GPS/JCP/TGT: It’s Time To Press The Call


We’ve spoken ad-nauseam about how the spread between supply and demand would start to buckle in May/June and take margins lower. Gap pretty much confirmed this last night. The call from here, however, is not on Gap. But it’s to press the JC Penney short. On the flip side, we’re changing our tune, and are getting positive on Target after being bearish there all year. This is the TREND and TAIL call. And as always, Keith will manage the TRADE.


The fact that we’re already seeing some people come out and defend their perma-faves by saying that the GPS blow-up is ‘company-specific’ is just flat out intellectually irresponsible. We weren’t shocked by the magnitude of this miss by any means – as outlined in our “4.5 Below” thematic piece from earlier this year where we quantified a 4.5 point margin hit for the industry – and don’t necessarily think it will be the last for GPS. Fortunately, they have the good grace of Eddie Lampert to financial engineer their way out of the worst operating environment in decades. 


We’re not making a call on Gap here.


We think that there’s much more money to be made in shorting JC Penney, and (gasp!) going long Target. What?!? We can hear the feedback already…”You guys have been so negative on Target all year, and you turn positive just as the industry thesis is starting to work?”


The short answer is ‘Yes’ and for very good reason.



We hate to point to Ackman as being the main factor – but the reality is that it is the fallout/windfall that we expect to see at JCP/TGT, respectively as the heavy hand of activism spanks the other cheek will create opportunity for real investors to make money here. We didn’t believe in the half-baked financial engineering story with Target in 2008, and we certainly won’t believe it now that Ackman has blown out of his TGT and shifted his focus to JCP.


One consideration here is that Target is actually a solid company. The concept is a winner, management is proven, it has square footage growth ahead, and has the benefit of the incremental shift towards its Membership Rewards model and P-Fresh rollout. More loyal customers and more consumables = more traffic.


While that’s all fine and good, our prior problem with it dates back to that fateful turn of events that started in 4Q07 when Ackman started his ‘assault’ in ultimately owning 3.55% of the company by the end of 2009.  The proxy battle begins!


Then on Target’s May 7 sales release in 2009, comps were in-line, but more importantly TGT noted that tight expense controls and better gross margins will lead EPS to be “well above estimates".  Credit quality also came in line vs. a trend of coming in slightly below plans. Then, four days later, TGT issued a press release titled “Questions That Attendees May Want To Ask At The Pershing Town Hall.’ In other words, TGT started to pull out all the stops to make Billy go away. Ultimately, Billy took it on the chin, and lost his proxy battle on May 28 of 2009 after it was clear that the momentum of the business was going against him.


The ‘strong cost control’ is particularly notable to us. Being cost-conscious is something most great companies have embedded in their DNA. But this is a company that has added $1.5bn in revenue (2.5% over 2 years) since The Ackman Assault, but has held SG&A dead even. And yes, that’s despite 9.5% square footage growth over that same period. Last we checked, a new store requires a few bucks.


Similarly, let’s look at capex. TGT had its precipitous decline in capex over that same exact time period. Any way you cut it, relative to prior trends, growth capex was cut by over a half such that total capex actually ran below D&A for three quarters.


Now it’s clearly headed higher. So at the same time the activist thorn in TGT’s side is removed, it starts to behave rationally again and invest to reaccelerate share gain. One thing we’ll give TGT credit for is being good stewards of capital – at least when they don’t have an activist dog barking in their ear.


We’re still concerned with near-term earnings quality (i.e. credit accounting for an outsized portion of the latest qtr eps) and will be watching that accordingly. But ultimately, our issue with TGT had been that lack of reinvestment around all this noise would preclude the company from hitting both sales AND margin goals. We’d give ‘em one or the other. But not both. That call has proven to be the right one.


Now, we’re approaching a point where the lag from TGT’s reinvestment and revenue growth has caught up. We think that numbers have stopped going down, and we’ll see a reacceleration in top line over the next 12 months.



In nearly every way that Target is a good company, JC Penney is not. It has a poor legacy real estate profile, over-exposure to apparel (in the worst apparel environment in decades), and over 50% private label/exclusive mid-tier brands that most consumers would not notice if they simply went away. One of the keys there is that JCP’s more vertical model relative to most other department stores (where it sources directly in Asia) means that it has fewer touch points between manufacturing and final retail sale to share cost pressures with partners. In times of excessive stress, JCP bears the pain.


On the flip side, to be fair, it also garners the upside as the environment improves. But in this space, the soonest we’ll see that will be 2013.


Keep in mind that when we see events like Gap missing plan/blowing up, this has a ripple effect. Was Gap planning on this? No. Nor were their vendors, the competitor down the hall in the mall that sells similar product, etc… this is where the chain reaction begins. JC Penney does not have a whole lot to stand on. Liz Claiborne might be great – but is really just a splash in the bucket for JCP (it’s much more meaningful for LIZ). Also keep in mind that JCP has been serially in and out of restructuring mode for the past decade. The ‘low hanging fruit’ has been largely picked.


