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JCP: Vintage is a Byproduct, Not a Strategy

Today’s announcement that JC Penney is granting board seats to two of its largest shareholders, activist Bill Ackman and real estate guru Steve Roth, is certainly something for the bulls to chew on.  Or is it?  After all, these are the guys who are supposedly going to “shake things” up at the middle-market department store at time when margins are headed south and sales growth remains in a holding pattern.  Additionally, the company announced a  series of “strategic” moves aimed at improving profitability (over time).  The key here is the “over time” part.  This is neither a quick fix, nor a near-term margin and/or sales enhancing strategy. Instead, this is an example of addition by subtraction.

 

JCP plans to do the following over the course of 2011:

  • Close 5 under-peforming stores. 

Closing just .0045% of the store base is hardly worthy of a press release let alone a conference call.  Importantly, management remains convinced that the rest of the store base meets acceptable performance hurdles. In other words don’t expect a major store closing effort.  The focus from management remains on growth.  Recall that the company’s April analyst day set out a 4% CAGR for comps over the next 5 years.

  • Finish the wind-down of the company’s legacy catalog business, including the closure of 19 catalog clearance centers.

For a company that was early in building out e-commerce it has been slow to let go of its legacy.  Perhaps this is because of an aging customer demographic or a reluctance to let any more sales walk out the door. Either way, this is a good move albeit one that is three years too late.

  • Close two call centers by consolidating operations into the remaining three facilities.

We’re not sure many people even realize JCP was operating 5 call centers nationwide to deal with customer service issues stemming from an aging catalog division.   For fun, try calling Zappos and then JC Penney. Compare and contrast.

  • Re-org the custom decorating business, which includes focusing on key markets (300 studios down from 525) as well as consolidating fabrication facilities into one location.

We know that JCP has long been known as a destination for window treatments (thanks to Sears for exiting the biz a few years back as well) but decorating too?  This announcement makes us wonder what other 1960’s era efforts are still being performed within the organization.  We understand that “vintage” can be a retail strategy, but we’re pretty sure that is not the intention here.

  • These efforts are expected to generate $0.07 in EPS in 2012, after cumulative costs of $0.13 over 4Q10 and F2011 to exit the abovementioned businesses.

On current earnings of $1.47 or the Street’s consensus of $1.71 for next year, these savings barely amount to much.  Yes they help, but the company by its own admission is still a long way from peak EPS earnings of $4.75 in 2007. 

 

Management’s conference call to discuss these (minor) tweaks to the company’s operations over the next twelve months as well as any insight into the “expertise” that Mr. Ackman and Mr. Roth bring to the boardroom were scant on details.  In fact, the biggest take-away from the call was not what might be on the horizon in terms of big strategic moves (like a DDS REIT structure?) but rather what’s not on the horizon.  The message continues to be that the organization needs productivity improvements (i.e sales) to leverage a legacy fixed cost infrastructure (i.e 1,100 stores) at a time when the company’s core middle-income consumer remains under pressure from many different angles.  So to paraphrase, it’s all about topline.

 

As such, with sales on the forefront and real estate and financial engineering near the bottom of the CEO’s priority list, we believe the fear of being short has been alleviated substantially with today’s announcement.  The newest board members, in our view, will have little impact on mitigating rising costs, accelerating the topline via merchandising prowess, or figuring out a way to jumpstart the company’s large but largely stagnant e-commerce businesses.  There is no doubt that new influence is better than no influence, but the big event that many have been waiting for seems to have occurred.  It’s now time to focus on the company’s earnings, which even in a great year are unlikely to approach $2.00 in the near term.  To get even close to $2.00, we would need to see a 120bps improvement in EBIT margins to 5.7% driven by sales growth.  Recall that 2010 will mark a peak gross margin year for the company as we head into the first year of apparel inflation in the modern era.  Even at $2 we would argue a multiple of 16x on the current share price seems rich for a no-growth department store.  In our view, the shares appear to be overdone on hope that this is just the beginning of big things to come, be it some hugely accretive sales driving plan or one in which the company shrinks it’s 1,100 store base to a meaningfully smaller size.  We don’t see this happening.

