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MIK/DG: STYROFOAM BALLS

After a period where private equity firms were buying retail and consumer brands as far as the eye can see, they are now clearly net sellers. You might come across an occasional KORS. But beware of the Michael’s of the world.

 

We’ve been waiting and waiting for Michael’s Stores to come back to market, and not only were we handed this little gift, but we got it in conjunction with a long-awaited Dollar General secondary! (there was severe sarcasm in that statement, fyi).

 

Seriously, let’s look at this from a thousand feet, which is where we get the best context. In doing so we see that companies taken private over the last 3-6 years need to ultimately come back out. After a period where LBOs ruled the roost, IPOs are back. So expect the calendar to be full. But not full of KORS, full of something else. 

 

We think it’s really important to dial back the mental clock for a minute to what was happening in 2006.

a) The market was on a complete tear, and the deal market followed.

b) From the time of the 2002 bottom to the 2007 peak, the S&P was up 95%, while retail (as measured by the MVRX) was up 165%.

c) During that same time period, we saw 34 retail/consumer discretionary IPOs. 20 of these were in 2005-06. In 2007, we only had 6, and then in 2008 there were none. Zero.

d) That ’06-’08 time period is most interesting. As our analysis shows, when we compare the purchase transactions for financial buyers vs. IPOs, there was a meaningful divergence in 2006. It was the start of a three year time period where the number of ‘going private’ deals outpaced IPOs for the first time since well into the 1990s.

e) This was the same period where everyone was afraid to short any junky stock, because all it took was a simple press release – or the rumor of one – that the company was being bought, and it sent the junk to new highs. Yes, many bad businesses were being bought at what seemed to be toppy prices.

 

In fairness, what seemed to be a toppy price back then ain’t looking so lofty anymore. Dollar General is up 164%, and we’re looking at an Enterprise Value of $18bn even. Over the 2+ years DG has been (re) public, it has nearly doubled its operating margin to 10%. For many reasons, we’d argue that the incremental boost in margin from here will carry with it an outsized capital cost. But nonetheless, EBITDA is up by 50% since the deal.

 

Michael’s is an interesting case because – unless bloomberg’s numbers are flat-out wrong -- it is already running back up around historical peak double digit margins. That’s not to say that Bain and Blackstone can’t profit nicely from the progress made since 2006, but we question what kind of growth anyone is buying into here. This story needs to have some serious teeth that we simply don’t see yet in order to be a winner.

 

As it relates to the concept, by no means is it bad. In fact, between Michael’s and Jo-Anne stores, they have a duopoly on stores completely dedicated to arts and crafts. But it falls into the category of ‘why does it need to grow’?

A colleague of mine asked me in our morning meeting yesterday: “Michaels Stores. Isn’t that where you go to get Styrofoam balls?” The answer is Yes, among many other things. It’s a great destination for teachers to get material for class, and for people that like ‘scrapbooking’ as a hobby. While the need for the venue will likely not go away, the reality is that ‘scrapbooking’ is not gaining in popularity anymore, and expenses related to education are not going up (as sad as it is to say).

 

Opinions aside, the product is largely a commodity, is increasingly available on Amazon, and is largely present in every Wal-Mart. We’re not suggesting that the Wal-Mart factor is anything new. Because it’s not. But it certainly has not gotten less intense over the past five years.  In fact, in the four years leading up to the deal, comps were +3-4% annually, and in the three years subsequent – comps average (-2%).

 

RETAIL/CONSUMER DISCRETIONARY DEALS: PRIVATE EQUITY BUYS VERSUS SELLS

MIK/DG: STYROFOAM BALLS - styrofoam balls


(CORRECTED) CZR: TRADE UPDATE

Keith shorted CZR in the Hedgeye Virtual Portfolio at $13.89.  According to his model, the TRADE range is between $11.89 and $13.97.

