Morgan Stanley Says Timing Is Tricky & Demand The Key Unknown For Specialty Retail, Department Stores And Brands

  • Morgan Stanley analyst Alex Straton thinks 1H23 Softlines Retail results likely remain challenged, if not further degrade from 4Q22 trend, on potentially recessionary-like conditions, ongoing outsized inventory levels, & tougher compares.
  • But in 2H23, the analyst sees a potential inflection in fundamentals on easier compares, some margin pressure relief, inventory normalization, the 53rd week benefit, & a recovering macro, among other tailwinds.
  • Softlines Retail inventory clean-up has progressed nicely, but 3Q22 spreads to forward sales remain high, said the analyst.
  • While inventory across the analyst’s coverage could be healthy by 2Q23, the analyst fears macro deterioration & subsequently softer demand could elongate this timeline, extending margin risk.
  • Against excess inventory, ongoing ‘23 recession fears, & too-high Street ‘23e EPS estimates, the analyst thinks the next move for the group is likely lower.
  • Softlines Retail stocks typically outperform the broader market during recessions, & by a material amount, said the analyst.
  • The analyst is most positive on value-oriented & growth businesses as recession looms & rates cool, & most negative on global apparel wholesale businesses.
  • The analyst continues to prefer Off-Price Retailers Burlington Stores Inc BURLRoss Stores Inc ROST and TJX Companies Inc TJX given likely fundamental acceleration, relatively limited ‘23e EPS risk, healthier relative inventory positions, & their defensive qualities in the face of recession.
  • The analyst is taking a more neutral stance on Brands this year, though the sub-sector view remains In-Line.
  • This is because brands offer a relatively less attractive risk-reward skew in recessionary periods, likely lag other sub- sectors on inventory normalization, and have outsized international exposure, most notably to Europe.
  • The analyst is most constructive on Nike Inc NKEOn Holding AG ONON and more negative on Levi Strauss & Co LEVI and PVH Corp PVH.
  • The analyst views Specialty Retail & Department Stores as “pick your poison.”
  • These sub-sectors offer the most relative upside in recessionary periods, and the analysis suggests many may have already bottomed.
  • The analyst views Bath & Body Works Inc BBWICapri Holdings Ltd CPRI and Lululemon Athletica LULU as the highest quality, but acknowledge opportunity to tactically dip into lower-quality names like Abercrombie & Fitch Co ANFAmerican Eagle Outfitters Inc AEOGap Inc GPS, and Macy’s Inc M, among others.
  • The analyst suggested to stay away from Nordstrom Inc JWN and Kohl’s Corporation KSS for now.
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