Growth can certainly be linear, but not always. It ebbs and flows, often times inflicting pain along the way. However, pain drives change, and for investors, that creates opportunity. We frequently find growth opportunities in companies recovering from downturns after restructuring, simplifying, and evolving into more efficient organizations. We are seeing this unfold today in the retail and apparel industry. After several years of share losses to ecommerce retail and margins pressured by bloated inventory, companies with strong brands are making changes to drive higher-quality sales leading to inflecting earnings growth. Not too long ago, many of these companies were left for dead. However, the ones that have survived are reaping the benefits. The first quarter of 2018 saw the best brick and mortar retail sales growth in three years, +3.5%, marking the third consecutive quarter of acceleration. Growth in e-commerce, while still outpacing brick and mortar, decreased as a percent of overall growth. (Exhibit 1)
Exhibit 1: E-commerce Impact to Retail Sales (ex autos & gas) - Quarterly
Source: Deutsche Bank
Better inventory management has enabled brands to optimize their channel mix. The days of stuffing and discounting excess inventory into their highly-visibly websites are over. This behavior not only lowered sales quality but had adverse effects on brand perception, resulting in a double-whammy for revenue growth. One of the reasons for improving brick and mortar sales growth mentioned above is better traffic trends. For the first time in several years, traffic is near a positive inflection. (Exhibit 2)
Exhibit 2: Traffic Trends at Brick & Mortar Stores
Source: ProdCo, Credit Suisse estimates Note: Represents calendar quarterly
Concurrently, the consumer is in the best financial health in years and should remain so for years to come. Unemployment is beneath 4%, interest rates are still low by historical standards, and consumers are enjoying the impact of shock-and-awe fiscal policy. While there is fear of a trade war slowing growth, the size and magnitude of fiscal tailwinds dwarfs this threat on an annual basis. (Exhibit 3)
Exhibit 3: Comparing the Size of Tariffs with Incremental Fiscal Policy, CY 2018 $BN
We are enthused by these developments, because it presents us with opportunities in a newly investable space. Many of these stocks currently fit within the recovery category under our growth philosophy. These types of investments can create great outperformance when identified correctly. The apparel space has underperformed the broader market until very recently, and we view its recent outperformance as sustainable.
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