Retail Earnings Press Releases Read Like March Weather… In Like a Lion, Out Like a Lamb
So what do in the retail sector now?
The Season of Beat and Lower
Walmart (WMT) and Target (TGT) did it. So did Best Buy (BBY) and Bath & Body Works (BBWI). Just this past week, Nike (NKE) and Foot Locker (FL) did it too.
These companies, like so many others in the retail sector, trounced earnings expectations for the fourth calendar quarter, which includes the all-important holiday season that so many retailers rely on to make an outsized portion of their annual earnings. And these weren’t just victories of cost containment… all of the companies I listed beat Wall Street analyst expectations for top line revenue growth too.
If you were reading the press releases of these – and so many other - retail companies, you would have been impressed. There was strong commentary about fourth quarter demand, plus most of the companies had made good progress working down the inventory glut that they found themselves sitting on at mid-year. Earlier in 2022, previously clogged supply chains were suddenly unclogged and retailers, who had ordered a little extra, hedging against shipments that would arrive late or never (a huge problem in 2020 and 2021), suddenly found themselves long too much stuff – clothes, home goods, electronics – into a decelerating consumer.
It all seemed great… until you got to the last three of four sentences at the bottom of the press release before the accounting statements show up.
The guidance. It was as cold as the holiday performance was hot. Reading the press releases reminded me of the old adage about March coming in like a lion and going out like a lamb. Reading through the retailer press releases issued in late February and March was kind of like that, except when it comes to earnings reports, investors want more roar and less bleat.
Hence, we have the season of the beat and lower. Retailers generally beat earnings expectations for the fourth quarter, but then lowered guidance for what they would make in either the first quarter of 2023 or the full year 2023.
In a way, “beat and lower” is a bit of misnomer, because most of these companies hadn’t ever issued any guidance before for 2023. But Wall Street analysts get paid to predict what companies are going to earn in future years, so there is always an expectation – or consensus - out there for what the guidance could be. And most retailers disappointed on that guidance metric… So what they really did was “beat and issue disappointing guidance” but “beat and lower” is just a lot more catchy, so we’ll call it that.
That’s not to say every company in the retail/consumer space pulled the “beat and lower.” There were plenty of weak zebras that missed Q4 expectations then lowered the bar even further for 2023. Kohl’s (KSS) comes to mind on that front.
There were even the rare companies that beat and raised – not only handily beating expectations for the holiday season but offering guidance that was above even the most bullish analyst expectations. Just this past week, Swiss athletic footwear company On Holding (ONON), maker of the suddenly white hot On running sneakers, blew through expectations, posting fourth quarter revenue of CHF367 million versus street expectations of CHF275 million and even better, told analysts to expect 61% growth for the first quarter of 2023, smashing the expectations for 38% growth.
But forward guidance like On’s was exceedingly rare this earnings season, as most retailers told analysts to look for 2023 to be a decline versus 2022 in both revenues and earnings, with second half results looking to show more growth than first half results, given easier comparisons in the second half of the year. Growth in the first half of 2022 still benefited from some post-pandemic carpe diem recovery spending, as well as a tighter inventory environment, which led to an unusually low level of discounting – and over-earning at most retailers. Things get easier to lap in the second half of the year.
But the big unknown is how will the economy look in the second half of the year. Right now, consensus wisdom says worse, and it’s probably right, thanks to stubborn inflation, interest rate hikes, and lately, increased layoff notices.
In an ominous sign this week, Citibank’s Research Department put out a report that said credit card spending in third week of March was down 13% year over year, a big drop from the down 8% result in the prior week. Some people may have lost their jobs. Others read that we are going into a recession and pulled back accordingly. Maybe some of those misers had their money deposited at Silicon Valley Bank (SIVB). No matter what the reason for the pullback, it’s not good news, especially for the companies that live and die by those credit card swipes.
To be fair, it’s worth noting that Chase consumer card transactions do not show this kind of drop off in the third week of March. So, we have mixed messages… which is sort of the story of the economy for the last year already.
Top-Down versus Bottoms-Up Investing
Conventional stock market wisdom from prognosticators on TV is very often, per investment industry jargon, top-down. Top-down means that the investor looks for big macro themes in the economy and then goes and finds individual stock ideas to express those themes.
