KORS: Predictably Positive


KORS’ Q4 preannouncement after the close hardly came as a surprise. We expected another blowout quarter and so did the market as reflected in the stock. While consensus estimates were at $0.13 compared to revised guidance of $0.14-$0.16, the stock is not trading on what earnings will do this quarter, or the next, but what the real earnings power of this company is 2-3 years out.


We’re at $0.16 in our model for Q4, which could prove conservative. The key difference is our expectation for +100bps of gross margin expansion relative to Street estimates assuming -40bps of margin contraction. With sales outpacing inventory growth this past quarter in addition to an increasing shift towards retail, this is/was the biggest variable near-term and is likely to be the source of further upside in the quarter.


With the runway ahead including robust store growth, regional expansion, product extensions and expansion driving 20%+ revenue growth and 30%+ earnings growth, we think KORS could approach $2 in EPS over the next three years. As highlighted in our note “KORS Light” last Monday, we think a brand like this with incredible earnings momentum and conservative expectations is likely to look expensive for some time to come.



Below is our note from Monday (3/12) for further detail:


“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 229 currently and plans for 600+, retail will be the key driver of growth in addition to multiple drivers within each channel of distribution.


KORS: Predictably Positive - 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 $1,240 per sq. ft. KORS already ranks among the most productive brands.

KORS: Predictably Positive - 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: Predictably Positive - 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: Predictably Positive - 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: Predictably Positive - 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: Predictably Positive - 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 4-7% 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
  • 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: Predictably Positive - 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: Predictably Positive - 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 +91bps in F13, +75bps in F14, and +50bps in F15 driven largely by this significant mix shift tailwind.

KORS: Predictably Positive - 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


President Obama’s Reelection Chances Climb Sharply -- Hedgeye


President Obama’s Reelection Chances Climb Sharply -- Hedgeye  - Screen Shot 2012 03 20 at 3.49.57 AM



If the US election were held today, President Obama would stand a 60.5% chance of getting reelected, according to the Hedgeye Election Indicator (HEI). President Obama’s likelihood of reelection is up from 58.6% last week, and at its highest level since May of last year, according to the HEI.


Hedgeye developed the HEI to understand the relationship between key market and economic data and the US Presidential Election. After rigorous back testing, Hedgeye has determined that there are a short list of real time market-based indicators, that move ahead of President Obama’s position in conventional polls or other measures of sentiment. One of those market indicators, the timing of the  performance of key equities, benefited President Obama’s chances in the Hedgeye Election Indicator model this week.



President Obama’s Reelection Chances Climb Sharply -- Hedgeye  - HEI



Based on our analysis, market prices will adjust in real-time ahead of economic conditions, which will ultimately shape voters’ perception of the Obama Presidency, the Republican candidates and influence the probability of an Obama reelection. 


Hedgeye releases the HEI every Tuesday at 7 a.m. ET, all the way until election day Tuesday November 6.




Follow us on twitter @hedgeye

Israel and Iran . . . Now What?

Conclusion: While recent comments by Israeli Prime Minister Netanyahu suggest an attack on Iran’s nuclear facilities by Israel could occur in 2012, it is not clear if he would have the broad support of the Israeli people.  Further, there are potentially a number of unintended consequences. As we highlight in the chart below, oil continues to trade with a premium due to the heightened rhetoric in the Middle East.


Israel and Iran . . . Now What? - Brent.03.19



Positions: Long Oil via the etf OIL

We are planning on doing a conference call in the coming weeks with a foreign policy expert on Israeli and Iranian relations, but in the meantime we wanted to provide some context on the next potential catalyst in this standoff.  Rather than introduce our own speculation, we’ve compiled specific public comments related to potential timing of an attack by Israel, the route or plan that the Israelis would likely follow, and some secondary consequences.


