LULU: Be Patient

Over our TAIL duration, LULU is arguably one of the cheapest stocks in retail. Unfortunately, stocks don’t trade on a 3-year duration. Those looking at near-term metrics see it as the most expensive. That = opportunity. Be Patient.


It’s hard to justify that a company that is comping 25% and growing top line at 53% should trade off when it beats the quarter and guides up (albeit slightly) on the year. But welcome to the world of high-expectations stocks. Even though margins were better than guided, the fact is that they were down, delevering into ONLY 47% EPS growth (you should read that with an element of intended sarcasm).


People who shorted this name at 30x earnings earlier this year got steamrolled because the reality is that it’s rare to find such a powerful brand with such Blue Sky growth (though we think UA gives it a run for its money and is cheaper). If it’s at 30x, why not 40x? 50x? Clearly this is not the right metric. What’s the right metric? From a TAIL perspective (our duration spanning 3-yeasr or less) we like EV/market opportunity.


This is easier said than calculated. If you look at LULU’s share of the Yoga market as it stands today, it is going to look expensive on every metric imaginable, and it will appear by all means a short. You have to believe that the company can grow the category, and take the brand into areas that we do not know exist yet. That’s where the biggest money has been made in retail – when brands consistently  do things that you never conceived as being possible.


In looking at LULU’s REAL market, we need to look at total high end sports apparel. The US Athletic Apparel Market is about $40bn at retail. Even Nike has only 10% share of that market. It’s massively fragmented. If we isolate to price points above $50 – which is pretty much where LULU lives, then we’re still looking at a $13bn market. Outside of the US, we think that the size is closer to 1.5x the US. So let’s say $30bn in aggregate.


Is LULU’s EV/Sales of 8.8x seemingly colossal? Yes. It’s a notch above KORS’ (unjustified) 8.5x, Chipotle’s 5.2x, UA’s 3.3x, NKE’s 1.9x and RL’s 1.8x.  But relative to addressable market size, it’s trading at 0.33x vs NKE at 0.60x, and RL at 0.45. The only name cheaper than LULU is UA, which is sitting at 0.15x.  You probably only care about this if you’re looking to really invest in the company as opposed to renting the stock. And this valuation certainly won’t prevent LULU from selling off as guidance is messy and the chart jockeys out there start eyeing the $61.33 200-day moving average (not our process…by the way). But the bigger picture view as to the premise that valuing LULU differently is definitely context worth considering.                   


Of course, ‘addressable market size’ is only important if a company has the team, vision, plan, capital, and allocation process to hit its goals. On our durations…

  • TAIL (3-Years or Less): There was nothing we heard on today’s call that changes our view that LULU does, in fact, have what it takes to take disproportionate share of the addressable market.
  • TREND (3-Quarters or Less): While we really like the company’s focus on innovation to lead demand instead of meeting it, the simple fact that they are not doing this already deserves a minor in the penalty box. Capped top line growth this year as LULU shifts its model won’t help its growth multiple near-term, nor will reinvesting better yy product cost deltas into innovation and material. These moves are for all the right reasons, but the market likely won’t care. The saving grace is that LULU’s SIGMA move this quarter was definitely positive, which offers up some Gross Margin support next quarter.
  • TRADE (3-Weeks or Less): The quarter is already out of the bag, so near-term factors are minimal. With growth acceleration and margin improvement on hiatus, our sense is that – as great a growth story as it is -- chasing it here is premature.


LULU: Sales Inventory Gross Margin Analysis (SIGMA)


LULU:  Be Patient - LULU SIGMA


Accountability and Outlook: Here’s a look at LULU’s variance between guidance and actual, as well as deltas in guidance for the balance of the year:


LULU:  Be Patient - LULU Deltas


Highlights from the Call:


Product Innovations vs. Chasing Near Term Sales:

- Shift in Thinking relative to last year- focused on avoiding buying in bulk to simply meet demand

- There is a brand cost associated with over ordering what people want today vs. focusing on what they will NEED down the road – near term focus results in markdowns

- Revenue upside will be limited as a result until Q4 with more modest comps mid-year (guided Q2 +LDD vs. +16E)

- Product innovation includes capsules (completed swim and commuter and planning new warm-wear, gym, cross-fit) as well as fabric infusions and technical investments



- +178% in 1Q12 reaching ~13% of sales vs. 7% in 1Q11

- Growth largely due to boost from transition to ATG platform last year

- Increases expect to be somewhat muted for the rest of the year with slightly lower penetration vs. Q1 in Q2/3 but will pop in Q4

- Seeing similar life span for products online and in store- not in the business of doing exclusives online

- Men’s penetration much lower online vs in store (overall 12% of sales in Q1)

- Expected to be accretive to long term GM target of 55% as penetration grows



- 85%-90% of the 25% Q1 comp due to increase in units with only a minor boost from pricing

