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FL: We Like It Here


With FINL’s Q1 results already preannounced, quarter-to-date sales will be one of the key takeaways from Friday’s call. Weekly footwear trends, after adjusting for a typical margin of outperformance in the athletic channel, suggest that June is tracking up +10%-11%. We think this translates to comps of +8.5% at FL and +7.5% at FINL quarter-to-date – both well above current expectations. In addition to our call to be long NKE into the print, we like FL here.


Consider the following:

  • FL is back to the level where it was headed into Q1 results when European and 1H performance concerns were heightened against tougher comps and demand uncertainty. With the Q1 river card out of the way reflecting solid results highlighted by sales coming in better than expected and Europe turning positive, we’re seeing similarly favorable results thus far in Q2 after which compares only get easier.
  • May footwear sales in the Athletic Specialty channel came in up +10% following +8% in April. Given an average 4-5pt margin of outperformance in the athletic channel over aggregate industry trends, weekly industry sales suggest June-to-date is tracking up +10%-11%. When taking into account the offset of apparel underperformance (and international in the case of FL), this suggests comps are tracking at +8.5% at FL and +7.5% at FINL quarter-to-date.
  • In looking at category performance, basketball is outperforming – a trend that we think has continued through June. With greater exposure here relative to FINL, we expect FL is tracking ahead of the quarter-to-date comp update we’ll get on FINL’s call Friday.
  • Through the first three weeks of May, FL highlighted that Europe had turned positive (up +LSD vs. –MSD in Q1), which is a stark contrast to most other retailers with exposure to Europe mitigating further weakness in a region that accounts for ~24% of sales. While we admittedly don’t have great visibility into how June is shaping up, there are two factors to consider re Europe, 1) early indications suggest trends are stable if not turning positive, and 2) compares here are also getting more favorable.
  • It’s tough to ignore the fact that FL is trading at 10x our F13 EPS estimate of $2.81 – a discount last seen back in ’08. This name has typically traded at 12x-16x EPS multiple. With earnings growth in our model at 35% this year and 14% over each of the next two years, we like this entry point on a story that now has less risk than a month ago when we last saw this price.

While FINL is at a level that reflects a heavy market discount for management’s ability to execute on what we view as conservative numbers, we think FL is a more attractive play here over the intermediate-term.


Here are a couple of our prior notes on FL:


FL: 1Q12 Report Card (5/21/12)

 

FL: A Much Needed Beat (5/15/12)

 

FL: Second Act: Roadmap Intact (3/7/12)


Casey Flavin

Director

 

FL: We Like It Here - FW Channel May 12

 

FL: We Like It Here - FW Category May 12

 


 

 



 


HOLX: Great expectations

There has been concern in the industry about Hologic (HOLX) and the Gen-Probe (GPRO) deal for some time now.  Mainly, there is concern about the level of dilution from the debt HOLX would have to raise in order to complete the acquisition, with the emphasis on the coupon rate.  We see the line in the sand at 8% on $3 billion raise, which seems completely feasible.

 

Regarding the core HOLX business, the 3D tomography technology may take some time to penetrate the existing 2D customer base, but management has set low expectations for its adoption, and we see upside into 2013.  Further, HOLX’s diagnostic segment should benefit with increasing physician utilization into the second half of the year. While others are cautious about the HOLX, we are comfortable being long.

 

HOLX: Great expectations - hospital lobbying


HedgeyeRetail Visual: Evolve or Perish

Companies that are not targeting for better than 30% of sales to come from e-commerce risk the consumer resetting that benchmark closer to zero. Retailers need to evolve faster than consumers, not vice versa.

 

Industry wide e-commerce penetration has grown drastically over the past decade which we estimate now accounts for ~5% of total sales from just 1% in 2000. Despite the widespread growth trajectory of the channel as a whole, there remains a notable bifurcation between companies who have truly laid the groundwork to lead the omni channel drive relative to those who remain squarely in catch-up mode.  

 

Most companies are currently aiming for MSD-HSD penetration in online sales as a percent of total revenues. But these are baby steps. The companies looking to grow via baby steps will get steamrolled. The retail landscape needs to move faster than the consumer, not vice/versa.

