RH Sends a Warning Sign on the Consumer, and Putting a Number on the Shrink Problem 9/8/23

0:01Live from the Nasdaq market site in the heart of New York City's Times Square this is fast Money. Here's what's on tap tonight. Losing its luster. A major warning on the luxury housing market, sending shares of our age to their worst day since the start of the pandemic. Is this a single stock problem or a canary in the consumer coal mine? Plus, the think on shrink retailers blaming the phenomenon for recent earnings misses. But just how big of a bite is shrink taking out of the other bottom lines? We've got the answers coming up. And later, all talk may have been about Apple's breakdown this week.

0:31But there's another group getting it hit even harder. What's dragging on industrials? And could they fall even further? We'll ask the chartmaster. I'm Melissa Lee coming to you live from Studio B at the Nasdaq here on the desk tonight. Tim Seymour, Guy Dami, Bono and Eisen and Julie Beal. We start off with the latest red flag for the luxury retail market. High-end furniture giant RH plunging after its CEO warned high mortgage rates and a weak housing market could weigh on its core consumer into next year. The stock sinking more than 15 percent. Its worst day since the start of the pandemic and falling into the red for the quarter.

1:04RH, not the only luxury retailer under pressure. Richemont, LVMH carrying all down since the third quarter, the end of the third quarter, beyond housing. China's weakness is also part of the story here. So if the high-end consumer is now starting to show signs of cracking, we're seeing challenges on the low end too. How worried should investors be right now? You were worried before because you got at RH. Yeah, and I love the company, and I think their ability to hold the line in terms of margins, in terms of pricing, is something that's been a big part of the success and the profile of the multiple.

1:35And it's not an expensive stock. And it certainly wasn't about what they reported today, right? They actually beat the streets small. The outlook was pretty cautious. This is a CEO that at times can get, I was talking to Karen about this earlier in the day, can get kind of emotional and sometimes really, you know, lay it out there in a way that's honest, sometimes maybe too honest. I think if you look at the consumer across the spectrum, we've talked about the different segments and we've almost seen it play out. And to the extent that this is another warning shot, we heard from Nordstrom's, too, who seemingly would have a similar clientele, if you think about it.

2:06And we're starting to hear from them about delinquencies. This consumer demographic is not falling straight to the ground. I do think it's a case where, as market players, we're looking at, is there really going to be strength in terms of their pricing ability? Is there going to really be the kind of demand? I still think there was an enormous pull forward in terms of where demand was for RH products and their wonderful products. And I think they're always going to have a consumer that's ready to pay what the premium is for those products. I wouldn't overreact to today's numbers, but we see ingredients and they're coming in from every piece of the demographic spectrum in the consumer.

2:42There are only so many large sofas one can have, Julie, in your home. So that is part of the RH problem. But management also talked about overconfidence in the pandemic price increases, which was interesting, I thought, too, because that gets to the notion of at some point you cannot raise prices even more. And with a consumer that's actually starting to count their pennies, so to speak, you know, they're really scrutinizing the prices. Yeah, I think that's a recognition. And there's a certain amount of humility that I appreciate, you know, when companies recognize that maybe they've pushed a little bit too hard on pricing.

3:13And so, you know, I think that's that's important. What is important, too, to take note is so they're going to have to mark down their inventory that they have. And their plans are to really refresh their inventory more regularly before they would, you know, refresh 15 to 20 percent. And now they want to refresh 80 percent. And when you start to do that, A, you know, your designers who rely on you for a certain sofa that they always use suddenly aren't always sure that you're going to have it. And you're also creating more fashion risk for yourself. So I think even strategically over the long term, this could be pretty challenging for the company to pull off.

3:48So I'm a little bit concerned about that. And it makes sense if you think about it for Gary Friedman. You know, this is someone who really had a background in fashion. And so it makes sense that this directionally is where he thinks it should go. But I think it could introduce more difficulty for the business. Yeah. Guy, what's your take here? It's not restoration hardware necessarily. I mean, I agree with what Tim said, obviously, Julie, as well. in terms of the quarter, yeah, it wasn't bad. And the full year guidance was actually pretty good. Two concerns I have, margins seemingly are compressing, which is obviously not a good thing.

