Barbara Ann Bernard, CIO of Wincrest Capital: “Retail is on sale”
Unicorns or Zebras?
I have just returned from a two week trip to Hong Kong, where one of my meetings was with bellwether, Li & Fung. By sales, Li & Fung is the 5th largest retailer in the world; they manufacture goods for Target, Victoria’s Secret, J.C. Penny, Tommy Hilfiger and the like. When the market was tough in 2016, due to destocking and deflation, many companies had to strategize how they would be able to compete with e-tailers. According to Li + Fung, 10% of all sales in the US are now done online. Online players (Unicorns) are growing their top line, but not necessarily their profitability, and the market is rewarding this-- creating a huge discrepancy in valuation. We prefer Zebras to Unicorns. Why? Because Zebras are: a) real; and b) black and white!
At Wincrest, we think the valuation discrepancy between e-tailers and brick and mortars has created an unparalleled opportunity to invest in certain retail stocks. The market judges e-tailers based on top line growth, irrespective of profitability, whereas brick and mortars get hammered on the bottom line, even if they are in the black. And I see opportunity particularly in items that are difficult to purchase online; things people want to try on… such as jewelry and bras.
Specifically, two companies that are category killers are Signet (NYSE: SIG) and L Brands (NYSE: LB). They dominate with +50% market share in their respective categories, and yet, they are both down 50% in the last 12 months and down 30% YTD. Both are fundamentally good companies trading at a fraction of their historical valuations.
Signet
Signet and L Brands are severely undervalued… But, they are cheap for different reasons. In the case of Signet, it has been criticized for not running its financing business optimally and, to its credit, Signet has admitted this. The financing business is less than 10% of profits. Signet gives credit in order to increase sales of its jewelry. Having just announced plans to outsource - i.e., sell - the financing business, at a historically conservative valuation of 1x book, that could yield $1 billion versus a market cap of $4.5 Billion. That would allow them to buy back 20% of their very cheap shares if they wanted to.
L Brands
L Brands has been perennially downgraded over the last 6 months with analysts citing among other things, too many physical stores and too big of a footprint. Many consider this to be the contemporary Achilles heel of the retail industry, with tons of retailers reducing their footprint in order to compete with e-tailers. However, L Brands reminds me of where Restoration Hardware (NYSE: RH) was a year ago. The founder and CEO is a large shareholder in both cases, and when Restoration Hardware announced that it was adding a modern line and (bravely) would no longer mail their iconic catalogue, it created confusion about their business model and the stock tanked. RH began e-marketing through social media and emphasizing their new modern line which, as we have seen, or as the share price would suggest, has gone incredibly well since then.
L Brands is a similar tale. They did away with swimwear, updated their offering with items like bralettes, and stopped mailing catalogues. This has created confusion about growth and margins. With a 5% dividend yield and tremendous alignment of interest with CEO Les Wexner being the largest shareholder, I foresee a similar future as RH. This is a brand I have always admired, but as a value investor, have always been too cheap to buy! I’m loving the opportunity. It’s my favorite fallen angel.
To hear more about Barbara Ann Bernard’s views on retail, as well as in Asia, view her recent appearance on CNBC’s Closing Bell.
