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GPS: 1Q12 Report Card

Conclusion: There is only one issue that matters here...and that's the trade off between operational execution and financial engineering. The latter is easy, but when you run out of net cash -- like GPS is doing -- execution is critical. We won't hang our hat there. 

 

 

Before we get all excited about the GPS quarter (they were 'Congratulated' half a dozen times in the Q&A), lets consider the following. Yes, sales were up 6%.That's great for a company that has comped down for the better part of 4 US Presidential Terms. But a) it faced an easy compare vs last year, b) weather helped, c) the Easter shift was a factor, and what no one is talking about, d) JC Penney just printed a 21% decline in sales. If GPS garnered only 1/10th of that, it helped comps by over 2%.

 

But here's our favorite stat. Depite the boost in sales, net income was flat. But EPS was up 18%. Share count vs last year? Down 18%.

 

Make no mistake, this has been a financial engineering story over the past 8-years. $11bn in repo has taken down the share count by 47%. As recently as 3-years ago, GPS was sitting on a net bash position of $2.3bn. Now it is down to $400mm. In other words, this did not need to be an operational improvement story to grow earnings. Now the share repo angle is largely over. GPS absolutely NEEDS to show consistent comp and/or margin improvement.

 

Does it have the next quarter or two in the bag? Probably. It goes up against two very easy quarters, and JCP will continue to hemorrhage share for at least a few quarters. But GPS has already conceded that it will reinvest some of its Avg Unit Cost savings back into price and product in 2H. We think that it will have to invest much more than it plans.

 

We don't like this one.

 

 

 

GPS: 1Q12 Report Card  - GPS S

 

Outlook: 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:

 

GPS: 1Q12 Report Card  - GPS Outlook

 


Highlights from the Call:


Domestic strength across all three concepts

In the process of making product corrections first highlighted back in Feb

Online up +18%  - investing in online media, mobile tech, etc.

Believe they have a competitive advantage in online - gaining share

 

Growth initiatives:

Franchise business added 3 new markets & 22 new stores

China added 7 new stores - on track for 30+

Athleta on track to add 25 stores

 

Product:

Old Navy - redesigned t-shirt business in Q1

Gap - color bottoms and color denim big driver in Q1

 

Marketing Investments:

Five new creative platforms

Gap - Be Right received well

BR - work good execution through direct mail

 

New Hire: Stephan (from H&M) to run Old Navy

Joining in October

Global experience - key for expanding Old Navy's success domestically

 
Sales +6% on comps up +4%

Higher AUC

Margins down only -15bps

New stores and franchise business accounted for 2pt spread

 

GM: -15pbs

AUR up

Merchandise margin down 150bps driven by higher unit cost

Occupancy costs leveraged 130bps (cautioned against extrapolating this level of leverage due to timing of openings etc)


Inventory: Inventory /store -7%

 

OpEx:

Up $62mm to $980mm due to marketing spend and store payroll

Marketing up $20mm to $139mm

 

BS:

CapEx = $148mm (net sq. ft. down -2%)

FCF = $216mm vs 104 yy

Cash $2Bn

SRA = $1Bn (Minimal repo in Q1)

 

Outlook:

FY:

Weather was very favorable in Q1

Includes 53rd week

Modest top-line growth

Healthy merchandise margin

Expect AUC to improve yy in 2H

Saving to be offest in part by reinvestment in product

Expect leverage on positive comps

Will be investing more in domestic growth initiatives - don't expect operating leverage this year

Marketing investment step up to be similar in Q2 to Q1 = ~$20mm

With over 200mm shares repo'd in 2010-2011 at avg price of $19.60 comfortable with slower pace in 2012


Q&A:

 

Product Costs vs. Outlook:

  1. Feel good about AUC in 2H; It’s the AUR piece that will have to 'play out' as the year goes on
  2. Expect to cont. to increase store payroll and investment
  3. Minimal share repo will impact how EPS modeled

Avg. Unit Costs:

  • Entire 2H up 20% including holiday
  • Reinvesting some of those costs coming off into categories like suiting at BR, Denim at Gap
  • More Gap Fit (i.e.  athletic pants) are higher AUC than panties so less favorable mix shift
  • Re units, as pressure on AUC eases - pulled back most units on Old Navy given AUC increases so plan to increase units this year as costs subside

Concept Callouts:

  • Happy with new Gap Fit business
  • Kids and baby business very strong - broad based strength at Gap
  • At Old Navy new t-shirt initiative - wish they had more colored bottoms

Uses of Cash:

  • Share repurchase has been 'lumpy - wouldn't read too much into it'
  • Quick move in stock so program didn't keep pace / catch up