 

Instead, we believe that 2011 for JCP will be a year in which the Street realizes there is actually little that can be done in the near term to drive earnings measurably higher, or at least high enough to justify the current share price.  We’re modeling $1.33 for 2011 driven primarily by a flat topline and modest gross margin erosion equating to 24x earnings.  If there is one company that truly needs a job-driven macro recovery it’s JCP. Unfortunately, this is not a scenario we can predict with any confidence, any time soon.

 

Eric Levine

Director


Bearish: SP500 Levels, Refreshed

POSITION: Short SPY

 

At -6.2% downside versus +0.5% upside, there is a considerable amount of immediate-term TRADE risk in the US Equity market right here. Remember, tops are processes, not points.

 

That doesn’t mean we’re bearish on everything US Equities (we’re long Healthcare, Energy, and Inflation), but we are bearish on the Russell 2000 (IWM) and the SP500 (SPY).

 

What would have me cover my short position in SPY? 

  1. A US Dollar Index resuscitation above the intermediate-term TREND line of $78.66
  2. A breakdown of the VIX, below its immediate-term TRADE line of 16.95
  3. A breakout of the RUT (Russell2000) back above its immediate-term TRADE line of resistance of  789 

Realizing full well that the “flows” can trump the fundamentals on a Monday after a +91% stock market move that most index chasers are chasing, that won’t shake me from what I continue to see in both Emerging Markets and Bonds. I see inflation (that’s why these markets are going down) and so does the US Consumer or the XLY and XLP wouldn’t be dead in the water so far for 2011 YTD (2 of the 3 worst performing S&P Sectors).

 

My immediate-term TRADE lines of support and resistance are now 1273 and 1295, respectively.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Bearish: SP500 Levels, Refreshed - 1


Germany: As Good As It Gets?

Position: Long Germany (EWG); Short Italy (EWI) and Euro (FXE)

 

The question is set: is German data as good as it gets? While we like Germany and are currently long the country in the Hedgeye Virtual Portfolio via the etf EWG, we think there is an increasing probability that the data could roll (mean revert) over the next months, especially as Europe remains mired in its sovereign debt crisis.  We’re starting to get a preview of this from the DAX and German PMI and confidence surveys.

 

Germany PMI Services crawled higher to 60.0 in January versus 59.2 in December, while Manufacturing declined to 60.2 in January versus 60.7 in December, according to Reuters’ preliminary reading. Importantly, the 60 line (see chart below) is a heavy resistance level on a historical basis that is worth calling out; equally, we see a similar “topping” trend from recent German confidence surveys, including the Ifo Business Climate Index (see chart), which rose to 110.3 in January versus 109.8 in December.

 

Germany:  As Good As It Gets? - ger1

 

Certainly German fundamentals have remained strong and benefitted from the Sovereign Debt Dichotomy in Europe last year and the early part of this year. Despite a heavy move in imports in November, Germany’s trade surplus stood at a healthy €12.9 Billion; unemployment is outperforming the region at a consistent 7.5% rate; and industrial production figures were positive at 11.1% in November Y/Y.  

 

However, we caution that we’re seeing inflation rise globally, and Germany is not immune to this trend, which could erode capital market performance. German CPI rose to 1.9% in December Y/Y versus 1.7% in November and PPI came in at 5.3% in December Y/Y versus 4.4%.

 

All in, we like Germany’s growth outlook. Our GDP forecast for 2011 is ~2.5-3%, versus the Eurozone at ~1%.  

 

From a quantitative perspective on the equity side we caution that Germany is flirting with our overbought immediate term TRADE line of 7,163 on the DAX; we’d buy our position back closer to its intermediate term TREND support line of 6761.

