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Retail: Early Read on 2011 Leases

 

It’s that time of year again. With 2011 10-Ks starting to hit the wire, we just completed our initial look at the change in average lease durations by company. While the majority of retail has yet to file, our observations reflect the 40% that has already filed.  

 

We track these lease movements religiously, because it needs to triangulate with where a company is headed as it relates to its store size, desired locations, and how much it’s paying for rent. We particularly focus on this because these are all off-balance sheet, so naturally Wall-Street thinks that they are free of capital cost. That’s not true. There’s embedded growth in each of these contracts that needs to be included in analyzing each company. Some companies have more meaningful step-ups than others, which directly effects the sales comp hurdle needed too leverage occupancy. In addition, this is an area where – over a 2-3 year duration – we can see a material change in operating margins based on changes in lease agreements.

 

Our analysis reflected in the charts below calculates the weighted average lease duration. Clearly, there are differences by format. Mall-based stores will be closer to 4-6 years. Large format boxes in strip malls are closer to 10 years. Formats out in the boonies like Cabella’s and to a lesser extent, Costco, are significantly higher. Of course, there’s also the errant 100-year lease at some department stores. But all in, we’re looking at average duration of 6-7 years today.

 

The initial punchline is that it is a fairly even split between those companies lengthening vs. shortening duration of lease portfolios. We thought we’d see more movement here as landlords are presumably as desperate to fill space as ever. Too early to make a broad-based call, but this is an initial observation.

 

Here are some of the early callouts:

  • On the company-specific side, DKS, JWN and JOEZ are all positive standouts, with DKS offering up enough for us to revisit our long-standing negative view on its approach too property acquisition.
  • As it relates to negative divergences, we’d point out JNY, CRI, and DECK, with JNY in particular giving us yet more fuel for a structurally broken fire.
  • Companies with the healthiest positioning include KCP, FDO, DLTR, CROX, VFC, SHW, and BGFV. These companies have the optionality to alter lease terms in the face of unexpected margin pressures.
  • The companies with least favorable positioning include SKX, TRLG, GCO, DKS, and JNY. While not necessarily at risk per se (though it definitely bolsters the bear case on JNY), these companies simply have less flexibility to manage their costs given longer dated lease commitments. In some cases this can be viewed positively if a retailer takes on a longer commitment in exchange for more favorable lease terms. This might in fact be the case with Joe’s Jeans (JOEZ), which started to build its owned retail in recent years and has an average duration of 9.2 years.
  • Among the biggest changes over the past year, BGFV (-1.5yrs) and ANN (-2.9yrs) posted the most significant improvements while WRC (+1.9yrs), KSS (+3.1yrs), and UA (+3.2yrs) logged the most aggressive shift toward longer-dated leases (or deferred payments). We’re not surprised to see UA given it’s just starting to grow retail and aggressively, or even WRC for that matter with both at an average duration of 8.1 and 6.4 years respectively within reason, but KSS shifting from 23 to 26 years on a significantly more mature portfolio is more surprising.
  • Since 2007 the companies that improved the most include DKS (-4.2yrs), KCP (-3yrs), BGFV and CWTR (-2.8yrs), and MFB (-2.3yrs). As one of the companies with historically a very aggressive lease portfolio, DKS is worth highlighting given the improvement in duration from over 12 years to 8 over the last four years.
  • The biggest moves towards longer dated lease portfolios include KSS (+2.7yrs), COLM (+2.6yrs), COST (+2.1yrs), CRI (+1.9yrs), and both FOSL and DECK at +1.2 years. With all but KSS and COST at an average duration less than 6.5 years, these aren’t alarming shifts, but changes on the margin do matter and is something to keep an eye on given current margin levels.

With the remaining 10-Ks coming out over the next few weeks, we will republish a complete update on the changes to lease structures across retail sometime in April. Until then, these charts are likely to raise more questions than provide answers. We are available to discuss questions and welcome any comments that this analysis might initiate.

 

 

Updated for companies that have filed a 2011 10-K reflecting change in duration since last year:

 

Retail: Early Read on 2011 Leases - Lease1

 

Updated for companies that have filed a 2011 10-K reflecting change in duration since 2007 (4yrs):

 

Retail: Early Read on 2011 Leases - Lease2

 

Complete Set as of 2010 for historical reference:

 

Retail: Early Read on 2011 Leases - Lease3 2010

 

 


TIF: Hope

Ugly print. Raised guidance has a good element of hope on both Revenue and Margins. This is a great brand, and we want to own it at a price. But time is our friend.

 

Make no bones about it, this Tiffany print was not good. In fact, we’d call it flat-out bad. 1) EPS missed, 2) every single business unit decelerated on a 2-year basis, 3) the only division to NOT miss revenue expectations was Japan, 4) the Americas catalogue and internet business (6% of total) was actually down year on year (weak transaction count offsetting higher AUR), 5) the NYC flagship was up only 2% despite strength in tourist spending (they called out financial sector as driving weakness in the Northeast region), 6) this was the first time in eight quarters TIF did not leverage SG&A.

