Retail: 3 Stages of Grief


There is a difference between sharing assumptions and setting expectations. Here’s some great color we’ve picked out from some key industry players whose views are anything but similar.


One thing we find consistently surprising are managements’ comments about how “if all else fails, the consumer will absorb the cost of inflation.” In retail, that is almost never the case. Based on what the retailers, brands, and manufacturers are saying, the consumer will need to grow the size of their wallet by 3-5% on like-for-like product this year, and fork it all over to maintain peaky profit margins on so/so businesses.


What do Wal-Mart, VFC Corp and to a degree Macy’s all have in common? They’re forecasting healthy consumer spending in 2011 without meaningful margin erosion. How in the world can they do this with 87% of the year left to go and we’re two months away from the point where the highest raw material headwind the modern retail industry will hit margins?


Headed into 4Q earnings, these companies felt the need to give some context about their go-forward assumptions  for FY11 – which we think is fair.  But there is a difference between sharing assumptions and setting expectations.  A company that shares assumptions is likely to be more pliable with any outside forces that may impact cash flow. On the contrary when optimistic expectations are set so early in a year, the risk/reward rarely ends up in a good place.


Before we dive into the new information we got today on retail, there’s one thing that’s vital to consider. There are three stages of grief as it relates to raw materials.


1)  Control what you can control.

2)  Workup a strategic plan as to how you think your supply chain partners will react when faced with a meaningful change in their cash flow.  I’m referring to a brand like Adidas being on the lookout for how Nike plans to dramatically reinvent the ‘toning’ space (as the iPad did to Kindle).

3)  In addition to the two preceding points, plan for how a supply chain partner will look to squeeze when it’s hurt in other categories.


> For example…what happens if the ‘food inflation pass through’ is maxed out and Wal-Mart needs to face a food price increase at risk of losing additional traffic?

> Why not push it through to more discretionary and highly fragmented categories like apparel and toys?

> Go out and ask a CEO of a ‘basics’ apparel company if he knowingly funded markdowns in fresh fruit. He’ll say no, and he’s not lying. He’s simply unaware.


Let’s look at some of these recent comments and assumptions, to see if we can set our own expectations.




Here are the limited comments from WMT re: apparel.  Most interesting is the point about consolidating suppliers and adding back some exposure to footwear and accessories.  Clearly some of the category shifts in 2010 are being unwound.

  • “We posted mid-single digit negative comps in apparel. We have seen improving sales trends in men’s, ladies plus, and women’s, offset by a pull back in juniors. Customers are also buying closer to need, particularly in seasonal apparel. I’m encouraged by recent trends, as we add back assortment in key apparel categories, including shoes and accessories.”
  • “Space and assortment changes are now under way to improve our merchandise presentation, particularly in apparel, sporting goods, toys and hardlines in most of our U.S. stores.”
  • “Labor and higher cotton prices are affecting apparel and home categories. In softlines, we’re consolidating suppliers to improve purchasing power and leveraging our buying power with raw material suppliers.  We continue to work with our suppliers to reduce inflationary pressure where possible and only pass on price increases when they cannot be avoided.”

Hedgeye: Translation…Wal-Mart is changing its assortment to maximize productivity, along with consolidating its softline vendor base. When they run out of rope, they need to ‘work with suppliers’, which basically means “get better pricing from vendors.”



Not a ton of surprises in the current quarter as they had previously pre-announced, but a surprisingly confident outlook for 2011.  Keys to ’11: 

  • 3% same store sales guidance on top of a reported 4.6% would make this the greatest 2-year performance in over a decade.
  • Management is bullish on e-commerce and continues to invest heavily in e-com infrastructure.  Growth in the .com is worth about 100bps to overall comps.  Allows for potential reduction in clearance over time as SKU’s can be held centrally and distributed on a DTC basis.
  • Reiterated that strength in top-line is being driven by fashion-related items.  This is the key to management’s belief that they can take some pricing.  They will remain competitive on basics, but fashion remains the focus for the company.  Traditional brands (not specific here but I’m guessing JNY, etc.) are laggards and need reinvigoration from vendors.
  • Inventories well managed despite pulling inventory receipts forward to meet demand after successful post-holiday demand.  Inventory growth should mimic comp store sales momentum.  Sounds like there is real discipline here on the part of inventory management which is driving a cycle of better gross margins as well as reduced markdowns.

