HedgeyeRetail Visual: Profitability Slowing Already?

The shift in the delta between costs and prices suggests that profitability is slowing sequentially.


A 120bps sequential slowdown in the Apparel import price index (+2.7% in June vs. +3.9% in May) seems bullish in the face of a 50bp slowdown in Apparel CPI (+3.9% yoy in June relative to +4.4% in May). But that's not so.


The average retail price of a unit of apparel is about $10 while the cost is only $3.50.  So a 50bp slowdown in price equates to ($0.50) per unit, while a 120bp slide in cost is +$0.42. That's a net negative $0.08 per unit. 


This is not a doomsday scenario, but it is an incrementally negative change that most CEOs could care less about -- until they have to. 


HedgeyeRetail Visual: Profitability Slowing Already? - profitability slowing already

COH: Trade Idea Alert


Keith shorted COH in the Virtual Portfolio today on the short-side for a TRADE. While COH looks cheaper today 25% lower than when it reported 3-months ago, valuation is not a catalyst. We want to be clear that we hardly think this is a fat-tailed call after the precipitous drop. It is one of those names where the levels are sending a clear signal to sell at the same time fundamentals are more challenging on the margin. This might be a short-lived TRADE, but a good one nonetheless.

Here are a few things to keep in mind re the intermediate-term fundamentals:

  • The company is accelerating the rollout of men’s line to 100 stores in NA by the end of the F12 (this current quarter) from 42 at the end of FQ3 and will account for ~8% of total sales by year end ($400mm+).
  • At the same time, China is closing in on $300mm in sales and store growth continues at a heated pace on a relatively low base of 85. The focus here is increasingly on Tier 2 and Tier 3 cities to capitalize on the growing middle-class shopper that tend to shop at home versus overseas. Combined, these two initiatives will account for nearly half of COH’s top-line growth this year and then again roughly next year. As such, slowing demand in China increases the likelihood of more meaningful top-line deceleration. 

  • NA comps came in slightly better than expected in Q3 (6.7% vs. 6.2%E), but decelerated on both a 1yr and 2yr basis sequentially despite easier yy compares and strength in both e-commerce and men’s suggesting a more meaningful deceleration in the core women’s business.
  • Sales at U.S. department stores slowed and actually declined perhaps reflecting a heightened competitive environment. To keep this in perspective, COH’s exposure to the wholesale channel is well below its competitors at ~13%, but it suggests that perhaps department stores have more options (i.e. brands) available to choose from and so do consumers. We’re less concerned about the impact on Indirect sales than the pressure on COH’s retail store base from more aggressive brands like KORS, Kate Spade, and Tory Burch. This is will require COH to step up spending to defend its share in a way that it isn’t accustomed to marking an important shift in the domestic competitive landscape.
  • In addition, management dialed back its expectations for square footage growth in Japan (~18% of total sales) down 5% to +10% for F12 shaving roughly 1pt of top-line growth over the next 12-months. We think these factors combined will result in a deceleration in top-line growth over the next two years down from 15%+ last year and we expect again this year to 12.5% and 11% in F13 and F14 respectively.
  • The sales/inventory spread eroded 3pts sequentially to -5% with inventory growth up +21% in Q3. We’re willing to chalk some of this growth to new store inventory and buying in APac businesses and related inventories, but this is gross margin bearish if sales decelerate faster than expected.
  • This is particularly notable in light of gross margins rebounding up +100bps to 73.8% in Q3 after dipping below 72% in Q4/Q1. The elimination of in-store couponing as well as increasing international mix should be an intermediate-term tailwind though we expect the mix contribution to be more modest than originally expected with Asia slowing on the margin.

COH: Trade Idea Alert         - coh ttt



You Just Can’t WYNN

Wynn Resorts (WYNN) reported their second quarter earnings last night much to the chagrin of investors. It was a mess. Truly abysmal. Essentially, the company missed guidance and consensus estimates across the board. Things do not bode well for the company going forward. We would sit back on the sidelines and wait. Here’s why:


-Even taking into account Wynn’s poor luck at the tables, their results would have still missed consensus estimate. That said, investors were expecting a miss, so we’re not surprised that the stock is having a small relief rally. Also helps that the market is up today.


-Given the challenging fundamentals ahead in Macau for Wynn (ie more competition with Sands Cotai Central’s full opening,  anticipation for further slowdown in VIP, China Macro headwinds),  lackluster data coming out of Vegas, and the Okada overhang; we would take profits here.


You Just Can’t WYNN  - wynn compare

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On the surface, it may seem like a negative but gaming operators can reduce supply


  • Given demand trends, it shouldn’t be surprising that operators are reducing the number of slots on their floors
  • Rationalizing the slot floor cuts costs and improves yields
  • We would expect this trend to continue with more competition from new gaming states



To Hedge, Or Not To Hedge, That Is the Question: SP500 Levels, Refreshed

POSITIONS: Long US Dollar (UUP), Short Industrials (XLI), Energy (XLE), and German Bunds (BUNL)


Keith is out in California meeting with some of our larger west coast based subscribers, but managed to find a few minutes to sneak into Starbucks and short the SP500 in the Virtual Portfolio.   We’ve been waiting and watching on a price, and our risk management models gave us the signal today.  So, regardless of your strategy, we see this as an opportunity to hedge and reduce exposure.


