- We’re calling for moderating RevPAR growth assuming stable economic growth
- A worsening jobs/GDP picture could pressure RevPAR even more
- RevPAR tends to drive near-term sentiment
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)
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:
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.
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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.
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:
- Intermediate-term TREND resistance = 1369
- Immediate-term TRADE resistance = 1332
- 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
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
- CAPE GIRARDEAU OPENING
- MIXED: Cape Girardeau expected opening moved up two months ahead of schedule but the capex cost increased $10MM to $135MM
- 2012 CAPEX GUIDANCE
- BETTER: FQ4 2012 capex was a little below $30MM, below company guidance of $45MM
- POMPANO COMPETITION FROM SEMINOLE EXPANSION
- SAME: Pompano still doing well use to an aggressive marketing program and loyalty program. Pari-mutuel revs have also stabilized.
- MISSISSIPPI ENVIRONMENT
- SAME: Mississippi properties continue to face the realities of a sluggish economy and heightened competitive pressures
- PROMOTIONAL SPENDING
- 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.
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