HBI: Severe Pricing Gap Remains

We revisited the pricing disparity within HBI’s core basics category across 3 of its largest customers (WMT, KSS, JCP) which was prevalent in February. The pricing gap on like-for-like product remains what we’d call severe. 


In our 2/13 note "HBI: Pricing Disparity = Uncertainty" we addressed the gap in Hanes’ basics pricing across various mid tier department stores and mass retailers.  Additionally, we outlined our expectations for competition on price to heat up in 2H and as a result, while costs ease, pricing will buckle for HBI and offset the improvements on the cost side. In February, there was a prominent bifurcation in price points for like goods at KSS, WMT, AMZN & JCP. This gap is still in place today – down to the penny. Perhaps this is a positive for HBI that its customers are able to maintain such opacity. But we question how long the balloon can be held underwater.


Our expectations for price competition to headline the back half of 2012 stem from industry dynamics, primarily JC Penny’s radical shift in pricing which will stir defensive responses from KSS, SHLD (if it still exists), M, TGT and Amazon.  As of today, we have little transparency into what kind of traction JC Penney’s “Fair and Square” pricing strategy has gained on the consumer however we can say that from where we sit, Ron Johnson and team have started doing a better job conveying the strategy’s message. Previous ads have been replaced with the actual math (see below) – a watch that cost $30 last year, cost $21.99 when on sale (last year) and then $17.59 with an additional 20% off now costs $15…. everyday – clear as clear can be. Compare messaging from KSS vs. JCP. It’s like night and day.


Right now (and unchanged from February’s check), for the same commodity Hanes 5 pack of crew T-Shirts, KSS pricing is 36% above JCP. Likewise, for an identical 4 pack of boxer briefs, KSS pricing is 44% above JCP. After adjusting for online BOGO and volume incentives, KSS remains 42% and 50% above JCP for the same two items respectively. The pricing disparity here doesn’t address Wal-Mart who actually has the best price for Hanes’ basics in undershirts, boxer briefs & socks (see chart 2 below). Interestingly though, at WMT, across the 3 basics categories, Hanes’ pricing is at a premium to Fruit of the Loom & Starter (GIL) for the items we analyzed (chart 1).


Near term, we expect the results tomorrow after the close to be in line with consensus (-$0.33), if not slightly better. The company has been on the road constantly over the past two months and has been extremely bullish about its prospects. It has all the visibility it needs this quarter. But as for visibility into 2H, the lock on revenue evaporates.  Looking out to the intermediate term however and considering the implications a price battle could have for the commodity retailers like HBI, we’re shaking out at $1.54 vs $2.50E for F12. For additional takeaways following the 2/15 call, see our note "HBI: Fail"


HBI: Severe Pricing Gap Remains - WMT brand pricing


HBI: Severe Pricing Gap Remains - HBI basics


HBI: Severe Pricing Gap Remains - JCP ad


Earnings Week At Hedgeye: Spotlight on Retail


Earnings Season for the Retail Supply Chain kicks off in earnest later this week with both Hanesbrands and UnderArmour showing their wares. We think that the broader take-away from this earnings season will be one of complacency – though it might not be fully apparent at the time. Companies have a great excuse in unfavorable winter weather, and little visibility into what the real underlying sales trends are in April due to the rather severe impact that the change in the holiday calendar is having on the top line. Specifically, Easter was on April 24th last year, while this year it fell on the 8th. Given what we think is about a 3-week ramp of sales into the Easter holiday, the event definitely pulled sales forward into the month of March. As a result, companies who operate on a January – December fiscal calendar will recognize Easter spending in Q1 vs Q2 last year. We can argue anywhere from a 1% to 5% impact on sales results for March/April. The reality is that the companies are largely unaware of the actual magnitude of the shift either. But any kind of soft comps in April will probably be given a free pass.


On top of the holiday calendar shift, the industry is at the tail end of a meaningful ramp in commodity costs that has the Street modeling a significant ramp in earnings growth in 2H12. That’s where we get concerned. People tend to forget that Gross Margins are not all about costs, there’s also a revenue/pricing component. All of the retailers are planning to keep lower commodity costs in 2H. But no one is banking on any peers breaking rank. JC Penney’s EDLP strategy will absolutely put Kohl’s on defense. That’s 12% of the apparel industry right there. What about Target, Sears, Amazon, Gap/Old Navy… The numbers start adding up. Margins are a zero sum game in this business. If prices come down, someone has to pay for it – either the brand, the manufacturer in Asia, the retailer, or the consumer. The only safe bet for us is that it won’t be the consumer.


