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R3: ANF, China vs. CAFTA, HOTT, HIBB, BKS

 

R3: REQUIRED RETAIL READING

March 29, 2011

 

 

 

 

RESEARCH ANECDOTES

  • The belief that ‘any press is good press’ is just not reality – case in point, ANF’s new “Ashley” bikini…a padded top for girls starting at age 7. In fact, after releasing the product on its Abercrombie Kids website over the weekend, the company removed “push-up” from its description. No stranger to controversial marketing tactics including the infamous Quarterly, which reappeared briefly last year, the company has taken its edginess down from 20s, to teens, and now to 7-year olds. 
  • Add Hot Topic to the growing list of companies that will no longer report monthly sales. Among additional changes at the corporate level, the company’s CEO Lisa Harper has taken over primary merchandising responsibilities. While reflecting on the turnaround underway relative to her experience at Gymboree, Harper highlighted the task ahead is less structural a la GYMB and more about merchandising, planning, and product with a clear focus on turnover.
  • Texas-based sporting goods retailer Academy Sports will be celebrating the grand opening of its first store in the state of Georgia with a 70,000 sq. ft. store in Atlanta this Friday, April 1st. While Hibbett Sports may prefer the date to have greater meaning, the reality is Academy has become a better competitor in recent years compared to its historical position as the industry’s low-cost player. With both DKS and HIBB both focused on expanding westward, Academy’s latest move may stifle the company’s progress as it looks to secure its core markets.

OUR TAKE ON OVERNIGHT NEWS

 

Cotton Prices Expected to Fall in 2011 - Cotton prices are expected to plunge 51% to $1 a pound by Dec. 31, according to the median in a Bloomberg survey of 14 analysts and traders. Farmers around the world are planting more cotton to profit from high prices. Cotton rose to $2.197 on March 7, the highest in 140 years of trading in New York, after flooding in Australia and Pakistan and freezes in China ruined crops. The U.S. Department of Agriculture estimates that cotton crop output may rise 11% next year (beginning August 1), compared with a 3% gain this year. Analysts are predicting that production will increase from most of the world’s major cotton producers this year, and that the U.S. will plant more than 13 million acres of cotton this season, up from 11 million acres last year.Hedge funds are already cutting bets on higher prices by the most in three years, the report indicated.<SportsOneSource>

Hedgeye Retail’s Take: As Manny Chirico of PVH noted this morning, brand manufacturers are only seeing spot rates starting to come down, but there has not been any buying actually taking place just yet. Weighted average cost could, and should, go up even as cotton retreats. Best case, we think that a better planting cycle helps 2013. Do you want to invest based on 2013 numbers? Didn’t think so…

  

Chinese Industry Slammed by Rising Costs - Higher labor and materials costs, and the maturing of its economy have pummeled the Chinese apparel and textile production industry in recent months, leading to mass factory closures, cost control measures and a certainty of higher prices to come for customers. Factories across the manufacturing zone in the Pearl River Delta and on the eastern seaboard have reported cutbacks and closings in the past six months, largely due to soaring cotton prices and the increased salary and benefit demands to attract workers. Factory bosses now say they expect a streamlined, more efficient and higher-end production chain to emerge, but the transition period will be difficult. In short, big changes lie ahead for the world’s largest maker and exporter of apparel.<WWD>

Hedgeye Retail’s Take: Consistent with what we heard out of Li-Ning last week suggesting labor cost increases of +10%-15% are not a near-term aberration, but rather a trend that will continue ‘in coming years.’

 

Central America Warming Up to CAFTAIn the five years since the Central American Free Trade Agreement was implemented, U.S. and European apparel brands and retailers have faced sourcing challenges but are now said to be looking to increase business in the region. While the recession hit Central America hard and led to a decrease in U.S. apparel import volume in 2009 and created an uncertain business climate for the seven CAFTA countries, trade has begun to bounce back in the past year and companies are now exploring new investment opportunities. Central America’s apparel and textile industry could attract significant apparel investment by 2015 as U.S. and European brands shift activities to offset deepening sourcing woes in Asia, industry experts said. <WWD>

Hedgeye Retail’s Take: There has been a clear shift in focus by many retailers that have started to look beyond China to both Central and South America as alternative export markets. Increased labor rates have closed the gap and with transportation costs also starting to weigh on margins, proximity matters. VF has had a clear relative advantage here in recent quarters as one of the few brand manufacturers with Mexican-based production. The problem is that capacity in Asia vs. Central America is 20 to 1.

