DECK (Deckers): New Long Idea. We’re adding DECK to the Long Side of our Position Monitor. We think that the top and bottom line will show momentum in 2022 – one of the few retail names to do so – at the same time there is an egregious valuation disconnect from ONON (On Holdings). Deckers is known for owning the Ugg Brand, one of the most consistent cash cows in all of retail, but its also owns the Hoka running brand (acquired in 2013) – which is white hot and growing 10x the average footwear brand, and should build to a $3-$4bn brand at retail over a TAIL duration vs about $1.3bn today. Interestingly, the closest comp for Hoka is ONON, which is putting up similar growth characteristics, but trades at 60x+ EBITDA. How we’re doing the math, the market is currently valuing Hoka at 50% of ONON’s multiple, and is giving you Ugg, Teva and Sanuk scott free. The stock is off with general retail by about 30% since November, despite our view that the prospects for the Hoka and Ugg brands have strengthened (this is a good winter for Ugg boots – as much as we hate playing the weather card). A valuation disconnect alone is not enough for us to go long any name. Valuation isn’t a catalyst. But we’re coming in ~10% ahead of consensus for 2H (ending March) for DECK, and another 10% ahead over a TAIL duration. The pair trade of Long DECK short ONON makes obvious sense to us, though we’re remiss to put such a high quality growth brand like ONON on our short list. We get to 75%-100% upside over a 3-year (TAIL) duration due to outsized earnings growth, and as higher multiple Hoka becomes a bigger part of the portfolio.
SIG (Signet): New Short Idea. Adding SIG to short Bias list. Post covid this name likely goes back to being a melting ice cube that is built to be cheap (mall-based Jared and Kay Jewelers), especially in Macro Quad4. We highlighted the PCE category strength with Jewelry and Watches being 50% ahead of 2019 levels in 2021. That demand level is not sustainable. SIG has turned to M&A for some incremental growth buying Diamonds Direct at the jewelry peak for $490mm or 1.1x sales and 7.1x EBITDA. That doesn’t look expensive at first glance, but keep in mind SIG’s EBITDA margin just went from 7.4% pre-covid to ~14% this year. It’s reasonable to think Diamonds Direct did the same, i.e. it paid a mid-teens multiple on EBITDA for normalized earnings. We think comps are likely to revert, the question is will it be violent or more gradual, for now we’re modeling the latter. The main earnings driver from here is likely stock buyback, and the company announced an accelerated plan. The street doesn’t look too far off for this year (fiscal 2023) at $10.70, we’re at $10.40, but we’re not sure if the whole sell side has the acquisition modeled in yet since it closed this Q, and again we are assuming the sales reversion is gradual. The consensus has straight-lined the new peaked covid margins and giving SIG positive sales growth, which we see as highly unlikely for this heavy B&M model. On 3-year out EPS of fiscal 2025 the street is at $11.30 while we’re at $8.50 after buyback and an earnings stream still declining from there. We see further downside for SIG to $60, at least until longer term consensus expectations get revised materially lower, which puts $40-$50 in play.
KSS (Kohl’s): Are these PE buyers serious? News came out over the weekend that Acacia Research – which has only $200mm in AUM but is backed by Starboard – is making a $64 per share bid for KSS (went out Fri at $47) valuing it at $9bn. Not to be outdone, Sycamore is reportedly preparing a bid for $65. We’re short KSS, and though the take-out developments will go painfully against our positioning on Monday at 9:31, we’re not removing the name from our short list. The reality is that we’re not going make the irresponsible move in removing a name from our list before our clients have the chance to act – given that the upside will be immediately priced into the stock tomorrow morning. Secondly, and most importantly, we’re not convinced a deal is going to happen. First off, the timing of a deal right now is absolutely ridiculous. Apparel companies, including KSS, are operating at peak sales, margins and earnings right now. KSS is likely to clock in close to $8 per share in earnings this year, but closer to $4 per share over a TAIL duration. A $64 price suggests a 16x multiple – or a ‘super peak’ on underlying earnings. Makes no sense – especially that both Starboard and (especially) Sycamore’s game is to take the companies public again after 5-7 years of milking for cash. To be clear, KSS will be lucky to still be in business in 5-7 years – especially given the existential risks accelerating in the apparel business in the form of SHEIN, Primark (Online), and Amazon. On top of that, this is not a real estate play (35% of stores owned, 20% ground leased, 45% traditional lease). If it were Macy’s, Dillard’s or Nordstrom, we could understand the real estate angle. Their stores are tied to Regional Malls which is like waterfront property. KSS operates solely in strip malls – which are a dime a dozen with unlimited supply. KSS also has 20-year long-dated leases (peers in strip malls are at about 7 years) with very little optionality to shutter the stores or change the footprint in a meaningful way. Lastly, Kohls is run reasonably well – for what it is. If an activist and p/e buyer want to come in and clean house and put in a ‘rock star’ management team to transform the business, we’re confident it will fail. We’ve seen this story before…it’s called JC Penney.