Hedgeye:  Net/net, Macy’s is confident that their merchandising initiatives (My Macys, private/exclusive brands, and emphasis on fashion) will help drive a second year of LSD positive comps.  If successful, this will be the single best two year sales run in the modern history of the company.



VF Corp.:

The company is guiding toward 8%-9% top line in 2011. Let me repeat… Guiding to 8%-9% top line in 2011. 

  • Remember that the old model called for 3-4% growth from the base business and 3-4% from acquisitions.  This time, however, there is no mention of acquisitions.
  • VFC did not put up organic top-line growth like this since midway through last decade.
  • Guidance is based on 8% top-line with flattish margins y/y (GM down 100bps offset by SG&A leverage). Don’t you think that just MAYBE this is a little optimistic?

One of the X-factors here is the competitive dynamic between Levi’s and VFC (Lee and Wrangler).  These brands are the $20-$30 mainstay at WMT.  Levi’s intends to take price increases in one fell swoop. VFC will likely be more measured and gradual. Notable VFC comment:

  • “In terms of 2011 for our Jeanswear America businesses, we anticipate men's single-digit growth in revenues. At the same time, unit volumes are expected to decline at a mid single-digit rate, offset by new programs in pricing...Some initial price increases have taken effect in February, with some additional increases planned as the year progresses. On the cost side, we're keeping a tight reign on expenses and reengineering products. Nevertheless, the combination of pricing and cost controls will not fully mitigate the increases in product cost, and as noted earlier by Bob, our domestic Jeanswear margins will be down this year.”

Hedgeye: In men’s, the only growth will come from whatever pricing sticks. If competitors break price, then pricing is at risk in one of the most stable and profitable businesses for VFC. Keep in mind that expectations call for pricing to largely offset unit declines in the domestic business with international growth both in Europe and Asia the key drivers of global top-line results. Overall, we’re perplexed as to why and how the company set these expectations so far out with so much uncertainty yet to come.



  • “I can tell you in this environment all apparel companies are raising prices and retailers are seeing it everywhere. They’re seeing it from U.S. suppliers, Central American suppliers, Asian suppliers, and as I said, we’ve implemented price increases, some of which took effect this week. And we’ve also solidified pricing through back-to-school and you’ll see higher promotional prices and prices in the marketplace than you did the prior year.”
  • “What I’m seeing is a lot of retailers be willing to push branded basics a little bit more and they are going to be a little bit more cautious for high price point, high fashion, high mark down risk items especially I think in back-to-school and leading into the holiday season.”
  • “Overall, I think you’ve got a lot of people that understand that if you’re raising prices in a certain category, that volumes are going to come off. There’s a question, obviously, about how much. And as I alluding to earlier, what a lot of retailers are doing is they’re making those decisions in a lot of the apparel categories that they pre-buy which is the bulk of apparel. They are cutting units and more where they realize that they have more mark down risks. So I think what the retailers are trying to do is to make sure they don’t end up with a huge mark down exposure, for example, next holiday.”
  • “So if you saw prices come down from these levels substantially we’re probably, they’re just starting to match the price increases that we’ve secured in the marketplace for back-to-school. And, as I said, if they stay at these levels you’re going to see us continue to increase price and actually the retailers fully understand that. We’ve been communicating with them on that all along and they’re hearing that from other suppliers around the world.”

Hedgeye: We know that Wal-Mart is consolidating vendors and changing up its mix. HBI did well with WMT last year – though it got a mini shot in the arm with Carter’s down and out. Will it be using its cost cuts to gain more share at WMT?