As of 2:15pm today, the SP500 was up 0.63% to 1,372.  Akin to many of the equity market rallies we’ve seen over the past three years, the rally over the last week from the 1,327 level on July 12th was characterized by light volume.   The other important factor in our quantitative models is volatility.


The VIX, a measure of SP500 volatility, is down almost 3% on the day to 16.00. Over the past three years, a VIX level of 15ish has pretty consistently signaled a near term bottom in U.S. equities.  We’ve highlighted this in the chart below.


To Hedge, Or Not To Hedge, That Is the Question: SP500 Levels, Refreshed - VIX


The primary fundamental catalyst over coming weeks is earnings season.  Currently, 73% of the 63 companies that have reported earnings in the SP500 have beat results.  Interestingly, according to analysis from Bloomberg, the entire SP500 is expected to report a -2.1% decline in earnings year-over-year this quarter.  It is difficult to make a case for equities when earnings are not growing.


The other key point related to corporate earnings is that downward revisions are a major headwind, especially into 2013.  Currently, SP500 EPS estimates for Q1 2013 and Q2 2013 are for 14% year-over-year growth in each quarter.  Those numbers are likely going a lot lower.



Daryl G. Jones

Director of Research



Several issues have us concerned despite our expectation for a decent quarter and guidance.



We expect IGT to report an in-line to slightly better quarter than the consensus of 29 cents.  In a sea of misses, a meet is not such a bad thing.  Guidance shouldn’t change much, also probably a positive on the margin.  We appreciate IGT’s cash flow generation and willingness to return cash to shareholders and the favorable long-term fundamental backdrop for the slot industry makes for a favorable long-term story – on the surface. 


On the other hand, IGT has also held in better than most of our names through the turbulence of the past 3 months.  Moreover, there are a few issues that concern us that could weigh on the stock.  Given the following issues – which probably haven’t been appropriately vetted by investors and analysts – we prefer to be on the sideline for now.

  • Industry replacements will likely fall in CYQ2 versus last year.  During the next two years new and expansions units (including Canada) should grow at a healthy clip and drive large YoY increases in total shipments.  However, replacements still make up the lion’s share of total NA shipments and it is disconcerting that after several years of growth, they appear to be stalling out at about 55,000 units/year.
  • We’re once again hearing that there is an ongoing brain drain at IGT.  When CEO Patti Hart joined the company in 2009, there was the expected changing of the guard.  We are now hearing – 3 years later - that there is more discontent and departures among key box and content developers.  The brain drain may have an impact on the next wave of developments down the road.  The wave of new openings and IGT’s share procurement in Canada may hide the impact for a while, but it raises an important red flag for long-term investors.
  • According to AppData, Double Down’s MAU looks like they’ve taken a breather since April and DAU’s also look flat QoQ at 1.4MM.  While DoubleDown is not going to make or break the quarter, it is a sore topic for many investors.  Therefore, disappointment in interactive may elicit an exaggerated response from the investor community, especially given that Patty has marketed this segment as a large source of growth for IGT.


F3Q Detail


We estimate that IGT will report $576MM of total revenue (2% ahead of consensus) and in-line adjusted EPS of $0.29.


Product sales of $264MM at a 53.7% gross margin

  • NA sales of $167MM and gross margin of $94MM
    • $105MM of NA box sales: 7,150 gaming machines at an ASP of $14.7k
      • 4,250 replacements and 2,900 new units, including shipments to:
        • 684 units to Scotia Down
        • 1,425 units to Cleveland and Toledo
        • Over 400 units to PNK’s Baton Rouge
      • ASP’s should be down sequentially due to mix and volume discounts on large orders which shipped this quarter
      • We expect margins to be down slightly on a QoQ basis to 56.4% from 57.1% in the March Q
    • Non box sales of $62MM
      • We expect a sequential uptick due to the Revel opening, for which IGT provided the system.
  • International sales of $97MM and gross margin of $48MM
    • $77MM of box sales: 4,500 units at an ASP of $17.1k
    • Non box sales of $20MM
    • 49% gross margins down from 50% in the March Q
  • Gaming operations revenue and gross margin of $312MM and $187MM, respectively
    • End of Period install base of 56,750
    • Core gaming operations revenue of $272MM, implying an average win per day of $53/day
      • Maryland Live Games came online but only for 23 days of the quarter
    • $40MM of interactive revenue
      • $29.6MM of DoubleDown revenue
      • $10.5MM of other interactive revenue
  • Other stuff:
    • SG&A: $101MM
    • R&D: $55MM
    • D&A: $19MM
    • Net interest expense: $20MM
    • 37% tax rate
    • Weighted average shares outstanding: 294MM

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