• run with the bulls

    get your first month

    of hedgeye free


COMPLIANCE: Greek Eggs And Ham

Greek Eggs And Ham


As an ignorant investor, my main question is if there is truth in investment.


Ted Rees, Professor of Ignorance, Retirement University of Hard Knocks


This is a true story.


Back in “the day” – around the late 1980’s – early 1990’s – when the wave of truly nasty people flooding into the brokerage industry was topping what turned out to be a very long-lasting crest – one highly successful retail brokerage firm trained its new recruits by having them stand in military ranks every morning shouting the dialogue from Dr. Seuss’ Green Eggs And Ham.  If you were ever a child – or if you have one – you know the book.  The story is something of a literary oddment as the narrative is enfolded within its own telling.  Unlike other children’s books, there is no reference to an outside world (parents, school, sibling, dog).  Dr. Seuss has created a self contained reality whose curious focal dish – a unique reality within a unique reality – lies doubly hidden, or doubly absurd, at the heart of the book.  


Sort of like the Greek CDS.


While PhD theses are likely not being written about literary structure in the works of Theodore Geisel (Dr. Seuss’ alter ego) this volume was seized upon by stockbrokers in the late 1980’s as a training manual for persuasive argument.  At the height of the depth of the financial profession – when barely-literate kids were being summoned to the boardrooms of seedy brokerage operations in lower Manhattan – the give and take between Sam and his unnamed prospect became a template for how to handle a phone conversation with a potential stock buyer.


I would not eat them on a plane!


But, Mr. Jones – (for some reason the universal prospect was always called “Mr. Jones” in stockbroker training scripts) – if I could show you how eating them on a plane would benefit you, then wouldn’t you agree that it might be something you should eat?


I would not eat them in a box! 


But, Mr. Jones, if I could show you that the smartest money in the world eats them in a box, then wouldn’t you agree that maybe you should eat them in a box?


This was the rigorous training through which myriad new stockbrokers were put before being unleashed on the public.  In other words, the degree of information they were trained to absorb about the investments they were flogging was minimal.  And they were explicitly told that giving prospective buyers too much information about a stock would result in them losing the sale.  If you give people stuff to think about, they are going to think about it.


Today we have an argument that investors should be informed – that much of the carnage in the investment markets is the fault of Emptors who failed to sufficiently Caveat.  One problem with this refined form of Blaming the Victim is that it presupposes that a person of average intelligence and education can, by a bit of regular diligence, learn enough about their investment portfolio to make informed decisions about whether to buy, or stay away from, an investment.  This completely overlooks the fact that investment vehicles are being created by people with PhD’s from MIT who were trained to design rocket engines, create the next generation of atom bombs, and enhance the range and efficiency of military spy satellite communications.  With Wall Street beckoning, and with government funding for basic scientific research at historically low levels, high-frequency trading systems are clearly a greater societal priority than missile defense or the manned Mars mission. 


Which means the default setting is for the individual investor to get screwed.  Actually, we maintain it is not “collateral damage,” but conscious policy – which brings us to the SEC’s current Financial Literacy Study.  Mandated under Dodd-Frankenstein, the Commission must submit its findings “of retail investors’ financial literacy” to Congress by 21 July.  In January the Commission began accepting “public comment on financial literacy and investor disclosure issues.”


We have sampled a few of the comments – far less voluminous than those submitted regarding the Volcker Rule (see our Screed of 24 February, “Mr. Volcker Goes To Washington.)  We suspect this is primarily because retail investors remain at a monumental informational disadvantage: most of them probably do not know the SEC wants to hear their opinion.


A number of the comments touched on the bizarre fact that, in a nation that considers itself the flagship of Capitalism’s fleet, there is no economic education for our young – and certainly no practical guidance on structuring an investment portfolio, how to select between stocks and bonds, how to assess the differences in ratings for government and corporate debt, how to hedge using listed options, currency arbitrage and its inherent risks – or even how to open a bank account and balance a checkbook.  A sixteen year-old cannot get behind the wheel of a car without passing a written test that at least demonstrates some basic awareness of the fundamentals of good driving, but a 21 year-old can blow his patrimony with options trading.  What does it say about a society that activities for which no education or training are required include handling the finances of your family (or your company), and purchasing a gun?


