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Market Cycle

The market is in a weird spot to kick off 2023. So far, this year feels like the inverse of 2022. High inflation, which defined most of the last year, seems to have given way to a narrative of falling inflation. Wages data, small business surveys, CPI, and ISM data (all items we cover regularly on the weekly market recaps) suggest softening.

The graph above is called “The Psychological Pitfalls Of A Market Cycle”. It’s broken up into four distinct areas indicated by the colors. The orange color on the far left is the Mark Up phase of a cycle, next is Distribution, followed by Mark Down, and ending with Accumulation in the dark red before the cycle repeats again with Mark Up.

We have had three consecutive inflation reports that showed no major inflation concerns. In fact, two of those three reports actually contained negative surprises! The Fed on Wednesday acknowledged weakening inflation while also mentioning that they still have work to do. Anyways, it is clear that the market’s narrative has shifted to declining inflation and that the Fed will pivot dovish sooner or later. Therefore, now is a great time to look for some early cycle outperformers.

The Soft Line Industry

Before I dive into why this sector could be good for cycle moves in the near term, lets discuss what soft lines are. If you google what the soft line industry is, you will see a site that says they sell primarily soft merchandise. Not a very helpful explanation, but it is technically correct and is a term that is used in retail quite often.

Soft lines are retailers that sell smaller items that are usually soft. Consumer items like linens, clothing, shoes, bags, towels, mats, pillows, and sometimes even beauty products. These kinds of goods may be called soft items. They are typically more difficult to handle in the supply chain than hard goods. Hard goods are stackable, easy to store, and easy to transport while soft goods need to be packaged carefully, they can wrinkle, they need to be presented aesthetically in stores, and are more sensitive to restocking.

Soft Line – Early Cycle Mover

Now back to the cycle. The uncertain backdrop of the economy appears to be closely tied to the health of the US consumer. With that said, I believe the soft line industry is at an interesting value point. Morgan Stanley’s US Soft Lines Retail Equity Analyst, Alex Straton, called the coming year a ‘tale of two halves’ in a Thoughts on The Market Podcast last week when discussing soft lines.

What they meant by this is that the first half of what retailers are facing is harder expectations from an income statement perspective caused by an ongoing excess inventory overhang (Nike’s large inventory in the end of 2022 is a great example of this) and possible recessionary conditions from a macro perspective. An article from Morgan Stanley claimed that census forecasts for the S&P 500 have earnings growth at almost 4%, this is overly optimistic in their view. Consensus earnings growth expectations specifically for soft lines are even more optimistic at 15%.

These stocks can be moved significantly based on earnings revisions. If we have negative earnings revisions ahead based on the assumption that expectations are unrealistic, it’s likely that the stocks move downwards from here, hitting a bottom sometime in the first half of the year.

The second half of the year presents a very different story – hence the tale of two halves. If earnings revisions/expectations become more realistic, the industry will be in a position to more easily meet top line returns and margins may receive year-over-year relief. This relief may come from falling fright costs, falling price of cotton, promotions, etc. On top of that, as we go through the year, inventory should mostly reach normalization. Lastly, a recovering macro perspective should be more solidified in the second half of the year. With this improving backdrop and the fact that soft lines are early cycle outperformers, they could quickly pivot off the bottom and see gains.

It is impossible to ever call a bottom accurately and consistently on anything. But given the case for the industry turn around as we have laid out, there are a few data points to keep an eye on to help you realize when the time to initiate might be near. The first indication is 2023 guidance, and we should get more information on this in the coming weeks as earnings season continues.

The other item that we will spend more time explaining is inventory levels. Cleaner levels are essential to having a view on how long the margin risk that hit retailers in the second half of 2022 could potentially linger into this year. Last year, there was a lot of market discussion around the inventory problem. It was seen as a key risk to earnings with oversupply and lagging demand creating the perfect storm for pressuring margins.

Today, retailers have made good progress of working down inventory levels in the third quarter of 2022, but there’s still much room to go. Look at the examples below from Tapestry’s ($TPR) Q1 2023 earnings report, Ralph Lauren’s ($RL) Q2 2023 earnings report, Nike’s ($NKE) Q2 2023 earnings report, and VF’s ($VFC) Q2 2023 earnings report. What we would rather see here is that inventory levels are in line with forward sales growth.