- Cost improvements (primarily due to raw materials vs. labor) expected to be offset by investments in innovation

- Pricing product introductions to market but seeing improved margins on product as they are improved/innovated

- Seeing a better balance of full priced selling with more normalized markdowns driven by better inventory balance



- Just launched E-commerce site in Australia (May); planning country specific launch in UK and Hong Kong later this year

- Canadian comps running MDD while US stores comping mid 30s (aggregate +25% comp)

- Brand recognition in New Zealand/Australia ~3 years behind the US but stores on track & comping well

- Yoga market continues to grow in Asia

- See both Europe and Asia attractive though Asia is more compelling


Full Year Guidance:

- Guidance updated to reflect Q1 outperformance through relatively unchanged- weaker Canadian dollar expected to be offset by strong store productivity & e-commerce

- Revenue upside limited until Q4 due to restrained sales chasing near term and focus on innovation

- Gross Margin expectations maintained around goal of 55% (-188 bps) due to higher product costs partially offset by more normalized markdowns from balanced inventory levels as well as occupancy leverage




CONCLUSION: We don’t see the early innings of this Chinese rate cut cycle as a signal to get bullish on China’s economy or equity market at the current juncture. Moreover, we do not find it prudent for investors to increase their asset allocation exposure to commodities here.


HEDGEYE ASSET ALLOCATION: 0% exposures to commodities; average daily exposure to commodities since the start of APR ’11 < 3%. Not being invested in an asset class is, in fact, a risk-managed decision.


THEMES AT PLAY: Deflating the Inflation; Bernanke’s Bubbles


If, in 2008, after a -28% drawdown in commodity prices from their YTD peak (as measured by the 19-commodity CRB Index), you increased your gross exposure to this asset class on the heels of China’s first interest rate cut (SEP 16 of that year), you were dead right – for five days. The CRB Index rallied +9.5% to another lower-high in the week post the Chinese interest rate cut and then proceeded to plummet -46.4% from there to its ultimate bottom on MAR 2, 2009.




As we penned in the conclusion of our FEB 21 note titled: “CHINA LOWERS RRRs – NOW WHAT?”: “… we think it’s important to note that the potential for Chinese growth to reaccelerate due to easier monetary policy is structurally impaired absent a removal of curbs within the property sector.”


Alas, GROWTH remains the most important factor in our core three-factor fundamental screening process. While each reflexive factor (GROWTH/INFLATION/POLICY) is indeed vital to the process, we continue to stress that buying on rate cuts alone is akin to buying stocks on valuation – neither are truly catalysts in and of themselves. A positive inflection in GROWTH needs to become a probable outcome in order for market participants to broadly see opportunity.


For China, whose benchmark Shanghai Composite Index closed down -0.7% ahead of the rate cut, that is simply not the case at the present moment given the current Chinese GROWTH model:




Moving along, at the current juncture we would add that given the recent acceleration to the downside in Chinese economic growth statistics/expectations, China may need to implement a fiscal stimulus package as well to cause the slope of its economic growth to inflect in a positive direction. On this front, has been our official view since early OCT ’11 that China is unlikely to pursue such a strategy ahead of the late fall changing of the guard atop the Politburo and perhaps even as far out as the MAR ’13 change in the presidency and premiership.


That’s a long time from now as it relates to the heighted financial market volatility borne out of gaming policy expectations emanating from the ECB to the PBOC to the Fed and back again.


Per Wikipedia: “ If previously implemented retirement policies are followed, no other current members of the [Politburo Standing Committee] will continue to serve in that capacity. About 70% of the members of the Central Military Commission and the executive committee of the State Council will also turnover in 2012, resulting in the most significant leadership transition in decades.”


Given the potentially massive changing of the guard atop China’s economic and political leadership, it is our view that it will take a material economic slowdown for China to announce an economic stimulus package and/or materially peel back the existing curbs on its real estate market over the intermediate term. The latest commentary out of various Chinese policymakers afford us conviction in this view: 

  • “The country will steadfastly continue curbs on the residential real-estate market and won’t flip-flop on its policies,” per an unnamed Housing Ministry Official via the Shanghai Securities News. This statement echoes a similar pledge out of the State Council (via the official state-run Xinhua News Agency) earlier in MAY.
  • “China has no plan to introduce stimulus measures to support growth on the scale unleashed during the depths of the global credit crisis in 2008… The Chinese government’s intention is very clear: It will not roll out another massive stimulus plan to seek high economic growth… Current efforts for stabilizing growth will not repeat the old way of three years ago… Pumping in government money to achieve growth targets is not sustainable and China will instead focus on encouraging private investments in railways, infrastructure, energy, telecommunications, health care and education,” per an article on economic policy via Xinhua. 

