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FL: A Much Needed Beat


Conclusion: We expect a solid beat driven by strong domestic sales through Q1, which should offset continued weakness in Europe. Near-term the stock is at a precarious level as it is just below a convergence in both its TRADE and TREND lines. The percent move down on a penny miss will likely exceed stock upside on a penny beat. If we’re wrong on the quarter, Friday won’t be fun. But we have enough confidence in the FL story to use that as an opportunity to get in to a name that ran-up 35% leading up to its analyst day back in March.


FL Risk Management Levels


FL: A Much Needed Beat - FL TTT

TRADE (3-Weeks or Less):

We’re at $0.81 for FL headed into Friday’s print before the open ahead of Street estimates at $0.74E.

  • April sales in the Athletic Specialty channel came in better than we expected up +8%. This implies the Feb-Apr quarter was up a robust +12.5%. Based on the Hedgeye FL Comp index below, which has proven to be a strong indicator, we expect comps up +9% vs. +6.7%E to drive sales up +11% vs. +6.7%E.
  • Offsetting strong domestic sales will be European weakness, which started off the quarter down HSD. Our sense is that trends out of Europe likely deteriorated further during the quarter and will come in down low double-digit resulting in a 3-4pt drag on aggregate comp. This offset is the reason why we expect FL to underperform our comp index for the first time in the last seven quarters and is the greatest variable regarding Q1 comps. If Europe came in down HSD in the quarter, we could see FL post a double-digit comp and upside to numbers.
  • Assuming robust top-line sales, we are modeling +100bps of gross margin improvement driven primarily by occupancy leverage up +90bps and a +10bps contribution from merchandise margin. We are also modeling SG&A up +7.5% considerably higher than consensus (+2.5%E) reflecting 9% growth in core SG&A including $8mm in incremental marketing spend offset by a $3-$4mm reduction in Fx.

TREND (3-Months or More):
The company is focused on driving both growth and operational improvements over the intermediate-term in the form of store presentations and net growth (primarily in Europe) for the first time in five years. We think the biggest opportunity is in the women’s and apparel businesses. We like to see FL driving store growth in Europe when it should be able to strike favorable lease terms; however, near-term it will likely moderate new store productivity. In addition, with tough comps again next quarter, we think upside earnings surprises will be limited for another quarter before easing in 2H. The risk would be if higher pricing out of Nike sticks with FL, but not the consumer, or that the pressure we expect to see in the mid-tier softlines space bleeds into the athletic specialty channel. But we don’t think either of those is likely. 

TAIL (3-Years or Less):

After delivering on his 5-year plan 3-years ahead of schedule, Hicks recently outlined his latest 5-year plan in March. The focus will remain on the next leg of improving apparel assortment and mix, growing the international store footprint (more productive than domestic base), and expanding its digital platform. Some of these efforts (i.e. women’s, apparel, and kids) are likely to gain traction sooner than others, but the bottom-line is that we like the earnings visibility here over the next 12-24 months. We’re shaking out at $2.40 for the year above the Street at $2.28E and $2.75 for 2013 vs. $2.50E. 


The biggest risk here is definitely the Euro, not from a translation standpoint as much as what would fundamentally change in the business if a draconian break-up of the Eurozone comes to fruition. Remember that FL is a pan-European retailer, with a common banner in each country. That’s a double edge sword. On one hand, it makes it easier to assort, operate and serve stores in each country. One currency certainly has made that easy.  We’re not going to make a call on FL via ‘Euro Break Up Risk’. But from a risk management perspective, just keep in mind that it is a quarter of profits that could be under fire from multiple Macro angles that management has never had to consider.

