Motley Fool Hidden Gems Investing - Investors Check the Label on Retail

Episode Date: January 15, 2025

Abercrombie and Fitch and Lululemon’s strong holiday previews weren’t good enough to keep the market happy. But long-term both brands are on track. (00:14) Nick Sciple and Dylan Lewis discuss: - Why Wall Street wasn’t keen on strong holiday updates from Abercrombie and Fitch and Lululemon, and where these brands sit in their market opportunity. - Aritzia’s continued expansion into the U.S. and how the everyday luxury retailer is appealing to the key shopping demo. - The dominant theme in physical retail right now: in-store experiences matter, especially for Gen Z shoppers. (15:10) Asit Sharma and Mary Long discuss the changing reality for homeowners and insurers in light of increasingly common natural disasters. Companies discussed: ANF, LULU, ATZAF, ALL. Host: Dylan Lewis Guests: Nick Sciple, Mary Long, Asit Sharma Engineers: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

Dylan Lewis. Strong holiday for retailers, but is it a fit? Motley Fool Money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motley Fool analyst Nick Sciple. Nick, thanks for joining me today. Nick Sciple. Great to be back here with you, Dylan. We've got a bit of a retail rundown on today's show. Reminds me of our old industry-focused days, digging into one specific sector. We've got updated numbers from Abercrombie & Fitch, Aritzia, and Lululemon to dive into. I think it's funny, because one of the themes that we're going to be talking about today is, on the surface, a lot of strong numbers coming out from the

retailers. Market not necessarily agreeing, though. That's right. Really strong results from these mall retailers. However, as the market often is, it's, what have you done for me lately? I thought you were going to put up numbers even better than what you reported. I think you're seeing that a little bit with the retailers this week. So, first up, Abercrombie boosted Outlook for calendar Q4 and also their full-year expectations earlier this week. And the stock is down about 20% from where it closed last week. So, yeah, help me wade through this one a little bit, because on the surface, some strong reports here. Yeah, for me, I think it's mostly an expectation story here.

You've got an increase in guidance for fourth quarter net sales growth to a range of 7% to 8% from the prior, 5% to 7% guidance for the full year, net sales growth around 15% up from the 14% to 15% previously guided for, and affirmed prior fourth-year operating margin outlook of 16% and the full-year operating margin outlook about 15%. That means you let those numbers flow through, operating income expected to be up 50% year-over-year, really strong numbers. But I think What you're seeing here is the guidance maybe came in a little bit lighter than analysts had expected. You've seen some accelerating trends during the quarter. It could be that they just sandbagged a little bit on the guidance and didn't give the analysts exactly what they

were looking for. But if you look at the headline numbers, not a lot to complain about, and maybe it's just over-excitement about Abercrombie & Fitch. This is a stock that's performed very well over the past few years. Yeah, I could understand some high expectations here. I think, if you go back to the beginning of 2023, Abercrombie is something on the order of a five-bagger. There's been a lot of growth built into this company and some high expectations alongside that. It's interesting to check in, though, because as we look at valuation for this company right now, shares are at the cheapest that they've been in the past year. I think they're currently around 13X earnings. We have seen this story

before with Abercrombie. It's become incredibly popular, been one of the leading brands for a while, and then gone through a period where it was not. It was out of favor. That is the cyclicality that we run into on the apparel side. From my personal, first-hand interaction with the brand, I see Abercrombie boxes coming to my house because my fiancée orders it. They seem to be hitting the basics, they seem to be hitting the denim categories particularly well right now. How do you feel like the company's positioned? Yeah, if you just look at the numbers, I think they're in a great spot. You mentioned being on target when it comes to merchandising, that really goes back to leadership. CEO Fran

Horowitz took over the company in 2007, really brought a merchandising focus to the business, have been able to be more responsive to trends and get those products to customers when they're interested in them. Also, you think about how Abercrombie has changed from maybe we were kids, the business approach has changed. They announced just a couple of years ago they're going to change their target demographic from teens to folks in their early 20s up to their mid-40s, which I think is the demographic your fiance is in. Really having some success in that demographic, has got their merchandising back online, and really repositioned the brand in a way that when folks say, hey, I went to go buy something at Abercrombie, folks

don't look at you with a side-eye anymore. I think the business is in a great spot. But as you mentioned, in retail, in apparel, you're really only as good as your last clothing line. We'll see if they can continue to deliver on that. But I think the culture is good and the positioning of the brand is great. Nick, we have come a long way from the t-shirts with A&F emblazoned on the chest from our childhood, haven't we? That's right. Well, I certainly have, Dylan. Lululemon also giving investors an early glimpse at the holiday quarter this week and raising their guidance. Also being met with a bit of, you're wearing that from the market. So, is it a similar story here? Is this an expectations game?

