Barron's Streetwise - Underpants Armageddon

Episode Date: April 5, 2024

Why Calvin Klein maker PVH got the worst of an apparel stock drop. Learn more about your ad choices. Visit megaphone.fm/adchoices

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So most exposed European apparel company we cover. Europe's tough. Hello and welcome to the Barron Streetwise podcast. I'm Jack Howe. And the voice you just heard is Ike Barachov. He's an analyst at Wells Fargo Securities covering apparel, including PVH. That's the company that makes Calvin Klein. Its shares were down 22% on Tuesday of this past week.

Shares of Hanes Brand brands were pulled 11 percent lower at the same time is this a case of underpants arm jackson give me a little echo effect here i want folks to take me seriously yeah yeah i gotcha underpants armageddon armageddon armageddon armageddon armageddon that. That's our echo effect? Budget cuts. Listening in is our audio producer, Jackson. Hi, Jackson. Hi, Jack.

It's not just underpants Armageddon. There are other clothing items involved. For one thing, PVH also has the Tommy Hilfiger brand. There's no N. It's not Tommy Hilfinger. It's Tommy Hilfiger. Oh, that one. Did you know that's how you say it?

No, no. Yeah, it's like you're trying to say Hilfinger, but you have a stuffy nose. Hilfiger. Go figure. So there were a lot of stocks that traded lower besides PVH and Hanes on Tuesday this past week. VF, which makes the North Face. Tapestry, they have handbags. And Ralph Lauren, those all fell by mid-single-digit percentages.

PVH is kind of a clothing roll-up. It's called PVH because it used to be known as Philips Van Heusen. I hope I'm pronouncing that right. Philips Van Heusen, if you're not familiar, is a brand of dress shirt. And if you're not familiar with dress shirts, that's something that people used to wear when they went to the office. And if you're not familiar with offices, that's where people used to go when they worked. This is before people worked in their pajamas from home. Some of us still throw on a collar a couple of times a week and go into the

office. I felt like that was directed at me. No, no. You're great just where you are. Okay. So I wanted to learn about what was happening with PVH and other clothing stocks. And I reached out to Ike Borachov. He's a clothing analyst at Wells Fargo Securities. Yeah, I mean, I think PVH has had a good run. I think the sector has had a big run. I think that we can take a step back before we go kind of PVH specific. You look at this group back kind of around October of last year, it was pretty dire, you know, a dire, you know, outlook for the consumer, rate of change on spending was going the wrong way. We had all these big red flags from a consumer standpoint, most notably

the student loan moratorium. And we kind of like went through it, everything was okay, our holiday was pretty good. And I think everyone kind of woke up one day and said, wow, these stocks are pretty cheap. And cyclically speaking, if the economy is okay and we're going to make our way out of this, I want to own consumer discretionary. This is kind of the cycle that I want to kind of ride. So I think that drove a lot of the upside in the space. Now, PVH specifically, today what happened, remember, they've got a large chunk of their business in Europe, about 45, 50% of the business, big. So most exposed European apparel company we cover, Europe's tough and it's a wholesale business. And I think what we learned is that when things are tough there and order books are coming in from their retail partners, those order books

were getting cut a couple of months ago. So high expectation stock has had a big run, numbers coming down. This is kind of what happens is you have big sell-offs. There's basically three reasons why PVH got hit harder than everyone else. First, as Ike says, it has outsized exposure to Europe, nearly half of revenues. And second, it's getting proactive there. Management on its earnings call said it would cut 30% of the online platforms it sells through in Europe. It wants to eliminate online third-party sellers there altogether. The idea is to go after only quality sales in order to support pricing and profit margins. Of course, that means cutting out weaker sales, which will make for an overall sales decline. Management said overall sales are likely to drop 6% to 7% this year. Wall Street was predicting a decline, but one of closer to 2%. There's a third reason that PVH got hit so hard, and that's that the stock had been doing well

between the company's third quarter earnings report and its recent fourth quarter report. Shares had risen more than 50%. There's fairly new management. Just before the pandemic, PVH brought in a former executive from Ralph Lauren and Gap and H&M. And he was there to drive a turnaround effort. And then three years ago, the company made him CEO. His name is Stefan Larson. And then two years ago, Larson presented this plan for his turnaround. It's

called PVH Plus. And the idea is to grow digital and direct-to-consumer sales of the company's two key brands. That's Calvin Klein and Tommy Hilfiger. Here's Ike. The way we would kind of frame this business is inefficiently run for the past decade, very low margin, not the most optimal business. When you think about balance sheet, cash flow, margin structure, Stefan Larsson came in a couple of years ago, hired a new team, hired a head of supply chain. And a lot of that backend got kind of rebuilt. And I think there's an expectation that these margins, which are around 10% today, should be higher.