Casey Flavin



FL: A Much Needed Beat - FL Comp


FL: A Much Needed Beat - Monthly FW 1 yr growth


FL: A Much Needed Beat - Monthly FW category sales T3W 1yr chg


Below is our key takeaways following FL’s investor day on March 6th regarding our intermediate-to-longer term view:

We attended FL’s headquarters analyst meeting to review Ken Hicks’ report card on the 2010-2014 Plan and to walk through his goals for the next 5-years. We came away with essentially the same view that we walked in with. The stock has a favorable risk/reward profile and trades at a reasonable multiple if not at a discount, but faces increasingly tougher comps in the 1H at the same time growth out of Europe is slowing limiting upside surprises to earnings over the intermediate-term. As a result, we think there will be a more attractive opportunity to get involved in the stock at lower

Not surprisingly, many of the key initiatives of Hicks’ new 2012-2016 Plan were layovers from two years ago given the opportunity for further progress. The two new initiatives include an increased focus on both the customer as well as high-growth businesses (i.e. Women’s, Apparel, Kids, & Team). The bigger callout on the day was the introduction of Hick’s
long-term targets (see below), which were higher than we expected suggesting $3.50 in earnings power at a 14% CAGR over the next five years.

Naturally, we take a critical look at targets like this and ask if we think they’re achievable. However, given Hick’s track
record at JCP and now FL, where he hasn’t missed a number, perhaps the better question is WHEN, not IF these goals will be met. Here’s a look at the latest key objectives compared to the 2010 plan as well as the key takeaways from the

FL: A Much Needed Beat - FL 5YrPlan


Key Takeaways:

  • There are multiple operational systems that the company currently has in various stages of testing and implementation that are at the core of the first initiative in Hicks’ new plan. These include systems for planning product allocations, labor management, measuring shelf productivity, as well as heat mapping technology for use in tracking traffic flow. We think each will play a role in not only improving the customer experience, but also driving incremental sales productivity and margins (objective #5). The potential timing of these systems are less certain, but the labor management piece will be rolled out this Spring and is expected to start yielding results as early as this fall.
  • Customizing locally relevant assortments is another key element to better address customer needs from urban to suburban locations down to specific differences in cross town purchasing preferences. While there are systems currently in place that enable management to tailor assortments, improved data mining from additional tools will increase the impact of these efforts and productivity particularly as it relates to apparel product assortments (think colorways, team preferences, etc.).
  • We think the high-growth opportunities with the greatest upside are women’s and apparel. Management sized each as an incremental $100mm opportunity along with kid’s and Team. It’s important to note that these aren’t mutually exclusive efforts. In fact, Hicks suggested that women’s stores will start to look more like an apparel store than its traditional footwear format. This could translate into a mix of 75/25 apparel to footwear shown in store resulting in sales of roughly 50/50. Whatever the mix shakes out, Hicks stated emphatically that FL will significantly step up its commitment in apparel. In addition to working with a new design firm to test formats, Lady Foot Locker will be undergoing transformational change in 2012/2013. 
  • Besides ramping net store growth for the first time since 2006, FL is also testing new store formats at Champs, Lady Foot Locker and Kid’s Foot Locker. New store formats at Champs include a change in presentation with apparel on the walls and footwear on floor on bleacher-like shelving. Make no mistake, it’s not a coincidence that FL is taking a page right out of Nike’s retail efforts. One of the pleasant surprises in terms of unexpected detail on the day was slide #32 showing apparel/accessories penetration as a percent of sales at 24% today compared to 31% back in 2003. While the firm’s selling strategy was decidedly different then and referred to as ‘when they sold cotton by the pound,’ if management can get apparel share up 3pts it would equate to nearly $200mm in incremental revenues.
  • The growth opportunity in Europe remains a key element of management’s brand expansion strategy. This includes both stores in new underpenetrated markets in Eastern Europe as well as a new banner concept altogether. The company is currently testing a new banner called the Locker Room in the UK that features performance product (e.g. cleats, sticks, uniforms, shoes, etc.) in a larger 4,000 sq. ft. footprint compared to the average 2,900 sq. ft. European store with two more slated to be open in time for the 2012 London Olympics in July and August. The majority of FL’s new store growth (60-70 net openings annually) will continue to be European based.
  • Within stores, House of Hoops remains an important brand expanding initiative. There are now 50 House of Hoops shops up from just 10 at the start of 2010 and management sees an opportunity for over 100+ in total globally with the potential to add an incremental $50mm. Assuming a similar rate of growth, House of Hoops rollouts could add 40-50bps to top-line growth in each of the next two years.
  • With a strong balance sheet including $850mm in cash at year end, it is clear that management is committed to investing in growth, but at a measured pace. While the company could accelerate store openings, it plans to thoroughly test new formats before committing the capital to support it. Importantly, the company just raised the dividend by 9% and announced a new $400mm SRA where it can put excess FCF to work.


