prev

MCD – THAT’S THE THING ABOUT HIGH EXPECTATIONS

MCD reported 1Q results this morning and, while the initial glance was encouraging, the upward revision in the firm’s FY11 commodity inflation outlook is weighing heavily on the stock.

 

MCD is an impressive organization that creates value for its shareholders, jobs for the economy, and serves billions of people globally.  I have been bearish on the stock since December and released a Black Book to that effect in January.  While March comps in the U.S. exceeded my expectations, as well at consensus, concerns about margin sustainability – concurrent with a likely slowdown in comparable restaurant sales growth – are coming to the forefront. 

 

MCD reported global comparable restaurant sales growth of 3.6% for 1Q11.  The March numbers showed strength in the U.S. with comps coming in at +3.0% versus consensus at 1.7%.  MCD took a 1% price increase in early March and will likely take more this year.  Europe, in spite of austerity measures being implemented across the continent, saw comparable restaurant sales growth of 4.9% in March (consensus +3.2%) and 5.7% in the quarter.  The company also took a 1% price increase in the first quarter.  APMEA was slowed somewhat by the impact of the disaster in Japan as March comparable restaurant sales eked out a 0.5% gain year-over-year (+2.0% consensus), rounding out 3.2% growth for the first quarter. 

 

 MCD – THAT’S THE THING ABOUT HIGH EXPECTATIONS - MCD US

 

 MCD – THAT’S THE THING ABOUT HIGH EXPECTATIONS - MCD Europe

 

 MCD – THAT’S THE THING ABOUT HIGH EXPECTATIONS - MCD APMEA

 

 

While comps exceeded expectations, on aggregate, restaurant level margins declining for the first quarter since 1Q09 (prior to that it had been 3Q05!) was what generated the most attention.   With compares becoming more difficult as the summer progresses, gaining leverage over operating costs will be difficult.  In addition, management raised its FY11 guidance for its food cost basket from +2 to 2.5% in the U.S. and +3.5 to 4.5% in Europe.  It seems almost certain that a significant price increase will be necessary to absorb this inflation.  While MCD pointed to its track record of not having raised prices since last 2009, it is important to note that commodity costs were deflating until recently for MCD; a price increase will be necessary at some point in 2011.  As the chart below shows, the decline in margins brings MCD out of the “Nirvana” quadrant – positive comps and margins – for the first time since 1Q09.

 

 MCD – THAT’S THE THING ABOUT HIGH EXPECTATIONS - mcd quadrant

 

 

On the ability to “manage through an inflationary environment”, management assumed a defensive tone on the call, referencing 2008 as an example of the company successfully navigating an inflationary environment.  While this is true, I believe the point I made regarding the overdependence on beverages is applicable in this instance.  Frappes and smoothies in 2Q and 3Q proved to be high-margin items for MCD and, coupled with year-over-year commodity favorability, were highly accretive to the company’s bottom line.  Furthermore, the beverages were highly effective sales drivers.  Per our MCD Black Book, we estimate that frappes and smoothies counted for 5.7% and 5.9% of the 2Q and 3Q10 comps, respectively.  For reference, 2Q and 3Q10 comps for the MCD U.S. business were 3.7% and 5.3%.  If our estimates are correct, MCD U.S. excluding frappes and smoothies, declined on a same-store sales basis in 2Q and 3Q10.  The initiatives being rolled out this summer, namely strawberry lemonade and an additional flavor of smoothie, have big shoes to fill. 

 

The MCD franchise system is more robust than any other in the business.  However, as was pointed out on the earnings call, it is easy to keep a franchisee happy with growing market share and increasing margins.  It will be interesting to see how franchisees will react to the ever-expanding menu and increasing commodity costs, all the while attempting to maintain the low prices that corporate aligns the brand with. 

 

The sentiment around this stock shows just how high expectations are for the stock.  These expectations are difficult to meet and, in 2Q and 3Q of 2011, McDonald’s has a tough few months ahead of it.  Guest counts, long the lifeblood of the company’s comparable sales growth, are likely to be negatively impacted by any steep price increases.  Inflation looks like it is almost certainly going to require a steep price increase on the part of the company.  This is certainly the most interesting period for this stock in the last seven years.

