Retail analyst: ‘Casualization’ is the No. 1 theme of the pandemic

JP Morgan Retail Analyst Matt Boss joins Yahoo Finance Live’s Julie Hyman and Brian Sozzi to assess the state of retail, four key trends to watch for, and how COVID-19 could impact department stores throughout the year.

Video Transcript

BRIAN SOZZI: It has been a busy week for reads on the health of the country's retailers. Some, like Abercrombie and Fitch and American Eagle Outfitters, struck upbeat tones on consumer demand post-holidays. Others, like Lululemon, not so much. Joining us now is one of the best retail analysts on Wall Street, Matt Boss over at JPMorgan.

Matt, good to see you here this morning. I really liked what you wrote here in your latest note. You're saying, exiting the pandemic in 2022 could prove more challenging than entering it in 2019 for a lot of retailers. Why is that the case?

MATT BOSS: Yeah. As you think about the cost of doing business, you have rising wages, you have inflationary costs on the input side. So as you think about what retailers are laying out, you're lapping stimulus on the top line, freight costs are still higher, you kind of have a tale of two worlds as we think about moving into 2022.

I think front half of the year, that's where you face some of these increased costs until you fully anniversary it about mid-year, as well as anniversary-ing the stimulus from two years ago. But as we move into the back half of the year, I think the positive side of the picture is really what matters-- meaning holiday was strong. Trends exiting holiday I think continue to be strong. And the underlying consumer I think is in a very, very strong place if we look at some of our Chase credit card data.

BRIAN SOZZI: Matt, I'm going to contain myself for a second in wanting to talk about Gap. And you're right to call it-- or put it in the penalty box. But you have a couple of themes out here. One of them being market share gainers-- in this environment, who is gaining market share?

MATT BOSS: Yeah, as you look at category by category, I think the number one theme that's played out over the pandemic that I think was strong into the crisis and actually take share out, it's casualization. You're seeing it everywhere. You're even seeing it here in the workplace. So I think the active and denim players come out of this in a much stronger market share position with a larger total addressable market.

That would be Nike, Lululemon. I think Under Armor is a very interesting catch-up play within this the athletic space. And then the beneficiaries on the denim side-- obviously Levi's would be your core manufacturer. And I think American Eagle at these valuation levels is extremely compelling.

So that would be, in my opinion, one of the larger picture themes. I think one other thing that I would point out is digital penetration as a theme obviously exits the pandemic in a much, much higher level. I think your number one beneficiary there from a category perspective is accessories and handbags. So Capri and Tapestry, this structurally sets their margin profile higher than where they were when we entered the pandemic two years ago.

JULIE HYMAN: Matt, it's Julie here. I'm definitely feeling all of these trends, particularly the casualization. I'm curious about the bottom half, if you will. You talked about the two halves within retail here. And you talked about the outperformers. Who do you think is not keeping up in this situation?

MATT BOSS: Yeah, so I think what you want to look for is the third theme, which ties into the more caution that we have. Look, its fact that inflationary costs are a reality. And that's also facing the consumer.

And so it's going to cost more money at the grocery store. There's no question it's going to cost more money to fill up your car at the gas station. Heating costs are higher. So as you think about where the consumer is pressed, to me, value becomes king.

And that would be for us on the positive side the off-pricers as well as the dollar stores-- so TJ Maxx, Ross stores, Burlington, as well as Dollar General, Dollar Tree, Five Below-- I think all beneficiaries. Where I'm more concerned is sort of that extra dollar, meaning the in-between models where, you know, was the pandemic a positive or do they actually come out somewhat in a weaker place?

Mid-tier department stores I think have lost share during this period. I think they lost share during this consolidation of trip. I think that the discounters and the off-pricers took share from mid-tier department stores. Also more concerned on some of the core specialty that's more, I would say, less apt as a destination-- so if I think about Ollie's Bargain Outlet-- to me, they're somewhat caught in the middle.

They don't sell food. They're not a destination. They're more discretionary. And as that consumer is spending more at their primary destination, which may be a Walmart, Target, Dollar General, Dollar Tree, I think that they may spend less in that extra destination.

BRIAN SOZZI: Matt, let's lock in on the department stores. The flavor of the moment in this space seems to be spin-off to create some form of value. You have Macy's exploring the sale of its online business. You have Nordstrom reportedly looking to spin off Rack. I mean, do you see any of those things happening at these companies?

