Today after the close, Starbucks announced what we expected them to announce one year ago; the company is set to produce its own Verismo home-brewer for at-home espresso and coffee beverages.  As a signal of intent, the company stated at the top of its press release, “Starbucks targets global leadership of the nearly $8 billion premium single cup category”.  The “Verismo system by Starbucks” will be sold online and at select Starbucks retail stores, as well as specialty retailers across the U.S., Canada, and in select international markets, according to the press release. 


Our thinking on this topic has been the same for the last year; Starbucks wants to control its customer’s experience of its product.  We saw evidence of that that in Howard Schultz’s commentary, the ending of the distribution agreement with Kraft, and now we are seeing it again with this aggressive move against Green Mountain.  We are copying our post from February 2011, below.  


In particular, we would direct you to the quote in today's press release from Starbucks president of Channel Development for Starbucks, Jeff Hansberry: “We now have the opportunity to reach millions of customers who have been looking and waiting for a uniquely Starbucks solution in the fast-growing premium single cup coffee market with a coffee quality, taste, roast variety and design sensibility that is consistent with Starbucks brand and reputation."


In the post from last year, we also cited Hansberry in a press release from February 2011, this time making a strikingly similar statement to the quote above: "The single-serve coffee category in the U.S., and much of the world for that matter, is in its beginning stages of development.  At this very early stage, there are numerous contenders and no demonstrated, long-term winners related to either format or machines. Following our very successful introduction of Starbucks VIA® Ready Brew in the U.S. and into a growing number of international markets, Starbucks will continue to explore the many single-serve and on-the-go solutions and options available to us, and to participate in those where we can better and more conveniently serve our customers wherever they may be. Look for further announcements from Starbucks as we continue to expand our presence in the premium single-serve category.”






The future of the single-serve category is Starbucks’ to shape.  While the company may engage in several philanthropic endeavors, I do not see GMCR as one of their causes.


The importance of social and digit digital media channels and investments in technology to our overall strategy is increasing and becoming a significant competitive advantage as we create rich, emotional engagement with consumers and enhance their Starbucks experience, while at the same time benefiting from the lower cost of customer acquisition.  -Howard Schultz, 1Q11 Earnings Call, 1/26/2011


I’m not privy to the thought process or grand strategy of Starbucks but I have been covering the company since the day it came public.  A few weeks ago, I spent a weekend reading The New Rules of Retail, by Robin Lewis and Michael Dart, a tour de force that I believe offers a tremendous look-back and look-forward at the past, present, and future of retail.  I highly recommend it.


Without wanting to spoil the book, the key shifts in the consumer that Lewis and Dart outline pertaining to the new, third “wave” of retail are:

  • From needing “stuff” to wanting experiences
  • From conformity to customization
  • From plutocracy to democracy
  • From wanting new to demanding new and demanding now
  • From self to community

The shift from ubiquitous brands such as GAP and Levi’s to niche brands, from large chains to small brands, and from (perceived-to-be) socially irresponsible firms to (perceived-to-be) socially responsible firms certainly corroborates with The New Rules of Retail thesis.   I see the first bullet as being most crucial here; the chains that offer an experience, and the anticipation of such, are thriving while those standing still in this regard are faltering.  Starbucks offers an addictive product and Schultz has succeeded, for many people, in creating a “third place” between work and home.





Starbucks has learned some lessons the hard way.  Simply by way of human nature, confidence can grow to outsized proportions and a company’s store base can grow in step with that.  Lewis and Dart, in discussing Starbucks, references an internal memo from Schultz  to then-CEO Jim Donald from 2/14/07 that was highly self-critical, lamenting the concept’s move towards standardized, aroma-less, uniform stores that were seen as “sterile” and “cookie cutter”.   Moving back towards former practices and restoring the experience has yielded positive results for Starbucks.  On new channels of growth, and Via in particular, Lewis and Dart have this to say (page 194), “If Via, it’s new instant coffee brand, is going to have sustained resonance in the supermarkets, it will be because people associate it with the Starbucks experience in the stores.  If that experience remains strong and powerful, Schult’z wholesale strategy for growth will succeed.”


If Lewis and Dart’s argument is credible, and I believe it is, the idea of Starbucks putting their coffee through the Keurig machine does not make sense.





Starbucks has certainly been taking up a lot of airtime of late, beginning with the dispute with Kraft, then with their most recent strong earnings release, and now with the speculation around the myriad of possible avenues they may take towards growth in the single-serve market.  I believe that the quote in the last paragraph is crucial to this whole story; customers have to associate the consumption of Starbucks’ products with the Starbucks in-store experience for it to truly gain traction and serve as a vehicle for earnings growth.


