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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The company laid out the following four priorities in yesterday’s earnings release: stabilizing top-line growth, resetting their cost structure, optimizing the company’s asset base and refining their organization structure. We note the first priority represents a slight shift in strategy via prioritizing sales over profits. We think these priorities make a lot of sense but until we see meaningful progress, we are hesitant to get more constructive. In terms of the new CEO, the company noted the search remains ongoing. Given the business remains in flux, we remain sidelined. Shares are -4% in pre-market trading.
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.
BBBY’s transformation is based on many as-yet unproven assumptions. OM recovery now shifts towards GM from an SGA-driven recovery last quarter. Within GM are assumptions on sales leverage, improved sourcing, reduced couponing, with persistent pressure from Beyond+ membership growth. It’s hard to model such improvements when 1Q19 guidance was well off the mark, and the near-in story appears to be worsening before inflecting in 2H19. Management’s focus on profit over sales is a positive, but our Retail Deleverage thesis is based on driving slightly positive comps at brick-and-mortar and mitigating fixed cost deleverage. The fact that brick-and-mortar comps continue to run -MSD, we believe is an indication that BBBY simply has too many stores (supply) for customer demand. However, with activists seeking to expedite change and an aggressive buyback plan to support EPS, we remain sidelined. After market shares were -9%.
With activists now entering the scene, we choose to move to the sidelines. We have been thematically negative since mid-2017 and continue to believe BBBY’s current path of negative comping stores, little pricing power, and the shift online will result in further margin erosion. However, we note that activist engagement 1) sparks conversation on changing the status quo (which is typically not working) and 2) puts pressure on management to either execute and deliver results or engage in a proxy fight for board seats. Given that the role of the activist is to spur change to effect positive performance outcomes, we step aside. Regardless of whether new leadership ultimately emerges, the current BBBY strategic path is likely to prevail throughout FY19.
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.
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