 

 MCD – THAT’S THE THING ABOUT HIGH EXPECTATIONS - mcd sell side rating

 

 

Howard Penney

Managing Director


Oh, Brazil…

Conclusion: We continue to think Brazil's central bank simply isn't doing enough to fight inflation and, for the first time in this current cycle, we think that policy makers are risking a substantial loss in their credibility by refusing to be more proactive in reigning in accelerating inflation and its associated expectations.

 

Position: Bearish on Brazilian Equities for the intermediate-term TREND. Bearish on Brazilian real-denominated debt for the intermediate-term TREND.

 

Let’s cut right to the chase; even though Brazil’s central bank hiked its benchmark Selic rate +25bps yesterday, we continue to think they simply aren’t doing enough to fight inflation and, for the first time in this current cycle, we think that policy makers are risking a substantial loss in their credibility by refusing to be more proactive in reigning in accelerating inflation and its associated expectations.

 

While yesterday’s move came as no surprise to Brazil’s interest rate futures market, it did surprise consensus expectations of another +50bps hike, which would’ve been the sixth in the past year. Simply put, we don't find the central bank's "wait & watch" approach prudent in the face of accelerating inflation and accelerating inflation expectations.

 

Oh, Brazil… - 1

 

At the time, we attributed the Bovespa’s late-March bounce to the fact that our Brazilian Stagflation thesis (which we introduced back in November) had become consensus – meaning that as supply of incremental sellers dwindled, short-covering and valuation buying would support the market. Moreover, the central bank’s rhetorical easing off of the tightening pedal at the end of the month also helped boost Brazilian equities a bit further.  Specifically, Tombini & Co. stated that the cost of reducing CPI to its target range of 4.5% +/- 200bps in the current year was “too great”, and that they would postpone tightening efforts into 2012.

 

As we continue to warn, however, just because a central bank is done tightening doesn’t mean that inflation is no longer an issue. Simply put, Brazil is not China in this regard. One of the reasons we’re long Chinese equities in the Virtual Portfolio is because we think that Chinese CPI has topped out or will likely top out in the next couple of months, due to China’s proactive monetary policy over the last 15 months.

 

Contrarily, as we explicitly warned in November, Brazil’s monetary policy has been more reactive in nature, and, combined with today’s retreat in the severity of tightening, we expect Brazilian consumer and producer prices to surprise to the upside over the next couple of quarters. Cheap valuations aside, that’s not good for Bovespa margins. Economically speaking, that’s not good for Brazilian growth as higher prices stymie consumption growth and inflate the deflator by which real GDP is calculated.

 

With aggregate consumption at 81.7% of GDP in 2010, higher prices and higher interest rates certainly have the ability to meaningfully depress Brazilian growth rates by slowing household spending and straining the government’s budget. Based on our analysis of consensus reactions to the recent “budget cuts”, the latter point is an underrated issue that has the potential to add further upward pressure on Brazilian interest rates. As we called out in a report on March 3 titled “Brazil: One Step Forward; Three Steps Back”, the supposed budget cuts were rife with misleading accounting and/or flat-out bad assumptions regarding subsidies, etc. Net-net, we think the Brazilian central government could wind up missing its deficit reduction target in 2011. Brazil is not unlike India in this regard.

 

As we outlined a few weeks back in a March 30 post titled, “What’s Next For Brazil?”, one of the few things that remain supportive of the Brazilian economy is persistent real strength, and we continue to remain bullish on the currency for the intermediate-term TREND – particularly vs. the USD. If, however, the Brazilian government is able to finally implement a successful plan to weaken the real (after several months of failed attempts), that could potentially pose a systemic risk to the Brazilian economy from an inflation/inflation expectations perspective. We continue to wait and watch for more signs of Big Government Intervention on this front.

 

All told, we are jumping back on the bearish side of Brazilian equities after a brief, but cautious pause. The combination of reactive, rather than proactive, monetary policy and the potential for a marginal deterioration in fiscal policy is likely to keep inflation on the up-trend over the coming quarters. We were correct to warn clients in January (see report: “Time to Buy Brazil?”) that the Bovespa was not a feasible play on inflation on the long side this time around and we continue to affirm this conclusion.