All in, there were few surprises. There is clearly a substantial opportunity for further development of initiatives that
are already in progress, which should ultimately help to drive earnings towards $3.50 overtime.

In the meantime as we look out over the next twelve months, year-end results came in right in-line with our expectations.
The two biggest deltas were a stronger than expected start to Feb up mid-teen on a tough comp and incremental weakness in Europe (down -9% in Q4). Net net, we are shaking out at $2.25 in EPS for this year. We like the name over the long-term TAIL duration (3-Years or Less), but think that the later could limit upside surprises to earnings over the intermediate-term and present a more attractive opportunity to get long FL stock.


 FL: A Much Needed Beat - FL LTTgts



Worse Than Bad Champagne . . . The Coming Debt Hangover

Conclusion: The long term impact of debt-to-GDP over 90% is protracted periods of below average economic growth with a meaningfully negative impact on cumulative GDP.

We often write about the impact of debt-to-GDP north of 90% and its detrimental impact on growth.  This ratio and level was popularized by Carmen Reinhart and Kenneth Rogoff in their seminal work, “This Time Is Different: Eight Centuries of Financial Folly.”  In their research, Reinhart and Rogoff analyze over 200 years of data from a group of more than 60 advanced economies.  The results are summarized in the table below, but the key takeaway is that at or north 90% debt-to-GDP, of which there are 352 observations, economic growth slows to 1.7% on average versus 3.4% growth on average at lower debt levels.


Worse Than Bad Champagne . . . The Coming Debt Hangover - chart1


In a subsequent paper published last month, Reinhart and Rogoff consider the impact of longer term periods in which debt-to-GDP remains above 90%.  They define these as “debt overhangs as economic episodes where the gross public debt / GDP exceed 90% for five years or more.”  In their research, Reinhart and Rogoff identify 26 debt overhang periods in 22 countries going back to the early 1800s.  This data currently excludes the unfolding cases of Belgium, Iceland, Ireland, Portugal, and the United States.


Not surprisingly based on Reinhart and Rogoff’s prior work, periods of debt overhang lead to below trend line economic growth for extended periods.  In fact, of the 26 observations of debt overhang periods, only three observations resulted in above average growth (Belgium from 1920 – 1926, Netherlands from 1932 to 1954, and the U.K. from 1830 to 1868).  Collectively, the average growth for debt overhang periods is 2.3% per annum versus 3.5% per annum for period in which debt-to-GDP is below 90%. 


Clearly, then, economies with more debt grow at a slower pace, but the more concerning issue is the cumulative impact.  The average duration of a debt overhang period is twenty-three years.  If we extrapolate the impact of 1.2% growth per annum over twenty-three years, the cumulative impact is substantial.  In this paper, Reinhart and Rogoff use a baseline analysis and show that at the end of the average debt hangover, real GDP is 24% lower than in periods where debt-to-GDP is below 90%.


Worse Than Bad Champagne . . . The Coming Debt Hangover - chart2


Interestingly, as the chart below highlights, the current period may shortly become the most indebted period of the last century.  The chart shows gross public debt-as-a-percentage-of-GDP for 70 advanced and emerging countries.  The 22 nations considered advanced economies are, in fact, at their most indebted ever and exceed the indebtedness of the emerging markets by a ratio of greater than 2:1. Logically, then, we may be entering the most meaningful and lengthy debt hangover in modern economic history.


Worse Than Bad Champagne . . . The Coming Debt Hangover - chart3


The common refrain from many who support more aggressive government spending and higher government debt levels is that interest rates continue to allow funding.  In effect, if markets are not concerned about solvency risks, why should policy makers care?  Firstly, they should care because of the impact to long-term growth.  Secondly, in 11 of the 26 examples of debt overhang, real interest rates were lower, and therefore did not prove an adequate predictor of future economic performance, or risk.