To put some numbers behind the madness, consider the following:


a)      The current consensus earnings growth forecast for the next 12-months is 23%. We have not seen this kind of growth since we came off of recessionary earnings numbers in 2010.


b)      The market is giving this earnings growth a 17x p/e. We’ve only seen that kind of multiple five times in 3-years, but always at times when the group was still clearly under-earning. Who are we to say that it is NOT under-earning today? But to make this case, we need to see a considerable upshift in consumer spending alongside another decline in raw materials costs. We don’t like that call.


c)       Revenue: 4Q was the first time in 3-years where revenue growth in retail was below 7%. Granted, it was on a tough comp vs the prior year, but the 2-year run rate has been stuck squarely at 10% for the past five quarters.


d)      EBIT Margins have been down for the past  three quarters by an average of about 50bps. The consensus is banking on a reversal in EBIT margins in 2H and in 2013. Such a sharp reversal would be the first time we’ve seen a non-recessionary rebound to that degree in well over five years.


e)      We’re going on six consecutive quarters where inventories are growing faster than sales. Maybe this supports the case for a sustained top line, but certainly not at the margin levels people are expecting in 2H.


So where do we want to be invested? We like stories that have asymmetric factors that will allow them to work in any climate, such as LIZ, URBN, FINL, DECK, ANF, NKE and RL. We don’t like names that will get stuck in the middle of the margin madness, such as KSS, JCP, HBI, GIL, CRI and JNY.






Brian P. McGough
Managing Director

Argentina, Imploding

Conclusion: Keep a small space on your white board(s) for the risk of another large-scale Argentine default over the long-term TAIL. At a bare minimum, another bout with domestic hyperinflation is an elevated risk over that duration, as the country seeks to deplete the very resources it needs to maintain stability in its currency.


In NOV of 2010, we wrote a note titled, “Is Argentina Signaling a Cyclical Peak in Emerging Market Asset Values?” in which we used Argentina’s country-specific fundamental outlook to highlight our generally-bearish thoughts on EMs. Using the MSCI EM Equity Index as a proxy for “EM asset values” we were roughly +4% too early in making that call (though the index did experience a -31% peak-to-trough decline in the months following our publication). Looking to Argentine equities specifically, the country’s benchmark Merval Index is down roughly -29% since NOV 4, 2010. In addition to the equity market crash, the nation’s 5yr CDS jumped +378bps (roughly +62%) since then and its currency, the Argentine peso, is down -10% as well.


Argentina, Imploding - 1


As with all of our research, the point is never to take victory laps, but rather to inform our clients on pending material risks (+/-) that we view as increasingly probable. With Argentina, another round of domestic hyperinflation (per IASB standards) is not at all out of the realm of possibility over the long-term TAIL. Ironically, this is likely to come alongside a continued popping of Bernanke’s Bubbles across the commodity market(s). As we walk through in the analysis below, structurally lower commodity prices = a structurally higher probability that Argentina is forced to default on its external sovereign debt over the long term.


Per the oft-maligned Institute of Statistics and Census of Argentina (INDEC), agricultural and petroleum products account for 66.2% of Argentina’s export revenue. Soybeans alone make up 24.1% of the total, followed by fuel and energy products at 12.2%, and then cereals (mostly wheat and corn) at 8.3%. The reason we focus on Argentina’s export revenue is because FX reserves have become the primary source for Argentina’s servicing of its existing stock of external debt – especially given that Argentina remains locked out of international credit markets largely as a result of private creditor holdouts from its $95B default in 2001 and subsequent ’05 and ’10 restructurings (eventually totaling 92.6% of the original defaulted amount).


Recent legislation has dramatically increased Argentina’s reliance on its stock of FX reserves to service international debt. In MAR, the Argentine Senate approved President Fernandez’s proposal to eliminate the “free-and available” clause from the 1991 Dollar Convertibility law that was largely responsible for helping Argentina overcome hyperinflation by pegging the peso at a 1x1 rate vs. the USD. This allows the Argentine Treasury to use all of the central bank’s FX reserves to fund whatever purchases policymakers desire, including servicing international debt. Previously, the law had stipulated that the country was only able to tap FX reserves in excess of the domestic monetary base.


The Treasury, which now has unmitigated access to the central bank’s $47.5B in FX reserves, has already used $16.2B of FX reserves since 2010 to service the country’s external debt; another $5.7B of those reserves are budgeted for debt service in 2012, leaving the country with $41.8B at year-end (assuming no little-to-no growth in the existing stock). At that pace – which could easily accelerate given the socialist agenda of President Fernandez – Argentina will run out of reserves by 2020 (again, assuming no growth). Per Bloomberg, Argentina has $82.3B, $31.5B, and $2.2B in USD, EUR, and JPY denominated debt outstanding, respectively.


