Retail: The Cost of Sales


December sales didn’t quite materialize as many had hoped. While the ratio of beats-to-misses was net positive at 2:1 (16 companies beat to 8 misses) the resounding takeaway this morning is the cost at which these sales came. With the majority of retailers looking to clear inventories in the midst of an unseasonably warm holiday selling season (least snowfall in over 50 years) coupled with consumers coming in later to purchase, promotional activity accelerated into month end crippling margins across the industry.


The result is ‘guide-down’ activity outpacing ‘guide-ups’ by a count of 8-to-6 this morning. More important is the magnitude of Q4 revisions i.e. JCP (-38% consensus/prior guidance), PLCE (-26%), AEO (-19%), and KSS (-14%). Consistent with last month’s sales performance and our Key Q4 Themes, margins continue to come in weaker than expected particularly at the mid-tier where there is clearly blood in the water. Just a week after SHLD lowered its guidance, both JCP and KSS lowered their own while GPS missed comp expectations yet again.


Volatility continues to increase in retail and is expanding the bifurcation between upward and downward revisions as is clearly evident through the first two months of the quarter. We expect Q4 results to reflect this reality and for volatility and this bifurcation to remain clear and present through the 1H at a minimum in an increasingly more competitive pricing environment.


A few additional callouts in December:

  • The High/Low-end performance spread remains divergent. Within department stores, JWN +8.7%, M +6.2%, SKS +5.8% were solid while JCP +0.3%, KSS -0.1% came in slightly above and below expectations respectively, but both materially lowered Q4 guidance. BONT -0.7% continues to be the department store laggard.
  • Food/Grocery continues to outperform driving results at discounters. Both COST and TGT reported the food/grocery up LDD outpacing all other categories. While COST came in better than expected, TGT came in light as home and hardlines weighed on sales. Notably, TGT was one of only a handful of retailers highlighting its inventory position noting they were in ‘very good condition’ at month end.
  • TGT’s results mark its second consecutive sequential comp decline since Aug11 and its lowest 2yr comp of +1.3% since Jan11. This was perhaps the only negative earnings revision due to weaker sales instead of margins imploding in December. The key here was TGT’s favorable inventory position headed into the holiday that allowed it to be less promotional. Weakness on the margin at TGT a net positive for WMT.
  • GPS posted the biggest miss of the month coming in -4.0% vs. -1.9%E. Perversely, this could be viewed as incrementally positive reflecting lower promotional activity = stronger margins; however, we would strongly caution against such optimism given the visible stress in GPS’ competitive set.
  • JCP & KSS reported the most significant negative Q4 earnings revisions of the monthly contributors. Of the companies to report seasonal results, PLCE and AEO took the honors. Consistent with the rest of retail, both highlighted sales coming in as or better than expectations with ‘margins down due to increased promotional activity.’ That was clearly the tag-line du jour this month.
  • The clear positive standout of December was M. Not only did comps come in better than expected (+6.2% vs. +4.7%E), they also raised guidance (i.e. not at the expense of margins). Online continues to drive sales coming in up +36%. More importantly is the company’s more aggressive stance towards capital allocation. Macy’s announced it would double its dividend as well as significantly increase its share repurchase authorization by $1Bn from the $850mm, which was just reinstated in Aug11. Good for PVH, RL and others over-indexed to M.
  • At the category level, hardlines were negative while softlines/apparel was positive at both COST and TGT. Despite SHLD noting weakness in appliances sales were up at COST and home was up at both KSS and TGT.

Longs: LIZ, WMT, NKE, RL



Casey Flavin


Retail: The Cost of Sales - total SSS


Retail: The Cost of Sales - 1 yr comps


Retail: The Cost of Sales - 2 yr comps


Retail: The Cost of Sales - 3 yr comp


Retail: The Cost of Sales - Equal Weighted SSS


Retail: The Cost of Sales - TGT Sales Grid



Lowered Expectations: FLAT Trade Update

Conclusion: Economic growth is slowing at a slower rate, which is a leading indicator for accelerating growth. As such, we’ve decided to part ways with the flattener.


Earlier this morning, Keith booked a rather sizeable gain vs. our cost basis in the Hedgeye Virtual Portfolio via a sale of the iPath U.S. Treasury Flattener ETN (FLAT). Having held the position since late FEB ’11, our use of the time-tested buy-and-hold technique was driven primarily by our once highly-contested belief that: 

  1. U.S. economic growth was slowing based on our PTA analysis… supported by Reinhart and Rogoff data (sovereign debt structurally impairs growth beyond 90% of GDP);
  2. Consensus (both sellside and buyside) estimates for U.S. economic growth were going to be dragged dramatically lower as the data came in light; and
  3. The U.S. Treasury yield curve would flatten from a near all-time wide as a result of #1 and #2. 

As a result of point #3, the FLAT ETN finished 2011 up +26.8%.


Lowered Expectations: FLAT Trade Update - 1


Looking ahead to the game that’s in front of us, our process continues to focus on the slope of growth – rather than the absolute – as macro markets continue to be driven by slopes, spreads, probabilities, and ranges, NOT neatly-wrapped full-year growth and inflation targets. We’ll be discussing these modeling concepts in greater detail on our 1Q12 Themes Call next Wednesday; for now, refer to Howard Penney’s Early Look from yesterday for more on this subject.


