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Bath & Body Works: A Wells Fargo Top Retail Stock Pick

It’s been a tough 2022 for retail-related stocks, with the S&P Retail Select Industry Index dropping 35% year to date.
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It’s been a tough 2022 for retail-related stocks, with the S&P Retail Select Industry Index dropping 35% year to date.

And Wells Fargo retail analysts don’t see a quick recovery. “We remain downbeat on the near-term fundamental prospects in our space,” they wrote in a commentary.

They cite several negative trends:

· Foot traffic has weakened. “Foot traffic trends have continued to deteriorate since April,” the analysts said. June marked the largest year-over-year decline of 2022, with traffic down 10% over the last five weeks.

·Web traffic also has slid. It dropped 10% in June from a year earlier, the analysts said. To be sure, “the key difference between web and foot traffic is that while year-on-year trends are slowing on the web, the three-year trend remains very healthy,” they said.

Inventory is building, and promotions are ratcheting up. “Coinciding with slowing traffic trends, the markdown cadence is at the highest level we've seen in the past 18 months,” the analysts said.

On the plus side, “we see a decline in international ocean freight rates for the first time,” the analysts said.

“That, alongside normalizing processing times at domestic ports and a stabilization in domestic dry van spot rates, leads us to a sense of minor relief in inventory-acquisition and transportation-cost headwinds.”

Another plus is news that the Biden administration may lift some tariffs on Chinese consumer goods as soon as this week to fight inflation, the analysts said.

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“At a higher level, this would be a clear net positive for the space,” they said. “But exposure to China has come down meaningfully across our group over the last several years. We estimate China sourcing exposure is now just about 9%.”

That means “any tailwinds from tariff reversals are likely to be overpowered by inflationary pressures,” the analysts said.

Top Picks Include Bath & Body Works

Their top picks in the retail industry are Bath & Body Works  (BBWI) , a body-care products retailer; Capri Holdings  (CPRI) , a fashion brand company that includes Michael Kors; and Tapestry  (TPR) , a fashion brand company that includes Coach.

As for Bath & Body Works, it has a “robust business model,” with a vertically-integrated structure and a domestic supply chain, the analysts said.

It also has a strong brand in replenishment categories, such as home fragrance, soaps and sanitizers, amid a highly fragmented competitive landscape, they said.

Turning to Capri, “we find the story compelling,” the analysts said. “The Michael Kors brand is stabilizing, and we believe the Jimmy Choo and Versace assets are undervalued.”

That’s particularly the case as growth in the luxury apparel/footwear/accessories categories continues to recover,” the analysts said.

Looking at Tapestry, “we believe TPR will continue to benefit from an improving outlook for the handbag category, enhanced data analytics capabilities, exposure to China, and increasing penetration of the higher-margin digital business,” the analysts said.