“Organisms that treat threats as more urgent than opportunities have a better chance to survive.”
If you only have time to read one chapter of Dan Kahneman’s Thinking, Fast and Slow this summer, I’d go with Chapter 26, Prospect Theory. It helped me bridge some gaps between the fractal dimensions in our models (math) and behavorial factors.
Prospect Theory is a behavioral economic framework that will be much more relevant to the next generation of economists than this one. It will take time to pound the Keynesianism out of our system. Sadly, seeing centrally planned economic systems in Europe and Japan (maybe at some point in the USA) fail, will be the only way to expedite this evolution.
On pages 282-283 of Kahneman’s latest book, you’ll get Prospect Theory both with a simple picture and three bullet points of prose:
1. “Evaluation is relative to a neutral reference point.”
2. “A principle of diminishing sensitivity applies to both sensory dimensions and the evaluation of changes in wealth.”
3. “The third principle is loss aversion… losses loom larger than gains.”
And that brings me right back to the top of this morning’s Early Look quote, to the bottom of your gut feeling at Friday’s lows, and back again to yesterday’s biggest market rip in 2 months. Your Prospects of Survival in this business depend on your process.
Back to the Global Macro Grind …
Losing other people’s money isn’t cool. Losing your own money is even less cool. If you are doing both at the same time, my sense about the matter doesn’t really matter – where your emotions fit on the slope of the loss aversion curve does.
That’s why we bought red on Friday and sold green into yesterday’s close. When it comes to your decisions to buy or sell something, there really are no rules about reversing everything you did in the prior day. I am not Warren Buffett. I am your Risk Manager. The only rules in our profession are self imposed by the institutions who think they are managing our risk.
But what is risk? What are these institutional investing styles? Why are either measures relevant to what’s happening in your portfolio today as opposed to risk measurements and style factors you may have used in 2005-2007?
There are many more questions here than answers. My goal, at the top of every risk management morning, is to Embrace Uncertainty and have markets pick me. The more I try to pick markets, the more risk I impose on myself. What is supposed to work, rarely works. And what shouldn’t happen, usually happens. Either accept that, or whine about it – it’s reality.
I sold my SP500 (SPY) long position yesterday – here’s why:
- Immediate-term TRADE upside resistance into the close = 1329 (so I only had 1% upside left)
- Immediate-term TRADE downside support into the close = 1288 (2% downside makes my risk vs reward 2:1)
- Immediate-term RANGE of risk (3 day probability model) = 89 S&P points (that means volatility will be real)
- US Equity Volatility (VIX) was down -12.3% on the day but holding my TRADE and TREND lines of support
- US Equity Volume was down -17% versus the average volume of last week’s down days
- US Equity Correlation Risk to the US Dollar Index remains wacky elevated at -0.96 (USD vs SPY)
Multi-factor, Multi-duration Risk Management – that’s how I roll. On the immediate-term TRADE duration (3 weeks or less), those were the 6 glaringly obvious reasons to be at least a lot less net long. Catalyst wise, I gave you my calendar ones in yesterday’s note.
In the Hedgeye Portfolio, we opened the day with 16 LONGS, 4 SHORTS and closed the day with 10 LONGS, 8 SHORTS. That’s easily the most aggressive 1-day swing in what can be considered a proxy for my “net” exposure in 2012.
But was it aggressive? Or wasn’t it aggressive enough? Maybe I should have sold everything and gone to 100% Cash. Maybe I should have shifted to net short. Maybe I shouldn’t have done anything at all.
Maybe I should just stick with the process and take the high probability cut at the ball, and live with it.
And I will.
With the US Dollar Index down for the 2ndday in a row, we bought that long position back yesterday on red. That position is one we have been pounding the pavement on with clients as the most asymmetric long-term long idea in Global Macro (email for Theme #3 in our Q2 Macro Themes called “Asymmetric Risks” and you’ll see the long-term mean reversion case for Strong Dollar).
In addition to the aforementioned Correlation Risk of staying long the SP500 (SPY) in the face of a -0.96 USD/SPY correlation this morning, here’s a refresh of the other big immediate-term USD correlations jumping off the page:
- Commodities (CRB Index) = -0.92
- Euro Stoxx600 = -0.97
- Gold = -0.89
That’s why I re-shorted Gold (GLD) yesterday too.
There’s rain in Connecticut, but Prospects of Survival out there this morning look better than bad.
