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WWW: Opportunity Knocking


We've been working more and more on WWW since the PSS acquisition, and while today's pre announcement by no means is positive, it does not change the underlying reason why we've been warming up to it. It draws attention to risks in Europe, which we probably under appreciated. But we're seeing downward revisions in next year's EPS below a level we think the company will earn.

 

Consider the following:

  • WWW’s European business has been a drag on performance for several quarters now and continues to be. Underestimating this headwind has been a big miss by management and has lead to earnings disappointments in each of the last two quarters for the first time in over 4-years. WWW is not alone as the rest of retail has suffered a similar plight. While this underperformance is not new news, continued weakness is coming in below expectations and that’s not good for near-term results – we get that.
  • It’s worth noting, however, that EMEA was already running down double-digit in Q2 so it’s not clear yet if there’s incremental weakness, or simply a delay in sales reaccelerating. We expect the company to elaborate on this later today.
  • EMEA accounts for ~25% of revenues and a similar if not slightly greater portion of WWW’s earnings. Relative to our expectation for Q3 EMEA sales to reflect improvement coming in down –HSD, this update impacts revenues by an incremental $6-$10mm in the quarter and $0.15 in EPS for the year. At historical multiples (~14x EPS), we’d expect this to impact the value of the stock by ~$2/share near-term.
  • Furthermore, once the PLG deal closes (early Oct), EMEA will account for closer to 15% of revenues. With less than 10% of the PLG business coming out of Europe, we expect distribution expansion alone to reaccelerate sales in Europe.  
  • Outside of Europe, the base business is positive and improving with U.S. wholesale and retail both posting positive quarter-to-date performance. In addition, revenue compares getting increasingly more favorable over the next three quarters as the company laps slower European demand and the timing of military orders in 1H.
  • The margin setup also gets more favorable ahead. WWW took it’s medicine last quarter clearing excess fall/winter product. While this accounted for a -200bps gross margin hit, it also resulted in WWW’s sales/inventory
    spread turning positive for the first time in 10 quarters – very positive for gross margins headed into 2H.

Continued weakness overseas begs the question regarding the timing of the PLG deal to be completed in early October. While it will likely tarnish the timing suggesting an offset to what might be an eroding base business, we expect WWW’s base business to stabilize near-term and continue to post top and bottom-line growth in the single-digits and double-digits respectively.


More importantly, the positive impact of the PLG acquisition on NewCo is still largely underappreciated and outweighs this latest delta. While the company continues to guide to $0.25-$0.40 and $0.50-$0.70 in EPS accretion, we expect closer to $0.50 and $1.00 in F13 and F14.


To be clear, this incremental weakness out of Europe is unfavorable on the margin, but is not material enough for us to alter the positive outlook we have on the intermediate-to-longer term upside in earnings. We’re shaking out at $3.45 and $4.30 in EPS for FY13 and FY14 well above consensus, which still does not fully reflect the pending acquisition. All things considered, we’d be buyers on weakness this morning.

 

 

 WWW: Opportunity Knocking - WWW S

 

 


Draghi’s Newest Rescue Plan Revealed in September ECB Presser

Takeaway: the ECB’s sovereign bond buying resumes but it is far from the elixir to cure Europe’s ills in one shot. Growth will remain under pressure.

Positions in Europe: Long German Bonds (BUNL); Short EUR/USD (FXE); Short Greece (GREK)

 

Central Bankers of the World Unite!

 

Today ECB President Mario Draghi issued much of what was leaked in recent days – the newly invented Outright Monetary Transactions (OMTs) program. It will buy bonds on the secondary market of Eurozone member states, targeting bonds with maturities of 1-3 years. Draghi stated the program’s goal as: “OMTs will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro.”

 

Draghi shied away from calling the scope of purchases unlimited, instead he stated that the buying size will be adequate to reach objectives and provide “a full and effective backstop that removes tail risk from the Euro area.” Draghi stated that OMTs buying will be fully sterilized (as to not influence money supply growth); will cover any country to the extent it is warranted (and/or request) with strict conditionality (including the adherence of ongoing fiscal consolidation programs); and that these bonds do not carry a senior creditor status. Of note that is that the Securities Market Program (SMP) will be terminated as of today.

