Holiday Spending Was Strong — Watch Q4 Lululemon, Abercrombie Earnings

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The backdrop for fourth quarter retail earnings can’t be any better than it is right now and two names in particular stand to benefit.

The strong consumer continues to see the U.S. economy through and tariffs on some goods have been reduced. The National Retail Federation released its holiday report Thursday, saying consumers spent 4.1% more during the 2019 holiday season than they did in 2018, with the total at $730.2 billion. The NRF’s estimate was 3.8% to 4.2%.

Lululemon reports fourth quarter earnings in March and the on-trend, digitally driven retailer already raised revenue and earnings guidance for the quarter this week. Lulu now expects revenue of between $1.37 billion and $1.38 billion, up from a previous forecast of range of between $1.31 billion and $1.33 billion. Management now expects earnings per share of between $2.22 and $2.25, up from a prior estimate of $2.10 and $2.13.

Moreover, Morgan Stanley analyst Kimberly Greenberger wrote in a note this week that she sees strong holiday spending for Lulu, which included strong full-priced selling and limited markdowns. Stronger high-margin men’s sales, a point of improvement of late, would provide upside to gross margin. Also, production efficiencies, keeping costs down, would also lift the gross margin.

Greenberger raised her comparable sales estimate for the quarter to 18.% from 12%, her gross margin estimate to 57.9% from 57.5% and EPS to $2.25.

One risk to Lulu is its valuation, trading at a relatively elevated 42 times next year’s earnings. The stock is up 2.5% this week. Abercrombie and Fitch may also have upside to its fourth quarter. Management recently reaffirmed flat 2% comparable sales growth year-over-year. Wedbush Securities analyst Jen Redding said “momentum builds into 2020,” saying she also sees limited promotions and markdowns for the quarter.

The reduction of tariffs, as part of the phase one trade deal between the U.S. and China, also provides upside to earnings estimates for all retailers, as the cost of importing product falls. For Abercrombie, “list 4A tariff reduction couldstem downside risk to 2020 gross margin,” Greenberger said.

For retail at large, the recently elevated risk that a phase deal two does not happen soon could truncate capital expenditures, or long-term term investment in new assets.