My immediate-term support and resistance ranges for Gold, Oil (WTIC), US Dollar, EUR/USD, and the SP500 are now $1, $90.57-94.12, $80.82-81.97, $1.26-1.28, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
President Obama’s odds of winning reelection slipped to 56.5%, according to the Hedgeye Election IndicatorDaryl Jones (HEI). That’s the lowest reading on the HEI since early February, and it marks the fourth consecutive weekly decline. The HEI measures the likelihood that President Obama would win reelection if the election were held today.
Hedgeye developed the HEI to understand the relationship between key market and economic data and the US Presidential Election. After rigorous back testing, Hedgeye has determined that there are a short list of real time market-based indicators, that move ahead of President Obama’s position in conventional polls or other measures of sentiment.
Two of those indicators, the relative strength of the US dollar versus a basket of international currencies and the weak overall performance of the US stock market, contributed to President Obama’s weaker chances to win reelection, according to the HEI.
Based on our analysis, market prices will adjust in real-time ahead of economic conditions, which will ultimately shape voters’ perception of the Obama Presidency, the Republican candidates and influence the probability of an Obama reelection.
The model assumes that the Presidential election would be held today against any Republican candidate. Our model is indifferent toward who the Republican candidate is as the sentiment for Obama and for any Republican opponent is imputed in the market prices that determine the HEI. The HEI is based on a scale of 0 – 200, with 100 equating to a 50% probability that President Obama would win or lose if the election were held today.
Hedgeye releases the HEI every Tuesday at 7am ET until the election November 6.
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Conclusion: There’s still wood to chop here, no doubt. But this is a sub $3bn company acting like a $10bn company. If we’re right, than URBN is trading at about 7.1x our next year EBITDA estimate. If you want to short that, knock yourself out.
We think URBN is headed higher. We like this one across all three of our durations, TRADE, TREND, and TAIL. The tone and cadence of management’s approach this quarter makes this a tough story to build a negative case against – particularly in a space where we think we need companies with asymmetric factors on the long side in order to take them higher.
We went into the quarter thinking that URBN was one of the few names that had the luxury of a disproportionately favorable miss/beat balance (the market rewards a penny beat more than it penalizes a penny miss). Over the past six months URBN has had one of the most major management changes we’ve seen in a retailer relative to its size in a very long time. Our rather strong sense is that this team will be given a free pass to shake things up near-term, and that any upside (even if by accident) will be a bonus.
Let’s not bend any facts here. The quarter stunk. URBN took 8.6% sales growth and morphed it into a 10.1% EBIT decline. But relative to expectations, it was slightly better. One comped a comp (Urban), while the other (Anthro) comped down on the easiest compare of the year. There were definitely puts and takes. But the big take-away came from simply listening to this management team.
They sounded so extraordinarily focused – such a stark contrast to the URBN of six months ago. Seriously…go back and listen to the past two calls. Night and day. That’s what you get when you bring in the founders to save the day.
The message is simple.
- Hire all the right talent.
- Empower each of them to come up with a concise plan, to which they will be held accountable.
- Give them the financial and human resources to achieve the plan.
Along the way, they’ve got shared services initiatives (DC just going up for 3Q) that should allow URBN to leverage the back-end across concepts while investing in areas like mobile and digital to more efficiently flow product and reach new customers.
They don’t really give comp forecasts – which is great bc forecasting comps is ridiculous. They simply focus on the process to put up the numbers, and hold themselves accountable to execute. Anyone reading this knows that I (McGough) rarely throw out public kudos to management teams, but the bottom line is that listening to these guys is like listening to a company with $10bn in revenue, not $2.5bn.
There’s still wood to chop here, no doubt. But we’re coming up with estimates about 20% above consensus. If we’re right, then URBN is trading at about 7.1x our next year EBITDA estimate. If you want to short that, knock yourself out.