  • “I think consumers, especially at the mass-market, are a little more sensitive to price – elasticity in price movement. But there’s definitely room. If I look at the way the pricing has gone in the past, I mean, you can buy, in certain cases, nine pairs of underwear in a bag. Do you need nine pairs for a week or do you need seven pairs for the week? So there’s ways to keep price points down at retail by reducing the assortments and other things, let’s say, for example that could mitigate the price increases. And that’s – we work through with the retailers.”
  • We have strong sell-through from retailers in the men’s and boys’ socks categories in the quarter
  • I mean, the cost in Asia has skyrocketed. I mean, T-shirt prices in Asia have gone up over $9 a dozen since last year this time. They’re just not competitive. The pricing out of China, in all categories not just our basic T-shirt category, but every – across the board everywhere are up anywhere between 15% and 25%. So what’s happening is that retailers are scrambling in general the find product. And I think it’s going to play well for people that are producing in this hemisphere, ourselves and the industry at large, to capitalize on what we think is going to be a big shift in terms of where people looking to manufacture and source their products. We have a lot of inquiries from people that are calling us now looking for product

Hedgeye: Interestingly, the perennially bullish GIL management team has one of the more lucid opinions on the retail environment. That said they are the only company we’ve heard call for a “soft landing” in cotton prices.




MPEL beats and provides a positive Q1 outlook.  The reasons they missed our Street high estimate are not exactly negative.



You wouldn’t know it by the stock price but this should’ve been a good day for MPEL’s stock.  They beat the Street for the second straight quarter (a big deal for the gang that couldn’t shoot straight since the IPO).  More importantly, Q1 is trending above Street estimates and direct play appears to be growing as a percent of VIP which should be good for margins.  Numbers look like they are going higher, again.  Unfortunately, the stock market, and particularly gaming stocks, are not cooperating.


MPEL reported net of $774MM and Adjusted EBITDA of $134MM. Net revenues were in-line with our estimate while Adjusted EBITDA was 6% light - but still above consensus.  The $9MM EBITDA underperformance vs. our estimate can be attributed to higher corporate expense and higher direct play (vs. our estimate) at CoD.  Corporate expense was $3MM higher than our estimate due to a higher bonus accrual; the run rate should be lower.  We overestimated the VIP win percentage which appeared higher per our monthly data but in reality wasn’t because direct play was higher.  Going forward, higher direct play should help margins as player rebates are on average 30bps lower than junket commission rates.


City of Dreams


CoD net revenues of $489MM and adjusted EBITDA of $98MM were 3% and 12% below our estimates, respectively.  Net casino revenues were $27MM below our estimate, primarily due to VIP revenues

  • Direct play at CoD was 19% in 4Q210 vs. our estimate of 15% (3Q10 was 13%) resulting in RC volume that was 5% higher than our estimate, or a 66% YoY increase. 
  • VIP net revenues were $447MM, $13MM lower than we estimated
  • The combination of lower reported net revenues and higher RC volumes resulted in us overestimating hold percentage by 20bps, resulted in a net revenue miss of $20MM vs. our original projection and an EBITDA impact of roughly $3.5MM
  • Mass revenue of $126MM was $1MM below our estimate.  Table volume was a bit light of our estimate while hold was better
  • Slot win of $30MM was 6MM below our estimate due to lower slot handle and lower win percentage

Net non-gaming revenues were $12MM above our estimate, driven by House of Dancing Water, better RevPAR and lower promotional expenses.  We believe that fixed expenses increased to $69MM at CoD compared to our estimate of $60MM and $55MM in 3Q2010.

  • The company says this is because of the incremental cost of the HODW show – but you would think this would be accounted for in non-gaming expenses.
  • However, the above statement doesn’t jive with the show being breakeven on its own- in which event you would have margins decrease in net non-gaming revenues, not an increase – so we assume that a lot of the costs did get captured in our fixed expense estimate.  Looks like the show added about $8MM of incremental fixed expenses



Altira net revenues of $245MM and adjusted EBITDA of $46MM were 1% and 17% above our estimates, respectively.

