Time to take fashion’s “increasingly unrealistic” earnings guidance with a grain of salt.
Wells Fargo retail and specialty softlines analyst Ike Boruchow believes rising inflation and its impact on consumer spending mean fashion and retail companies “appear more likely than not” to miss the rosy 2022 projections many issued heading into the current calendar year.
Amid strong employment data and wages registering double-digit increases year-over-year, consumer confidence is beginning to flatten out and could weigh on the second-half outlook.
Boruchow wrote in a research note that “discretionary categories appear to have ‘overshot’ on consumer spending by 10-20 percent in 2021 compared to pre-COVID run rates and normalized wallet share,” which means companies in the sector face a “very challenged” environment.
The analyst downgraded his ratings outlook on shares of VF, Ralph Lauren and TJX from “overweight” to “equal weight.” The retail group lowered price targets on 18 of the 23 companies it covers to reflect a “more difficult trading environment for the sector” as Boruchow expects more downward revisions over the next nine months.
According to Boruchow’s analysis, companies had issued their guidance expecting last year’s strength to continue. But Wall Street has already seen a first-quarter slowdown and without the stimulus checks that propped up last year’s consumer spending, the outlook for the remainder of the year becomes increasingly muddled.
Then there’s the inventory factor to consider. If consumers tap the brakes on spending, all the inventory retailers are pulling in to meet today’s brisk demand could force many to resort to marking down product, which in turn erodes margins.
Boruchow cited different factors for downgrading VF, Ralph and the Marshalls and TJ Maxx owner. The North Face parent will need time to adjust to new brand head Kevin Bailey, who just replaced six-year veteran Doug Palladini. Ralph, meanwhile, is part of a highly fragmented apparel category that’s been “over-earning” for the past 18 months and stands to suffer if consumers lose their appetite to spend. Labor inflation and mounting cost pressures will limit the near-term margin upside for off-price leader TJX, Boruchow said.
Wells Fargo retail analysts believe Capri, Tapestry, Under Armour and Nike represent their best long-term picks.
Capri is gaining on Michael Kors’ growing profitability, Versace’s $2 billion revenue trajectory and Jimmy Choo’s improving sales. Tapestry is seeing the benefit of improving average unit retail numbers, tighter inventory controls, lower promotions and Kate Spade bouncing bak. Tapestry chief financial officer Scott Roe, known for his M&A prowess with VF, could help the accessible luxury firm with any potential new deals after its pays down $400 million in debt, Boruchow said.
Wells Fargo analyst Kate Fitzsimons sees Under Armour having “decent cushions” to margins going forward, along with high profitability versus pre-Covid, with gross margins benefiting from greater inventory discipline. Nike is expected to gain as Vietnam production normalizes following last summer’s Covid outbreak. And while China’s nationalist streak stymies Western brands’ ability to reach double-digit growth, Fitzsimons expects Nike to go on the offensive in the region as inventory levels improve to match demand.
For now, the National Retail Federation (NRF) is still forecasting U.S. annual retail sales growth of 6 percent to 8 percent, or $4.86 trillion to $4.95 trillion, through December. Jack Kleinhenz wrote in the retail trade group’s April Monthly Economic Review that the outlook is complicated by the high uncertainty associated with the war in Ukraine and its effect on the world economy.
“While the United States has a limited trade link with Russia, the war continues to overshadow economic news and could have a potentially serious effect on prices for energy and commodities, adding to inflation concerns,” the chief economist said.