NKE: Eight Bucks

No changes to our view. We love the unrealized earnings power here and are putting our model where our mouth is. But it’s important to be mindful of duration.


The quarter was outstanding. We thought they’d beat the consensus by better than a dime. The headline print was $0.03 better however the tax rate was higher than expected, which muted EPS by about $0.06. We can’t really call that ‘non-recurring’ because the fact of the matter is that with the US business en fuego, Nike is earning a greater proportion of its profits in higher tax jurisdictions. But operationally, Nike crushed it.


Relative to our expectations, revenue and SG&A both came in better, while Gross Margins missed. The latter came as an initial shock to us. Clearly, input costs are still an issue, and the company has too much apparel inventory in China and Europe. On the flip side we saw futures ACCELERATE on every basis you want to analyze…1 yr, 2 yr, C$, R$. Of note is the North America futures number – which was +22%. Now…let’s put this into perspective. This is an $8bn business. If we assume that 85% of this business is on the futures program, then we’re talking about $1.5bn in annual revenue. That's like adding an UnderArmour, a New Balance, an Asics, a Skechers and a couple of Crocs.


By our math, the NFL deal, which flips from adibok to Nike in early April, will probably be around $200-$300mm in year 1. That’s the lower end of where Reebok had it. That’s also why we think Nike will double this rate in year 2. And likely grow it by 50% in year 3. If this is the case in year 1, then let’s say $200mm of it is set for delivery within Nike’s current futures window. Assuming that 85% of Nike’s US business is on the futures program, that suggests that the NFL deal helped futures by about 5%. So…22% minus 5% = 17% growth in North American futures. For what it’s worth, we have to look back to the Clinton Administration to find the last time the North American business grew at this pace – and back then the company was stuffing the channel with apparel product and was STILL half the size it is today.


Obviously, we did not like the Gross Margin pressure. It’s uncharacteristic for Nike to miss on the Gross Margin line given that it has such great visibility into its supply and demand as far as six months out. Could it be that the inventory clip on margins is just hitting them harder than they’re admitting? Or could it be that the cost environment is simply not deflating like the entire world in global retail seems to think? Maybe it’s a little of both. But if any of it has to do with lack of realized cost deflation, then there’s going to a big wake up call for others in the industry that don’t have the same kind of control over their supply chain (which is somewhere between 98-99% of retail).


We’re tweaking our estimates – and we mean tweaking. We’re still looking for earnings in 2014 starting with an $8. The Street is at $6.75. 


NKE: Eight Bucks - NKE SIGMA


Here's a link to Monday's preview headed into the quarter - "NKE: 3 Peat".


Brian P. McGough
Managing Director




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URBN: A Winner In 2012

Keith added Urban Outfitters to the Hedgeye Virtual Portfolio today. This is a name we’ve watched for the better part of the past year while it was a lightning rod of the hedge fund community. But we think that the setup for the stock is turning favorable across multiple durations.


TAIL (3 years or less): 

This is one of the few companies that can put up double digit square footage growth over the course of our 5-year model – and likely beyond. It’s not married to one concept that will simply max out growth when it runs out of malls – like what we saw at brands like Gap, American Eagle and Ann Taylor. We don’t think that its two major brands – Urban Outfitters and Anthropologie – are broken. They had fashion problems over the past year, which we think stem from poor execution by management. Fashion is a tough business, but when the right buying infrastructure is in place, there shouldn’t be a whole lot of risk for a company that sells third party brands.  Rather, URBN got sloppy in both product selection, quality and even PR. It lost sight of who its customer is, and merchandised accordingly. Yes, there is a customer ‘piss off’ factor that hurts for a time. But ultimately if URBN has the right organization in place, it will have the right product, which it will then sell to the right customer.


The good news from our perspective is that a merchandising issue like this for a vertically integrated company often takes 1.5-2-years to fix. But for URBN, we can see results much sooner. We saw CEO Glen Senk ‘step down’ in early January, and we saw founder Richard Hayne – who is extremely well liked and respected by the organization -  stepping back in totake control. Ted Marlow is also back heading the Urban Outfitters brand, after leaving when Senk was chosen for the CEO role.


Bears on this name say that this will never be the URBN of old. We could care less. It does not need to be the URBN of old to work from here. Recouping only half of its margin erosion of the past two years gets us to 12x earnings and 6x EBITDA based on today’s price. We’ll take that any day.


TREND (3 months or more):

While we’re not looking for an immediate turnaround, we should start to see tangible results within two quarters. Starting with the April quarter, revenue compares at both Anthro and Urban get increasingly easy. More notably, its inventories are exceptionally clean. The company’s move in our SIGMA analysis is unlike most other companies in retail (see below). Given our concern about 2H margins for the space in aggregate, we think that URBN will buck the trend in every direction. Better working capital and capex driving better margins simultaneously with better execution and sales.


TRADE (3 weeks or less):

The stock has stopped going down on bad news, the short interest as a percent of float is high at 12%, and 53% of sell side ratings are NOT Buy. Near-term risk management levels on Keith’s models are :


TRADE = 28.15

TREND = 27.05


He’ll be managing risk around near-term positioning from a PM vantage point. Looking longer out, you’re going to see us get louder on this one. We think it could be a LIZ-like winner in 2012.


URBN: A Winner In 2012 - URBN SIGMA


URBN: A Winner In 2012 - URBN levels

Growth Slowing: SP500 Levels, Refreshed

POSITIONS: Long Utilities (XLU), Short SPY, XLI, and XLY


Both my Fundamental Research and Risk Management positions are crystal clear. Global Growth Slowing (like it has after Q1 of 2008, 2010, and 2011) as inflation accelerates sequentially, remains the most important signal coming out of our globally interconnected macro model.


Strong Dollar is the only long-term protection against rising inflation expectations. Since I am long the US Dollar again, I expect that to eventually A) Deflate The Inflation (bad for Commodities) and B) provide a stimulus for Global Consumption, on a lag.


Across all 3 of my core risk management durations (TRADE, TREND, TAIL), here are the lines that matter most: 

  1. Immediate-term TRADE resistance = 1409
  2. Immediate-term TRADE support =  1376
  3. Intermediate-term TREND support = 1291 

In other words, if a Strong Dollar emerges ($85-88 on the US Dollar Index), the market should hold 1291.





Keith R. McCullough
Chief Executive Officer


Growth Slowing: SP500 Levels, Refreshed - SPX

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