Travel, Leisure Companies Look Compelling in Consumer Cyclical

The consumer cyclical sector underperformed the broader market in the first quarter, with prices falling nearly 11%, over 600 basis points below the approximate 5% decline the market chalked up, as of March 25.

Exhibit 1: U.S. consumer cyclical stocks underperformed the broader market in the first quarter.

- source: Morningstar

As such, the median consumer cyclical stock trades at a discount to our fair value estimates, with over half (51%) of stocks in our sector coverage trading in 4- or 5-star territory. Yet, while the high number of undervalued mid- and small-cap stocks lowered the median valuation, on a market-capitalization basis, overvalued large-cap stocks bring the sector into fair value range. We contend that travel and leisure stocks are among the most undervalued, as we believe the market has undue concerns about the impact that the conflict in Eastern Europe and rising domestic prices will have on consumers' desire to travel.

Exhibit 2: Investors should consider leisure stocks.

- source: Morningstar

As mobility restrictions are being lifted, we anticipate discretionary spending will shift toward services at the expense of goods. This dynamic is beginning to manifest in the improving results we are seeing in the U.S. lodging industry, where revenue per available room is at 105% of 2019's level, according to Smith Travel Research, through March 19.

Exhibit 3: U.S. revPAR nears 2019 levels, highlighting improving travel demand.

- source: Morningstar

This represents a marked improvement from the 78% posted in the first week of the 2022. While we acknowledge that the volatile global political environment and rising prices may interrupt the travel industry recovery temporarily, we contend that consumers' excess savings and pent-up demand will mitigate these risks and cause an immaterial impact on bookings over a longer horizon. When combined with the increased adoption of hybrid work arrangements allowing more flexibility for workers, we have an optimistic outlook for the travel industry and forecast a full recovery to 2019 levels by 2023.

The pandemic has shaped consumer shopping habits over the last two years. And even with restrictions easing, we suspect that some consumer trends, such as e-commerce and omnichannel shopping, have staying power. According to Euromonitor, over 35% of all apparel was sold via e-commerce in 2021, a significant jump from 17% in 2016.

Exhibit 4: Elevated e-commerce sales are the new normal for apparel retailers.

- source: Morningstar

We see this elevated portion of e-commerce sales as the new baseline for retailers and agree with the Euromonitor projection that nearly 50% of retail apparel sales will be via e-commerce by 2026. With this dynamic, we believe retailers will need to continue to optimize e-commerce platforms to avoid losing sales in a quickly shifting marketplace and remain engaged with consumer trends.

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Hanesbrands HBI Star Rating: ★★★★★ Economic Moat Rating: Narrow Fair Value Estimate: $26 Fair Value Uncertainty: Medium

We believe narrow-moat Hanesbrands, currently trading at a 40% discount to our $26 per share fair value estimate, offers a good opportunity for investors. Although fourth-quarter results were relatively tepid and included guidance for 2022 operating margins that fell short of our expectations, we remain confident in the company's long-term strategic plan, Full Potential. We view the plan favorably, particularly its emphasis on widening the athleisure brand Champion, and we think the firm is in capable hands under former Walmart executive Steve Bratspies, who took over as Hanes' CEO in August 2020.

Bath & Body Works BBWI Star Rating: ★★★★★ Economic Moat Rating: Narrow Fair Value Estimate: $85 Fair Value Uncertainty: Medium

Narrow-moat Bath & Body Works is attractive, trading at a 40% discount to our fair value estimate. We contend that the recent selloff of the stock is a result of the market fixating on near-term pricing and profitability normalization. However, with the Victoria's Secret spinoff complete, we're focused on Bath & Body Works' ability to remain agile and pursue growth opportunities that more align with the business, leading to market share gains both at home and abroad. Outside its home turf, we see opportunities through digital and physical store channels that should support its brand intangible asset on a global scale.

Poshmark POSH Star Rating: ★★★★★ Economic Moat Rating: None Fair Value Estimate: $23 Fair Value Uncertainty: High

Trading at a 40% discount to our $23 fair value estimate, we see shares of Poshmark as attractive for investors looking to gain exposure to the apparel market. While the path to profitability may be more arduous than we initially anticipated, largely due to stronger-than-expected competition, we still believe in the long-term trajectory of the business. Between the accelerated adoption of online resale, the ongoing mix shift toward e-commerce in the industry, and the resilience of price-competitive resale in economic downturns, we see Poshmark at the confluence of three positive tailwinds.