WRC: It’s In the Cosmos

Tough to find anything good about this quarter. Sales look flat-out bad. Bookings are ‘ok’ but in actuality are really only as good as mgmt credibility. Questionable. The biggest issue is cutting SG&A when 90% of cash flow is derived from other Brands’ content.


Report Card: D-  WRC missed on the top line even after setting expectations for a year over year decline. In addition to the expected decline in wholesale results however, which was amplified in Q1, European sales were down(-13%) and Korea (1/3 of Asian business) experienced a sharp sales decline driven by double digit comp decreases. Additional markdowns in the sportswear channel as well as continued macro economic uncertainty in Europe & Korea will offset the expected 2H recovery. Although Underwear bookings (37% of sales) are flat and management does not expect a slowdown in replenishment, it’s pretty tough for us to bank on what management says.  


All in, just about every piece of WRC’s businesses disappointed, and inventories remain very much out of whack (5th consecutive quarter of a negative sales/inventory spread below -10%). SG&A was down 5%, which helped cushion the blow. But we can’t imagine that PVH or RL – whose brand names account for nearly 90% of WRC cash flow, appreciate such meaningful SG&A cuts when the business is down. There’s still plenty of sales and gross margin risk here. We’re not going to fall on our sword and chase it.


What Drove the Miss?


This was largely a revenue miss, (-7%) vs. -1E.


  • Sportswear (52% of sales & 42% of EBIT),  was originally expected to be down $25-30mm in Q1; sales materialized down ~$40mm (-11%) which contributed ~6 points to the 7% sales decline in Q1
  • Underwear (37% of sales & 47% of EBIT), was about flat in the quarter
  • Heritage (11% of sales, 12% EBIT) down 10% largely due to planned reduction In lower margin sales (note: every sale any company ‘walks away from’ is usually one where it is simply undercut in price, or someone else simply has a better value proposition).
  • By Geography, US and EUR were the biggest contributors to sales decline both down 13% (US =40% of sales, EUR 20%)
  • Asia +9% (Korea, ~1/3 of Asia, DD comp decline with sales down 6%)
  • Mexico, Central & South america +3%
  • Canada -2%
  • GM down 112bps due to product cost inflation, costs +7-10% vs prior expectations of +5-7%
  • SG&A down 5% (deleveraged 80bps) resulting in EBIT margin -190bps


WRC: It’s In the Cosmos - WRC SIGMA


Deltas in Forward Looking Commentary


In order to properly measure performance relative to original expectations, we look at management’s 2012 guidance headed into the quarter as well as the key deltas in Q1 results vs. expectations :



First Quarter Guidance:

  • 1Q12 revs expected to be down primarily as a result of $25mm reduction in US sportswear sales to off price and value channels MISS: Revenues came in down 7% Driven by increased markdowns as well as weakness in Europe & Korea in addition to decline in off price sales

Full Year Guidance (Former Guidance in Black. Revised in Red):

  • EPS $4.20-$4.45 REDUCED: now $4.000 to $4.25
  • Revenues: +MSD (4-6%) REDUCED: now flat to +2%
  • Gross margin expansion UNCHANGED Continue to expect product costs to be flat YoY
  • First half to be challenged by cost inflation and currency headwinds with stronger 2H12 UNCHANGED
  • Product costs expected to be up 5-7% in 1H, down 7-10% in 2H WORSE: Product costs +7-10% YTD but will be down 7-10% in 2H
  • SG&A as percent of sales expect to increase in 1H12 due to restructuring of the business but improve in 2H UNCHANGED: Will continue to invest in growth initiatives but have levers if sales slow
  • Expect to add nearly 150,000 square feet of new space in 2012 ( have identified 60,000 square feet) REDUCED: now planning 120K square feet
  • Will be skewing new square footage towards ASIA and emerging markets until there are signs of improvement in Europe UNCHANGED


Highlights from the Call:



Revenues: -7% below original expectation due to Markdowns in US Sportswear, Soft retail comps, Weakness in Europe & Korea