In a typical hangover scenario, we’d recommend comfort food, vitamins and a lot of water.  The more realistic scenario for nations experiencing a debt hangover is to endure the short term economic pain of reducing government debt.  As we are seeing in Europe though, in a highly politicized world that is often easier said than done.



Daryl G. Jones

Director of Research


TJX: 1Q13 Report Card

We continue to be extremely concerned about the inventory/margin setup for retail in 2H – which plays right into the countercyclical nature of TJX. No surprise that its 1Q metrics look so good. With inventories rising at SKS, JWN and M, earnings are likely to improve from here. TJX will look expensive, and it should.



Inventory growth continues to be a key concern/theme out of 1Q12 results, which is good for off-price retailers like TJX. As we indicated in our earlier note "Retail: Complacency Today, Hope Tomorrow", while we’ve been seeing inventory growth outpacing sales in the mid-tier (KSS and Macy’s mid-tier business), we’re now seeing sharp negative sales/inventory moves out of the upper tier department store players as well; both JWN & SKS sales/inventory spreads deteriorated sequentially in Q1. TJX and ROST have been on a tear, but the reality is that as long as there are signs of inventory building out there, it will be a bullish set-up for them over the next 12 months.  In fact, TJX is at a point in its cycle where it is clearing at high margin (revs +11.3% vs inventory -3%), and we think will revert soon enough to buying higher-priced, higher quality goods that need to find a home (ie Polo and Armani in TJ Maxx). While TJX’s revised guidance remains $0.03 below consensus at the high-end, comp expectations of 2-3% appear conservative. This will likely continue to be like Chinese water torture for the bears, as both earnings, and the stock should grind higher.


What Drove the Beat?

After having originally guided 1Q13 comps to +2-4%, TJX over delivered +8% (which came out on Sales day). This additional $200m+ in sales disproportionately flowed through to gross margin with little incremental SG&A resulting in 90bps expense leverage. 1Q top line resulted from significant improvements in traffic with a slight benefit from an increase in average ticket. FX contributed a favorable 40 bps to the 220bps operating margin expansion. The remaining 180bp was driven by improved merchandise margins, and the remainder was buying and occupancy leverage off an 8% comp.  TJX ended the quarter with inventories (-3%) overall and (-7%) on a per store basis resulting in a meaningful 11 point sequential improvement in the sales/inventory spread (now +15%).


TJX: 1Q13 Report Card - TJX SIGMA


Deltas in Forward Looking Commentary?


In order to properly measure performance relative to original expectations, we look at management’s first quarter results relative to management guidance as well as any updates to previously provided full year 2013 outlook:


TJX: 1Q13 Report Card - TJX delta


Highlights from the Call:


Comps: +8% driven by significant increases in traffic with average ticket up slightly

  • Above plan sales and record flow through resulted in record profitability
  • Saw significant increases in traffic across every division
  • Warm weather boosted demand though sales remained strong in regions driven less by weather
  • International momentum remains strong

Divisional performance

US Marmaxx comp +8%

US Home goods +9%


TJX Europe: highest first quarter segment profit in history

  • Broad based strength in Europe from UK and Ireland, Germany and Poland
  • See lots of room for further improvement
  • Remain the only major off price retailer in Europe

TJX Canada: comps +6%

  • Segment profit improved significantly
  • Opened another 6 Marshalls stores in the quarter


SG&A 90bps leverage

  • Driven by expense management on above plan comp
  • Added very little incremental SG&A to 200mm+ revenue outperformance

EBIT Margin: +220bps

  • Strong flow through of above plan sales
  • 40 bps due to positive FX impact
  • 8% comps would typically drive 120 bps improvement, drove 180 bps increase ex FX
  • Merchandise margins drove 90 bps of the 180bps improvement ex FX
  • Some buying and occupancy leverage

