“One of the truest tests of integrity is its blunt refusal to be compromised.”
Key Takeaways
Key takeaways
- Another big short was a Hedgeye client. Yes, they fired us – coincidently when we took the other side of their core short position. I won’t pretend that I was happy about this…it hurt – both my ego and my wallet.
- The way I see it, anyone with such a low integrity investment ‘process’ (if you want to call it that) will likely fall victim to their own close-mindedness towards differing trains of thought, new data inputs, and thoughtful financial analysis.
- GameStop (GME): So Many Ways to Win, But The Clearest Is The New Console Cycle; New Management and Transformed Board Means Real Strategic Change; New Activist Shareholder With a Proven Track Record and Big Vision
- Capri (CPRI): You Get Paid On What The Portfolio is Evolving Into – Huge TAIL Call; Trend Results Are Bullish; Catalyst Calendar is Lining Up
The big picture
#Accountability, #Transparency, and #Trust. If you know Hedgeye, our history, and the principles on which our great company was built, then you know these three words intimately. They permeate throughout everything we do and say. If you were to ask me to sum it all up into one word, it would be #Integrity.
in·teg·ri·ty: The practice of being honest and showing a consistent and uncompromising adherence to strong moral and ethical principles, values and processes. In ethics, integrity is regarded as the honesty and truthfulness or accuracy of one's actions.
Got a nice ring to it, huh? But let’s face it, anyone can say that they have a strong moral and ethical compass. During peacetime it’s easy to put yourself out there as a ‘high integrity’ person. Every sane person that is looking for a job, or hedge fund looking to gather assets puts on the Integrity hat as part of the interviewing/vetting process. But it’s when things get confrontational, when difficulties arise, and when someone challenges your prevailing view, then that’s when you see a person or organization’s true colors come to light. And often Integrity ain’t part of that equation.
From where I sit – difference of opinion can be a beautiful thing. My team and I debate issues all the time – sometimes fiercely. It’s not always pretty, and yeah, I might drop the occasional f-bomb, but the interactions are always respectful, process-based, and without fail lead us to better investment decisions for our Institutional Clients and Hedgeye Retail Pro subscribers. I hire high Integrity winners and I respect their input – even when completely counter to my own train of thought.
Differing thoughts prove to be even more powerful when talking to our clients. I for one am blessed to sit in a seat where I can talk through the bull/bear merits of many dozens of retail investment ideas with some of the smartest people on the Street – real thought leaders. I get smarter with each conversation, especially given that most of my counterparties understand that Integrity is the cornerstone of any investment process that can stand the many tests of time.
Then there’s the inevitable exception(s) to the rule.
My Analyst Jeremy McLean and I made several controversial calls as last year came to an end. Long Capri (CPRI) at $25 calling for a 2-year triple was one call. People thought we were way too bullish. They still do. But I enjoy the back and forth as to why I think our process is leading us to a big money-making call. Going Long GameStop (GME) was another. That one proved to be a lightning rod. No shocker given that roughly 100% of the float is held short as the market is betting that this company becomes the next Blockbuster Video. I disagree – more on that below.
Statistically speaking, it was inevitable that some of the GME shorts are Hedgeye clients. I had a great conversation with one bearish fund manager that strongly doubted our activist angle on the name – but ultimately read through our presentation and gave the idea a fresh look. No wonder he runs one of the best performing Hedge Funds of the past 10-years – his process includes using many forms of high-quality inputs that might run counter to his natural bias against an idea – to get him closer to the alpha-generating truth. He’s a winner, and he hired a team of winners. Good Hedgeye match, and great long-term partner.
Then there are the haters…it just so happens that they are those with the biggest short positions in GME. Two in particular. One was not a client of Hedgeye, but one of our Senior salesmen reached out to start a constructive dialogue. The investor’s answer… “just another idiotic call from the morons at Hedgeye.” The salesperson reminded the PM that this particular moron (me) called for RH to be a 10-bagger+ when the stock was $30 and it’s now flirting with $450. Needless to say we didn’t get the chance to engage in a fruitful debate with that fund. They already have all the answers.
Another big short was a Hedgeye client. Yes, they fired us – coincidently when we took the other side of their core short position. I won’t pretend that I was happy about this…it hurt – both my ego and my wallet. But the way I see it, anyone with such a low integrity investment ‘process’ (if you want to call it that) will likely fall victim to their own close-mindedness towards differing trains of thought, new data inputs, and thoughtful financial analysis. Also, if you feel so strongly about an idea, wouldn’t you want to engage in a debate to attempt to convince me to change my mind? I guess when you’re the smartest guy on the planet you don’t need thought-provoking research to make you better.
