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.
Good, but may not be good enough to dissuade shorts. The holiday comp result is being met with an aftermarket stock reaction -1.4%. A holiday comp of +5% was good, but not great as we had hoped. Although small, Europe took a turn for the worse, as did the Home category for Anthropologie, turning negative for the first time in five years. We note that the Home/Gift/Accessory category can grow to almost 40% of the holiday season but diminishes materially entering the spring season. We believe that UO brand’s comp was capped by full-price selling but delivered upside to merchandise margins with historically low levels of markdown. Anthro brand’s Home category miss was offset by reduced clearance units; merch margins should expand, albeit below plan. Free People also had unexpected modest merch margin pressure. Although more difficult 1H18 comp compares may embolden short sellers, spring is one of the strongest product seasons for all three brands. With strong brand equity, differentiated product, and a model that mitigates fixed-cost deleverage, we support URBN shares at these levels.
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.
After delivering three consecutive quarters of best-in-class fundamental performance, URBN shares are trading -5% YTD as investors shed shares. At issue is the ability to comp the comp beginning in FY1Q19. With many names pulling back, we looked across our universe for the optimal combination of 1) increased visibility on cash flow growth, 2) improving return metrics, and 3) reduced risk as measured by attractive valuation metrics. We lay out five reasons that sum up our thesis which are detailed further in the note.
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 market on 12/10/18, URBN filed its 10-Q. In the Management's Discussion & Financial Analysis, URBN commented on consolidated QTD comparable retail segment trend, “Thus far during the fourth quarter of fiscal 2019, comparable retail segment net sales are running mid-single-digit positive.” With just over one month completed, we choose to maintain our 4Q18 comp estimate of +5.0% (Cons +5.1%) and our 4Q18 EPS of $0.82 (Cons $0.81). The quarter is patterning as expected, with Black Friday/Cyber Monday results driving upside to a +MSD comp, and the post-Black Friday lull giving some of that upside back. We forecast URBN 4QTD retail segment comp to be +5%. We also note that UO brand had comp pressure in December from weak tech and media performance LY that has been resolved this holiday season and could result is modest improvement.
After market on 12/10/18, we expect URBN to file its 10-Q. We expect another solidly positive comp report, but do not expect a material acceleration from the +MSD guidance provided on their most recent earnings call. In fact, 4QTD, our proprietary promo checks show URBN consolidated promo levels are running “Deeper” to LY (see Exhibits 4-10 on pages 5-7), corroborating a highly promotional environment. We note however that promotions at UO are “Flat” but UO was the only brand we follow that was “Better” YoY during Black Friday/Cyber Monday weekend in our entire tracking universe. For UO, recall last year this brand had a material comp deceleration in December due to its tech and media categories as well as margin pressure from incurring expensive digital marketing during the peak pre-Christmas season. Anthropologie and FreePeople are “Deeper” QTD; we note “Deeper” promotions were mostly on clearance vs. full-line. Still, we are keen to see any inflections in promotions for each of these brands during the rest of the quarter. In the Management's Discussion & Financial Analysis, URBN comments on consolidated QTD comparable retail segment trend. We expect commentary similar to: “Thus far during the fourth quarter of fiscal 2019, comparable retail segment net sales are running mid-single-digit positive.” With only one month completed, we choose to maintain our 4Q18 comp estimate of +5.0% (Cons +5.1%) and our 4Q18 EPS of $0.82 (Cons $0.81).
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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