Mr. Ted Rees – about whom we know only what he posted on the SEC’s website – asks: “I guess the banking collapse is another type of deception, where the banks disguised bad investment as good investments.  Perhaps in translation, this means what can you put into your documents to cover truthfulness?”


What can issuers or brokers say, under current regulation, that is so misleading as to effectively constitute fraud, even while legally permitted?  That’s a great question, Mr. Rees.  Today’s securities markets are not fundamentally different from the 1980’s and 90’s, the roaring, cocaine-fueled days when – as one banker disdainfully said at the time – “they turned the business over to the bridge-and-tunnel crowd.”  In those days having a college degree was seen as laughable, and an MBA was a liability.  The business was all about selling.  You won’t eat green eggs and ham with a fox?  How’s about you eat them on a box?  You don’t want to eat them in the rain?  No problem!  You can eat them on a train!  All I know, Mr. Jones – you gotta eat them.


It is abundantly clear that neither the individual investor nor Congress learned anything from the misdeeds of the retail stock market in its Wild West days.  But Wall Street learned its lesson as many Bad Actors saw in the great implosion an epochal ratification of the dictum that crime does pay.  In fact, on Wall Street crime generally not only pays, but even after one is caught the net take is likely to remain near-astronomical.  The punishment is routinely light – the fine is a small fraction of the money made from the illicit behavior; the Bad Actors must affirmatively neither affirm nor deny that they ever did anything wrong (if you are a lawyer, you understand that clause – if not, find a lawyer and get them to translate for you) and solemnly promise that they will not in future do the things they anyway never admitted doing in the past.    


We do not have global figures to hand, but the loss of personal wealth surrounding the demise of edgy brokers was pretty astounding.  Federal prosecutors charged in 1996 that the demise of A.R. Baron – which they branded a “criminal enterprise” – left customers with losses of $75 million – in 1996 dollars.  This includes losses taken by investors on both sides of the Atlantic.  Indeed, it seems Baron singlehandedly forced a change in the regulatory relationship between the UK and the US because of the number of wealthy British investors who had lost tens of millions of dollars in their brokerage accounts.


The A.R. Baron failure also led to the downfall of Richard Harriton, president of Bear Stearns Clearing, and to Bear paying a $38.5 million settlement to the SEC.  According to an article written at the time (Gretchen Morgenson in Forbes, February 1997, “Sleazy Doings On Wall Street”) Bear Stearns Clearing was handling 12% of the NYSE’s daily volume through its more than 2,100 clearing customers, among whom were a large number of small brokerage firms – including a number of outfits that the SEC had in their crosshairs.  Over the years, Bear had cleared for Rooney Pace and D Blech & Co, to name but two brokerage companies whose failures likewise left tens of millions in losses in their wake.  


It was decidedly suspicious that Bear kept these firms on as clearing clients, even as problems grew with the firms’ customer base, and with their trading positions.  Clearing is the sensitive nerve center of the brokerage business.  Clearing firms are first to get wind of potential problems with their correspondents (customer firms) and famously ruthless in self preservation –Lehman is still suing JPMorgan, its main clearing broker, for “siphoning $8.6 billion of critical assets in the last few days prior to its September 15, 2008, bankruptcy” (Reuters, 1 February, “JPMorgan Slashes $710 Million Lehman Bankruptcy Claim”).  Indeed, the SEC said Bear Clearing “took extraordinary steps to keep Baron in business,” including allowing millions of dollars in unauthorized trades to remain in Baron customer accounts.  Harriton, charged personally with fraud, ended up settling with the SEC.  He paid one million dollars and – without admitting or denying the Commission’s charges – agreed to be barred for life from the securities industry, with the odd qualification that he was to be permitted to reapply for regulatory clearance after two years.  A brief hunt on line reveals Harriton is now president of an entity called Park Avenue Consulting, of which we were not able to find anything other than a LinkedIn listing.


The quote that best sums up Wall Street’s attitude comes from the Morgenson article.  “Bear Stearns spokesperson Hannah Burns says: ‘Clearing is a very, very proprietary business for us, and we don’t want the public knowing about it.’”