Inventories: down 7% per store vs. 12% increase last year



  • Customer transactions have increased mid teens over the past 3 years
  • Research shows TJX attracting younger customers
  • Market penetration still well below most US department stores
  • E-Commerce remains an opportunity to draw customers in the future (E-commerce will not be top line accretive in 2012)
  • Plan to grow square footage by 4-5% annually over the next 2 years
  • More than 100 markets where there is a TJX or Marmaxx and no Homegoods creating opportunity
  • Maintaining 10-13% annual EPS growth guidance


  • May is off to a strong start


EPS: $2.27-$2.37; 14% to 19% increase over $1.99 last year (Increase do primarily to 1Q outperformance)

Comps +2-3% vs. original guidance of 1-2%

Pre tax margins 11.1%-11.5% 20-30 bps above original guidance

Share Repurchase: $1.2-$1.3bn in FY13 including $250mm in Q1


2Q guidance

EPS: $0.47-$0.50 cents ($0.01 benefit from FX)

Top line: $5.7-$5.8bn range based on comps +2-4%

May: comps planned to increase 5%,  June: flat to up 1%, July: +1-3 %

Gross Margins: 27.2%-27.4%; down 10bps to +10bps YoY, merchandise margins expected to be up, -10bps impact from FX

SG&A: 16.8%-17% range, down 10bps to +10bps YoY (reflects 30 bps of incremental growth investments)

EBIT Margin: 10%-10.4%, down 20bps to +20bps (includes 10bps negative FX impact)

Tax Rate: 38.5% (higher than last year)

Net interest 8m-9m range

Share count of 752 mm shares




Marketing and Advertising Spending in 2012:

  • Pretty flat though impressions are up leveraging corporate marketing initiatives
  • Will be more prominent in 2H
  • Have kicked it up for gift giving in Q4

Investment Spending

  • Slight increase in 2Q but investments are on plan for the full year
  • Corporate expense +$13mm in 1Q, planned to be up 20mm in 2Q with majority in investment spending
  • 1H increases in 30-33mm but back half in +10mm range
  • Able to leverage SG&A slight in 2H on flat to +1% comp to due timing of investment spending


  • Long term debt ($775mm) with nothing due near term
  • No plans at this point in time to increase leverage but remain open

Traffic Increases

  • Are seeing new customers in that average age is decreasing a bit
  • Large percent of new customers are younger (18-35 range)
  • Maintaining the older customer as well

Marmaxx segment margins:

  • Improvements coming across the board with new stores and old stores
  • Across the country in all demographics


  • High percent of sourcing done in Europe- very specific by country
  • Have learned what the mix needs to be by country
  • Adding countries to improve assortments- currently 700 people in merchandising department
  • 6 or 7 main sourcing offices around the world with additional satellite offices
  • Will be growing sourcing team through new hubs and additional buying persons in main offices
  • Sourcing team is constantly traveling


  • Only off-price vehicle in Europe
  • Europe has a long runway of opportunity
  • Merchants overall in Europe are more seasoned than a year ago which has benefitted
  • High increases in traffic patterns in Europe
  • More and more opportunity to increase store count- taking advantage of current real estate opportunity
  • Now guiding Europe to a 5.2-5.8% segment margin on a 53 week basis, 280-300 bps improvement over last year on a 4-5 comp
  • Pleased with current momentum in Europe
  • Learning from Europe E-commerce in terms of working online in the off priced sector- learning about average order, basket, communication, etc.
  • E-commerce business getting stronger and stronger
  • TJX does not perform better in a weaker macro setting

Segment margins hitting record highs

  • Planning comp conservatively, every comp is about $0.05
  • Strive to beat plan

Category Drivers

  • Apparel and Home have been terrific
  • Tremendous color changes in fashion this year
  • Mens/kids strong against the board
  • Buying structure allows team to take advantage of changes in fashion, weather, etc.

Comp Drivers

  • Planning for average ticket to be up slightly with most of comps driven by traffic 

Rural & Urban type stores

  • See more and more possibility for additional stores in rural and urban markets
  • Continue to learn and can improve on real estate targeting
  • Opportunity for home goods to have urban and rural stores as well- volume of stores is less than chain avg but margin is in line


  • Results from buying team executing on the merchandising side
  • Starting to see a younger customer with the store being a great vehicle for younger customers getting their first apartment


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The Bureau of Labor Statistics released CPI data for the month of April this morning.  The spread between CPI for Food at Home and Food Away from Home continues to narrow.