 

 

CZR shares have been extremely volatile as investors and analysts try to determine fair value.  In our view, outside of an option on internet gaming, CZR's core casino operations provide zero value given its huge debt burden of >$22 billion.

 

Better regional gaming performance and a recovery in Vegas still do not justify any equity value.  Investors may be playing roulette with the internet gaming option.  A federally legislated US online poker market is no sure thing and even if it does occur, investors may be too optimistic on expectations for timing.

 

(CORRECTED) CZR: TRADE UPDATE - CZR2


CZR: TRADE UPDATE

Keith bought CZR in the Hedgeye Virtual Portfolio at $13.89.  According to his model, the TRADE range is between $11.89 and $13.97.

 

 

CZR shares have been extremely volatile as investors and analysts try to determine fair value.  In our view, outside of an option on internet gaming, CZR's core casino operations provide zero value given its huge debt burden of >$22 billion.

 

Better regional gaming performance and a recovery in Vegas still do not justify any equity value.  Investors may be playing roulette with the internet gaming option.  A federally legislated US online poker market is no sure thing and even if it does occur, investors may be too optimistic on expectations for timing.

 

CZR: TRADE UPDATE - CZR2 


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LIZ: Buying on Sale

Keith added LIZ to the Virtual Portfolio into the close on today’s high Beta pullback just above his quantitative model’s TRADE line of support.  

 

No change to our thesis on the name here but today’s pull back is another opportunity to get involved with our favorite sm-mid cap growth story that we expect to double in 2012. Now that LIZ is a double-digit stock, has largely shed its debt burden, and is beginning to reveal its top-line growth potential, investors are starting to take notice. We think the Street’s numbers are still too low and the stock is trading at a significant discount to the value of Kate Spade alone. Investors will start looking at $1 in earnings power in three years.

 

Below are links to our 2/27/12 preview to the fourth quarter as well as our take headed out of the print. We also reflect on the 3/13/12 announcement of George Carrera to replace Andy Warren as CFO.

 

LIZ: Much Beneath the Surface (3.13.12)

 

LIZ: Noise = Buying Opportunity (3.01.12)

 

LIZ Q4 Preview (2.27.12)

 

LIZ: Buying on Sale - LIZ TTT

 


PVH: Levers & Drivers

 

There is nothing that materially changes our view on PVH post call – we still like it here and beyond 2012. The earnings beat was largely in-line with our view headed into the event. In addition, with persistent uncertainty in Europe we’re also not surprised in management taking a more conservative view of Q1; However, with sales trends at both CK and Tommy running well ahead of plan quarter-to-date, we think PVH is going to pull a RL and end up coming in above the Street’s original $1.32 despite guiding to $1.20-$1.25.

 

With Tommy and CK continuing to drive the company’s results as it works through a turnaround in its Heritage business, it is increasingly evident that PVH’s earnings growth is more stable than most other branded retailers given the number of drivers and levers at its disposal. This doesn’t suggest that there isn’t risk in the model, but simply that PVH has cushion if needed that many others don’t. We think the upside in 2012 numbers will come from stronger (than guided) sales rather than a reduction in spending and are shaking out at $1.36 for Q1 and $6.45 for 2012. With earnings power of $8 in 2013, we think the stock is headed higher.

 

Here are few callouts re 2012 from the call:

  • QTD CK comps up over 10% and Tommy in the teens vs. guidance of +4%-5% growth for each so revs continue to track above plan. Wholesale is also tracking ahead of plan suggesting upside to guidance.
  • Already seeing turn in Heritage margins here in Q1 (most effected by macro factors), which is notable given our view that Heritage is not a very defendable business.
  • The Spring/Summer order book is up 13% yy in Europe quarter-to-date (~70% of sales).
  • 2012 guidance was raised by $0.10-$0.30 to $6.10-$6.20 – mostly due to tax rate coming down from ~29% to ~24-25% as more profits realized overseas from Tommy as well as more aggressive debt reduction, $300mm in 2012.
    • This is not a 1x, but permanent shift. While we’d typically point to a lower quality earnings that is not the case here, but a new reality for the company given where profits are generated i.e. Tommy.
  • At CK, royalty revenues will decelerate to MSD growth this year driven by 1) take back of CK bridge line from WRC, 2) more conservative ordering by European retailers, and 3) a planned reduction in sales to the off-price channel.
  • SG&A spending growth will be up MSD driven by higher pension expense, multiple new launches (e.g. CK Bold underwear and new fragrances), as well as continued support for Tommy’s “Meet the Hilfigers” campaign.

