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CRI: Getting heavier in one of our top shorts

Our conviction remains high on this one. Keith taking advantage of today's low-volume pop to add to our short position. 

 

We've included additional detail on our short thesis below as outlined in our 5/9 report "CRI: Short It."

 

CRI: Getting heavier in one of our top shorts - CRI TTT

 

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).

 

NKE...Check

 

<chart2>

 

AAPL...Check

 

CRI: Getting heavier in one of our top shorts - AAPL for CRI

 

GIL...Check

 

CRI: Getting heavier in one of our top shorts - GIL for CRI

 

Now look at CRI. HUH?

 

CRI: Getting heavier in one of our top shorts - CRI for CRI


 

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.

 

CRI: Getting heavier in one of our top shorts - CRI category mix


 


DNKN – A LIQUIDITY EVENT BUT…..

Not for the average shareholder…

 

If you are a DNKN shareholder you are happy because the stock is working.

 

I have my reservations about what “reality” means for the company.  I have yet to see evidence that the stated long-term growth rate can be achieved.  As I have said in the past, sweetened up deals for franchisees in new markets and a clear preference for less disclosure as opposed to more on the part of management is not encouraging.

 

Looking at the comparable-store sales trend, the two-year average is declining.  High single-digit same-store sales growth is impressive but the change on the margin is not, as it stands, pointing higher.  Despite the lack of importance of comps for a franchised business, it is likely that a continuation of this trend would spur concerns more broadly about the company’s ability to grow.  If comps decline to 5% and bulls capitulate on that, but the pipeline and returns on new units are shown to be healthy, I will be the first to react by advising clients to take advantage of the selling.  As before, I will remain skeptical of this story until I see the data to convince me otherwise. 

 

The DNKN senior executives continue to be all glowing about “future demand” while the largest shareholders can’t sell their stock fast enough.  Remember, the senior executives at DNKN are employed at the company because the largest shareholders put them there. Knowing this it should come as no surprise that the company will use additional leverage to take out selective shareholders of their stock.   

 

Yesterday, at an investor conference the company’s CFO Neil Moses had this to say – “So it should come as no surprise that we’re sitting at about 4.2 times debt-to-EBITDA today. You're right; we've talked about being very comfortable in the 5, maybe even 5.5-times range. We're very fortunate because I talked about having dual wide-space opportunities in terms of growth, but there's also quite a bit of stability to our business. If you look back over the last 12 years and you say, "What are the worst comp stores – Dunkin' Donuts U.S. comp stores sales performance you've recorded in 12 years?" It's minus 1%. So, our business is very stable during the economic downturn where some of our competitors experienced mid-single-digit negative comps. We were basically flat.

 

And so, I think that business model allows us to support a lot of debt. If we levered it up back to the 5 times range, the most likely use of cash, I think, would be a share repurchase program we've already announced, I think a pretty aggressive dividend program earlier this year. When we talk about share repurchase, it probably wouldn't be public float because we're about 70% publicly owned today and 30% owned by our private equity owners. So, it might take the form of a share repurchase from our private equity owners. That would be the most likely use of cash, at least, in the short term.”

 

I know this is common practice and is good news for the stock in the short run; it’s a red flag for me.  With the dividend news out of the way and now the share repurchase strategy; we are back to fundamentals driving the story.  On this metric the trends are slowing.  

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


BYD AND HOUSING DATAPOINTS

Recent housing data bodes well for BYD’s local LV business.

 

 

April housing data continued a positive recent trend in Las Vegas.  We’ve shown in the past that housing prices were the number one driver of gaming revenues over the last 15 years both in the US and the locals Las Vegas market.  Clearly, BYD would benefit immensely from home price inflation.

 

The median price of a single-family home sold in April gained 2% over the last year bringing the 3 month moving average to almost flat.  Single-family home sales increased 3%, while new home sales jumped 35% in April.  While those figures are important in terms of price stability reliability, actual pricing is the key variable.  Case-Schiller pricing data is probably more reliable but we only have data through February 2012.  Up to that point, the data showed similar trends to the Greater Las Vegas Association of REALTORS (GLVAR) data as seen below.

 

BYD’s net gaming revenues have been trending flattish in recent quarters, yet EBITDA has been substantially higher due to a smaller cost structure.  If housing prices and thus gaming revenues continue the trend, the flow through should be high and BYD should continue beating estimates for the foreseeable future.

 

BYD AND HOUSING DATAPOINTS - BYD1


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INITIAL CLAIMS: TREADING WATER

Initial Claims

Initial claims came in at 370k for the second week in a row. Incorporating the 2k upward revision to last week's print, claims fell by 2k. Rolling claims also declined, falling 5.5k to 370k. On a non-seasonally adjusted basis, claims rose 2.5k to 328k. Over the last few weeks, claims have been treading water, making only slight movements up or down. We expect to see claims rise in the summer months based on faulty seasonal adjustment factors. 

 

INITIAL CLAIMS: TREADING WATER  - Raw

 

INITIAL CLAIMS: TREADING WATER  - Rolling

 

INITIAL CLAIMS: TREADING WATER  - NSA

 

INITIAL CLAIMS: TREADING WATER  - NSA rolling

 

INITIAL CLAIMS: TREADING WATER  - S P

 

INITIAL CLAIMS: TREADING WATER  - Fed and Claims

 

2-10 Spread

The 2-10 spread tightened 3 bps versus last week to 145 bps as of yesterday.  The ten-year bond yield decreased 3 bps to 174 bps.