  • Gross VIP revenues were $8MM better than our estimate driven by hold that was 10bps above our estimate.  Direct VIP was negligible.
  • Mass table win was $3MM lower than our estimate due to weaker than estimated hold.  Drop increased 98% YoY.
  • We estimate that fixed costs were $18MM compared to our estimate of $21MM and our prior quarter estimate of $15MM

Other stuff:

  • Mocha slots revenues were $2MM above our estimate while EBITDA was $1MM better

Risk Monitor: European Bank Swaps Mixed

Position: Long Sweden (EWD); Short Euro (FXE)


Below we include a portion of a product offering from our Financials’ team, the Weekly Risk Monitor for Financials that tracks CDS across global banks. The table below covers major banks throughout Europe and the trend week-over-week was mixed, tightening for 23 of the 39 reference entities, widening for 15, and flat for 1.


Risk Monitor: European Bank Swaps Mixed - sw1

Risk Monitor: European Bank Swaps Mixed - sw2


Our attention remains acutely on the health of each of the PIIGS due to their volatility and contagion effect across the continent. We have particular focus on Spanish banks given their recent widening, and high foreign exposures (4x higher than to Greek banks, or $989.8 Billion), according to the latest data from the Bank of International Settlements.


The European credit markets continue to be an important indicator of risk for us. As the chart of 10YR government bond yields below presents (and in sharp contrast to the outperformance of the equity market of the PIIGS year-to-date) yields continue to trend higher, a reflection of the risk premium to own the debt and deficit imbalances of these nations.


Risk Monitor: European Bank Swaps Mixed - sw55


We remain long Sweden (EWD) and short the Euro (FXE) in the Hedgeye Portfolio with the EUR-USD trading in a range of $1.34-$1.37. From a fundamental standpoint, we continue to like countries like Sweden and Germany that demonstrate fiscal discipline, political stability, and a healthy growth profile for this year and next.


Matthew Hedrick


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.



Conclusion: Knapp Track comparable restaurant sales in January indicate that the casual dining recovery has resumed.  Importantly, Knapp underlines value as a factor that will continue to be important.  As commodity pressure flows through to the P&L, concepts that lack pricing power will likely suffer as the 2011 scenario plays out.


Knapp Track preliminary results for January suggest that the casual dining recovery seen in the third quarter has recommenced in January.  January comparable restaurant sales of +0.6% signifies a sequential uptick in two-year average trends of 115 basis points.  Adjusting for bad weather, January’s number would have been +2.3%, which would imply a 150 basis point increase in two-year average trends (also adjusting December per the adjustment provided in last month’s Knapp Track report), excluding weather.  Q410 saw a sequential slowdown in comparable restaurant sales to +0.6% from +0.8% in 3Q10.  On a two-year average basis, however, quarterly comparable restaurant sales trends accelerated by more than 90 basis points sequentially.


Comparable guest counts in the casual dining space saw a sequential gain from a revised -1.8% result in December, according to the most recent Knapp Track report.  January’s preliminary decline of -1.5% shows that the “recovery” is far from secure, especially as companies look to pare back their use of discounting as a driver of traffic as commodity inflation accelerates.  On a two-year basis, January’s result implies a sequential acceleration of 100 basis points.


In this month’s report, Malcolm Knapp highlighted several interesting factors that he believes are critical to consumer behavior.  Firstly, the effects of the financial crisis persist with mortgage defaults and high levels of unemployment burdening attitudes.  Another interesting point he makes is that value (quality of the value proposition and the efficacy of the messaging) remains a key driver of traffic.  Value is relative.  The casual dining brands that can “take the pain” and absorb commodity cost increases, either by further margin gains in other areas of the P&L or by prudent hedging, will likely outperform those that have to implement price gains that make their service less affordable.



