Retail: Key 4Q Themes


Conclusion: Here’s some of the most telling management quotes from 3Q, as well as our take on three important themes. With higher opex in 4Q – some which has been deferred – and 5 quarters of Inv/Sales erosion, elasticity will be a major factor in flushing out margins.



In looking back over Q3 results, several notable themes have emerged from Retail.  Most notably, they related to the following…

  • Driving Operating Expenses Higher.  This was a common theme across all sub-categories -- especially among the poorer quality companies that need to catch up on years of deferred spending. Whether it be in the form of incremental marketing, added head count, or various IT improvements (e.g. mobile POS functionality), retailers are having to work harder and spend more to drive sales.
  • Price Elasticity. Simply put, the better the product, the lower the elasticity. This has nothing to do with price. It’s all about perceived value.
  • The Inventory Growth/Gross Margin Trade-Off. Five sequential quarters of sales/inventory erosion without commensurate decline in margins is absolutely unsustainable. There’s meaningful Gross Margin risk if the consumer does not comp the 5.2% holiday performance from last year.

Here’s a quick look at some key commentary from management teams, as well as our take…


1) Elasticity:

HBI: “While units have declined, sales dollars are still quite strong. And even with the third price increase that was effective in late September, sell-through data across our major accounts indicate elasticity is at or better than our expectations…” – CEO Rich Noll

CRI: “Excluding Canada, we're forecasting inventory units at year-end to be up slightly over a year ago, with dollars up in the low 20% range reflecting largely the ongoing impact of higher product costs.” – CEO Michael Casey

GPS: “You put your plan together. Consumers respond to it, or in some cases, in Old Navy's case in October with their comp, did not respond to a level we had hoped for, so we have to make some adjustments and make sure we're aggressive in terms of our pricing, sharpen up our value proposition, and make sure we're prepared to compete in the fourth quarter… Strategically, I said in the opening comments, we have to broaden the bands of our pricing. We've been testing this, we just didn't do it all of a sudden. We've been trying that in certain categories and we've been getting good response.” – CEO Glenn Murphy

TGT: “As we expected, our guests have demonstrated a propensity to spend about the same dollar amounts through this period as they otherwise might have, essentially managing their household budgets by decreasing the number of units purchased.” – CFO Doug Scovanner

JCP: “We are on track the first couple weeks in November. We are seeing the kind of increase in AUR that we planned and we are seeing the corresponding decrease in units that we planned. So I think that we have every reason to believe at this point in time in the fourth quarter that we are on track to achieve our AUR expectations and that we will have the units necessary to take care of Christmas.” – CEO, Mike Ullman

DKS: “If we got into the gun and ammunition business, that's pretty price-sensitive business and that has not reacted particularly well to price increases. We take on the Nike side, the Under Armour side, if the brands bring to market great products, great designs, and technological advancements, the customers have pretty much stepped to the plate and said, yes, I need to have that product, whether it be increases in prices along key styles of football cleats, basketball shoes, running shoes, compression product, North Face products. Columbia has moved up their average unit retail with their Omni-Heat pretty substantially, and the customer has accepted that.” – CEO Ed Stack

GCO: “The overall theme is that ASPs were up. And for the obvious reason of the cost base driving costs to us in our branded businesses, and as we've discussed before, our expectation has always been that we get some of that back or all of that back, with retail price increases. And that's essentially the pattern we've been seeing.” – CEO Bob Dennis

PERY: “We have not been able to pass along full price increases to offset cost inflation in basic due to this fact. We have been able to get price increases in fashion goods, but in products where the consumer has not accepted the increases, retailers have had to be more promotional to move the inventory, which has resulted in higher markdowns. Our fall Perry Ellis Collection product did not perform to expectations. Some of the product that was not differentiated enough in the eyes of the consumer to warrant an increase in price, thus the value equation was wrong. We are looking at fourth-quarter increases in our organic store businesses of mid-to high single digits, driven by units down LSD, price increases in the HSD area, consistent with Q3.” – CEO George Feldenkreis


Hedgeye Retail: We think all the talk of high-end vs. low-end, is blown out of proportion.  The bottom line here is that great product will not be price sensitive. Product that is ‘above average’ is on the fringe with price increases – in that perhaps a good process or marketing plan can make a difference. Product that is ‘average’ will have a problem. ‘Below average’ is a disaster.  


