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FTK: Under Pressure (On Margins)

For months we have been bearish on Flotek Industries (FTK). The case we’ve made is that large oilfield services (OFS) players have seen their revenue come under pressure from lower energy prices. When cost cutting measures come into play, chemical suppliers like Flotek will be the first to undergo price renegotiations, which in turn hits their margins.

 

Flotek reported its second quarter results today. It missed on the top line ($78MM vs. $81MM estimate) but beat on headline EPS ($0.25 vs. $0.22 consensus).  That headline number is noisy, skewed mostly by a change in the fair value of warrant liability. Operating income (does not include unusual items) was a big miss, which was largely ignored this morning.  Operating income came in at $15.6MM vs. $17.3MM expected.

 

 

FTK: Under Pressure (On Margins)  - FTK metricsmatter

 

 

Yet after reporting second quarter results, Flotek enjoyed a +15% pop in their stock. We were not short FTK in the Hedgeye Virtual Portfolio but after this pop, we will look to short again when price and timing line up accordingly. Hedgeye Energy Analyst Kevin Kaiser outlines his two-fold bearish thesis on FTK below:

 

1.            Top line growth is slowing faster-than-expected as drilling activity slows onshore North America;

2.            Gross margins would contract sequentially as pricing power slips and input costs remain sticky in the Company’s Chemical and Drilling business lines.

 

We were spot on for the first point, but the second point we missed. Apparently the Street is willing to take the company’s word on guidance for gross margins despite our case with regard to pressure on large OFS players like Haliburton (HAL) and Baker Hughes (BHI). We think that margin guidance + the high short interest (18%) is why the stock is so strong this morning.

 

In essence, this quarter is being spun very well by market participants. On our quantitative model, FTK has broken out above our TREND line of $10.82, so we will wait and watch here.


CRI: Turning Point

Conclusion: The strategic implications of this CRI deal with JCP are spot-on with what we think is a very underappreciated risk in retail. It may give CRI a near-term revenue lift due to channel-fill, but it is ill-equipped to manage undifferentiated product across channels with polarized price points. This will ultimately be its undoing.

 

We’ve been waiting for this announcement that Carter’s is opening a shop inside JC Penney. It makes perfect sense, actually, in the context of the store that JCP is trying to build. But while these ‘partnerships’ seem equal, the reality is that they’re not, and this one favors JCP by a country mile. Ultimately, we think that this will be CRI’s swan song.

Consider the following…

 

1)      JCP has a bidding process for all its shops. CRI no doubt went up against Gerber, Disney, Circo, Zutano (highest unit count on Amazon) and others for this business. It is definitely a sales/margin trade off. Note that VFC’s Lee recently lost out to Levi’s in JCP as it did not chase price. Good long term for VFC. Bad short term. CRI is the opposite.

 

2)      CRI’s challenge is that it puts similar product into every channel of distribution. Look inside Wal-Mart, Target, Macy’s, Amazon, and Kohl’s. They all have product that is remarkably similar. That’s fine when a brand is small, but as it grows up, it gets very dangerous.

 

3)      Oh and by the way, the same product is in Carter’s own stores, and on its web site, and it’s almost always 40-50% off.

 

4)      Look at what happened when Liz Claiborne launched Liz & Co inside none other than JC Penney 6 years back. The product looked very similar to what was selling at Macy’s, but at a lower price. It didn’t take Macy’s too long to cut Liz. The market’s reaction was not pretty – the stock went from $43 to $2.

 

5)      How does Carter’s in-store promotional strategy synch with Johnson’s ‘Every Day Low Price’ strategy? So if a product is $14.99 list in a Carter’s store, it will be knocked down to $8.99 on day 1. On average, the whole lot will clear at about $6.00. If Johnson holds true to his Plan, then he’s going out with an initial price in the $6 range. How will Macy’s feel about that when they’re selling the same thing down the hall for $10? Wal-Mart at $9?   

 

6)      CRI is setting up this deal with its largest customer’s top competitor – KSS. Let’s think of how that discussion went for the CRI sales rep to Kohl’s. “Hey…Just want to let you know that we’re starting a program with JC Penney to do exclusive shops with product that is at least as good as what we’re selling to you, but will be listed at a 30% discount. You cool with that? Good. Nice knowing you.”