Inventory:

  • Were up +10% last yr, down -7% in Q1
  • A little lean in Old Navy headed into Q2

Marketing Spend:

  • Seeing increased traffic and sell-through at Gap
  • Ramping direct mail effort and online at BR
  • More marketing behind Gap brand to showcase product (athletic fit & t-shirts)
  • Expect a step up in traffic from spend

Operating Expense:

  • Store growth will increase absolute rent investment
  • Plan to make investments this year in the domestic business
  • In 2008-2011 the expense base has stayed relatively flat despite int'l expansion
  • Now that they are seeing product assortment improvements, they want to propel those initiatives

Old Navy:

  • Final changes to value proposition will be in place by end of May = sharper pricing, assortments
  • Merchandising and store team element key to success from June on when chgs should be reflected

Competitive Share Gain:

  • Old Navy is not JCP's #1 competitor
  • Sure everyone in value business got a little piece

Athleta:

  • Productivity /ft is very impressive
  • Team has brought a leading operating example to Gap Inc.

International - Old Navy Expansion:

  • Japan had a +13% sales increase in the quarter
  • China committed to 30 stores - did 7 in Q1
  • Franchise business up 30%+
  • Modeling after successful global model for Japan intro - push model, very little localization

Customer Demo:

  • Opportunity for more customer in the mid 20s-30s
  • Brand hasn't been as relevant to them in recent years
  • New marketing pulling in broader consumer set

Piperlime Transition to Physical Store Model:

  • Taking blue print from Athleta
  • Have a central design team for the stores to bring the brand to light

Product & Price:

  • 2011 didn’t stay true to value proposition that they offered in 2010, they just have to get back there - 'tweak it'

Operating Margin Cadence:

  • More spend in 2H?
  • No real chg to view
  • Expect some top-line and margin expansion in 2H as deleverage expenses


Oversold: SP500 Levels, Refreshed

POSITIONS: Long Healthcare (XLV) and Apple (AAPL); Short Industrials (XLI)

 

Our core fundamental themes have not changed (#GrowthSlowing and #DeflatingTheInflation), but prices have. With the SP500 100 points lower (and AAPL $100 lower), plenty are selling low now. That’s not what we do.

 

Across risk management durations, here are the lines that matter most: 

  1. Intermediate-term TREND resistance = 1369
  2. Immediate-term TRADE resistance = 1346
  3. Immediate-term TRADE oversold = 1317 

In other words, we don’t get paid to freak-out and sell on moves under 1320. We get paid to book gains on the short side and, slowly, take up gross invested long positions. On the bounce to lower highs, there are no rules against re-shorting what we cover.

 

KM

 

Keith R. McCullough
Chief Executive Officer

 

Oversold: SP500 Levels, Refreshed - SPX


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Q1 2012 SLOT SHIP SHARE OBSERVATIONS

IGT the big winner

 

 

In terms of ship share, we believe IGT was the only winner in 1Q 2012, on a sequential basis.  The slot market remains super competitive with WMS and Konami particularly aggressive on pricing.  Q1 replacements were down slightly YoY to an estimated 14,900 units but used units are accounting for a bigger % of sales.  In Ohio, for example, ~15% of the units are used/participation.  Casinos are increasingly putting caps on participation units and showing a preference for preferring fixed fee and 80/20 deals vs. % coin in (WAP) type games in an effort to improve margins in a low growth environment. 

 

Here are the estimated CQ1 2012 market shares (based on shipped units):

  • IGT:  33%, up from 30% in CQ1 2011
  • WMS:  19%, down from 21% in CQ1 2011 despite aggressive pricing
  • BYI:  14%, unchanged YoY
  • KNM:  17%, down from 20% in CQ1 2011 
    • Konami was admittedly very aggressive on pricing in Q1
    • We believe Konami growth is stalling and they will likely be a share donor this year
  • MGAM:  2%, double the 1% in CQ1 2011
  • ALL:  11%, unchanged YoY (our guess until the company reports next quarter)

 Q1 2012 SLOT SHIP SHARE OBSERVATIONS - slot


CLAIMS TREAD WATER WHILE YIELD SPREAD COMPRESSES FURTHER

Initial Claims - Uneventful Print

Initial jobless claims rose 3k last week to 370k, though was flat after the 3k upward revision to last week's data. Rolling claims fell 4.75k to 375k. On a non-seasonally adjusted basis, claims fell 18.3k to 323k. Last week we profiled the year-over-year trend in rolling NSA claims as a barometer for avoiding the inherent seasonal distortions. That analysis showed that claims were still improving at roughly at 10% YoY rate. This morning's data point continues that trend.  

