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 BURL, Ross 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 NKE, On 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 BBWI, Capri 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 ANF, American Eagle Outfitters Inc AEO, Gap 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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