 

Oh, Brazil… - 2

 

The confluence of slowing growth (topline deterioration) and accelerating inflation (margin compression) relative to consensus already bearish forecasts is likely to make the “cheap” Bovespa look expensive when earnings forecasts start to be revised down to economic reality.  Moreover, the likelihood that the central bank is going to have to re-accelerate tightening measures in the latter half of the year continues to make us bears on Brazil’s bond market as well.

 

Happy shorting and happy Easter.

 

Darius Dale

Analyst

 

Oh, Brazil… - 3


The Week Ahead

The Economic Data calendar for the week of the 25th of April through the 29th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.

 

The Week Ahead - weeek


the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

COTTON EYE JOE

“He came to town like a midwinter storm… but all he had come for was having some fun.”

-Rednex

 

Conclusion: While the global cotton situation can be characterized by tight supply relative to demand, we would advise you not to buy this soft commodity at this time. Production is rebounding, consumption is decreasing, and historical analysis lend credence to our view that aggressive forecasts for stockpile rebuilding are actually not that aggressive after all. Thus, we do not see current prices as a buying opportunity.

 

“Stay long of The Bernank’s Inflation,” has been one of our more successful themes over the past 3-6 months, and with the USD setting up for may be an expedited move to the downside over the next 8-10 weeks, we’re been looking to increase our exposure to certain commodity markets. Cotton, in particular, has been one of the commodities we’ve been bullish on for the last couple of quarters, so we put our up-and-coming intern Freddy Masotta to the test with the following question – “should we be buying the dip in the cotton market?”

 

 With cotton futures trading slightly above $166.00, cotton has made a nice run over the past twelve months while riding an inverse correlation of -0.80 to a sinking US Dollar. In total, the numbers are staggering: cotton is up +29.2% YTD and +114.4% over the last twelve months while the US Dollar Index is down -5.9% and -8.3%, respectively.Over the past three weeks, however, the correlations have changed. Cotton is down -11.8% over the past month and currently has a three-week positive correlation of 0.64 with the greenback. Though not what we’d consider statistically significant, we would be remiss not to remind you that the US Dollar remains quantitatively bearish across all three of our key investment durations: TRADE, TREND, and TAIL. As the inverse correlation between the two is firmly broken, we viewed this as a unique opportunity to delve into cotton’s supply and demand fundamentals.

 

COTTON EYE JOE - 1

 

On the supply front, production is expected to pick up for five out of the world’s seven largest cotton producers in the 2010/11 season. India, the United States, Brazil, Central Asia, and Australia should all make significant rebounds and see their cotton production increase by double-digit percentages over their disappointing 2009/10 levels; as a whole, global production is estimated to increase by 13.6% during this season. However, China and India, the world’s largest and fourth largest cotton producer, respectively, are likely to face production declines. This will mark the third time in as many years that China’s cotton production has declined.

 

One concern on the supply front is the -27.8% drop off in the world 2010/11 beginning stock, but production this year seems to be sufficient enough to make up for the majority of this decrease. It is also important for investors to keep in mind that it typically doesn’t take more than a couple of years for ending inventories to refill. And given the severe weather incidents that plagued the last planting season (flooding in Australia, drought in China, freezing in Latin America, etc.), the “comps” for this projected rebound in supply are easy to say the least.

 

The main driver on the demand side has been China. The surging demand in China presents a legitimate concern in regards to the global cotton market and supply and demand fundamentals. China faces restricted supplies from all sources in 2010/11 and will likely be constrained by a lack of foreign exports. Further, declining area and weather problems in China are likely to reduce production to a five year low. This, coupled with tight beginning stocks, probably has bulls everywhere licking their chops. We argue, however, that this is likely priced in at current levels – especially given cotton’s massive run-up YTD. In addition, China’s cotton consumption is forecast to decline by 6% in the 2010/2011 season, while, globally, cotton consumption is expected to decrease between -1% to -2% as global clothing brands delay purchases into the latter half of the calendar year (courtesy of the Hedgeye Retail team).