Highlights from the Call
- $34mm increase in net new stores sales (14 new stores)
- 2% increase in Retail comps (incl. DTC)
- Urban: +6% vs. +2.3E
- Positive comps across all categories
- Free People: +2% vs. +6.1E
- Opened largest store to date with full floor of intimate apparel ("Intimately Free")
- Anthropologie: -2% vs. +0.3E
- Positive regular price comps in women's apparel
- Catalog showed significant aesthetic improvement throughout the Q
- Retail Store Segment Sales +7.5%
- Comparable Store net sales (-1%)
- Transactions (-1%)
- Avg Units per Transaction (-2%)
- Partially offset by AUR +2%
- Terrain: Excellent Spring season from weather; opened 2nd store in Westport, CT
- DTC net sales +15%
- All brands posted healthy DTC growth
- Wholesale +2%
- 19% increase in Free people wholesale; 30% increase in sales to specialty accounts
- Offset by transition of Leifsdottir to Anthropologie Brand
- All of the UK stores were challenged
- Urban stores in Germany tracking above sales plan
- Urban/Anthro DTC Europe sales gains in excess of 30%
GM: (-131 bps)
- Store occupancy deleverage related to increased store openings
- Increase in new and non comparable European stores
- Slightly higher markdowns on some women's categories across all brands
SG&A +11% (+62bps as % of sales)
- Primarily due to deleveraging of direct controllable expenses due to negative comps
- Increase in comparable retail inventories + 11% at cost, +5% in units
- Total comp store inventories +8% at cost
- Remaining due to acquisition of new store inventory and wholesale inventory
Dick Hayne CEO Goals:
- Fill management roles with top talent- met quickly with a solid team of merchants leading the brands
- Strategy to reignite top line growth - Emphasizing growth through 4 initiatives
- Increase productivity in current channels through marketing, improved product and tech
- Acquire more customers by expanding distribution channels- more robust presence in Europe and Asia
- Expanding product offerings (i.e web exclusives, Free People intimates)
- Acquire new concepts to compliment current brands- nothing currently in the pipeline but reviewing opportunities
- Ensure Brand leaders have tools, talent, capital to succeed
Shared Services Initiatives:
- Special focus on supporting e-commerce and international growth initiatives
- Rolled out mobile POS to store last year- continue to expand number of devices
- Capabilities will be expanded to fulfill store or online out of stock from any store in the US
- Launching IPAD POS device later this year
- Expect West coast fulfillment center to be open in 3Q13
- Will substantially reduce delivery times to west coast customers
- Will help reach service goal of US of 2 days or less
- Focused on customer facing talent
- Improving the scope of digital recruiting
- Enhancing merchant development program
Outlook for the Remainder of the Year:
- Weather may have been a pull forward of sales into Q1
- Planning 14 stores in Q2
- Gross Margin Rate (absolute rate of 35.6%) will be similar to Q1
- Sales exceeded conservative plans but benefitted from favorable weather in March- full year plans unchanged
- 55-60 stores
- 21 URBN
- 16 Free People
- 21 Urban Outfitters
- 16 Anthropologie
- 1 Terrain
- 1 BHLDN
- Planning 2H margin improvement based on product content and lower mark down rates
- Planning mid teens increase in SG&A for the remainder in the year due to DTC investments, ramp in marketing and further investments in people
- Capex: $190-$200mm driven by new stores, fulfillment center and home office expansion
- 2013 Effective tax rate 36.5%
- Will satisfy customer demand & Reduce out of stock
- Will focus on fulfilling from locations where demand is weakest
- Some exclusive items are being returned to stores, with new system, items can be shipped back without mark down potential
- Substantial improvement in aesthetic & product content in Catalog- better customer focused product
- Seeing progress in merchandising assortment
- Will be awhile before reaching rhythm of Anthropologie from years ago
- Expecting to take some markdowns but seeing strong fundamental signs
- Anthropoloie working on complete overhaul of website- it has gotten stale just like calendar was stale before recent refresh
- Working on rightsizing the Home size based on market
- Still working towards desirable pricing/product mix
- UK requiring localization- Will develop and source product specific to certain markets (both brand and designers); brand remains scalable
- Website- approach to visual can be improved
- Plan to do some additional cross referencing across channels (recently referenced in store sales online which yielded a productive week)
- Have added new components to intimates site
- Expanding other categories beyond Free People Intimates
- Continue to work on social media aspect of site and blog- getting new reader with updated blog and look books
- Urban and free people in process of launching loyalty program
- Anthropologie in the process of reinvigorating loyalty brand
- See nice lift in traffic as a result
- Category mix shift driving 11% cost increase in inventories as opposed to cost inflation
- Inventories were relatively clean at the end of Q4
- All buyers make mistakes- in the process of clearing some excess through markdowns
- 90 day ownership better than the prior year
- Expect to make incremental progress as the year develops on markdowns
- Change in mix driving shift in AUR with weather increasing amount of inventory
- Expecting to return to desired inventory levels but will remain slightly elevated due to mix change
Top Line Guidance
- Remain optimistic and believe inventory is well positioned
- Expecting to take fewer mark downs as the year progresses
- There MAY have been a pull forward in sales but not guaranteed