 

Some companies however, like URBN are thinking long term, targeting half of its sales online as early as 2017 with penetration currently sitting at an already industry high of ~20%. Interestingly, industry data suggests URBN is one of the most exposed to the younger spending demographic with ~53% of online sales from consumers 34 and younger which lends well to the e-commerce opportunity long term. URBN is still far from the highest penetrated in the growing e-commerce channel with WSM e-commerce sales accounting for ~38% of revenues (44% including catalog) and the office superstores (which is driven largely by small business commodity-product order fulfillment) exceeding 40%.

 

Alternatively, there remains substantial opportunity for several retailers that currently operate a largely wholesale model like NKE, RL & VFC. It’s amazing to see that Nike’s e-commerce penetration is a third of UA and LULU. It has a much larger installed base of revenue, but it will begin to rapidly close this gap (while the others continue to grow – as they are winners as well).

 

Ultimately, we like companies like URBN that are targeting 50% penetration…maybe they fall short, but they’ll get close. Anyone simply targeting 10-15% has risk of getting bypassed by the consumer and having that ratio ultimately going to 0%.  (i.e. BBBY.)

 

HedgeyeRetail Visual: Evolve or Perish - E Commerce COTD


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Watch the Incentives

“Call it what you will, incentives are what get people to work harder.”

-Nikita Khrushchev

 

Nikita Sergeyevich Khruschchev served as Premier of the Communist Party of Russia from 1958 to 1964. In Russian Communist Party terms, Khrushchev was considered a liberal reformer, especially vis-à-vis his predecessor Stalin.   Although to be fair, a comparison to Stalin is a relatively easy comp in that regard.

 

The irony of using a quote on incentives from a prominent Communist leader is not lost on me.  Obviously, most attempts at Communism, with China currently being a slight exception, have failed to actually provide the incentives to create economies that are sustainable, flexible, and adaptive.  The root of this is that the actual individuals who underscore any economy do not have the correct incentives in a communist society.

 

Just imagine, if you will, an economic system in which the harder you work and the more you make, the more the government takes from you.  Sounds crazy, no?  Or perhaps it just sounds a little like the escalated taxation system that we have also developed in the West in which the more you make the more the government takes and then the more they spend.  And then when they can’t take anymore from you without the risk of popular unrest, they just borrow.  Then the governments default and feel shame. 

 

But I digress.

 

Contemplating incentives are critical when considering the investment landscape.  As it relates to Europe, one of the more interesting charts I’ve seen recently is that of real euro exchange rates.  The chart was produced by the Peterson Institute for International Economics.  The chart, which is highlighted in the Chart of the Day, indexes real effective exchange rates based on relative labor costs.

 

This chart shows Germany versus the so called PIIGS – Portugal, Ireland, Italy, Greece, and Spain.  The analysis is staggering in that it emphasizes the massive advantage that Germany gets from having a fixed currency, the euro, across the Euro-zone.  Instead of the currency market acting rational and increasing the value of the German currency, the Germans are given a long term relative advantage by being part of the Euro-zone.

 

So, on one hand, despite domestic political pressure, Germany is clearly at least somewhat incentivized to protect and sustain the euro.  That said, while the euro does provide Germany with a long term and sustainable economic advantage, the Germans are not incentivized to protect the euro at all costs.  Germany will exist just fine if the euro failed, while for many nations – Italy, Spain, Portugal, Greece, and so on, it will be an unmitigated disaster.  Those nations would effectively be shut out of the international debt markets and would likely experience massive inflation.

 

Arguable Ray Dalio said this best, when he wrote in a recent note:

 

“For this reason, we think the popular assumption that the Germans and the ECB (which requires agreement of the key factions within it) will come through with the money to make all these debts good should not be taken for granted. Said differently, we think there are good reasons to doubt that European bank and sovereign deleveragings will be prevented from progressing to the next stage in a disorderly way, without a Plan B in place. This "fat tail" event must be considered a significant possibility.”