 

We believe cotton could continue to correct from here, as the aggressive production and consumption numbers presented in the 2011 USDA Cotton Outlook appear quite feasible when analyzed with a historical lens. While total supply is expected to decrease by -0.4% this season, consumption is expected to decrease by a greater amount in the 2010/11 season, falling -1.6%. Needless to say, we urge caution to any investor thinking about buying the dip in the cotton market.

 

Darius Dale

Analyst

 

COTTON EYE JOE - 2

 

COTTON EYE JOE - 3


R3: JNY, Groupon, GPS, Puma, TOY and Luxury

OUR TAKE ON OVERNIGHT NEWS

 

Jones Group one of bidders for Jimmy Choo- report - Clothing maker Jones Group Inc  is one of three potential buyers for upscale shoe and handbag maker Jimmy Choo, Dow Jones reported, citing people familiar with the matter.A spokeswoman for Jones Group, whose brands include Nine West and Jones New York, declined to comment on the report. Jones Chief Executive Wesley Card told Reuters in February that his company was looking to buy brands that would help extend Jones' reach, particularly into overseas markets. "Acquisitions are an important part of our growth strategy," Card said at the time. Last year, Jones bought high-end shoemaker Stuart Weitzman.Bahrain-based Investcorp INVB.BH and German luxury company Labelux Group have made a joint offer for Jimmy Choo, while U.S. private equity firm TPG is also in the process, according to the Dow Jones report <Reuters>

Hedgeye Retail’s Take: Let me get this straight…JNY potentially competing against middle-eastern oil money and deep-pocketed German Lux group for iconic brand Jimmy Choo. JNY does not have the wallet for this. It hasn’t even paid off Stuart Weitzman deal in full yet (deferred purchase price and ownership structure).  The fact that JNY is aggressively going after more deals speaks to the state of its base business. If not for strength in its Jessica Simpson line (sustainable???), JNY would be pre-announcing – again.

 

Groupon gets hyper-local - Groupon has acquired Pelago, creator of location-based check-in service Whrrl. The deal is the latest sign that the daily deal space is converging with geolocation, making it possible for businesses to present offers to consumers based on where they are. The move comes a little more than a month after LivingSocial, Groupon’s primary rival, began testing a mobile app feature that lets consumers search for deals within a half-mile radius of their current locations. In announcing the acquisition, Groupon CEO Andrew Mason praised Whrrl’s platform, which allows users to share recommendations for activities and places to go. When others heed that advice the recommender earns “influence points.” Brands and merchants can encourage consumers to visit the promoted bricks-and-mortar locations by offering contests and prizes to people who check in at those locations. <InternetRetailer>

Hedgeye Retail’s Take: There’s no way Groupon could afford to go on a roadshow looking for a $20bn valuation with the competitive gap narrowing. This move was pure defense – but it will probably work.

 

Michael Kors, Valiram Group Team Up - As part of its plan to expand in Southeast Asia, Michael Kors Inc. has partnered with the Valiram Group to bolster business and open stores in Malaysia and Singapore. The first freestanding Michael Kors store in Malaysia is scheduled to bow in August in the Pavilion Kuala Lumpur. The 3,500-square-foot boutique will showcase ready-to-wear, handbags, small leather goods, footwear, eyewear, watches and fragrances from Michael Kors, Kors Michael Kors and Michael Michael Kors. The debut of the company’s first Singapore boutique is also slated for August. It will be housed in Scotts Square, a luxury shopping center opening later this year in the city’s busy downtown shopping district not far from the Grand Hyatt and Marriott hotels. <WWD>

Hedgeye Retail’s Take: Great example of how easily scalable great brands are into new geographies, and how the brands (content) are ultimately more valuable than the retailers (distribution). One has limited growth, the other is blue sky.