Why can't these margins go up several hundred basis points? They think the margins can get to 15%. Larson's background is supply chain, demand-driven supply chain. And that is basically a way for them to connect real-time demand to the sourcing aspect of things and to basically lower the costs on sourcing and kind of match that with real-time demand and become much more profitable. Clean out the unproductive tail of inventory, all that clearance stuff we always see in the aisles at the end of season. Get rid of that, clean up distribution, and kind of get the supply chain matched up with point of sale. Their former management team licensed out a lot of their business. So anything that was basically North America women's wear was licensed out to a partner,

meaning they did not directly manufacture and sell that product. Larson came in a year ago and said, we're not doing that. This doesn't make any sense. We want to own our brands. We want to control distribution and point of sale. So what you'll see over the next couple of years is a lot of these large licenses start rolling off that partner into their own P&L. It's going to create a lot of incremental revenue for the business. And if you believe in the management team's ability to scale and sell that product at a healthy margin, it's got massive earnings power.

So they were clear goals. By 2025, the company said that sales would reach $12.5 billion and operating margins would be 15% and free cash flow would be a billion dollars. And it's not really close on any of those. I think that PVH was kind of a reverse Tesla this past week. You see what I mean there, Jackson? Does it have to do with self-driving safety issues? Not exactly. It has to do with what the shares had done before the news and how they reacted afterward. PVH had had a giant rally up to the news, and the news is not what I would call catastrophic, right? But the shares absolutely took a bath. It's because they were giving back

some easy gains. Now compare that with Tesla, which we talked about in this podcast a week ago. We compared its stock performance. We said it was woefully underperforming Toyota recently. That business has been tough. China has become the low-cost leader in electric vehicles. And customer preference just has all of a sudden shifted in favor of hybrid vehicles. Customers want hybrids for now until they see just how quickly EVs are going to take off. Okay, so Tuesday, remember, was underpants Armageddon, right? On that same day, Tesla reported its first drop in deliveries since the covid shutdown.

And the analysts at Wedbus called it, quote, a black eye and quote, a nightmare and quote, a train wreck into a brick wall. Well, those are those are almost always bad. And that analyst, by the way, has an outperform rating on the stock. So you can imagine that the news was just not so good. But the shares only came down 5% on that news. Why? Because they had already been doing so poorly. So when you see a stock out there and you see it's down a certain amount on the news,

it's not always just about the severity of the news. Sometimes it's about what the stock had done immediately before the news. That's a law of finance that we'll call the self-driving underpants effect, right? The old by the rumor, sell the news if it's new news that you didn't expect. Sell the news if it's... Don't sell the expected news as much. That's another one. Maybe you could turn that into an acronym.

Let's work on it. In this case, there are some long-suffering PVH shareholders who had thought, now's our moment. The company is headed toward greater efficiency. Margins are going to be respectable. And the stock had already started working and everything was great. And now they got the news on what's really kind of a macro effect in Europe. Right. The European economy has grown at only about half the rate of America's economy since before the pandemic. dynamic so if customers are a little skittish on demand there for apparel and all kinds of things it's understandable this is a macro effect not something about pvh in particular but it doesn't matter those investors now will have to wait for their big turnaround and so they're disappointed

and thus the decline management by the way says the plan for those 15% operating margins by next year is, quote, fully intact, even if it may take a year or two longer, end quote. In other words, not so intact, but, you know, directionally intact, timing-wise, less intact. There are plenty of bright points for PVH. Fourth quarter sales and profits beat estimates and operating margin during the fourth quarter was the highest on record for that quarter. That's good. Inventory is sharply lower. Both of those key brands are growing and there are some wins for the marketing department. Jackson, do me a favor. Get your browser and go over to PVH his homepage in the middle. You're going to see a photo of a,

it's loading. Oh yeah. I know. And, uh, then he's got tousled hair and he's sitting on a city rooftop and he's wearing only boxer briefs and he's biting into an apple. You see him there.