Is getting fired by a client for doing my job how I want to start 2021? In this case, yes, it is. My children noticed I was bummed out that night at the dinner table. I explained what happened – including that I stuck to my guns and made what I think is the right call for my clients despite pressure to bow to a paycheck. When my son said “I’m really proud of you Dad” it hit me like a brick wall that the principles by which we conduct ourselves in business can have far-reaching effects to those closest to us – the next generation of high-integrity leaders.
Macro grind
Ok…Back to the Retail Idea Generation Grind…let’s talk CPRI and GME…
GameStop (GME)
1. So Many Ways to Win, But The Clearest Is The New Console Cycle
The first, and simplest, way to win is the launch of the new console cycle. Simply put, the street is mismodeling the sales and profit opportunity expecting sales to be $700mm below 2019 levels, or just a 16% comp after 2 years of down 20-30% with a huge demand catalyst. For 2021 we see 30% comps and EPS of $2.50, while the Street is modeling a loss of 0.07ps. That’s with a stock of $17 today (and $14 when we first made the call). Based on the cycle alone, we get to a stock of $30. The volatility here is not for everyone…but the upside is real.
2. New Management and Transformed Board Means Real Strategic Change
GME has a new management team as of early 2019 and has added 8 new board members in the last year. The new team has experience at retailers like Advance Auto, Best Buy, Target and Home Depot. New board members include the former president of Walmart US and an owner of an eSports franchise full of teams competing in various games. They have had over 18 months to get the cost structure right-sized and make progress on store rationalization, but there is still much for them to fix, and much they can execute on strategic opportunities.
3. New Activist Shareholder With a Proven Track Record and Big Vision
There is now a call option on a huge turnaround and big value creation with the stake taken by Ryan Cohen (co-founder of Chewy.com), who starting a “friendly” activist campaign, but is willing to do what it takes to execute his vision for GameStop. Cohen knows how to build an ecommerce ecosystem around a quality, engaged, and loyal consumer base. There is perhaps no more engaged consumers than the core gaming market when it comes to attention and discretionary spending allocation. He started buying around $4 and recently upped his stake with the stock in the teens. Now at 13%, he is in this for the long haul, and will do whatever it takes to see the opportunity in front of GME to be seized. That could mean a stock $100+. We’re not sold on that angle yet…but at this price, don’t have to be.
Capri (CPRI)
1. You Get Paid On What The Portfolio is Evolving Into – Huge TAIL Call
The evolution of the portfolio is what gets you paid today buying CPRI. Even after the run in the stock since our call in November, our math suggests that you are paying today for the Kors brand, and are getting Versace and Jimmy Choo for free. As the margin profile across all three brands explodes over the next two years, and as the portfolio mix skews further towards higher-growth/multiple Versace and Jimmy Choo, you get paid through both outsized earnings growth and multiple expansion. Our SOP suggests $86 in 3-years (see math below).
2. Trend Results Are Bullish
Over holiday the company’s efforts to take up pricing (AUR) in the core Michael Kors business appears to have been successful. Closed stores in Europe can’t be ignored across the portfolio, but the top line is accelerating due to pricing, which is more margin accretive than the company has guided.
3. Catalyst Calendar is Lining Up
Earnings upside is the key catalyst here, and the derivation of the earnings upside (higher than expected top line growth, pricing and gross margin expansion), should flow through to multiple expansion. In 2H21 (FY ending March), we’re at $1.92 in EPS vs the Street at $1.26. Next year we’re at $4.00 vs the Street at $3.45, and then we have ~$1 in added EPS power each year thereafter – and are about $1ps ahead of consensus each year. The consensus remains way too low over a TREND and a TAIL duration. CPRI should financially de-lever completely over a TAIL (2-3) duration – faster than the Street is modeling, fully eliminating the debt burden -- one of the bigger parts of the bear case today.
Capri Sum-of-Parts Valuation Model
Our levels
Immediate-term @Hedgeye Risk Range with TREND signal in brackets:
UST 10yr Yield 0.92-1.04% (bullish)
SPX 3677-3763 (bullish)
RUT 1942-2021 (bullish)
NASDAQ 12,701-12,952 (bullish)
Tech (XLK) 127.41-131.14 (bullish)
Energy (XLE) 37.14-40.42 (bullish)
Financials (XLF) 28.50-29.85 (bullish)
Utilities (XLU) 60.10-61.99 (bearish)
Gold Miners (GDX) 34.11-38.93 (bearish)
Bitcoin 28,176-35,495 (bullish)
Make it a great one…
Brian McGough
Managing Director
