Today (5/29/2019) BMO, ANF reported an EPS beat on higher than expected sales and lower than expected SG&A. The company’s two core brands traded places in terms of comps with Abercrombie brand beating Cons of -1.5% with a comp of +1%, while the Hollister missed Cons of +3.4% with a comp of +2%. Hollister’s US business remains robust and the miss was due to Asia and Europe weakness. Our long-term Underperform thesis remains unchanged with deleverage persisting, as we are hard pressed to see the company inflect back to positive brick-and-mortar comps across the chain without the reliance of discounting over the next few years. Reiterate Underperform as we believe Teen space remains highly competitive and will continue to lack substantial pricing power. On the miss and lower than expected 2Q guidance, shares traded down 27% on the day.
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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%.
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.
During 4Q18, inventory risk continued to increase as sector inventory grew at a faster rate than sales. Given a macro backdrop that is no longer fueled by tax stimulus, we believe this is harbinger of margin pressure in FY19. Note that this is a snapshot entering 1Q19, so any top-line weakness in 1Q will result in even greater inventory excess. We expect this inventory risk to build progressively throughout FY19 as retailers try to “comp the comp” but lack pricing power and must simply drive unit volume to deliver positive comps. Simply put, sector wide business and performance risk has materially increased.
ANF continues to defy expectations. BMO on 3/6/19, ANF delivered another solid quarter on higher than expected comps and better than expected gross margin. Hollister remains on track with a 6% comp on top of an 11% comp last year, while A&F brand's comp inflected negatively due to weakness in women's tops and dresses. In addition, brick-and-mortar comps remained negative this quarter. As such, our long-term Underperform thesis remains unchanged, as we are hard pressed to see the company inflect back to positive brick-and-mortar comps across the chain without the reliance of discounting over the next few years. In addition, with fixed costs for the sector on the rise, we see future risk to margins and note Teen competitors (both online and offline) continue to pressure pricing. Reiterate Underperform as we believe Teen space remains highly competitive and will continue to lack substantial pricing power. ANF is up 21% since reporting 4Q18 earnings BMO on 3/6/19.
The January reading plummeted, falling two rankings from December’s reading of 3/10, suggesting investors started re-shorting stocks during the January rally after being sidelined at year end. In January 45.7% of retailers posted a short position >15% (up from 39.1% in December). Since we last published this report on 12/17/18, the XRT is up 1% vs. the S&P 500 +4%. 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.
Although many companies posted sales upside for the holiday season, we think the upside is the result of deeper promotions (despite clean inventory) in order to coax consumers to shop. CPRI and TPR reported quarterly earnings last week that echoed this sentiment. Both companies cited a promotional environment, among other issues, that resulted in misses on the top-line and on gross margin vs consensus. We expect general misses to gross margin and sales given the trend of deeper promotions over the last four quarters from a peak score of 43 or “Flat” in 1Q18 to 33 or “Deeper” in 4Q18.
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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