 

INITIAL CLAIMS: TREADING WATER  - 2 10

 

INITIAL CLAIMS: TREADING WATER  - 2 10 QoQ

 

Financial Subsector Performance

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

 

INITIAL CLAIMS: TREADING WATER  - Subsector performance

 

Joshua Steiner, CFA

 

Allison Kaptur

 

Robert Belsky

 

Having trouble viewing the charts in this email?  Please click the link at the bottom of the note to view in your browser. 

 

 



Market Hangovers

“You come home, and you party. But after that, you get a hangover. Everything about that is negative.”
-Mike Tyson

 

Yesterday Keith, myself, and our head of consulting, Michael Lintell, had a meeting with one of our long term subscribers in our New Haven office.  Not only does this client have a great long term track record in their respective market (which happens to be Europe), but they are massively outperforming this year as well.  I won’t get into the intricacies of our discussion, but at the end of the meeting we all collectively agreed that this is not the type of market that you want to trade with a hangover.

 

For those that have never had a hangover before, Wikipedia defines a hangover as follows:

 

“A hangover is the experience of various unpleasant physiological effects following heavy consumption of alcoholic beverages. The most commonly reported characteristics of a hangover include headache, nausea, sensitivity to light and noise, lethargy, dysphoria, diarrhea, and thirst, typically after the intoxicating effect of the alcohol begins to wear off. While a hangover can be experienced at any time, generally speaking a hangover is experienced the morning after a night of heavy drinking. In addition to the physical symptoms, a hangover may also induce psychological symptoms including heightened feelings of depression and anxiety." 

 

Arguably the way the market is trading currently, with the SP500 down 5.7% for month to date, it is creating feelings of depression and anxiety in many stock market operators.  In effect, a market hangover over that is akin to taking down too many Jägerbombs the night before (for you old timers a Jägerbomb involves dropping a shot of Jägermeister into a glass of Red Bull and then chugging it).

 

The last five days of trading are prime examples as to why you need all of your wits about you.  Yes, some investors with true long term duration don’t have to adjust exposures and worry about monthly or quarterly performance, but the reality is that most of us do have to worry about short term performance.  In a market like this, the only way to really capture marginal performance, especially when correlations are heightened, is to “buy ‘em” when other people are selling and “sell ‘em” when other people are buying.

 

In the Chart of the Day, we emphasize the volatility of the last week.  The SP500 started the period at 1,328 then traded down to 1,295 then ripped up to 1,331 and then dropped back to 1,300.  Much like a hangover, that kind of short term volatility can be nauseating.  We actually look at it in a positive light and use it as an opportunity to adjust exposures accordingly, and gain performance edge.  While everyone’s strategy is unique, email our head of consulting at if you want some help developing a more proactive risk management strategy for your portfolio.

 

Obviously the key driver of recent volatility in equities is Europe.  This morning we are getting more of the same.  On one hand European equities are at the highs of the day and respecting yesterday’s late day rip in U.S. equities.  On the other hand, there remains little chance of resolution to the sovereign debt mess in Europe, especially given the shifting politics.

 

Currently, the positive sentiment is centered on increased chances of Euro-area deposit insurances and the growing likelihood of Eurobonds that were supposedly discussed at yesterday’s summit.  In reality, though, no new progress was made and the next summit is not until June 28th.  Frankly, European Central Bank President Mario Draghi probably summarized it best yesterday when he said:

 

“Euro bonds make sense when you have a fiscal union, otherwise they don't make sense. They are the first step towards a fiscal union.”

 

We have said it many times, a monetary union is no union at all without a strong political and fiscal union.  Until that occurs, the Euro is doomed to fail.

 

The one global macro market that is slowly shifting from being in hangover mode to recovery mode is natural gas.  In our best ideas call yesterday, we emphasized our shift from being long term natural gas bears to getting more constructive on natty. Some of the key reasons are as follows:

 

1.   Bottoms are processes, not points. And after a 3.5 year bear market in gas that saw the front-month NYMEX contract fall 80%, we think that bottoming process is in motion; front-month gas has bounced convincingly off the $2/Mcf level, gaining 30% in a month to trade over $2.60/Mcf, and has regained its TRADE and TREND lines on our quantitative model.

 

2.   Production growth is slowing, and will continue to slow. Gas production is already slowing on the margin: +4% YoY in early May versus +9% in 4Q11. We see that decline accelerating as oil prices move lower. Our research indicates that the average full-cycle cost to produce 1 Mcf of gas in North America is ~$5.50/Mcf ($2 cash cost and $3.50 PD FD&A cost), which suggests that producers in aggregate are well below breakeven.

 

3.   Demand from the power sector is surging and won’t stop. The U.S. power sector has responded to the low gas price by increasing consumption 44%, or 7.5 Bcf/d, YoY in the first week of May, taking market share away from coal, nuclear, and hydro in a short amount of time.

 

4.   The 2012 storage issue is priced-in. We will hit storage capacity this fall. That is probably the most consensus opinion on natural gas there is in the market right now. In fact, in an April 2012 survey of investors and industry professionals, 78% said that we will hit storage capacity this year.

 

5.   From a long-term perspective, sentiment is still bearish on natural gas. From 1995 – 2006, non-commercial traders (hedge funds, mutual funds, etc.) were net neutral on natural gas. Only since 2007 have non-commercial traders been heavily, consistently, and correctly short the commodity.

 

Just like real hangovers, most hung over markets will eventually recover.  We believe natural gas is one of those markets.

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Market Hangovers - CotDay

 

Market Hangovers - VPP


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