Yeah, I think so. Lululemon, again, increased guidance, expecting sales to grow 11% to 12% to about $3.5 billion. That's up from prior estimates. Also now forecasting fourth quarter earnings per share to be between $5.81 and $5.85, up from previous guidance from $5.56 to $5.64. I think when you see some of these numbers, the increase on guidance, it's hopefully a sign that Lululemon is turning the corner on the performance of the business. We've seen some disappointing results in 2024 in the Americas region, which is really the bulk of Lulu's business, had a 2% decline in comparable sales in the most recent quarter. Perhaps this release, give some optimism that the business has turned a corner, the stock has

found its bottom, but still execution ahead of the company. In addition to what we got in terms of holiday numbers and the drop there, we also heard from Lululemon's CEO, Calvin McDonald, this week. He was at the NRF Big Show. I'm going to go straight to the CEO here. Lululemon is aiming to double sales and pass 1,000 stores in the coming years. What are the levers there? How do they get there? Yeah. I mean, so, the company talks about, really, three big levers for the business. First off, product innovation, how can we sell to more customers? The big growth opportunity there is in men, they think they can double sales of menswear

products by 2026. Today, it's just about a quarter of sales for the business. Also, it's aiming to double the revenue it generates from digital sales. You see this focus on a lot of folks in the retail business, not only, kind of, driving sales at the physical store, but also opportunity to grow digitally. Then the big opportunity is outside the U.S. I mentioned the struggles in the U.S. market, tepid same-store sales growth. The big opportunity is to grow revenue outside the U.S. They have a goal to quadruple revenue outside North America with a large proportion of that coming from China. The real story for Lululemon today is, can we continue opening stores outside of the U.S.,

outside of North America? If the brand can continue to resonate in those markets the the way it has here, then there's lots of growth ahead of the business. Last retailer I wanted to bring into the conversation for today was Aritzia. No preview from them. We got the real deal results, not a guidance update. And unlike what we saw from the market with Abercrombie and from Lululemon, the street is cheering what we saw from Aritzia. Shares up for about 15%. I know that this is one that you follow relatively closely as part of your work with Fool Canada. Where do you want to start with their earnings? Aritzia is a recommendation in multiple full Canada services. Like Lululemon,

is an apparel retailer coming out of Vancouver. Like Lululemon, the story for Aritzia is international expansion. Lululemon has already squeezed the juice they can out of expanding from Canada in the U.S., but Aritzia today is really about a U.S. expansion story. You've got about half of their revenue coming from the U.S. today, and that's expected to grow quite rapidly. Just to give you some numbers from the third quarter, delivered 12% increase in net revenue compared to the prior year. But if you drill further into that, U.S. net revenue up 24% year-over-year, seeing accelerated momentum in e-commerce. One thing to call out too is lots of success opening stores in the U.S. They're paying back in 12-18 months. The big highlights in 2024 was repositioning

several flagship stores in New York, and that's really pulled through into the performance for Aritzia. Look at their guidance. They updated their guidance for the full year, 2024, calling for 15% revenue growth year-over-year, margin expansion of 450 basis points in gross margin. The business is really performing quite well. Also, last thing to mention, they mentioned on the earnings call that the guidance that they have for the fourth quarter is really just projecting the trends they had in place during the third quarter. But they called out that they've seen an acceleration in performance in the fourth quarter. So, just reading through that, they've kind of sandbagged guidance here.

So, you had a really strong guidance release and management's telling you they're likely to beat that. This is a company that I think has lots and lots of room to continue expanding in the U.S. And if they can do that, lots of room for growth for the stock. If you're unfamiliar with Aritzia, like me, prior to some of my conversations with you and our colleague Jim Gillies, you'd be forgiven if you're a U.S. listener of Motley Fool Money because they are still very much in their early days in that expansion. To give you a feel for this company and kind of where they sit, they say everyday luxury. That's kind of the theme for them.

