Waiting for closet rotation: Q3 headwinds well- telegraphed, potential catalysts C24, PT $40
Our view: Notwithstanding Q3E margin compression, headwinds should moderate sequentially as transient expenses normalize and, as we move through F25, as contribution from ~35% square footage growth over 15 months begins to ramp. Key near-term caveat, in our view, will be management tone around seasonal sales trends and consumer demand outlook. But while women’s apparel and, more broadly, small-cap discretionary remain largely out of favour, in our view, ATZ is an excellent candidate for flow of funds on sector rotation in 2024. Refer to our 2024 Consumer Outlook for details. Target to $40 (-$1).
Key points:
Forecasting Q3 EPS $0.40 (unchanged), forecast range $0.39 to $0.43 (average: $0.41) when ATZ reports in early January (~ Jan 10). Q3E revenue decline -1.1% Y/Y to $617.7 MM consistent with guidance “flat to slightly down” and includes modest FX tailwind ~50 bps. Our Q3E GM% and SG&A % in line with guidance -200 bps and +300 bps respectively, as revenue decline and cost headwinds drive margin compression and deleverage. Having said that, the pace of each is forecast to improve from H1, with another sequential improvement expected in Q4. Components of F24 margin headwind should be resolved as we move through F25: i) 150 bps from IMU, ii) 150-200 bps of spending initiatives, iii) 125 bps subsiding transitory costs related to new DC, plus, iv) operating leverage and other initiatives.
F24 a year of transition and investment, return to growth expected in F25. F24 openings back-end loaded (3 of 8 stores to open very late in Q4), F25 should be more balanced: 4 in Q2 and 7 in Q3 for total square footage growth of 20% including repositioning/expansions of three flagship stores in Manhattan (5th Avenue, SoHo, and Flatiron).
Cost and cash flow headwinds should be transient. F24 capex guidance $220 MM implies acceleration in H2 close to $140 MM vs H1 $84 MM. According to regulatory filings, ATZ repurchased 443k shares in Q3 for $10.5 MM. Notwithstanding sequential acceleration in FQ3, capital commitments and uncertain demand backdrop likely constrain near-term buyback. Adjusted net debt/LTM EBITDA of 1.5x in F23A rises to 2.5x in F24E, moderates to 1.7x by F25E.
Maintaining SP rating, PT $40 (-$1). With the challenging macro backdrop, ATZ is likely to remain a “show me” stock despite our view that the LT opportunity is real. We still believe post-COVID ATZ is a much stronger player with substantially better and lower-cost real estate opportunities, revenue 2x pre-COVID levels, and enhanced brand awareness. As we move through H2/F24 and into F25, as the macro backdrop becomes clearer, and if the margin evolution occurs as management outlined, a compelling buying opportunity could emerge.