Earlier in The New Rules of Retail, on page 149, Lewis and Dart outline control as a key attribute of successful retailers heading into the next phase, or third wave, of retail.  Having maximum control, if not outright ownership, of their entire supply chains from creation through consumption, is a key characteristic of the winning brands.


The dissolution of the agreement with Kraft fits neatly into this framework.  Both sides have been outspoken in their public and mutual admonishments.  Starbucks, for its part, has alleged that Kraft failed to meet certain provisions of their arrangement, including keeping Starbucks involved in major marketing initiatives.  Whether or not one agrees with this statement – I have no insight to how true or untrue it is – what is clear is that Starbucks are expressing a frustration at a lack of control over the distribution segment of their value chain.  In extricating itself from the agreement with Kraft, Starbucks will likely take a charge that will ultimately prove to be an investment in that it will allow the company to assume more control of its distribution chain in perpetuity.


Given the healthy nature of Starbucks' balance sheet, I think any incurred cost will be kept firmly in perspective; the company appreciates the importance of control.


The single-serve saga is just another act in this play and I do not believe the overall theme will change.  Starbucks is a company that is forward looking and our view is that the coffee machine will be revolutionized by the entrance of the company into the business.  Here is my prediction of what the new Starbucks machine will be like (if not at first, then version 2.0, 3.0 etc.).  Notice that while some of these attributes seem fanciful, they all have founding in both Starbucks’ quest for control and the overall direction of retail, as described by Lewis and Dart and as confirmed by the trends within the space:

  • The design of the machine will evoke the design and feel of the Starbucks store and experience.  I would think black and green, as well as the Siren logo, will feature (experiences)
  • The name will also likely evoke the store.  “My Barista”, “The Siren”, or other names along those lines are likely (experiences)
  • The experience will be customizable, perhaps a touch screen or another user interface that allows the user to provide the machine with specific instructions as to the composition of the coffee they would like (customization)
  • A “menu” (like a playlist in iTunes), where one can save a recipe or style of coffee for repetitive use and save it with a name like, “Jim – morning coffee” (customization)
  • Connection to the internet via home computer system to allow the sharing of “menus” and reception of coffee ideas from Starbucks and fellow machine-owners.  This also allows a direct tap into social networking for the new machine (community)

I’m sure this imagining of ours will be received by many with a high degree of skepticism.  I have two questions and a quote for you.  First, the questions:  If not Starbucks, who?  If not now, when?  This machine, or something like it, will happen.  Starbucks has the ambition, financial muscle, and forward-thinking management team to make it happen.  And I believe they will want to be in the driver's seat, they didn’t seem overly content sharing control with Kraft.  Second, the quote, from ex-Hedgeye Technology Sector Head and friend of the firm, Rebecca Runke’s Black Book in November 2009: “Mobile phones won’t get a lot smaller than this.  After all, they have to reach from your ear to your mouth.” – Fortune magazine, 1989, about the Motorola TAC mobile phone.


I believe Starbucks will ignore the naysayers and enter the single serve market by revolutionizing it.  As we have outlined in the prior “parts” of this post, beginning in January, “Starbucks will do to the single serve coffee maker what Apple did to the market for portable mp3 players”.   In The New Rules of Retail, Lewis and Dart write the following on Apple, “Each purchase, be it an iPod, iPhone, iPad or otherwise, is then customized by each customer to reflect their individual tastes.  This is one of the best examples of a co-creation of experiences with Apple as the platform.”  Starbucks will create a co-creation of experiences between the office, the home, and the store in the same fashion.





To finish, I would like to cite a press release from Starbucks that, at least by our interpretation, further corroborates with our thesis:


“The single-serve coffee category in the U.S., and much of the world for that matter, is in its beginning stages of development.  At this very early stage, there are numerous contenders and no demonstrated, long-term winners related to either format or machines. Following our very successful introduction of Starbucks VIA® Ready Brew in the U.S. and into a growing number of international markets, Starbucks will continue to explore the many single-serve and on-the-go solutions and options available to us, and to participate in those where we can better and more conveniently serve our customers wherever they may be. Look for further announcements from Starbucks as we continue to expand our presence in the premium single-serve category.” - Jeff Hansberry, president, Starbucks Consumer Products Group.