As was the case with Target, we think that the diversion of management’s attention – especially at a time when industry and Macro factors will demand it most – will also hurt on the margin.


Our industry call all along had been that we’d start to see the dominoes fall relative to expectations in May/June – and we’re sticking to our guns. We do not – by any means – think that GPS is one-off. It is just the beginning.


GPS/JCP/TGT:  It’s Time To Press The Call - TGT Capex 5 20 11


GPS/JCP/TGT:  It’s Time To Press The Call - TGT 5 20 11


GPS/JCP/TGT:  It’s Time To Press The Call - JPS 5 20 11





Notable news items and price action from the past twenty-four hours, as well as our fundamental view on select names.

  • RRGB reported EPS of $0.58 versus consensus of $0.24.  The company beat consensus on the top and bottom line.  Comps came in at +1.9% versus consensus at +0.8% and restaurant margin was 19.8% versus consensus of 17.8%.  The first four weeks of 2Q comped 0.5% higher than the same period in 2010. 
  • RRGB was raised from Neutral to Buy at Stern Agee.  The stock was also upgraded from Underperform to Buy at BofA.
  • TXRH’s Board of Directors authorized the payment of a cash dividend of $0.08 per share of common stock.  The payment will be distributed on July 1, 2011 to shareholders of record at the close of June 15, 2011.
  • MCD is digging its heels in and refusing to call time on Ronald McDonald despite campaign groups’, that link the mascot (and happy meals) to childhood obesity, requests that the fast-food company stop using the clown to market to children.
  • PFCB CEO Bert Vivian sold 20,000 shares of PF Chang’s stock on 5/19.
  • JACK traded up 5.6% on accelerating volume yesterday.  Stronger top-line performance at Jack in the Box and Qdoba in 1Q surprised investors when results were released after the close Wednesday.  Nearing completion of its refranchising program, the company is far better poised from a business perspective relative to recent times.  Commodity costs remain a concern for the foreseeable future.  See our note from yesterday for more details.
  • CBOU and WEN also gained on accelerating volume.
  • CPKI, DRI, and CAKE all gained on accelerating volume.




Howard Penney

Managing Director


The Macau Metro Monitor, May 20, 2011




Pansy Ho said, “We have been very hopeful that this [Cotai approval] obviously could happen within the year.”  Ho would like to maintain a strategic role in MGM China, saying, “I believe that to be an MVP, most valuable player, like when you are in a ball game you do not always have to be the one kicking the goals, you would like to be there to be the best assistant."


Asides from opening an MGM Grand hotel this year in Hainan Island, MGM wants to enter Taiwan with non-gaming and leisure projects.



Macau's Composite CPI for April 2011 increased by 4.88% YoY and 0.10% MoM.


Data on levies collected for entry into the casinos at Marina Bay Sands and Resorts World Sentosa suggests 5,400 Singaporeans go to the casinos every day. 

Early Look

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Whys and Wherefores

This note was originally published at 8am on May 17, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Faith is an island in the setting sun, but proof is the bottom line for everyone.”

-Paul Simon


My wife Laura and I had a wonderful time at a fundraiser in Greenwich, CT last night. Our good friends were raising money for The Bowery Mission. Founded by Albert Gleason Ruliffson in 1879, it was one of the first missions established for the homeless in America.


The United States of America is one of the most generous lands that our world has ever known. If you give Americans an opportunity to give, they often will. If you give them a chance to lead, many of them do so by example. There is a faith in this country that cannot be centrally planned out of our hearts.


Faith, accountability, and trust. While these principles may not always resonate intuitively with being “bearish” about a market price, there’s an important investment point to be made here. You have to be able to separate your patriotism, religion, and confirmation biases from the daily risk management discipline that will separate you from the flock. You either have faith in your process, or you don’t.


In his morning tweet, the Dalai Lama complimented this point by reminding us that, “reliable and genuine discipline comes not from repression, but from an understanding of all the whys and wherefores of our actions.”


The Whys and Wherefores of what gets you to buy, sell, and hold; the Whys and Wherefores of what gets you to trust, love, and give; the Whys and Wherefores of what it is that gets you out of bed every morning to do what it is that you do…


It’s all there.


No matter what we do in this profession. No matter where we go in this life. The answers to these questions define and shape not only our individual character, but our collective culture.


Back to the Global Macro Grind


Having authored the Global Macro theme of Growth Slowing As Inflation Accelerates, I know exactly why it is that I have been taking down my gross exposure and tightening my net exposure (longs minus shorts) for the last 3 weeks.


Last week I sold all of our Oil. This week I sold all of our Gold. We now have a zero percent allocation to Commodities in the Hedgeye Asset Allocation Model.