 

All that said, the company raised guidance for the year, but back-end-loaded it. TIF flat-out admitted that inventory will grow faster than sales throughout FY13 and any GM degradation would be offset by SG&A leverage.  That makes sense – but only if the company can grow its top line as planned, though it’s worth noting that its swing in our SIGMA analysis is extremely bearish for Gross Margins.

 

Tiffany is one of those great global brands we’ll always be on the lookout to buy when controversy gives us a shot. In fact, the stock has been a fairly miserable performer in a space that has been lit up since the KORS IPO. It’s +10% vs.  KORS +122%,  COH +35%, LIZ +56%, and VRA +24% (pre-print). As such, it’s not a surprise that the stock is up on TIF’s outlook.

 

But the reality is that there is simply too much in question as it relates to intermediate-term trends – even for a company with as powerful a brand as Tiffany. Just dial the clock back 3 and 6 months and see how consumer spending trends have changed by region. Now, headed into FY12 we need to be patient through 2-quarters of weaker top line, inventory build and margin degradation in hopes that things recover in 2H. If anyone can pull it off, we think it’s TIF. But we don’t see why it’s worth chasing here. Let’s see where 1H earnings expectations shake out to assess the potential for capitalizing on misaligned expectations.    

 

Brian P. McGough
Managing Director

 

TIF: Hope  - TIF SIGMA

 

TIF: Hope  - TIF Sentiment

 



Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.32%
  • SHORT SIGNALS 78.48%

BWLD – BEAR IN BULL MARKET

It’s difficult being bearish on a stock when the stock has been moving in a bullish trend with major indices hitting three-year highs and speculative growth stocks catching a bid.

 

U.S. spending habits seem to be positive for consumer stocks currently but elevated gas prices are impacting confidence.  Last Friday we saw the University Of Michigan Index Of Consumer Sentiment unexpectedly fell in March, coming in at 74.3 versus 75.3 in the month prior expectations of 76.  Looking at the price action of stocks of consumer facing companies, it is clear that certain segments of retail are doing very well.  Preliminary reports of AAPL’s new iPad sales are positive and the company’s stock is now up 45% for the year.  Homebuilder stocks are hitting highs not seen since 2008 and high-end retailers from Lululemon (LULU) to Harley Davidson (HOG) are hitting multi-year highs.  Restaurants, too, are seeing their stock prices surge.  YUM, MCD, CMG, and SBUX are some of the strongest stocks in the space.  BWLD can be included in that group but stands alone in that none of the other restaurant companies are facing protein cost inflation of 50% or more in 2012. 

 

Looking at the recently filed 10-K, we see that BWLD offers the following statement on chicken wing prices’ impact on the company’s P&L: “A 10% increase in the chicken wing costs for 2011 would have increased restaurant cost of sales by approximately $3.8 million”.  The 2010 10-K had a similar statement except the impact was $3.9 million.  If we assume a similar sensitivity in 2012, a tax rate of 34%, and shares out of 18.5m, then the table below offers us an idea of what kind of an impact wing price inflation may have on BWLD EPS in 2012. Assuming that 2012 wing price inflation will be +50%, which is certainly in play if not conservative, implies a $0.68 impact to BWLD’s EPS. 

 

BWLD – BEAR IN BULL MARKET - BWLD wing sensitivity

 

BWLD – BEAR IN BULL MARKET - chicken wings

 

 

Another potential cost headwind is labor.  Given the minimum wage hikes that were brought through Arizona, Colorado, Florida, Ohio, and Washington, we believe that a significant increase in labor costs could further impact the company’s P&L.  18.2% of the company-owned Buffalo Wild Wing restaurants are in those markets.

 

BWLD – BEAR IN BULL MARKET - bwld min wage

 

 

Despite impressive same-store sales trends over the past month and favorable weather conditions in Buffalo Wild Wing’s markets, EPS estimates have not increased for the full year and have even declined for 3Q12. 

 

BWLD – BEAR IN BULL MARKET - bwld consensus EPS

 

 

In order to avoid wing price inflation having a significant impact on wing price inflation, three things need to happen:

  1. The company needs to raise prices without hurting demand (higher gas prices are not helping)
  2. Management needs to cut G&A without impeding growth in the future
  3. High single-digit same-store sales are needed for the remainder of the year

 

In our view, the probability of all three of these factors working out in the company’s favor is not high.  Expectations for the company’s same-store sales trends are extremely high with 1Q consensus at 10% for 1Q and 6.5% for FY12. 

 

In short, BWLD’s stock price now anchors largely on one factor: the top line.  How rapidly and sustainably the company can grow the top line is going to be crucial for BWLD this year.  The new TV and radio spots, along with the digital advertising campaign and increased presence during March madness will help in the near-term. 

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 

 

 

 


DNKN: BUILDING’S ON FIRE

Those in the know cannot get out of this stock fast enough.  The sequence of events since this company went public does little to inspire confidence that Dunkin’ Brand is the best growth story around.

 

The CEO of Hedgeye, Keith McCullough, often repeats this phrase: “Watch what people do, not what they say”.  When thinking about Dunkin’ Brands’ stock at this point, we feel that his advice is highly apropos. Here is a timeline of events that have occurred since the company went public.

