A change of heart on apparel retailers

Lately, I have been putting 80+ hours per week at the hospital, so it has been difficult to get time to write. However, I have managed to stay abreast of my positions and current events more or less.

I closed the Impinj position last week. One piece of evidence for closing the short was simply the fact that the stock rose above $30. I wrote in my article that the technicals looked “awful”, and wrote the following, ” …the stock fell through $30, tried to break back above and failed to push through.” Well, it did end up pushing through. And then some. This rendered one support for my thesis invalid.

I generally use some kind of loss-limiting mechanism on my shorts. Usually it’s a system of halving my short if it goes the wrong way and I don’t know why. I also think of the process as thesis invalidation, which is a broad term that encompasses both price stops and discovering new arguments that might weaken the thesis.

As part of my due diligence on Impinj, I started reading conference calls of apparel retailers (Impinj’s largest customer base), and I was surprised to find myself liking what a lot of these management teams were saying. Many of them mentioned improving inventory management as an initiative. Furthermore, several mentioned initiatives to ship from store and buy online and pick up in store. Such moves ought to increase the turnover of inventory by turning mall stores into miniature distribution centers.

Such inventory focused initiatives ought to be tailwinds for Impinj, both by improving the health of the retail sector and by increased sales to more inventory focused businesses. There may be a lagging effect of 2016’s retail weakness that shows up in Impinj’s next quarter or two, but I bet it will probably guide a little higher and bounce after the next quarter.

I managed to close my short with minimal losses by concentrating on the key price level at $30. I closed around $31, and the stock took off afterward. I still wouldn’t go long the stock as I find it far too expensive and I can buy growth more cheaply elsewhere. And I may go short again if the valuation starts to get really ridiculous.

I am instead turning around and calling a bottom in the mall retailers. These stocks trade at absurdly low valuations. I can pick up some of the fast fashion brands, like Express, for nearly 5X free cash flow (EV/FCF).

Express has had a tough time competing with Zara and H+M, however has worked over the past year to speed up their time to design and now stands on better ground to compete. They are working on ship from store and buy online, pick up in store initiatives. They have 25% of sales online and are working actively to increase this. They have tons of cash and are buying back stock aggressively. They think there is still room to cut down on costs to minimize losses from same store sales declines. 50% of stores are up for lease within the next 2-3 years, giving management an opportunity to close loss-making stores and boost earnings.

Express has a track record of pretty conservative guidance. The best scenario management presents is a flat to low single-digit same-store sales environment. I can envision scenarios (like a broad based recovery in consumer spending) where Express has positive same store sales. Even if they hit guidance, the stock will still be cheap.

There are macro drivers for the mall-based retailers too. Nearly all of these companies pay the absolute highest corporate rate and would be direct beneficiaries of tax reform. While there may or may not be an eventual tariff placed on importers, one thing I know for sure is that the dollar is higher since the election, especially against the yuan, and the president is no longer committed to calling China a currency manipulator. Currency moves are mitigating any eventual tariffs that the new administration might place on imports from Asia.

I put on a very large position in Express, and it is now the largest single equity position I hold. I obviously have a lot of additional research to do in the name, but Thursday’s 7% move in high volume (for a really insignificant piece of news) indicates to me that a big move might be about to start in retail, and that I’m not the only one looking at this.

I also think there are perhaps better retailers out there that I don’t know yet. The entire sector might be due for a turnaround. It is the one sector out of all U.S. stocks that seems to be universally trashed, and the thesis behind the short is obvious and well-known: malls are dying and Amazon is taking over the world. But a new thesis is emerging – A malls will survive, C malls will die. As the market shifts from the idea that all malls will die to some malls may survive I think there will be a revaluation of PE multiples across the sector.

I’ll probably spend a lot of my precious free time digging in the retail sector for the next few weeks to see if I can invalidate this thesis.