Potential Timing of Attack

As for the timing of the attack, Prime Minister Binyamin Netanyahu told Israeli TV after his trip to Washington that, “it's not a matter of days or weeks but also not of years” before Israel would resort to military action in response to the potential nuclear threat from Iran. (UPI)


YNet News, Israel’s most read newspaper, reported that Israel will attack Iran no sooner than November of this year (after the presidential election).  This came out through a White House official after the meeting between President Obama and Prime Minister Netanyahu in early March. (Ynet)


Dr. Emanuele Ottolenghi, a senior fellow at the Foundation for Defense of Democracies in Washington added, “I think the Israelis will take that action only if they feel that their back is completely against the wall, that Iran is about to cross the finish line on its road to a nuclear weapon, and no-one else is willing to do it.” (ABC)


Potential Attack Plan


The following information came from an interview with Dr.Ottolenghi. He said that the most likely route of entry would be either a northern route (through Turkey and Iraq or Syria and Iraq) or a southern route (along the Iraqi/ Saudi Arabian border).  The southern route is much longer thus he said it would be less likely because the attack would test the outer limits of the Israeli Air Force, and might result in in-flight refueling. (ABC)


Dr. Ottolenghi further suggested that all of the countries involved in the attack passage (potentially Turkey, Syria, Iraq, and Saudi Arabia) would possibly face resistance from Iran if they opened their air space to an Israeli air strike. (ABC)


As far as the type of attack that Israel would exercise, Dr. Ottolenghi hinted that if the attack were to occur it would come from air attacks and missiles and not from a pre-emptive nuclear strike as such actions are unprecedented. (ABC)


Consequences for Attack

Debating the consequences of an Israeli attack we think it will be useful to look at the event of a failed destruction of the Iranian nuclear facilities.  The former head of the Mossad, Meir Dagan, said during a recent interview on 60 Minutes that no attack could stop the Iranian nuclear effort, but rather only delay it. (CBS)


The entirety of his interview can be found below:;contentBody


Dr. Ottolenghi’s view is that the primary issue with a failed attack is the fact that Iran would still have their nuclear facilities in tact and would then have a reason to back out of the Non-Proliferation Treaty.  He said this would be the WORST case scenario, but he presented other more likely alternatives.


1.    Hezbollah attack on the northern border from Lebanon

Mark Fitzpatrick, director of the Non-Proliferation and Disarmament Programme at the London-based International Institute for Strategic Studies (IISS) says, “the Shia Islamist group Hezbollah, has more than 10,000 rocket launchers in southern Lebanon, many of them supplied by Iran.”  He went on to state that the arsenal of missiles stockpiled in Lebanon have the range capability to hit all of Israel.


2.    Hamas attack from the Gaza Strip

Fitzpatrick added that the Hamas also had the capability to launch their own missile based attack from the Gaza Strip, which could be devastating for Israel as this combination amounts to a military strike from both the northern and southern borders simultaneously. (BBC)  This strategic cooperation also poses the risk of the violence expanding into a bigger war in the Middle East. (CBS)

3.    Closing the Strait of Hormuz

BBC News reports that if the Strait of Hormuz was blocked that could result in “extended naval conflict between the US and Iran, and in the short term, there could be a significant impact upon oil prices.” (BBC)  It is reported that 17 million barrels of oil are transported through the Strait of Hormuz each day which amounts to 20% of global supply. (ECON)  The Economist went on to say, “Even a temporary closure would imply a disruption to dwarf any previous oil shock”.


4.     Attack against oil installations along the Arabian shore of the Gulf

Karim Sadjadpour, an Iran expert at the Carnegie Endowment for International Peace, said “If Iran tries to destabilize world energy supplies - whether launching missiles into Saudi Arabia's oil-rich eastern province or attempting to close the Strait of Hormuz - the U.S. isn't going to stand aside idly.” (BBC)

5.    Iranian attack of American targets

If Iran were to retaliate with option 3, 4, or 5 Dr. Ottolenghi said this would draw the U.S. into the conflict.  Dr. Ottolenghi made the repercussions of U.S. involvement clear when he said, “it could spell the end of the regime if the Americans were drawn into this conflict.” (ABC) 


6.     Regional war

Dagan said that he thought the result of an Israeli attack would, “ignite regional war”.  Dagan also said that he thinks the U.S. should step in and intervene instead of the Israelis.  (CBS)


While one would think, at least based on some government rhetoric, the decision to launch an attack could rally the people of Israel around the government, a recent study published by Tel Aviv University and the Israeli Democracy Institute suggests otherwise.  They reported that only 31% of Israelis support a unilateral strike against Iran by Israel while 63% are opposed.  Ultimately, the sentiment could be a key factor in any decision Netanyahu and his cabinet make.


