Investment Bellwethers: Four Pivotal Brands
Investor Headline: Slowing topline growth in tandem with increased marketing and IT spend leads to margin contraction and a disappointing bottom line.
This is a sad assessment for many retailers in the omnichannel world of 2015. And the second half of 2015 could get worse. At its annual investor meeting on October 14, Walmart spoke to an “okay” U.S. economy and a trends shift to discretionary items such as apparel. Back-to-school was “pretty good,” Halloween is “off to a good start,” and Holiday is expected to be highly promotional but “fine.”
Gee, this doesn’t sound like such a great outlook. And there’s more. Walmart predicts lower profits for the next few years as the company ups its investment spending on omnichannel capabilities. The stats? Sales guidance for the current fiscal year came down to flat from up 1-2 percent, thanks to the U.S. dollar’s strength.
This is a red flag for other retail, vendor and investment communities. 3Q earnings season for consumer discretionary companies, specifically retailers and brands, could be disappointing and erratic. We are seeing analysts revising estimates lower to factor in sluggish topline trends. Moreover, 4Q is looking increasingly gloomy as high inventory levels, along with a consumer that is increasingly less impulsive and less interested in “stuff,” is likely to lead to earlier and deeper promotional activity, potentially impacting 4Q sales and margins.
What’s the real problem here? We’ve become inured to the consumer’s indifference — or more precisely the educated and mercenary shopping tactics of a digital value shopper. Many external factors are also driving constrained profitability near term, including the headwinds of currency, increased expenses related to demand creation, higher retail labor costs, and investments in omnichannel execution. Tech is a major investment line item since seamless digital integration is missing at most retailers. This, combined with inventory levels growing more rapidly than sales, has many investors running to the exit. High inventory levels entering the holiday season is not a good thing. There always is a reasonable explanation, along with remedial plan, but high inventory just aggravates an already difficult profit outlook.
So to get a better perspective on the outlook, we did a reality check and looked at 3Q results for four companies we consider to be bellwethers, All four have strong brands and management teams.
VF Corp’s results are a testament to currency’s ability to obfuscate results. Approximately 40 percent of VF Corp’s revenues occur outside of the U.S., thus the dollar’s strength reduced an 8 percent currency neutral sales gain to the reported 2.5 percent, and earnings to a 1 percent decline from a currency neutral 14 percent increment. The power brands, The North Face, Vans and Timberland, grew sales double digit. Furthermore, the two largest coalitions, Outdoors & Action Sports and Jeanswear, which represent a combined 80 percent of sales, are on track to grow projected nearly 10 percent in 2015, according to CFO, Scott Roe. However, inventory levels rose 12 percent on a reported basis, a cause for concern despite the vibrancy of the bulk of VF’s businesses.
VF management attempted to allay worries, explaining inventories expanded in anticipation of early October receipts as well as the company’s growing direct to consumer retail store fleet (147 more stores year over year). That said, CEO Eric Wiseman acknowledged, “We know that there’s excess inventory out there in the retail channel, but it’s not in our brands.” VF Corp. expects to see year-end inventory back in line with revenue growth. So far in 2015, VF’s inventory growth outpaced sales growth in every quarter, however, in the final quarter of 2014, inventory growth was half of the revenue gain. Hopefully history will repeat itself!
Despite modestly beating 3Q sales and EPS estimates, Under Armour, with a largely US-based sales mix (about 85 percent), had currency reduce top line growth from 31 percent to 28 percent. CFO, Brad Dickerson, sees elevated inventory growth rates over the next few quarters as the company focuses on flowing seasonal floor sets earlier. For 2015, he projects 27 percent sales growth and a 15 percent gain in operating income gain.
At footwear company Skechers, a 27 percent sales gain, along with a 29 percent increase in EPS, didn’t satisfy investors. According to CFO David Weinberg, the increased inventory is appropriate based on backlogs and forecasted revenues into early 2016. Despite the sluggish domestic macro retail environment, Skechers is on track to open 12-17 stores domestically and 12 through international distributor and franchise partners for a total of 1,280 stores at year-end.
A number of changes—restructuring, acquisition and integration— are in process at Wolverine (Merrell, Sperry, Hush Puppies, Saucony, Keds, Stride Rite, Sebago and more). Wolverine spoke of a “mixed” back to school season, eroding consumer confidence and of retailers becoming more cautious during the quarter. The company sees this tougher environment extending through the first half of 2016 as inventory levels appear relatively high across the retail landscape. Management spoke to the high quality of its inventory along with the expectation that it would take a few quarters to work through the excess as it simultaneously protects its brands. Wolverine lowered 2015 sales and earnings guidance to reflect third quarter trends.
Given these mixed results and outlooks for four leading brands in vibrant categories, we think caution is the only watchword. Department stores as well as specialty apparel stores are particularly at risk this Holiday. A few more earnings reports of a muted top line performance along with blotting inventories would turn the Holiday into a Schmoliday. Brands should be working double time to connect and convert consumers at the digital lease line, as increasingly, browsing and brand selection occurs online. We are in uncharted territory as consumers continue to flex their independent-minded purchase power; traditional sales tactics are losing out to a customer who is in the driver’s seat. And these conditions are unlikely to change through mid-2016. Under the circumstances, Under Armour and VF Corp. remain best of class stocks for your portfolio…as well as your closet.