And I see some headlines that are kind of interesting with this business that seem to get at a mix of kind of a cult following for the brand and what they are able to establish, and also a little bit of the kind of drop culture of fashion. So I'm just going to rattle up a couple here. These Aritzia sale finds will be the backbone of my 2025 wardrobe. Another one, how these $150 Aritzia pants took over the young working woman's closet. It feels like they are tapping into a pretty direct relationship with customers and are kind of very quickly becoming one of the go-to spots for that really coveted 20 to 40 demo.

Nick? That's right. I mean, if you look at the squares for sale per square foot of the brand, I mean, they're higher than Lululemon, lots of other, kind of, really attractive retailers that they've been able to. So, they're, kind of, a brand of brands. They've got lots of, kind of, sub-brands that are unique to them that they sell in the Aritzia stores, and they've been really responsive to trends in merchandising, been able to, kind of, stay on top of what folks are looking for. You know, part of why you've seen the stock, I mean, the stock has more than doubled in the the past year. A part of that is they got into some trouble on their inventory back

in 2022 and 2023. Many retailers did during the pandemic when they had issues getting supply to customers. They ordered lots of inventory ahead of demand and the market ended up being a little bit over-inventory. Over the past year, they've been able to get their merchandising a lot more under control, be a lot more responsive to customers. I really think it's showing in performance. You talk about the popularity of the brand. One thing I would just look up, is just pull up Aritzia Warehouse Sale. Every year they have it in Vancouver and Canada, and the line stretches for miles and miles of young women showing up at the crack of dawn so they can get the kind of one or two

sales opportunities a year that Aritzia offers. So, I mean, these are stores that pay back, again, in 12 to 18 months. They have performed as well in Austin, Texas, as they have in Vancouver, Canada, and Montreal. This is a brand that's traveled quite well, and I think they're going to continue to do as we proceed forward in 2025. Unfortunately for you and me, I think the pickings are a bit slim for fellas over at Aritzia. I think looking through what they make available online, I see that they have jackets available for men. They have some cool outerwear stuff, not very much else. Is the menswear segment kind of an opportunity for them similar to Lululemon,

but maybe a little bit earlier on in the story? That's right. I think long-term you will see Aritzia expand into midswear. In 2021, they bought 75% of Raining Champ, which is a Vancouver-based men's athletic wear brand. They're able to buy the remaining 25% of that in 2026 to get up to 100% growth. That's an opportunity to expand the brand. I think you will see expansion. One thing that is attractive to you, though, Dylan, even if there aren't products for you, they do have the boyfriend area at the Aritzia store. Set aside, or you can go get coffee and have a drink and entertain yourself while your significant other has a good time shopping. They may not have a lot of products for men to buy, but they do know the male shopping

experience in these stores and have tried to make it as convenient as possible. I think that's helped them. That's smart. It accidentally dovetails with something that I did want to talk about. There was a piece out in Bloomberg this week with the headline, The Era of Finance CEOs Running Retailers Is Over. And the gist of the article was pointing to Abercrombie's success with Fran Horowitz, you mentioned her earlier, at the helm of that company, her background being in merchandising

and them really nailing the in-store experience and focusing on what customers want, rather than having a more dollars and cents, bean counter approach to retail. It seems like that trend is back and companies are being rewarded for that focus on the customer. Yeah, I think so. that's really the part and parcel of retail, is being able to follow the fickle interest that retail customers have. You think about the companies that have had success historically, I mean, TJX, the whole business is just being able to purchase stuff low and get it out to market. So, I think apparel retail is a business that really defies financial optimization,

it's really about staying on top of the trend quarter-to-quarter, making the right bets, and The companies that remain focused on that, I think, are the companies that are going to continue to show success over the long term. And I think we see some surprise in that while we would expect the younger shoppers out there in retail to be a little bit more digitally oriented, in fact, that is something that goes from Gen X to millennial to Gen Z. There is a desire, there's a willingness to be in-store and to be touching things, to kind of have these places to go to to shop. It's not just an e-commerce experience that people are looking for. Yeah, if you look at surveys out there today, there's a higher propensity for Gen Z to shop in person than you see among the millennial and the Gen X demographic. Maybe you're seeing the early signs of this with the mall retailers that are probably going to over-index to the Gen Z demographic more than you see in other segments of the retail market.