How To See The Opportunity

As we look across the soft line space for opportunities to take advantage of for an early cycle move, make sure that you’re sticking to sound fundamental and intangible analysis. What I mean by fundamental is if the company is growing or outperforming (beauty stores like Ulta are a great example of this), look for diversification in selling channels, be aware of company events such as restructuring or leadership changes, understand if their margins reasonable, and look to see if investors are rewarded with buybacks, dividends, and/or sufficient price appreciation. What I mean by intangible is if the company has a strong brand, if the brand has value, if that brand value had an upward trajector, and do the products speak to the consumer.

If you can answer most of these items in a positive light, then you may have located a good company for this early move.

For me, certain subsectors of this industry particularly interest me and others that don’t. One to avoid, in my opinion, is activewear. These items saw strength in Covid as people gained a higher affinity for staying healthy, exercising, and taking care of their bodies. Long term, the category has really nice upside potential, but for the purposes of getting early cycle returns, the lingering strength from Covid may negate the strategy.

My other point is on mid-tier brands vs luxury/high-tier brands. A debate as old as time. I lean high-tier, for a couple of reasons. One is that higher wealth consumers will be less affected by a recession if one happens. The global economy is growing, China is opening, and India looks to be on the verge of its most performative decade ever. These items will boost attention to and desire for world-renown luxury brands. Another point I have is called revenge shopping. The Economist touched on this phenomenon which is where people are more willing to splurge on high-end items currently because they have been pinching pennies and living a stressful life since Covid that they feel they should treat themselves.

My Picks

Having said this, here are a couple of stocks I have my eyes on:

Tapestry ($TPR), the luxury brand company that operates through Coach, Kate Spade, and Stuart Weitzman. P/E ratio of 12.3, pays a 2.57% dividend, and has had decent sales growth over the last five years.

Ralph Lauren Corp. ($RL) sells premium lifestyle products including the well-known Ralph Lauren clothing brand but also sells accessories, home furnishings, and many other soft line products. P/E ratio of 17.3, pays a 2.35% dividend, and has performed great share buybacks of the last 10 years.

Steven Madden Ltd. ($SHOO) designs, markets, and sells fashion-forward footwear through several well-known brands including Steve Madden, Anne Klein, GREATS, and others through wholesale and direct-to-consumer segments. P/E ratio of 11.4, pays a 2.3% dividend, and has shown impressive sales growth over the past decade with the exception of 2020.

Burberry Group PLC ($BURBY) is a holding company that designs, manufactures, and sells apparels and accessories under the luxury Burberry brand. P/E ratio of 21.18, dividend yield of 2% that pays semi-annually, and touts some very stable margins and impressive FCF per share.

I also like Columbia Sportswear ($COLM) but did not dive into them too much as I believe seasonality may dampen the early cycle mover strategy discussed here.

Of these five, I have initiated a small position in Steven Madden Ltd. ($SHOO) and will wait for their earnings report on February 23^rd before adding heavy. The reason for this is so that I can get another temperature check on the inventory levels, sales levels, and the margins are trending in the right direction. So far, sales and margins are. Inventory, which is the key, still needs improvement however.

Thank you for reading! If you like pieces like this, follow my Twitter or my CommonStock page where I post updates on the economic data throughout the week. And go check out the 3X discord where I’m actively conversing about ideas like this!

Regards,

Dividend Dollars

This earnings break down is brought to you by 3X Trading, a community that highlights experience and expertise of the professional within. While other groups relay on algorithms or inexperienced traders, 3X relies on its team of seasoned professionals to navigate markets, providing you with analysis, classes, and a personal service to ensure they are always informed and making good trading decisions, for any strategy. Join the Discord server for free and learn from dividend investors and day traders alike. I frequently share analysis and insights throughout the week, so I hope to see you in there!

Summary

On Thursday, 1/26/2023, Comcast ($CMCSA) reported fourth quarter earnings that beat most expectations despite a lack of strength in subscriber growth and losses from Peacock (their streaming service).

Performance

Earnings per share came in at $0.82 for the quarter, beating expectations of $0.77 by 6.4%. Revenues came in at $30.6B beating expectations of $30.4B and a previous quarter of $29.8B. Good news so far!

Unfortunately, Adjusted EBITDA fell by 15% to $8B from $9.5B from the prior quarter. This was mostly due to higher severance expenses as hinted at by CFO Mike Cavanagh in the third quarter call. He said, “As we enter the fourth quarter and look to our year ahead, we remain focused on driving long-term growth during an increasingly challenged economic environment… We expect we will be taking severance and other cost reduction-related charges in the fourth quarter in anticipation of expense reduction actions that will provide benefits in 2023 and beyond.”

