Guilo - A term for a Person of white ethnicity used by Cantonese speaking Asians.
I thought about this term when watching Steve Leisman on CNBC yesterday morning. CNBC’s senior economics reporter (oxymoron, I know) was incredulous that Feng Shui could have anything to do with the PBOC’s number choice for the lending rate cut. Yes Steve, the Chinese are a superstitious bunch and they do believe that numbers matter.
Now I’m not the China expert at Hedgeye. That role belongs to Darius “da gezi” Dale. However, I did just get back from a 3 week trip to China and some other Asian countries (of course, I went to Macau) so I feel like an expert.
A few general observations from my trip are in order before I get to the sector analysis:
- More than one Mainlander commented to me that there are a lot of people being paid to do worthless things like digging ditches, filling them in and then re-digging
- A lot of construction – hope there is demand
- Government development contracts are done on a big scale – instead of building one hotel, they want you to build 10 for instance – again, hope there is demand
- Flying domestically sucks but the trains are great
- Saw a lot of buildings outside the main cities but not a lot of people
- The best jokes in China are the ones ridiculing the central government – quietly of course – maybe playing to the audience
And now on to the subject that’s near and dear to my heart and the main reason for my trip to Asia: the leisure sector. First, the hotels in Beijing and Shanghai are great – all new and all very well-staffed. I couldn’t pick my nose without a Chinese finger there to help. Loved the service. I visited quite a few and they were all overstaffed. Chalk one up for the Americans who manage but do not own any of these hotels. Margins, shmargins. Many of the hotels were also part of mixed use development, so it’s difficult for the owners to determine ROI on the hotel piece. This might explain the extravagance of the hotels and the favorable management contracts for Starwood and Marriott.
On to the gambling world and its capital – China. As most of you know, China plays a major role in the world of gaming. Las Vegas has become almost an afterthought. Macau is the largest gaming market in the world with the vast majority of the business originating from mainland China. In June, Macau gaming revenues grew 13% MoM on top of 7% growth YoY. Investors would be cheering most markets with that kind of growth, but not here. Macau gaming stocks traded in the US (LVS, MPEL, WYNN) are down 25-30% since their YTD highs in April. The concern lies in the sharp VIP slowdown. VIP comprises about 70% of gaming revenues in Macau and although margins are lower than in the Mass business, VIP volumes really haven’t grown sequentially since June of last year. In fact, VIP YoY growth went negative in June 2012 for the first time in 3 years.
For the purpose of this Early Look, we will update the rather timely analysis we did on 5/22/11 in a note entitled “VIP SLOWDOWN IN THE CARDS”. Yes, we’re pimping our research a little here (somebody’s gotta do it – this is a business after all), but there is also an interesting macro angle to the analysis that’s appropriate for this forum and once again timely. At that time, we found that Macau VIP volumes were highly negatively correlated to changes in the China Reserve Requirement (peaked at a lag of 9 months at -0.85) and the China 1-Yr Lending Rate (peaked at a lag of 11 months at -0.75).
The timeliness comes in because China began loosening on June 7th followed by another rate cut yesterday. If history is a guide, we’re still 3 quarters away from material improvement in VIP but at least there is a light at the end of the tunnel. From a near-term perspective, the rate cut is probably indicative of a weaker economy than many thought. If weak VIP volume growth continues to drag these stocks down, there will be a tremendous buying opportunity – a la 2009, the last time VIP cracked. As long as growth in the Mass segment continues its strength – up 30% in June – further estimate reductions, while likely, shouldn’t be devastating.
While it may not be time to back up the truck just yet or even start it, the keys should be in the ignition because these stocks are cheap and help is on the way. Stay thirsty my friends.
Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Germany’s DAX, and the SP500 are now $1, $97.21-102.74, $82.30-83.21, $1.22-1.25, 6, and 1, respectively.
Guilo and Managing Director – Gaming/Lodging/Leisure
With nearly $270mm in mid-tier share up for grabs in June, the off-price channel is the big share gainer.
If we assume that the underlying 2yr revenue trend of ~-8% from JCP’s first quarter remained consistent in June, this would imply revenues down ~14% for the month creating a loss of ~$230mm. Adding on the $40mm in sales that KSS ceded in June at a time when it should be benefiting from JCP's strategic mishaps, we estimate a total of $270mm in mid tier share was up for grabs.
With M’s revenue growth slowing from +$80mm to +$20mm in June, we think the off price retailers have been the biggest beneficiaries of JCP's & KSS’ lackluster execution. Assuming half of ROST & TJX’s domestic dollar growth was in categories overlapping with JCP/KSS, the two combined account for ~40% of the share ceded in June. As we've been saying, Ron Johnson better be aware that the off price competition is indeed snagging a large portion of the sales he’s losing. It won’t be easy to recapture these customers from the off-price channel even if the new strategy gains traction in 2H.
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Keith added KSS to the Hedgeye Virtual Portfolio today on the short-side of what appears to be a world-class squeeze. While KSS may look cheap today trading at just above 9x 2013 consensus EPS, valuation is irrelevant at this point given the fundamental event risk we see throughout 2013.
Here are some factors that we expect will continue to weigh on performance:
- JCP isn’t the only mid-tier retailer ceding share of late – so too is KSS. We’re seeing the consumer shift increasingly to both the off-price channel as well as the dollar stores. In reality, some of these customers are gone for good while the balance will require incremental spending in the form of marketing, systems, and likely personnel to win back.
- To that end, with both sales and gross margins coming in light last quarter, KSS’ saving grace was to pull back on SG&A materially to salvage EPS. This suggests the prior point is not likely to turn near-term.
