Good Morning Hedgeye RetailDirect subscribers.
Key Retail Callouts for the Week – 6/21
“The heart of a father is the masterpiece of nature.” - Prevost Abbe
Eye on the ball and finish balanced.
-McLean
1. 24 Hour Fitness filed, closing 100 of 400 locations. Also filing was a small custom apparel company Blank Label. We’re just a few bankruptcies away from eclipsing last year’s record count as we’re not quite halfway through the year. On the ‘coming soon to a bankruptcy court near you’ list are Ascena, Tailored Brands, Guitar Center, Brooks Brothers, Francesca’s, and RTW Retailwinds (New York & Co).
2.Peloton Call Replay Deets. for video & audio replay of yesterday’s thought leader call on ‘What’s next for PTON’.
3.NLS, our favorite micro-cap seeing a breakout this week. With the virus spreading perhaps the market is realizing that demand will remain elevated for months, especially as consumer start to think about exercise in the winter. Lockdowns started when weather was starting to get warmer and nicer outside, people had the option to exercise outdoors. When winter approaches there will be many people looking for indoor at home exercise options, and at a price point much more in the NLS range than the PTON (it’s a tailwind for PTON as well, we just suspect the majority that can afford that and wanted it, already pulled the trigger). Bowflex just debuted a new adjustable barbell and curl bar, and there is likely demand for it. Many retailers remain low or out of stock on fitness equipment of all kinds. Demand is coming at minimal acquisition cost, meaning high incremental margins for the likes of NLS.
4.Wage pressure. Article below talks about backlash in Canada as retailers reduced the ‘hero’ wage rate back to normal levels. We have to wonder if the same happens in the US soon, which begs the question, how much of the retail wage increases around Covid-19 are permanent? Will consumers vote with their wallet enough to pressure employers to preserve higher wages, or will they be willing to eat higher prices to offset it? We’ll see. Perhaps there is an SG&A pressure that will not be going away, as it is really hard to justify cutting wages for those who have worked through this crisis, or perhaps with increased supply of labor in the coming recession the wage trend will revert lower. TGT accelerated its plan to hit a $15 min wage by end of 2020 yesterday by announcing it would start in July. By our math that $2 increase has upwards of 65cents in EPS pressure, or 50bps in margins. Retail was slow to adjust wages vs the national average coming out of the recession, then has seen rapid growth in recent years to make up that variance. Now its wage rates are some of the fastest growing. How can we see the profit profile of retailers being anything but structurally lower? Is there hidden efficiencies to offset this? Technologies to make running a big store possible with much fewer employees than they are today? At the same time the shift to ecommerce and door to door fulfillment is making the sales some at lower gross margin. We struggle with how many retailers would be able to get to recovery EPS results at or above 2019 as the market seems to be pricing in. As we pivot to the Macro Quad3(stagflation) outlook (where TGT performs worst historically) the TGT short looks even better, currently sits on our short bias list.
5.Apparel import vol. Data was released a week or so ago, but with the debate on the health of US apparel, it’s something else to consider. Unit imports were in decline due to tariffs in late 2019. April saw a new low under Covid with unit imports down 41%. For reference, within that imports from China so far in 2020 has seen units in Jan down 25%, Feb down 36%, March down 42%, and April down 48%. Will apparel retail be able to clear spring goods, and then will retail have all of the fall goods it needs on the shelf to drive sales as store re-open? Not an easy answer here, but perhaps take up the risk premium assigned to apparel retail forward EPS.