An example of such a top-down theory would have been to buy, at the first sign of vaccine approval, companies that benefitted from the post-pandemic reopening of society in 2021. Hotels, casinos, movie theaters, and other companies operating in the sectors most impacted by lockdowns.
Here's a chart showing the stock of hotel group Hilton (HLT) outperforming the S&P 500 by over 13 points in 2021…
The outperformance of amusement park operator SeaWorld (SEAS) was even more dramatic in 2021, as it crushed the S&P 500, with price appreciation of 105% versus the S&P 500’s 27%...
Another big top-down theme that we saw play out last year was the energy trade. The thesis there was that after an extreme disruption to energy consumption – as people stopped driving and flying during the height of the pandemic – that demand would come roaring back as the world normalized. And that surge in demand would meet a constrained capacity for producing more oil and gas, as capital expenditures in fossil fuel exploration and production had plummeted in recent years for a variety of factors, including a hangover from a period of overinvestment in the early 2010s, divestment of some institutional investors from the fossil fuel industry for environmental reasons, and management teams who were motivated by stocks grants and saw that investors were rewarding money spent on stock buybacks more than dollars poured into exploration.
Surging demand for oil met constrained supply, resulting in oil prices - which had briefly gone negative (!!!) because storage facilities filled up during the peak of pandemic lockdowns and freshly pumped oil had literally nowhere to go – recovering to levels not seen in years by mid-2022. Talk about a rebound - from negative $37 in April 2020 to $124 in March 2022….
These are classic examples of a top-down investment theses.
Bottoms-up investments instead rely on predicting how individual companies will perform versus market expectations using a combination of financial modeling and analysis with a qualitative overlay that looks at factors like competition, management quality, and customer relationships. A bottoms-up analysis of stocks like Hilton and SeaWorld might have led you to the same conclusion (buy the stock!) as the top-down analysis did – although in both cases the stocks started to take off well before the earnings started rebounding. The bottoms-up investor often buys when their estimate of future earnings varies to the upside versus the general consensus in the marketplace, as opposed to betting more broadly on the industry as a whole.
Right now, the conventional wisdom and knee-jerk top-down analysis will tell you to stay far away from companies reliant on consumer spending – and avoid stocks of retailers, apparel and footwear, gaming and lodging, restaurants, etc. Why invest in consumer discretionary companies when the odds of recession seem so high?
For much of the last year, I have been in the camp of a “soft landing” – believing any recession, were it to come, would be shallow. Recent events – namely the failure of Silicon Valley Bank – have put the Federal Reserve in a pickle. The Fed has been tightening – increasing interest rates – to fight off high inflation, which seemed like a logical move given overall unemployment remains low, and thus the economy fairly healthy in the present. But the need to extend financial support to failing banks – and avoid a “run on the bank” for the entire regional banking sector - runs counter to the need to tighten and rein in inflation.
At least for today, I’ll leave the discussion of whether the Fed is doing the right or the wrong thing to the many thoughtful macro analysts writing here on Substack and elsewhere. But suffice to say, our odds of a meaningful recession have exploded in the last few weeks, pulling me out of the soft landing camp.
Why Would You Ever Want to Buy a Consumer Discretionary Stock If the Economy is Going to Get Worse???
It’s such an obvious question. Plenty of top-down investors are going to avoid economically-sensitive sectors like retail entirely. Why be a hero and try to buy stocks in companies that are fighting a major headwind to their business momentum? And knowing that conventional wisdom will lead to fewer buyers of such stocks is yet another reason not to buy them… ultimately stocks go up and down because of the demand for them, and if you take out a bunch of possible buyers – demand will almost certainly be lower.
But one of the reasons I like the consumer discretionary sector is that even when the overall pie is shrinking, there will be companies that are growing. Market share dynamics play a huge role in how well individual consumer discretionary companies will perform. Even when households in aggregate cut their budgeted spending by 10% (a big haircut!), a company that goes from taking 0.01% of the household budget to taking 0.02% of the household budget will still grow by 80%.
In consumer, there is always a bull market somewhere… which explains the anomalies – companies like On Holding and Crocs (CROX), which came in with strong guidance for 2023, even amidst a tough consumer backdrop.
Technology is another sector where market share gains can trump sector woes.
In consumer discretionary as well as technology, there is no such thing as reversion to the mean. Outliers can stay outliers for a long time… look at companies like Nike (NKE) or Microsoft (MSFT), which have absolutely trounced the S&P 500 over the last 20 years….