MATT BOSS: I think the ideal scenario is that the companies provide additional disclosure so that investors can gain a greater understanding of how much of the growth today is coming from the e-commerce channel and how much of that going forward is coming from that mix of business. I think secondarily, profitability metrics-- meaning, look, these companies have, in the last three years, worked hard.

They've invested a tremendous amount of capital on the e-commerce and digital front. That said, omnichannel is really the key, especially for the mid-tier department store. Saks is a very different animal. It's a luxury retailer with much higher price points. And so the profitability of separating online relative to brick and mortar is very different.

Saks at a brick and mortar perspective, those stores are global tourist destinations in major metropolitan areas, very different than having 500 stores or more, in some cases, at the mid-tier department store with very different price points and a very different profitability level. Macy's has said in the past that when they have cut brick and mortar stores in a region, they actually see e-commerce suffer as well.

So there's a mindshare versus market share that I think the mid-tier department stores have as it relates to omnichannel. To me, the most important thing that we're watching and we've called out more recently that we think business momentum has been stronger at Macy's than the other mid-tier department stores. To me, look, if you can achieve consistent, low single-digit, positive same-store sales in the department store channel and maintain the profitability coming out of the pandemic, I think that's going to be the way on a multi-year that you achieve a multiple and a valuation that would be more reflective of performance rather more the financial engineering side, which I'm not so sure five years from now really benefits these retailers in the end.

BRIAN SOZZI: Matt, at the top, I joked a little bit about Gap being in the penalty box. Earlier this week, they dropped a new hoodie from Kanye West-- that partnership. It was just a Black cotton hoodie-- 100% cotton, pretty ridiculous. What gets that stock out of the penalty box? And what does their longer term outlook look like?

MATT BOSS: To me, the key to the gap is Old Navy. So if you think about Old Navy and Athleta, that's basically 70% or more of the mix going forward. The Gap and Banana stabilization there is the opportunity. Look, I think Yeezy with Kanye is an opportunity to create a potential halo effect that could spread across other categories within the Gap.

But the workhorse here is Old Navy. And that's where they've seen more issues in the last two quarters, particularly through holiday with lighter inventory levels and some snafus on the supply chain. They've said that the fourth quarter would be tough in terms of inventory and assortments at Old Navy. You would see sequential improvement in the first and the second quarter, but you really wouldn't be able to judge Old Navy for the assortment and the inventory until the back half of the year.

So as you talk about the penalty box, this one for us is a show me story. I think Kohl's in the department store land is the other show me story. Both of them had inventory issues coming into holiday. And I think, you know, the supply chain dynamics for all of retail will probably not be fully cleaned up until we exit the second quarter.

BRIAN SOZZI: Matt, I was going to ask you about one other name but you mentioned Kohl's there briefly. We have covered that name extensively here. Why is Kohl's in a perpetual turnaround?

MATT BOSS: It's a great question. I mean, right now, it's an inventory dynamic where we obviously have larger picture inventory concerns in the retail landscape. Kohl's had cut more than five, upwards of high single-digits, private label vendors directly into this. And so they found themselves in a much under-inventoried position-- women's inventory actually down more than 35% coming into the holiday season.

They've changed their stripes. They're expanding athletic. They have the Sephora partnership that will be scaled, basically be coming out of the summer. So when I called this one a show me story, and, to your point, a perpetual turnaround, the opportunity really here is can they drive traffic with Sephora-- which will be, again, at a scaled moment coming out of this summer.

But to me, the Holy Grail here is really, can that create a halo effect for women's apparel? They've never really been able to get women's apparel to grow in line or above the industry average. So they have the penetration that's increasing on the athletic and active side. I do think that that's a positive.

They are a destination on the home side. But the problem is the mix of women's apparel is too great to continue to underperform. So the idea here is drive traffic with Sephora, increase your brands-- they have Calvin Klein, Tommy Hilfiger, Cole Haan that are also launching post-- will be scaled post-summer. So to me, that's going to be the make or break here.

But, look, that core apparel space, especially on the women's front, it's very competitive. It's going to be an uphill battle. But that's what we're watching in terms of Kohl's.

BRIAN SOZZI: Stellar insights here. Appreciate you coming on. Matt Boss, Retail Analyst at JP Morgan, good to see you.

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