 

Germany:  As Good As It Gets? - ger2

 

European markets have seen short term gains this month on assurance from China and Japan that they’ll buy European bonds, and speculation that European ministers (including the Germans) will increase the European Financial Stability Facility (EFSF) pot.  However, long term we continue to expect underperformance for Europe’s fiscally strained nations, as we view the “band-aid” bailouts for Greece and Ireland (perhaps Portugal next) as short term fixes to longer term fiscal imbalances. Political instability in such countries as Ireland, Italy, Hungary (to name a few) will continue to stoke these imbalances.

 

We remain short Italy via EWI and the Euro via FXE in the Hedgeye Virtual Portfolio.

 

Matthew Hedrick

Analyst


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R3: JCP, WWW, GPS, Twitter

R3: REQUIRED RETAIL READING

January 24, 2010

 

 

 

 

RESEARCH ANECDOTES 

  • Among the product highlights out of this year’s Outdoor Retailer Show is Merrell’s new “Glove” line of minimalist footwear set to launch in February – one of several new brands to enter the category in 1H 2011. Interestingly, the brand will be providing ‘instructions’ on barefoot/minimalist running techniques with each pair in an effort to reduce the risk of injury to ‘heel-strikers’ (i.e. just about every runner out there) who are unlikely to transition naturally to running on their toes.
  • In a sign that mobile texting/social networking/emailing is becoming ever more pervasive, a video gone viral shows a women falling into a mall fountain while texting on her phone. While the ‘victim’ is exploring the potential outcomes of litigation, the whole charade begs the questions of just how much mobile push interaction is too much. (view the video here).
  • It was only a matter of time before Twitter and a merchandising opportunity came about.  Enter Tweet Rings, customizable rings engraved with your favorite Tweet.  In the old days this would have more of a “quote” ring but limiting the text to 140 characters is certainly much cooler!

OUR TAKE ON OVERNIGHT NEWS

 

J.C. Penney Appoints Ackman and Roth as Directors - J.C. Penney Co., the third-largest U.S. department store chain, named William Ackman to its board after the activist investor became its biggest shareholder.  Steven Roth will also become a director after his Vornado Realty Trust built a stake in the retailer, J.C. Penney said today in a statement. The company also announced plans to close some stores and wind down its catalog and outlet operations.  Ackman’s Pershing Square Capital Management LLP bought a 16.5 percent stake in the Plano, Texas-based retailer in October, at the same time that Vornado disclosed owning 9.9 percent. The investors “intend to consult with each other in connection with their respective investments in the common stock,” they said at the time. <Bloomberg>

Hedgeye Retail’s Take: Now what?  With these two now on the board, does that make it easier of harder for them to influence a major shake up? 

 

Old Navy and Ann Taylor Look to Summer - For the summer season, Ann Taylor is taking some risks and adding variety, while Old Navy is emphasizing bold colors and crisp patterns in sync with its perennial casual, upbeat attitude. “We were inspired by the idea of road trips, whether it’s a family vacation or a single dude heading to Las Vegas. It’s about freedom, and hitting the open road,” said Chad Hinson, creative director for marketing at Old Navy. “There is such an optimism about summer.” He was interviewed at the Old Navy showroom on Sixth Avenue, which was adorned with retro travel posters of spots such as the Grand Canyon and the Cedar Point amusement park in Ohio to set the mood for the men’s, women’s and kids merchandise displayed. Among the outfits were a one-piece polka dot swimsuit with a tropical print sarong and V-neck cardigan, and a banded, gathered skirt with a printed chiffon tank and long knit vest seen in the “summer nights” group.<WWD>

Hedgeye Retail’s Take: You have laugh at the prospects of summer with the majority of the country sitting in a deep freeze at the moment.  That “road trip” does sound good right about now. 