Which bears directly on the SEC’s mandate to report on financial literacy and investor disclosure issues as they relate to the private investor.  After the Bear Clearing case, the Commission made moves to substantially overhaul the clearing business.  Some of this resulted in tighter controls governing counterparty risks, and some attempted to tighten controls on illegal short selling, an activity that often takes advantage of slippage in clearing processes.  But none of it has resulted in the investing public being made any wiser about what happens once they hang up the phone after giving their broker an order. 


“Professor” Rees’ terse comment to the SEC says it all.  Still, we thought to read some of the lengthier submissions.  One comes from the Association of Independent Investors, a newly-formed entity based in Vermont and headed by a former Wall Street executive who was active in the industry from 1 and was a senior executive at Merrill Lynch (they invite you to visit them at www.aiinvestors.org).  The Association makes several salient points.  One is the blurring of the regulatory line between brokers and advisers, and an attendant confusion over the professional’s duty to the customer.  “With commission rates at or near zero, broker-dealers have been pushing into the fee-based, or advisory account business.”  The Association says brokers, who are held only to a Suitability Standard (the customer was smart enough to know the risk they were taking, and they could afford the loss, so it’s not my fault the Emptor failed to sufficiently Caveat) “have been offering fee-based advisory accounts for years by taking advantage of regulatory loopholes and by lobbying for special rules,” including registering as both stockbrokers and investment advisor representatives. 


Dual registration brings the professional under the jurisdiction of both the Securities Exchange Act of 1934, and the Investment Advisers Act of 1940.  Where dual registration would logically lead to a professional having two intertwining sets of obligations to their customer, the practice is often to wear the hat of the ’34 Act (the stockbroker’s suitability standard) while marketing a product that comes under the fiduciary standard of the ’40 Advisers Act.  “Regulators have bent over backwards to accommodate the brokerage industry in this,” says the Association, calling for an end to dual registrations.  The letter stops short of championing Chairman Schapiro’s efforts to apply the fiduciary standard across the board, saying rather than brokers should be either fish or fowl, but not a cross between both.


The letter quotes an Investment Company Institute report that “the average expense ratio for an equity mutual fund was 1.45% in 2010.”  In their disclosures (this one’s for you, Professor Rees – a lie permitted under the rules) investment managers are permitted to “dismiss their fees as not material.  But when asset-based fees are put into the proper perspective, it becomes obvious how they destroy investor value.”  Using an example a sixth grader could replicate, the Association says that an investment manager who generates an annual return of 10% actually charges 15% of that return in annual fees.  “Or more realistically,” they write – because if you are generating 10% a year, you are leaving the mutual fund and starting your own hedge fund – “if your return was 5% with the same fee and expense assumptions, you paid a whopping 30% of your return in fees.”


The Association does not push for changes in fee structures.  Instead they recommend that worst of all Wall Street bugaboos: full transparency, including “an annual accounting of all fees and expenses (in absolute dollars) that investors incur in connection with the management of their accounts.”


Regulators routinely allow the industry to define what constitutes “material charges.”  In a zero-interest rate world, we think even an SEC examiner would agree that 1.45% is “material,” yet Congress addresses this, not in terms of fair treatment for the investor, but in terms of Caveat Emptor.  Just some of the green eggs and ham the industry gets to peddle to the public.  We wonder whether there might not also be an element of cartel-like collusive behavior in an industry where every hedge fund manager charges 2 / 20 (two per cent management fee, twenty percent of profits) and where mutual fund management charges run in a tight band.  Of course, industry participants will tell you it’s a “standard,” and it is, of course, sanctioned by the SEC.  Oh, and OPEC uses a “benchmark.” 


But investors typically do not get to question concepts like the materiality of management fees.  This is largely due to Regulatory Capture – the SEC allows Wall Street to tell them how to regulate, what to regulate, and how much to regulate.  The industry does not have to do an exceptional amount of haranguing to shove the green eggs and ham down the investors’ throats, as the bulk of the heavy lifting has already been done by Congress and the regulators.  All a broker has to say is “Fund Family One, or Fund Family Two? – ‘Moderate Risk,’ or ‘Average Exposure’ – unless of course you prefer the ‘Not-Too-Risky-But-Not-Too-Risk-Averse Fund.’” 