 

Our skepticism runs high that such market intervention would end favorably for the region or that Draghi can truly remove tail risk from the region, however we expect a significant bounce across European capital markets and the common currency in response to the changing of the goal posts. This is very apparent today, but is it sustainable? Certainly Draghi is out to prove that he can maintain price stability and preserve the common currency – “full stop”.

 

Concerns with the OMTs:

  • While buying on the shorter end of the curve may suppress yields on short-term maturities, what will prevent the longer end from running away?
  • How will the ECB decide on the size of its purchases?
  • Could this OMTs intervention be complicated by the German Constitutional Court decision on 9/12 regarding the ESM?
  • How does Bundesbank President Jens Weidmann, who was the one voice of dissent in today’s decision, complicate the Eurozone’s united policy voice?
  • How impactful can this program be – similar to the SMP – until the Eurozone has a structured Fiscal Union?

 

Interest Rates on Hold

 

Regarding the policy decision, the council decided that the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.75%, 1.50% and 0.00% respectively, which was in line with our forecast.

 

Interestingly, growth targets were revised down (versus the staff projection from June) as inflation projections were revised up. Again, this represents our fundamental case that despite all the market intervention, prices will (in time) reflect the underlying health (or lack thereof) in the region.

 

GDP growth:

-0.6% and -0.2% for 2012 (versus -0.5% and 0.3%)

-0.4% and 1.4% for 2013 (versus 0.0% and 2.0%)

 

HICP inflation:

 2.4% and 2.6% for 2012 (versus 2.3% and 2.5%)

 1.3% and 2.5% for 2013 (versus 1.0% and 2.2%)

 

For Draghi’s complete Introductory Statement click here.

For the press release of the Technical features of the OMTs click here.

For the press release of Collateral requirements click here.

 

Draghi’s Newest Rescue Plan Revealed in September ECB Presser - 2222. eur

 

Matthew Hedrick

Senior Analyst


SNAP: Food Stamp Participation Decelerates

Takeaway: Dollar stores like $FDO and $DG rely on customers using food stamps to boost revenue. Fewer people on food stamps is a negative for them.

One of the most unique metrics out there is the Supplemental Nutrition Assistance Program (SNAP) participation rate. SNAP is a fancy term for food stamps and the rates had peaked a few months ago with nearly 15% of the country enrolled in SNAP. The latest stats dropped yesterday and participation growth is continuing to decelerate.

 

One sector that relies on a high SNAP participation rate is dollar stores. Think about it: dollar stores are basically taking in a boatload of federal cash as people on food stamps hit up Dollar General (DG) and Family Dollar (FDO) for their milk, bread, beans and other necessities. It’s been a boon for dollar stores, helping to drive comps, sales and traffic. If the SNAP participation rate continues to decline at an accelerating rate, dollar stores will likely see a decline in the aforementioned metrics unless they can make up for the lost SNAP customers.

 

 

SNAP: Food Stamp Participation Decelerates - SNAPrates

 


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Unlimited Possibilities

UNLIMITED POSSIBILITIES

 

 

CLIENT TALKING POINTS

 

UNLIMITED POSSIBILITIES

Central planners around the world are a force like no other. The amount of power they have and how quickly they can use it (intentionally or unintentionally) is astounding. So it should come as no surprise that this morning, Super Mario Draghi came out and basically said “let’s rock!” The plan is that the ECB will begin an “unlimited” bond buying program. Never mind the 8 to 10 handles the S&P 500 futures ripped before the open; slowing growth on a global scale seems to be what everyone is looking for these days. Whatever it takes, right?

 

 

SHORTING GOLD

With the central planner cartel getting ready to do some serious bond buying and undertake equally bodacious easing measures, the focus has now turned to gold for many investors. Drive down the US dollar, gold goes up and vice versa. Makes sense as we believe growth is slowing and will continue to do so for some time unfortunately. Here’s Keith’s thesis, word for word, on why he’s short gold even with this morning’s massive rip to the upside:

 

“I’m short Gold here. On balance, until turning bearish on Gold in Q1 of 2012, I have been a Gold bull since 2003. I have #timestamped 35 long/short positions in the GLD since founding the firm in 2008 (been right 30x). 

 

The more wrong I am on Gold (from here), the more right I’ll be on #GrowthSlowing.”