2) Inventory/GM Trade:


GPS: “Our Q4 planned inventory unit buys are down. Similar to Q3, we expect our inventory dollars per store at the end of the fourth quarter to be up in the mid to high single digits.” – CFO Sabrina Simmons

CRI: “Overall the quality of our inventory remains excellent. Consistent with last quarter, roughly 5% of our inventory is characterized as excess, a consistent proportion of total inventory as a year ago. And we're well reserved for the expected losses on these items.” – CFO Rich Westenberger

PLCE:When you look at the mall-based competition, we have kept our value space and kept notably below their price points 25% to 30%, but I think what we have seen there is we have seen very high inventory levels and very high degrees of promotion really all year. You can see it in the margins with the mall-based competitors and you can see it in the sales they are running. We don't anticipate, based on their inventory levels, that that is going to end anytime soon.” – CEO Jane Elfers

M: “Our stores are more set than ever for the holiday selling, and we hope that that pays off. Remember, though, that the higher in-transit will continue to be a factor at year-end, and at this point we expect to end the year with balance-sheet inventory up 6% to 7%, but comp-store inventory up less than half of that amount.” – CFO Karen Hoguet

JCP: “Our gross margin in the third quarter was impacted by the softer-than-expected selling environment, which resulted in higher promotional activity and more markdowns in the quarter.” – CFO Michael Dastugue


“The other half was in markdowns to clear the goods that -- we felt we needed to be in the right stock position coming into the fourth quarter. We are very satisfied with what we own today in terms of inventories appropriate for the fourth quarter. I would say as to the outlook for the fourth quarter, the reason we feel more confident about maintaining the margin at flat or slightly down is that, last year, we had a very difficult margin for the fourth quarter.” – CEO Mike Ullman

DKS: “Merchandise margin increased as a percentage of sales, primarily due to the continued effective inventory management, as evidenced by less clearance activity compared with last year and a shift in product mix...Meanwhile, inventory per square foot increased only 0.1%. On a consolidated same-store basis, our sales increased 4.1%.” – CEO Ed Stack

DLTR: “Consolidated inventory per selling square foot decreased by 1.2%. Inventory turns have been increasing for the past six years, and we expect this trend to continue for the full year of 2011. We have gotten better with looking at stores as far as clustering them and determining how to open them up, what inventory categories are going to be important store by store. So a lot of it is technology that we have been able to implement and continue to gain efficiencies that have continued to help us.” – CEO Bob Sasser

WSM: “Product sourcing initiatives and a strategic promotional calendar combined with tight inventories and strong expense management offset lower selling margins that resulted from a more promotional competitive environment.” – CEO Laura Alber

BKE: “Last year, we felt like we missed some business by being too low on our denim inventory, as well as certain top categories, and also in the men's outerwear, we did not have everything shipped to us last year, so we improved our inventory position there. So we felt that our inventory -- we wanted to capitalize on some of opportunities for holiday on several of those categories.” – CEO Dennis Nelson


Hedgeye Retail: Inventories have come down over each of the last two quarters, but not at the rate they need to in order to avoid a scenario where retailers are forced to get increasingly more aggressive on pricing. We’ve seen deterioration in the sales/inventory spread in apparel for five consecutive quarters without meaningful Gross Margin erosion. That is simply (and mathematically) not sustainable.


3) Accelerated SG&A/Marketing Spending:

VFC: “As we entered the year, what we indicated was, for the fourth quarter, that we thought our marketing spend could actually be down a little bit in the fourth quarter given that, given that we were up against such a -- that big increase in 2010 ($45mm in Q4 and an incremental $100mm in FY10). But at this point in time, we are spending some more. Again, we have seen such great success relative to our overall marketing spend and the investments that we have been making beyond on our brands. We are convinced that it at least plays a part in terms of the momentum that we are seeing. So at this point in time, we will spend more in the fourth quarter than we did over the high level of last year.” – CFO Bob Shearer