Just as Aristotle says all literature can be reduced to six basic dramatic elements, the staggering majority of investment products are clones of a small handful of basic ideas and are differentiated almost exclusively by their packaging, not by behavior or performance.  The SEC might start by asking individual investors whether they are aware of that.  In fact, the recent paucity of retail activity in the markets may indicate that even the public can only be fooled so far – Abe Lincoln may yet be proved right, that you can not fool all the people all the time.   


We think the most useful comment comes from Muriel Siebert, CEO of Muriel Siebert & Co and holder of a number of Firsts, including first woman to hold a seat on the NYSE, and first woman New York State Superintendent of Banks, in which capacity she used to refer to herself as the “New York SOB.”


Siebert – who knows as much about the industry as anyone – says “the playing field has become far from level” for retail investors, “with computerized trading accounting for an estimated 50%-80% of trading, with complex products they cannot understand and with venues offering prices they cannot access, I believe retail investors are justified in having lost confidence in a system that places them at a decided disadvantage.”


Siebert makes the point we made earlier: “stock brokers are mandated to ‘know their customer,’ but investors are not mandated, other than by the principle of caveat emptor, to know their stock brokers.”  Siebert makes a number of administrative recommendations that we find reasonable, including a standardized and transparent process around product disclosures, and she proposes that new account paperwork include a basic investor quiz to determine whether the customer has even the vaguest of notions of what they are doing.  And she points out that, unless securities and markets regulation is made global, there will always be a refuge for scoundrels. 


Several years ago Siebert decided there was a crying need for investor education and, through her foundation, created the “Personal Financial Program,” a basic curriculum that is now used in hundreds of high schools in ten states, including New York and Florida.  In New Jersey, Siebert writes, “by 2014 high school students will be required to demonstrate proficiency in financial literacy in order to graduate.”  This is a huge step from the world we live in today, where financial knowledge and investment methods are actually kept secret, revealed only to a chosen few.  Even the undergraduate business major is not likely to have more than a rudimentary knowledge of what goes on on Wall Street.


The New York Times reported last year (14 April, 2011, “The Default Major: Skating Through B-School”) that “business” is the most popular undergraduate field, accounting for over 20% of majors, with more than 325,000 bachelors degrees awarded annually.  But, cautions the report, business majors “spend fewer than 11 hours a week studying outside of class,” the least of any broad major.  Business majors also “had the weakest gains during the first two years of college on a national test of writing and reasoning skills.”  Finally, business majors “score lower than students in every other major” on the GMAT, the entry exam required for MBA programs.  Whatever it is we’re teaching our youth, it is neither entrepreneurship, nor how to think for themselves.


As another comment letter says, “when I went to school I learned everything from finger painting to Fibonacci numbers, but I was rarely taught important practical topics.”  If Einstein famously (though perhaps apocryphally) believed Compound Interest to be the single greatest human mathematical discovery, then why is it not taught in school?


The long and the short of it is: unless you have worked on Wall Street for ten years – been through market cycles, economic cycles and electoral cycles – you stand an exceptionally slim chance of understanding even a basic financial product such as a long-only mutual fund.  Meanwhile all around us we are being offered heaping plates full of green eggs and ham.  The sellers do not care whether it is what we like – nor even if it is good for us.  All they know is they have a quota to fill, and must get us to eat as much of the stuff as possible. 


We acknowledge that not all outcomes of transparency are pretty.  Hedgeye loyalists know we are fixated on the notion that a strong dollar is the only thing that will make America strong.  Everything else is kowtowing and temporizing.  A transparent marketplace, coupled with a strong dollar, would have consequences for the stock market, for the commodities markets, for the financial firms that make their fortunes in those rigged markets, and for the politicians whose campaigns are paid for by those firms, and who return the favor by keeping the markets rigged.


Does anyone really believe Congress wants investors to understand how this actually works?  Still, we think it’s worth a try.




Moshe Silver

Managing Director / Chief Compliance Officer



Still Selling? SP500 Levels, Refreshed

POSITIONS: Long Utilities (XLU), Short Consumer Discretionary (XLY)


I Time-Stamp everything we do because I believe in transparency and accountability. Time-Stamping doesn’t mean we are always right. It simply means we don’t have to tell stories about nailing everything.