 

Intermix Opens Flagship in Toronto -The retailer’s first international store, a 2,500-square-foot flagship on Bloor Street in Toronto, will bow in the fall, and a Canadian rollout is planned. “Why shouldn’t we be in every international city in Canada?” said Khajak Keledjian, chief executive officer of Intermix. “After that, it will be easier to go to Western Europe.” Intermix will open six to eight stores this year, including a 2,700-square-foot unit in Greenwich, Conn., this spring and a 2,800-square-foot shop in the Meatpacking District here in the fall. Other growth opportunities include men’s-only stores. “Not a day goes by that I’m not asked to do men’s,” Keledjian said. Intermix did $100 million in sales last year, a strong, double-digit increase over 2009, Keledjian said. “We had a great fourth quarter revenue-wise, but it was questionable in terms of margins,” he admitted. Intermix’s 24 units average $1,500 in sales per square foot, he said. <WWD>

Hedgeye Retail’s Take: Impressive performance for the boutique chain.  However, with a heavy Manhattan footprint it will be interesting to see how growth beyond one of the world’s fashion capitals treats productivity and margins.  Nonetheless, $100 million from 24 units certainly trumps most specialty retailers.

 

Sales Shortfalls spur Inventory Concerns - Not even a month gone, and 2011 is already proving problematic.  A string of fashion firms have revised fourth-quarter guidance in the last two weeks — with many warning along the way that the consumer mood might not remain quite as buoyant as they hoped it would after the sales boom early in the holiday shopping season. Now that New Year’s hangovers are long gone, consumers may once again be slamming their wallets shut in the face of continuing high unemployment, ongoing mortgage foreclosures and spiraling prices — on everything from food to clothes to gasoline. The result is an inventory overhang for both retailers and vendors. <WWD>

Hedgeye Retail’s Take: Despite some C-level types suggesting unit shortage will help drive demand out in California a few weeks ago, the risk of over-inventoried retailers/brands is increasing, which will only add fuel to the fire of pricing dynamics over the near-to-intermediate term.

 

Diesel Pumps Up Shoes - Diesel footwear is getting a makeover. For fall '11, the lifestyle brand will embark on some major moves to boost the fashion in its footwear offering and depart from its athletic-inspired roots.  "It's good for us," said Luigi Mezzasoma, CEO of Diesel shoes and bags, noting that the company has built a footwear collection that better aligns with the brand's image as sophisticated denim. "We can be closer to our DNA, which is strong and sexy, and be on trend in the market as we move from athletic to hybrid and more fashionable [styles]." "We're a fashion company, not an athletic company," added Tony Strippoli, Diesel's VP of sales for footwear, bags and kids' product. "We can credibly interpret trends from athleisure to runway [and] take the footwear in any direction we want to." <WWD>

Hedgeye Retail’s Take: It may be tough to argue its ‘athletic’ heritage, but given the company’s fashion focus on the apparel side of the business and an increasingly competitive athletic category, the move is a step in the right direction and one the company should have made a long time ago.

 

Snow and Taxes Might Benifit U.K. Online Retailer’s - Snow and frigid air, along with the approach of new taxes, helped boost online sales last month in the United Kingdom, where shoppers spent 25% more than they did in December 2009, according to a report released today by Interactive Media in Retail Group, a trade group, and Capgemini, a consulting firm. U.K. consumers spent 6.8 billion pounds (US$10.9 billion) in December, the report says.  That also represents a 7% increase over November. Unusually severe winter weather led more consumers to shop online last month, the report says. Spending also increased as consumers bought items ahead of the 2011 increase in the value-added tax, which resembles a national sales tax. The standard tax rate this year increased to 20% from 17.5%. “The ongoing trend of consumers putting down the car keys and turning on their computers is only set to continue particularly as consumers use the power of the web to make their money go further as the economy recovery remains fragile,” says Chris Webster, head of retail consulting and technology at Capgemini. <InternetRetailer>

Hedgeye Retail’s Take: Expect a similar effect stateside after anomalous January weather– something we expect to hear more about on sales day next week. Retailers over-indexed to e-commerce on a relative basis like Williams-Sonoma, J.Crew, Cabelas, The Limited, Urban Outfitters, and Saks to name a few with e-commerce accounting for over 15% of sales will have a competitive edge near-term.

