Although the meat of earnings season is in the rearview mirror, there are still some big earnings reports due in the weeks ahead. That means there is still opportunity for investors to make good money … on the short side of retail stocks.
Last week, investors who were short the retail sector came away big winners as the department store quartet of Macy’s Inc (NYSE:M), Kohl’s Corporation (NYSE:KSS), Nordstrom, Inc. (NYSE:JWN), and J C Penney Company Inc (NYSE:JCP) all reported miserable earnings. All four stocks were absolutely butchered, as was the rest of the retail sector.
I don’t think the butchering is over. There are a handful of retailers yet to report, and while some may surprise to the upside, there are a handful which I think are set to follow in the footsteps of the big department stores.
I’ve put together a list of my three favorite near-term retail stocks to short, with bad earnings as the catalyst.
Let’s find out what they are.
Retail Stocks to Sell: L Brands (LB)
I tend to be a contrarian investor. Thus, I usually like depressed stocks with low risk and high reward profiles.
But that just isn’t the case with L Brands Inc (NYSE:LB), the parent company of Victoria’s Secret and Bath & Body Works. The company reports after the bell on Wednesday (conference call on Thursday morning), and I think the stock is set to spiral lower.
As natural beauty has trended in, push-up bras and aesthetic-oriented lingerie have trended out. The exit of the swim and apparel category from VS is also weighing on financial results. A decline in mall traffic has hurt in-store sales, and online sales momentum hasn’t been enough to offset those declines.
The valuation ostensibly looks compelling (12.5 times trailing earnings now versus about 25 times just a year ago), but there really aren’t any signs of a turnaround materializing. Comps fell 13% in February, 10% in March, and 5% in April. According to Google Trends, May is off to a rougher start. Search interest related to Victoria’s Secret is down about 34% year-over-year in March, versus a 26% decline in April.
The valuation on a forward basis also implies more room to fall for LB stock. Earnings are compressing, so the trailing price-to-earnings multiple is really irrelevant. The stock is trading at 14.6 times next year’s consensus earnings-per-share estimate. That isn’t terribly cheap for a struggling retailer with tons of mall exposure. It also doesn’t stack up well with a mid-single-digit earnings growth outlook (which is what the always overly bullish Street expects over the next five years).
At some point, LB stock finds a bottom and becomes a buy. The company sells goods (intimates, candles, lotions and fragrances) with secular appeal, so there is a huge perpetuity value attached to L Brands.
But that point is not now, especially on the heels of mall traffic woes accelerating. LB stock cratered after its last earnings report. I think that trend continues this week.
Retail Stocks to Sell: Michael Kors (KORS)
Michael Kors Holdings Ltd (NYSE:KORS) stock once had its day in the sun, trading right under $100 per share in early 2014. But as the air came out of the wheels of the KORS secular growth story (that tends to happen often in retail), the stock slid … and slid and slid and slid.
Now, KORS stock sits under $37 per share. The contrarian in me wants to buy, but much like LB, I can’t pull the trigger. I actually think there is more downside ahead for retail stocks and Michael Kors in specific, with the major downside catalyst being the Q4 report on May 31.
KORS is a premiere retailer of trendy handbags, watches and accessories. But here’s the thing about handbags, watches and accessories: they aren’t selling. Macy’s said handbags and watches were weak. Kohl’s said accessories were weak. Nordstrom said accessories were weak. Huge watch and leathers player Fossil Group Inc (NASDAQ:FOSL) put up disastrous numbers recently.
Web traffic analytics site SimilarWeb shows that KORS’ popularity is waning. Fellow web analytics site Quantcast shows that online traffic is down year-over-year. Google Trends also gives a bearish read, indicating that search interest has fallen at a mid-to-high-teens rate over the past several weeks.
All in all, the growth story at KORS is just completely unraveling. The problem is KORS stock still isn’t cheap enough to reflect that reality. The stock is trading at 9.2 times forward consensus earnings, and that isn’t terribly cheap considering earnings are expected to compress at a 2.5% annual rate over the next five years. That means the stock could stay flat, and the multiple will only get bigger.
I don’t like that setup, especially for a company with as big headwinds as Michael Kors.
Just like LB, KORS stock becomes a buy at some point. But not now. With a weak earnings report on the horizon, I think shorting it is the smart move here.
Retail Stocks to Sell: Ralph Lauren (RL)
My third favorite upcoming retail short is Ralph Lauren Corp (NYSE:RL). The company dazzled Wall Street for most of 2016. But then the CEO exited in February after disagreements with the founder and chairman. The Q3 report was pretty bad (comps down 4%) and the guide wasn’t much better (full year revenues down low double digits). Sell-side chimed in with gloom-and-doom reports, and the stock has been somewhat left for dead.
I think it goes further south when RL reports before the bell on Thursday. All my research suggests things are only getting uglier for Ralph Lauren.
SimilarWeb gives a mixed read on RL’s online traffic share, but Quantcast shows significant year-over-year declines in web traffic. Meanwhile, search interest related to Ralph Lauren is plummeting. Piper Jaffray’s Spring 2017 Taking Stock With Teens Survey found that RL was one of the brands losing relevance among young shoppers.
Overall, it looks like Ralph Lauren will report some pretty ugly numbers yet again. The problem here is that the valuation is not prepared for this bad news.
Much like the other two retail stocks on this list, RL stock has been beaten up recently. Also like the other two stocks on this list, it still remains too expensive considering its bleak growth outlook. The stock trades at 14.7 times the forward consensus earnings estimate. Growth over the next five years is pegged at a measly 2.8% per year, and that feels optimistic considering revenues are in free-fall. A mid-teens multiple for realistically flat growth doesn’t make much sense.
I think the short-into-earnings thesis makes a lot of sense for RL.
As of this writing, Luke Lango was long FOSL and KSS, and may initiate a short position in RL, KORS, and LB over the next 72 hours.