4:23And all their inventory seemed to be getting in line. You know, the sales growth that should be supporting that is actually worse. So you still probably don't have equilibrium in terms of inventories. But I think it speaks to a bigger picture now. You know, we've heard from the lower end to the way you started the show. You know, the lower end has told a story. Now we're hearing it from the high end. And, you know, I'll say this, the consumer is in probably a difficult straight. I know you have everybody come on and say the health of the U.S. consumer, their want to spend, all those things. I get it.

4:51But we're in an environment now where things are going to get a little dicey with a rising interest rate environment. And if you think interest rates are still going higher, as I do, I don't think it really bodes particularly well for the U.S. consumer. When people do renovations, they typically tap their home equity, Bono, and at these rates, you're probably not going to want to do that. So are we really hearing that there is pressure on both the low? I mean, think about Dollar General. We saw a similar percentage move on the back of Dollar General earnings as we are seeing on the high end restoration hardware.

5:23Yeah, I mean, I think you really hit the nail on the head there in terms of the, you know, home equity and refinancing and ability to tap equity and wealth. There's a stat out that's saying that essentially the wealth for the consumer within the U.S. is at its highest level. And that's in large part because of the last two or three years. With that said, ability to access that wealth is what's here. And then you have the second thing. And I don't think this is the first time that we've seen signs, notwithstanding the lower end consumer, the higher end consumer, which is also trading down and looking for ways to shop at Walmart and Target for discretionary and more core goods.

6:01And what you're seeing here is that with a name like restoration, you have the option of whether or not you're going to turn over the purchases that you've made or whether you're going to try to get an extra year or six months or nine months from said purchase. So I think it's a bit of a two-pronged situation, whether or not you actually have the money to make the purchase and whether or not this is really going to be, you know, cut down to the screws and make a determination of whether or not you can get a little bit more useful life out of what is, to me, a bit more of a durable good. Well, you know, if I tuned in right now, Bonwin, I would have thought that you were talking about Apple and whether or not consumers are going to buy the iPhone 15.

6:40So it's interesting that we're getting this data point, you know, today, or we're discussing this data point today, just days ahead of Apple's launch. It's the same sort of thinking, isn't it, Tim? I mean, are you going to upgrade your phone or are you going to wait a little bit longer because you can? Well, I just bricked my phone a couple of days ago and had to buy the 14 ahead of the 15, so I'm not a good example because I needed a phone, and this always seems to happen to me. But I do think if you think about the ASPs and the ability that Apple was able to hold, I think there's a real parallel here.

7:07I like that because one of the things we heard about our age, and although I said they've been able to hold the line on pricing, they also acknowledged that they were overly aggressive in terms of their product and quality design, but the pricing around their contemporary line, and they did this last quarter, and I think they're going to have to give some ground. That's what worried, I think, the market more than anything. I think the affluent consumer has a point, but there is a point where also what we've seen is them progress through goods to leisure. And that's been part of the progression that's been going on in the space.

7:36And that's where RH and Apple both fall on the wrong side. So we had a big week around Apple. I think what we tried to point out is China is an issue, but Apple's issues are really more about where it sits in terms of discretionary. It really felt like the China story this week, Julie, was sort of the straw that broke, if you can call, you know, the 8 percent decliner so that we saw on Apple this week broke the camel's back here. But it's all these other concerns, the potential that maybe the high-end consumer will not be there to open their wallets for the 15 or the 15 Pro. That's the real concern here.

8:08Yeah, I think it's, you know, we need to think about the high-end consumer even within segments of itself. So a lot of people would consider, you know, the high-end consumer for RH, that is more of an aspirational purchase for a lot of their consumers. And that's why I think you're seeing that weakness. I think that's a story of the trillion dollars in credit card debt that we have. I think that's actually more prescient. On the Apple side, I think you're absolutely right. It really is a function of, we know there's not going to be a revolution, but rather an evolution in terms of how much better the phone is than the 14.

