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.
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.
Today(11/20/18) BMO, ROST beat on EPS of $0.91 vs. Cons of $0.90 on a reported +3% comp vs. Cons of +2.8% driven by very healthy traffic. Ongoing basket increases suggest healthy top-line trends continue amidst the strong consumer backdrop. The company noted that merchandise margins were up 20 bps but were more than offset by 50 bps of higher freight costs and 15 bps of buying and distribution expenses. The company beat on SG&A in terms of Cons despite deleveraging 30 bps YoY due to previously mentioned wage investments. The company repurchased 2.9M shares during the quarter for $278M. Although freight and wage costs may pressure margins in the near-term, over the long-term we believe the off-price model will continue to be successful, especially when considering consumer backdrop may be peaking and off-price model is defensive and even more valuable in weaker economic environment. Shares traded off 9% on guidance.
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.
As we enter the most critical period for retailers, we thought it an opportune time to provide thoughts on structural trends in U.S. retailing. With 2H18 by all measures expected to be solid, we look ahead to the set up for 2019. This note addresses why we believe 2018 may be as good as it gets and highlights the parameters for long-term winners, as well as how to navigate the choppy trading backdrop. We discuss 1) the current backdrop, 2) the investor base driving stock performance in 2018, 3) why we believe long-horizon money is unlikely to invest at current levels, 4) the looming pressure of wage inflation and potentially tariffs, and 5) why the oversupply problem will continue to weigh on 2019 and 2020 margins.
The Wolfe Retail Monthly Short Report is published using the end-of-month reported short interest positions. Our Retail Monthly Short Report helps to gauge sentiment on individual stocks.
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