  • Now anticipate these trends to continue through 2012
  • International sales (60% of revs in Q1) down 3%
  • Growth in Asia (+9%) and Latin America (+3%) offset by Europe
  • China led Asia, +30%
  • International growth was offset by Korea (1/3 of Asia) down 6% despite some market share gains
  • Europe: down 13% due to continued macroeconomic stress
  • Growth slowed in Germany, France, UK
  • US: Revenues down 13% primarily due to sportswear  which included $30mm reduction in value channel sales and markdowns in Calvin Klein

Retail: +7%

  • Added 39K feet
  • Comps down 2%
  • Latin American comps +DD
  • Europe comp flat
  • Asia comp down 5%
  • Planning to add 120K of square footage this year

Calvin Klein: (-7%)

  • Growth in underwear & DTC offset by declines in US and European wholesale jeans
  • CK underwear +3% with DD growth in US and Asia
  • Men's +7% with launch of bold
  • Jeans: (-11%) reflecting reduction in value channel sales
  • Women's down DD

Heritage (Speedo)

  • Most revenue decline reflected planned elimination of low margin sales


  • Increased markdowns to clear fall/holiday impacted results
  • Spring summer merchandise sell troughs are more encouraging






Full year

  • Expect Net revs to be flat to +2% (+2-4% constant currency)
  • Expect EPS to be in the $4.00-$4.45 range


  • Expect 2Q revenues and earnings to be down YoY (less so than first quarter)
  • Planning comps to be down
  • Will continue to invest in growth initiatives which will increase SG&A YoY
  • Products costs up 7-10% will continue to impact the bottom line


  • Expect improvement in all key operating metrics
  • Product cost headwind becomes tailwind with costs down 7-10% driving gross margin expansion
  • 2H Regional Growth Expectations:
  • Expect LSD in US in 2H
  • Latin America and Asia expect return to DD in 2H
  • Expecting a decline in Europe in 2H




New Store Productivity:

  • Korea having significant impact on comps and thus overall retail group
  • Additional square footage dependent upon timing and location which is included in overall retail projections


  • Some of the cuts through variable expenses associated with retail particularly in Asia
  • Overall tight cost control in the quarter whether it was new hires, replacements, etc.
  • None of the pullbacks expected to have impacted any long term investments
  • Continue to be levers to reduce SG&A if need be
  • Will be making investments in core strategic plans and initiatives

Gross Margin:

  • Will continue to see FOB costs in 2Q, but in 2H, retail mix and low costs should push GM higher
  • Expect to lift gross margin in 2H considerably

Off Priced sales reduction:

  • Full $30mm took place in 1Q


  • Really pleased with the results in China with revs +30% in the Q over 50% last year
  • Total retail +20%
  • Did see some falloff in foot traffic in particular in Shanghai and Beijing with impacted comp results overall
  • Expect traffic trends to improve
  • Continue to focus on presentation at POS, visual merchandising at a store fixture level, improving service, etc.
  • WRC remains bullish on China- no intent to pull back on new store openings


  • Know in the first quarter WRC performed slightly better than competitors and gained market share
  • Saw a significant improvement in march which is expected to continue
  • Believe they are now outperforming the department store competition
  • No new store square footage plans in Korea as of now
  • Roughly $200mm business
  • Major change in the quarter was a DD comp decline


  • Continued to grow in Northern Europe, Germany up slightly, UK flat, France up slightly however trends slowed from Q4
  • Spain and Italy continued to be down DD, expect these trends to continue
  • Continue to actively explore new relationships in Europe

Women's CK

  • Had great results on colored denim- sell through better than some of past launches but only 10% of women's business
  • For Fall, have a major replenishment program planned on denim, increasing penetration on denim where in the past WRC has pulled back and focused more on lifestyle

Latin America:

  • Constant currency revs +10%
  • Have been investing in infrastructure to really build up the platform for long term growth
  • Brazil down slightly in the quarter on top of +55% increase in last year
  • Planning Brazil to be up currently for the same year, HSD-LDD growth rate there

Positive wholesale results in 2H:

  • Combination of visibility into bookings (primary reason for driver) as well as product initiatives
  • Large portion of the business is from Chaps which is largely booked already for 2H
  • Expect CK sportswear to decline in 2H in wholesale based on fall bookings and product launches in the US and Europe

Forward bookings

  • Chaps up substantially with bulk of 2H growth through Chaps
  • Seeing increases in golf and outdoor that are looking strong for 2H
  • Underwear is roughly flat (large portion of the business is replenishment)