By the way, who would have guessed that Nike shares actually outperformed those of Microsoft over the last two decades, which coincided with the explosion of the internet and cloud computing?
It’s true that a rising tide lifts all boats… and a falling tide can lower those boats as well. And in sectors with high correlation between stocks – like energy – it’s hard to play the outliers. You are going to have a lot of trouble finding a traditional energy company that goes up when the price of oil is getting crushed.
But in consumer discretionary – where there can be a wide dispersion of performance across individual stocks – looking for outliers can be a viable and even lucrative strategy. If you can be a contrarian and run into the burning building and find the companies that are encased in a metaphorical flame-resistant suit, you are going to make above-average returns.
Which Consumer Companies Can Outperform in 2023?
I think there are two possible categories of consumer discretionary companies that can outperform the market substantially in 2023, even if we get a recession in the second half of the year.
The first group is secular share takers. Companies like the aforementioned On Holding and Five Below (FIVE), a souped-up dollar store which specializes in tween/teen-friendly categories like toys, candy, electronics accessories, and cosmetics. These companies are share takers. But unfortunately everyone knows that, and they trade at sky-high multiples. ONON shares trade hands at a whopping price-to-earnings ratio (P/E) of approximately 58, versus the S&P 500 at 18. FIVE has a P/E of 36 – not as frothy as ONON shares – but still twice the P/E of the S&P 500 index.
Expectations are high for these companies, which puts them at risk. Results will be good here… but will they be good enough to justify their lofty valuations? I’m not sure – which is why I am waiting for a pullback (that admittedly may never come) on these two companies.
I mentioned in my last piece that I have been a fan of plastic shoemaker Crocs (CROX) for the last year. It too has been a secular share taker, in both its plastic shoes and even more so in its recently acquired loafer company, Hey Dude. Strong results have propelled CROX shares from a P/E of around 5 at its lows last summer to its current P/E of 11 (based on estimated results for 2023). But this stock is much cheaper than the average stock in the S&P 500, and I think visibility on its growth in 2023 is higher… so it’s one share-taker that I am happy to bet on here.
The other category of retail stocks to go fishing in is the potential sandbaggers. These companies set the bar ridiculously low when they guided 2023 earnings expectations. One interpretation of such uninspiring guidance is that things must really be falling apart quickly at these companies – and in some instances, this will definitely be true. But in others, management is just setting a really low hurdle so they can fly over it and report a series of earnings beats. When you anchor intentionally low, you are a sandbagger.
There are some companies that are perennial sandbaggers, and beat earnings nearly every quarter as a result.
Even though sandbagging is a well-known and well-established practice on Wall Street, when the proverbial sh*t is hitting the fan – which is a state that many smart people think we are at the precipice of – it’s hard to differentiate a company that is really about to take a big hit from one that just sandbagged.
One company that stands out to me as a possible sandbagger is athletic retailer Foot Locker (FL). Despite reporting a much better than expected same store sales result of 4.2% in the fourth quarter of 2022 (expectations were for -6%) and reporting $4.95 in earnings for the year, Foot Locker is guiding to 2023 adjusted earnings per share of just $3.50 at the midpoint of the range, which implies that same store sales could fall as much as 5.5%. Even though Nike – its largest vendor – did guide for a contraction in sales to its wholesale channel in the next few quarters – and Foot Locker is among the largest of its clients in that channel – it still feels like a sandbag to me.
Foot Locker took a real tumble last year – for good reason - when Nike said it would be pulling allocations of some of its most coveted products away from Foot Locker. But comments made during Foot Locker’s analyst day last Monday seem to indicate that the relationship between these two companies is improving. And in the last several quarters, Foot Locker has made some real progress in diversifying its vendor base, going deeper into hot products like the aforementioned Crocs, as well as Decker’s (DECK) Uggs. It has also rounded out its athletic profile, bringing in goods from upstart companies like On and casual athletic styles from companies like VF Corp’s (VFC) Vans and Converse, which is owned by Nike.
Foot Locker’s analyst day was the first one it has held in several years, and it served as kind of a coming out party for new CEO Mary Dillon, who joined Foot Locker in September of last year. Dillon was previously the head of cosmetics retailer Ulta Beauty (ULTA), one of the most successful growth stories in retail over the last decade. From 2013 to 2022, Ulta grew its earnings from $2.74 to $24.11 and its stock price increased by more than six-fold over the last decade…
Dillon took the CEO reigns at Ulta back in the summer of 2013. When the 61-year-old left the $26 billion market cap Ulta to join the much smaller, $4 billion cap Foot Locker – it was a bit of a headscratcher for me, and I think many other longtime consumer analysts familiar with the history of these two companies.