 

 “Luxury triangle" of brands to be landed in Shanghai - The 3,000-sqm Austen Branded Goods City is scheduled to open this year in the Gubei New Area, Shanghai, setting the site up as the city's new shop window on major European branded goods.  The 30-plus brands moving into the mall in Gubei New Area are all showing luxury goods of top quality, including Weill, one of France's oldest fashion brands, Lauren Vidal, a designer label on sale in Paris' Lafayette department store, and Italian brand Tricot Chic is also well-known, for its bright colours and feminine styling. Austen City is not expected to adopt a business model characterised by exclusive buy-outs or distribution. Rather, it will be directly involved in shop design, production, marketing and after-sales services of the brands on offer. Constituting a second leg of the triangle is 180-year-old Takashimaya, one of the largest department store chains in Japan. The group's first store in China is to be in Gubei, on a business area of 40,000 sqm. <FashionNetAsia>

Hedgeye Retail’s Take: Ditto on the Michael Kors comment. When you’ve got the content, you’ve got the growth. Period.

 

Gap Streamlines its International Operations - Now that Gap Inc. is out to conquer the global business-to-consumer e-commerce market and other retail venues, the chain retailer is rolling all of its international operations into a single unit and putting one executive in charge. Gap, No. 23 in the Internet Retailer Top 500 Guide, is consolidating all of its foreign e-commerce and store programs in Europe and China under a new unit to be headed by Gap Europe and strategic alliances president Stephen Sunnucks. Gap’s streamlined international operation will include 530 stores across 30 countries. Gap in the past two years also has launched e-commerce operations for shoppers  in Austria, Estonia, Belgium, China, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia Slovenia Belgium, Spain, Sweden, the United Kingdom, and elsewhere. <InternetRetailer>

Hedgeye Retail’s Take: This makes perfect sense. While the investment community at large is focused on Gap’s inability to comp – especially in the US – the International chess board is being set, and GPS is accelerating stock repo in the interim. Don’t bet against this one.

 

Nordstrom eyeing Hudson Yard - Nordstrom Inc. is eyeing the massive Hudson Yards project under development on the far west side of Manhattan where it could open its first full-line store in the city. After years of combing Manhattan for a site and considering a number of alternatives, the Seattle-based department store chain is “looking at the potential of Hudson Yards,” said a source. “They’re in discussions with Related Cos.,” developer of Hudson Yards, a 26-acre commercial and residential project to be built over the rail yards near the Hudson River located between 30th and 33rd Streets and 10th Avenue and the West Side Highway.  “It’s fair to say they’re interested and considering it, but nowhere close to any kind of deal or commitment,” the source added.  Nordstrom is also considering other sites in Manhattan, but Hudson Yards seems like its best bet given the enormity of the project and its ability to provide Nordstrom’s space requirements of at least 180,000 to 200,000 square feet, a parcel extremely difficult to find in Manhattan, particularly in an area dense with upscale shoppers. <WWD>

Hedgeye Retail’s Take: Huge potential win, and huge potential waste of capital.

 

Puma Opens Eco-Friendly Concept - As Europe’s activewear giants race to clean up their act on the sustainability front, Puma on Wednesday inaugurated its revamped Boulevard de Sébastopol flagship, combining high-tech interactive features with eco-friendly materials for merchandising and decor. Materials included energy-efficient lighting and FSC-certified sustainable wood, while clothes hangers are made from cornstarch.

The store’s new look is urban and colorful, however, with exposed concrete walls, video screens, loud comic-inspired wallpaper, puma cat-shaped coat pegs in the changing rooms and clusters of green and red poufs. Old-school metal sports-room lockers used as merchandising units come decorated with sports trophies. Local artist collective 9eme Concept collaborated on the store’s design.  A red joypad wall on the first floor carries 32 iPads loaded with interactive content for customers to play with, such as Puma’s new iPad and iPhone Life Scoreboard application, where users can vote on a flow of open questions pitting two subjects — such as Mac versus PC — against one another, and then check the scores. <WWD>

Hedgeye Retail’s Take: Very interesting idea, and great way to stay fresh with a younger audience.