  • US replenishment is up DD in the US
  • Not seeing any inventory reductions that aren't relative to sales
  • Seeing a slowdown in replenishment in Europe

2H Comparable store sales expectations:

  • Expect low positive comp stores sales in 2H reflecting improvements from tactical initiatives
  • Up against lower comps in 2H11
  • Expect accelerated growth in total retail in 2H through productivity improvement in non comp stores, additional square footage
  • April comps down as expected due to Easter shift
  • Off to an incredibly strong start in May

Retail Operating Margin

  • Current forecast shows GM continues at a 4 wall basis of over 65% near 68%
  • Expecting a 20% contribution margin on a full year basis


  • Expect a slight increase of out the door price in the Fall
  • Quality and value of the product is going to be enhanced
  • Have not been any price increases in the Spring, did take some up in the Fall which carried over and there has not been any resistance to pricing

Costing (Inflation)

  • Costs up 7-10% depending on the category
  • Seeing similar reductions in 2H, expecting costs to be flat YoY
  • Anticipating LSD increases on an annual basis go forward via labor rates, material costs, etc.

Reduction in 2H marketing:

  • Reductions in marketing spend will closely reflect change in revenue growth/declines

Women's marketplace:

  • Great deal more competitors in women's with new entrants frequently
  • Highly fragmented category
  • Need more insight into the consumer which is particularly true in the consumer
  • A piece of 2H spending is on additional customer analytics

M&A Potential:

  • No change in the strategy- believe there is a significant organic growth opportunity
  • Will evaluate opportunities as they arrive but priorities rest in the current business and execution of plan

Share Repurchase:

  • EBITDA approaching $350mm, generating $270-280mm in Free cash
  • Have 189mm authorized to repurchase
  • Using share count of ~43mm for guidance

CK Bridge:

  • Still delivering product throughout 2012 and will not impact Q1 or Q2 and may have slight impact in 2H
  • Not expecting this to have any significant impact on operating results



What the Heck Is Going On In Brazil?

Conclusion: We see limited downside in the Brazilian real over the intermediate term and, thus, remain bullish on Brazilian equities given the erosion of this headwind. Further, along with China, we view Brazil as the safest place to be in the EM space, from a fundamental perspective, over the intermediate term.


Virtual Portfolio Position: Long Brazilian equities (ETF: EWZ).


In recent weeks, Brazil’s Bovespa Index – a market we’ve explicitly favored on the long side since SEP ’11 – has come under a fair amount of selling pressure in recent weeks (down just over 9% from a MAR 13 cycle peak). We attribute this largely to weakness in the Brazilian real, which is down roughly -12% vs. the USD from a late-FEB cycle peak. The key issue here as it relates to the Brazilian equity market is two-fold: 

  1. An increasingly subdued outlook for currency appreciation/an outlook for outright depreciation limits the appeal of Brazilian assets to international investors.
  2. A weaker currency – particularly vs. the USD – drives up the cost of servicing international debt as well as expenditures on FX and interest rate hedging for Brazilian corporations. All of this acts as a headwind to earnings growth. 

To point #1, net foreign inflows into the Bovespa Stock Exchange were negative in MAR (-R$1.29B) and for a large portion of APR, where late-month buying saw the month finish with a net positive inflow of R$474M – just 36.6% of the previous month’s outflows. Additionally, aside from the Argentine peso (currency of a country with a host of serious issues to contend with), the Brazilian real screens most bearishly from a market perspective over the NTM across our investable EM coverage universe.


What the Heck Is Going On In Brazil? - 1


What the Heck Is Going On In Brazil? - 2


What the Heck Is Going On In Brazil? - 3


To point #2, Brazil has the second-highest real interest rate in the developing world at 3.76% (behind Russia’s 4.30%); this forces a great many domestic borrowers to turn offshore for sources of cheaper capital – particularly in the USD debt market, where Brazilian issuers have sold a record $27.35B of USD-denominated debt in international markets in 1H12. Those repatriated inflows have slowed dramatically in recent weeks, however, with only $1.75B of that coming since the end of MAR.