 

Borders Liquidators Squeeze Cash From Doomed Stores - At the Borders Group Inc. store on Broadway near Wall Street, box sets of Stieg Larsson’s best- selling “Millennium” trilogy, including the “The Girl With the Dragon Tattoo,” sat on a table near the door last week on sale for $69.39 -- a liquidation markdown of 30 percent. The set costs half as much on Amazon.com Inc. (AMZN)’s website, where it was listed for $34.58 -- with free shipping. Amazon’s Kindle e-book editions were even less, priced at $27.97. At Wal-Mart Stores Inc.’s website, the three books sold for $34.96. Borders, the second-largest U.S. bookstore chain after Barnes & Noble Inc. (BKS), filed for bankruptcy last month after management shuffles, firings and debt restructuring failed to combat falling book sales and competition from Amazon and Wal-Mart. It pledged to shutter about a third of its stores. <Bloomberg>

Hedgeye Retail’s Take: Creditors have recently rallied for BGP, but the downward thrust of this business has it heading inevitably South.

 

Carven Opens First Store Having in four seasons resuscitated dormant French fashion house Carven, designer Guillaume Henry now holds the keys to the brand’s first women’s wear store under his tenure, at 36 Rue Saint Sulpice on the Left Bank here. Its doors open today.  The boutique, once the spot of a 19th-century brothel, has had numerous lives before becoming a Carven store. “I stumbled across this boutique by chance and thought, this is perfectly situated in the heart of Saint Germain and opposite the Saint Sulpice church,” said Henry. Eric Chevallier — who is also responsible for visual merchandising at Paris’ concept store Colette — was called in to design the Carven space. “I wanted to use all the codes that are emblematic of Paris daily life,” he explained, while standing with Henry in the pristine, home-like 800-square-foot store.  <WWD>

Hedgeye Retail’s Take: Best known stateside as one of the featured brands at Barneys’ stores this season, selling the brand’s fragrance license last year was probably the right move in hindsight enabling management to focus on continuing to build brand momentum.

 

EU Law Could Choke E-Commerce Startups - It's an old story in Europe: ham-fisted regulation stunting growth and innovation. This time it's new legislation that could affect the e-commerce industry. A proposed EU directive will  change online return policies, which could end up hurting ecommerce startups. The bill is not yet final, with many more steps before eventual passage in June, but here's where it stands today: Customers would get 14 days, instead of 7 days currently in most European countries, to return goods, with a further 14 days to send them back. Crucially, the merchant would have to give customers a full refund even before receiving the goods to ensure they're not damaged.  For any order over 40 euros, the merchant would have to offer free returns. Merchants would have to offer shipping and free returns across all European countries. The law would hammer e-commerce startups' margins and raise prices. <BusinessInsider>

Hedgeye Retail’s Take: Clearly an effort to maintain the highly fragmented nature of European markets – this regulation would debilitate retailer’s profitability in the e-commerce channel. In addition to the swallowing the shipping cost – a factor many domestic retailers are coping with – the full refund before receipt policy would require added staff and costs to recover returns that been damaged or used in the process.

 

 


THE CONSUMER'S WAR OF ATTRITION

The Sisyphean fight that is Bernanke’s refusal to acknowledge reality is becoming more and more apparent to the consumer.

 

The other day, Darden reported softer than expected top line numbers, especially at the Olive Garden.  While management noted some issues with promotional offerings that did not resonate with the consumer, the underlying trends for the consumer are not as healthy as they were in 4Q10.  Clarence Otis, CEO of Darden restaurant said that higher gas prices “serve as a tax” on the consumer and that it had a “dampening effect on sales trends in February.”   Is does not look like the policies in Washington are going to change and the war of attrition consumers are facing looks to be continuing for some time to come..

 

The strong earnings season, positive conflicted government data, and it’s looking more and more like a Bernanke recovery and not a consumer recovery.  The fourth quarter of 2010, many have said, confirmed that a consumer recovery was in the bank.  Consumer data emerging in 1Q11 is now calling that view into question.

 

The expectation that the consumer will lead this recovery from start to finish is unreasonable.  the support mechanism are not there.  Yesterday the government reported that excluding the effects of changes in tax payments and Social Security contributions, disposable income would have risen 0.3% in February and 0.2% in January rather than the 0.3% and 0.8% reported.  Consumer prices, as measured by the consumer spending deflator, rose 0.4%, the fastest growth since June 2009.  Inflation rising, house price depreciating, and the looming prospect of interest rates increasing are factors that do not point to the consumer staying rock-solid throughout this process.