 

Toys ‘R’ Us Expanding e-Commerce  - One way Toys ‘R’ Us Inc. is supporting its burgeoning e-commerce program is by opening its first dedicated distribution center for fulfilling Internet orders. This July, Toys ‘R’ Us, No. 37 in the Internet Retailer Top 500 Guide, will open a new 300,000-square-foot distribution center near Reno, NV. The center, which will eventually employ about 120 workers and another 230 part-time workers during the peak holiday season, will fulfill orders for Toysrus.com and Babiesrus.com. “As more consumers enjoy the simplicity and ease of online shopping, Toys ‘R’ Us continues to invest in e-commerce enhancements to advance customer service and satisfaction across all shopping channels,” says CEO Larry Storch. “We believe the facility will play an important role in further accelerating our company's online business growth and order fulfillment.” <InternetRetailer>

Hedgeye Retail’s Take:  It seems odd that such a seasonal business would require a fully allocated DC that would add to cost structure year-round. This puts pressure on the company to knock their e-commerce strategy out of the park.

 

Underwear Sales Heat Up in Men's Retail - Forget simple white briefs: Men’s underwear has discovered fashion and technology. The sector has been growing rapidly on the back of those two trends, which is part of the overall boom the men’s wear market has seen across all categories following the depths of the recession. A plethora of bold colorblocking and oversize logos and advances in high-tech temperature-regulating applications that keep the wearer cool and comfortable are expected to continue to propel sales this fall. In the three months ending February 2011, the men’s underwear market generated sales of $1.24 billion, up 13 percent from the three months ending February 2010. In the 12 months ending February 2011, men’s underwear sales generated $3.9 billion, up 8.6 percent from the same year-ago period, according to The NPD Group.  <WWD>

Hedgeye Retail’s Take: Great for Warnaco (CK Underwear), and opportunity for Hanesbrands (which competes at the lower end of this market).

 

Shoemakers Urged to Avoid Competition Over Low Prices - Low-priced shoe exports to the EU may cause further trade penalties, warned the Local Shoemaking Association after the recent removal of EU shoe anti-dumping duties.  More shoe orders from the EU were received after the removal of duties which resulted in a drop in export prices. However, industry experts indicate worries over a new round of competition over prices, stressing that this might result in new penalties to be imposed on shoe exports. <FashionNetAsia>

Hedgeye Retail’s Take: Be careful what you wish for.


HBI: Don’t Bet Against HBI

Top line momentum + transparency on the cost side are factors few companies have in this environment.  The market has figured it out – but in this instance, the market is right.

 

 

Investment Conclusion

It’s tough to bet against HBI at this stage. The company has solid top-line momentum and a high degree of transparency on the cost side – unlike almost every other company in retail (sans GIL). As it relates to revenue, there’s still three quarters of the Gear for Sports acquisition that give the model implied growth, but also continued organic growth due to considerable momentum with several marketing campaigns (ie watch Oprah today). Let’s not forget that this company is not afraid to miss top line targets; its done it plenty of times in the past.  But don’t bank on it in reported numbers until January ’12. On the cost side, this is a company that has the luxury of directly procuring nearly all raw materials instead of relying on another partner in the supply chain to look out for them. Anyone that is beholden to someone else in the chain immediately exposes themselves to risk of the unknown. In this business, ‘the unknown’ is far worse than severe fluctuations in costs. At least the latter can be managed proactively by nearly any management team. In the meantime, you’re looking at a name trading at 8.2x EBTDA, 9.5x earnings,  and that throws off enough cash to pay down its considerable debt burden within a 4-year time period. We’ll keep a sharp eye on the overwhelmingly positive sentiment factors right now (8 out of 9 analysts have Buy ratings, and only 6% of the float is short), but we think that – at least for the time being – that the consensus has this one right.

 

 

Overview of the Quarter and our Model

Solid quarter for HBI with Q1 EPS of $0.49 topping our estimate of $0.34. The beat was broad-based coming in better than expected on every line item. Strong top-line results (+12% vs. our +10%) driven by the Outerwear and International businesses coupled with less significant gross margin contraction and greater SG&A leverage drove 60bps in operating margin expansion in the face of the toughest compare of the year. The Street was also looking for $0.34.

 

On the margin, we’ve adjusted several lines in our model to reflect the traction that’s clearly evident in the business as well as the company’s ability to successfully mitigate higher costs. The bottom-line here is that following Q1 results, increased full-year guidance of $2.70-$2.90 up from $2.60-$2.80 actually looks conservative.

