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TGT: Trend Brewing?

Today we added a short TGT position in the firm's virtual portfolio following a strong move higher for the retailer and the majority of the sector.  Below we include our latest thoughts following last week's January sales release:


Despite January expectations that were gradually ratcheted down, Target’s results were once again disappointing.  This marks the second month in a row where internal projections called for a low to mid single digit increase and results failed to materialize. 


Interestingly, there remains a major divergence between the growing, P-Fresh driven performance in the food and consumables category and the rest of the store.  Unfortunately, grocery induced traffic does not appear to be leading to an acceleration in discretionary spending at this point.  While two months doesn’t make a trend, scrutiny surrounding the company’s topline initiatives centered on 5% rewards and P-Fresh is on the rise. Over time, these strategies should work.  However, sales expectations need to be taken down in the near term.  Management’s guidance for low single digit increases in February is a start, but this is clearly not the 4+% comp trend we were originally expecting to see for most of 2011. 


TGT: Trend Brewing? - TGT matrix


Eric Levine


Inflation...In Obama's Popularity

Conclusions: President Obama’s approval rating is inflating, and with it, his chances of re-election.


Clearly, we’ve been a loud voice in the debate on whether inflation currently exists.   Regardless of how the textbook defines inflation, our view is simply that inflation occurs when prices go higher.  To deny inflation in most commodities is ignorant, but, conversely, deflation continues to occur in housing prices.  Interestingly, now that the dust has settled post the midterm election, we are beginning to see inflation in the approval rating of President Obama, and with it, his chances of a re-election are steadily increasing.


We look at two key measures for Presidential Approval, the Rasmussen Presidential Approval Index and the Real Clear Politics poll aggregate.   We will grant that all polls have their biases, but what matters in polls happens on the margin, and in both of these polls President Obama’s approval is improving:

  • Rasmussen Presidential Approval Index – In its most recent reading this poll was a -8, with a breakdown of 36% strongly disapprove and 28% strongly approve.  As noted in the chart below, President Obama has seen a noted improvement in this poll over the last few weeks as his ratings were mired in the -11 to -20 range for much of late 2010.
  • Real Clear Politics Poll Aggregate – This collection of polls tells much the same story as the Rasmussen Approval Index.  For much of the second half of 2010, President Obama’s approval rating was lower than his disapproval rating.  In fact, his approval rating bottomed on August 10, 2010 at 44.4.  In early January of 2011, President Obama’s approval ratings surpassed his disapproval ratings for the first time since July 22, 2010.  Currently, President Obama has a 49.8 approval rating and 43.8 disapproval rating.

At the same time, since the start of this year, the political futures market has also begun pricing in a more favorable chance for the Democratic Party candidate to win the 2012 Presidential Election.  In fact, this contract is now trading at 60.4, which is close to a 1-year high. So for those who have written off President Obama and the political outcomes associated with him losing in 2012, we would recommend caution. 


But the question remains, what is driving this Inflation in Obama Popularity?  We would point to a number of factors, which include:

  • With the election season behind us, less money is being spent on negative advertisements targeting the President;
  • President Obama is shifting towards slightly more moderate positions in certain areas and, more generally, reaching out to the Republicans in bipartisanship;
  • The stock market has been quite strong over the past few months and has tracked President Obama’s approval rating closely.  While a strong stock market does not help the millions of people on food stamps, it does make those with investable assets marginally more confident; and
  • Finally, the President had an opportunity to show real leadership around the Tucson shooting which was received and perceived favorably by many.

Inflation exists in many commodities and around the globe, but we are also seeing it close to home in the approval ratings of President Obama.


Inflation...In Obama's Popularity - dj rasmussen


Daryl Jones

Managing Director

RL: Before The Quarter

Here we are again, waiting for another quarter from RL. And of course, the ONLY question I’m being asked is “How much will RL beat by given management’s sandbagging track record, and is it in the stock?”


The answer is they’re going to beat meaningfully. We’ve got ‘em at $1.52 vs. the Street at $1.29 (20%). Then we’ve got 4Q (Mar) at $1.28 vs. the Street at $0.88 (45%).


There are several factors to consider about this quarter.

  1. The company guided to high-teens growth in total company sales, and noted that Retail will lead that growth. Huh?
    1. They guided to high teens for Wholesale too. Fall rollout of Lauren handbags to 150 US doors is partially driving this.
    2. But we’re just at the point now where RL’s retail segment is larger in size than wholesale.
    3. Let me get this straight…two divisions of equal size accounting for 95% of revenue. One will grow high teens, and the other will be more than that. How does that equate to high teens for the parent?
    4. We think that Retail will grow by 30% in the quarter. Why?
      1. First and foremost, The Chinese and Korean licenses are both being folded into Retail – instead of wholesale like all previous licenses have been. Is this just accounting? An optical illusion to goose the perception of growth? Perhaps. But strip out 4% of a 23% top line growth expectation, and I’ll still be impressed.
      2. RL turned on its UK dot.com business in October. This alone should boost e-commerce as a percent of total from 3.5% to 5%. And yes, it carries an incremental margin north of 50%, and serves as the best avenue to flush out goods at end of season.


In aggregate, we have sales  growing by 23%. If we’re right on that, then in order to justify their ‘GM down 100bp’ guidance, we’d need to peg SG&A up near 30% in order to get closer to the consensus. That’s not going to happen.


Is it in the stock? RL saw record selling activity in December by several senior executives. Regardless of what the stats say, my sense from talking to investors is that there simply is no consensus on this name.  But one trend is clear in looking at other names in retail – investors are paying for top-line growth. RL fits right in.