At 11:02AM EST on Friday my note said “Selling Green” at 1374 in the SP500. That was my immediate-term TRADE line of resistance then and it remains so now. Across all of my core risk management durations, here are the lines that currently matter most: 

  1. Immediate-term TRADE overbought = 1374
  2. Immediate-term TRADE support = 1363
  3. Intermediate-term TREND support = 1290 

In other words, what was immediate-term TRADE resistance is now support at 1363 – and if that support fails to hold, there’s no legitimate support to the intermediate-term TREND line of 1290.


Interestingly, but no surprisingly, going back to when we started the firm (2008) we have never NOT corrected to my intermediate-term TREND line after seeing an intermediate-term TREND top. Neither have we NOT seen VIX 15 being an explicit signal to sell US Equities.


Notwithstanding Growth Slowing could easily see US GDP Growth cut in ½ (Q4 to Q1), our risk management process has not changed.



Keith R. McCullough
Chief Executive Officer


Still Selling? SP500 Levels, Refreshed - SPX

European Banking Monitor

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .


Key Takeaways:

* Greece's debt swap was largely in line with expectations last week; on a week-over-week basis, we saw relatively little movement in several key risk indicators. Most of the series were essentially unchanged or continued on their pre-swap trajectories. European and US interbank risk receded further last week with the Euribor-OIS shrinking 4 bps week over week, while the TED spread shrank 2 bps. This is less of a catalyst for further upside now that both of these measures have largely renormalized.



Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 4 bps to 54 bps.


European Banking Monitor - 111. Euribor


ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  


European Banking Monitor - 111. facility


European Financials CDS Monitor – Bank swaps were wider in Europe last week for 31 of the 40 reference entities. The average widening was 2.6% and the median widening was 2.4%.


European Banking Monitor - 111. banks


Security Market Program – The ECB's secondary sovereign bond purchasing program bought €27 Million sovereign paper in the week ended 3/9, after three straight weeks of no purchases. The bank bought a mere €183 Million in the first two weeks of February, versus €2.2 BILLION in the week ended 1/20 and €3.8 BILLION in the week 1/12. When questioned in last week’s ECB press conference on the lack of buying over the last 3 weeks, Draghi only answered that the SMP is a non-standard measure that is “neither eternal nor infinite.” Clearly, with the some €1 Trillion injection of liquidity across the LTROs, the Bank is paring back buying and watching the results of sovereign bond auctions. The trend in 2012 continues to be banks issuing debt at lower yields compared to previous auctions. We do, however, continue to wonder exactly who is meeting this demand for PIIGS paper.  


European Banking Monitor - 111. smp



Matthew Hedrick

Senior Analyst

investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.


No change to our full month GGR forecast of HK$24-26 billion, up 23-33% YoY.  



Average daily table revenues (ADTR) jumped to HK$790 million this past week, up from HK$776 million in February.  Month to date, ADTR is in-line with February. 


Remember that the comp is fairly easy as VIP hold % was the lowest in 2011.  Nonetheless, overall business levels should be considered very strong and above consensus expectations.




MPEL appears to have lost a lot of share in the past week, no doubt due to hold, while Galaxy gained the most.  Relative to trend, MGM seems to be performing the best in March while MPEL and LVS are below.



KORS Light


With KORS announcing that insiders are selling $1.24bn in stock in a secondary after a meteoric 148% rise in 3 months since the IPO, we’d like to shed some light into what you’re buying from management.



First off, we can argue all day that KORS is expensive. In looking at earnings and cash flow, there’s no way to justify where it trades. But great brands with incredible earnings momentum and conservative expectations will always look expensive. We have about another three quarters where yy compares will make fighting the tape a difficult battle for anyone on the short side here. But for anyone really buying it here, take a look at relative value. The comparisons are clearly out of whack to us.  


With an Enterprise Value of $9.4bn, KORS compares to…

1)      COH at 21.2bn (44% of COH Value, with 16% of its’ cash flow)

2)      Both LIZ and VRA at about $1.5Bn respectively

3)      TIF’s $9.1bn (KORS is 3.3% ABOVE TIF EV!)