UA: “While we expect a generally consistent level of dollars spent as implied in our prior guidance, our higher top line guidance should allow us to leverage this line to a greater extent. We now expect marketing spending as a percentage of net revenues between 11.2% and 11.3%. This additional leverage in marketing will be offset by higher spending in selling costs related to our direct to consumer business as we continue to invest to drive current and future growth.” – CFO Brad Dickerson

GPS: “One of the big investments we've made and I'm comfortable doing it, is to make sure we continue to keep up a fairly aggressive level of marketing in 2011, 2012, and probably beyond.” – CEO Glenn Murphy

JCP: “SG&A for the quarter came in better than anticipated…this was driven primarily by our decrease in marketing spend, lower credit costs and benefits realized from our expense reduction initiatives.” – CFO Michael Dastugue

DKS: “But I think that most of our issues from the outdoor standpoint were really self-inflicted, from what we did from a marketing standpoint, and as we kind of moved into the third quarter, we thought that we would be more aggressive and we would change some of those marketing dollars back to that category of business, and we're pleased with the results.” – CEO Ed Stack

PSS:Our marketing is increased for next year into 2012 and will be refocused obviously as it relates to our ongoing strategy. So the messaging is segmented proportionately to our strategy.” – CEO Payless ShoeSource LuAnn Via


“We are looking to reallocate some of the money that we spend, and, for instance, we are looking to spend a relative amount more on marketing, but we are looking to take other expenses out. And we are looking to invest where we can grow and invest to connect with consumers and invest in the front end and customer facing.” – CAO Doug Treff


Hedgeye Retail: We’re going to start to see a lot of deferred SG&A spend. Unfortunately for those companies, the ones that they’re catching up to are still putting coin to work.  We’re going to see competitive spreads widen.


Take a look at the industry SIGMA for Q3-to-date. Operating margins have improved on the margin which is good, but the sales/inventory spread essentially remained flat – not good at all. Rather than getting more aggressive in flushing out inventories headed into what is lining up to be a highly competitive holiday season, the industry sacrificed some sales to improve profitability over the short-term at the expense of risking greater deterioration in profits over the intermediate-term. As we have seen over the last several months, sales are decelerating. One of the key factors that has propped up consumer spending to date has been a reduction in the personal saving rate. While it could go lower, we don’t expect to see it with home values continuing to decline.


Inventories have come down over each of the last two quarters, but not at the rate they need to in order to avoid a scenario where retailers are forced to get increasingly more aggressive on pricing. We expect the worst of it to play out in the domestic mid-tier market.



Longs: NKE, LIZ, WMT, RL


Retail: Key 4Q Themes - Industry SIGMA


Retail: Key 4Q Themes - Industry Pods


Retail: Key 4Q Themes - NRF Analysis



Not Good: SP500 Levels, Refreshed

POSITION: Long Healthcare (XLV)


Long anything here is not good. The SP500 is in a Bearish Formation (bearish across all 3 risk management durations): 

  1. TAIL resistance remains up at 1270
  2. TREND resistance (was support) now at 1203
  3. TRADE support is loosely held at 1158 

I think the bulls are trapped for now and have to sell all bounces provided we remain < 1203.


King Dollar is breaking out. The Correlation Crash remains a very relevant risk.



Keith R. McCullough
Chief Executive Officer


Not Good: SP500 Levels, Refreshed - SPX


Who knew what when? Our price divergence model shows that KONA is outperforming peers over the 6 and 12 month time horizons but underperforming on 1 week, 2 week, and 1 month durations.    


All of our previous work on KONA suggested that the company was headed in the right direction.  In June 2011, the board fired the CEO Marc Buehler and now we have learned that CFO Mark Robinow is no longer with the firm.


The company made the announcement of Mark leaving the firm in a press release announcing a share repurchase program of $5 million.  As I see it, the important news is the fact that Mark is no longer the CFO, not that the company thinks their stocks represents a good value.


However, even putting Mark’s departure aside, the announcement of a share repurchase program represents a big red flag!  The first use of any cash the company has should be to build stores not buy back stock.  In my view, the stock repurchase plan is an admission by the current executive team that the departure of the CFO is a real problem.


Until further notice, any positive bias we may have had on KONA is no more. 


As one client said to me this morning, it's “amateur hour” in The Grand Canyon State!