Starbucks wants to control the supply chain from creation to consumption to best serve their customers.  This is clear from the thesis I have laid out, and it is also underlined by Mr. Hansberry’s statement this morning.   At the most recent Annual General Meeting, the global nature of Starbucks’ business was emphasized again and again.  Keurig is, in my view, a more U.S. centric brand than Starbucks would like for a partner in the global single-serve market.  I believe Tassimo, a brand with global penetration, would be a more suitable partner.




Howard Penney

Managing Director


Rory Green


Oil Price Shocks are Leading Indicators of Recessions

Conclusion:  As consumption of oil eclipses 5.5% of GDP, it has historically had clear negative impacts on economic growth.  This relationship is only further enhanced when the there is a “price shock”, so when oil moves up at an accelerated pace.

We recently stumbled upon a tweet that a major brokerage firm did an analysis of the correlation between GDP and the price of oil dating back to 1970 and found that there was literally no correlation.  We’ve heard other pundits suggest that increasing oil prices are, perversely, good for growth.  Or that increasing oil prices are, at the very least, indicators of improving demand and thus an improving economic outlook.  Well, to put it mildly, we beg to differ.


In this note, we wanted to start with some recent history and a series of charts that highlight the impact of rapidly increasing oil prices on certain economic indicators:

  • Brent Oil versus World Food Prices - In the chart below we show one of the derivative impacts of high oil prices, which is that these energy input costs also influence other commodity oriented products, in particular food.  As this chart shows, oil and food prices have basically moved in lockstep over the past nine years.  In fact, the correlation over the period is 0.81, so high, which isn’t totally surprising given that energy is a major input into the production of food.  According the Bureau of Labor Statistics, the average U.S. consumer spends more than 10% of their pre-tax income on food.  Energy is an input cost for food and naturally impacts the cost of food.

Oil Price Shocks are Leading Indicators of Recessions - Food.brent


  • Brent Oil versus Jobless Claims – The relationship between jobless claims and Brent oil is an obvious one if you look at the chart below.  Specifically, a rapidly increasing price of oil is historically an accurate leading indicator for jobless claims.  This occurred three times to note over the last two plus decades, in the late 1980s, in the late 1990s, and in late 2007.

 Oil Price Shocks are Leading Indicators of Recessions - jobless.brent


  • Brent Oil versus Durable Goods Orders – The image below emphasizes that as the price of Brent has stepped up durable goods growth has decelerated.  Durables goods are those goods purchased that are expected to last more than three years.  In the most recent report, durable goods were down -4% year-over-year, with the biggest decline, not surprisingly, in civilian aircraft orders, whose key input cost is jet fuel.  This negative correlation between durable goods orders declining and higher energy prices further supports the idea that consumers, and companies, are unwilling to make longer term, larger ticket investments in an uncertain input cost environment.   

Oil Price Shocks are Leading Indicators of Recessions - dgoodsandbrent



Charles Hall, Steven Balogh, and David Murphy did an analysis of the connection between the price of oil and when recession can be expected, examining the Minimum Energy Return on Investment (EROI).  In their assessment, recession is likely to occur when oil amounts to more than 5.5% of GDP.  Logically, this makes sense.  Even based on the very tainted calculation of CPI, the average U.S. consumer spends 9% of his or her income directly on energy, with the majority allocated to gasoline.  This obviously also excludes the derivative impact of increasing energy costs, such, as we noted above, the increasing costs of food.


Hall, Balogh, and Murphy also modeled out various scenarios of price increases, which we’ve highlighted in the chart below.  They found that price shocks versus gradual increases in prices are much more detrimental to near term GDP growth.  There models considered two types of price shocks.  The first being a 10% price increase that either happens gradually over 5-6 quarters or that happens quickly within two quarters, and the same scenario only with a 50% magnitude price increase.   


Oil Price Shocks are Leading Indicators of Recessions - chart3



Based on all scenarios, the price of oil was a headwind to growth but if a price hike transpired in a shorter period of time it would lead to a more dramatic and an almost exponentially negative impact on GDP growth.  As energy prices accelerate, it creates uncertainty related to the future, which slows decision making.  We actually see this clearly in the durable goods orders chart above.  Consumers slow their durable goods orders in conjunction with increasing energy prices because of both the price, but also increasing concerns related to future economic demand.


The chart directly below shows this long term impact of oil accelerating quickly and reaching 5.5% of GDP going back to 1970.  While certain large investment banks may not have been able to measure the correlation, the relationship is quite obvious in the chart. 


