Seven Irrational Retail Valuations 13 comments
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Before the onset of a recession and consumer pullback, investors rarely had to spend a lot of time ascertaining revenue visibility. After all, a rising tide lifts all boats. Find a hot stock, read all the glowing analyst recommendations, and buy knowing that it shouldn’t be too hard to hit forecasts. In a negative growth environment, revenue visibility becomes a much more important aspect of your investment analysis. Cloudy outlooks mean tentative investors, which usually equates to two very scary results - volatility and loss of market premium. However, this also means that time spent researching revenue drivers can provide that much more of an edge as panicked and confused investors dump their shares.
Nowhere is revenue visibility more of a problem than for apparel retailers. After all, it’s easy to defer clothing purchases especially when consumers are feeling poorer and poorer. And, it’s anyone’s guess when pocketbooks will open up again and where that money is going to flow. The trendiest retailers before the recession may not necessarily be the trendiest retailers after. Take a look at the following table:
click to enlarge
I’ve divided the table into three categories:
- Growth retailers - Urban Outfitters (URBN), The Buckle (BKE), and J. Crew (JCG).
- A turnaround story - Gap (GPS).
- Established “mature” retailers - Abercrombie (ANF), Ralph Lauren (RL), and Guess (GES).
You’ll notice a decided growth premium being paid for the growth group with P/Es in the high-20s just a year ago. And, for the more well established retailers, P/Es were just in the low- to mid-teens.
Interestingly enough, stock performance has hardly been correlated to EPS performance. Using forward earnings like those that I discussed in my previous post on multiple valuation, we find that forward P/E premiums are all over the place and no longer neatly in their general categories. Has something fundamentally changed about the retailers in the list, or is something else at work here?
The first culprit is probably the fact that analyst estimates are all over the place. No one really knows how much these retailers will make next year. Will there be a rebound? Will they have fresh designs despite massive inventory build-ups? Will they be able to win back old customers? However, even in trying to smooth this by averaging P/Current FY earnings and P/Forward earnings, we still see rather skewed multiples being paid.
The truth is that many of these companies are not fundamentally changed by the recession. Their inability to sell clothes is not unique to each store but a result of a systematic scaling back of consumer spending. If and when apparel demand returns, the fundamental growth vs. mature vs. turnaround stories will remain in place, yet Mr. Market seems to care little about this fact right now. That means there have to be some great opportunities for someone who can see through the haze.
Disclosure: None
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This article has 13 comments:
Wouldn't that be true no matter which way the market winds blew?
Thing is, for most retailer, there's sales on (1) opening a new store (licensing fees, like most franchises) and (2) sales of product. Product sales have been one of the beneficiaries of consumer credit (along with houses). Why should apparel bounce back before, say, housing or automotive sectors?
As far as retail rebounding before housing or automotive sectors, I think just because the price point is lower and because clothes are a less durable good and more "liquid" that it will be easier for consumers to buy marginal items of clothes as opposed to replace a house or a car (much less buy an additional one).
Personally, since they DO distribute the cash as dividends (and buybacks), I would go with enterprise value over freecash flow.
BKE is now below $20. Its p/e is below 10. Its profits are rising. It pays a good yield. It has no debt. It hasn't over-expanded. It is a great buy here.
It ahs a massive short position. Likely also manipulated and naked shorted. Being short that stock is idiotic unless you are covering the dips and hoping weak hands sell to you.
Long terma great buy. Short term crooks control the price now. But they are idiots as well, paying the divvy, the carrying costs, etc. The dumb shorts will get killed in this name.
thanks for the catch. I will have to fix this chart. I used year ago share price to calculate my current P/Es. Should have checked better.
I agree with your thoughts on BKE and in fact have been looking at it very closely.
If the situation has fundamentally changed for the worse I would expect the consumer to trade down (Walmart, Target)--leaving these apparel retailers with significantly lower sales. And of course even a few percent decrease in sales seems to decimate profits for them.
On Jan 15 11:28 AM PastTense wrote:
> The fundamental question is whether this is a normal-type recession
> and demand will return in a year or so--or if the economic situation
> in the US has fundamentally changed for the worse (that consumer
> spending in recent years was because of increases in debt and the
> chickens are coming home to roost...)
> If the situation has fundamentally changed for the worse I would
> expect the consumer to trade down (Walmart, Target)--leaving these
> apparel retailers with significantly lower sales. And of course even
> a few percent decrease in sales seems to decimate profits for them.
These companies ARE all fundamentally changed by this - and what we have going on is not a mere recession.
Don't imply that Mr. Market an idiot. Mr. Market burned a lot of people over the last 7 years.