- KSS ended 1Q12 with the sales to inventory spread sitting near 3 year lows of -5% as operating margin compares become less favorable over the next 2 quarters and it implements EDLP. Additionally, KSS highlighted unit inventories +2% in June however May unit inventories were down -5% with dollar inventories +7%. We sense that the 7 point sequential swing in unit inventory growth into June implies an even greater build in dollar inventories. In light of sales running -2.6% in both May and June, it is likely the sales to inventory spread has deteriorated further headed into the last month of the quarter.
- Given June sales results, July will have to come in +6.5% in order to simply meet consensus expectations for a -1.3% Q2 comp (updated Q2 guidance provided after the May miss calls for a modestly negative comp). With compares easing into July, a +6.5% comp implies a 70bps deterioration in the 2yr trend but regardless, this is no ‘gimme.’
- FY11 Revenues grew 2.2% with E-comm accounting for 1.5% of the annual growth and new stores contributing 2 points to the top line. The core KSS business contracted. Dot.com is great, but KSS’ brands are simply not powerful enough to drive the top line long-term.
- Lastly, with TRADE and TREND levels of support at $44.26 and $47.87 respectively, it’s sitting at a point where the fundamentals and price mesh well within Hedgeye’s Risk Management framework.
More reasons to be short vs long coming out of June sales.
Our major themes and ideas remain largely unchallenged by June SSS.
1) Battle taking place for dominance in the mid-tier, with ensuing ripple effect through supply chain. Short M, JCP, KSS, JNY, HBI, CRI
2) Off-price retailers taking disproportionate share from the mid-tier -- which will be tough to recapture (psychologically and economically). Short JCP -- though the off price model is not being challenged today, but it will be in 3-6 mos -- a consideration for TJX and ROST.
3) May of last year was when the draw down in saving and increase in revolving credit first started to benefit personal consumption. This trend accelerated from July through September at which point it accounted for more than half of the increase in consumption. As such, come 2H personal consumption growth at the current rate is likely to become increasingly stressed.
Mid-Tier Remains in the Spotlight: of the 10 misses reported this morning, KSS (-4.2% vs +2.8E), GPS (0% vs. +0.4E) and M (+1.2% vs. +2.5E) were noteworthy given the market share JCP has put up for grabs.
KSS: KSS highlighted Men’s as the outperforming category though its comp was flat in June- all other categories were negative. Interestingly, KSS only provided inventory unit growth which was +2% in June. In May however, unit inventories were down -5% with dollar inventories +7% on -2.6% revenue growth creating a ~-10% sales to inventory spread. With sales -2.6% again in June (and unchanged from May), the +2% unit inventories relative to -5% in May suggests a further deterioration in the spread. While KSS guided Q2 to the low end of its $0.96-$1.02 range (in line with consensus at $0.96), July comps need to come in +6.5% to hit the consensus -1.3% Q2 comp.
GPS: Although GPS’ June performance was just shy of expectations, there was a notable acceleration in the underlying 2 yr trend across all concepts domestically (int’l slowed). Regardless, it’s no surprise that GPS is comping years of a contracting business and will need to accelerate growth further to meet expectations with FY12 guidance sitting at $1.78-$1.83 relative to consensus of $1.94E.
M: While we don’t consider M (+1.2% vs. +2.5E) to be a mid-tier retailer, the month’s miss is notable in that M has been the only company to outright attribute some of its strength to share gains from JCP. Recall M guided June comps to be slightly below the +3.5% Q2 guidance suggesting the month’s performance was shy of internal expectations. M now needs to comp +6% in July to reach the +3.5% consensus (and guided) Q2 comp which implies a 150bps acceleration in the 2 yr trend relative to June- no easy task. A slowdown at M as well as light results out of GPS & KSS suggests more share is being eaten up by the off pricers.
No Slowdown for Off Price Retail: ROST (+7% vs. +4.5E) and TJX (+7% vs. +3.3E) both posted strong June beats with 2 yr comps accelerating sequentially for both retailers. Both companies increased guidance for the quarter and highlighted inventories as a positive. ROST average in store inventories ended -5% in June with TJX describing them “in great shape and turning fast.” We expect JCP customers to continue to flock over to off price concepts and see little pricing risk in the subsector given excellent inventory positioning headed into 2H.
High End Rebounding: After a slowdown relative to mid and low end retail over the past 2 months, JWN (+8.1% vs. +4.2E) & SKS (+6% vs. +4.2E) posted strong June results. Outperformance drove a boost in the spread between high-end retail and the rest of the Monthly comp sample to 4 points vs. 1 point in April. Notably, JWN highlighted sales as consistent throughout the month with the final week the strongest suggesting high end strength headed into July.
LTD: LTD continues to outperform (+7% vs. +2.4E) posting the biggest beat in June (4.6 points) with Victoria’s Secret comps accelerating +11% at both Brick and Mortar and Direct. With sales growth improving sequentially (-0.3% vs. -6.3% in May) and inventories coming down (+10% per square foot vs. +11% in May), the sales to inventory spread jumped 7 points with LTD already highlighting merchandise margins as having been up significantly.
Keith bought IGT in the Hedgeye Virtual Portfolio at $15.74. According to his model, the TRADE support is at $14.82 and the TREND support is at $15.31.
With good earnings visibility over the next few quarters and an aggressive stock buyback, we believe there is limited downside to the stock. Positive catalysts include a potential FQ3 earnings beat and strong international sales which would lead credence to the company's aggressive international market share goals. We remain positive on the slot sector as we think the industry is in the early innings of a 3-5 year bull cycle.