What the Heck Is Going On In Brazil? - 4


We interpret that last nugget in two ways – one negative and one positive: 

  1. It suggests international capital markets are drying up – which they indeed are. Per Bloomberg, global issuance of junk-rated USD-denominated debt fell -27% MoM in APR as those bonds fell -1.1% (per a Credit Suisse index) – good for the largest monthly decline since NOV. No junk-rated Brazilian company has been able to price a deal since Magnesita Refratarios SA’s MAR 30 sale of $250 million worth of notes.
  2. Brazilian corporates, which rushed to take advantage of the window of opportunity afforded them in the global low-volatility environment at the beginning of the year, simply have lower near-term borrowing needs. Brazil’s lowly $1.6B worth of APR issuance contrasts with a record $15.5B of issuance out of Asian corporate borrowers for the month – many of whom may be accelerating issuance to get ahead of what we’ve identified a probable breakout in global volatility/widening of credit spreads over the intermediate term. Net-net, the Brazilian real, which has underperformed every EM currency (vs. the USD) over the last three months appears to have limited downside from a capital inflows perspective, given that Brazil has front-run a slowdown in the repatriation of international capital that looks to impact other EMs in the coming months. 

Getting back to point #2 above, we look no further than the recent string of bad operating results out of companies like Vale SA (world’s largest iron ore producer), Fibria Celulose SA (world’s largest pulpmaker) and Telemar Norte Leste SA as proof of what weakness in the BRL/USD cross has done to corporate profits in Brazil. In fact, in the three quarters through 1Q12, YoY growth in Bovespa EPS (which has averaged -39.6% in that time frame) has trailed YoY growth in revenues and EBITDA by an average of 5,877bps and 2,809bps, respectively – largely highlighting the impact interest payments and other non-operating expenses have had on corporate earnings in Brazil.


What the Heck Is Going On In Brazil? - 5


Importantly, as the currency’s decline slows and finds a bottom (likely well ahead of other EM currencies), we anticipate that the erosion of this massive headwall (“headwall” > “headwind”) will become a pseudo tailwind, on the margin, for Brazilian equities. The next few paragraphs detail why we think the Brazilian real has limited downside from here (vs. the USD, relative to other EM currencies) over the intermediate term.


Looking to our proprietary G/I/P analysis, our predictive tracking algorithms suggests Brazil’s monetary easing cycle will trough here in 2Q12 and likely shift the central bank’s policy bias to neutral through the remainder of the year.


What the Heck Is Going On In Brazil? - BRAZIL


Central Bank President Alexandre Tombini has presided over -350bps of interest rate cuts since we first signaled that their policy bias would shift to dovish in AUG ’11. Thus, it appears increasingly likely that his board is close to entering a period of respite in order to judiciously monitor the pass-through effects of these previous rate cuts. Further, given the mere 25bps of proximity the Selic currently has to its Financial Crisis trough of 8.75% (an all-time low), we think incremental cuts may be viewed as an unwanted signal of fear and/or desperation out of the central bank that could threaten its credibility – especially given the politicized nature of the aforementioned rate cuts (essentially at President Rousseff and Finance Minister Mantega’s constant urging).


What the Heck Is Going On In Brazil? - 7


Per the central bank’s own survey (latest poll conducted on APR 27), domestic inflation expectations over the NTM are far from far tame, having increased each week since mid-FEB. This jives with our long-term view on the domestic inflationary pressures within the Brazilian economy; there’s simply too little slack throughout several key areas in the economy to convince market participants that “everything’s under control” from a long-term inflation expectations perspective. We walk though this topic in great detail in our 75-slide Black Book on Brazil titled “The Roadmap for Investing in Brazil”; please email us for copies in the event you missed it come through live in AUG ’11.


What the Heck Is Going On In Brazil? - 8


Additionally, recent weakness in the BRL/USD cross is eroding the currency’s marginal strength relative to global food and energy prices – which serves to threaten reported inflation statistics to the upside in the coming months. Notably, the IGP-M inflation index, which has been known to lead the benchmark IPCA CPI index by 2-6 months, bottomed in MAR. While we don’t see material upside in Brazil’s headline inflation rate over the intermediate term, this data point is in support of our model’s view that Brazilian CPI bottoms here in 2Q and accelerates in the back half of the year – likely preventing the central bank from reaching the midpoint of its inflation target of +4.5% (+/- 200bps), which it has repeatedly promised to accomplish by year’s end.