I wouldn’t chase it here, as there’s admittedly not enough controversy in the name. But If we’re right with $6.13, $7.34, and $8.34 for the next three years, respectively, then it suggest 20% CAGR EPS growth with a bullet proof balance sheet. We never like pulling multiples out of the air – but the reality is that others will. Let’s use a number a bit below the growth rate. 18%, or 18x? It suggests $110 today (where the stock is), $130 in a year, and $150 in 2.



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We’re not expecting a LVS sell-off as better relative volume growth and tame expectations could combine for a positive stock market reaction to earnings.



LVS dropped 9% the day after earnings were released.  The two issues we had with the quarter were that whisper expectations were way too high and MBS volumes dropped 20% sequentially.  On the other hand, the analysts seem to have little concern about the MBS performance despite the fact the property would’ve missed expectations with normal hold.  Less than a week after LVS reported its 4Q2010 results, one Asian analyst cut their target for Genting on fears that it too experienced a similar sequential drop.   While we have no illusions that Genting’s VIP volumes were up a whole lot, our belief is that they were at least in-line and possibly marginally better than 3Q volumes.


Our 4Q2010 projection of S$399MM EBITDA for RWS is marginally ahead of consensus, but given the sell-off in the stock, in-line should be good enough.  We believe Genting gained volume share from LVS.  Genting should also provide an update on their junket licensing progress.  Our understanding is that they are expecting approval in the first quarter and if they do, this could be a nice catalyst for Genting to grow their VIP business. 


October was the strongest month of the quarter by far.  November was slow, as seasonally expected. While December enjoyed huge foot traffic, high 90’s occupancies in the hotel and Universal ran at capacity, we don’t think that strong retail traffic translated to huge gaming volumes which is why this quarter is softer than many had initially hoped for and forecasted.  


Below are the details behind our projections for RWS:

  • Total net revenue of S$806.7MM
  • Non-gaming revenue of S$129MM
    • Room revenues of S$27MM (S$260 ADR & 85% occupancy); F&B and other revenue of S$29MM
    • S$59MM of park revenues (7,750 visitors per day)
  • Net gaming revenue of S$678MM
  • S$9.5MM/day in gross casino revenues
    • S$136.6MM of slot revenues (S$800/win per day)
    • Gross VIP revenues of S$470MM and net VIP revenues of S$272MM
      • RC Volume of S$16.5BN, 2.85% hold
    • Mass table revenue of $269MM
  • Variable expenses of S$243MM and fixed expenses of S$165MM essentially flat with S$163MM in Q3, which we think is a good reference for fixed expenses until RWS opens the west zone and marine park

Retail: China Rate Move is Material


Here’s a question the average Retail analyst is not asking, but should.  “What is the relevance of China’s move today to raise rates (again) by 25bps to 300bps above Fed Funds?”


Our Macro team has been all over how Asian (and even global) growth is slowing on the margin, yet global inflation is accelerating. As Keith put it this morning,


“…the Chinese and Indian governments are going to perpetuate this investment theme, as they do not get paid to be willfully blind to the effects of inflation on their common people over the long term. In other words, China is doing what it has to in order to address what Bernanke refuses to.


In the short-run, this is the pain that Asian central bankers are willing to impose on their stock markets. Over the long-run, seeing inflation destroy their sovereign bond markets, corporate margins, and their citizenry’s buying power is a really bad idea”


Will this immediately hurt US/European brands who will notice a near-term slowdown in demand in China? Our sense is that the answer is ‘probably not.’


Does it mean that it ups the ante for US companies looking to China to find cheap labor given that wage pressure and product costs have already resulted in higher product costs out of Asia? Probably.


The bottom line is that at any given time, China is incrementally exporting more inflation (to US) or importing inflation. Neither is a particularly comforting place to be. The best positioned companies are those who have a revenue base in China that is similar in size to its sourcing business. Being net neutral Yuan/USD is the lowest risk model. That’s Nike and Adidas. Ralph Lauren also screens well.


Other global brands/supply chain partners like Li&Fung, H&M and Inditex are probably Ok. 


US brands that sell 100% in the US and have 100% of product manufactured 8,000 miles away are – for the most part – in trouble. We still think estimates are too high out there by 10-20%.


I can say with certainty that every restaurant operator has been looking at CMG restaurant level margins with sheer amazement.  Undoubtedly, the financial performance has been nothing short of amazing in FY10 with restaurant-level margins that are about 1000 bps above comparable companies on average (please refer to the chart below for more details). 


CMG ON ICE? - CMG ROP margin comp


The lines that make up the biggest difference between CMG and the competitors are Labor costs and Occupancy and other.  News has emerged via the Wall Street Journal that Immigration and Customs Enforcement (ICE) officials are scrutinizing CMG’s employment practices.  Following the company being forced to dismiss hundreds of employees in Minnesota, ICE is going to examine the eligibility of CMG employees in Washington, DC, and Virginia.  Perhaps this piece of news goes some way towards explaining the “magic” CMG formula for restaurant-level margin outperformance.  If it were proven that the company has not been paying appropriate wages, it could possibly shed light on where some, or all of, the 500 to 700 basis points difference in labor costs is coming from.


CMG is due to report 4Q10 EPS on Thursday, February 10 after the market close.


I expect the company had a strong quarter, with same-store sales up 9-10% and EPS that can easily beat the consensus estimates of $1.30.  Clearly a beat would not be uncharacteristic for this company, so I expect the 2011 outlook to be a primary driver of the stock’s performance.  While significant food inflation is a given for CMG in 2011, higher labor costs might not be completely factored in.


As we can see below, Chipotle’s outperformance of another burrito concept, Qdoba, is nothing short of remarkable.  It will be interesting to gauge Chipotle management’s tone on the earnings call with regard to margin outlook and, of course, to hear the reaction to the recent ICE news.


CMG ON ICE? - burritos


Howard Penney

Managing Director


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