Ok, I admit it. I am a lease junkie. I don’t mean to beat a dead horse on issues like differences in rent escalators and contract terms, but the reality is that they matter – a lot. The difference between a 10 year duration and 5 year duration equates to a multi-point swing in margins for most retailers. That can’t be looked over when some of these guys are operating in the mid-single digit margin range.
A client asked me to deliver a comparative analysis of lease structures for different retailers. Note that such projects are a regular part of our business, and upon completion are ‘embargoed’ for a period of time specified by the client – after which I can share if I so choose. This is one where the results were clearly worth sharing. It brought several questions to the forefront for me that I previously did not appreciate.
The analysis looks at the total duration of lease portfolios for different retailers, which we calculate using disclosure of minimum obligations by year on off balance sheet assets (Y Axis). Then on the X axis, we plot the 2-year change in portfolio’s duration. It other words, what is the duration, and are recent actions by management extending or shortening that duration.
There’s no right or wrong place to exist on this chart, but it definitely opens up a few questions regarding management’s growth philosophy where such investments are being accounted for, and how they are funded.
Making sweeping statements based on the analysis would be intellectually dishonest, as there’s no right or wrong place to exist on this chart. This is really more of a tool to ask management teams the right questions regarding growth philosophy, where such investments are being accounted for, and how they are funded. Some observations…
1) Generally, I like shorter durations, as it suggests that the companies have the most optionality lengthen it if they’d like and boost margins vis/vis deferring payments. Not a strategy that I recommend, but it is a lever available nonetheless. Some companies (DKS, DSW) will argue that they are confident enough about their business plan such that they can model sales far enough out to warrant at 10-15 year lease. I find that tough to stomach. The only time I prefer longer-tailed agreements like this is when companies that have ample liquidity take advantage of suffering landlords and lock in longer agreements on the cheap (i.e. we just leased our new San Diego office for a buck a foot. How? It is a new space originally built for Lehman. Enough said…).
2) CAB: How scary is Cabela’s? 20-year duration in its portfolio, with a whopping 4-year growth rate in that over 2 years. Yes, this suggests that new stores are being added to the tune of about 25 years in duration. Good luck with that.
3) LULU: I’m a very big fan of LULU. But this is a negative datapoint for me. A 10.5 year duration is not horrible, but the fact that this grew by 2.25 years at the same exact time the company meaningfully broadened its exposure to the US suggests to me that US stores are being added at a rate far higher than 10 years. It makes me wonder what margins would look like with terms on these new stores closer to a high single digit rate. Definitely something to look in to.
4) UA: Under Armour originally concerned me with a doubling of its rate over the past 3 years to 6.25 years. But this is largely because a) UA is building a retail store network that previously did not exist (which takes up off balance sheet liabs), and b) athlete endorsements are growing at a rate disproportionate to sales as UA invests in businesses like basketball and training. I’m ok with this.
5) HIBB: How could I do this analysis and not mention Hibbett? 4.2 years and has not budged in years. These guys have the ultimate flexibility with their ‘Wal-Mart remora’ real estate strategy. I particularly like HIBB in ’09 bc it should see a reversal in almost every pressure point of the P&L and balance sheet. Consider this…Aside from weak urban business, sales have slowed because of HIBB’s inability to close on new deals over the past 2 years at a rate to facilitate its’ stated growth goal. At the same time HIBB built a DC and installed JDA (ERP system) which are well-needed operational investments. On top of that, the product cycle has been lousy. Now UA is sparking a healthier product cycle, JDA and DC investments are done, and the weakness in credit markets and business trends is making better real estate available at a greater number of mom and pop locations. Not only should growth accelerate in ’09, but margins should go up and take incremental ROIC with it.
6) COLM: I like Columbia, and with a 7-year duration I am not worried. But a 2year boost in duration over 2 years (as it opens more retail) bugs me.
7) DKS: DKS much look good with a 2 point improvement, but that optic is driven by Golf Galaxy. Strategy remains risky.
8) Nordstrom, Kohl’s and JC Penney all hovering around 9 years. But JWN duration improved by a year, KSS was relatively flat, and JCP eroded by a year. I like KSS, have been warming to JWN, and despite a strong near-term incentive structure at JCP, am so grossly uncomfortable with the story that I need to hold out and be greedy on that one.
So many more questions to ask and answer here. Let me know if you’d like to discuss.
The analysis looks at the total duration of lease portfolios for different retailers, which vs. the 2-year change in the portfolio’s duration.