  • First, our consolidated top-line assumptions remain little changed for the year up +12% taking into account stronger growth than we expected in the company’s International business and a modest ramp in Outerwear driven by early success at Gear offsetting more modest growth assumptions in Innerwear due to less meaningful from timing related space gain contribution.
  • GMs contracted -108bps in the quarter 100bps less than expected in the face of the toughest compare of the year +460bps proving the company can mitigate higher commodity costs. With supply chain efficiencies of $8mm-$10mm, or 75-100bps a quarter, offsetting less onerous commodity costs as we look out to the balance of the year, we’ve taken up margins modestly in the 2H to flat and down -25bps in Q3 and Q4 respectively from down -50bps in each quarter.
  • SG&A leveraged better than expected with dollars coming in below our expectations with added distribution costs to handle higher sales volume coming in much lighter than anticipated. Additionally, despite the perception of increased marketing spend given a multitude of new campaigns, the company confirmed that marketing spend will stay in-line with historical spend of $90-$100mm annually.

 

All in, given the $0.15 beat in the quarter and approximately $0.08 of added benefit attributed to both gross margins and SG&A over the balance of the year, we are taking our numbers up to $2.95 and $3.40 for this year and next ahead of what amounts to conservative guidance. While inventory growth of +30% (+26% ex Gear) is higher than we’d like to see at this point in the year, taking inventory early may in hindsight be an opportunistic move with retailers potentially looking to take stock earlier than usual heading into BTS.

 

 

Few Key highlights from the call:

 

Retailers/Inventory:

“what is interesting is that retailers are taking very different approaches to managing inventory as cost increases start to hit them throughout their entire apparel floor. Some are extremely conservative, some are pretty aggressive using as an opportunity to gape share, they will start to normalize later in the year, we clearly did anticipate in our guidance somewhere during the year we would see unit levels drop on in aggregate for retailers.”

Consumer:

“We are seeing a pickup in spending and confidence that help may help mitigate that a little bit. We are seeing consumers actually start to travel back up scale in terms of retailers and show a predisposition to begin spending higher prices per unit, that bodes well for the economy throughout the year.”

 

Re Pricing

“We got the lion's share of pricing secured. We feel fine about it and remember we price on a run rate basis, not to try and make a fiscal year and so we look at what we think the go forward rate is from a inflation stand point, both with cotton, oil and wages, as we put in prices, that should take care of not only 11 but cascading in to 12. We are fine from a pricing perspective”

 

 

HBI 1Q FY11 Earnings Call

 

P&L Notables:

  • Sales Increased 12%Reflecting:
    • o Innerwear: (Flat)
      • Innerwear Operating Margin -400bps
      • Deterioration Reflects:  higher cost cotton and commodity cost throughout the quarter and price increases that were not implemented until mid quarter
        • o Outerwear segment: +37%
        • o Hosiery:  -6.9%
        • o International segment sales: +24%
        • o International Business
        • o Direct to Consumer: -2%
  •  
    •  
      •  The fact that price increases were only in place for two months in the quarter contributed to a 23% decrease in operating profit.
  •  
    •  
      • Across-the-board strength in Gear For Sports, wholesale casual wear (Hanes), retail casual wear (Just MySize andHanes), and retail active wear (Champion).
      • 19% was due to Gear for Sports Acquisition
  •  
    •  
      • Strength in all geographies - Canada, Latin America, Asia and Europe. Operating profit increased 86 percent (75% Constant Currency).
  •  
    •  
      • Sales from Brazil, China and India all saw 40%+ revenue growth

 

  • Gross Margins 34.2% down 108 bps
    • o Spoke to GM in Q&A

 

  • SG&A up 4.5%
    • o Spoke to SG&A in Q&A

 

Balance Sheet:

  • Inventories up 30%
    • o Reflects the normal seasonal build for back-to-school, Gear for Sports acquisition, and higher Cotton and Commodity costs.
  • Continue to have a priority of deleveraging and will continue to pay down debt with free cash.