Briefly looking back, the 2008 stimulus package was CNY4 trillion or 12.7% of GDP at the time – that’s a fairly large hurdle to climb for an economy that is roughly ~50% larger in size (on a nominal basis) from its year-end 2008 level. Moreover, some CNY2.8 trillion of that package ultimately wound up in the form of incremental LGFV debt – an asset class that poses material risks to Chinese banks’ balance sheets  over the long-term TAIL.


All told, we don’t see the early innings of this Chinese rate cut cycle as a signal to get bullish on China’s economy or equity market at the current juncture. Moreover, we do not find it prudent for investors to increase their asset allocation exposure to commodities here. If China is signaling anything to those willing to pay attention – it’s that both Chinese domestic and global growth are slowing at a faster rate in the immediate term. Be on the lookout for confirmation of this conclusion in China’s MAY economic growth data dump this weekend.


Darius Dale

Senior Analyst


Keith shorted MGM in the Hedgeye Virtual Portfolio at $11.37.  According to his model, the TRADE resistance is at $11.71 and the TREND resistance is at $13.15.



We're negative on the long-term outlook for US casinos given the structural changes in the economy - read: housing - and more importantly, the bleak demographic outlook.  The average age of the high margin slot player continues to increase, younger generations are not playing slots, and that great gambling baby boomer generation will eventually die off.  In real terms, a return to peak EBITDA for MGM looks like a pipe dream to us.


Over the near-term, we don't see anything more than sluggish Strip growth.  Worse, 2012 EBITDA estimates look too high for MGM.  Q2 is looking more and more like a miss.  Historically, 1Q REVPAR is very strong and current Street estimates call for even better REVPAR in 2Q and 3Q.  We think this is unlikely as a difficult macro environment and difficult comps will weigh on future quarters. 




Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Not Good: SP500 Levels, Refreshed

POSITIONS: Short Industrials (XLI)


Bernanke did not deliver on what some conflicted and compromised people were begging for, so the USD rallied from this morning’s lows and Gold sold off. Stocks are well off their highs, making lower-highs, again – and that’s not good.


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

  1. Intermediate-term TREND resistance = 1369
  2. Immediate-term TRADE resistance = 1332
  3. Long-term TAIL support = 1283 

In other words, we’re a long way from 1283 – and the bigger question now is does that line hold?


I do not know, but we did sell into this hopeful move.


Hope is not a risk management process.



Keith R. McCullough
Chief Executive Officer


Not Good: SP500 Levels, Refreshed - SPX


In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance.

OVERALL:  BETTER - better weather, a favorable calendar, and higher operating margins, particularly in Black Hawk, drove an EBITDA beat


    • BETTER:  leverage ratio 5.7x came down a little bit from 5.8x last quarter
    • MIXED: Cape Girardeau expected opening moved up two months ahead of schedule but the capex cost increased $10MM to $135MM
    • BETTER:  FQ4 2012 capex was a little below $30MM, below company guidance of $45MM
    • SAME:  Pompano still doing well use to an aggressive marketing program and loyalty program. Pari-mutuel revs have also stabilized.
    • SAME:  Mississippi properties continue to face the realities of a sluggish economy and heightened competitive pressures
    • WORSE:  Saw an uptick in promotional spending in the Kansas City market due to the recent openings of the new casinos. Biloxi promotional spending environment continues to be fierce.





"Overall, we had a solid quarter marked by incremental revenue growth resulting from our refined business model, more favorable weather conditions than last year and an increasingly renewed asset base.  Even after adjusting for the fact that fiscal 2012 had an additional week when compared to fiscal 2011, we grew revenues and adjusted EBITDA."


- President and Chief Executive Officer Virginia McDowell



  • They have now collected all of their insurance recoveries
  • No R/C borrowings outstanding
  • $0.5MM of capitalized interest for the Q and $1.1MM for the year



  • Blackhawk, for the first time since ASCA opened, had market share growth. 
  • Have turned a corner in Vicksburg
  • Disruption impact of the consolidation of LA operations was in the range of $300k 
  • Pompano:  Coconut Creek opened recently but they have had improved promotions and the roll-out of their guest loyalty program.  Racing revenues have stopped declining.
  • Cash build is temporary as Cape Girardeau construction ramps and have notes that they will likely take out next year
  • Impact of the extra week? Just pro-rata the quarter.
  • Update on closing of Biloxi? 
    • Sometime in the summer
  • Cape Girardeau budget increase was infrastructure-related
  • New competition coming into Blackhawk over the next 6 months? 
    • They are in discussions with the new property owner next door and are going to work together to strengthen their pod of properties. They are also renovating the rooms there and using the Pompano as an example. Have done a lot to the slot floor, poker room, and putting in a new buffet.
  • No change in customer behavior/ spending patterns over the last few weeks
  • Any overly promotional markets out there?  Biloxi is really the only one there... very competitive for mid-week business.  Margaritaville opened without a big impact but is a very promotional environment there. Also saw an uptick in Kansas City.
  • Feels like there may be more M&A as companies' balance sheets are more in order and there has been compression in the bid-ask spreads.  They are always looking.



