Motley Fool Money - 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

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Strong holiday for retailers, but is it a fit? Motleyful money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motley Fool analyst Nick Seiple. Nick, thanks for joining me today. 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 and Fitch, Eritzia, and Lulu Lemon to dive into.

And I think it's kind of funny because one of the things, 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 outlaw. look of 16% in the full-year operating margin outlook about 15%.

That means you let those numbers flow through operating income. Expect 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 the 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 analyst 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 overexcitement about average. Karpi and 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. So, 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

13 times earnings. And we have seen this story before with Avercabby. 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. And that is kind of the cyclicality that we run into on the apparel side. From my personal firsthand interaction with the brand, I see Abercrombie boxes coming to my house because my fiancé 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 for maybe we were kids. The business approach has changed. They announced just a couple 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. So, you know, really having 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. So 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. So 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 percent to about 3.5 billion. That's up from prior estimates. estimates also now forecast in fourth quarter earnings per share to be between 581 and 585, up from previous guidance from $5.56 to $5.64. So I think when you see some of these numbers, the increase on guidance, it's hopefully a sign that Lou Lemon is turning the corner on the performance of the business. We've seen some disappointing results in 2024 in the America's region, which is really the bulk of Lulu's business, had a 2% decline in comparable sales.

in the most recent quarter. So, perhaps this release gives 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 Lulu's CEO, Calvin McDonald, this week. He was at the NRF Big Show. And I'm going to go straight to the CEO here. Lululemon is aiming to double sales and pass a thousand 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 is 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. grow digitally. And then the big opportunity is outside the U.S. I mentioned the struggles

in the U.S. market, limit, you know, 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. So the real story for Lou Lemon today is, can we continue opening stores outside of the, outside of the U.S., outside of North America? If the brand can continue to resonate in those markets 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 Eritzia. 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 Lulu Lemon, the street is cheering what we saw from Eritzia. Shares up for about 15%. I know that this is one that you follow relatively closely as part of your work with Full Canada. Where do you want to start with their earnings? Aritia is a recommendation in multiple. full Canada services. Like Lou Lou Lemon is an apparel retailer coming out of Vancouver.

Like Lou Lou Lemon, the story for Ritsia is international expansion. Lou Leman has already kind of squeezed the juice they can out of expanding from Canada in the U.S. but Eritzia 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, US net revenue up 24% year over year, seeing accelerated momentum in e-commerce. And one thing to call out too is lots of success opening stores in

the US. They're paying back in 12 to 18 months. The big kind of highlights in in 2024 was repositioning several flagship stores in New York. And that's really pulled through into the performance for Eritzia. Look at their guidance. They updated their guidance for the full year. year, 2024, calling for 15% revenue growth year-over-year, margin of 450 basis points in gross margin. So the business 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. They called out that they've seen an acceleration in performance in the fourth quarter. So just reading through that, they've

kind of sandbag 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 Eritzia, 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 Motleyful 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 Eritzia sale finds will be the backbone of my 2025 wardrobe. Another one, how these $150 orritsia 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 Lulu Lemon, 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 the Eurytia stores and they've been really responsive to trends in merchandising, being 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's more than doubled in the past year. Part of that is they got kind of got into some trouble on their inventory back in in 22 and 2023. Many retailers dead during the pandemic when they had issues,

getting supply to customers. They ordered lots of inventory kind of 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. And 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 Eritzia 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 Eritzia 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 in Montreal. This is a brand that's traveled quite well, and I think they're going to continue to do so as you proceed forward in 2025. Unfortunately, for you and me, I think the pickings are a bit slim for fellows over at Eritzia. 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 Lulu Lemon, but maybe a little bit earlier on in the story?

That's right. I think long term, you will see Eritzia expand into Midswear. In 2021, they bought 75% of Raining Champ, which is a Vancouver-based men's athleticware 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. And I think you will see expansion. And, man, one thing that is attractive to you, though, Dylan,

And even if there aren't products for you, they do have the boyfriend area at the Eritzia 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. So 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. And I think that's kind of helped them. That's smart. And it actually kind of accidentally dovetails was 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, the whole business is just being able to purchase stuff aloe 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-endix to the Gen Z demographic more than you see in other segments of the retail market,

seeing how well these mall retailers have performed, maybe says some. 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 wants you to be. And the companies who have success in this market are going to be the ones who do that. Nick Seiple. Thanks for joining me today to talk all things fashion. You're my go-to correspondent when we're talking fits.

Appreciate you. Any time, 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, Asa Charma, about the changing reality of home insurance in the United States. Some of the best lessons don't come from a classroom. They come from experience.

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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, also, 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 100 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 100 years from today. But what will insurance look like? That's hard to tell. I really like 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, you know, 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 time

scale 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 Palisites. This is one of the wealthiest zip codes in the U.S. 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. Osset, 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 interests. 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 ceding 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 it 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 is 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 insure, 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 floodplain 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 price or 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 a, 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. 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 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 will be on the hook for and what we won't be should the worst happen.

Asa Chama, thanks as always for the insight, for the information, and for spending time with us here on Motley Full 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 hire or sell anything based solely on what you hear. All personal finance content follows Montefool editorial standards and is not approved by advertisers. The Motley Fool only picks products that personally recommend friends like you.

For Nick Seiple, Mary Long and Austin Sharma, I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow.