Overall, there’s probably not many analysts/PMs out there who are short/underweight Retail that are not scratching their heads wondering what they’re missing, and why today’s sales are so strong. If they’re not asking that, then they’re being intellectually dishonest.
We’ve spent the past few hours debating, crunching, and thinking about what all this means. And at the end of the day, we’re sticking to our guns that retail will roll meaningfully in 2H (actually, with margin pressure becoming apparent in June).
Yes, there was definitely an overwhelmingly high number of beats relative to expectations. But there’s a lot of factors at play…
1) Sample size: Let’s not forget that over the past year, the number of companies represented in the sample went from 33 to 23 – and because one of those companies is Wal-Mart, we’ve seen $260bn in revenue go silent. Look at it this way, we have a $14 trillion economy with a 73% consumption rate – so about $10.2 trillion in PCE. Wal-Mart’s US sales account for about 2.6% of that. Better yet, WMT accounts for 7.1% of all dollars deployed at retail in the US.
2) Target didn’t exactly knock the cover off the ball. It beat expectations by 90bps, but still printed a (-5.5%) comp, as strength in consumables and Home was offset by weakness in/mix shift away from apparel and footwear.
3) COST continues to confirm our view on inflation with both fresh foods and food and sundries still up in the LSD range while meat and produce increased reflecting MSD inflation. In addition, gas contributed +3% and +7.5% to SSS for both COST and BJ respectively. Our view is that while this won’t be the first or second crack in the retail industry’s margin equation, it will add to the pain as the retailers choose to capture consumables inflation costs at the expense of discretionary product margins. (i.e can’t take up price on milk, eggs, and chicken – so look to extract margin in categories like underwear, shirts, toys, etc…).
4) There’s no doubt that higher-end products and brands are outperforming. Not a shocker. JCP -0.3, Macy’s +0.9%, Nordstrom +5.1%, and Saks +11.1%. This is definitely a positive for Ralph, and to a lesser extent Guess and PVH.
5) Mesh that with another major undisputable fact…after drawing working capital down to the lowest level in the history of modern day retail, we need to start to see inventory flow into – and then out of – the system in order to allow any of these companies to grow sales. I don’t think anyone would dispute that Gross Margin variability is headed higher – but companies won’t talk about that when their most important month of the quarter is left to go. While this will be more of an issue in 2H, it is likely to be a factor this quarter as well.
So now what?
We’ve got another month of meaningful acceleration in sales. Who’s going to short retail after we saw a seemingly inexplainably strong March, and should see a better than 1,000bp ramp in April? Well… I might. But then in May we get the deceleration and it is on product that has a higher cost embedded in the margin. Then a month later the consumer runs out of QE2 support. Our financials analyst, Josh Steiner, noted this morning to clients how history shows that the end of any period of quantitative easing has put the brakes on improvement to the employment picture for an average of 5-6 months. We have no reason to think it will be different this time around.
That means that we either need wage improvement to drive income, which we’re not going to bank on.
That leaves us with two remaining levers to boost personal consumption – taxes and savings rate. Taxes are sitting at about 9.5% now, one of the lowest levels on record. Yes, that sounds so low, and most people reading this wish they could have this rate. But math is math. Even if you argue that the government understates the tax numbers (why not? They have no problem misrepresent other numbers – like the CPI ) at least give them the benefit of the doubt that they consistently misrepresent it. The latest trajectory is near trough, and it’s probably not going any lower.
If there’s one area where we think we could be wrong, it’s with the personal savings rate. It’s crept up to 5.6% from close to zero over the past few years, and this is a direct trade-off with consumption. Could the consumer draw down savings in 2H and be sitting there with no savings, but still be spending? Yes. We’re Americans. That’s what we do. But the savings rate came down over time as interest rates came down, which has obvious implications for purchasing power. With rates today sitting near zero, it scares me to think of what the consumer environment will be later this year if we’re right with our thesis, and the consumer draws down savings back towards zero while interest rates have nowhere to go but up.
I work in an office of hockey heads. But I think the scenario I just described is like ‘pulling the goalie.’
For all these reasons, I’m a seller into strength over the next two months. Favorites include LIZ, PSS, FL, ROST, RL. Least Favorites: WMT, TGT, CRI, JNY, JCP.
Additional SSS Callouts:
- The strongest performing categories were food/grocery (TGT, COST), women’s and men’s apparel (KSS, COST), and home (ROST, KSS, TGT). On the contrary, softness in footwear was highlighted by several retailers (KSS and TGT) given its sensitivity to the Easter shift.
- Weekly trends were consistently stronger throughout the month with the weakest results in week 5 due to the Easter shift. The one notable exception is COST, which realized a +1-2% benefit from the shift and extra day in March compared to the rest of companies that expect the tailwind in April.
- Given the importance of April to Q1 results, there were few changes to corporate Q1 outlooks with three exceptions: 1) Macy’s, which increased its April comp outlook following stronger than expected March sales and a tailwind of both shift and a planned cosmetics promotion; 2) ROST, which expects to come in ‘somewhat above’ initial Q1 EPS guidance; and 3) Gap, which took Q1 EPS down by $0.04 to reflect events in Japan.
- COST continues to confirm our view on inflation with both fresh foods and food and sundries still up in the LSD range while meat and produce increased reflecting MSD inflation. In addition, gas contributed +3% and +7.5% to SSS for both COST and BJ respectively.
- JCP noted that inventories remain in-line with expected sales trends, though they did sneak in that they saw higher volume of clearance merchandise – suggesting possible margin pressure. They did comment, however, that the Liz Claiborne product is performing ‘exceptionally well.’
- Consistent with recent results, ROST highlighted that pack-a-way still accounts for roughly 47% of total inventories while consolidated inventories increased 35% up from 27% in February. We continue to expect that higher pack-a-way to provide a margin benefit in the 2H.
- From a regional perspective, performance was strongest in the Southeast and SoCal (COST, BJ, KSS, TJX, TGT) and weakest in the Northeast (GPS, TGT, TJX).
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WYNN should report an all-around monster quarter. Vegas may be the biggest surprise.
What shouldn’t surprise investors is that we are 11% above the Street for Q1 Wynn Macau EBITDA. What may surprise is that we are high on the Street for Las Vegas EBITDA. A combination of strong hold and big volumes may have done the trick in Vegas.
We estimate that WYNN will report 1Q2011 net revenue of $1,230MM and EBITDA of $357MM; 8% and 17% ahead of Street estimates.
We project that Wynn & Encore Macau will report net revenue of $874MM and EBITDA of $292MM in 1Q2011, 4% and 11% ahead of Street, respectively
- We estimate gross and net gaming revenues of $1,056MM and $819MM, respectively
- VIP net win of $553MM
- Assuming direct play of 11%, Rolling Chip of $29.5BN (up 46% YoY and 7% sequentially) and hold of 2.7%
- Rebate rate of 80bps
- Mass table win of $191MM
- Table volume of $798MM and hold of 24%
- Slot win of $74MM
- Handle of $1.43BN and win% of 5.2%
- Non-gaming revenue, net of promotional expenses of $55MM
- Variable expenses of $462MM ($411MM of gaming taxes and $45MM of incremental junket commissions above the rebate)
- $26MM of recorded expenses for non-gaming revenues
- Fixed expenses of $94MM
WYNN Las Vegas
We estimate that Wynn Las Vegas will report $356MM of net revenues and $87MM of EBITDA, 6% and 18% above the Street, respectively.
- We estimate net casino revenues of $172MM
- Table win of $160MM; table drop up 20% YoY to $668MM and hold of 24%
- Slot win of $45MM; volume up 10% YoY to $742MM and 6% hold
- Discounts and other of 16% or $33MM
- $239MM of non casino revenue and $55MM of promotional expenses
- $53MM of SG&A and $5MM of doubtful accounts
- Corporate expense: $22MM
- D&A: $101MM
- Stock comp: $8MM
- Net Interest expense: $58MM
Conclusion: Simply put, the Ryan budget dramatically reduces the size of the federal government over the long run and thus reallocates capital back to the private sector, which could be incredible bullish for economic growth in the United States.
The current budget debate in Washington is amongst the most heated and partisan we’ve seen since the beginning of the Obama administration. On the conservative side of the equation is, of course, the Ryan budget, which was introduced two days ago by Representative Paul Ryan the Republican from Wisconsin. Philosophically, the basis of the budget is simple; it both reduces taxes and dramatically reduces the size of the government over ten years, with a focus on restructuring the cost of healthcare.
The Congressional Budget Office, at the request of Representative Ryan, presented their analysis of his budget yesterday. In the introductory section of the analysis, the CBO stated:
“To prevent debt from becoming unsupportable, policy makers will have to substantially restrain the growth of spending, raise revenues significantly above their historical share of GDP, or pursue some combination of those two approaches.”
In theory, the budget situation is actually that simple: either raise taxes or cut costs, or both. Politically, and practically of course, the solution is far from simple, but the outcome of the Ryan budget, albeit at the expense of restructuring healthcare, may provide some real long term economic advantages for the United States versus the fiscal status quo.
The key components of the Ryan budget are as follows:
- Healthcare – The Ryan budget would convert the current Medicare system to a system of premium support payments and would increase the age of eligibility of Medicare. On Medicaid, the federal share of Medicaid would be converted to block grants to the states, which would grow with population and CPI-U. The Ryan budget would repeal all components of the 2010 Patient Protection and Affordable Care Act (more commonly known as Obamacare). Finally, several limitations of punitive damages in medical malpractice would be implemented;
- Other spending – Under the Ryan budget, mandatory and discretionary spending, other than that for mandatory healthcare (outlined above) and social security, are cut from 12% of GDP in 2010 to 6% of GDP in 2022 (this is below pre-WW2 levels); and
- Revenue – Under the Ryan budget, federal government revenues grow from 15% of GDP in 2010 to 19% of GDP in 2028, and remain at that level thereafter. For comparative purposes the long run average of federal government revenue as a percentage of GDP from 1960 – 2011 is 17.6%. So, in essence tax receipts in Ryan’s proposed budget are slightly above the long run percentage of taxes as share of the U.S. economy and ~27% above current levels.
Unfortunately the CBO analysis didn’t offer a comparison of the Obama budget versus the Ryan budget, but they did offer a comparison of the Ryan Budget versus their Extended-Baseline Scenario (normal scenario) and Alternative Fiscal Scenario (draconian scenario). In the table below, we’ve also included the CBO’s most recent estimates of the Obama budget, albeit the ten year budget ends in 2021 and not 2022. The clear take away from the ten year budget comparison below is that the Ryan budget effectively outpaces both the federal government’s current fiscal path and the proposed Obama budget in reducing the budget deficit over the next decade.
The longer term fiscal benefits of the Ryan budget are even more compelling according to the CBO. By 2050, the federal government would be running a 4.25% budget surplus (as a percentage of GDP) under the Ryan plan versus -4% in the CBO’s normal scenario and -26% in the more draconian scenario.
In evaluating the long term benefits of the Ryan budget from an economic perspective, we think three key factors are most relevant, which are as follows:
Long term structural debt – The most thorough analysis of the impact of long term debt is This Time is Different by Carmen Reinhart and Kenneth Rogoff. The key take away from their analysis is that as sovereign debt balances accelerate and eventually reach the 90% debt-to-GDP level, which we have coined the Rubicon of Sovereign Debt, growth slows dramatically.
In fact, their analysis of 2,317 observations has a statistically significant 352 observations at, or above, 90% debt as a percentage of GDP. Collectively these observations show us that GDP growth averages at 1.7% beyond the Rubicon of Sovereign Debt, which is almost three standard deviations below the collective growth rates at lower debt levels. The Ryan budget by 2050 has debt-as-percentage of GDP at 10% according to the CBO, while the CBO’s baseline and draconian scenario take debt-as-percentage of GDP to 90% and 344%, respectively.
