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Some Retailers Used the Pandemic to Accelerate Turnaround Plans. Those Stocks Are Getting Rewarded.

Paul Yeung | Bloomberg | Getty Images
  • Companies such as Ralph Lauren and Under Armour are reaping the benefits of changes made during the pandemic, and investors are noticing.
  • According to BMO Capital Markets analyst Simeon Siegel, much of the industry has been shielded by "Covid cover" during the health crisis.
  • This has allowed management to do more work outside of the spotlight than they would have otherwise been able to do, including shuttering stores and cutting jobs.

Some retailers have used the past year and a half to accelerate turnaround plans and prune fruitless assets while Wall Street wasn't watching as closely.

Companies such as Ralph Lauren and Under Armour are now reaping the benefits of those efforts as shoppers head back to stores to restock their closets — and investors are noticing.

According to BMO Capital Markets analyst Simeon Siegel, much of the industry has been shielded by "Covid cover" during the health crisis. With shoppers hunkered down at home, expectations were low. That gave companies time to work outside of the spotlight, making strategic moves like shuttering stores and cutting jobs, he said.

"Public companies are slaves to the next quarter's results," Siegel explained in an interview. "It's very hard, therefore, for a public company to create any meaningful shift in strategy without causing waves and ripples."

What the pandemic did, however, was take revenue off the table. It put investors' expectations on a temporary pause, Siegel said. "For the first time in forever it allowed companies to look beyond the next quarter."

Not all retailers have been nimble enough to take advantage of this unique moment. But Under Armour and Ralph Lauren this week proved that they initiated change and it is paying off. In the coming weeks, a number of other retailers ranging from Macy's to Gap will report quarterly results, and Wall Street will be watching to see how the trend plays out. Analysts and investors are looking for signs that businesses are holding the line on promotions and keeping inventories lean so as to not weigh on profits.

As the U.S. economy reopens, many Americans are flush with cash. Spending is shifting back into apparel, as people begin to travel, visit with friends and family, and children are heading back to school. The result: Retail sales are growing again.

Under Armour takes pricing power

Under Armour on Tuesday reported its fourth consecutive quarterly profit, as its turnaround efforts drove continued momentum.

Sales of $1.35 billion were almost double what the company booked a year earlier and topped 2019 levels. While Under Armour has been a beneficiary of more kids returning to team sports and adults heading back to the gym, the company has also made a concerted effort to sell more merchandise at full price, thereby driving up the amount customers spend per purchase.

Throughout the pandemic, Under Armour has forged ahead with its plans to exit between 2,000 and 3,000 partner stores, which will leave it with 10,000 by the end of next year. In turn, the company is growing its more profitable direct-to-consumer business.

Evercore ISI analyst Omar Saad estimates Under Armour has proactively shed about 10% of its business compared with 2019, leaving it with a "smaller but healthier base" to grow.

Adjusting for various dispositions, including Under Armour's sale of MyFitnessPal, its revenue growth is clocking in at closer to 20% above pre-pandemic levels, Saad said.

"The strategic decision during the pandemic to rebase their sales, promotions, and inventories for healthier growth going forward ... we're pleased to see real tangible pay-offs already in the form of acceptance of higher prices and expanded gross margins," he said in a note to clients.

With sales expected to climb more than planned, Under Armour has rosier expectations for this year, including booking a profit instead of a loss.

"Into 2022 and beyond, there's certainly opportunity for us to have some power ... in terms of the brand continuing to improve and to also raise prices," Chief Executive Patrik Frisk told analysts during an earnings conference call. "And we'll have more opportunity now as we become stronger."

The company cited running shoes as one example where it has been able to elevate prices. Today, it sells a pair for $160 that used to go for $100, it said.

Under Armour shares closed Tuesday up 7.5%, as investors cheered the upbeat outlook. On Wednesday, the stock accelerated even more, recently up nearly 6%. Year to date, shares are up nearly 40%.

Ralph Lauren gets smart in North America

Ralph Lauren is also rethinking its retail partners, in a bid to make each sale more profitable and to maintain a strong perception of its brand compared with other luxury peers.

CFO and COO Jane Nielsen commented during a conference call on Tuesday that coming out of the Covid pandemic, Ralph Lauren's wholesale partnerships are "stronger, healthier and more collaborative with a focus on marketing ... and an appropriate level of inventories as we build back into demand."

Throughout 2020, she said, Ralph Lauren exited a number of lower-tier wholesalers and significantly culled its presence in off-price retailers.

Ralph Lauren's earnings for the period ended June 26 of $2.29 per share trounced analysts' estimates of 86 cents, as those efforts clearly paid off. The company is also forecasting larger-than-expected sales growth for the full year.

Coming out of the pandemic, Wells Fargo analyst Ike Boruchow said Ralph Lauren is proving to be in the "early innings of realizing the fruits of that labor. ... The gains they are receiving are not showing any signs of breaking down."

Ralph Lauren joined Louis Vuitton and Tiffany parent LVMH, along with Michael Kors parent Capri Holdings in posting strong results in recent days. Its shares closed Tuesday up 6.1%. The stock pulled back a bit on Wednesday, but shares are up about 19% this year.

Lingerie maker Victoria's Secret, which this week officially spun out of L Brands to begin trading as its own public entity, is another retailer that has given Wall Street evidence that its efforts to cut back on discounting and slash other unnecessary costs are paying off.

Morgan Stanley analysts on Tuesday initiated coverage of Victoria's Secret at overweight, calling it a "credible turnaround story" and "one of the most attractive names in the specialty retail space."

Victoria's Secret shares closed their first trading on the NYSE up 26.6%. They were adding to those gains on Wednesday.

According to BMO's Siegel, Under Armour, Ralph Lauren, Capri Holdings and Victoria's Secret offer the best examples of the "Covid cover" trend that he's been tracking. He cautioned that some companies are benefiting from a healthy consumer environment today, but the sales gains won't last because those companies haven't adjusted their strategies.

"There are companies that are going to return to promotions as soon as their neighbors start promoting," Siegel said. "Then we will see the winners and losers."

Siegel's note doesn't provide examples of companies in this category, and only time will tell which ones fit the description.

Companies such as Gap Inc. and Calvin Klein owner PVH may struggle to keep sales growing, however. Both have underperforming assets that could hamper longer-term growth. Gap is still working to fix its Banana Republic work wear brand to be more relevant with shoppers, while PVH is still heavily reliant on wholesale partners, which accounted for 50% of its business last year.

"Covid provided a cover to plan the business and refashion the business for the future, rather than for the next quarter," Siegel said. "That doesn't mean every company took advantage of that."

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