 

2011 Guidance

  • Expect Sales for FY 2011 to be within the rage of  $4.9 billion to $5 billion
  • Expect free cash flow to be between 100-200 million
    • o Expect to reduce year-end debt levels by the amount of free cash flow
  • EPS  for 2011 at $2.70- $2.90

 

 

Q&A:

 

  • International Business Drivers
    • o Strong positions in Canada, Mexico and brazil. Overall you will see continued strength in the teens in International .
    • o China: All of the major developing markets have a long term growth potential. Our categories are used all around the world. As middle class grows HBI benefits. Focused on developing china, Mexico, brazil and India.
    • o In china focused on building the basics business first. Intimate apparel will be built out later.
    • o International up 17% on constant currency. Believe that international should be able to deliver low teens. All geographies are performing well.
  •  
    •  
      • Only weak region is Japan. It is a 75-80 million dollar business.

 

  • Gear For Sports/ M&A environment/ Gold Toe:
    • o Acquisitions are not a major part of our strategy. Three are a lot of opportunities to grow business. Clearly tuck-in acquisitions are helpful. On the look out for acquisitions but acquisitions are not necessary for success of HBI.
    • o Gold toe has been perennially on sale. They have passed on the acquisition in the past.
    • o Low profit quarter for Gear for Sports when seasonality is taken into account.

 

  • Innerwear /Elasticity
    • o Weakness in Innerwear growth due to tough comp
    • o "From a profit perspective its simple we are starting to see the impact of inflation. Price increases have not hit innerwear yet. Will begin to see rebound in second and third quarters."
    • o Company has embedded a substantial unit fall off in guidance for FY 2011.
    • o 400bps of EBIT margin deterioration
  •  
    •  
      • Last year there were huge space gains and fixture fills (approximately 30 million).
  •  
    •  
      • Higher commodity prices
      • Price increases not passed through yet

 

  • SG&A
  •  
    • Was unplanned. Still in marketing mode (Marketing expected to be 90-100 million for the year). Bulk of SG&A dollars went to G4S. Might see SG&A  dollars go up.
    • Through the remainder of the quarters SG&A will be leveraged. Rate will continue to improve (dollars up but leverage as a % of sales up)
    • SG&A dollars were up about $11 million.  Gear  represented ~$12 million of SG&A in the first quarter (Excluding Gear, SG&A was relatively flat in dollars)

 

  • Elasticity
  •  
    • From retailer perspective, retail  inventories are where they should be. Interestingly however, retailers are taking much different approaches to managing inventories. Some are being conservative, others are using this time period to take share.
  •  
    •  
      • Unit levels have dropped off in the aggregate for retailers.
  •  
    • No consumer elasticity impacts as of yet.
    • Seeing a pickup in consumer spending and confidence. Seeing consumers travel back to upscale merchandise.
  •  
    •  
      • As there is better visibility feel more secure in negotiating with retailers and feel more comfortable with position.
  •  
    •  
      • "It is the end of the deflationary environment in retail"

 

  • Pricing/Cotton
  •  
    • Have the lion share of their costs locked in.
  •  
    •  
      • Use run-rate pricing
  •  
    • Work directly with merchants who become involved in the futures market.

 

  • Gross Margins
  •  
    • Excess service costs spilled over very little but was not material.

 

  • Inventory
  •  
    • Inventory in 11 will be up 50million
  •  
    •  
      • Inflation costs +100
      • Turns will improve by +50

 

  • Competitor Responses to price Increases
  •  
    • Every single company is having to deal with huge inflation. No one is immune. Every company is going about inflation differently. There are a few big global players who have been surprised by the increased.

 

  • Average Interest Rate on all debt?
  •  
    • 7.5%

 

  • Outerwear
  •  
    • Overall increase was driven by G4S.  Even so, everything was up excluding G4S (~18% Excluding g4s)

 

  • Direct -Sales Segment
  •  
    • Down about 2%. Comps were up 2%. Internet business was soft. Attribute softness to a mid quarter change in mailing strategy and timing.  Believe it will turn around later in the year

 

  • Transportation and Energy Prices
  •  
    • Built into guidance is oil at 100

 

 

Brian McGough

Casey Flavin
Robert Belsky


Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

next