seeing how well these small retailers have performed maybe says something about Gen Z's willingness to go shop in person. And again, part and parcel of retail is being responsive to those customers and being where the customers want you to be. And the companies who have success in this market are going to be the ones who do that. Nick Seipel, thanks for joining me today to talk all things fashion. You're my go-to correspondent when we're talking fits. Appreciate you. Anytime, Dylan. Just don't come to me for fashion advice. Coming up, to get a mortgage, most lenders require you to have home insurance, but insurers are fleeing places like Florida and California that are facing increasingly

common natural disasters. Up next, my colleague Mary Long talks to Senior Fool Analyst Asit Sharma about the changing reality of home insurance in the United States. Asit, we're talking today about insurance, but what spurred this conversation is largely the fires that are happening in Southern California right now. And just kind of before we dig in, I want to make a note that, of course, our hearts go out to everybody who is directly and indirectly affected by these catastrophes. We're recording this on Tuesday, but as of Monday, around 40,000 acres in Southern California are ablaze. 150,000 people are under evacuation orders. 24 people have died. Hundreds of thousands are without power. Water is tough to come by.

All water storage tanks in the Pacific Palisades area specifically will have been dry for a week by the time this conversation airs on Wednesday. There are a lot of stories wrapped up in this, a lot of policy stories, a lot of climate change stories, and of course, human stories. Today, though, we're going to focus on the business angle because there's a larger conversation to be had about insurance and home insurance, particularly. In prepping for this, Asit, you brought up the history of the insurance industry. The very basic idea of spreading risk among a number of people, a large number of people, that's been around for a long time. But insurance as a business, as we know it today, that's only really been around for a few hundred years. Fire insurance came to be after the Great Fire of London, destroyed 13,000 homes in 1666.

Why did you flag that for me? Why is the history and the recency of insurance as a business relevant to a conversation about insurance today? Mary, insurance is something that's a little esoteric and it changes at a glacial pace. So if you think about it, we really don't know what the long-term types of insurance will actually evolve into because this industry changes very slowly. I have a theory that if we fast forwarded a hundred years from today, I could still tell you what a candy business would be like. I am certain, I would bet my house that candy bars will still be an item in grocery stores a hundred years from today. But what will insurance look like? That's hard to tell. I really liked

that you brought up the great fire of London. Before that, there weren't a lot of enforceable codes that had to do with housing in the city of London. They banned timber construction after the fire. They standardized the use of bricks. They had a lot of urban planning after the Great Fire of London. And this all impacted what was then a nascent industry. But as you point out, insurance in some form or another has been around for hundreds and hundreds of years. I note that reinsurance, the idea that one insurer cedes some of their revenue stream to another insurer, was in existence in the 1400s. I think the first recorded contract is from 1370, but it really only became standardized around the 18th century. So this sort of gives us an idea

that the world changes, insurance changes slowly, and the timescale is hard for us to understand, but things do evolve and they're not like they were before. And I think this will be pertinent to the rest of our conversation because climate change has something to do with the changing nature of insurance today. Well, and in these especially high-risk areas, you're seeing a lot of insurance companies just begin to not offer service at all because in California in particular, you're seeing this happen. It's also happening in Florida. Last summer, State Farm canceled hundreds of homeowner policies in the Pacific Palisades. This is one of the wealthiest zip codes in the US. And effectively, State Farm said,

we can't charge you a high enough premium to make this a financially viable business model. Now, that's in part because of regulations in California that limit how much insurers can charge for premiums. But you have this larger problem of companies deciding that it's too financially risky to insure houses in certain areas. This, again, has happened in Florida as well. Allstate also announced in 2023 that it had stopped writing new home policies in California after years of losses, is there a financially viable way to insure homes in disaster prone areas, especially in light of seeing so many insurance companies saying, no, it's not? I mean, theoretically there is, Mary. It doesn't happen overnight. But there are really four

parties that are involved in making such a thing happen. The first is, okay, the insurance company. They will over time take in more premiums and they'll also increase their loss reserves. So they'll take more revenue in, but account for more losses and understand that it's not going to be the most profitable business in their book. That's contingent on a reinsurer agreeing to buy more of the insured interest. So a reinsurer, again, just to define this once more, is a party that will buy some of the risk from an insurance company. They'll get the revenue, they'll buy that revenue and they'll be responsible for the associated claims that may arise in the future. So the language of insurance is interesting because when you sell your stream of premium