All in, while it is not in our list of top three, we still like the stock here. We’re shaking out at $6.45 for 2012 on 5% total revenue growth driven by 9% growth at CK, 7% at Tommy and Heritage down slightly and 50bps in margin expansion.

 

While PVH works to stabilize its cash flow business (Heritage), it’s doing what the best brands do that license out their brands in order to grow into international markets – it’s starting to take back control of its own content. Driving brand sales directly at higher margin was key to RL’s success through much of the last decade as the company bought in its licenses. We don’t expect PVH to be any different. With earnings power of $8 in 2013, we think the stock is headed higher.

 

Casey Flavin

Director

PVH: Levers & Drivers - PVH S

 

 

 

 


DPZ: ANOTHER DATA POINT SHOWING SLOWING SALES

Based on continuing evidence of slowing sales trends in two markets, we are turning bearish on DPZ over the TRADE (3 weeks or less) and TREND (3 months or more). 

 

Only three years ago, the Street was worried that DPZ’s balance sheet had too much leverage.  The liquidity crisis at the time definitely amplified those fears but the fact remains that deteriorating fundamentals for a heavily levered company can have a severe impact on the financial health, and value, of that company.  We’re not drawing any conclusion that DPZ sales are falling dramatically but industry data from Sales Trac Weekly Data suggests that pizza sales are underperforming in the U.S. for the first two months of 2012 and this morning’s release from Domino’s Pizza UK & Ireland was not encouraging for the global business.  The timing of this slowdown is also interesting given the recent recapitalization that the company undertook along with the payment of a special dividend.

 

Domino’s new debt structure means that the company is less levered at 5.4x debt-to-EBITDA versus 6.8x in 2007.  With respect to the company’s adherence to the terms of its debt covenants, the company said on a recent conference call regarding the recap that “we estimate our EBITDA would have to drop by over $100 million, or global retail sales would have to decrease by over $1.8 billion versus the levels that we achieved in 2011 before the covenant would be at risk of breaching its primary financial covenants.”  There is a significant amount of financial flexibility in the company’s capital structure but sales softening may heighten the standards to which investors hold the company from a leverage perspective.

 

Through the first two months of the year, we are seeing pizza category sales growing 3-4% (sequentially down from 4Q trends) with sales trends turning negative during the last few days of February. We are assuming that the category was negatively impacted by weather during 1Q as consumers are have been out and about more than during a typical January/February period.  We will get more data next week regarding March trends but elevated gas prices and continuing warm weather may lead to further disappointing data. 

 

Today, Domino’s Pizza UK & Ireland reported slightly different same-store sales at +3.5% versus 4.2% in 2011.  Importantly, management hinted at further disappointment possibly coming in the second quarter results, saying, “We may have a softer comparative for the second quarter of the year”.

 

There is a lot of noise within sales trends this quarter with the weather impact and various calendar shifts that have impacted some company’s reported results.  We are withholding judgment at this point until we gain further conviction but there is evidence of the underlying trend moderating, at least from the strong acceleration that was seen in 4Q11.

 

DPZ: ANOTHER DATA POINT SHOWING SLOWING SALES - dom uk irl

 

DPZ: ANOTHER DATA POINT SHOWING SLOWING SALES - dpz pod1

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 

 


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