What the Heck Is Going On In Brazil? - 9


What the Heck Is Going On In Brazil? - 10


If Tombini’s cutting-edge SAMBA (Stochastic Analytical Model with a Bayesian Approach) forecasting techniques start to jive with our own quantitatively-based G/I/P outlook and support a marginally-hawkish shift to a neutral policy stance, we would expect Brazil’s interest rate and FX markets to respond accordingly. The one wild card here remains Finance Minister Guido Mantega and his politicized drive to weaken the real to protect Brazilian manufacturers and exporters from what he and President Rousseff have publically identified as a “currency war” beget by a “very adverse; very perverse” flood of international liquidity stemming from a developed-world “monetary tsunami” (i.e. QEs, LTROs, APPs, etc.).


As highlighted earlier, the slowdown of inflows of foreign capital/demand from Brazilian corporations to issue abroad largely coincided with Mantega’s broadening of the scope of the country’s financial transactions (IOF) tax in FEB. The new requirements force Brazilian corporations to pay 6% on international loans proceeds with maturities up to five years (from one year and then three years prior). This is on top of a 6% tax rate on foreign investor proceeds from investment in Brazil’s domestic fixed income market, a 6% tax rate on foreign investor’s margin deposits for futures contracts, and a 6.38% tax on foreign credit card purchases.


On positive in all of this is that Mantega has been known to completely rescind iterations of the IOF tax, as he did with the IOF tax on foreign investor equity transactions back in NOV. His own commentary leads us to believe he’s likely to reverse his harsh stance against currency appreciation alongside any confirmation/urging from the central bank in the coming months:


“We established regulatory measures exactly for that, to add and take away. The IOF is one of those, we introduced it, then we can take it away when it’s no longer needed.”


All told, we’re buying Brazil for a trade here, though our bullish fundamental outlook suggests we could hold it for longer if the quantitative setup shifts in our favor. Our proprietary risk management levels for the iShares MSCI Brazil Index Fund are included in the following chart:


What the Heck Is Going On In Brazil? - 11


Lastly, before we conclude this note, we wanted to share with those of you who follow Brazil closely our own “nuggets” which Moshe Silver, Hedgeye’s Portuguese-speaking Chief Compliance Officer, mines the Brazilian local press each day for relevant economic and political commentary. We always find local market color to be additive to our research process, so we wanted to share with you a few of his more interesting callouts from recent weeks: 

  • SELIC and savings – on the heels of yesterday’s cut in the SELIC rate to 9%, O Globo columnist Miriam Leitao presents an analysis of the effect of reducing the SELIC rate on personal savings in Brazil. She says that fluctuations in the SELIC rate can drive average returns on investment funds below the returns on normal savings accounts. Profits from investment funds are taxed at rates ranging between 15%-22.5%, while savings accounts are not subject to tax. Leitao quotes a study that finds 16 out of 20 scenarios in which a passbook savings account has a better return than average securities investments, with the SELIC at 9%. If there were a rush to passbook savings accounts, writes Leitao, funds available for real estate lending would swell, as banks are required to make 65% of savings account assets available for real estate loans. The government has to be careful, says Leitao: if they make savings accounts too attractive, it could disrupt the market for public debt, which is largely owned by investment funds and banks. Leitao says the government will have to find a workable resolution to this situation. Without it they will be in a bind and unable to continue to lower rates.
  • President Rousseff to announce savings policy – Brazil’s president Rousseff is set to announce new government policies covering personal savings accounts. Reported in Veja, President Rousseff looks set to upset a large number of her citizens as she announces changes to passbook savings accounts designed to reduce the profitability of the accounts. Observers say Rousseff is forced into this – introducing a wildly unpopular policy in the middle of an election year – because reducing the profitability on savings accounts is the only way to prevent “a stampede” of investors out of the fixed income investment funds, which are seen as critical to enabling the government to roll its billions in federal debt issues. According to Veja, there are 10,800 private funds, which invest principally in government paper. 22% of these funds invest in federal debt – but they represent 65% of the total R$ 1.85 trillion invested.
  • Central bank cautious on rates – the latest central bank COPOM monetary policy committee minutes released this week said “given the cumulative effects and in view of the policy measures implemented to date, any further monetary easing should be undertaken with moderation,” leading observers to say further rate cuts will depend on the pace of recovery in Brazil’s economy. 
  • Transportation – President Rousseff proposed a R$ 32 billion package for urban transportation projects, saying funds should especially be directed to metro projects – again, though not explicitly stated, it is clear the country’s major cities do not have sufficient urban transport facilities for the World Cup.
  • Tax breaks for industry – finance minister Guido Mantega said payroll taxes will be reduced starting in July in the textile, auto parts, aerospace, footwear, and capital goods sectors, among others.  Mantega also said subsidies will be increased for the manufacturing sector and for exporters who have suffered because of the appreciation of Brazil’s currency. 
  • Social spending at record high – the government’s Minha Casa, Minha Vida (“My House, My Life”) cash transfer program spent at record levels in the first quarter of 2012, laying out more than R$ 5 billion, which is more than five times the spending for the same period a year ago, and nearly half the budget allocation for this program over the next three years.  It was not reported how the government intends to account for expenditures going forward, but we remind readers that off-budget facilities that are routinely applied to social programs, a “spend today, figure it out tomorrow” approach that Brazil still has not managed to shake.
  • Government to capitalize banks – Brazil’s major state owned banks, Caixa and Banco do Brasil, are discussing cuts in the rates in their credit lines.  As part of the government’s program to reduce banking spreads, the treasury is contemplating additional financing if the cuts in credit spreads affect the banks’ capitalization as required under Basel 3.  The issue of government guarantees becomes more important for Brazil’s private banks.  Before the 2008/2009 financial crisis, state-owned banks had issued about 30% of total credit.  That is now up to 43%.  Private banks have suffered greater rates of delinquencies and defaults.  If the credit spreads are to be brought down further, they fear they will not have the profit cushion to permit them to operate.  