to a reinsurer, it's known as seeding your income. So you're giving up some of your income, but you're also taking a little bit of risk as an insurer off of your table and letting what's often a very much bigger company take some of that risk. So that's the second party, the reinsurer, they're going to agree to buy more of that interest. And the third party is us, the homeowners, right? We have to agree to pay a higher premium. We will get incentives for disaster-proofing features. So we take a hit both ways. We pay more for insurance and we have to invest more in our houses if we live in these disaster-prone areas. And the fourth party are the governmental entities. So the municipalities, state and local governments, they have to fund

better disaster infrastructure if we're not going to be able to change climate overnight. So they may do this by any number of value-added taxes, think property taxes. They may come up with some other innovative solutions, or they may create pools to subsidize insurance in order to avoid greater economic disaster. What disaster would that be? It's people leaving an area, migrating out of an area. So there's an incentive for that fourth party to go ahead and put some of their capital at play to preserve this whole equation. But short of this complicated interrelation among these four parties, it's getting really tough to find a viable path forward. I'm going to put some numbers behind what we're seeing specifically play out in California right

now. So California's insurer of last resort, it's called the Fair Plan. This was established in the 60s, but it's grown big over the past four years. The state through that Fair Plan is now exposed to nearly $458 billion in potential damages. And that's a figure that has tripled since 2020. So just in the past four full years. FAIR policies are exposed to $6 billion in the Pacific Palisades neighborhood alone. FAIR itself only has about $700 million in cash. That is a really long way from $6 billion, not even to mention $458 billion. How does any insurer, whether it's a state program like FAIR or a private company, how do they fill that massive, massive gap when a catastrophe strikes? I'm not sure they can. Look at Mercury General. This is a small publicly

traded company. About 80% of their insurance premium revenue is concentrated in California with decent exposure to homeowners policies. Their stock is down about 27% since these wildfires started. And if you know nothing else about the company, that indicates a kind of risk that is faced by a smaller concentrated insurer. So my question is, why would a larger diversified insurer even want to participate in a scheme where the probability of large claims is rising each year, continuously rising, and the frequency of occurrence is also rising? So insurance itself is based on an insurer's ability to predict statistically the frequency of events. If you've heard of terms like the 100-year flood plain for flood insurance, you sort of get a sense

of how this is thought of by insurers. You can predict the magnitude of events. That's not hard to do. But if you can't really call the frequency of them, you may not be able to figure out a way in which you're charging even a pricier premium to your insured parties, but build up enough of reserve and profits that you can pay out those claims. So I don't know, given the government stepping in with some incentives, with some capital, how any entity, even a public entity that hasn't been funded enough, like the fair plan, as you mentioned, can cover these risks. I'm going to attack this from a consumer angle kind of as we close up, because in prepping for this, I came across what is, I think it's an understatement to call this a pretty jarring

number. The Connecticut Insurance Law Journal has estimated that 80% of Americans do not have adequate home insurance. If you are a homeowner, especially if you live in a disaster-prone area, how can you be sure that you are fully insured should disaster strike and you need to take advantage of your insurance plan? Yeah, my apologies to dentists in advance, because I'm going to say this is maybe second only to having to go get a tooth extracted, But this shows the value of maybe having an insurance agent, being able to understand what's in your policy is the best way to make sure you're fully covered should a disaster strike.

And I know that's hard. I mean, if you get a hard copy version in the mail of your insurance policy, it's a tome to read. And even if you get a PDF version, who wants to thumb through that? Who wants to read through that? But it's one exercise where it really pays to drill down to understand where you're covered, where you're not, where you are insured maybe at a percentage of the replacement value of your house, where you might be excluded because of something that happened when your roof was installed. There are so many details. If we don't specialize in this, I think this really begs that we go to the experts, in many cases, the people who sold us the policies and get a clear understanding

of what's at stake so that we know what we'll be on the hook for and what we won't be should the worst happen. Asit Sharma, thanks as always for the insight, for the information, and for spending time with us here on Motley Fool Money. Thanks a lot, Mary. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. The Motley Fool only picks products that it personally recommends to friends like you. For Nick Seifel, Mary Long,

and Austin Sharma, I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow. Thank you.