Yeah. So they got, uh, the actor from The Bear. That's Jeremy Allen White. And it's the Hulu cooking drama, The Bear. It's a show about cooking. Just do me a favor and quickly enact a scene from the show to give folks a flavor. Why do I ever start a restaurant?

This is chaotic and terrible. Yes. That's the famous catchphrase. Don't stop making sandwiches. Yes, chef. It feels like I'm watching it right now. I mentioned Jeremy Allen White because management mentioned him four times in their most recent earnings discussion, they called that campaign the biggest cut through campaign in all of the fashion industry, which sounds like a good thing, right? Oh, yeah. I am a little disappointed in PVH over this campaign, if I'm being honest. This moment is supposed to be about body positivity, right? That's all we hear. Accepting yourself, creating realistic beauty standards.

And they've got this man with the slim torso and everything. And I don't really feel seen, Jackson. I don't. He has a couple tattoos. I don't know. I feel like if celebrity chefs are what it takes to sell drawers these days, that's fine. But give me a billboard with like Emeril Lagasse and low rise trunks. That's that's bam.

How about Guy Fieri and hipster briefs? Take me to Flavortown. OK, I was where was I? I was we were coming to the stock. What do you do with the stock? The stock has sold off. It's given back a lot of its recent gains. It's 11 times earnings. What do you do with it here? Ike says he's sticking with it. What's in their control? What's out of their control? What's execution? What's macro? So this seems very much macro to us. Things that would have broken our thesis if the inventory became misaligned, if the supply chain was malfunctioning, creating pockets of clearance or markdown. None of that's happening. Gross margins, selling margins, which is really the key, super healthy, cash flow, buying back a large chunk of the stock.

I think they announced a massive repurchase program with the news last night as well. So especially at these valuations, which are back to trough levels, I mean, those are the things that we kind of look for. So not a thesis breaker to us. Not every analyst is so confident. Of course, Morgan Stanley's analyst, Alex Stratton, slashed her price target from $134 to $110 on a stock that's close to where it was trading recently. She wrote that they think the stock remains range bound until we see evidence of PVH plus plan execution. I want to get to a couple of more apparel stocks.

Maybe this is a good time for a break. What do you think, Jackson? Sounds good. Are you trying to think of more celebrity chef underpants combinations? Maybe. Don't you dare say Chef Boyardee at Logjohn's. We'll be right back after this quick break. Welcome back.

I was speaking with Ike Borchoff, the apparel analyst over at Wells Fargo Securities about PVH. He's bearish on another underpants stock, Hanes Brands. I asked why. A simple answer is just balance sheet. I think that what you really look for and you can see with those names that we're favoring these are good very very high cash flow businesses very very clean balance sheets a lot of financial flexibility which is really what you

need when you've got periods of volatility you know again across the sector across the globe things are okay right now but we've got an election year coming, which is always troubling for discretionary. People like to sit on their couch and watch whatever news program suits them best, but they don't go out and spend money. And this holiday is going to be really tough. I don't know if you knew this, Jack, but each of the last four years, we have gained an extra selling day versus the last year to show. And when I say extra selling day, I mean the time between Thanksgiving and Christmas. This year, we're going to have five less selling days. So we've got some issues.

And so where I'm going with this is flexibility, balance sheet health. So what is, to go back to your original question on HBI, Haynes Brands, this is a company that's six times levered. They've made a lot of acquisitions, poor acquisitions over the past several years. We're going back many, many, many years. It's a business that is highly dependent on selling high margin branded product at Walmart and Target. I think that that's risky considering what private label has done in that space for a long time. They own the Champion brand, which had a couple of good years a while ago, but it's been downtrending massively. Now they're trying to sell it. So, but if I'm going to dumb it down to just one simple answer, it's just

