Retail - eating my share of humble pie
Worse than my expectations
I owe this newsletter an update on my retail thesis and here it is - I was dead wrong.
I write this in light of two of my names - BBWI and ANF - guiding down in outcomes that were not my base case. ANF reported this AM and the stock is down 30% pre-market. Among many concerning things about this print:
The company guided the top line down from 4-5% sales growth to 0-2% for 22’
Margin outlook was cut to 5-6% from 7-8%
Inventories are up 45% y/y just as the consumer starts to show weakness
EPS guide cut to $3.80-$4.15 from $4.30-$4.70
Operating margins down to 19% for quarter due to cost increases from inflation versus long-term guide of 25%+
Inventory up 29% (management says this was according to plan)
In more concerning news, Target and Walmart both missed on earnings and are concerned on inflation.
At this point in time, it’s not clear to me how strong or weak the consumer is, but retailers are definitely feeling the pain on inflation and supply chain.
Learning lessons
What can be learned from this terrible call on my end?
On March 2nd, I wrote what now looks incredibly dumb:
“Normal” retail is not a good business. ANF is guiding to do 7-8%ish operating margins in 2022. Embedded in that forecast is that Europe and other parts of the world continue to come back from COVID and buy close to the prices they’re buying at now. If history is any indicator, those forecasts don’t always play out perfectly and that is one of numerous risks of investing in retail… And yet… I think a lot of these concerns are priced in… The market IMO thinks we’re going to end up with retailers who flood the market with supply and consumers who don’t want to pay for the latest Hollister jeans when gas costs $5 a gallon and their variable rate mortgage resets higher… This is a take, and there are probably other risks I’m overlooking, but my thesis here is the consumer has more attachment to ANF and other strong retailers than the market expects.
These concerns were not priced in and the consumer is not showing enough resilience to avoid expectations coming crashing down. Even though both BBWI and ANF looked to trade at attractive valuations with strong balance sheets (and IMO still do), those valuations clearly existed for a reason. For 2022, I overestimated margins and free cash flow. I don’t think this makes the long-term any less attractive, but for timing entry I clearly cost myself by buying at 30%+ premiums to where those stocks are now.
Lessons learned:
When the market has very clear concerns that expectations / management guide is too high, take caution
Understand “priced in” is a judgment call and expectations can always worsen
What’s next for retail?
Supply chain and inflation issues should eventually end and ANF is saying just that:
With $468m of cash (and about to open at <$1bn market cap), the company has a lot of dry powder for buybacks and already has been aggressive this year on the buyback front:
Bath and Bodyworks similarly is saying it will continue to gobble up shares and many of the headwinds on COGS are temporary.
Both names trade at <10x P/E and have a lot of capital available for capital return. Expectations are low and sentiment is terrible. In the spirit of a deep value investor, I like this setup.
As a long-term investor, I don’t have significant concerns here and am keeping these positions on. That said, timing matters a whole lot and I erred here by thinking I could bottom-tick these names at what seemed like cheap valuations. They got a whole lot cheaper.