Morgan Stanley: Timing is Tricky and 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 cleaning has been progressing well, but forward sales spreads for 3Q22 remain high, according to 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 still prefers Off-Price Retailers Burlington Stores Inc (NYSE: BURL), Ross Stores Inc (NASDAQ: ROST) and TJX Companies Inc (NYSE: TJX) given likely fundamental acceleration, relatively limited ‘23e EPS risk, healthier relative inventory positions, & their defensive qualities in the face of recession.

This year, the analyst is more neutral on Brands but his sub-sector view stays In-Line.

This is because brands are less appealing in times of recession, tend to lag other sectors on inventory normalization and have outsized international exposure.

An analyst is the most constructive. Nike Inc (NYSE: NKE), On Holding AG (NYSE: ONON() more negative on Levi Strauss & Co (NYSE: LEVI) and PVH Corp (NYSE: PVH).

The analyst views Specialty Retail & Department Stores as “pick your poison.”

These sub-sectors provide the greatest relative upside in periods of recession, and the analysis suggests that many may have bottomed.

Analyst views Bath & Body Works Inc (NYSE: BBWI), Capri Holdings Ltd (NYSE: CPRI) and Lululemon Athletica (NASDAQ: LULU) as the highest quality, but acknowledge opportunity to tactically dip into lower-quality names like Abercrombie & Fitch Co (NYSE: ANF), American Eagle Outfitters Inc (NYSE: AEO), Gap Inc (NYSE: GPS( Macy’s Inc (NYSE: M), among others.

An analyst recommended staying clear of Nordstrom Inc (NYSE: JWN) and Kohl’s Corporation (NYSE: KSS) for now.