4)      UA at $4.8bn (UA offers better long term growth with less competition and lower risk)

5)      LULU at $10.1bn (I view this almost identical to UA in many ways. All Blue Sky here. UA looks better to me at this value dispersion)

6)      RL at $15.4bn. You believe that KORS is at 61% of RL’s EV? C’mon…


In an effort to shine some light on the composition of KORS’ runway, here is a look at how we see the KORS story playing out over the next few years:




We see KORS growing revenues at a 28% CAGR over the next three years as the company shifts its mix increasingly towards retail distribution and into the Handbags/Accessories category (see tables below). With the company still in the early stage of growing its store base at 231 currently and plans for 600+, retail will be the key driver of growth in addition to multiple drivers within each channel of distribution.


KORS Light - KORS RevMixTable




The key to our expectation for a 36% CAGR over the next three years in retail revenues is predicated primarily on new store growth as well as increased productivity from both product expansion and extensions as well as a favorable tailwind from KORS’ store maturity/productivity curve.

  • Compared to other high growth concepts and established luxury apparel brands, at $1,280 per sq. ft. KORS already ranks among the most productive brands.

KORS Light - KORS SalesPSqFt RelChart

  • In looking at KORS’ long-term store growth targets, there are a few important considerations. First, the number of mall/lifestyle center locations available, and second, the COH roadmap.
  • There are nearly 1,300 U.S. malls and lifestyle centers over half of which are considered A or B locations. In addition to these 600+ mall/lifestyle locations, there are plenty of free standing stores available as well. After 15+ years, COH is up to 488 stores in the U.S. 
  • As part of their long-term planning, KORS has targeted 400 stores domestically just over 2x its current base of 188. Our sense is that KORS has no business being in a ‘B Mall’. So we think that their 400 US store target sounds about right. Keep in mind that existing stores are on ‘Main and Main’. Translation – as it relates to new store productivity, we’re inclined to think that this number trends down, not up. This is not to say that incremental dollars, ,or comps, will come down. But very simply that there will be a shift on the margin to a less productive asset. As long as the rent per sq/ft is in check, we’re ok with that.

 KORS Light - StoreGrwthvsCOH

  • Take a look at the store growth trajectory for KORS in conjunction with COH’s own store historical store growth footprint. Combined with the store productivity charts below, one can see the acceleration in store growth, and category expansion coupled with higher priced product that drove a 6-year period of 20% revenue growth from 2003 to 2008.
  • Given the breadth of product assortment not only in accessories (e.g. handbags, small leather goods, watches, jewelry, etc.), but also apparel, in addition to its smaller store format (KORS at ~2,000 sq. ft. vs. COH at ~2,500 in Year4) we think KORS can ultimately achieve similar levels of productivity ASSUMING NO MEANINGFUL DEGRADATION IN STORE LOCATION PROFILE.
  • We think this highlights the key issue with KORS. Category expansion will likely get it the comp it needs. New stores will get the growth – optically – that it needs. But does channel fill related to less desirable locations ultimately take down aggregate sales/square foot at a rate faster than its lease agreements allow it to lower costs?  We have to wait a year – at a minimum – to find out. But this is very key.
  • Our model has KORS coming in over $1,350 in sales per sq. ft. in F12 reflecting an accelerated path compared to COH at this stage due to its aggressive product expansion strategy early on, which played out for COH years later

KORS Light - KORS RevPSqFt ChartRel

  • In addition to square footage growth another key consideration is the store maturity curve, which is at an inflection point and will provide a multi-year tailwind to store productivity. Aside from a modest store base, the incremental store growth over the last two years will result in an acceleration in the maturity curve as illustrated in the chart below.
  • Based on typical industry peak productivity timelines, we assume that the average KORS’ store reaches maturity in its third year of operation after which it becomes mature.
  • Assuming new store productivity at its current rate of approximately 80% in Year1, 90% in Year2, and 95% in Year3, the base of mature stores operating at 100% productivity will increase from 32% in F12 to 59% in F15. This will result in a blended productivity rate of increase from 90% to 95% over that timeframe.