KONA – BIZZARE EVENTS - subsector fbr



Howard Penney

Managing Director


Rory Green


the macro show

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Initial jobless claims came in at 393k versus 390k consensus and a revised 391k for the week prior.


THE HBM: YUM, MCD, DNKN, CBRL, KONA, CAKE - initial claims 1123



Notes below from CEO Keith McCullough


Santa needs turkey and beverage.

  1. ASIA – Equities are crashing again after the NOV Chinese PMI print came in at 48 vs 51 and stocks moved back into the -20% peak-to-trough zone for the YTD (HK -2.1% and down -26.7% from YTD high; India down another -2.2% and down -23.3% from YTD high); both Hong Kong (which we’re short) and Singapore reported very elevated inflation readings (+5.8% and +5.4.% y/y)
  2. EUROPEAN STAGFLATION  - this is still my call and it’s not consensus; European consensus is for a recession – Stagflation gets a much lower equity market multiple; on the Stag side of the ledger, Germany and France reported awful Manufacturing PMI #s of 47.9 and 47.6, respectively this morn; Germany has plenty of debt to issue in NOV/DEC and their auction today was not good.
  3. TREASURIES – the Long-Bond and US Dollar is where this November Santa is at! 10yr plummeting to 1.90% this morning and finally immediate-term oversold as the Yield Spread continues to collapse (down another 9bps wk/wk to 164bps wide).

Deutsche Bank and Dexia are the lead dominos in a long list of European banks getting in line for bailout funds.





THE HBM: YUM, MCD, DNKN, CBRL, KONA, CAKE - subsector fbr





YUM:  Yum! Brands said Tuesday that it will separate its India business from Yum! Restaurants International and create a separate divison, a standalone, called Yum! Restaurants India.   Niren Chaudhary has been promoted to president of the new division.  CEO David Novak said that he is confident that India will turn into “a major growth engine for Yum”.


MCD: McDonald’s is testing out a new style, conceived by Paris designer Patrick Norguet, at a store in Villefranche-de-Auragais, according to the LA Times.  The redesign is part of an effort to change the chain’s image in France from teen hangout to family restaurant.


THE HBM: YUM, MCD, DNKN, CBRL, KONA, CAKE - MCD villefranche reimage



DNKN:  Dunkin’ Donuts is launching a twitter promotion that gives fans the chance to win a Keurig brewer and a box of Dunkin’ Donuts K-Cups.  One winner per hour will be randomly selected from anyone that tweets the hashtag #DDKCUPPACKS and shares how Dunkin’ Donuts K-Cup packs keep them running throughout the holiday season.  The promotion begins at 6AM Friday and ends at 11AM; there will be five winners, total.





CBRL: During Cracker Barrel’s earnings call yesterday morning, management expressed confidence in sales trends which are, according to the company, improving in November from October.  Advertising guidance for the year was unchanged.  The company aims to raise price 2-3% in FY12 and notes that beef, dairy and coffee costs are up sharply.


KONA: Kona Grill says that Mark Robinow is no longer Executive Vice President, CFO, and Secretary of the company, effective as of 11/21. In the same press release, Kona Grill announced the authorization of the repurchase of up to $5 million of the company’s outstanding common stock.  We are changing our stance from positive to negative.  Buying back stock is the wrong decision in our view, given the cash position of the company and the need for store growth.


CAKE: Cheesecake Factory was maintained “Equalweight” at Barlcays.




Howard Penney

Managing Director


Rory Green




The Macau Metro Monitor, November 23, 2011




Total visitor arrivals increased by 13.6% YoY to 2,376,643 in October 2011.  Visitors from Mainland China surged by 30.5% YoY to 1,466,545 in October 2011, with the majority coming from Guangdong Province, Fujian Province and Hunan Province.  Mainland visitors traveling to Macau under the Individual Visit Scheme totaled 577,691, up by 20.5%.





Singapore Changi Airport passenger traffic was up 8.3% YoY to 3,878,788 in October.  September passenger traffic grew 12.5% YoY.



S'pore CPI increased 5.4% YoY, surpassing economists' forecast of 5.2%.  Core inflation in October was +0.3% MoM and +2.3% YoY.  



