RH reported 1Q18 EPS of $1.33 vs. Cons of $1.01 on the back of a comp beat, but modest total top-line miss. The EPS upside was largely driven by a gross margin beat of 130 bps (38% vs. Cons of 36.7%). RH also flowed through the 1Q18 EPS upside and raised FY18 EPS by 13% at the midpoint resulting in the new range of $6.34 to $6.83 (vs. Cons of $5.90). Adjusted 2Q18 EPS guidance also was well-above the Street with a guided range of $1.70 to $1.77 vs. Cons of $1.53. We continue to view RH’s business not as an omnichannel retailer but as a Direct-Commerce, or “D-Commerce,” retailer. 96% of RH’s transactions are shipped directly from their fulfillment centers regardless of whether the order originates online or in-store. Only 4% of purchases result in store-bought inventory. With superior brand equity, a consumer that willingly pays “ticket” for differentiated product, and a model that avoids the brick-and-mortar deleverage phenomenon, we reiterate our Outperform.
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Omnichannel 301: The Four Factor Success Model. In this primer, we answer the question, “What should an investor look for to see if a retailer is successfully making the shift to e-commerce?” A successful omni model has four critical elements: 1) positive comps in both brick-andmortar and e-commerce, 2) a fixed-cost breakeven leverage point reduced to the flat to low-single-digit range, 3) channel earnings parity (e.g., an e-commerce order value is >2x that of the store transaction value), and 4) highly accretive e-commerce EBIT margins. If these four criteria are met, the omni-retailer will be highly incentivized to grow ecommerce as quickly as possible to generate both higher margin rate and greater earnings power. Each of these factors is explained in detail in this note and this process can be used to analyze any retailer that is shifting its business from brick-and-mortar to e-commerce.
Solid all-around quarter; conservative guide. 1Q18 was solid all around as ULTA reported EPS of $2.70 vs. Cons of $2.48. We note that about $0.06 was from a lower-than-guided tax rate. The strength was driven by strong reception to ULTA’s offerings in the fast-growing (and underpenetrated) skincare business, offset by weakness in select prestige brands. ULTA’s mass segment included two new mass brands, Morphe and ColourPop, that were available only through ULTA’s retail and each of their own direct-to-consumer sites. As we shift into 2Q18, the addition of the Fresno DC, wage increases, new store openings, and increased advertising are expected to weigh on margins in the company’s lowest volume quarter. In addition, management stated they would prefer to see a resurgence in prestige product innovation before becoming more aggressive with its outlook. We continue to believe ULTA is uniquely positioned at the crossroads of providing a highly differentiated in-store experience, brand access, and the convenience of direct-to-consumer for the Beauty Enthusiast. As such, we reiterate Outperform rating.
When the facts underlying our thesis change, we revisit the risk/reward of our position. While we maintain longer-term deleverage concerns stemming from the omnichannel shift, the following facts have changed: 1) DKS management de-risked FY18 EPS by providing 2018 guidance in November 2017 that EPS could be as much as 20% lower than FY17, 2) demand-stimulating tax reform was instituted and so far, we note demand improvement, 3) our checks show DKS’ promotional cadence in 1Q18 improved from 2017 (see Exhibit 8 on Page 9), and 4) cleaner inventory and innovation suggest a new footwear cycle may be starting. As such, the equity no longer merits a trough multiple, which we reserve for companies in secular decline and waning operating margins. Therefore, we upgrade shares to Peer Perform. Although the valuation multiple has already rerated 5x from the trough, we believe DKS has the potential to grow merchandise margins throughout 2018, and therefore see upside potential to earnings. On the upside quarter and a 15% short position, DKS traded up 26% during the day.
Those fundamentally turning benefit the most in a rising tide. Reports have beat sales and earnings but with very few “clean” reports. A rising tide has on outsized beneficial impact on the best fundamental companies – BURL, KORS, LULU and ULTA reporting this week.
WSM has strong brands that are reclaiming lost market share, albeit with increasing costs to create the seamless and convenient customer experience. E-commerce is already 54% of total sales. 1Q18 showed the power of turning comp positive and turning deleverage into the opposite, and equally powerful, leverage. While we recognize the solid quarter, we cannot help but worry about competitor Wayfair (W - OP) and Amazon (AMZN – OP, Scott Mushkin) and their quests for market share at any cost. 1Q18 results would suggest that quality over price is what drives the WSM customer and this customer may indeed be different from the W and AMZN consumer. WSM remains cheap, even after a 15% move after market, but we look for sustainability of the strong performance.
The setup is mixed as: 1) tax stimulus is supportive of demand, 2) spring was unseasonably cool, 3) 2QTD has rebounded due to pent-up demand, and 4) 1Q18 sector promos were “Flat” YoY (click here for our 1Q18 Wolfe Promo Tracker). We are positive on URBN, ROST. We are cautious on the Gap brand at GPS, WSM, LB but believe stocks for all three reflect expectations for margin pressure.
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After early-quarter momentum driven by an earlier Spring Break/Easter, our April checks showed a dramatic slowdown in sales momentum as unseasonably cold temperatures delayed purchasing. We pay particular attention to end-of-quarter changes in promo activity as it is indicative of whether inventory units are on plan. We noted increased promos in April at AEO, EXPR, GPS (at both Gap and Old Navy), LB, Urban Outfitters brand only, and WSM (all concepts) suggesting they all lost momentum in the last month of the quarter. Click here for the Wolfe Promo Tracker excel model.
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