 

CLAIMS TREAD WATER WHILE YIELD SPREAD COMPRESSES FURTHER - headline 4

 

CLAIMS TREAD WATER WHILE YIELD SPREAD COMPRESSES FURTHER - rolling 2

 

CLAIMS TREAD WATER WHILE YIELD SPREAD COMPRESSES FURTHER - NSA

 

CLAIMS TREAD WATER WHILE YIELD SPREAD COMPRESSES FURTHER - NSA rolling

 

CLAIMS TREAD WATER WHILE YIELD SPREAD COMPRESSES FURTHER - S P

 

CLAIMS TREAD WATER WHILE YIELD SPREAD COMPRESSES FURTHER - FED

 

2-10 Spread Breaks Down Further

The 2-10 spread tightened another 8 bps versus last week to 148 bps as of yesterday. The ten-year bond yield fell 6 bps to 177 bps.

 

CLAIMS TREAD WATER WHILE YIELD SPREAD COMPRESSES FURTHER - 2 10

 

CLAIMS TREAD WATER WHILE YIELD SPREAD COMPRESSES FURTHER - 2 10 QoQ

 

Financial Subsector Performance

The table below shows the stock performance of each Financial subsector over four durations. 

 

CLAIMS TREAD WATER WHILE YIELD SPREAD COMPRESSES FURTHER - Subsector Performance

 

CLAIMS TREAD WATER WHILE YIELD SPREAD COMPRESSES FURTHER - table

 

Joshua Steiner, CFA

 

Allison Kaptur

 

Robert Belsky

     


BYD: THIS IS NOT YOUR FATHER’S IP

BYD pulls the trigger on a very accretive acquisition.

 

 

Could this be the deal that finally gets this stock its due?  Numbers were already going higher but BYD is adding a huge amount of EPS and cash flow without adding to leverage.  The acquisition of Peninsula Gaming is a big positive on many fronts with limited downside.  Shocking, really, that there was this good of a deal out there.

 

 

Here is what we like:

  • Huge accretion:  There are a lot of unknowns (borrowing rate and allocation of excess purchase price to goodwill) but we estimate the deal could be accretive to BYD’s 2013 EPS to the tune of $0.30-0.40 or 50-70%.  On a free cash flow basis, we calculate accretion of around $0.90-1.00 per share or 30-33% accretion.  As a percent of normalized free cash flow (BYD is under-spending on maintenance capex for a few years), the accretion climbs to 50-55%.  Maybe it’s not management hyperbole when they call the acquisition “a transformative transaction”.
  • Acquiring stable cash flow:  All four of Peninsula’s mature properties have been generating stable EBITDA.  Moreover, gaming revenues at each property have been up since January and market shares are all on a stable to upward trend (see charts below).
  • Protected markets:  While there is always potential for new competition, there are no new properties anywhere on the horizon that could materially impact any of the Peninsula properties.
  • Acquiring growthy cash flow:  Kansas Star, the new property in the portfolio, significantly exceeded expectations in its first full quarter of operations, generating almost $27 million in EBITDA.  That’s a 60% annualized ROI on a temporary facility.  The permanent facility (Phase II) will open in January 2013 at a cost of $83 million (funded by Peninsula and not BYD) which could add another $10-20 million in EBITDA.
  • Assets are in good shape:  The properties in the aggregate are newer than BYD’s existing properties so there are no deferred capex issues.
  • Financing:  We don’t calculate any increase to BYD’s leverage as a result of this deal.  Moreover, setting Peninsula as a subsidiary and putting the debt on the sub provides BYD with a lot of financial flexibility (read:  Borgata).  That flexibility is probably worth the additional interest cost of subsidiary financing.  Nice risk management move by BYD management.  They also secured a $144 million seller financed note with no interest in the first year.  Look for BYD to buy this out after year 1 or 2.

 

The not as good (there’s not much not to like):

  • Potential for an equity raise:  Management didn’t rule out raising equity to fund the $200 million cash piece of the acquisition.  With the stock where it is, we would not like to see dilution.
  • Little in the way of synergies:  While this is not a huge issue since the price is right, we don’t see any cost cutting opportunities and are not optimistic that B-Connected will provide a lot of revenue synergies.
  • Expensive Earn-out provision:  7.5x EBITDA exceeding $105 million in 2015 at Kansas Star.  This takes away a lot of the upside but it is understandable given the growth trajectory of the property.

 

BYD:  THIS IS NOT YOUR FATHER’S IP - byd1

 

BYD:  THIS IS NOT YOUR FATHER’S IP - byd2



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