From a slope perspective, U.S. economic growth is still slowing. It is, however, slowing at a slower rate than before, which means that the intermediate term slope of probable economic growth scenarios is flattening out (no pun intended). While certainly not an outright bullish catalyst for beta, it is decidedly less bearish than it was a year ago. 


Bottoms, like tops, are processes, not points.


What would get us to start sending emails titled: U.S. Growth Accelerating?: 

  1. Further strength in King Dollar, which has shown a positive correlation to improving labor market trends over the past 40-plus years of data;
  2. Further Deflating of the Inflation as a result… a direct benefit to the “C” in the C + I + G + NetExp equation (i.e. ~70% of the total);
  3. Quantitative confirmation of the Bullish Formation in U.S. equities in the Treasury bond market… key yield breakout/FLAT breakdown levels to watch are included in the charts below. 

Until then, manage the immediate-term risk associated with the proactively predictable game of tug-o-war between perma-bulls and perma-bears that occurs at every top or bottom.


Darius Dale

Senior Analyst


Lowered Expectations: FLAT Trade Update - 2


Lowered Expectations: FLAT Trade Update - 3

Bullish TAIL: SP500 Levels, Refreshed

POSITION: Long Consumer Discretionary (XLY, Long Utilities (XLU)


No one said that being a stock market operator in a centrally planned Keynesian world was for the faint of heart. But this continued strength and stability in the US Dollar has positive implications for the purchasing power of Americans. I bought back WMT and EAT today.


Across all 3 risk management durations in our model, here are the lines that matter most: 

  1. TAIL support = 1267
  2. TRADE support = 1264
  3. TREND support = 1218 

So I have TRADE and TREND support (immediate-term) below my TAIL…


And, I guess, that’s what every man needs when managing the implied risks of his birthday.





Keith R. McCullough
Chief Executive Officer


Bullish TAIL: SP500 Levels, Refreshed - SPX

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Keith bought MPEL in the Hedgeye Virtual Portfolio at $9.61.  According to his model, there is TRADE resistance at $9.98 and TREND support at $9.19



As we mentioned yesterday in "MACAU: A DETAILED ANALYSIS OF THE DECEMBER #S", we believe MPEL should exceed consensus Q4 EBITDA estimates by the largest margin among the Macau operators.  Currently, we're 12% ahead of the Street.  MPEL’s continued growth in Mass revenues should boost margins and the company will benefit from a strong January due to the timing of Chinese New Year.  MPEL trades at a 30-40% discount to the peer group and at under 7x 2012 EV/EBITDA is near an all-time low.



WMT: Buying

KM buying WMT back on retail weakness after selling higher last week. We like WMT over all three of Hedgeye’s risk management durations for the following reasons…


1) US business is inflecting after years of investing to turn the cruise ship. This is partially apparent in WMT outperforming peers this holiday -- in part due to layaway plan, but also due to better alignment outside of consumables.    


2) Great play on stronger dollar heading into 2012. 

3) Street estimates are low next year by 3-4%. Not huge, but meaningful for WMT. 

4) Though not really 'new' is share repo is a part of many investors' thesis, the fact is that the Walton Family is slowly but surely taking the company private. 

5) Sentiment (per our backtested indicator) has never been worse.  


WMT: Buying - WMT update


WMT: Buying - WMT sentiment


Scarce US transactions in Q4 but 2011 was a better year overall



Market M&A Trends for Q4

  • Q4 US hotel transaction volume fell to $1BN from $3BN in Q3 2011 and $4BN in Q2 2011.  But US transaction volume ended 2011 almost doubling that of 2010’s total.
    • The number of US hotel transactions in Q4 was significantly lower QoQ
    • US Average Price per key in the Upper Upscale segment has dropped steadily since Q2 2011
    • The European market, particularly in the UK, was more active than that of the US
  • REITs/JVs accounted for the majority of the market activity
  • Accor took part in several deals as part of the firm’s Group Asset Management strategy 
  • According to Fitch, hotel delinquencies continue to improve as November’s 12.7% rate was below September’s 13.3%

Luxury Segment

  • Average Price per Key
    • Q4 2011
      • US average: $224,785 (3 transactions)
      • Elsewhere average: $621,382 (6 transactions)
    • Q3 2011
      • US average: $632,270  (2 transactions)
      • Elsewhere average: $858,612 (2 transactions)
    • Q2 2011
      • US average: $406,250 (4 transactions)
      • Elsewhere average:  $788,461 (3 transactions)

Upper Upscale Segment

  • Average Price per Key
    • Q4 2011
      • US average: $207,026 (6 transactions)
      • Elsewhere average: $348,667 (5 transactions)
    • Q3 2011
      • US average: $253,736 (8 transactions)
      • Elsewhere average: $338,661 (4 transactions)
    • Q2 2011
      • US average: $355,382 (13 transactions)
      • Elsewhere average: $250,152 (2 transactions)

Chain Scale

L: Luxury

UU: Upper Upscale

U: Upscale

M: Midscale

E: Economy



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