2Q19 Promo Rating: “Flat;” 1Q19 Rating: “Flat.” Our 2Q19 Promo Score was slightly worse than 1Q19, with a score of 36 out of 100 (versus 37 out of 100 in 1Q19).
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Recent rumblings of excess inventory growth have pressured the stock down ~9% in one week. Mid-day Tuesday, a store channel check report suggested heavy inventory levels flowing into stores. Based on our store checks, this is true – new, full-price flows of early/transitional back-to-school merchandise are indeed flowing into stores. The new flows are coincident with the biggest traffic driving portion of the quarter and the “Monster Sale” promo. To be sure, we will be watching promos in July like a hawk. Admittedly, weather is not great, but then again management expected a tough 2Q19 with demand pulled forward into 1Q and tough compares. With a 38% short position, what appears to be typical inventory cadence is being interpreted as inventory risk. We disagree. We believe what we are seeing is the in-store preparation for the high-traffic portion of the quarter and the earlier flows management discussed and planned for on the call.
This custom model provides a template for calculating the impact of a 25% tariff on goods from China imported into the U.S. including average unit cost increase, margin hit in basis points, earnings reduction and average unit retail necessary to offset tariff impact.
Use our Tariff QuikCalc Model (click here) to quickly calculate the impact to a retailer's cost, margins, earnings, and, most importantly, to determine the percent increase in prices needed to offset the tariff. We have done this work for our coverage universe, but this is only a small sample of the retailers, vendors, and manufacturers impacted. Therefore, we developed a "quick and dirty" model to give you a general sense of the impact. For the average specialty retailer, we estimate an average unit cost increase of 4.2%, which if entirely unmitigated through price increases results in an average earnings reduction of 35%. The average unit price increase necessary to offset the higher tariff is 2.1%.
PLCE beat on comp, GM, taxes, but missed big on SGA largely due to incentive comp. PLCE reported 1Q19 Adjusted EPS of $0.36 vs Cons for LPS of ($0.48). Comps came in at -4.6% vs Cons. -7.8%. Despite May QTD store comps running -20% vs +24% LY, 2Q19 guidance brackets Cons. FY19 EPS guide increased ~9% above Cons and embeds lowered 2H19 expectations, removing a hurdle for many investors.
1Q19 beat o comp, GM, taxes; missed big on SGA. PLCE reported 1Q19 Adjusted EPS of $0.36 vs Cons for LPS of ($0.48). Comps came in -4.6% vs Cons. -7.8%. Gross margin was materially better, deleveraging 30 bps vs Cons expectations for 430 bps of deleverage. Despite the Gymboree liquidation, merchandise margins actually increased (a sign of pricing recapture) due lower average unit cost and better than expected markdowns, which was directionally consistent with our "Flat" promo read for the quarter. SGA was the one huge miss, coming in $11M higher than we expected due primarily to higher incentive compensation and was offset by $10 million lower stock-based tax comp expense than we had modeled - due to the stock price being materially higher during the quarter than expected. Inventory remains a shade higher than sales. Pre-market, shares +5%.
The April reading was the fourth consecutive month at 1 or the worst score possible. In April, 50% of retailers posted a short position >15% (up from 47.8% in March). We note the percentage of retailers with a short position over 15% continues to increase month-over-month. We rank Sector Sentiment on a scale of “1” being the most negative sentiment to “10” being the most positive sentiment. The basis for the ranking is based on the number of retailers in the sector with >15% short positions.
We’ve been tracking progress throughout 1Q19 and feel comfortable enough to raise our comp and above-Cons Loss per Share (“LPS”) estimate for 1Q19. We note an earlier wind down of Gymboree website and stores (neutral/positive), a positive promo inflection from “Deeper” to “Flat” this quarter (positive), and what looks like a return to inventory discipline (positive). This is offset by likely too-high Cons for 2Q19 (we are at an LPS of $0.34 vs. Cons EPS of $0.16) and talk of potential tariffs. For our full thesis, we suggest three prior notes and webcasts: 1) 1Q19 Promo Check Update, 2) Single Best Idea note from 3/20/19 and 3) Deep(er) Dive note from 4/8/19.
Making progress. This note tracks PLCE’s QTD progress with our post-Easter and Spring Break proprietary store and promo checks. For our full thesis, we suggest two prior notes and webcasts: 1) Single Best Idea note from 3/20/19 and 2) Deep(er) Dive note from 4/8/19. The first note focused on historical examples of the bankruptcy impact on the surviving company, Gymboree accretion and sensitivity analysis on sales and EPS, and the impact of stock-based comp accounting on taxes. The second note covered PLCE’s competitive positioning, market share opportunity, and executional risks.
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