As I interpret it, his point is primarily that incentives are not fully in place for Germany and the ECB to provide a carte blanche bailout of Europe.   Therefore, the more likely scenario is that sovereign debt debacle continues in Europe.

 

And if you don’t want to believe me or Ray Dalio, then take Angela Merkel at her words.  According to reports from last night:

 

The chancellor told lawmakers a quick move to eurobonds or other forms of joint liability would be constitutionally impossible in Germany and insisted that "supervision and liability must go hand in hand." She said they could only be considered if and when "sufficient supervision is ensured."

 

Changing topics slightly, this morning we will be launching coverage of the Industrials Sector with Jay Van Sciver.   Hopefully, you won’t hold the fact that he has a Yale degree against him (we certainly don’t).  In addition, he also has over a decade of experience covering Industrials from the buy-side.  Like many of our Sector Heads, he will cover a broad universe and go to where the action is in terms of investable ideas.  In the call today, he is going to discuss some of his investment ideas as well a deep dive on airlines.  Email if you are institutional investor and would like to participate.

 

Not to totally steal Jay’s thunder, but his initial view of the airlines is not overly positive.  In fact, some airline “stalwarts” such as Delta and United have more than 85% buy ratings from the sell side.   Delta, in particular, is at almost a 52-week high and only 1.2% of its shares are short.   This isn’t totally surprising since Delta is “cheap” on conventional metrics.

 

Now if this time is totally different for the airlines, Jay may be wrong on his thesis.  That said, it is a little hard to believe that much has changed in this highly competitive industry.  Just like every other period in modern airline industry, management teams are incentivized to shift planes to competitive routes to suck the profits out of those routes and eventually out of the system.

 

A key catalyst from Jay’s research is the American bankruptcy, which may actually kick start a new bankruptcy cycle.  By the end of Q3, AMR should have lower costs than both Delta and United and these costs will be rapidly passed on to customers.  Since Delta and United cannot rapidly cut costs to compete since many costs involve long tail labor expenses, their profitability will come under increasing pressure in Q3 and beyond. 

 

I should probably stop there at risk I give away too much and you aren’t incentivized to sign up for Jay’s call at 11am eastern today.  But I will leave you with one quote on airlines from Sir Richard Branson:

 

“I’ve always said the quickest way to become a millionaire is to start as a billionaire and get into the airline business.”

 

Of course, Branson has his incentives as well, which are to keep competitors out of the airline business!

 

Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1, $88.02-93.62, $81.99-82.63, $1.24-1.26, and 1, respectively.

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Watch the Incentives - Chart of the Day

 

Watch the Incentives - Virtual Portfolio


THE M3: MPEL/MANILA; UNEMPLOYMENT

The Macau Metro Monitor, June 27, 2012

 

 

MELCO CROWN SET TO PARTNER IN MANILA CASINO WSJ

Belle Vice Chairman Willie Ocier said the company is in talks to have MPEL to operate the casino portion of its $1 billion resort project but declined to provide further specifics.  Although nothing is finalized, a decision could come as early as today.  

 

Though Belle, a property developer, owns the casino license, it lacks gambling experience, so it signed an agreement to outsource the casino management to Philippine bingo operator, Leisure & Resorts World.  The two companies were to evenly split the resort's EBITDA, said a source.  The new deal may see MPEL take over Leisure & Resorts' 50% share of the resort's revenue, the source said.  Leisure & Resorts will still likely remain involved in the project in some capacity, however.

 

Belle has one of four licenses to build casinos in the Manila Bay area.  It is controlled by the country's richest man, Henry Sy.  The other licensees are Bloomberry Resorts Corp, who is set to open a $1.2 billion casino-resort in early 2013, Resorts World Manila, and Universal Entertainment Corp, a pachinko company run by Kazuo Okada.

 

EMPLOYMENT SURVEY FOR MARCH-MAY 2012 DSEC

Macau unemployment rate remained unchanged at 2.0%.  Total labour force decreased slightly by 1,000 from the previous period to 344,000; the labour force participation rate stood at 71.9%, down by 0.5% points.

 

 

 

 


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