 

7)      CRI does not need to disclose how big Kohl’s is as a customer, because the reality is that as a percent of aggregate sales no one is within a stone’s throw of 10%. But that’s bc CRI’s own retail business accounts for about 55% of sales versus only 29% for Carter’s wholesale. But that’s comparing apples and oranges. We need to either gross up wholesale, or take down retail for an even comparison. Either way, looking at EBIT is a fair comparison. In the regard, both Carters US brand wholesale and retail each account for about 45-47% of EBIT. International accounts for the rest, more than making up for Osh Kosh, which is perennially in the red. KSS might only account for 3-4% of CRI’s total sales, but it is closer to 6-7% of profits.

 

8)      This is not just about KSS. There are going to be so many moving parts across retail in 2H. Heck, there already are. That will intensify. The dominoes that fall in footwear, housewears, underwear, fragrances, etc…will cause reverberations that are impossible to predict. For example, JC Penney’s Tourneu shop could take share from Macy’s on the margin at ridiculously low prices. Macy’s might not strike back in the jewelry category, but rather in its terms or pricing with Outerwear vendors like Columbia, Underwear like Hanesbrands, or moderate ends of the portfolio of apparel/footwear from companies like Jones Group. The cross-currents here will be fierce, and we have yet to gain conviction that anyone is really prepared for it.

 

Growth has come from Playwear. That’s less defendable than the core baby biz (i.e. Competes w/Old Navy)

CRI: Turning Point - category

 

Can’t look at the wholesale/retail split by revenue, as it grossly understates the importance of the wholesale business.

CRI: Turning Point - revebit

 

Company-Operated retail stores and mass retailers have grown in importance

CRI: Turning Point - channel


CHART DU JOUR: IT’S ALL ABOUT SLOT VOLUME

We’ve always believed that slot volume is the ultimate indicator of a Vegas recovery

 

  • Our predictive model has been proven effective in projecting monthly slot volume on the Strip as indicated by the high correlation between the red and blue lines
  • MGM is as close to a Strip pure play as there is and its stock has closely tracked changes in slot volumes on the Strip
  • We’re not optimistic about slot trends over the near term and maintain that Vegas may be in a secular slot decline due to poor demographics and an aging core slot customer base

 

CHART DU JOUR: IT’S ALL ABOUT SLOT VOLUME - strip2


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.33%
  • SHORT SIGNALS 78.51%

OH SNAP: Have Food Stamps Hit Peak Enrollment?

We’ve analyzed the latest data for the Supplemental Nutritional Assistance Program (SNAP), better known as food stamps. Since President Obama took office in 2008, the participation has shot up drastically over the last four years. Currently, about 15% of the nation or about 46 million people are enrolled in the SNAP program.  

 

The year-over-year growth rate is actually declining at an accelerated rate. At the current trajectory, it should go negative by October. While a positive for the American taxpayer, dollar stores like Family Dollar (FDO) and Dollar General (DG) are going to feel the pressure as more people wean themselves off food stamps. Over the last five years, the growth in the SNAP program has been a positive for dollar stores, driving new business. All good things come to an end, though. Keep an eye on names like FDO and DG as the SNAP participation rate drops.

 

 

OH SNAP: Have Food Stamps Hit Peak Enrollment?  - SNAP Aug


Short Selling Opportunity: SP500 Levels, Refreshed

POSITIONS: Short Industrials (XLI) and SPY

 

Since February 15th, 2012 this is the 9th time I have issued a Short Selling Opportunity note. Maybe this will be the 1st time out of 9 that I am wrong. Maybe not. That’s the game. You either buy or sell here. You don’t hide from accountability.

 

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

  1. Immediate-term TRADE resistance = 1405 (lower highs)
  2. Immediate-term TRADE support = 1388 

Every time I do this, I feel like I have to re-live the last 5 years. It’s weird. People are pressured to buy high and sell low, I guess.

 

Given the fundamental growth picture in the world, this one looks as clear to me as the other 8 shots were.

 

As Gretzky said, you’ll miss 100% of the shots you don’t take.

 

KM

 

Keith R. McCullough
Chief Executive Officer

 

Short Selling Opportunity: SP500 Levels, Refreshed - 1


HedgeyeRetail Visual: SNAP/FDO Update

 

Latest data shows modest uptick in the percent of Americans benefitting from food stamps (otherwise known as SNAP – Supplemental Nutritional Assistance Program) to about 15%. Don’t be fooled. The year/year growth rate is actually declining at an accelerated rate. At the current trajectory, it should go negative by October.


We think that growing SNAP participation has been a significant tailwind for dollar stores over the last 5-years. The absence of which we think is something that will temper their top-line growth rate on the margin. We remain bearish on FDO.  

 

HedgeyeRetail Visual: SNAP/FDO Update       - SNAP

 



 

 


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