 

The consumer has no purchasing power on an inflation-adjusted basis and, when excluding transfer payments, the outlook is very negative.  At best, we can expect consumer spending to remain at its current level, but that would imply no meaningful increase in the savings rate or balance sheet repair.  Regulators are also proposing a draft definition of a “qualified residential mortgage” that could, when finalized, preclude all but the most conservative mortgages from being defined as “qualified residential mortgages”.  Under the proposed rule, among other stringent conditions, buyers seeking a mortgage to buy a home will be required to put down at least 20%.  As our Financials Team wrote this morning, the current version of the definition is expected to be a headwind to the housing market.  The current downward slide in home prices and the prospect of a new era of sky-high down payments is disconcerting to say the least. 

 

Not surprisingly, the Conference Board reported today that consumer confidence fell significantly in March; reaching a three year high in February.  As we have been highlighting in the past few consumer posts, the expectations component is largely driving the overall index and was again instrumental in March as it fell to 81.1 from 97.5 (previously 95.1); the present situation component rose to 36.9 from 33.8 (previously 33.4).  Overall, confidence fell to 63.4 from 72 (revised from 70.4).

 

As Keith alluded to in this morning’s Early Look, inflation is not a positive sign for a market experiencing 30-year highs in corporate margins.  The consumer’s margins certainly aren’t at peak levels and the pain is coming through in the numbers.

 

THE CONSUMER'S WAR OF ATTRITION   - conconfmarch11

 

THE CONSUMER'S WAR OF ATTRITION   - conconfexpmarch11

 

THE CONSUMER'S WAR OF ATTRITION   - conconfpresmarch11

 

Howard Penney

Managing Director

 


BERNANKE – PEEING INTO THE WIND

The Sisyphean fight that is Bernanke’s refusal to acknowledge reality is becoming more and more apparent to the consumer.

 

The strong earnings season, positive conflicted government data, and it’s looking more and more like a Bernanke recovery and not a consumer recovery. The fourth quarter of 2010, many have said, confirmed that a consumer recovery was in the bank.  Consumer data emerging in 1Q11 is now calling that view into question.

 

The expectation that the consumer will lead this recovery from start to finish is unreasonable.  the support mechanism are not there.  Yesterday the government reported that excluding the effects of changes in tax payments and Social Security contributions, disposable income would have risen 0.3% in February and 0.2% in January rather than the 0.3% and 0.8% reported.  Consumer prices, as measured by the consumer spending deflator, rose 0.4%, the fastest growth since June 2009.  Inflation rising, house price depreciating, and the looming prospect of interest rates increasing are factors that do not point to the consumer staying rock-solid throughout this process.

 

The consumer has no purchasing power on an inflation-adjusted basis and, when excluding transfer payments, the outlook is very negative.  At best, we can expect consumer spending to remain at its current level, but that would imply no meaningful increase in the savings rate or balance sheet repair.

 

Regulators are also proposing a draft definition of a “qualified residential mortgage” that could, when finalized, preclude all but the most conservative mortgages from being defined as “qualified residential mortgages”.  Under the proposed rule, among other stringent conditions, buyers seeking a mortgage to buy a home will be required to put down at least 20%.  As our Financials Team wrote this morning, the current version of the definition is expected to be a headwind to the housing market.  The current downward slide in home prices and the prospect of a new era of sky-high down payments is disconcerting to say the least. 

 

Not surprisingly, the Conference Board reported today that consumer confidence fell significantly in March; reaching a three year high in February.  As we have been highlighting in the past few consumer posts, the expectations component is largely driving the overall index and was again instrumental in March as it fell to 81.1 from 97.5 (previously 95.1); the present situation component rose to 36.9 from 33.8 (previously 33.4).  Overall, confidence fell to 63.4 from 72 (revised from 70.4).

 

As Keith alluded to in this morning’s Early Look, inflation is not a positive sign for a market experiencing 30-year highs in corporate margins.  The consumer’s margins certainly aren’t at peak levels and the pain is coming through in the numbers.

 

Howard Penney

Managing Director

 

BERNANKE – PEEING INTO THE WIND - conconfmarch11

 

BERNANKE – PEEING INTO THE WIND - conconfexpmarch11

 

BERNANKE – PEEING INTO THE WIND - conconfpresmarch11


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COSI - HEADED TO PROFITABILITY

The reported 4Q10 results and management’s comments from the conference call were all very positive for the company:

  1. The quarter ended with 10 months of positive same-store sales (and continues into 1Q11 with positive comps in January and February)
  2. The same-store sales trends in 1Q11 suggest that the company’s two-year average numbers are now positive in March.
  3. Restaurant-level cash flow in 4Q10 grew to $1.84 million from $1.72 million, up 7%.  Margin improved YoY for the second consecutive quarter, up nearly 130 bps.

