I never thought I’d say this, but I’m actually getting even more negative on JNY. In going through today’s 1Q results (several times), I’m increasingly convinced that these guys either have an astounding poker face, or they simply and honestly do not know what is about to hit them. No one ever accused Wes Card and John McClain of being liars or deceiving investors, and nor will I. But the stress points in the model are more brittle than anytime I’ve seen at JNY in the 13-years I’ve followed it. My most recent thought had been that this is a company that is destined to earn between a buck and $1.50 in perpetuity. Now, barring a positive event that I cannot envision as hard as I try, I don’t think that JNY will ever earn over $1.00 per share again. With the stock at $14.95, the consensus likely does not agree with me.
What’s changed on the margin?
1) My confidence in JNY’s ability to squeeze water from a stone.
- JNY discussed its Brand Optimization Process, which actually sounded rather encouraging at face value in a Six-Sigma-ish kinda way. But when you really peel back the onion, it simply does not synch with the company’s financial initiatives and capacity. In the quarter, Sales were up only 2% excluding Stuart Weitzman, and organic SG&A was flat. How many companies in retail have we ever seen go through a ‘Brand Makeover’ without a capital infusion, and have it actually work? In this business, it is near impossible to cut costs and build brand allure/grow revenue simultaneously. For the full year, they’re looking at only $25mm in incremental SG&A growth, which is simply not enough for a $3.7bn company. Perhaps they’ll argue that they already have in-house resources that can be shared (design, distribution, etc…), but I’d fire back and say that this jeopardizes existing brands.
- Without success in its core, Jones will be Jones and simply buy more assets, right? Not so fast… It’s latest deal (Stuart Weitzman) is only 55% paid for – with the remainder due at the end of 2012. It is currently sitting at 33% net debt to total capital, and can’t take that much higher without putting this balance sheet at serious risk. That’s why we cringe when we hear about JNY bidding for assets like Jimmy Choo.
2) Margin Risk Is Material
- Inventories were up 28% (3.5x sales growth) which the company spelled out in great detail (kudos for the disclosure), 10% of this was JNY pulling forward business ahead of price increases. Another 5% was excess goods from prior season. That’s not good. While it’s commendable for JNY to pull forward product to manage costs, this does not pull forward the time during which customers will take delivery. Translation, JNY needs to take on greater fashion risk in exchange for COGS risk. They’ve proven to be quite adept at execution and supply chain optimization, but not quite on the fashion trend side of things. I don’t like this trade. Case in point from the Q&A…
- Question: “gross margin compression guidance in 2Q is a little bit wider than you had originally expected, now 150 to 200BPS vs. 150 originally. Why?”
- Answer: Well, I think some of it is you just sharpen the estimate as you get closer and with the trends that we’ve seen and there’s still a heavy level of promotion and just the general kind of uncertainty with the consumer enables me to just sharpen it up a little bit. The current quarter’s always easier to do than the one after that, so...”
- They guided to 2Q revenue anywhere between -1% and +3%. If the current quarter is easier for them to forecast, what does it say for the back of the year?
- JNY is talking about 1H10 being its toughest comparison of the year, when last year’s conditions were near-perfect. As a result, margin improvement will be back-end loaded. What?!? Is this really the year to bank on margin expansion in 2H? Management said that the consumer is not resisting price increases yet, but then noted that they have not really pushed much through yet. They’ll be relying on significant price increases sticking in 2H to offset dd cost increases. Do I worry about Ralph Lauren sticking price increases? Nike? Guess? CK? No, no, no and no. Jones’ brands? Yes.
3) Here’s a statement that bugs me… “We continued our strategy of focusing on our core competencies, controlling inventory, and identifying opportunities for cost efficiencies and savings in both our operations and in our supply chain.” If I’m going to invest in any business, I want a management team to have a clear, quantified and borderline cocky plan for how it is going to grow profitably and organically. That’s not what JNY is giving us. They’re doing the cost-cut dance, and are basing 2H growth projections on consumer confidence. Its gonna take more than Nine West espadrills and Jones New York Easy Care White Blouses to drive meaningful growth here.
4) Cash Flow? They guided to $175mm or better. We need to see the company earn at least a buck in earnings AND have working capital as a source of cash. Best case, I think we’ll see one or the other. Realistically, JNY pulls out the stops to protect its balance sheet, but takes it on the chin on its P&L. This is where we’re most different. They noted that should the business climate erode from here, FY11 gross margins could be down 50-100bps. We’re at -200bps.
5) Consensus Revisions: I really don’t care a whole heck of a lot where the consensus ends up on this name (doubtfully below our $0.78 and $0.85 for this year and next). We’ve got a stock trading at $14.95 that will never earn over $1.00 again. Let’s also keep in mind that from a top-line perspective, NY just finished its last quarter of easy yy compares. This thing is the poster child for a company that NEEDS margin. Few people on the sell-side are big fans here, but there’s only 6% of the float short, which remains quite low for JNY.
JNY’s SIGMA Chart Looks Awful. Being Sucked Down and To The Left is Never Good.