Of course, there is also a view that that Netanyahu is bluffing and that if he really believed that the Iranian threat was comparable to another Holocaust, he would have already taken action.  As Jeffrey Goldberg aptly wrote for Bloomberg yesterday:


“But, if true, Netanyahu is proving himself to be an adept poker player. Obama told me in an interview that, “as president of the U.S., I don’t bluff."  Whether Netanyahu bluffs is perhaps the more important question.”





Daryl G. Jones


Director of Research


Israel and Iran . . . Now What? - ME2


SP500 Levels, Refreshed: Parts Unknown

Keith and I are taking the Hedgeye show on the road this week.  We started the day in beautiful Winnipeg, Manitoba, are now in Minneapolis, and head to Boston tomorrow.  And no doubt, we’ll have a few stops in between.  For those of you that happen to find yourselves in beautiful Minneapolis, we’ll be hosting a Hedgeye Happy Hour at Brit’s Pub at 1110 Nicollet Mall.


Not unlike some of our travels, roaming between major cities over the course of the last few days, the SP500 now finds itself levitating to Parts Unknown. Currently at 1,411, the SP500 is bumping up to our TRADE resistance line at 1,413.  The updated levels – 1,413 sell TRADE, 1,379 buy TRADE, and 1,291 buy TREND – are outlined in the chart below.


The question from here is not what to do about what’s happened in the year-to-date (yes, it has been a good year for equities), but really to consider what will happen next.  A couple questions we would recommend considering before chasing equities into Parts Unknown:


1.   The VIX is now at levels not seen since last summer, so what kind of complacency is baked into the stock market?

2.   Growth is not accelerating.  In fact, today we received a sign from the corporate sector that corporate decision makers may be more cautious on growth, with Apple deciding to pay a dividend.  As always with management teams, watch what they do.  Are equities priced for sequentially decelerating economic growth?


3.   We are on the road this week briefing some of our key subscribers on Japan and accelerating sovereign risks there.  Not to say a debt crisis is imminent, but it is a probability that is moving from the tail to the normal distribution.  Are equities pricing in the potential of another debt crisis?


Ultimately as Michael Bloomberg, and I’m sure many others before him, said, “People are worried about the unknown.”


The question remains: are investors worried enough?




Daryl G. Jones


Director of Research


SP500 Levels, Refreshed: Parts Unknown - SPX



NIKE: The 3-Peat

The sentiment, calendar, and consensus nature of the average Buy rating does not lead us to be particularly bullish into the print. But at some point over the next 2-quarters, there’s likely to be some form of exodus of people who rented the stock that will allow those with a long duration to capitalize on the REAL call, which is that 2013 and 2014 will be a 3-peat.


The Punchline here is that if you were to ask the average analyst what they think about Nike today, they’ll say ‘Buy it because A) the order book is both solid and strengthening, B) while revenue builds, NKE starts to anniversary cost pressures from a year ago, and C) the impacts of price increases start to take effect. In addition, there’s the sentiment associated with an extremely robust event calendar with 1) UEFA European Football Championship (note to Americans – Europeans think that this is like the World Cup excluding Brazil), 2) The Olympics in London, and 3) Nike taking over the NFL license as the new season kicks off in the summer.


All this makes for a great momentum story. That’s why the stock is up 22.7% year to date – more than 3x the S&P.


So now what?


Will the company have a great quarter? Yes. They will. We think that they’ll beat the $1.16 consensus by at least a dime. Then it’s off to the races as it relates to event flow.

But mark my words, there will be some event by August that will prompt momentum money to peel off this trade – even if that event is time itself. Most momentum investors probably know that, and will therefore look to do it sooner rather than later.  We’ll never fault anyone for booking a gain. So hats off to them. 


But at the same time, this creates an opportunity for people that have wanted to invest in the company but have seen the stock zip past them faster than LeBron James on a breakaway dunk.


