Heightened supply risk for 2019. During 3Q18, retailers took a turn for the worse, as inventory increased modestly at a faster rate than sales. With no ability to raise prices to drive comp, retailers must rely on increased unit volume to drive sales growth. Note that this is a snapshot entering 4Q18. Most results, save for a few exceptions (e.g., TGT – PP, COST – PP, covered by Scott Mushkin, and LULU-OP), have missed holiday sales. We expect inventory exiting 4Q18 to show even higher inventory-related business risk.
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The December reading rose for the second consecutive month, suggesting with valuations pulling in short sellers may be derisking. The November reading was 2 out of 10. In December 39.1% of retailers posted a short position >15% (was 42.2% in November). Since we last published this report on 12/17/18, the XRT is up 6% vs. the S&P 500 +2%. 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 believe 2018 may have been “peak season” for retailers. We continue to believe in the Retail Death Curve phenomenon. The 2018 lift in mall traffic was against easy compares and pent-up demand. Despite clean inventory in 2018, there was no evidence of broad-based pricing power. Retailers were as, if not more, promotional than prior year and “bought the comp.” Tax reform savings were reinvested in store-related wages and deferred capital spending – both contributing to a higher fixed cost infrastructure than before tax reform – adding to greater deleverage risk.
It’s preannnouncement season. Post-holiday preannouncement season is here. With up to 85% of sales completed, retailers know their 4Q fate. As such, we are publishing a post-holiday promo tracker update with our call outs on upside and downside performance for the quarter. Often, the holiday success or disappointment translates into a similar outlook for the forthcoming year. With valuations pulling back in 4Q, we believe our positive call outs are worth a look ahead of 4Q18 preannouncment season and as long-term outperformers in the sector. We expect preannouncements from at least the following companies: ANF, AEO, PLCE, EXPR, CPRI, LB, LULU, ULTA, URBN, W.
Sector Sentiment 2, on a Scale of 1 (worst) to 10 (best): The November reading rose from the October reading of 1 out of 10 with 42.2% of retailers posting a short position >15% (was 44.4% in October). Since we last published this report on 11/14/18, the XRT is down 11% and therefore investors may have taken some money off the table. 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.
3Q18 Consumer Sentiment Poll scores 5. 1 out of 10 (vs 6.2 in 2Q18). Each quarter, we send out a brief survey to gauge investor sentiment prior to earnings, where 1 is “Terrible” and 10 is “Excellent.” Thanks for replying, if you did! Survey results are completely anonymous, and the greater the response rate, the more conclusive the results, so please consider participating next time.
There are many moving parts and LB will reveal its new strategy next spring. The current quarter and expectations for ongoing pressure in 4Q18 are backward looking in assessing LB’s ability to turn the business. We care about the prospects for a sustained turn beginning in 2019. Typically, year one of a turnaround exhibits further margin erosion (often material) before we see initiatives take hold. There are several historical examples of turnarounds to refer to (e.g. TPR - PP, KORS - OP, RL – Not Covered) where margins and comps worsened before recovering, and management lowered the bar meaningfully as they gave themselves breathing room to execute the right go-forward strategy. We believe LB has two category-dominant brands, but the work to resurrect VS’ brand image will take time, investment, and could get worse before getting better. In reaction to ongoing struggles, LB shares were down 18%.
Since the mid-August, the XRT is -7% vs. the S&P 500 -4% as investors took money off the table after retailers may have had their best quarter during 2Q18 since 2H18 compares are tougher, economic fundamentals may be peaking despite a still robust consumer, and 2019 headwinds abound. Our promotional checks continue to suggest that demand is not translating to pricing power, even with the entire sector extremely disciplined on inventory supply. Our 3Q18 Wolfe Promo Tracker (click here to view) showed “Flat” sector promos to LY. The average current NTM P/E across our coverage universe has fallen more than 4x turns from 19x to 15x over the past three-months. With margin pressure returning in 2019 despite a still strong consumer, we opt for known winners - URBN, the Off-Price sector, LULU, PLCE being names we would look to accumulate on sector pressure. Longer-term, we remain cautious since sales upside is translating to margin upside in a select few retailers and as long as negative brick-and-mortar comps persist margin deleverage remains.
The October reading exceeded the September reading of 2 out of 10 with 44.4% of retailers posting a short position >15% (was 43.5% in September). This is the third straight month of percentage increases. The last time the sector sentiment was a 1 was in July 2018 when 45.7% of retailers posted a short position of >15%. 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.
3Q18 Promo Rating: “Flat;” 2Q18 Rating: “Flat.” Our 3Q18 Promo Score was 39 out of 100 (vs 40 out of 100 in 2Q18). Our Promo Score tracks YoY promotional activity as a proxy for merchandise margin direction. We pay particular attention to end-of-quarter changes in promo activity as it is indicative of whether inventory units are on plan. Click here for the Wolfe Promo Tracker excel model.
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