Casino worker average salary has reached MOP 13,500 in Q3.

Santa Mario

This note was originally published at 8am on November 18, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“We should not be waiting any longer.”

-Mario Draghi


In one of the more suspicious central planning moves to-date, it appears that the new Italian Chief of Central Planning, Mario Draghi, is working on changing the date of Christmas.


Santa, as you can see, is really red. This whole thing about the Nasdaq and US Small Caps being down for 3 consecutive weeks in November (SP500 down -3%) has Bernanke’s central plan for reaching “escape velocity” from the chimney under fire too.


If Americans and Europeans change all of the rules and all of the dates, there’s really a lot we can do. You see, this is what these people fundamentally believe – they can save us from, well, just about any problem they perpetuate.


The aforementioned quote came from Santa Mario this morning where he started calling out the Germans in Frankfurt. “Where is the implementation of these long standing decisions?” Draghi asked.


Q: Qu’est ce qui ce passe avec Le Bazooka pour les banks? demanded Monsieur Sarkozy.


A: “If politicians believe the ECB can solve the problem of the Euro’s weakness, then they’re trying to convince themselves of something that won’t happen.” –Angela Merkel


Bad German Santa. Bad.


Back to the Global Macro Grind


Yesterday I covered shorts and bought some of our Hedgeye Best Ideas on the long side (ask for the replay of our analyst team’s Best Ideas Call from last Friday), taking my net long position in the Hedgeye Portfolio to one of its most bullish leans in November (12 LONGS, 8 SHORTS).


That doesn’t mean I believe in Le Pere Noel or that a few Keynesians by the name of Mario are going to save me on the long side either. It simply means that I am doing what my risk management process allows me to do – Fade Beta.


Fading Beta means buying on red and selling on green. It’s not as complicated as figuring out the European catalyst calendar. It’s just math. I base these decisions on a model that I’ve built. I don’t have to ask my boss for permission to act on its signals.


The risk management signals aren’t perfect, but they’ve been better than being Bad Beta in November. We’ve booked 13 consecutive gains on the long side of the Hedgeye Portfolio and have gone 17 for 19 in November. Beats believing in Santa too.


Like all of you, I’m proud of my team and process when they are working together. I’m not a whiner. I celebrate winning. And hopefully that message is resonating with your process. At the end of the day, this business is all about the score. Winning matters.


Where do we go from here?


On the bounce, sell on green, again.




All low-volume rallies to lower-highs in Asian, European, and US Equities are to be sold until consensus fundamentally starts to come to grips with what the Germans are saying. 

  1. If any European banks are going to be bailed out, German banks get to go first (Deutsche Bank, Commerzbank, etc).
  2. If any French or Italian banker thinks Lagarde or Draghi are getting them a priority pass ahead of German banks, they should think that through again…
  3. If and when all of these Greek, French, Italian, etc banks prove that they can’t raise money (read: secondaries in the public market), they have to tap their sovereign leaders first, then start begging for the EFSF funding. 

Like intermediate-term tops in markets, the deleveraging of balance sheets is a process, not a point. There have been plenty of points in the last 3 to 24 months where pundits have made the call that “this is it – this is the bottom for the banks”, but the process of marking bank stocks and their equity values to market continues to trump all hopes.


Hope (and begging for Santa Mario), is not a risk management process. And “printing money”, according to Merkel’s spokesman on the economy this morning, “… at the end of the day means inflation…” and “every German is very much scared about inflation.”


As Ben Bernanke anchors on the 1930s (instead of the 1970s Stagflation), the German Zeitgeist is anchoring on the 1920s. Interconnected risk is not managed on one duration to suit the needs of one country’s central banking narrative over another’s. Interconnected risk is multi-duration, multi-factor, and global.


If you don’t get that yet, you probably still believe in Santa coming this November too.


My immediate-term support and resistance ranges for Gold (bought more yesterday), Oil (Bullish Formation and inflationary), French CAC (Bearish Formation), and the SP500 (Bearish TAIL; Bullish TREND) are now $1722-1778, $98.12-101.96, 3002-3146, and 1212-1239.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Santa Mario - Chart of the Day


Santa Mario - Virtual Portfolio


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