Our point is that the company has invested so heavily in its consumer alignment, product innovation, and sales distribution organizations over the past three years, which we think has resulted in competitive positioning that is worlds ahead of any traditional competitors. This means that while momentum traders will be concerned that ‘comps will be tough and growth will roll’ next year, the reality is that Nike is going to repeat CY2012 again, and then again.


This was best evidenced at Nike’s recent innovation summit in NYC, which we had the pleasure of attending. The degree to which Nike has elevated the playing field is simply jaw-dropping. To be clear, we’re not talking about simply making updates to existing product platforms, or aligning apparel better with footwear. Those things are nice, but the updates don’t drive sales, they maintain them. Better product alignment is a productivity booster, and good for a couple of growth points in sales. But is not revolutionary.  Nike simply does not borrow R&D and marketing dollars from one side of the organization and give it to another. That’s called ‘pissing off your employees and not growing revenue.’


Nike, rather, has invested in new platforms like FlyNet. We can’t do it much justice here, but the picture below shows a glimpse of the new line – which will hit stores in July. It is a combination of ‘lean and green manufacturing’ with new materials and an extremely commercial new design to make one of the lightest running shoes ever made. (Note: for those of us who are more sedentary, the average runner has around 14,000 heelstrikes per hour. You think that a few ounces per shoe does not matter? Do the math…).  This can be as big or bigger than NikeFree (which will still grow when FlyNet launches).


NIKE: The 3-Peat  - NKE flynet

Source: Nike Innovation Summit


Another game-changer – pardon the pun – is the Nike+ Fuelband.  Most people know about Nike+, and how the chip in Nike shoes can synch up with your iPod to collect training data and share electronically with friends and coaches. We also all know that about a week after that came out, running shops were selling little pouches for $3 that allowed you to put the chip on any other brand of shoe you wanted. 

But the evolution of this technology is astounding.

One major change is that while there is still a chip, it feeds off several weightless electronic sensors built into the sole of the shoe. No Nike shoe, no Nike+.

More importantly, they rolled this out to basketball and training, and made it far more digitally integrated. Simply put, they’ve taken the concept of ‘going digital’ beyond any consumer brand aside from Apple. Now you can download a workout schedule for dozens of different athletes across many sports, and literally train with and compete against them (and your friends). The technology tracks vertical lift, speed, cadence, lateral movement, acceleration, and even ‘lazy time’ (time you spend sitting idle during a game).

And yes, the technology is attached to shoes ranging from $90 to $160.


As it relates to how the 3-Peat theme plays out in our model, we get to EPS estimates that are nearly a buck higher than consensus for each of the next two years.

That’s about 20% annual EPS growth for the top player in a global growth space with extremely difficult barriers to entry, and a structural advantage from a sourcing/selling perspective as China gains share of the world economy. It has a consistent track record for executing operationally, making the right human and financial capital deployment decisions, and overdelivering on expectations. Tack on $8 per share in net cash, and enough annual free cash flow to comfortably buy back 5% of its current market cap per year, and this is a pretty good place to be.

Does it look expensive on the consensus numbers (19.5x forward estimates?). Yes.

But on our numbers, we’re looking at a multiple closer to 16x earnings and 10x EBITDA. We’re cool with that.



This is where TRADE considerations matter.

As noted the consensus is for a bullish momentum trade.

The ‘buy ratio’ is right in line with where it’s been for 2-years – but the actual upside to sell side price targets is only 2%. That’s the lowest it’s been in at least 3-years. 


NIKE: The 3-Peat  - NKE buy ratio

Source: Bloomberg 


Also, the ‘short interest ratio’ numbers reported by most data providers are a bit misleading. It suggests a ratio near three-year peaks. But the reality is that we’re only looking at 0.9% of the float short the stock – that’s at a trough. The short interest ratio is high simply because volume is at its historical trough. Volume = conviction. The buying audience here is feeling thin to us. 


NIKE: The 3-Peat  - NKE short interest

Source: Bloomberg 


One last factor to consider about Nike is how and when it sets expectations. We’re sitting here today at the exact time of year when Nike is preparing its budget for FY13. The company has its own unique biorhythm where any negativity that could come out tends to happen around this time of year. A large part of compensation for General Managers is delivering on expectations – or should we say OVERdelivering on expectations. This is when teams at Nike are probably submitting more conservative plans than they really think that they can achieve. That’s pretty apparent in looking at the company’s guidance history.