Dillon clearly saw some potential in Foot Locker that others did not see. And if she can succeed in accelerating growth and profitability at the company – which is not only relatively small compared to Ulta but also much more mature – then she will certainly earn herself an undisputed spot in the ranks of the greatest retail CEOs of all-time. (I would argue that she has already earned that spot based on the performance of Ulta Beauty alone.)
During the analyst day, there was some interesting information presented that suggested that Dillon is applying some of the same analytic tools to Foot Locker as she used at Ulta. Too much to get into today, but if you want to hear more about her plan for Foot Locker, let me know in the comments and I’ll tackle the Dillon playbook for Foot Locker in a future piece.
One clear dynamic at play here with Foot Locker is the phenomenon of the newbie reset. When a new CEO comes in, they can give themselves a clean slate and set the bar wherever they want to set it. There is no greater temptation to sandbag than when the macro outlook is murky… but the second most popular time to sandbag is when the CEO is new. Why not set the bar low so you can clear it from the get go? You only get this kind of fresh slate once.
So yes, Virginia, you will be able to make money in retailers in 2023. But you will need to be selective. I recommend you restrict your digging for ideas to the secular growers – the share takers – and companies that you believe are sandbagging.
Feedback Welcome
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If you have questions about anything I wrote or constructive criticism, leave that too, and I will do my best to answer your questions and make necessary adjustments reflecting your feedback. One question I would have for my readers… was this too long, too short, or just right? I covered a lot of ground here, which means it was long – perhaps too long for the modern attention span? You let me know what you prefer – I’m writing this for you.
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Some Interesting Things I Read This Week
I know there are a million people out there curating links, so I am only going to include this section if I read something interesting that I think you might have missed. I won’t be sharing reading just for the sake of putting something here. I trust that you know I am reading a lot of stuff.
The Case Against (Some) Buybacks
New York Times, 3/6/2023
The Vibecession: The Self-Fulfilling Prophecy
Kyla’s Newsletter on Substack, 6/30/2022
An oldie but goodie – much of macro analysis has a short shelf life, but I would argue that a lot of this is still relevant – and speaks to the economy of mixed messages that I referenced at the top of this essay.
Writers Guild Says It’s Pushing to Prohibit AI-Generated Works Under Contract in Negotiations
The Hollywood Reporter, 3/22/2023
TL:DR – AI is going to make almost as many lawyers as technologists rich, also, we might have writer’s strike, which is seriously the last thing that beleaguered Big Legacy Media needs.
Beyoncé’s Ivy Park Is Dead. But Who’s To Blame?
The Root, 3/24/2023
Key Lesson:
“When a collaboration like this fails, everyone wonders who’s to blame. Is it on Adidas for not marketing the products enough? Or is it on Beyoncé for not understanding the appeal of her brand? Normally I would never blame Queen Bey for anything, but Ivy Park never quite felt like it matched her public persona. The girl from Houston might be all about stylish tracksuits and sneakers, but Beyoncé, the global megastar, doesn’t put out that vibe. From a fan perspective, you trust brands when they align with someone’s area of expertise. It’s why athletes sell sneakers and chefs sell cookware and food products. Rihanna became famous for the sex appeal of her music, which is why Savage x Fenty and Fenty Beauty make perfect sense.”
I Spent Two Years Revenge Spending. It Was Hard to Stop.
New York Times, 3/2/2023
An anecdotal explanation of why consumer spending has stayed so strong for so long, despite inflation, rising rates, banking jitters, layoffs, and other assorted reasons for worry. Anyone else have this problem?
Prosperous Investing!
Disclaimer: This content is for informational and educational purposes only and does not constitute financial advice or a recommendation for a particular investment.
Disclosure: The author may have a personal financial interest in securities mentioned. At the time of publication, personal investments included BBWI, CROX, and FL shares.
Not too long. Just right. Full bodied, open personal comment, substantive. Thank you
Thank you for your writings. You invited future subject requests. ‘companies with buy-back strategy are currently worthwhile investment considerations’