Declining government spending – For starters, government spending is a large percentage of GDP (between 29% and 35% in recent years), so, in theory, cutting government spending dramatically could be a drag on the economy. Further, and as the argument of Keynesians, higher levels of government spending or stimulus are required in periods of below average GDP growth.
To test the impact of declining government spending introduced by the Ryan budget, we analyzed real GDP change from 1960 to 2009, and year-over-year government spending changes in the same years. Interestingly, in the five years with the slowest year-over-year growth in government spending, GDP in those years grew on average 4.74%. Conversely, in the five years with the largest year-over-year change in government spending, GDP grew 1.10%. The average of real GDP growth over the entire period was 3.2%.
Now, admittedly, this is a somewhat simplistic analysis, which we will be refining further. A key pushback is obviously that as GDP growth slows, certain entitlements naturally kick in, and vice versa. Interestingly, if we look at one year out after the five most dramatic ramp ups in government spending, GDP growth does reaccelerate to 3.3% on average, which is just above the long run average. While this is encouraging for Keynesians no doubt, it is still somewhat anemic growth given easy comparables. So, while this analysis needs refinement, it does appear to lend credence to the idea that government spending does not have a comparable return to the same capital allocated to the private sector.
Long term low taxation levels - Under the Ryan budget, federal government revenues grow from 15% of GDP in 2010 to 19% of GDP in 2028, and remain at that level thereafter. For comparative purposes, the long run average of federal government revenue as a percentage of GDP from 1960 – 2011 is 17.6%. So, in essence, tax receipts in Ryan’s proposed budget are slightly above the long run percentage of taxes as share of the U.S. economy. While this may seem less conservative, in reality, it’s quite conservative when compared to the current alternatives. For example, by 2022 the CBO baseline estimate has government taxes at 21% of GDP, and President Obama’s budget has government revenues as a percentage of GDP at 19.3% by 2021, while Ryan has this statistic at 18.5% by 2022.
So, the long run debate continues, are lower taxes better or worse for the economic growth? We know where we stand on that, but if you don’t believe us, take the CBO’s word for it, which in their analysis of Representative Ryan’s budget wrote:
“To the extent that marginal tax rates on labor and capital income would be lower as a result, future output and income would be greater in the long term, all else being equal.”
To many, the Ryan budget is scary. It dramatically attacks the long term expenditures and structural deficits of the U.S. federal governments by cutting costs to unprecedented levels. The reality is, though, based on the fiscal history of the modern United States, this plan could be wildly bullish for the U.S. economy in the long run as it dramatically allocates capital away from the government and into private hands where it will potentially be much more efficiently allocated.
Daryl G. Jones
Initial Claims Fall 6k (10k net of revision)
The headline initial claims number fell 6k WoW to 382k (10k after a 4k upward revision to last week’s data). Rolling claims fell 6k to 389k. On a non-seasonally-adjusted basis, reported claims fell 4k WoW.
We have been looking for claims in the 375-400k range as the level that can begin to bring unemployment down. If this level is held, we expect to see unemployment improve. We consider unemployment to be ~200 bps higher than the headline rate due to decreases in the labor force participation rate. In other words, if the labor force participation rate were at the long-term average level of the last decade, unemployment rate would be 10.8% rather than 8.8%. So when we say that claims of 375-400k will start to bring down the unemployment rate, we are actually referring to the 10.8% actual rate.
Our healthcare team has done substantial work on unemployment by age, and we include one of their charts below. The bottom line is that most of the improvement in unemployment has gone to the 55-64 year old demographic and the 20-34 demographic, while the middle aged demographic has yet to see employment growth.
One of our astute clients pointed out the relationship between the S&P and initial claims shown below. We show the two series in the following chart, with initial claims inverted on the left axis.
Yield Curve Widens Slightly
We chart the 2-10 spread as a proxy for NIM. Thus far the spread in 1Q is tracking 35 bps wider than 4Q. The current level of 271 bps is slightly wider than last week (266 bps).
Financial Subsector Performance
The table below shows the stock performance of each Financial subsector over four durations. We have adjusted our durations to show a different snapshot than we were previously.
Joshua Steiner, CFA
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