Structural improvements in many businesses, strengthening balance sheets, generally depressed valuations and a still solid consumer backdrop are paving the way for bullish stance in investment in the fashion sector.
Wells Fargo retail and softlines analyst Ike Boruchow compares the current environment to the post-Great Recessionary period in 2008-2009 that led to the “setup” to 2011 that saw rising raw material prices—particularly, cotton pressures—and inflation woes. Calling the two periods “eerily similar,” Boruchow said the one constant then and now is how consumer spending has remained healthy despite economic challenges. And the demand backdrop from the robust consumer sector is expected to remain solid in 2022, according to Boruchow.
Just how healthy is the consumer?
The third quarter 2021 household balance sheet shows total net worth rose $2.4 trillion to $144.7 trillion from the second quarter, according to data from Wells Fargo equity strategist Chris Harvey. That’s a 34 percent increase in three years from a household net worth of $108 trillion as of the third quarter 2018.
Inflationary pressures have been centered around freight and logistics in the supply chain. Rates for the cost of transporting goods both by sea and on the ground have surged over the last 12 to 18 months. Those cost pressures are expected to peak during the first half, according to Boruchow’s estimates.
As for how fashion firms and retailers in his coverage universe fared in 2021, the analyst said solid top-line growth—in many instances, above 2019 levels—was driven by pent-up demand exiting out of the 2020 pandemic, along with a “prosperous consumer benefiting from government stimulus in the absence of full employment.” In addition, a muted promotional environment helped to drive healthy gross margins.
Supply chain dynamics last year worsened in August, due to Covid-related factory closures in Vietnam, and that in turn resulted in limited inventory supplies and rising inflationary pressures. Boruchow expects some overhang since he predicts the early part of 2022 will be a challenge. That, in turn, could pressure stock prices and provide an entry point for investors. But by the second half, Boruchow becomes more bullish as cost pressures prove transitory and balance sheets are “extremely clean.”
In Boruchow’s universe, luxury and athletic brands—companies oriented toward the higher-end consumer—generally have been able to maintain or expand their forward multiple over the last 12 months. Among his “Top Picks” for investors in 2022 are Tapestry, Capri Holdings, Farfetch, ThredUp, Academy Sports and Outdoors and Under Armour.
He cites Tapestry for improvements the business has undergone over the past 18 to 24 months, including a step-up in the margin structure driven by improving AURs (average unit retail), tighter inventory controls and a pullback in promotions. He also noted the firm’s new CFO, Scott A. Roe, who was the former CFO at VF Corp. and is “well regarded for his M&A prowess and shareholder-friendly capital allocation.” Tapestry’s plan to repay $400 million in debt by the end of the year will strengthen its balance sheet and could position the owner of the Coach, Kate Spade and Stuart Weitzman brands for more M&A activity down the line. “All in, the story remains compelling, and we expect momentum to continue and earnings power to continue to strengthen,” Boruchow said.
As for Capri, the Wells Fargo analyst noted that the Michael Kors business continues to “morph into a leaner, more profitable brand,” one that’s driven by more full price sell-through, fewer promotions and pricing increases. Versace has begun to “fire on all cylinders, and our confidence is growing that the brand will hit its $2 billion revenue” target, while Jimmy Choo continues to see improvement in sales.
Even though Farfetch shares were among the worst performers in his coverage universe in 2021, Boruchow said he remains bullish on the stock. One reason is the impending deal on the Richemont/Yoox Net-a-Porter partnership. Another is the belief that Farfetch can scale margins going forward. In addition, the company has a multi-year opportunity in China via tailwinds from the channel shift to e-commerce.
ThredUp made the cut as the analyst said tailwinds to the resale firm’s business model has “strengthened” during the pandemic, Boruchow said. With ThredUp as the only “managed marketplace” serving the “mass apparel resale market, we believe the business has a wide competitive moat via its infrastructure and technological capabilities,” he said. And even though the company isn’t yet profitable, the analyst said it has demonstrated improving scale in recent years.
New customer acquisition throughout the pandemic, AUR efforts including selective price increases and a subtle push with “better” and “best” offerings plus value offerings has Boruchow bullish on shares of Academy Sports + Outdoors. Merchandise margin gains from localization, private label and reduced shrink, as well as a multi-year supply chain initiative ramping up in 2022 should provide a plus to the company’s margin story.
Under Armour, which Boruchow’s colleague Kate Fitzsimons covers, made the list of Top Picks because its turnaround playbook began to take hold in 2019. While Covid drove a 15 percent revenue decline in 2020, the pandemic also “proved to be a huge accelerant to the company’s full-price efforts, aided by an emphasis on focused technical product, distribution clean-up, tight inventories and benefits of a $525-$575 million restructuring, Fitzsimons said.