Darius Dale

Senior Analyst


The title of this note may be a little harsh but there is a chance that it is not.  Some are betting that there is more pain to come and some are buying the stock on account of the "massive" 50% decline.  We are not buyers here and see potential for, if anything, further downside.   We see no reason to own this stock besides the size of its market and that lone positive is overshadowed by the plethora of negatives and possible future negatives facing the company. 


“It ain’t what you don’t know that gets you in trouble.  It’s what you know for sure that just ain’t so.”

-Mark Twain


There are a lot of red faces among the sell-side analysts covering Green Mountain Coffee Roasters.  Anyone in the business can empathize with those putting forth a mea culpa to clients today but still, even after last night’s “surprise”, Mark Twain’s aphorism is worth bearing in mind.  What investors knew “for sure” has caused a wild ride in this stock over the past 18 months.  Giving management the benefit of the doubt, despite huge cash burn and recurring accounting concerns, was a leap of faith that has proved costly for many. 


We wrote a note on April 5th stating the following: “The question is: how bearish is bearish enough?  We think the stock could go to $25.”  In that note, “GMCR: THE SLOW BLEED OF THE GREAT COFFEE BUBBLE”, we highlighted several things we didn’t know for sure and the worrying harmony that existed between the most negative scenarios in our model, insider selling, and allegations outlined in a Class Action Complaint filed against the company.  The financials, we said, were the “big unknown”.  To a large extent, they remain so.  The emperor has fewer clothes than the market thought.  Does he have any at all?  We think Green Mountain has a business, and is a going concern, but there could be more pain in store.  With management’s credibility essentially vaporized over the course of a staggeringly poor showing during last night’s earnings call, the unknown unknowns are taking more mind-share among investors.


These unknowns are like landmines; there are difficult to see until it’s too late.  We think an accordingly prudent approach to this name is appropriate; investors should take a "show me" approach to management's projections, given the reputational blow that this company has inflicted upon itself.  If one of these still-buried landmines blows up, not only would that pose a problem in and of itself, it could set off others.  As sales disappoint, disgruntled shareholders are likely to add their voice to class action complaints and other investigations.  There is potential for it to get ugly. 



Still-Buried Landmine: Accounting Shenanigans


Given management’s hour long fumble last night, the question that people are asking is what type of internal controls the company has in place.  When prodded about what factors were behind the “moderating” sales growth, CEO Larry Blanford provided a telling response: “I think all of us are trying to take into account the – kind of these underlying factors and we’re still trying to understand them.  So that’s the honest answer.” 