leverage and balance sheet. I also asked Ike about his favorite apparel stocks. This is a very cyclically, you know, dependent group, you know, where are we in the cycle? And you kind of look at the group today in 2024, profitability margins are at 10 to 15 year low. And that's important because what we basically look for in our top ideas is who's got recovery characteristics to them with some signs of life. Inventory in the channel is extremely well controlled and clean right now so a lot of margin upside there costs are down rate costs are still down and commodities like cotton these all these apparel guys are flowing through uh very low cost cotton so a lot of visibility there as well

there's been restructuring so we want recovery we want margin recovery in large cap we really like nike in the uh apparel retail side gap has been one of our top, top calls that we made a couple of months ago in the off price sector. We really like Burlington is the best way to play that. And then I'll continue to, you know, echo. We still like PBH on the apparel vendor sides. Thanks. Ike. I want to add one more thing while we're on the subject of clothing and it is about, I guess, legs, right? Levi Strauss. During Underpants Armageddon, those shares sold off. It wasn't a great day for denim either. But then two days later, on Thursday, Levi's shares soared.

They ended the day 12% higher. Why? You know why. Business is good. There was a financial report and market share gains. There was raised guidance. All the kinds of things that investors like to see. But I want to highlight that management noted it's seeing rapid growth in, quote,

it's seeing rapid growth in, quote, loose fits for men and women, with both of those up 40% in its latest quarter. Okay, so Jeffries analyst Randall Connick responded to that Levi report. Longtime listeners might remember Randy. During the very early days of this podcast, this podcast started right around when folks got sent home in the beginning of the COVID pandemic. And I reached out to Randy and asked, what's going on in stores? And he talked to us about it. And he was sitting at the time in his car in a Dunkin' Donuts parking lot, because that's what we were all doing to figure out ways to work from home. If we have kids at home, we were going and doing whatever we could to find quiet spaces. Anyhow, he put out a note calling Levi's Good News a dire sign for tights maker Lululemon.

You know, Luloo Jackson, right? How could I not? I have some Lululemon. For me, they make work pants. Are they slim fitting? Yeah, unfortunately. Okay, well, what do you mean unfortunately? It seems like I'm behind.

I'm always like 10 years behind the trend. It seems like a lot of people my age are wearing looser fitting, you know, boot cut, straight leg, even parachute pants I'm seeing. You're on top of things. Listen to what Randy wrote. He wrote, fashion in bottoms is shifting to wide leg. And that's not a strength for Lulu because they don't have a lot of exposure there. He also wrote, the athletic super cycle appears to be over. You know about the athletic super cycle, right?

I'm unfamiliar. That's not the thing that leaves the Peloton all sweaty. It's a long period where people have been wearing more casual clothing, athletic clothing. Athleisure renaissance. Okay, so he says that appears to be over. Now, in his view, the collapse that happened for Under Armour, that could be a preview of what's in store for Lulu. He predicts a Lululemon share price decline of more than one third. He's quite bearish on Lulu. That's not an underpants Armageddon. That's a tight pants typhoon is what my sources are calling it.

I'll be listening for the emergency weather alert. And I think that's it for now about apparel. What do you think, Jackson? Have we got it covered for the time being? I think we've got it fully clothed and covered. My wife said the other day, do you have pants for tomorrow? And I was sitting next to my young boy and I said, which one of us are you talking to?

And she said, him. And I made a harmless joke, right? I said, just something silly. I said, I don't think his pants will fit me. And she said, I don't think your pants will fit you. Oh no. And my son said, I don't think your pants will fit you. And my son said, dad, why did mom just burn you so bad? I don't know, son.

I don't know. I want to thank Ike Borachov from Wells Fargo Securities and thank all of you for listening. Jackson Cantrell is our producer he's swapping out his tight pants for flare legs as we speak i got the sewing machine out myself you can subscribe to the podcast on apple podcast spotify wherever you listen if you listen on apple podcast you can write us a review you could you don You don't have to. We're also on YouTube. That's probably not true. Don't listen to him.

I swear. If you have a question you'd like to hear answered on the podcast, you can record it. A voice memo. What do you do? You hit the thing on your phone, voice memo app. You email it to jack.how. That's H-O-U-G-H at barons.com. And that's it. Keep it fashionable-g-h at barons.com and that's it keep it fashionable i'll see you next week

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