8:43And so it's really hard to justify some of those price increases for people who are starting to have a little bit of nervousness. It's not necessarily the ability to pay because most people have a job and can. It's the confidence to start shelling out for big ticket items. That's what's starting to kind of seep away. All right. And by the way, you can catch a CNBC exclusive with RH CEO Gary Friedman this evening. It all starts 6 p.m. Eastern time on Mad Money. As Tim had mentioned, he's always colorful, so you won't want to miss that. Beyond the consumer struggles, retailers also grappling with another major problem, shrink.

9:14CNBC's retail reporter Gabrielle Fon Rouge has been analyzing the balance sheets of several large retailers determine just how much money they're actually losing. Now, Gabrielle, welcome. Thank you. It's interesting because finally, you know, retailers are actually, you know, putting a number next to shrink where they haven't always before. What have you found? Is it really as big of a problem as they're making it out to be? Yeah, exactly. Thanks, Melissa. So we have spent the last couple of weeks poring through securities filings, listening to these earnings call transcripts. They've left a series of clues throughout all of them about how much it costs.

9:45So we've been doing the calculations and what we found is that but it's in line with the industry standard. Retailers are supposed to budget for about 1 % to 1.5 % for shrink. And you look at lows, lows reached their highest levels of shrink in fiscal 22. It reached almost a billion dollars. Yes, that's a big, scary number, but that's just 1.03 % of sales. And of course, it has been growing over time for them. You can see in the numbers right there, starting in about fiscal 2017, you had about half a percent. And so over time, it hasn't been growing in the same rate as their sales, but it's still within the standard.

10:21And then if you want to turn to how that compares to losses from other factors with retailers, Target is a really great example of that. In fiscal 22, they lost about$753 million to shrink. We knew that number already. But if you take a closer look at their 10K, you'll see that they lost$3.6 billion from liquidating discretionary merchandise that they didn't need, plus other kinds of freight costs, product inflation, but mainly all of that liquidation. Is that called shrink, though? I mean, that sounds to me like loss of margin. I mean, what am I missing here? It sounds to me like a retailer that has had issues with inventory like they all have.

10:55How can you file this under shrink? So the 3.6 is not filed under shrink. It's just a good comparison, right? They talk a lot about shrink. Investors are thinking about it. Analysts are talking about it. But if you look deeper in the balance sheet, that's not where their profit drains are. They're losing it from things like excessive merchant, you know, discounting, clearance, liquidating. You saw that also at Dick's. Dick's was, you know, they had never talked about shrink in 20 years. And then they finally brought it up. They put it in their press release. You know, our margins are under pressure because of shrink.

11:23They lost about$27 million from shrink during the quarter. But they lost about$54 million from liquidating outdoor inventory. And yes, only$27 million. Right. Is that even material? It seems like a drop in the bucket here. So why do you think retailers are doing this? This is just sort of a look at this problem over here so you don't look at these other ones over there. Yeah, so I think we've got two classes of retailers here. One, you know, look, Lowe's has their shrink has increased. It's still within the industry standard, but that's a problem for investors. If you know if half a billion dollars could be in profits, then, yes, you're going to want to get a hold of that issue.

11:55For some of the other retailers, they're feeling pressure on so many parts of their business. You know, you've got a consumer slowdown. You've got higher spending on lower margin products, a shift towards consumables. People aren't shelling out for clothes and apparel, you know, over at Macy's. That's a problem. So they're trying to talk about the things that, you know, sounds like it's out of their control to distract from some of the things that are within their control. All right. Gabrielle, thanks so much for coming by. Thanks, Melissa. Gabrielle Fon Rouge, CNBC.com. Julie, your take on this?