Oil Price Shocks are Leading Indicators of Recessions - chart5



We actually did an analysis of the U.S. economy’s current situation relating to oil consumption.  Based on the assumption that U.S. GDP is roughly $15.0 trillion, that the U.S. uses 19.5 million barrels of oil per day, and based on the current average price of Brent oil for the year at $116 per barrel. Employing that math, U.S. consumption of oil is at 5.51% of GDP, which is clearly in the danger zone.  Now, obviously, our assumptions can be manipulated a little each way and WTI oil is trading at a lower price, but the key point is that we are at, or very close, to a ratio of oil to GDP of 5.5%.


Oil Price Shocks are Leading Indicators of Recessions -  gdp.oilprices



In terms of whether a shock has occurred, the price of Brent has increased 26% from the start of Q4 2011 to today.  Obviously, this isn’t a 50% ramp in the price of Brent, but it is in the realm of a price shock that negatively impacts growth as cited in the study above.


The simple fact is this: nine out ten recessions since World War 2 have been preceded by an increase in oil prices.  Coincidence? Perhaps . . .



Daryl G. Jones

Director of Research






ECB Presser YouTubed

-- At today’s meeting the Governing Council of the ECB decided that the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 1.00%, 1.75%, and 0.25% respectively. Draghi forecasts a very “gradual” to “slow” recovery in Eurozone GDP this year on account of increased foreign demand, low interest rates, structural reforms, and (with stress) an improvement in the risk environment as the major factor propelling this recovery.


To this last point, we’d say this is a large “gamble” considering that even if the market can cope with Greece, there are plenty of other peripherals that are not in a stable fiscal stead. Draghi also stressed the work of the two 36 month LTROs as decisive measures to put Europe back on track (remove “tail risk”) to see improvement, yet he wasn’t able to show material evidence that real lending has happened in response to these huge liquidity dumps, and called on governments and banks to continue reforms and repair balance sheets to support recovery. He did make it clear that they’re in a wait and analyze phase on the impact of the LTRO programs, and don’t have a third scheduled. While these comments are all well and good, we must not forget the pressures of reduced tax receipts to limit debt and deficits in an uncertain credit market, and the stresses on banks that are in the process of writing down their PIIGS paper and repositioning to meet higher capitalization ratios, mandated by June 30th.


Finally, and published after the call, the governing council decided to again accept as collateral any debt instruments that are issued or fully guaranteed by Greece. Yamas!


The language on its main economic outlook was unchanged, noting “signs of stabilization in economic activity at a low level” versus “substantial downside risks” in the February 9th report. The bank said it expects the Eurozone economy to “recover gradually in the course of this year”, but again was quick to say that “this outlook is subject to downside risks”. The Bank forecasts annual real GDP growth in a range between -0.5% and 0.3% in 2012 and between 0.0% and 2.2% in 2013. When compared with the December 2011 Eurosystem staff macroeconomic projections, the ranges have been shifted slightly downwards.


On inflation, the Bank holds roughly the same view, namely that inflation is “now likely to stay above 2% in 2012, mainly owing to recent increases in energy prices, as well as recently announced increases in indirect taxes, and they expect annual inflation rates should fall below 2% in early 2013. The March 2012 ECB staff macroeconomic projections for the euro area foresee annual HICP inflation in a range between 2.1% and 2.7% in 2012 and between 0.9% and 2.3% in 2013. In comparison with the December 2011 Eurosystem staff macroeconomic projections, inflation forecasts have been shifted upwards, notably the range for 2012.”


Finally, Draghi noted the pace of monetary expansion remains subdued. The annual growth rate of M3 was 2.5% in January 2012, up from 1.5% in December 2011. Loan growth to the private sector also remains subdued. However, its annual rate (adjusted for loan sales and securitization) picked up slightly in January to 1.5% year on year from 1.2% in December. The annual growth rates of loans to non-financial corporations and loans to households (adjusted for loan sales and securitization) stood at 0.8% and 2.1% respectively in January.



Top Q&A Responses:


-If LTRO effects are not realized, what else can the ECB do?  Mario Draghi (MD): (laughs) both LTROs have such a complex and powerful effect, so we have to see how financial and economic landscapes have changed following operation. We must thoroughly analyze this.  We have done the LTROs, so now we want to see the effects.