  • "We expect to open Cape Girardeau by November 1 of this year, two full months ahead of our initial schedule, and will complete the rebranding of Vicksburg within the next several months (F2Q13).  Further, as we continue to renew our asset base and provide guests with more options and more experiences, we have an aggressive schedule of targeted capital improvements planned for our properties during the coming months, including renovated hotel rooms, new buffets and a full rollout of our enhanced customer loyalty program."
  • "Black Hawk benefited from favorable weather conditions, completed facility enhancements, including renovations to the poker room and casino floor, and a reduced gaming tax rate compared to the fourth quarter of fiscal 2011."
  • "Pompano continued to exhibit revenue growth resulting from changes to our game mix, enhanced food and beverage amenities and the rollout of our enhanced customer loyalty program during the prior quarter, while competing with a major new expansion at our nearest competitor."
  • "Waterloo showed strong growth in adjusted EBITDA margins during the a result of operating improvements and reduced costs."
  • "Adjusted EBITDA margins decreased... primarily a result of severance and marketing costs resulting from the consolidation of our riverboat operations into a single facility.  We are benefitting from a lower cost structure in Lake Charles as a result of consolidation following the sale of our smaller riverboat in February 2012."
  • "Our properties in Mississippi continue to face difficulties stemming from a lagging economy in the area.  In particular, our property in Lula is facing increased competitive pressure from competing facilities in Arkansas.  However, in Vicksburg we benefited from operating improvements... partially offset by construction disruption associated with the ongoing rebranding of the facility."
  • "Kansas City property, however adjusted EBITDA decreased... primarily as a result of competitive market pressures following the opening of a new facility in the area during the quarter.  Our property in Boonville increased adjusted EBITDA margins... as a result of operating efficiencies and the introduction of the Farmers' Pick Buffet in the beginning of this fiscal quarter."
  • "We are currently renovating the 253 hotel rooms in the main hotel tower in Lake Charles and 237 rooms in the Isle Black Hawk Hotel.  We expect the $15 million complete refurbishment of the Lake Charles rooms to be completed by November 1, 2012.  In Black Hawk we are replacing carpet, wall coverings, and furniture at an expected cost of approximately $2.0 million, and expect to be completed by December 1, 2012."
  • "Intend to open additional Farmer's Pick Buffets in fiscal 2013 including at Cape Girardeau, Pompano, Black Hawk and Waterloo.  Additionally, we plan to add a Lone Wolf bar in our Waterloo facility."
  • "Expect to introduce [Fan Club loyalty] program to five additional properties during the first and second quarters of fiscal 2013, and intend to have it fully implemented across the portfolio by the end of fiscal 2013."
  • The expected cost of Cape Girardeau has been revised up $10MM to $135MM
  • "The appeal hearing for the gaming license awarded to Nemacolin Woodlands Resort for the final resort license in Pennsylvania was held on March 7, 2012. No date has been determined for an expected ruling on the appeal or the ultimate resolution of the matter.  We expect to begin construction on the property following a successful conclusion to the appeal process and receiving any other necessary approvals, and to open the property approximately nine months after the commencement of construction."
  • FY2012 capital expenditures were $75.2MM, of which $34.9MM related to Cape Girardeau, $0.7MM related to Nemacolin and $39.6MM related to maintenance capital and projects at our existing properties.
  • Net leverage, as calculated under our senior credit facility was approximately 5.7x 
  • Unusual items in the Q:
    • $112.6MM write-down to the value of Biloxi after the sale annoucement
    • Recorded a charge of $16.1MM related to the sale of our smaller riverboat and associated gaming license in Lake Charles, Louisiana, completed on February 9, 2012
    • Impairment charge of $14.4MM against the goodwill at our Lula property
    • Net revenues and operating income for the fourth quarter include $8.6MM of insurance recoveries 
    • Accrued approximately $2.0MM, including interest, in connection with a judgment issued in a legal case in connection with the Company's previously owned property in Vicksburg, Mississippi, which was sold in July 2006.  We are appealing the judgment and plan to vigorously defend our position.
  • FY2013 Guidance 
    • D&A: $76-78MM
    • Cash income taxes: < $5MM (primarily related to state taxes)
    • Interest expense (net of capitalized interest): $83-85MM
    • Corporate & development expenses: $40MM (including stock comp)
    • Capex: $140-150MM (including approx $85MM spent on Cape Girardeau)
    • Pre-opening of $5.5MM related to Cape Girardeau
    • FY13 will have 52 vs. 53 weeks in FY12