We have long been calling out this trend; the advantage that restaurants enjoyed over grocers in 2011, in terms of lower price increases year-over-year, continues to fade.  Grocers were forced to raise prices in line with inflation to protect margins during 2011; we believe that restaurants benefitted from that.  Last year, restaurants’ strong top-line trends helped the industry mitigate the impact of inflation on margins.


Ahead of the next CPI report, we will be publishing some work specific to several companies in the restaurant and food retail spaces and their comparable sales growth through inflationary and deflationary cycles. 


Looking ahead, we believe that the restaurant industry’s ability to lap difficult comps during the summer months may be negatively impacted if the “food value spread” turns negative.  Management teams at McDonald’s and Jack in the Box, among others, have highlighted this metric as being instrumental in their thinking about pricing. 





Howard Penney

Managing Director


Rory Green


Retail: Complacency Today, Hope Tomorrow

Conclusion: Macro and Micro are converging in a way that contextualizes a simple, yet powerful story about the state of retail. Hindsight positives plus deteriorating inventory spreads being led by high-end retail is not what bulls want to see. 





Let’s step back and put some of the bigger picture datapoints in retail into context. They all point to complacency today, and a good element of hope built into financial models in 2H. Consider the following…

1)      This morning’s CPI report showed that apparel/accessories CPI accelerated by 20 basis points on both a 1 and 2-year basis.  

  1. The absolute change of 5.12% is the highest reading on record since December 1990. At face value, this comes across as extremely bullish.
  2. But consider this…in 1990 roughly 70% of Apparel you put on your body was made in the US. Costs were high, elasticity of demand was a big issue, pricing was critical, ‘the era of the mall’ kept supply in check, and ultimately, competition was rational.  When costs went up, consumer prices followed. In fact, for the 30-years leading up to 1990, average price increases clocked in at 3.5%.
  3. Then we went through a massive outsourcinig wave thanks to changes in the US Government’s arcane import regulations geared toward protecting dying US textile mills. Now only 5% of what we wear is made in the US.
  4. Over this 22 year time period, per capita unit consumption of apparel went up by roughly 50% (from 40 units/yr to 60). In other words, the industry drove prices lower and stimulated additional unit purchases. This took industry margins about 500-600bps higher, despite lower prices.
  5. Today, there is almost no more room to outsource. But simply to get more efficient in how outsourcing is being handled. Retailers can’t drive increased unit demand AND margins by lowering price anymore. Finally, with 'the era of the mall' has transformed to 'the era of selling to the consumer at a transparent price  -- mall or no mall.' Translation, they NEED higher prices to stick, or simply need to be very conservative with inventory buys.

Apparel CPI (yy chg).  

Retail: Complacency Today, Hope Tomorrow - 1

Source: Bloomberg


2)      The CPI readings are definitely positive, but we can’t exactly call them bullish. Keep in mind that we’re looking at April data. This is very much a lagging indicator. It mirrors any pricing success that the industry is seeing TODAY in its reported 1Q results.

3)      But with these results, we’re also seeing inventories rise. KSS, SKS, JWM, M…all of them have an eroding sales/inventory position. This is how it starts, folks. Each retailer has a slight erosion on the margin, but assures people that it is manageable. The reality, however, is that they are powerless over what the competition will do as their respective inventories get too high.


Retail: Complacency Today, Hope Tomorrow - 2


4)      The biggest concern for us is that the two retailers with the worst sales/inventory deltas are Saks and Nordstrom. It’s way too premature to call for the death of the high end consumer – people have been calling for that for the better part of a decade. But this has been a ‘safe haven’ in the midst of KSS blindly fighting JCP in the mid-tier (collectively KSS and JCP account for about 15% of the industry). Our call all along has been that these factors would start to bleed in to 2H, and put estimates at risk.





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