While Nike does not ‘guide’ officially, it gives enough pieces of the puzzle for analysts to do their job. What happens more often than not is that Nike takes down estimates – thinking that they’re being realistic – but they end up coming in ahead of where estimates were in the first place before they lowered guidance. Sounds confusing, but hopefully the chart below illustrates it. 


NIKE: The 3-Peat  - NKE expectations vs reality

Source: Factset


The Punchline is that the sentiment, and time of year does not lead us to be particularly bullish into the print. But at some point over the next 2-quarters, there’s likely to be some form of exodus of people who rented the stock that will allow those with a long duration to capitalize on the REAL call, which is that 2013 and 2014 will be a 3-peat.


NIKE: The 3-Peat  - Nke SIGMA


Brian P. McGough
Managing Director





We understand why Dunkin’ Brands is selling its stock, but why are they selling into such a promising growth story?  Announcing the decision late on a Friday was also curious.  Along with the announcements of Outback Steakhouse potentially going public again, it is clear that Bain Capital is looking to reduce its exposure to the restaurant sector while the going is good.  If Dunkin’ is the best growth story in town, why are they selling?


DNKN’s stock has been trading well recently, along with the market, in the run up to the dividend announcement and the continuation of bullish underlying fundamentals in the restaurant industry.  Our view on the longer-term TAIL still stands.  Opportunities for the company to grow west of the Mississippi are far less abundant than the bulls believe.


The evidence for our view is as follows: announced new unit openings are lagging actual openings, which is leading to a decline in the backlog of potential new units being opened.  Until we are proven wrong by greater disclosure from Dunkin’, we will continue to be bearish on the company’s growth prospects per the announcements of new contracted openings by the company.


Compounding this uncertainty is the aggressive strategy being pursued by MCD and, less concerning for DNKN, WEN in the North East breakfast day part.  McDonald’s is a tough competitor and its new breakfast initiative in the North East, including cheese Danishes, muffins, and banana bread, is a signal of intent to take share from Dunkin’ Donuts in its most important region.


Much of the optimism around the growth story recently was brought about by the recently signed procurement and distribution agreement with a Dunkin’ Donuts franchisee-owned cooperative.  Having spoke with our contacts in the Dunkin’ Donuts franchisee community, we believe that the hype may not be matched by reality as time passes. 


The contract should benefit the system overall, but we are waiting for action; year-to-date, only nine contracted new restaurant openings have been announced.  The rollout of the supply chain benefits will happen over a three year period.  From our conversations with franchisees it also seems that DNKN will not receive supply chain rebates or incentives going forward; rather, those rebates will now go to the franchisee-owned co-op.   The franchise savings from the new arrangement will be greatest for franchisees in new markets.  “All regions will benefit” but clearly the 200-300 basis points of projected savings for the biggest beneficiaries is not representative of the total system.


On an annual basis, DNKN EBITDA currently benefits from approximately $8-12M in rebates from suppliers.   In order to compensate for that going away over the next three years, it is imperative that growth in new franchisee units accelerates sufficiently in order to compensate for that decline.


Most of the research notes that we see on Dunkin’ tend to focus heavily on same-store sales as a key metric for the health of the company.  We would agree that comparable restaurant sales growth is an important metric but it is not the most important metric for driving incremental value for shareholders.  Since Dunkin’ is a franchised business, its EPS growth is far more leveraged to new unit openings than to comparable restaurant sales.  Call us skeptics but we are not encouraged by the company’s lack of disclosure on this issue.  Unless we see a dramatic ramp up in announcements of contracted new unit openings, we will retain our current stance.


Recent same-store sales trends remain consistent versus last quarter (with a slight benefit from favorable weather trends).  We continue to hear that the majority of the improvement in same-store sales is coming from average check and not traffic although the company is also less-than-forthcoming with details on this topic.  The question remains whether check is up due to success of K-Cup sales, increased food mix, or pricing.  Items like the steak and egg breakfast sandwich and other new lunch items released in 2011 are helping check but we believe that traffic growth is minimal to slightly negative. 







Howard Penney

Managing Director


Rory Green





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