KORS Light - KORS StoreMaturityCycle

  • All in we’re looking at a 36% CAGR over the next three years in retail revenues driven by new store growth, increased productivity from both product expansion and extensions as well as a favorable tailwind from KORS’ store maturity/productivity curve.

KORS Light - KORS IncrRev TablebyChannel




At 46% of total sales, the wholesale channel is still a sizeable business for KORS. While we think retail will account for the majority of incremental revenue growth (65%-75%) over the next three years as noted in the table above, we expect wholesale to account for a meaningful 25%-30%. Our revenue contribution from this channel is driven primarily by new door growth and conversions. Consider the following:


New Wholesale Door Growth:

  • Over the last three years, wholesale door growth has averaged 345 per year ranging from 287 to 432.
  • We expect incremental annual door growth over the next three years to be in the range of 275-325 driven primarily through international expansion (2/3) as well as domestic additions (1/3).
  • As such, We think KORS can double its European store base over the next 2-3 years growing to over 1,000 doors.
  • We assume domestic doors will operate at a productivity level similar to new conversions (~$500k/yr) and international doors to operate at a rate of ~$150/yr. This lower rate of productivity is due in part to more limited category representation in many of these new locations which include specialty shops that typically carry only KORS’ ready-to-wear apparel for example instead of accounts/doors that carry apparel and accessories.
  • This would suggest a global wholesale door count of 3,250 by F15. As a point of reference, Ralph Lauren sells through nearly 10,000 wholesale points of distribution domestically and in Europe combined suggesting substantial opportunity for further growth.
  • We estimate that new wholesale door growth will account for 7%-12% growth in the wholesale business and 5-7% of incremental growth in total revenues.


  • There are approximately 1,800 doors in North America, roughly 1,000 of which are conversion targets. With ~250 conversions already completed there is an opportunity for at least another 750 wholesale door conversions.
  • The productivity of wholesale doors that are converted typically run 3x pre-conversion sales levels. With wholesale door productivity running at ~$200k annually in 2010, we assume new conversions are generating close to $600k per door.
  • Despite a target of at least 100 conversions per year, we expect that figure to be considerably higher and are assuming 150 conversions per year over the next three years - a rate that is likely to decelerate thereafter.
  • We estimate that wholesale conversions alone will account for 6%-10% growth in the wholesale business and 3-5% of incremental growth in total revenues.


  • Another thing to keep in mind is KORS’ e-commerce business, which is currently operated in partnership with Neiman Marcus and accounted for as wholesale sales. KORS sells product to Neiman’s at wholesale, which is in turn sold through michaelkors.com.
  • The company has been taking steps to bring the e-commerce business in-house. We estimate that KORS online sales are $30-$40mm at retail accounting for $15-$20mm in wholesale revenues. This implies e-commerce accounts for ~2.5% total revenues (at retail) slightly below where COH’s e-commerce business stands currently.
  • When the company brings this business in-house it will shift revenues from wholesale to retail, but improve profitability as well. While we do not have the exact timing of this eventuality accounted for in our model, we will adjust our numbers accordingly when this change is made.

KORS Light - KORS WhlsDoorContrib




Licensing accounts for only ~5% of KORS revenues, but ~17% of F12 EBIT. While not a key revenue driver, KORS has multiple avenues with which to grow its licensing business.

  • In conjunction with Fossil, watches is KORS’ most significant licensing business currently at approximately $300 in revenues at retail.
  • The other licensees of note are Estee Lauder for fragrance and Marchon for eyewear both of which are more modest businesses.
  • Fossil is also the exclusive licensee of KORS’ fashion jewelry line, which is the business with greatest upside potential in our view aside from watches. We think this could be another $300mm+ business for Fossil at retail.
  • We think the long-term opportunity for these four businesses could reach over $1Bn in retail revenues equating to $180mm+ in revenues for KORS. Assuming consistent ~60% profit margins, the license business alone could account for over $0.30 in earnings, or over $8/share in value over time.