-Regarding the Greek PSI, the ECB has swapped bonds that were exempt from CACs and the ECB has made no statement on this to date, can you comment?   MD: the bonds swapped were from our SMP bond purchasing program and were therefore in the public interest and deserve protection. The balance sheet of the ECB must be protected. Only when protected can the Bank issue price stability for the union.


-We’re in the third week without SMP purchases, is this program history?   MD: correct, inactive in the last 3 weeks. SMP is neither eternal nor infinite.


-How confident are you in the fiscal compact?   MD: I’m confident that the fiscal compact will be implemented. We need countries to give up a level of their national sovereignty around fiscal policy. We cannot have one or two countries pay for everyone else, nor under present conditions could we issue joint bonds. We need rules in place, “pillars of trust” if you will, between countries, and this trust is essential for a monetary union.


-Your thoughts on collateral rules?  MD: they could be looser. 


-Regarding Greece, markets are nervous on PSI, is this justified, or is it what you were expecting? What if PSI doesn’t get sufficient participation?  MD: markets are not nervous today, but rather happy, and they know more than I do.


-Should NCBs prepare for exit of Greece?   MD: there is no plan B; having such a plan would admit defeat. It would be to conceive a reality that goes beyond the treaty.



Additional Q&A:


-Interest rates in Germany are way too low, what happens when Germany heats up and rates in the Eurozone are too low?   MD: we must have monetary policy that is correct for the whole Union. Now, the rate is supportive and accommodative to maintain price stability.


-Last month you didn’t discuss interest rates moves, discussed this month?  MD: No


-Are you confident that Greek PSI will be a success?  MD: unfolding at present time, so inappropriate to comment.


-Overnight ECB deposits are high, are you worried about the LTRO’s impact?  MD: the rise in overnight deposits is just a mechanic consequence of the liquidity creation. We expect the deposit facility to go up in the immediate term, but adjust over the medium term. What we’ve seen is that the identity of the depositors and borrowers are different, so money is being circulated.


-Juergen Stark said today that the ECB balance sheet is shocking. Should we be worried?   MD: not sure what he meant. He agreed on the LTRO, but left before new collateral rules were issued. I will talk to him to see what he means.


-How concerned or upset are you about a leaked Bundesbank letter; are you concerned the ECB is not speaking with one voice?  MD: First I should say that my personal relationship with Jens is excellent. Nobody, contrary to the press, is isolated in the governing council. The ECB has cherished Bundesbank policy for price stability. But now, we’re all custodians of stability. The substance and content of the letter is present in all of our minds, including Target 2 balances. So we share these views. We are all in the same boat, and there’s nothing to gain in arguing outside of the council.




Matthew Hedrick

Senior Analyst

Early Look

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Risk Managing Inflation Expectations: TIP Trade Update

Conclusion: As we have seen repeatedly throughout history, stability in the U.S. Dollar is acting as a governor on the slope of inflation expectations. As such, we have sold our long position in TIPS.


Virtual Portfolio Positioning: Sold our long position in the iShares Barclays TIPS Bond Fund (TIP).


Yesterday afternoon, Keith sold our long position in Treasury Inflation Protected Securities on the strength of a TRADE line breakdown amid signs of stability in the U.S. Dollar Index, our leading indicator for the slope of intermediate-term inflationary pressures. Conversely, a breakdown of the DXY through its TREND line would, once again, get us increasingly hawkish on the intermediate-term slopes of domestic and global inflation readings.


Risk Managing Inflation Expectations: TIP Trade Update - 1


Risk Managing Inflation Expectations: TIP Trade Update - 2


Fundamentally, USD stability acts as a governor on global food, energy, and raw materials prices, and, as a result, a governor on global producer and consumer prices due to the marginal decrease in supply-chain pressures. Particularly in the U.S., given that there is “slack in the labor markets” and that “capacity utilization remains subdued” (to borrow the Fed’s own lingo), the only thing really moving the dial on domestic PPI and CPI readings  is the purchasing power of the U.S. dollar and its impact on price-setting across global commodity markets.


Further, increased clarity in the Republican primary has also been interpreted as dollar-bullish, because it inches consensus one step closer to the generational debate about debts, deficits and monetary policy that we expect to come alive in the months leading up to the general election.


All told, keep your eyes on the aforementioned quantitative levels, as the slope of inflation expectations continues to be the driving force of asset prices globally – a relationship we attribute to investors favoring the reflationary effects of easy monetary policy in the absence of true underlying economic growth momentum and improving fundamentals.


Darius Dale

Senior Analyst


Risk Managing Inflation Expectations: TIP Trade Update - 3


Market share stabilizing in more than one area.