Argentina, Imploding - 2


In addition to tapping FX reserves for debt service, the rule change now gives the president access to increased “loans” from the central bank (now 20% of LTM total vs. 10% prior). We view it as highly unlikely that the central bank is paid back on time and/or at all if the sovereign is ever in a pinch – lest it continue nationalizing domestic assets, such as the recent YPF SA takeover. The ouster of Spain’s Respol from its controlling stake in its Argentine unit is but one of a long series of credibility-damaging maneuvers Fernandez has either initiated or endorsed since winning reelection last fall:

  • New legal restrictions (up to criminal prosecution) on domestic purchases of foreign exchange;
  • Legislation forcing importers to require approval from the federal tax agency for all overseas purchases; and
  • Forcing dividend-paying banks to hold 75% more capital (designed to deter them from making dividend payments to international shareholders).

The common theme with these measures is that they have each been more-or-less designed promote financial repression in the form of quashing capital outflows, which, in essence, artificially prop up central bank reserves. Over the long term, however, there is little the country can do to salvage the near-irreparable damage Fernandez has done to the country’s already-low international credibility among investors. Capital inflows will become increasingly scarce over the long-term TAIL, limiting growth in FX reserves, which would already be under assault in a sustained Strong Dollar environment. The following commentary in the wake of the YPF SA seizure lends credence to our long-held view:

  • “I am seriously disappointed by yesterday’s announcement. We expect the Argentine authorities to uphold their international commitments and obligations, in particular those resulting from a bilateral agreement on investments with Spain.” – European Commission President Jose Barroso
  • “A takeover sends a very negative signal to international investors and it could seriously harm the business environment in Argentina. The measure creates legal insecurity for all European Union and foreign firms in the country.” – European Union Foreign Policy Chief Catherine Ashton
  • “Argentina aimed to take over YPF cheaply and the company demands compensation… The expropriation isn’t anything more than a way to cover up the social and economic crisis Argentina is suffering at the moment.” – Repsol Chief Executive Officer Antonio Brufau

As an anecdote, I’ve exchanged correspondences with former Argentine Central Bank Chief Martin Redrado over his 2010 termination for refusing to tap FX reserves to supplement public spending and service international debt due to its inflationary consequences; needless to say, his worst fears are being realized in real-time. More importantly, perhaps the worst is yet to come for his home country.


As such, keep a small space on your white board(s) for the risk of another large-scale Argentine default over the long-term TAIL. At a bare minimum, another bout with domestic hyperinflation is an elevated risk over that duration, as the country seeks to deplete the very resources it needs to maintain stability in its currency. Per the chart below, the FX non-deliverable forwards market is pricing in a -20% decline in the Argentine peso over the NTM. At this pace of introducing new [bad] economic policy initiatives, we’d expect even more downside over the long-term TAIL.


Darius Dale

Senior Analyst


Argentina, Imploding - 3

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In preparation for PENN's FQ1 2012 earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.



Telsey Advisory Group Spring Consumer Conference (3/28/2012) 

  • There is a process in place to legalize slots at the tracks. We own two of the seven tracks. We recently signed an MOU with the governor and we anticipate relocating those tracks to Austintown and to Dayton. There'll be a spend at each facility of $200 million, including the license fee, and we also agreed to pay a $75 million relocation fee at each facility.”
  • “They'll have a 33.5% tax rate plus some sort of horsemen subsidy. We expect that to be around 10% to 11% and we have some guarantees if that exceeds 45%. The biggest thing we buy for the relocation fee is a buffer, a 50-mile buffer around our stand-alone facilities and also around our slots at tracks. There are a few exceptions to that 50 miles. Scioto Downs, that I talked about, is one of them. I'll get to the other two. This is still contingent. There are more developments necessary. There is – there needs to be an agreement signed with the horsemen and there needs to be a resolution to the constitutional challenge. So we're excited for the progress that we've made in Ohio, but this is not yet shovels in the ground go time.”
  • "Hollywood Bangor recently added table games, one example, seven poker tables and six blackjack tables. There's a 16% tax rate and – not quite as exciting as our other stories, but there is certainly an opportunity for incremental EBITDA at that property."
  • [January/February trends] “We've seen more spend particularly on the higher tier customers.  February, as you said, there was an extra day and there was also great weather that contributed to our results. January was a good month, not quite as good as February, but so far we're pleased with the quarter. And I don't think that as a company we're quite ready yet to determine whether the consumer's back. I think that there's more optimism right now.”
  • [Kansas cannibalization] “It's still better than expected.”

