Investors may not have sufficiently accounted for the impact of stretched consumer finances on the discretionary sector. Just as importantly, investors need to determine which consumers are most affected. We’ll review the dichotomy going on in the consumer discretionary sector and give a bearish trade on an outperforming stock once thought to be immune from some of the pressures. Presumably, those attending the Monaco Grand Prix a week ago, or Roland Garros (aka the French Open) still have positive net savings rates. If they reduce spending it is simply because they choose to do so, whereas consumers at the lower end of the socio-economic ladder may not have the luxury of choice. To some extent, the haves and have-nots divide explains the difference between the consumer discretionary stocks that have outperformed versus underperformed this year. For example, Ralph Lauren is a luxury brand — albeit an accessible one relative to supreme or aspirational luxury brands such as Hermes, Versace, Prada or Zegna. Ralph Lauren has comfortably outperformed PVH Corp which is the world’s largest dress shirt and neckwear company, but whose brands, which include Calvin Klein, Tommy Hilfiger, Van Heusen, and IZOD may be a notch or two down on the fashion brand pyramid/hierarchy. RL PVH YTD mountain Ralph Lauren vs. PVH, YTD There are other examples. Royal Caribbean , up 14% year-to-date appeals to a more affluent consumer than Carnival Corp , down 18.7%. RCL CCL YTD mountain Royal Caribbean vs. Carnival, YTD As a final example consider Toll Brothers , the luxury homebuilder has gained more than 18.3% year-to-date while D.R. Horton which focuses on more value-oriented, younger and first-time home buyers has fallen 2.75%. TOL DHI YTD mountain Toll Brothers vs. D.R. Horton, YTD However, two industry groups within the consumer discretionary sector have not followed this pattern to the same degree. Those are auto manufacturers and restaurants. Among the auto manufacturers that are included in the consumer discretionary index, Tesla which does skew towards the luxury end, is the worst performing, down more than 28% year-to-date, while GM is up 25%. This relative performance can be explained by several factors, but I will highlight three. First, Tesla profits have been falling recently, while GM’s have been rising. Second, the rapid growth in Tesla revenues and profits were a function of a secular shift towards EVs that saw EV sales growth materially exceed ICE sales growth. That trend has slowed. Third, Tesla was trading at a substantially higher multiple than GM was. In other words it was priced for high-growth, whereas GM was trading at a single-digit multiple, a difference so pronounced when we create a comparative chart we need to plot GM’s estimated P/E on a secondary axis: As an investor it’s easy to explain why one company outperformed another with the benefit of hindsight. Far more difficult of course is to attempt to identify potential opportunities ahead of time, which brings me to restaurants. The trade: Chipotle The best-performing restaurant in the consumer discretionary sector so far this year is Chipotle Mexican Grill Inc. (CMG) up a market-crushing 36.8%. While three of the other sector constituents are lower on the year, Darden (DRI) -8.5%, McDonald’s (MCD) -12.7% and Starbucks (SBUX) -16.4%. CMG DRI YTD mountain Chipotle vs. Darden, YTD Much like the Tesla/GM comparison you’ll observe that Chipotle trades at a much higher multiple than Darden, and Chipotle has enjoyed far faster sales and profit growth than Darden has over the past five years. Chipotle has benefited from a wealthier consumer — their average customer makes more than $80k per year and has a college degree — and a customer preference for Mexican-styled cuisine. Even so, this demographic is not ultra-luxury, and may eventually feel some economic pressure. So the question I’m asking myself, and you may want to as well, is can that enormous outperformance continue thus justifying its sky-high multiple? It is not my habit to short-stocks, but I am tempted occasionally. One way an self-directed investor could bet that the stock will not regain its recent high is to sell an upside call spread. For example one could sell the June $3200/$3210 call spread for about $3.35 ($335 in total as each contract has a 100 multiplier). DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