12:24Well, I mean, I remember a million years ago when I was a sell side analyst covering retail, and you would have so many retailers blame weather for bad quarters. and you'd go into the store and you'd see a bunch of chartreuse sweaters and you'd be like, no, you guys didn't execute well. You didn't, you know, you didn't pick the right inventory and that's why your numbers are bad. But they would always point to weather as like the dog ate my homework. And I think shrink is a little bit becoming that where a few retailers talked about it and suddenly everyone feels like that's a good get out of jail free card for, you know, inventory in terms of when they double bought their inventory because of the supply chain.

12:57And so, you know, I think it's just kind of smoke and mirrors. I know Guy has a couple of chartreuses. Guy, what color is chartreuses? It's like a yellow-green, if I'm not mistaken. Like neon. Tim, you see, you put me on the spot. It's neon, and I know the answer. So you shouldn't do that. And I don't know what the problem with chartreuses. I have an entire chartreuse room. I'm sure you do. Fantastic. All right, coming up, we only had four trading days on Wall Street, but that's still enough to bring you a chart of the week. What caught the attention of our traders? We'll reveal that ahead. But first, industrial size losses for the XLI this week.

13:33Will the drop continue? Our chart master is here to tell us what direction the sector is heading next. Stick around. Much more Fast Money in two.

13:47Welcome back to Fast Money. Industrial is the worst performing sector in the S &P this week. The XLI down almost 3 percent since Labor Day. Rollins, Southwest Airlines, and Boeing are just some of the names taking the sector lower this week. So where does it head from here? Who better to ask than the chart master, Carter Braxton Worth of Worth Charting, who also brought along his giant keyboard? Carter, what do you see? I have that, too. So, well, all sectors were down, of course, this week, except for utilities and energy. But let's look at a few charts and really try to pick apart not only the sector, but some of the sub-industry groups and so forth.

14:18So the first we have is a comparative chart. You see very clearly three lines. And the message here is that the middle, the industrial sector, that's every industrial stock. But what you see on the top, of course, is the divergence between machinery stocks and road and rail stocks. Right. So that big, heavy industrials such as Cummins and PACCAR, which are in the machinery and Ingersoll ran and Eaton, not to mention Caterpillar Deer, are outperforming the sector, whereas equally important names such as the big rails are underperforming. So another way to look at this chart is to hold the sector as a constant.

14:54And now you see the real. You're talking about, you know, 2 ,500 basis points, 2 ,600 of divergence. And at this point, the question is, which has the proper message? If you have machinery stocks breaking out to all-time highs, how do you get a recession? And yet, if you've got road and rails rolling over, something can't be right. Either way, I don't like the sector. And let's look at a few other charts just to sort of pull this all together. There is the machinery sub-industry group, and you can see a well-defined move and a breakout to an all-time high. By contradistinction, take a look again at road and rail, the next chart, and you'll see that we never could get to the all-time high.

15:34So put them all together is the XLI, right? It's the spider that measures the sector. And that's the final chart here. And what you're going to see is, of course, a slight breakout, but basically failing. And so I think at a minimum, we're going to come back to trend. And that trend line, not randomly, is picking up the COVID low. So my hunch is buy, sell or hold, overweight or underweight. You want to be underweight industrials here. If you held machinery stocks specifically, though, does the chart look, I mean, the chart looks different already. So how does it look? That's right. So you always want to try to favor relative strength and things that are working.

16:08Things that are working typically working for a reason and things that aren't working. you sort of get what you pay for in life, right? So, yes, all things held equal. You want to go with those that are outperforming. All right. Thank you, Carter. We'll see you shortly on Options Action. Bono, and your take on industrials. I mean, it's tough. They've already broken through that 50-day moving average, and it doesn't necessarily look good for them or bode well, I would say. And then the other concern is we talk about, like, changes in leadership, and we've seen some outperformance if energy moves away from some of the more growthy tech names.

16:38If we don't have industrials picking up some of that steam, it really doesn't bode well for the overall market. So I think Carter's points are right on point. And I also would say overall, it does paint a slightly grim overall picture for the market. It's amazing how just three weeks ago, certainly by mid-July, end of July, we were talking about the expansion of the market and the breadth. And there you were. But Carter hit it. It's a false breakout. So if you look at six months, so not back to mid-July, but if you look all the way back six months, You can see that industrials have underperformed the S &P by almost 8 percent and transports by 7 percent.