 Barclays Capital High Yield Bond and Syndicated Loan Conference (3/26/2012)

  • [I-gaming] I don't think we expect federal legalization this year. There is the potential for state by state. If it happens state by state, that raises a lot more questions. You have to look at what kind of bill it is, who is allowed to be involved, what the tax rates are going to be, how hard it is to get a license. So we're kind of in wait and see mode on that, although we've had some discussions so if something is legalized we would be able to move quickly.”
  • “Charles Town is doing very well, Penn National is doing very well, the Gulf Coast is struggling along a little bit, Illinois is struggling because of the new competition there, and that's kind of how it looks as far as our markets go.”


Q4 Conference Call:

  • "I think there's some continued expectations for improvement, although relatively minor in the markets that are not going to be affected. The markets where we've got cannibalization taking place, it will be very difficult to maintain – certainly almost impossible to improve and very difficult to maintain, and we are showing some expectations for some declining margins in those businesses where we're expecting cannibalization. And then we've got to help kind of offset the whole piece is – we've got some pretty good expectations for where we think margins will be relative to the new properties opening."
  • "Relative to markets of concern, well clearly Charles Town with Anne Arundel opening is clearly going to be one of those that we are going to be very focused on and we will be reacting appropriately. But Anne Arundel also has a little bit of an impact on Perryville and even less impact on Penn National. We've got the full year to see how the whole thing in Illinois pans out with the Rivers Casino. If we look at last couple of months results in Illinois that has been a little bit concerning. And then obviously there is the Pinnacle opening in Baton Rouge and we've got our property opening in Kansas, that's going to have an impact. So, clearly it's very difficult to predict."
  • "Let me just talk about the ramp up in Ohio. I think Carlo you are right. I think the good proxy for how that's going to evolve over the first two to three years would be Penn National out in Grantville, PA. That's the way we are thinking about a ramp up there, both from a revenue growth standpoint and also margin improvement standpoint. So, I think that is the right proxy to use as you think about Toledo and Columbus opening later this year.”
  • “Given the projections for racing in general and the prospects of what looks on a going forward basis in New Jersey, they came to a conclusion that the previously booked goodwill need to be written off [on the Freehold track JV]. I can tell you at this point there is no more goodwill in the joint venture, so it's all been written off and although there is a very small remaining delta between the underlying land values and the total book values, they're comfortable that we are going to be okay with that on a going-forward basis.”
  • [Sioux City litigation] "We are looking collectively at various sites right now and are hopeful that we have some agreement reached by midyear to continue to move forward with our business in Sioux City and enhance our operations there. We are hopeful that the litigation that's out there can be put to rest through an agreement that can come together between us and our non-profit sponsor. But, a lot more to come between now and midyear."
  • [Casino Rama] “As you saw in our guidance we have reached an agreement to extend our existing relationship for another six months, which takes us out to September 30 of this year. We've been told by the Ontario Lottery and Gaming Commission that they suspended the RFP process and they are not sure what direction they're going to take yet with the Rama contract, and I think it has broader political implications. They're trying to determine what they want to do strategically going forward with overall gaming in the province, which we're just a part of. So, we've been told that hopefully within the next couple of months they'll provide us with a little bit more direction on where they're going to go and it's tough to predict right now what's going to happen between – post- September 30, but it is a very politicized process right now that really is out of our hands.”

Covering France (EWQ): Trade Update

Position in Europe: Long German Bunds (BUNL)

Moments ago Keith covered France (EWQ) in the Hedgeye Virtual Portfolio. We’re taking this price opportunity to cover for a TRADE; our intermediate term negative view on France hasn’t changed. Below we provide our quantitative levels on for EWQ:


Covering France (EWQ): Trade Update - 11. ewq


This Sunday marks the first of two French presidential election votes. While the leading two candidates, the incumbent Nicolas Sarkozy and Socialist Francois Hollande, will advance to the second round vote on May 6th, recent polls suggest Hollande will beat Sarkozy 29% to 24% in Round 1 and 58% to 42% in Round 2, according to CSA.  


What’s broadly clear is that both candidates plan to increase taxes and impose fees on financial transactions.  Both have declared to reduce the country’s deficit to 0% (as a % of GDP), Hollande by 2017 and Sarkozy by 2016.  Both guide to reduce the deficit to 3% by 2013 versus 5.3% in 2011.


However, Hollande has signaled an even more socialist agenda, which we think should result in the inability of the state to meet its deficit and debt reduction targets. Hollande wants to increase spending by €20 MM over five years (by repealing €29 MM of tax breaks and generating revenue by separating retail and investment bank operations and raising the income tax on earners over €1 MM to 75%) and reduce the retirement age to 60 from 62.  With the country’s debt rising to the 90% level, we expect growth to be compressed, as proven by the work of Reinhart and Rogoff. Finally, Hollande has stated that if elected he will renegotiate the EU budget compact and that he will not accept austerity as rule for countries.


Taken together, we think these policy moves will disadvantage the broader economy versus its European peers.


Matthew Hedrick

Senior Analyst

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