Howard Penney

Managing Director


The Macau Metro Monitor, February 22, 2011



A group of Macau casinos, excluding Sands China, have sent a fax to the Legislative Assembly requesting a meeting with the standing committee discussing the government’s law proposal on a ban on smoking.  The operators are "deeply concerned" with the “contradictory” statements made by the government after the second draft law was released and believe one year is too short to create a non-smoking zone for up to 50% of the total area.


Sands China was left out of the discussion because it was still discussing the issue internally and had not been informed the fax would be sent to the Legislative Assembly.


According to the S'pore Ministry of Manpower (MOM), building firms can expect to pay an average of $320 more a month for every Work Permit holder between now and July 2013.  Companies in service sector will pay an average increase of $260 monthly for each Work Permit holder, while those in manufacturing will fork out $130 more.  However, all employers of S-Pass holders can expect to pay an average of $240 more per month for each of these workers over the same period.


Firms in services and construction where 'the scope for productivity improvements is greatest' will see higher levy rate hikes and tighter levy tiers, Finance Minister Tharman Shanmugaratnam had noted in his Budget speech.



Jan CPI rose by 4.92% YoY and 0.93% MoM.  Among the different sections, notable increase  was observed in the price index of Miscellaneous Goods & Services (+9.21%), Clothing & Footwear (+6.86%), Transport (+6.71%), Food & Non-Alcoholic Beverages (+6.13%) and Health (+5.75%), which was caused by higher charges for meals bought away from home, hairdressing and grooming services, and outbound package tours, dearer prices of clothing and footwear, airfare and general food items near the Lunar New year, as well as rising prices of gasoline and LP-gas.


Total labor force was 331,000 in 4Q, comprising 322,000 employed and 8,900 unemployed. Compared with 3Q, total labor force and number of the employed increased by 1,300 and 1,700 respectively, while number of the unemployed decreased by 500.  The majority of the employed were engaging in Recreational, Cultural, Gaming & Other Services (24.1%)



A real estate company has purchased a 100,000 square meter land parcel in Henguin's new area, the city’s biggest land parcel designated exclusively for a $3 billion yuan, 5‐start hotel apart from Ocean Spring Resort.


Another consensus beating quarter from MPEL and Q1 looks like it is off to a very good start.


"We are pleased to report another solid quarter of operating results, driven by continued improvements in the fundamentals of our business. Our fourth quarter results demonstrate our success in driving operating leverage and in improving the profitability of our portfolio of asset. Our mass market table games business continues to grow and has set a new company record for table drop and gross gaming revenue... Similarly, our rolling chip segment remains strong with gaming volume in the fourth quarter of 2010 setting a new company record. We look forward to the continued success of this ground-breaking show, as well as the opening of additional guest amenities in 2011."

- Mr. Lawrence Ho, Co-Chairman and Chief Executive Officer of Melco Crown Entertainment



  • City of Dreams:
    • Net Revenue of $489MM and Adjusted EBITDA of $98MM (vs. our estimate of $111MM)
  • Altira:
    • Net Revenue of $245MM and Adjusted EBITDA of $46MM (vs. our estimate of $39MM)
  • Mocha Slots:
    • Net Revenue of $31MM and Adjusted EBITDA of $9MM (vs. our estimate of $8MM)


  • Cost control and operating efficiencies are the key focuses for 2011 as they transition from a development to an operating company. They did raise their labor rates though.
  • First quarter results are off to a strong start - with volumes and visitations well ahead of last year. 5 biggest days of the company's history were recorded this year.
  • House of Dancing Water continues to sell out and draw visitation - which had a positive impact on occupancy, play levels, and F&B
  • Grand Hyatt is now reaching higher occupancies - with 85% and December surpassing 93%
  • Continue to have a favorable outlook from additional supply on Cotai. 
  • Consolidated EBITDA would have been $125MM if hold was 2.85%. 
  • They are comfortably in compliance with their 4.5x leverage test
  • Interest coverage: 2.5x
  • Expect to continue to reduce their debt balances from amortization and cash flow
  • 1Q2011 guidance:
    • D&A: $85MM
    • Corporate: $17-18MM
    • Net interest expense: $28-29MM
    • No meaningful capitalized interest or pre-opening expenses