17:11And this gets you back to that place where are these value traps? There's no question that a lot of these companies look interesting. And we've heard nothing but reasonable earnings out of 2Q from them. But I think you have to be careful, and I think it is the market positioning. It favors big cap tech, by the way. That tells you where people feel comfortable. Yeah. Guy, your quick take? The XLI, it is a bit of a false breakout. And Carter pointed this out in the Russell a couple of years ago, same type of chart. But you basically, to think this is going lower, you got to think Caterpillar has a bit of a double top here from the beginning of August.

17:40And that UNP, which I think is the second largest hold in the XLI, will continue to roll over. By the way, if you have a UNP chart, throw it up because this made an all-time high back in February of 2022, I think. And it has not performed since. So, as usual, I'm with CB Dubs on this one. All right. Coming up, an energized trade. Crude oil hitting levels not seen since last November this week. What's fueling the fire and what stocks are set to benefit from that boost? The trade right after this break. And later on Options Action, brokering gains. Investment bank stocks haven't been acting well recently, but our traders have a way to profit in spite of the ugly action.

18:15More Fast Money's right after this.

18:23Welcome back to Fast Money Time for our chart of the week. And it is, well, crude, obviously. It's this crude climb right there. WTI crude climbing more than 2 % and notching its second straight week of gains. The commodity hitting its highest level since November earlier in the week and settled today at more than$87 a share of the gains, taking some energy stocks to new highs. You flagged the move in Phillips 66, Guy. If you look at a chart, I mean, we have throw that sucker up because we're up against levels we last saw five years ago. And very quietly, and I know Tim can speak to this as well.

18:58You know, these levered under the radar screen energy plays have been grinding higher. A lot of them making all time highs right before our very eyes. I don't think I'll say it again. I don't think the market is paying enough attention to energy despite the move the commodity has had, despite the move that the services have had. I still think there's room to the upside in a lot of these names. Yeah, agree. And we're seeing a little bit of rotation within the energy sector. The breakout in the OIH is decided. Also, you're essentially at four and a half year highs on Schlumberger. I'll also point out that oil inventories are back to the lows we saw in 2000.

19:32You could inflation adjust them back to 1985. I mean, there's a real story here that I think energy prices stay high. Look at the move oil had this week with the move in the dollar. I mean, we haven't really been talking about the dollar tonight, but we have been talking about it a lot lately. That's usually terrible for oil prices, and it's been in the face of oil prices. There is also some thinking that Saudis need oil to remain high in order to pay for all the projects that they've got going, Julie. So it is in their interest to keep oil prices high. And therefore, we should be looking at WTI and we should be looking at Brent as at least having a floor under it, if not room to move higher.

20:06Yeah, I think that's right. I mean, you know, they have shown a very strong commitment to being able to hold back on supply and push pricing. And I think, you know, people mistakenly thought, well, you know, if China is not doing as well as we thought, that's OK. That's less pressure on the demand side. But, you know, I think they're thoughtful about, you know, keeping supply where it needs to be. What's, you know, a real problem for us here in the U.S. is I think the reason why investors aren't paying attention is that if oil prices are higher and gas prices are higher, inflation expectations have to anchor higher and the Fed has to either hold or even raise.

20:41And I think investors are just like, la, la, la, I don't hear it. I don't hear it. I think that's why no one's really wanting to admit that that's a pretty big factor in consumer confidence. Although that's I mean, we we saw the impact of this move in oil and it's it's been a swift move. I mean, that's what the airlines highlighted this week, Bonwin. So it's amazing. And on one hand, as Julia pointed out, investors can have earmuffs on. But on the other hand, there are plenty of stock stories out there that are telegraphing the impact of oil moving higher. Yeah, as Julie said, investors typically hear what they want to hear.