  • 7/27/11: Dunkin’ Brands’ shares have a successful IPO; the stock rises ~38% on the first day of trading.
  • 11/01/11: Dunkin’ Brands announces a secondary offering of 22 million shares of common stock.
  • 11/14/11: Dunkin’ Brands says lead book-running managers are waiving the lock up restriction for certain officers and directors.
  • 1/04/12: Dunkin’ Brands signs an exclusive procurement and distribution agreement with Dunkin’ Donuts franchisee-owned cooperative.
  • 3/06/12: Dunkin’ Brands begins dividend at $0.15 per share.
  • 3/16/12: Dunkin’ Brands announces secondary offering of 22 million shares of common stock.
  • 3/16/12:  Discloses in a regulatory filing that 1Q12 same-store sales are tracking between 6.7% and 7% at Dunkin’ Donuts U.S. stores, which is a sequential slowdown in two-year average trends.

Does this timeline suggest to anyone that the people in the know are excited about the growth prospects of the company?

 

The most significant omission from management’s disclosure continues to be the backlog of contracted new unit openings for Dunkin’ Donuts stores in the U.S.  Dunkin’ Donuts is, by far, the primary driver of growth for Dunkin’ Brands over the next few years and the U.S. market is the “white space” opportunity that has been so heavily touted to investors.  Where is the disclosure on the most pertinent factor for the Dunkin’ growth story?  Last Friday, the company disclosed that Dunkin’ Donuts comparable store sales growth was expected to come in at 6.7-7.0% for 1Q12, which implies a sequential slowdown in two-year average trends and is disappointing in that it also raises a concern about the sustained success, or lack thereof, that the company has had with K-Cup sales versus expectations.  In addition, we would be surprised if many other restaurant companies - particularly those with strong prospects - are seeing a sequential slowdown in two-year average trends with the weather benefit that is helping industry sales this quarter.

 

The question at this point is; if that sales data point is what the company was willing to disclose, how disappointing is the mysterious backlog number?

 

DNKN: BUILDING’S ON FIRE - dnkn pod1

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


THE HBM: DPZ, SBUX, YUM, DNKN

THE HEDGEYE BREAKFAST MONITOR

 

MACRO NOTES

 

Commentary from CEO Keith McCullough

 

I’m on the road seeing clients in Minneapolis – this melt-down in the Japanese Yen remains our top new risk mgt topic:

  1. CHINA – got Growth Slowing yet? Interestingly, but not surprisingly, the Hang Seng (-1.1%) snapped its immediate-term TRADE line of 21,255 overnight, joining India’s Sensex as the 2nd major Asian Equity market to break a significant line of momentum.
  2. US Dollar – my intermediate-term TREND line of support of $79.33 is once again under assault by central planners who are absolutely hooked on the inflation policy born out of it (Obama’s % chance of winning the election just shot up to another new high of 60.5% in the Hedgeye Election Indicator (+200bps wk/wk) - stock market inflation is a big factor in our back-test).
  3. GOLD – rising UST yields is bad for Gold on the margin. Period. Gold’s intermediate-term TREND line of $1691 remains broken as 10yr yields remain comfortably above my intermediate-term TREND line of 2.03%. 

KM

 

 

SUBSECTOR PERFORMANCE

 

THE HBM: DPZ, SBUX, YUM, DNKN - subsectors

 

 

QUICK SERVICE

 

DPZ: Domino’s was downgraded to underperform at BofA.  The PT was lowered to $34 from $41.  BofA believes that the catalyst (special dividend) has passed.  This seems like a good move to us by BofA but we are waiting for further data points to gain conviction that DPZ is going to underperform.

 

DPZ: Domino’s announced the completion of its recapitalization yesterday, along with a special dividend of $3 per share. 

 

SBUX: Starbucks was reiterated Buy at UBS and the PT was hiked to $61 from $52.

 

SBUX: Starbucks has opened the first Evolution Fresh-branded stores in Washington State. 

 

YUM: Yum Brands was initiated Outperform at Oppenheimer with a PT of $82.

 

YUM: Yum Brands’ KFC South Africa division is doubling stores in its delivery stable by the end of this year.

 

DNKN: Dunkin’ Brands is projecting comparable-store sales at its U.S. Dunkin’ Donuts chain will grow 6.7% to 7% for 1Q12.  We still believe that the company needs to disclose its backlog of new units.  The company’s future profitability is far more levered to new unit openings than comps and our contention, going on the information we have, is that the backlog is declining and not growing.

 

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

DPZ: Domino’s gained 3.4% on accelerating volume yesterday on news of the completion of its refinancing and special dividend announcements.

 

DNKN: Dunkin’ Brands declined -1.3% on accelerating volume.

 

CBOU: Caribou declined -3.9% on accelerating volume.

 

 

CASUAL DINING

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

RUTH: Ruth’s Chris gained 3.4% on accelerating volume.

 

THE HBM: DPZ, SBUX, YUM, DNKN - stocks

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


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