  • Likelihood of a partial smoking ban passing in Macau?
    • It would have an impact on revenues but they believe that the government will be receptive to hear their thoughts on implementation of a smoking ban
  • Have been surprised how strong volumes have held up post CNY.
  • Credit levels are quite healthy at current levels
  • House of Dancing Water has been performing very well on a stand alone basis - breakeven on a stand alone basis but with positive ripple effects on the rest of the business
  • No major developments on Taiwan gaming since the last call
  • Maintenance Capex for 2011? $60MM of total capex - the majority of which is growth rather than maintenance though
  • Ramp of direct play in 4Q vs. 3Q?
    • Direct play grew the business by 50% in the quarter at CoD
      • was between 15-20%
    • We saw 19% direct play in the quarter at CoD compared to 13% in the 3Q2010 and our estimate of 15%, which was part of the reason why EBITDA was lower than our projection. Hold percentage was therefore lower than we thought.
  • VIP/ Mass table splits:
    • Altira: 180 VIP tables, 30 Mass
    • CoD: 170 VIP tables, 240 Mass
  • Continuing to find more operating leverage throughout the organization.  Have ramped up amenities nicely at CoD. Continue to ramp up the Mass and Direct play business.
  • Didn't see any changes in rebate rates over the last few months
  • Haven't seen any need to change their bad debt provisioning policy, feel adequately reserved given their volumes
  • Thinks that the Chinese government measures are meant to cool the economy to prevent overheating.  Government wants to increase tourism. They are not concerned about the tightening measures which they believe will ensure steady growth.
  • Is the $115MM shareholder loan still outstanding? Any plans to repay it this quarter?
    • if they pay back the loan, it will be part of optimizing their capital structure - which they are looking at doing this year
  • Are they capital constrained currently?
    • Depends on new opportunities that present themselves - their current bank facility is more of a heavily amortizing project loan
  • Had about $35MM of scheduled amortization payments in the quarter and another $70MM of prepayments from cash flow generations. 
  • Future prospects in Japan?
    • Japan and Taiwan are two jurisdictions that they have done a lot of work on and have an interest in.  There is more consensus between the two leading parties in Japan than there has been in the past but sees it as more of a 2012 event.
  • Cotai Pact re: commissions with Galaxy. 
    • Started discussions a few months ago which have been positive. Think that the new neighbor will be happy to join the pact.
  • Altira - What is driving the growth in Mass revenues at the property?
    • Increasing membership in their database and visitation.  They did a lot of direct marketing and customer realignment between premium mass and regular mass play.
    • Corporate reorganization last summer also helped results in terms of marketing to their player base
  • Costs at CoD for 2011 - is 4Q a good run rate?
    • Plan is to be as efficient as possible but they will be impacted by labor rate increases and new amenity costs. Net net they think that costs will be controlled
  • Third tower at CoD? Are they gearing towards serviced apartments of more hotel rooms?  Is there future growth beyond CoD and Altira?
    • With hotel occupancy hitting north of 80% levels, they are in preliminary stages of dusting off those plans. That additional tower is a 1.5MM sq ft development  - which would  be a large addition to the property.  It would also likely involve additional gaming and retail capacity.
    • More likely than not it would be a hotel, not that enthusiastic about apartment hotels at the moment but will monitor the situation
    • As far as new properties - they still have a management contract on Macau Studio City and hope to eventually start that project
  • Cubic opening? They are in the final stages of government approval. Still looking at an end of 1Q early 2Q opening. Should be the best nightclub in Macau.
  • Opened 2 new junket rooms at CoD 
  • Hard Rock Cafe should open in Sept or 4Q2011

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