 

 

MANAGE THE RISK AND THE RANGE

You’ve probably heard this one before but we’ll continue to repeat it with no end in sight. It’s simple. You need to manage the risk and the range for any trade. If you are trading the S&P 500 and you know resistance is t 1407 and support is at 1398, well then you’re going to trade within that range and any deviation outside that range will make for a big move. Risk is simple. Too much is a bad thing, too little not a good thing. Get it together and figure out a risk level you’re comfortable with.

 

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ASSET ALLOCATION

 

Cash:                  UP

 

U.S. Equities:   DOWN

 

Int'l Equities:   DOWN   

 

Commodities: Flat

 

Fixed Income:  Flat

 

Int'l Currencies: Flat  

 

 

_______________________________________________________

 

TOP LONG IDEAS

 

NIKE INC (NKE)

Nike’s challenges are well-telegraphed. But the reality is that its top line is extremely strong, and the Olympics has just given Nike all the ammo it needs to marry product with marketing and grow in the 10% range for the next 2 years. With margin pressures easing, and Cole Haan and Umbro soon to be divested, the model is getting more focused and profitable.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG            

 

PACCAR (PCAR)

Emissions regulations in the US focusing on greenhouse gases should end the disruptive pre-buy cycle and allow PCAR to improve margins. Improved capacity utilization, truck fleet aging, and less volatile used truck prices all should support higher long-run profitability. In the near-term, Paccar may benefit from engine certification issues at Navistar, allowing it to gain market share. Longer-term, Paccar enjos a strong position in a structurally advantaged industry and an attractive valuation.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG

 

LAS VEGAS SANDS (LVS)

LVS finally reached and has maintained its 20% Macau gaming share, thanks to Sands Cotai Central (SCC). With SCC continuing to ramp up, we expect that level to hold and maybe, even improve. Macau sentiment has reached a yearly low but we see improvement ahead.

  • TRADE:  LONG
  • TREND:  NEUTRAL
  • TAIL:      NEUTRAL

  

_______________________________________________________

 

THREE FOR THE ROAD

 

TWEET OF THE DAY

“How one economist created the most realistic fantasy football league ever theatln.tc/PIwXtO” -@TheAtlantic

 

 

QUOTE OF THE DAY

“Conscience is the inner voice that warns us somebody may be looking.” –H.L. Mencken

                       

 

STAT OF THE DAY

Samsung’s Galaxy S III smartphone usurped Apple’s iPhone 4S as the top selling smartphone in the US for the month of August. That is expected to be short-lived with Apple announcing its next-gen iPhone on September 12.


MACAU: THE SSE MATTERS

Takeaway: Maybe less so over the near-term, but the performance of the China stock market impacts Macau gaming revenues.

Our statistical analysis has found that Mass gaming revenues and VIP volumes lag the Shanghai Stock Index (SSE) by 4 and 3 months, respectively.  That is, the YoY change in Chinese stocks is a statistically significant driver of the YoY change in Macau gaming revenues (GGR), albeit on a lag.  The upshot here is that while we still believe we are above consensus expectations for the rest of the year, based on the recent performance of the SSE, there could be 1-3% downside to our monthly YoY GGR projections. 

 

MACAU: THE SSE MATTERS - SSE1  

 

We’ve seen and authored studies in the past that showed no correlation between the Shanghai Composite and Macau gaming revenues (GGR).  An astute client of ours recently suggested that Macau could follow the same pattern as a number of US-based industrial companies that saw their China business lag the Chinese stock market.  The theory is that the SSE is a discounting mechanism that leads China's economy up or down which in turn contributes to or detracts from gaming revenues in Macau.

 

The good news is that July was such a poor month and the stocks have already taken a beating.  Moreover, when we plug the SSE impact into our model, it only reduces YoY growth by 1-3% depending on the month, as can be seen in the chart below.  However, we would be concerned if the SSE continues to fall.  Our near-term outlook (Trade) for Macau stocks is favorable, particularly LVS, but if the SSE falls further, that would bring some uncertainty into the intermediate or Trend call.  Our long term (Tail) view remains positive.

 

MACAU: THE SSE MATTERS - sse2


LULU: Math Matters

Takeaway: It’s critical to delineate between the brand, company and stock for a name like $LULU, which has great returns, but eroding oper metrics.

Conclusion: Let’s remove the emotion and look at the raw math behind one of the most perennially loved names in retail. It’s critical to draw delineation between the Brand, the company and the stock. We'd avoid it.