Whether that is actually an honest answer is a risk; suspicions we referenced in our April 5th note about Green Mountain’s compensation structure being levered to net sales could hold an explanation.  Has the company been managing revenues by ordering K-Cups from third-party roasters?  The calculus behind executive level bonuses may have provided some incentive for senior officers to follow that strategy. 



Still-Buried Landmine: The Demand Model was Not a Model To Begin With

Six months ago, on November 9th, Green Mountain’s CFO Frances Rathke said the following on her company’s “demand model” and its efficacy: “as we noted in our remarks, we’ve had it tested now by outside experts and we, as well as the experts, feel it’s a very accurate and predictive model.  So, I think, overall, for fiscal '11, the portion pack volume came in very close to what the model predicted, and I think, once again, we were comfortable that we can rely on this as we go forward, into fiscal '12 and the future.”


We cannot reconcile that statement with what the CEO said last night: “over the last several quarters we have seen a dramatic increase order volatility, which comes, we think, from the dynamic growth of our business, the expansion of brands and varieties in our Keurig Single-Cup brewing platforms and demand shifts between our channels.”  Time will tell whether or not there was any real model in place besides the model that dictated executive compensation as being a function of sales. 


This dramatic shift in tone has shaken the conviction of the firmest believers in the Green Mountain story and rightly so.  The company clearly has a very poor handle on the demand for its product and the sales-inventory spread (chart below) is illustrating a company in dire straits.





Still-Buried Landmines: Capital Requirements, Capacity Glut, Margin Contraction


Despite the myriad concerns facing the business, management continues to invest a staggering amount of capital into its business.  Its capital expenditures for 2012, projected at $525-575mm versus $630-70mm prior, and beyond are aimed at supporting the future growth of the business, per the company’s most recent 10-K filing.   Of this2010 guidance for capital expenditures, $165 million will be invested in increasing packaging capabilities related to the Keurig K-Cup brewer platform, $65 million will be invested in packaging capacity related to the Vue brewer platform, and the balance is spread between expanding the physical plants, coffee processing and other equipment and investment in information technology infrastructure and system.  It is clear that the company will still be burning cash in FY12. 


Our question is, given that its capex is aimed at future growth, to what end will this cash be burned?  If the growth outlook is changing and the company obviously cannot offer a lucid picture of what demand is looking like for their product, how is ~$550mm in capex arrived at?  The changing demand outlook has caused management to alter its capex outlook but will the company also be burdened by over-capacity?  Given that the company has been building capacity in anticipation of future demand growth, is moderating demand about to saddle the company with underutilized assets?


Finally, it seems possible that further write-downs could be on the way which would further weigh on margins.  What are the chances that management came clean on all of the company’s problems at once yesterday?  There are clearly too many questions still hanging above this stock and the management team is not inspiring confidence in anyone.


Is it “all priced in”, as some amazingly resilient bulls want to believe?  We think there are too many risks that that just ain’t so.



Howard Penney

Managing Director


Rory Green


Early Look

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In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance.



OVERALL:  WORSE: RevPAR was healthy and top-line was fine, but EBITDA missed expectations due to high SG&A growth and a higher contribution of occupancy to RevPAR than rate.  

    • SAME: 2013 and 2014 bookings are still looking good with most of the strength on the rate side. 
  • SG&A
    • WORSE: even excluding the one-time costs, SG&A was far higher than previous expectations
    • BETTER: Close-in bookings continued to be strong.  In the quarter for the quarter bookings were up 20% with equal contribution from rate and occupancy.  In the quarter for the year bookings were up 30% YoY, driven primarily by rate.  Rate strength was driven by group bookings and higher corporate rates.  They are still seeing a lot of activity come in that 90-day window.
    • BETTER: Hyatt was pleased with their progress and results of their renovations.  Renovations from their big five hotels contributed 190bps in margin improvements QoQ.
    • SAME: Hyatt continues to expect over 20 hotel openings in 2012
    • SAME: The company's long term outlook remained bullish.  The city seems to be absorbing new supply just fine with projected RevPAR growth in the mid-to high single digit range.  Both transit and group demand is up. 
    • SAME: On schedule and hope to open before 2016 Olympics, pre-opening development costs will continue. They still plan on engaging potential partners to complete the project down the road.
  • M&A
    • SAME: Hyatt purchased an asset in Mexico City and remain active in pursing M&A opportunities.  They have yet to see a strong pickup in the transactions market yet.
  • CAPEX:
    • SAME: 2012 guidance was raised from $350MM to $360MM due to the recently announced construction of Hyatt Place Omaha Downtown/Old Market.