The company has implemented a number of sales drivers, the most important of which, is online ordering.  During the past quarter, the company rolled out online pick-up to all of its company stores.  The company commented that they are seeing steady progress and adoption by consumers. 

 

Over the next couple of months the company is going to step up the communication and marketing of online ordering, which should drive significant incremental sales volumes.  Due to the urban proximity of the company-operated restaurants, the goal would be to drive an incremental 50 to 100 transactions per restaurant per day.  We estimate that this could add 20%+ to company store sales volumes.

 

Additionally, catering appears to be gaining significant traction.  In 2010, management made an investment behind catering to help them reach new clients and encourage increased frequency.  In late 1Q11, COSI launched a separate loyalty card program specifically for catering.  Catering sales trends in NYC have been so strong that the company added another sales person in that market to reach new customers. 

 

In 2010, the company made significant progress in reducing the company’s cost structure, which should lead to positive net income in 2011.  If the current trends continue, it looks like 2Q11 will be the magical quarter.  One thing to keep in mind is that with 51 million shares outstanding, the company needs to earn about $500,000 to report a $0.01 per share profit. 

 

 

COSI - HEADED TO PROFITABILITY - cosi comps

 

Howard Penney

Managing Director


LIZ: Positive Delta

 

LIZ’ guidance update provides us with a few nuggets on the state of business through February. There are puts and takes, but for a company that has only dished out disappointing news, this is somewhat of a positive. We still think that LIZ continues to have one of the most positive asymmetric risk profiles in  retail.  

 

In looking through the details of the release, the reality is that with the company maintaining its 2011 EBITDA outlook there is little to dissect here beyond the current sales performance within the company’s Direct Brands. As you can see in the chart below tracking comp trajectory by brand, sales have improved sequentially at both Mexx Europe and Lucky following disappointing December results, Juicy has picked up as well after decelerating in January and Kate Spade remains off the charts with comps up 90% YTD. These trends are consistent with an acceleration in the 2-year comps as well. Mexx Canada is the only negative callout with sales decelerating on the margin in February. As a reminder, while Fx is expected to provide a modest tailwind for Mexx in Q1, it provided a positive benefit of more than 6% last year suggesting that underlying sales are indeed improving. Overall, sales in the Direct Brands appear to be coming in slightly better than expected.

 

As it relates to Q1, the company also provided initial EBITDA guidance that suggests profitability is coming in lighter than the consensus (though LIZ did not offer any guidance before hand). The implied EBIT guidance suggests a loss of $57mm-to-$52mm compared to our estimate of a $29mm equating to EPS of (-$0.53-$0.57) vs. our (-$0.34E) and the Street at (-$0.27E) assuming a 25% tax rate. While likely due to a combination of both gross margin contraction as a result of both inventory clearance and inability to leverage SG&A, we expect the former to improve with stronger sales over the balance of the year and an update on the later at the analyst day in April.

 

It’s also worth noting the timing of the analyst day which was moved from the original date of March 31st. The sole reason for moving back the analyst day is due to management’s roadshow associated with the proposed offering of $200mm senior secured notes – the proceeds of which will be used to refinance the 5% Euro notes due July 2013 providing added flexibility.

 

Net/net, this is not a name without hair – the 1H was and continues to be one that is expected to be a choppy; however, with the full-year EBITDA outlook unchanged and sales trends improving on the margin, we view the announcement as a slight net positive for LIZ.

 

LIZ: Positive Delta - LIZ Comp Traj 3 11

 

Casey Flavin

Director


TALES OF THE TAPE: COSI, SBUX, BJRI, DPZ, THI, JACK, PNRA, BKC, WEN, YUM, DRI

Notable news items and price action from the past twenty four hours.

  • COSI reported strong sales trends for 4Q10 and continues performance into the current quarter.
  • SBUX, BJRI, DPZ, THI and JACK are speaking at the JP Morgan conference.
  • PNRA was downgraded to neutral from buy at SunTrust Robinson Humphrey
  • BKC co-chairman of the board, John W. Chidsey, will resign next month.
  • WEN plans to offer a super-foods-based salad this summer containing blueberries, strawberries, almonds and a dressing made with açaí juice.
  • KFC have unveiled a bun-less burger known as the double in New Zealand.  According to The Age, it has double the chicken, double the bacon, double the cheese, and doubles your risk of a coronary.
  • DRI recovered nicely yesterday after trading poorly in light of earnings last Thursday after the close and Friday’s cautious commentary from management during the earnings call on Friday.

TALES OF THE TAPE: COSI, SBUX, BJRI, DPZ, THI, JACK, PNRA, BKC, WEN, YUM, DRI - stocks 329

 

Howard Penney

Managing Director


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