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.
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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.
End of quarter fade. URBN reported 4Q18 comps of +3% vs. Cons of +4.5%. We believe e-commerce grew 12% to 13% while store comps ended the quarter -1% to -2%. In early January, URBN had reported holiday comps of +5% suggesting a material deceleration to end the quarter. All three brands faded during January up against tougher compares, colder weather, negative mall traffic, and general consumer malaise. Shares in the aftermarket are -1% in reaction to the 4Q18 comp. During 4Q18, we noted deeper promos at Anthropologie and Free People with UO less promotional. We believe that UO brand’s comp was capped by full-price selling and delivered upside to merchandise margins with historically low levels of markdown. We also note UO has 50 stores in Europe, which turned negative, and is about 20%/25% of UO brands sales. Anthro brand’s Home posted its first negative comp in seven years. Although Anthro had reduced clearance units and merch margins should expand, this result was below plan. Free People also had unexpected modest merch margin pressure. Although the 4Q18 miss coupled with 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.
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.
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.
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