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Deflationary Pricing Trends Drive Goldman to Downgrade Levi’s, PVH, Ralph

Retail sales have deteriorated, resulting in deflationary pricing trends that are now a key headwind for branded apparel companies.

That’s according to a Goldman Sachs report published Wednesday, which saw the investment banking company downgrade PVH Corp., Ralph Lauren Corp. and Levi Strauss & Co. stocks.

The tough backdrop for multibrand retailers has “negative implications for the supply chain,” Goldman Sachs analyst Alexandra Walvis, said, and the sector can expect a return to negative retail traffic and elevated inventories. And, as Walvis noted, the need for increased levels of promotionality to engage value-centric customers, is ongoing.

A tough holiday season and first half of 2019, plus execution errors at several department stores, led to elevated inventories and promotional activity that has been “exacerbated by an optimistic spring ordering season. Against this backdrop, we expect conservative buying patterns from core department stores for [the second half of 2019] and into summer 2020,” Walvis said.

Retailers, she added, will likely “more aggressively prioritize their strongest and best-performing brands and merchandise as they allocate shelf space, driving sharper share losses for brands with limited momentum.”

Brands that have strong direct-to-consumer (DTC) omnichannel commerce are likely to be more insulated from the risks resulting from high exposure to the department store channel, Walvis said. However, non-athletic brands where DTC businesses are skewed toward outlet stores, are more likely to also see challenged traffic trends in those locations. That’s because the promotional retail environment translates into a smaller value gap, and consumers, in turn, are less likely to feel the need to seek out the outlet centers, or may choose to shop for value discounts in other channels.

Goldman Sachs downgraded the three apparel firms’—PVH Corp., Ralph Lauren Corp. and Levi Strauss & Co— stock to a “Sell” rating. The equity research team is keeping its “Neutral” rating on shares of Kontoor Brands Inc., the Wrangler and Lee jeans business that was spun off by VF Corp. earlier this year.

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PVH Corp.

For PVH, Goldman Sachs is forecasting ongoing headwinds at Calvin Klein, and “expect Tommy Hilfiger growth to fade.” It also sees risk to “total company results given heavy exposure to North America wholesale and outlet channels, and insufficient investments in full-price DTC.”

The Goldman report also noted that while the Calvin Klein brand has been refocused with a digital first consumer strategy, it appears that the approach re-centers the brand as an underwear brand, which poses risk to growth in its core apparel accessories categories. Moreover, the Calvin Klein Jeanswear business remains challenged due to fashion misses and disappointing margin activity.

At PVH’s Tommy Hilfiger brand, there is a belief that the business has more room to grow as it exits its exclusive relationship with Macy’s for sportswear. But the large network of outlet stores and limited e-commerce exposure are risks. For now, it has a sizable point of sale presence in the department store channel, particularly at Macy’s, and it has benefited from the retro trend, which is viewed more as a fashion cycle than a secular trend. Walvis said there has been heavy representation of both brands—more so Calvin Klein, in the off-price channel—and cautioned that a larger presence would be imprudent as “exposure is already at a level which could be damaging to brand image and pricing power.”

Ralph Lauren Corp.

Ralph Lauren was downgraded due to persisting headwinds in the core North America wholesale market, “compounded by brand specific challenges at Polo and Lauren, fading [average unit retail] growth and lighter retail comps as outlet pressures weigh,” Goldman Sachs noted.

While the management team is working on a turnaround strategy that includes a pullback from the U.S. wholesale market, Goldman Sachs believes U.S. wholesale sector challenges will offset any incremental gains from execution. Further, fading AUR growth in the DTC channel is expected to drive both top-line and margin headwinds at Ralph Lauren. Walvis said the brand aesthetic is inconsistent with the streetwear and sportswear trends that are resonating in the market. And while the company has invested in marketing, special collaborations and an increased social media presence, the “core growth has yet to sustainably accelerate,” she said.

Levi Strauss & Co.

Levi Strauss completed an initial public offering earlier this year, and has solid brand momentum that’s driving healthy growth in DTC and international. Recent results, however, show it is still impact by headwinds in the U.S. wholesale channel.

The second quarter earnings miss was due largely in part to the challenging wholesale channel, where accounts totaled more than 70 percent of sales in North America, or 55 percent of fiscal year 2018 total company sales. Results announced earlier this month include projections that outlook would be impacted by a 200 basis point headwind to total company sales in the second half of fiscal year 2019.

As Goldman Sachs noted, “this deceleration in U.S. wholesale is a significant headwind to total company growth.” And while the company’s gross margin has benefited from sourcing initiatives and better supply chain management, Walvis said she expects the benefit will wane, with margin expansion driven by geographic and channel mixes.

Kontoor Brands Inc.

For now, Goldman Sachs sees cost cuts and solid free cash flow offsetting its concern over top-line trends at Kontoor. However, the tough North American retail environment means “inventories at many retailers are bloated, pricing is deflationary and the overall consumer retail backdrop is more uncertain,” according to the report.

Analysts also expect Kontoor to report a “challenged” second quarter result, driven by factors such as a tough year-over-year comparison and “continued pressure from key partner bankruptcies, particularly for the Lee brand.” Inventory levels are expected to be elevated in the second and third quarters as Kontoor exits several manufacturing facilities in Mexico and cycles the disruption from customer bankruptcies. The headwind from inventory pressures are expected to “begin to normalize” by the fourth quarter, according to the report.

As department stores continue to cede share, Goldman Sachs remains cautious on the longer-term outlook for the distribution channel. The research team is more positive on the trajectory of online, DTC and off-price due to secular trends. It also expects Walmart, Target and Costco to grow their share of apparel sales, and for the fast fashion channel to be more “muted” going forward.

Separately, Goldman maintained its “Buy” ratings for Under Armour and Tapestry.