We’ve written and talked about the similarities between the US Currency Crashing to lower-lows in Q2 of 2008 and 2011 for enough time now that you know that I will not move away from my risk management discipline of respecting The Correlation Risk between US Dollars and everything that’s highly correlated to them.


If you are a Risk Manager, the month of May has reminded you of the following realities associated with a US Dollar arresting its decline (USD Index TRADE line of $74.41 resistance is now immediate-term support – do not be short the USD here):

  1. Stocks stop going up
  2. Commodities stop going up
  3. US Treasuries stop going down

For us, this is good. In terms of how I am positioned in May, that is.

  1. US and International Equity Exposure = 9%
  2. Commodities Exposure = 0%
  3. US Treasury Exposure = 15%

The Whys and Wherefores as to what got me into these positions are reconciled every day with the same repeatable mechanism that got us to make our US crash call of 2008 and the “May Showers” correction call that we made in April of 2010. Whether I am grumpy or glad, our research and risk management process stays the course.


Are the inverse correlations associated with US Dollar moves going to hold forever? Of course not – correlation risk is never perpetual. Could they matter for far longer than the biggest net long position in hedge fund history can be rationally unwound? Mr. Macro Market is going to have to tell us the answer to that – and, in the meantime, I have plenty of time to buy things back.


Why and Wherefore should I have faith in this process?


Because when it works for me, I know why – and when it doesn’t, I understand wherefore I should evolve it.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1474-1499, $93.67-$100.12, and 1327-1336, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Whys and Wherefores - Chart of the Day


Whys and Wherefores - Virtual Portfolio

Intellectual Honesty

“I think we are very good at intellectual honesty.”

-Seth Klarman


I was flying to Kansas City from Denver last night and an outstanding interview in the Financial Analysts Journal bubbled up to the top of my pile – an interview with one of the world’s most thoughtful Risk Managers, Baupost’s Seth Klarman.


“We actually hire for intellectual honesty. In an interview, we work hard to see whether people can admit mistakes. We hold our people accountable to that standard.” (Klarman, “Ahead Of Print”, 2010 CFA Institute)


Accountability. Honesty. Standards.


That works for me and, from what I can tell, it works for a lot of our clients who understand that there is a difference between running a P&L and running a business. There’s a difference between rigorous research and disciplined risk management too. The best teams in this business do both.


“We have all our own money invested in the firm, and so we are very conservative. We have picked our poison. We would rather underperform in a huge bull market than get clobbered in a really bad bear market.” (Klarman, “Ahead Of Print”, 2010 CFA Institute)


Ownership. Preservation. Conviction.


Those principles work for me too.


“We ask people, what is the biggest mistake you’ve ever made? It’s a very open-ended question because it’s not solely an investment question, although prospective hires often answer it as if it were.” (Klarman, “Ahead Of Print”, 2010 CFA Institute)




Back to the Global Macro Morning Grind


In the face of awful US Economic data yesterday:

  1. CONFIDENCE: Bloomberg Weekly Consumer Comfort Index dropped to a fresh YTD low of -49.4 vs -46.9 last week.
  2. HOUSING: US Existing Home Sales  fell -0.8% for April, dropping from 5.09 million in March (seasonally adjusted annualized) to 5.05 in April.  This is a sharp divergence from the March Pending Home Sales, which increased 5.1% month-over-month.
  3. GDP GROWTH: US Leading Indicators for April were down (0.3%) sequentially vs. +0.7% in March (the sharpest decline in well over a year)

And … with the US Dollar down on the day… the inverse relationship (The Correlation Risk) between Fiat Fool policy and stocks continued to hold (USD down = stocks up). The US stock market was able to hold a +22 basis point gain. With the SP500 closing at 1343, it’s down -1.5% from its April 2011 YTD high, and down -14.2% from its October 2007 all-time high.


You mean, on alarmingly low-volume, the mistakes we’ve all made between late 2007 (where I got bearish too early) and early 2011 (where consensus has been too bullish on US Growth) has only equated to lower immediate-term and long-term highs in US stocks? Yep. This special case of making lower-highs in stocks has been occurring in Japan since 1992. Big Government Intervention has its perks.


No matter where I go this morning, the entire risk management community can see all of my mistakes. My current mistakes are attached at the bottom of every morning’s Early Look (my biggest mistake on the long side is currently Suncor (SU) at -5.3% and, on the short side, Consumer Staples (XLP) at -2.9% against me). My longer term mistakes are all time stamped on our website and on the back of my ankle.


Transparency. Accountability. Trust.


These are principles that plenty of politicians give lip service to. In real-life, they are extremely hard to achieve. I don’t think my firm is there yet, but I do know that the people I have working with me have Intellectual Honesty – and in terms of re-thinking industry standards on independent research, I think we’re well on our way.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are $1480-$1502, $95.16-$100.91, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Intellectual Honesty - Chart of the Day


Intellectual Honesty - Virtual Portfolio

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