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.
Yesterday (01/09/19), after market close, BBBY reported 3Q18 EPS of $0.18 aided by one-time tax benefits (Cons $0.18). The company missed on sales, comp, and gross margin, slightly offset by better-than-expected SG&A. The company reported comp of -1.8% vs. Cons of -0.3%. Gross margin was 50 bps lower than Cons and down 210 bps YoY. FY18 guidance is $0.01 above prior Cons, with EPS now near $2.00 (Cons $1.99). Notably, the company said they believe FY19 EPS will be about the same as FY18. We believe this will be challenging given the structural shift to omni and further margin deterioration as Beyond+ increases in penetration. We reiterate our Underperform and believe promotions and fixed cost deleverage will persist until the pace of store closures accelerates meaningfully. On the comments about FY19 EPS and with a 25% short position, shares are +16% today.
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.
We expect the trends of a highly promotional holiday combined with heavy-up investments, ongoing negative comps and continued roll out of Beyond+ to continue to cause material margin erosion for the next couple of years. We also see the challenges of the highly-branded nature of BBBY’s product offering as another headwind since it is not exclusive to them. Long-term, we see the store footprint as a major problem that remains in the very early stages of resolution and expect another material round of store closures in 2019. Reiterate Underperform
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.
After the market close (12/6/2018), ULTA reported $2.18, including $0.02 tax benefit, vs Cons $2.16. The quarter consisted of an inline comp of +7.8% (+4.4% Retail and +42.5% e-commerce), a miss on gross margin due to clearance activity, and better-than-expected SG&A. 4Q18 guidance was light, coming in at $3.50 to $3.55 (Cons $3.62). Another quarter of GM pressure and slowing average unit retail growth due to the clearance activity caused a 5% selloff in shares in the aftermarket. Despite near-term pressure on GM from a competitive beauty segment, negative mix shift impact, and freight increase, we view ULTA as a secular winner benefitting from Millennial beauty buying behavior. Reiterate OP.
With the transformation of RH completed over the past couple of years, RH is now positioned to capitalize on its luxury positioning. Th company has reduced its brand-dilutive Outlet presence, purged legacy inventory increasing cash flow growth, and shifted to an “on-demand” inventory model reducing operating risk. With nearly 96% of transactions shipped directly from the fulfillment centers, regardless of whether the order originates online or in-store, we view RH’s business model as a pureplay Direct Commerce model. In addition, The Galleries should be viewed as high-profile marketing, rather than potential sources of deleverage as they 1) provide brand experience marketing and 2) generate direct-commerce sales without the risk inventory burden. With superior brand equity, differentiated product, and a model that averts the brick-and-mortar deleverage phenomenon, we reiterate our Outperform.
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.
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