Our institutional approach to asset management affords invaluable insights to the granularities of how businesses deploy capital. This in turn informs our conclusions on issuers better poised for disproportionate value creation, which is the crux to alpha generation in our actively managed strategies. This exercise becomes even more imperative during times when macro clouds impair ground visibility. In today’s case, the global scramble for pandemic mitigation can obfuscate how troops on the ground are reassembling to capture massive demand shifts underway. Without careful study of these bottom-up efforts, critical components to our eventual economic recovery would be overlooked, leading to avoidance of upside participation for investors.
As part of our customary quarterly review process to the SWS Growth Equity strategy, which we benchmark against the Russell 1000 Growth Index, we delve into the fundamental justifications of our portfolio’s top contributors and detractors. The following two stocks are samples of the best and worst performers during 1Q2020, extracted from our strategy’s full quarterly review, available for download here.
Netflix, Inc. [NFLX]: +16.0%
A confluence of factors have caused Netflix to fare better during 1Q than many of its media and publishing cohorts within consumer discretionary. The most obvious is the increased streaming hours from consumers abiding by stay-at-home orders. However, other aspects of Netflix’s pure-play streaming business model are playing out in terms of portfolio construction. For example, not having the capital intensity of maintaining fiber and coaxial footprints like its cable cohorts translates into lower balance sheet burdens. Additionally, not having the expensive infrastructure of entertainment theme parks, cruise lines, and movie production studios (budgeted for theater box office releases), as Disney does, brings into light risks associated with going long DIS stock solely due to its Disney+ streaming launch. The latter has been on a drag on NFLX shares due to the misperception of winnertakes-all in the streaming wars. However, we continue to see tremendous upside in entertainment wallet spend on a service costing $13/month in the US, one that now addresses a global marketplace of increasing quantities of broadband subscribers. First quarter results published on Tuesday evening confirmed that NFLX is a net beneficiary of the current environment, with all geographic regions showing accelerations in paid net additions. Since 2019 marked the trough of adverse cash flow impacts, an artifact of ramping Netflix Original content that began five-years ago, higher platform utilization will also accelerate Netflix’s plans towards highly sticky, long-term cash generation.
Tapestry [TPR]: -50.7%
There were few places to hide in anything retail-oriented during the first quarter. This sub-sector of consumer discretionary affords us the opportunity to bargain hunt unloved names that are prone to cycles of favor. Such was the case that we identified with Tapestry, i.e. the parent to Coach, Kate Spade, and Stuart Weitzman brands. We saw an opportunity for fashion brands with largely mutually exclusive customers to optimize digital go-to-market strategies, to increase under-indexed Asian exposures, and to revitalize an asset that poorly managed its inventory in retail and discount channels. As painful as the headline price reaction suggests, our hedge of relative under-weights within brands/retailers is helping to soften the relative contribution. Index constituents faring worse included Capri Holdings [CPRI] and Under Armor [UA], with -71.7% and -58.0% returns, respectively, while Hanesbrands [HBI] and VF Corp [VFC] held up better but still posted stressed results of -46.0% and -45.3%. As we observe Coach’s stand-alone results during the ‘08/’09 financial crisis, we see its worst performing quarter posting a 2% YoY sales decline, as affordable luxury typically resonates as a retail therapy outlay. With a far better online presence than 11 years ago, Tapestry heads into this environment with better abilities to meet online demand shifts while having a balance sheet capable of enduring the current challenge. Brand revitalization of Kate Spade indeed has been prolonged, resulting in executive management shuffles. However, having a long-time board member, who’s also a former Goldman investment banker, at the helm increases odds for economic value creation, which we believe is underappreciated at current price levels. The shares’ 25% recovery off its recent bottom to us indicate how overdone the sell-off has been. As such, we continue to like our relative posturing in this segment of consumer discretionary and have the bandwidth to retain TPR as a distressed name with long-term upside.