 

 

It’s so easy to like LULU.

But we have to draw a massive delineation between…a) Lululemon the Brand, b) Lululemon Athletica the company, and c) LULU the stock. The first one is great. The second is good. And the third is below-average at best.

 

The Long term/TAIL, growth is there for this company if it properly allocates capital into fulfilling the Brand opportunity. This is a mere $1.2bn brand (closer to $600-700mm wholesale equivalent in comparing to the NKEs and UAs of the world), and there’s no reason why it can’t get to $3-$4bn over 5-years if it continues to execute. The key here is that if you look at share of the Yoga market, and what those revenue numbers suggest, it implies that LULU will own over 100% of the Yoga space. Clearly that’s not possible. But when you look at great brands in the past, they have continually proved investors wrong by creating new spaces and filling them with product ideas that most folks like you and I cannot even foresee. LULU is one of those companies.

 

BUT…And it’s a big ‘but’. When we remove all the emotion around the cult stock status it’s been awarded and simply look at the math, we can’t get our hands around the eroding productivity of existing assets.

 

By all means, we give LULU the credit it deserves for 100%+ returns on capital. But this is by way of churning out 7x+ asset turns on 25%+ EBIT margins. Maybe one of these factors is sustainable. But if LULU sustains both – as it is priced to do – then it will be the first company in recent memory to do so, aside from Apple. Sustaining both would suggest that there is something so special about it that it is massively undervalued even at current levels. So the simple question is really – “Is LULU = AAPL?” As great as it is, we’d give that one a definitive ‘No’.

 

While we’re believers in the concept and the brand, we can’t make the leap to assume that it can prevent a continued rollover in new store productivity. And in fact, we’re surprised that more attention has not been paid to the issue.

Here’s some geeky math on our thought process around the different between reported comps and the change in total sales/square foot. …

 

Let’s assume that…

1) total store sales yy chg = (chg in comp store sales growth/square foot + new store sales/square foot) + (yy chg in comp store size + chg in new store size).


2) Therefore yty % chg comp sales = (chg in all stores revenue/sq' - chg in new stores revenue/sq') + (change in all stores size - change in new stores size). Of course, the figures within the parens must be weighted by the number of stores.


3) If store size is basically unchanged then comp growth and the YTY % chg in sales/sq' in comparable stores should be the same.  in other words, comp growth = revenue/sq' growth in comp stores, when store size is unchanged.

4) therefore the difference between reported comp growth in each quarter and the YTY chg in all store sales/sq' in the same quarter will be the YTY % change in sales/sq' at new stores.  Again, in mathematical formula form:

comp stores sales growth - yty chg in all stores revenue/sq' = yty change in new stores revenue/sq' (again weighted by the number of new and comp stores)

5) But backing this number out, yields increasingly negative growth rates in new store revenue/sq', so what are we missing?

Using 1Q12 as an example:

comp growth (GAAP): 24%

YTY chg average sales/sq in all stores: 11%

YTY % chg in average store size: 1%

Residual: 12%

number of non comp stores: 42
number of total stores at qtr end: 180

so...

  11%=(138/180) x 24% + (yty chg in new store revenue/sq' x (42/180))

11%= 18.4% + (.223 x yty chg in new store revenue/sq')
(11%-18.4%)/.223 = yty chg in new store sales/sq'
-31.7% = yty chg in new store sales/sq'

 

In looking at these numbers on the heels of implied new store productivity going from 175% in 2010, to 95%in 2011, and then down another 30% in 1Q12, we think that we’re going to need to see a massive ramp in comp in order to offset this trend.

 

Maybe what we’re missing is the impact of dot.com, and the quirky accounting therein. Regardless, we’re going to point back to the simple ROIC calculation. Can the dot.com business grow faster than productivity at existing stores will erode? We’re not so sure. If that’s the case, then either asset turns or margins are coming down. That means that ROIC comes down. That means that a 30x+ p/e multiple matters again.

 

Will all of this come out with tomorrow’s print? Maybe. Maybe not. But we definitely would not touch the stock in advance of the quarter.The downside if this trend perpetuates is far worse than the upside would be if it reverses.

 

If I gave Keith the fundamental OK, he’d likely short this stock in a heartbeat.


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