The world is weighing in on retail.
And Wells Fargo, comparing company outlooks with broader trends in the consumer economy, decided to take a step back with a more cautious stance on consumer shares generally for now and downgrades for Ralph Lauren Corp., VF Corp. and The TJX Cos. Inc.
“Bigger picture, this is not the ‘fantastical and magical’ setup we had expected, and we now see ongoing macro concerns and negative revisions keeping our universe under pressure for the time being,” a group of Wells Fargo analysts, including Ike Boruchow, Kate Fitzsimons, Will Gaertner and Jesse Sobelson, said in analysis.
Accordingly, Wells Fargo is looking for 2022 earnings per share to come in 5 to 10 percent below current estimates on Wall Street.
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And as the analysts cut their projections, they downgraded Ralph Lauren, TJX and VF to “equal weight” from “overweight.” The bank also became more “selective” in its stock recommendations and pointed to “a highly compelling 12-month risk/reward” at Tapestry Inc., Carpi Holdings, Under Armour Inc. and Nike Inc.
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Last year, the fashion industry staged a dramatic rebound from the worst of the COVID-19 lockdowns — with many top companies crowing over their best year ever in the midst of the pandemic — but the backdrop has taken a sudden turn.
The pandemic-driven supply chain backups are continuing, inflation is at a 40-year high and proving to be a more than short-term phenomenon, and Russia’s invasion of Ukraine is upending the world order that’s held since the Berlin Wall fell.
All of that and more has filtered into retail stocks.
Wells Fargo said the companies they cover in the space are down 25 percent so far this year compared with a 5 percent drop for the S&P 500.
“On valuation, the majority of our coverage is now trading at recessionary levels — a 14-year low in price-to-earnings multiples — in advance of what we believe will be negative revisions in the next six to nine months,” Wells Fargo said.
The market is changing fast, but fashion has largely been holding fast to bullish outlooks that flow out of a year that enjoyed better prices and more full-price sell-throughs for many brands, tighter assortments and more expense discipline.
But consumers’ unusual buying patterns that materialized during the pandemic might not be sustainable.
The analysts broke down spending by category from 2014 through 2019 and then from 2019 and 2021, showing a rapid expansion in compound annual growth rates.
Jewelry, for instance, was growing at a 1 percent clip in the five years before the pandemic and accelerated dramatically to 22 percent growth over the past three years, the study found. Apparel and footwear was growing at a 2 percent rate before COVID-19 and then at 8 percent since the pandemic began.
Customers, in short, “overshot” their established spending in the categories.
Just how sticky those spending trends are could be fashion’s million — or billion — dollar question, and a key sticking point for retail outlooks.
“Despite the strong consumer backdrop, we’d characterize 2022 guidance as increasingly unrealistic,” Wells Fargo said. “Especially considering that the market expects that our discretionary categories appear to have ‘overshot’ on consumer spending by 10 percent to 20 percent in 2021 compared to pre-COVID[-19] run rates and normalized wallet share, the setup for our group from here appears very challenged in the near term.”
Taken altogether, it’s another warning flare for the industry that held up amazingly well last year, but might well face some trouble ahead.
“Inflation remains elevated — including commodity prices, which are eating into discretionary spending,” the analysts said, noting U.S. gasoline prices have risen about 45 percent over the past year. “Geopolitical tensions, most notably the war and Ukraine, are also a risk, particularly for many of our global names with large exposure to Europe. While many companies have noted continued strength in Europe, we believe there is potential for a slowdown if the situation in Ukraine worsens and spills further into the region.”
That could also pressure retailers’ newfound resolve to push full-price sales and not turn to price promotions to move goods.
“The biggest risk if consumers pull back on spending is top-line guidance misses, which is problematic in and of itself, but also likely will lead to higher markdowns and gross pressure,” Wells Fargo said “Many continue to push the narrative that companies have ‘overearned’ during the last 12 to18 months, and record-high gross margins are not sustainable.”
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