- Seeing Fashion shift towards bottoms
- Traditionally impacts women who want to go out and invest in new wardrobe items
- Duration of trend is unpredictable but typically last for some time
- Merchants are in touch with demand and are planning inventories accordingly
- Shift implies tops are less desirable, though some remain strong
- Will be additional mark downs in some top categories that aren't selling as well as last year
New Store Productivity:
- New stores opened in Q1 are performing at or above plan
- Great deal of strength in European DTC in Q1 at Urban Outfitters
- Businesses on the continent performed stronger than the UK in stores (issues with cold wet weather)
- Saw an over penetration in outerwear with seasonal product sales soft from cold weather
- Women's apparel most challenged business in the UK though it has been performing well in DTC and Continent
- All 3 brands have significant opportunity to expand presence in Europe and Asia
- Free People will be launching wholesale into the UK over the next
- Launching Free People DTC into Asia over the next 18 months
- Urban will also be launching presence in Asia over the next 18 months
- Ran a Spring season sale focused in the UK to keep inventory levels in check
- Anthropologie requiring localized assortment similar to Urban Outfitters
Gross Margin Guidance:
- Implies sequential deterioration in YoY margin rate change
- Planning occupancy deleverage in 2Q
- Opening 8 new stores above new stores opened in 2H12 as well as non comparable European stores
- There are markdowns anticipated in certain women's categories
- Planning for 200-250bps of improvement in annual GM rate
- East Coast followed by Midwest and South saw greatest growth in the US
- Some European stores suffered from cold/rainy weather- seeing direct correlation with weather
- Major Malls performing the best
DTC Mix Shift:
- Investing in the DTC business
- Have only been in DTC business for 10-12 years- already captured 20% of sales
- Expect the business to continue to grow at current rates if not accelerate
- Expect DTC penetration to reach 40% relatively quickly and anticipate rate going up
POSITIONS: Long Healthcare (XLV) Long Consumer Discretionary (XLY), Short Industrials (XLI)
I came into today a lot longer than I am now. I sold by my SPY and AAPL as we push toward my Selling Zone.
Since Equity Volatility has moved back to bullish TRADE and TREND, I can change the duration and volume assumptions in my immediate-term TRADE calculation in order to generate a range of probabilities instead of a point.
In other words, there are 2 immediate-term TRADE lines (1315 and 1329), and that generates my Selling Zone. On the way up towards that zone I want to be selling longs first, then re-shorting best ideas, selectively.
Across risk management durations that matter most, here are my lines right now:
- Intermediate-term TREND resistance = 1369
- Immediate-term TRADE zone = 1
- Long-term TAIL support = 1282
We held my long-term TAIL of 1282, and that’s the most bullish thing I can tell you. But I am also telling you to sell down gross and/or net exposure on the way up. Unless we see a close > 1369, the intermediate-term view for Q2 remains bearish.
Keep moving out there,
Keith R. McCullough
Chief Executive Officer
Keith just added CRI on the short side of the Hedgeye Virtual Portfolio. CRI remains one of our top short ideas across all durations, as outlined in our May 9th report “CRI: Short It”. Sales growth is slowing, underappreciated margin pressures are intensifying, and its largest holder is selling.
We've included our May 9th note below.
5/9/2012 11:29 pm
CRI: Short it
Nearly all the factors that kept this stock grinding higher while estimates came down last year are either slowing, or flat-out reversing, on the margin. We really like the 3/1 odds on the short side.
We think Carter’s is shaping up as a short again. After nearly a year of perceived positive factors at its back, we think that opacity related to organic earnings power will be gone, and competitive challenges will emerge at a time when it is shifting away from harvesting its prior investments, and will need to put capital in to its model that will put a ceiling on margin improvement at a minimum, and likely create meaningful downside if our industry call for increased competition and margin pressure comes to fruition. With that, sales deceleration is a near certainty barring another acquisition, and valuation is sitting near the seven-year peak.
We say ‘shaping up as a short again’ with full awareness that it did not do what we thought it should have done in 2011. In fact, we went into 2011 with estimates for the year at $1.75 and the consensus at $2.40. By year’s end, the Street came down, and down and down by 21%, and CRI earned an adjusted $1.94 (before $0.15 Bonnie Togs accretion). Yet the stock literally defied gravity and went the exact opposite direction – gaining 35% for the year (vs. virtually flat performance for S&P, RTH and the MVRX).
If there’s one rule of retail investing that we’ve learned over time, it’s that earnings revision is the key factor in determining the direction of a stock. Pull up thefunction on your bloomberg. With 9 stocks out of 10, you’re going to see that the stock price tracks (or leads) earnings in a very tight band. Take a look at NKE, AAPL, GIL earnings revisions vs. the stock (all courtesy of Bloomberg).
Now look at CRI. HUH?
Whenever we talked to people about this name, we were given the same bull factors ad nauseam:
1) The company had the toughest COGS comps in 2H11, in advance of which it took up prices by 10%. In doing the math, a 10% increase on a $10 product at retail almost entirely outweighs a 25% increase in a $3-4 product cost.