KORS Light - KORS LicTable


Gross Margins: 

  • The shift towards retail as a percent of total distribution will be a natural tailwind for gross margins over the next 3-5 years at a minimum. Here is a look at the magnitude of this tailwind assuming constant margins for retail and wholesale isolating the mix shift.
  • Sales growth outpacing inventory growth this past quarter is gross margin bullish despite what appears to be  management conservatism in looking out to next quarter. We are modeling margin expansion to continue next quarter (+100bps) and for the next three years up +98bps in F13, +75bps in F14, and +50bps in F15 driven largely by this significant mix shift tailwind.

KORS Light - KORS GM Mix



  • We expect SG&A growth to remain at accelerated levels relative to revenue growth over the next three quarters due primarily to growing corporate costs including added headcount to build out an e-commerce team, higher rent expense related to store expansion, wholesale conversion costs, new warehouse management system expenses, and increased international marketing to raise brand awareness.
  • We expect one of the more variable pieces of SG&A spend over the next two years will be international marketing spend in an effort to raise brand awareness. As noted on the latest earning call, sales hit an inflection point when brand awareness broke through 50%-60% domestically. In Europe, KORS brand awareness currently stands at ~35%. We think the company will invest aggressively to grow awareness overseas.
  • As higher productivity rates and new store growth continues to leverage KORS’ existing infrastructure, we expect the company to realize SG&A leverage in the 2H driving modest leverage in F13 as well as the following two years.

With gross margin expansion and SG&A leverage, we expect KORS to expand EBIT margins by 4pts over the next three years from 17% currently to over 21% by F15 resulting in 30%-50% earnings growth during that timeframe. We are modeling EPS of $1.01 for F13, $1.37 for F14, and $1.77 for F15.


Free Cash Flow:


Capital spending is higher in F12 at ~9% of sales relative to a more normalized range of 6.5%-7.5% in recent years to support the transition of a new warehouse and related equipment, store growth, and additional investment in IT infrastructure. As a result, we expect FCF to be ~$25mm in F12. We expect additional capital spending related to the new warehouse and international corporate infrastructure to keep F13 CapEx elevated (~8% of sales) as well before returning to a more historical rate thereafter. As a result, we expect KORS’ FCF yield to rebound to 5% in F13, 6.5% in F14, and over 8% in F15.



Casey Flavin









Commentary from CEO Keith McCullough


Greece, slowly, but surely falling off Most Read (Bloomberg) news wk-over-wk; China and Global Growth Slowing back in vogue:

  1. CHINA – worst Trade Deficit in 22yrs (let’s call that ever – and ever is a long time) at -$31.5B after last week saw that big sequential drop in Chinese IP growth (to 11% vs 14% in JAN despite Lunar shift). Growth Slowing. Chinese stocks looking for a rate cut.
  2. ISRAEL – someone knows something or someone thinks they do – what I can’t see here makes me call it out as the Tel Aviv25 Index not only moved to red for 2012 YTD last week, but is down another full 1% this morning (down -4% in since Feb 21). Iran?
  3. USD – the most important (and bullish on the margin for US Consumption Growth) recovery in the last few weeks has been the US Dollar Index recovering its intermediate-term TREND support of $79.36. With short-term Treasuries (2yr) breaking out above 0.26% TREND support and Gold struggling relative to oil, I’m out of Gold for now. Considering the short side GLD and looking to buy USD back.

VIX 15-17 range has proven to be the right zone to take down both gross and net for the last 4yrs.







THE HBM: GMCR, MCD, RUTH - subsector




GMCR: Green Mountain Coffee was downgraded to Neutral from Buy by BofA on Friday. The price target was lowered to $63 from $70.


MCD: McDonald’s featured in a Barron’s article this weekend where “the Trader” column detailed why the stock may be overpriced. 





GMCR: Green Mountain declined almost 16% on accelerating volume as SBUX announced the arrival of its new brewer and David Einhorn said that Green Mountain’s install base has no “true protection”.


SBUX: Starbucks gained 2.9% on accelerating volume.





RUTH: Ruth’s Chris announced 10% buyback of its 10% convertible preferred stock.  Retiring the 10% convertible preferred stock cost the company $60.2mm in cash which was funded by its $100mm senior revolving credit facility.  This move prompted Jeffries to raise its PT by $1 to $8.





RUTH: Ruth’s Chris gained 6.8% on accelerating volume.





Howard Penney

Managing Director


Rory Green



Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.