 

Eastern Mountain Sports to Open New Store in Manhattan - Eastern Mountain Sports announced it will open a new store on the Upper West Side of Manhattan this fall at 76th and Broadway. The 13,000-square-foot store will provide its respected, authentic service to the community’s outdoor enthusiasts while taking advantage of its proximity to Central Park and the wide array of outdoor activities that take place throughout the year. The store will showcase apparel and gear for cycling, kayaking, backpacking, camping, climbing, hiking, snowshoeing and skiing. In addition, Eastern Mountain Sports’ signature services will include expert bike and ski technicians, foot gurus for personalized fittings, a paddlesport section, and a comprehensive travel-planning library. <SportsOneSource>

Hedgeye Retail’s Take: Recent store growth at both REI and EMS reflect the strength that’s been evident in the outdoor industry for the past year. While we’d expect productivity of stores in Manhattan to be considerably higher than more rural locations, it will have to be in order to offset rents that are undoubtedly multiples higher.

 

Twitter Ad Revenues to Soar This Year - Twitter has received enough media attention to be a household word, but still has a relatively small audience. The Pew Internet & American Life Project found in September 2010 that just 8% of online Americans used the service. But eMarketer is cautiously optimistic about Twitter’s fledgling ad products. eMarketer expects Twitter to earn $150 million in revenues this year, the vast majority of which will come from the US. This represents a substantial increase over revenues of $45 million during 2010, the first year Twitter sold advertising. <eMarketer>

Hedgeye Retail’s Take: More importantly here is not the volume or penetration rates, but rather the quality of impact, which is where social sites like Twitter and Facebook have a decided edge on alternative options.

 

R3: JCP, WWW, GPS, Twitter - R3 1 24 11

 

 


RANDOM TIDBITS FROM MACAU

Just a few things we are hearing...

 

 

LVS

  • Launching a re-brand of the Four Seasons/Plaza - trying to regain some of the premium play they lost to WYNN
  • Announcement may come pretty soon post CNY from LVS about being able to sell the Cotai condos - this would be a positive catalyst for LVS
  • Labor may still be difficult for LVS to procure for Lots 5/6.  See below

MGM IPO

  • No surprise but hearing that MGM IPO will get announced post CNY – so that pushes it to March if they choose to do it at all
  • Given the recent strength, which looks sustainable, MGM may want to wait to get a higher price. 
  • Also, one of the biggest players from one of their biggest junkets went missing while owing MGM over $100 million.  It is our understanding that the junket has agreed to pay off MGM over time through offsetting commission advances.  Not sure if MGM needs to or will disclose this.

Galaxy Macau and other projects

  • Hearing that June 1st is the likely opening date
  • It's possible that 25-30% of Starworld's Rolling Chip volume could go over to Galaxy Macau
  • There will be an air-conditioned walkway between Galaxy and City of Dreams
  • As soon as they open, they will move into Phase 2 right away so there may not be as many free laborers for LVS - could be a negative for LVS
  • There will be 3,000 local workers that free up once the Galaxy project is done
  • Angela Ho’s theme park is another large development – all the residential units from Shun Tak are already under construction
  • University of Macau on Henguin.   
  • Light Rail Project is also going on 4- 5 year plan.

MACAU: DIFFERENT WEEK, SAME FORECAST

Our expectations for 36-40% revenue growth in January remain unchanged.

 

 

Another decent week in Macau as gross table gaming revenues came in at HK$14.0 billion through the 23rd.  Using this figure and what we expect will be a slightly slower last week in January heading into the Chinese New Year celebration, we continue to project full month gross gaming revenues (including slots) at HK$18.5-19.0 billion, up 36-40% YoY. 

 

In terms of market share, Wynn lost more share – we are hearing it's totally hold related – while LVS continues to track in-line with its 3 month depressed share of 16.5%.  MPEL experienced a huge jump from last week’s month-to-date share of 11.7%.  MGM gave up some of that share, dropping 140bps since our last update.

 

MACAU: DIFFERENT WEEK, SAME FORECAST - macau1


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