2) At the same time, CRI was boosting its off-price sales from 1% of total in 2010 to 4% in 2011, and while this would ordinarily be dilutive to margins, it was enough to help leverage SG&A.
3) While both of these two factors played out, CRI benefitted from the addition of the Bonnie Togs acquisition, which boosted sales by an average of 6% per quarter – again, a factor that (with some minor cuts to acquired SG&A) helped leverage SG&A at the greatest rate in nearly a decade.
4) And how could we forget the ultimate response? “The market is flat, I’m clawing to hang on to my return/loss for the year, and you expect me to short the stock of a company that Berkshire Partners is not-so-slowly taking private?
Now what have we got?
1) The good news is that CRI starts to anniversary its higher product costs (that’s the bull case), but unfortunately, it starts to anniversary its pricing initiatives as well. It’s all too often that people adjust one without the other. There are, after all, two components to gross margin. Costs are forecastable. But prices to consumers – especially for a company where 40% of sales come from vertically-owned-retail – are DEFINITELY not.
2) Off price sales should come down from 4% of sales last year, to about 2% this year. Yes, that’s good for gross margin. But on top of other factors impacting top line, it will make any form of SG&A leverage very difficult.
3) Bonnie Togs is still there. But it is officially anniversaried. Now it and Carter’s each need to grow on their own without the benefit of basic acquisition accounting helping the situation.
4) Expectations are lofty – at or above company guidance for sales and EPS.
- Revenue: Consensus at $2,370mm – ABOVE guidance of $2,300mm – $2,342mm.
- EPS: 2012 Consensus at $2.61 – ABOVE guidance of $2.51-$2.61
- Consensus EPS of $3.28 for 2013, and $3.63 for 2014. We’re at $2.70 and $3.00, respectively.
- With all these other factors no longer in CRI’s favor, we have a tough time stomaching the premise that thechart on bloomberg maintains its scant correlation under these circumstances with a 20% earnings reduction.
- If our estimates prove right, there’s no reason this stock can’t see the low-mid $30s. But under the most bullish consensus expectations, we still have a tough time getting this name in the upper $50s. We like the 3/1 odds of a short here.
5) And lastly…the “Berkshire is Buying” argument is pretty much dead in the water. Yes, they’re selling on the margin.
Historical context is important here...
We were asked a couple of weeks ago by a top client as to why CRI traded at such a high EV/Sales ratio (2.1x) circa 2005. Our answer sounded something like this:
This was when CRI achieved cult stock status. There were several factors, all related to post IPO action.
The pitch on the IPO was…
a) Shift away from basics into playwear
b) Shift from traditional dept store biz to serving 1) mass channels, and 2) company-owned retail.
c) CRI had new arrangements with Li&Fung – through which it cut its sourcing costs by nearly 1/3 and passed right through to consumers in the form of lower prices to gain share.
d) Remember that this period (ending April 2007 when LIZ went Ka-Boom) was easy for apparel retail. You could be an average brand and run at peak margins without much effort. The environment allowed CRI to sell into three completely distinct channels with like product without stepping on each other’s toes – and the Street was not only oblivious, but it also gave CRI’s multiple credit for this as a big positive.
e) Then in 2005 CRI bought Osh Kosh. In the ensuing 2-years, they cut employee count from 400 to less than 100. Margins went up temporarily, before growth slowed and the story became outwardly and visibly broken.
f) Pretty soon thereafter, people realized that this name was not infallible – that it can’t sell the same stuff through Target, Kohl’s, Macy’s and its own stores -- and that it can’t cut costs to keep margins high in the face of slowing growth.
g) Fred Rowan (CEO) got fired in 2008, and since then, the Mike Casey era has taken hold. Definitely a better regime. But there was just as much financial engineering as anything else (he was former CFO). CRI had to button up policies due to a markdown irregularity accounting issue w KSS, as well as an exec being charged with fraud and insider trading by SEC in 2010. Nonetheless, it’s got a long way to go before it’s worthy of ‘cult stock’ status again. Our point is that today it is sitting at 1.25x EV/Sales. That’s well below the prior peak of 2.1x, but the old peak is just that…the OLD peak. It need not apply any more.
Playwear has nearly doubled as a percent of CRI’s total over the past ten years. ‘Baby’ is a very defendable business – the Carter’s brand goes a long way with a new Mom swaddling her newborn. But in the Playwear category, it competes with everything from Children’s place, to Old Navy, to JC Penney and Wal-Mart private label. Not a place to hang your hat on.
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