The big takeaways from the following charts are that slot sales are surging and IGT’s installed base and participation share is (finally) stabilizing.  While we liked the slot sector over the near and long term, our concern surrounding IGT was continued declines in their participation share.  That is why chart 2 is so encouraging for our IGT thesis.  The stock is looking pretty washed out here.


Now that Aristocrat has reported, we can confirm that the top 5 manufacturers have shipped 62.4k units to North America.  If we include MGAM, which sold 1.4k units, that gets us to a total of 63.8k.  Our best guess is that the rest of the smaller suppliers (Speilo, Aruze, Ainsworth, etc) shipped a total of approximately 3k units. Tallying up the total gets us to a total of 67k North America shipments in 2011 compared to 63k in 2010.   We estimate that replacement comprised 54.6k of the total shipments to NA vs. 49.4k replacements in 2010 – an 11% increase.


In 2H11, replacements increased 7% YoY to 26.2k.  Almost all the YoY growth in 2H11 occurred in the 3rd quarter, which we estimate had 13.3k replacement shipments and was up 14% YoY while 4Q was up only 1% YoY at 12.9k shipments.


Our estimate for 2012 replacements hasn’t changed much since our last replacement market recap 6 months ago. We believe 2012 will come in at around 59k units with most of the growth back-end loaded, given the tougher 1H comparisons.




The following chart shows our estimate of participation and lease revenue share for the three largest players in the space.  As shown, IGT’s market share has been in a steady decline for almost 7 years since 2004. However, over the last 6 quarters, IGT’s share has been stable to slightly improving.  We view this very favorably.  Growth for IGT and the industry should resume with all of the new markets and casinos opening in the next few years.





VFC: M&A the Other Way

(Correction: Last sentance of opening paragraph was cut off in prior version)


We’re used to seeing VFC involved in M&A deals. It’s simply part of it corporate fabric and for good reason they have had a solid track record of success. But this morning VF is in a less familiar role as the seller of its John Varvatos brand. This is hardly a blockbuster deal (less than $100mm), but we like it for the following reasons:

  • There’s a lot of variety in the 26 primary brands that make up VFC’s consumer branded portfolio (see below), but Varvatos simply didn’t fit in. It’s a luxury men’s apparel brand that sells through luxury department stores like Barneys, Neimans, Bloomie’s, etc. in addition to its 10 free standing stores. VF has plenty of premium brands, but this was its only luxury brand. It was requiring incremental effort in order to maintain relationships with the department stores that VF wouldn’t have been dealing with otherwise – that’s now alleviated.
  • We like the timing. While not a blockbuster deal (financial terms weren’t disclosed), VF is selling an asset in the luxury end of its portfolio just when luxury retail is shinning. As such, whatever the value the deal comes out to (we suspect around $100mm; over $100mm in sales at HSD margin), it’s not likely to have been at depressed multiples.
  • It improves the balance sheet. The proceeds of this deal can be put towards reducing VFC’s debt-to-capital ratio. VF ended the year with a debt-to-capital ratio of 32% well below 40% where the company ended Q3 following the TBL acquisition. While slightly above plan (30% by year end), the company paid off nearly $900mm in debt during Q4 and can generate over $1Bn in FCF this year reflecting a 9% FCF margin despite ramping CapEx spending nearly 2x its historical rate in order to support continued growth, HQ relocation, new DCs, etc. With this level of FCF generation plus an additional ~$100mm from Varvatos, we expect VF to reduce its debt-to-capital ratio to the low-20s in-line with pre acquisition levels by year-end.

All in, this deal isn’t going to have a material financial impact, but the company is selling off a fringe asset in the least profitable segment of the business – it makes perfect sense. We like the stock here and the fact of the matter is that VFC continues to give the market reasons as to why it will likely never look cheap. Moreover, we think VF’s initial F12 outlook appears overly conservative, which shouldn’t come as a surprise to those that have followed this team.


Our model has VF growing EPS at a mid-teens rate over the next two years – without any stretch assumptions. Timberland growth alone gets us there, and we’re not making any heroic assumptions as to the use of VFC’s $1bn in free cash. With the stock trading at 13.9x our F13 estimate of $10.75, and about 10x EBITDA we can’t exactly call it cheap. But estimate revisions are likely to be headed up from here, and you generally don’t want to be on the wrong side of VFC when estimates are heading higher.


Casey Flavin



VFC: M&A the Other Way - VFC JVarvatos



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