JNY: Ruined Everything By Being Itself
Earlier this week we noted that this story would break down within 2-quarters. We did not expect it to be within 2-days. In this note we focus on what’s changed. Bottom line = If 2011 estimates don’t shake out close to a buck, this puppy needs to see more downward revisions.
- First off, the top line grew at 20%, while GAAP EPS was down 7%, and the triangulation of sales/inventories and margins is as bearish as we’ve seen for JNY in 2 years (see Exhibit 1).
- This might be nit picking. But don’t you love how this company prints a GAAP number of $0.34, but they say that all these impairment charges and realignment costs (due to underinvestment and mismanagement) are not a part of ongoing business. Why do they also have such costs in the year-ago period? Translation = yes, impairing assets and continuous realignment IS a part of JNY’s business. Note to management: Stop highlighting it as a non-recurring item.
- 20% top line was a full 6% better than our estimate. This included the layering on the Stewart Weitzman acquisition – as expected, as well as better than expected retail comps of 2.5%. But the bulk was driven by a greater push (and we mean Push) in Better Apparel and Jeanswear. Net/net, this should have resulted in a BIG gross margin number. Right?
- Nope. Gross margins were down 205 bps - which was entirely driven by the Wholesale Better Apparel and Jeanswear businesses. Management was not clear about the drivers, but continually highlighted input costs and freight costs. Here’s what we don’t get… These sales occurred during the third quarter based on product that was built/assembled in 2Q and composed of materials procured in 1Q. Translation = you can’t look at the $1.27 cotton price we see today and possibly imagine that this is showing up in JNY’s margins yet. That will hit in 1Q11. So what gives?
The reality is that we don’t know. That is super scary.
- Our sense is that Retailers, Manufacturers and other supply chain partners that actually have a risk management process are already jockeying for margin dollars from their weaker partners. Yes, that’s JNY. Think about it. If sales are weak in department stores, can Macy’s turn to Ralph Lauren and demand margin dollars? Not a chance. Historically, the weak brands have funded the stronger brands. But one major change of late is that LIZ has been pulled out of the equation given that it is exclusive with JC Penney and QVC. The department stores have a big set of crosshairs on JNY.
- Another reality is that there’s simply more ‘stuff’ to sell. Inventories were so lean over the past 2 years that orders finally ticked up eight months ago, increased product across most of retail, and has been hitting our shores since August. Yes, it means that top line numbers will be there. But in no way, shape or form does it mean that the margins will be there.
- In fact, when putting b) and c) together, we’d argue that the GM erosion hardly came from cotton over a buck – but more likely due to more units in the marketplace. This, on the margin is probably good for the TJX’s and ROST’s of the world.
- Retail sales were up 6%, including a respectable 2.5% comp. But then I ask… How come margins are still flat versus last year at NEGATIVE 6.2%? What would they look like if comps went negative? For a story where the bull case is so focused on a recovery in Retail margins – this print raised some serious questions. Sometimes margins are bad because it’s simply a bad business – not because profitability is ‘artificially depressed.’ Maybe a few years back it was artificially high.
In the end, our core thesis with JNY remains simple and unchanged. Without a major reinvestment in the company – JNY is locked into earning $1-$1.50 in perpetuity. When people start to believe $2 EPS numbers (which the Street did last week, and no longer does today with a 25% melt-down), then the short case becomes more powerful. When the cash flow stream inevitably blows up because the company can’t kick the can down the alley anymore, then we can put on our bull hats. Here, unless the Street ends up at about a buck in FY11, there’s more downward earnings revisions to come.