Fortunes are made and lost every day in the stock market. While the key to investing is to pick the winners, it’s also important to avoid the losers. While there are many solid TSX index stock opportunities today, there are some stocks that investors would be better off steering clear of.
Aritzia (TSX:ATZ) is an example of such a stock. Let’s go over why I would steer clear of it.
Slowing sales growth
While Aritzia’s stock is riding high at the moment, up 115% versus 2019 and 36% year to date, there do appear to be some concerning issues.
Firstly, Aritzia’s sales growth is slowing. In the fourth quarter of fiscal 2024, net revenue increased a mere 7%. This compared to net sales growth of 44% in the same period last year. Clearly, something major is going on here. More importantly, Aritzia’s same-store sales declined 3%, compared to 32% same-store sales growth in the same period last year. This means that the company has to spend more on new store openings in order to achieve sales growth.
These slowing sales growth trends speak to a consumer that has lost a lot of its buying power. It is not a surprising turn of events considering the higher interest rate environment that we are in, but it is nevertheless concerning.
Aritzia’s lofty valuation
Aritzia stock is currently trading at high-growth, premium valuations. This is a function of the rapid sales growth that the retailer achieved in its not-so-distant past, as well as high investor expectations.
It’s an understandable sentiment, given that Aritzia has achieved a lot since it went public a few years ago. However, I’m not sure how reasonable it is that Aritzia is trading at a price-to-earnings (P/E) multiple of 41 times last year’s earnings and 21 times this year’s expected earnings.
It just seems like too much can go wrong. First, we have the macroeconomic environment. Higher interest rates and inflation have driven up the cost of living dramatically. We know that the low interest rate environment of the past drove consumer spending much higher. If this is true, then it stands to reason that the higher interest rate environment of today will curb consumer spending. We are seeing this happen. As time goes on with higher interest rates, this will be magnified.
Declining net income
Finally, along with falling sales growth, Aritzia is experiencing rising costs. It’s a double-whammy that’s hitting the company’s bottom line. As such, adjusted net income in its latest quarter fell 51% to $105.6 million. This was due in part to rising selling, general, and administrative (SG&A) expenses. In fact, these expenses increased 17.6% and were 30.4% of net revenue compared to 27.4% last year.
While Aritzia’s product offering is in high demand right now, I also recognize that the retail apparel business is a highly cyclical one. The cycle can shift based on the economic health of the consumer, but also based on shifting preferences and trends.
The bottom line
While Aritzia has fared exceptionally well since it went public on the TSX index, this TSX stock is pricing very optimistic expectations. In my view, there are too many risk factors to justify Aritzia stock’s valuation.