6. HBI Bull Case. We’ve been asked to think through an HBI bull case a couple times in recent weeks. The announcement of the new CEO perhaps presents the opportunity for a new direction and new strategy, as we outlined in our note below. The long term bull case as we see it has to be around re-investing in the brands to protect or gain share (can you even remember the last Jordan Hanes commercial you saw?), getting back LSD growth out of core innerwear, keeping Champion on a ~MSD growth path leveraging international, and maybe getting some other international brands to grow. The new CEO is definitely an opportunity for positive change over the long term. However, in the interim there are several big concerns. First is the continued distribution losses as the Covid-19 impact accelerates the brick and mortar demise and potentially compresses 3-5 years of retail bankruptcies into 18-24 months. Next is the trajectory of EBITDA over the course of 2020; HBI itself adjusted covenants to accommodate EBITDA as low as $435mm for this year, given the leverage its hard to think equity investors will be comfortable owning a stock at mid-teens EV multiple and 6x plus leverage of trailing EBITDA (perhaps it doesn’t get that bad, but that was in management’s scenario considerations). Lastly is the new strategy itself. We think HBI’s margin milking strategy has meant share losses while preserving high EBIT margins. Reinvesting would mean protecting share/revenue, but we think it has to be at a margin closer to 9-10%. If it can get to $7bn in sales at 10% in a few years, you are trading at nearly 10x that out year number today. So there may be a time to be long HBI under new management, but we don’t think this is the time or price for that.
7. Retail Sales in Context. We’re looking at headlines talking about a record retail sales number this week, and I get the month over month was up a lot off of the worst ever by far. But by category, many of the numbers were simply the second worst we had ever seen.
We think this channel shift is going to have bigger implications in retail earnings than people realize.
8. Delinquency Head-Fake. Reported delinquency rates looked better on the margin for SYF/COF. The problem is that the data excludes those card holders that have participated in a forbearance program. So we will have to see a couple more months or so of data before we can appreciate what the actual impact unemployment might be having on credit portfolios. Our financials team presented an update on the major card lenders yesterday. If interested in the full call/presentation ping Within that call they highlighted commentary from the CEO of Capital One on forbearance, noting 3% of card loans were in forbearance at the end of May. Up from 2% in mid April. As more data rolls in on employment, forbearance, stimulus, and delinquencies expect to hear from us again on the big private label credit card risk for several large retailers; KSS, JCP, GPS, M, TGT, JWN, among others.
9.RoadTravel trending to about 90% of the baseline from Feb according to data from Inrix. That would mean YY trends somewhere in the area of down 20-30% factoring in seasonality. Recovering traffic is to be suspected with states re-opening. Per the NY times chart below, nearly all states are in re-opening phase. The question is can miles driven and run rate vehicle wear return to pre-covid levels in a reasonable time frame. so far none of the auto parts names have made it to our best ideas list (AAP, AZO, ORLY short bias list, MNRO which we’d consider maintenance/repair is a best idea. VVV also maintenance was removed from long bias). We think there is an large amount of uncertainty with how Covid disruptions will permanently change consumer/worker behavior, but that is what makes analyzing this time period so interesting, its unprecedented. We do strongly believe that miles driven is the most import demand driving factor for the auto maintenance/repair industry in aggregate. Cars need repair and maintenance from wear, wear comes from use, less use should mean less need for repair and maintenance. There are other puts and takes on underlying demand, but logically this is the most important driver and the market seems to be shrugging off the rather drastic near term changes and potential long term effects. We highlighted in our Auto Miles Driven Black Book (Link: NHTS/FHA data outlining miles by trip purpose (work commute in total about 40% we estimate when including return trip and attachment trips). We do expect work from home to be a long term trend, as it becomes a greater accepted practice across corporate America given everyone has experienced it and seen how it works. I think a lot of older workers will push for option to work from home perhaps even ‘til retirement. According to the U of Chicago report below, 37% of jobs in the US can be done from home. Then you also have 20.5mm people in continuing claims apparently not working. It should take a while before those get to pre-covid commuting levels. I think with the accelerated channel shift (to ecommerce) in retail you will have permanently reduced shopping trips. With shopping being ~15-20% of driving maybe there’s another couple points of miles driven pressure there. We’re not saying auto parts sales are going to collapse, but until we see driving volumes close to or higher than pre-covid levels we think it will be hard to see earnings in aggregate above those levels of 2019. Depending how the data trends, some of these tickers may become higher conviction short ideas.
Some interesting work from home data.
Source: Inrix.com
Source: NY Times
Source: Bloomberg/Citylab
10.Bearish TSCO Datapoint. New cases of Covid-19 in counties where TSCO has stores saw a big ramp in the last 5 days. Trailing week results are back to levels seen in early May. Testing is up, but the case trend outside of urban centers is still a concern.
Jeremy McLean
Director – Retail Team