The retailing business in the United States has fundamentally changed. Times will be tougher than in the past. People will not make credit-fueled purchases of $80 T-shirts made in China anymore. Throw the old P/E's out the window because they have no relevance anymore.
On a more technical note, if you assume earnings as a proxy for long term cash flow and anywhere between 8% and 12%, no growth P/Es are justified between 8 and 12 which is exactly where we're trading today on a forward basis. Basically, a lot of valuations today include dismal forecasts for 2009 and nearly no growth from there. Will we make astronomical returns as stocks rapidly return to their previous all time highs? Probably not. But, is there room for significant appreciation from current levels? I don't think anyone can deny that.
On Jan 29 11:31 PM 123 wrote:
> I think that you are wrong, dead wrong.
>
> These companies ARE all fundamentally changed by this - and what
> we have going on is not a mere recession.
>
> Don't imply that Mr. Market an idiot. Mr. Market burned a lot of
> people over the last 7 years.
>
> The retailing business in the United States has fundamentally changed.
> Times will be tougher than in the past. People will not make credit-fueled
> purchases of $80 T-shirts made in China anymore. Throw the old P/E's
> out the window because they have no relevance anymore.
You think there will be no growth-I think there will negative growth in earnings. I think we are now seeing the tip of the iceberg - we do not yet see the full effects of this recession in these retailers' earnings, but we will.
Basically my view is that your assumptions are misguided.
Also I think an 8-12% earnings yield (even a realistically stable one) is nothing to jump up and down about considering that inflation in the US is around 8-10% per year and maybe even higher in the future. You can thank Mr. Obama and the Fed for that.
I also think you miss my point. I'm not arguing that ALL retailers are a good buy right now. I'm saying that despite some being stronger than others, ALL have had their valuations compressed into a tight range. Logically, those which are "better" must be irrationally priced and provide more upside than the rest of the category. Furthermore, I advocated looking at multiple valuations on a FORWARD basis, which implies significant negative growth over the next year for many of these companies. Unless you believe negative growth will continue for many years into the future, I think that assuming one more dismal year and no growth for the rest of eternity after that is quite conservative.
Many economists are predicting an ECONOMIC (not necessarily market) bottom by the second half of 2009 and definitely by 2010. Even if we're mired in a credit restricted world after that, long run growth in the economy should continue to be at least modestly positive (~2%). Retailers are plugged directly into economic growth and, as such, I think I'm reasonably justified in believing that these valuation levels could be quite compelling.
On Jan 30 12:24 PM 123 wrote:
> "The market is unfairly punishing retailers"- Do you know how many
> retailers have gone bankrupt in the last year? This will continue
> and get worse.
>
> You think there will be no growth-I think there will negative growth
> in earnings. I think we are now seeing the tip of the iceberg -
> we do not yet see the full effects of this recession in these retailers'
> earnings, but we will.
>
> Basically my view is that your assumptions are misguided.
>
> Also I think an 8-12% earnings yield (even a realistically stable
> one) is nothing to jump up and down about considering that inflation
> in the US is around 8-10% per year and maybe even higher in the future.
> You can thank Mr. Obama and the Fed for that.
The economists think that all that needs to be done is to have credit flowing again. Well America and Americans are essentially broke - much of the spending that we've seen the last 3-4 years has been the result of massive asset (i.e. realty) price inflation. Americans then took out home equity lines of credit and spent that too. They took out money from credit card companies and spent that too.
OK so even if credit is not flowing now, and credit starts to flow, this will result in more of the same that got us into this mess. Any relief in the retailers will be short lived at best.
I guess that you are trying to say that these retailers are the exception to the overwhelming rule of struggling retailers, but WHY? How is Abercrombie's business, or Gap's business really all that different from, say, Talbots, or whatever? It's not, in my view. And just because their earnings have held up so far does not at all somehow guarantee that they will continue to hold up. Things could just get worse...and worse...and worse, and not you or any economist out there can tell me otherwise. Obviously I hope that doesn't happen because I live in this country and I want to have a good job and so on, but when it comes to investments or whatever that's something to consider.
No, I do not think there are really any safe paper assets at the moment. With the Fed and US government doing their darndest to dilute the value of the dollar, there is a real wipe out risk with any paper assets.
BTW I think there are some bonds that look halfway decent - for example Sears Holdings has bonds with a 24% or so YTM coming due I think 2011 or 2013. I mean there is a risk of bankruptcy but at least I suppose there you're getting cash instead of these phony buybacks that management does so their f*cking call options will go in the money.
But I haven't bought those bonds because I just don't have the money, also like I said there's a risk of bankruptcy there too and that debt is unsecured.