Embracing Uncertainty: SP500 Levels, Refreshed

POSITIONS: Long Healthcare (XLV); Short Industrials (XLI) and Basic Materials (XLB)


Tomorrow is an important day in reporting monthly U.S. economic statistics, the U.S. Labor Report is released.  Keith is on the road, but we were discussing the potential stock market reaction to the labor report and, in short, we actually have no idea how the market is going to react.  This is probably not the best answer for a group of people that get paid to tell you what direction the market and stocks are going to go, but sometimes the beauty of using a system based on chaos theory is that you just have to embrace uncertainty.


As it relates to the U.S. Labor Report tomorrow, I would highlight a couple of points: 

  1. Our Financials Team noted this morning that initial claims over the past few weeks have been coming in even worse than they would have suspected, even as last week’s claim, as reported this morning, fell 23K to 365K.                                                                                                                                                                                                       
  2. Last month the U.S. added 120,000 jobs and consensus estimates are looking for 160,000 jobs additions for April, so an acceleration.  Thus, a number tomorrow below 160,000 will be a disappointment.  

Interestingly, the recent Challenger job report released yesterday appeared to support our view that the job market may decelerate.  Specifically, planned job cuts increased by 7.1% from March to April and 11.2% on year-over-year basis.


Even as we embrace the uncertainty of the job report tomorrow, we’ll stick with our range in U.S. equities to adjust exposure and manage risk.  As outlined in the chart below, our TRADE resistance level is 1,415, TRADE support is 1,393, and TREND support is 1,359.  A close at, or near, the TRADE resistance line suggests that disappointing news tomorrow is not baked into market prices.


What the market will actually do tomorrow on this news, though, is not clear, but as Bob Dylan said:


“Chaos is a friend of mine.”


We agree.


Daryl G. Jones

Director of Research


Embracing Uncertainty: SP500 Levels, Refreshed - SPX



In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance.

OVERALL:  WORSE - While RevPAR was better than MGM's guidance, EBITDA missed the mark due to higher expense growth.  We would normally give companies credit for hold issues, however, since hold was actually 1% higher than last year across their portfolio YoY, it's a bit of a tough argument to make.  MGM China hold was also high and contributed more than $25m to the property.

    • BETTER: Despite the tough comp RevPAR for 1Q came in at 4% better than the 2-3% guidance.  However, most analysts had higher RevPAR in their estimates.
    • SLIGHTLY WORSE:  MGM now expects 2Q RevPAR to be up "mid-single digits" with a "strong forecast for the year." On the last call they said that "second quarter looks particularly strong and we think our RevPAR is going to grow nicely throughout the year" with mid to high single digit RevPAR growth achievable.  We don't think that investors were hoping for mid-single digit growth. MGM did qualify their guidance in that they think that if close-in bookings come in better than expected that they can exceed their guidance.
    • SAME:  Convention room nights on the books will be same as 2011, however, since the some of the MGM Grand rooms are out of service, convention mix should be slightly better than 2011
    • SAME:  MGM is optimistic about the higher level of group bookings YoY, the opening of Zharkana in 4Q,and modifications to Crystals which should provide easier pedestrian access to Aria
    • SAME:  Unclear if there is an impact from SCC but it's really too early to tell. If there any impact " it’s around the 3% to 5% in traffic, but is not necessarily showing up in play."
    • SAME:  They are still excited to be pursing potential development sites in the western part of the state
    • SAME:  Corporate expense ex stock comp came in at $37MM, just a tad above the moderate increase to "mid $30 millionish" that was guided to
    • LITTLE BETTER:  Stock comp was $9.3MM vs. guidance of $10MM
  • D&A
    • SAME:  D&A was $237MM vs. guidance of $235 million to $240 million
    • SAME:  Interest expense was $284MM vs. guidance of $285MM

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