the following...
  • 1. Revenue still has a long way to go to secure the inevitable 'downtrend' a. As I've been posting, I believe we are on a multi-year consumption downtrend. With that, could the public companies print average revenue growth rates in the mid-single-digit range for the foreseeable future instead of the 10-12% 10-year average? ABSOLUTELY! b. Importantly, one of the drivers to above average top-line growth in this space has been $30+bn in sourcing savings injected into the supply chain over 8 years to stimulate per capita consumption. As that factor unwinds, growth goes into hiding. c. Consider that from a top-line perspective, the industry is still a good 3 quarters away from reaching the new trendline growth, and 1-2 years away from setting a new baseline.
  • 2. Margins: I am absolutely convinced that margins will continue to trend down 100-200bp on both a 2 and 3 year basis for at least the next 1-2 years. Check out my posts on the supply chain squeeze for full color. Bulls will respond that even though the industry is likely never to post a positive margin comp again for another 3-5 years, the 1-year erosion should get 'less bad' in 2H.
  • 3. In the context of troughy valuations and weak earnings expectations, a 'less bad' margin trend piques my interest. That is, until it is squashed by the simple math that even a 'less bad' margin trend coupled with slower consumption nets out to around a -10% EBIT growth rate for the space. That puts the earnings revision and industry valuation analysis into a new perspective.