The quarter commentary brought a clear shift in strategy with FY19 as a year of investments: 1) new subscription business Nuuly, 2) new furniture distribution center in early fall, 3) new European home office in 3Q19, 4) construction of a new distribution facility in Europe, and 5) incremental talent for China T-mall local launch. During investment phases, companies face heightened business risk and results become extremely sensitive to deleverage risk. As such, shares often languish. Trading at 10x NTM P/E, near valuation lows, URBN reflects the uncertainty and risk that accompanies an investment year. With investments to build a robust 360 degree platform, we maintain our Outperform, although concede trading is likely rangebound until there is proof of concept and positive ROI on the new initiatives. Shares trading -7% in reaction.
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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.
With mall traffic down, consumer malaise, and weather disruption, all brands are below expectations thus far in 1Q19. We continue to believe in the product offering and strength of trend underlying the product at the URBN brands, but clearly note the tough compares will keep a lid on shares until 2H. We continue to believe in attractive risk/reward at these levels but are revising our EPS downward based on early indications of a weakening consumer backdrop.
We already know that URBN reported 4Q18 comps of +3% missing the then Cons of +4.5%. We believe merchandise margins were up at all three brands, but Anthro missed expectations for greater product margin recovery due to weakness in Home. Checks 1QTD show controlled, on-plan promotional activity at UO and Free People brands, but our checks show a clear continued pattern of Deeper promos QTD for Anthro. We are noting weakness in Home as well as a potential miss in the dress category within apparel. We perceive the Anthro weakness to be suggestive of a potential negative comp for the spring quarter as they work through issues to remedy product category misses. Based on our now-expected negative low-single-digit Anthro comp, and a generally tough start given weather issues, we lower our comps in 1Q and 2Q to slightly negative territory.
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.
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