Cable Communications

Comcast report 26,000 lost broadband customers for the quarter, attributing impact to Hurricane Ian which hit Florida and South Carolina in September. The hurricane caused severe damage and losses to the homes of subscribers. When looking at total customer relationships, the firm estimates the total number decreased by 36,000 and broadband increased by 4,000 when excluding the effects of the hurricane.

Though subscribers are growing, the pace has slowed compared to quarters prior to Covid. Competition from telecom and wireless providers are growing, and a housing slowdown in the US contributes to a lack of new customers as the shift to new homes. Total customer relationships of 34.3M increased slightly form 34.2M last year.

Comcast’s wireless segment, Xfinity, added 365,000 customers in the quarter, brining the total subscriber base to over 5.3M. Wireless customer growth has been consistent since jumping into the business in recent years. This was offset by a loss of 440,000 cable video subscribers as customers continue to cut traditional TV bundles in favor of streaming.

NBCUniversal

NBCUniversal is the business segment that contains the media (cable, streaming, and related advertising figures), studios (movie studios such as Universal Pictures, Dreamworks, and Focus Features) , and theme parks (5 Universal Parks and Resorts) businesses.

Revenues for Universal were up about 3% from the prior quarter to $9.8B. Revenues was boosted by the 2022 FIFA World Cup which aired on Peacock and their Spanish-language network Telemundo.

Though overall results are good, Peacock has continued to weigh on the business. Adjusted earnings fell by nearly 50% to $817M due to Peacock losses and severance expenses. $978M of that is attributed to Peacock losses compared to a loss of $614M last quarter.

This quarter, Peacock added 5M new paying Peacock customers to the subscriber base, brining the total number to 20 million. This increase could be attributed to the World Cup, football season, and English Premiere League. The company remains committed to earning a return on their Peacock investment, though next year doesn’t look like the year for it. Overall, Peacock’s losses for the year of $2.5B were in line with the company’s earlier outlook. Next year, Michael Cavanagh says they expect losses to be near $3B.

Theme parks remained a bright spot for the segment this quarter with $2.1B in revenue, right behind the studios revenue of $2.7B. Studios revenues were actually down compared to last quarter, however the segment ended the year strong with a #2 rank in the world wide box office for year thanks to movies like Jurassic World: Dominion and Puss In Boots: The Last Wish.

Sky

Lastly, Sky, the segment that holds one of Europe’s leading media and entertainment companies, reported 129,000 net customer additions. This was reflected in a revenue growth of $163M compared to last quarter. For the year, Sky revenues decreased 11.5% to $17.9B. When excluding the impact of currency, revenue only decreased $1.2%, highlighting the segment’s sensitivity to exchange rates.

Final Thoughts

These 4^th quarter results won’t change any negative sentiment around the company, but it’s a step in the right direction. Broadband customer growth is still anemic. I believe the lack of growth in the broadband service is mostly an economic one. Comcast is well positioned to combat competition and maintain pricing power. Broadband business lost customers this quarter for the first time. Average revenue per customer, however, grew 3.5% year over year. The cable segments’s EBITDA margin was flat versus last year, but would have hit a record 45% if the higher severance costs hadn’t hit.

Peacock showed better growth this quarter with 5 million net adds, but still reported a loss, crushing the margins of the Universal segment. Universal faces more challenges, but a rebound in theme parks and the growth in Peacock is a good step in the right direction.

Free cash flows took a hit for the year, dropping to $12.6B from $17.1B. Expenditures were heavily tied to a rebound in content and higher cash taxes. Both items should show less of an impact for 2023. The company’s balance sheet is strong and has allowed the company to raise its dividend by 7.4% to $1.16 for 2023, their 15^th consecutive increase. Approximately $17.7B was returned to shareholders this year through $4.7B in dividends and $13B in share buybacks.

Overall, $CMCSA still looks undervalued to me. It has the stability of a telecom stock with it’s focus on broadband, has potential growth aspects of similar streaming companies with Peacock, an impressive ability to bring in revenues at the box office, and a knack for stretching profits out of popular franchises with a growing theme park business. All of these items make them a diversified company that is hard to compete with and an attractive opportunity for long-term investors.

All information provided is available on Comcast’s Earnings page with access to the earnings releases, presentations, and transcripts. Both the Q3 and Q4 2022 earnings materials were used in this article.