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WEN - Talking Up His Book

As Keith pointed out yesterday, Bill Ackman would be talking up his book at the Ira Sohn conference.

Well apparently he made some comments about WEN!

Bloomberg is reporting that William Ackman believes WEN is worth $42. The WEN board has already determined that company is only worth $27 and agreed to be acquired by TRY. If Ackman is right the Peltz mystique will only grow bigger.

Personally, I think $42 is a pipe dream....


GMCR - Keeping an EYE on GMCR

Senior management at GMCR believes that there is a true evolution underway in coffee making with Keurig holding the number one market share. The coffee evolution goes like this - first, there was percolated coffee, then there was drip, now there is single-cup brewing. How big is the market? Currently, there are 90 million U.S. households that have coffee makers and now they have the opportunity to buy a single-serve system. And the numbers are impressive. In 1Q08, at home brewer unit sales were up 144% and Green Mountain K-Cups were up 68% YoY, respectively. The best part of the story is that that the razor-razor blade model is in full force and the more machines in the marketplace, the more K-Cups will be sold.

If all this is true why are key executives leaving and other insiders selling record levels of stock?

  • ValuationAt 20x EV/EBITDA the current rate of growth needs to be maintained or there will be multiple compression quickly. The chart is from our friends at FactSet.
  • Gross margins - Selling more, but at lower GMsIn 1Q08, GMCR's gross margin declined 220 basis points. The decline is largely due to the increase in sales of Keurig at Home brewers and related K-Cups, which have lower gross margins than most of the other products. GMCR is also experiencing higher green coffee and other commodity costs, and higher manufacturing costs due to the continued capacity investments. None of these issues appear to be going away any time soon, if ever. Despite a severe drop in gross margins in 1Q08, GMCR operating margin improved to 9.6% from 8.5%. The improvement in EBIT margins was driven by the lower SG&A as a percent of sales. Again, I believe that this is a trend that can last only so long, considering the current growth rate of the business.
  • The profitability of the Blade...From a consumer's point of view, brewing a cup of coffee from a Keurig home brewing system is slightly more expensive than traditional brewing methods. Therefore, critical to the GMCR investment case is the profitability of the K-Cups. On the internet, we find Retail prices for K-Cups are around $0.55 per K-Cup. On the most recent conf call management did not argue against prices in the wholesale channel at $0.30, with a 20% contribution margin. That implies a $0.06 profit per K-Cup. For licensed roasters, GMCR raised the royalty rate to $0.064 per K-Cup. The conclusion we can draw from this, is that on the surface there does not appear to be enough margin in the K-Cups for the supply chain to make any money.
  • The current need for cash is growing.The current need for cash is growing.

DKS: Drink Facts, Not Cool Aid

Apologies in advance if this sounds self-promotional (it's usually not my style) but I've been convinced for a while that the bullish consensus on Dick's is dead-wrong. The market drank the cool-aid and ignored the facts -- that unsustainable comp and margin drivers were masking one of the most aggressive rent structures in retail. It's unfortunate that the market does not care about these things until management says so.

Even with today's guide-down and subsequent downgrades, I don't think people really get the real story here. With the stock going from $27 last night to $20 pre-market, and now to $23, it's clear that the market is scratching its head and trying to make sense of what to do here. While every fundamental story has its price, there's still plenty of risk not priced in here.

It's IMPERATIVE to take a bigger picture view on this name. It is really a question of 'Then' versus 'Now.'

THEN: Over the last three years, Dick's has been blessed with the following.
1) A rock solid consumer.
2) The Under Armour comp cycle, which disproportionately helped DKS.
3) An easy competitive landscape - as Sports Authority was taken private by Leonard Green and subsequently closed stores. Also, other Sporting Goods retailers (like Hibbett) were behaving nicely as it relates to store expansion.
4) DKS took up its high-margin private label business from less than 10% to a low/mid teens rate today.
5) Major vendors like Nike, Adidas, Columbia, Champion and Russell funded DKS' margins through significant discounts and flat-out price rebates in order to hold off share loss to Under Armour. This was funded largely through lower sourcing costs due to cheaper Asian imports.

While the business was rocking and rolling, no one on Wall Street cared that Dick's has among the most aggressive rent structures in all of retail. In other words, it is moving into locations that its profitability cannot afford relative to Kohl's, Bed Bath & Beyond, and Best Buy (examples of companies with whom it competes for retail space). As such, Dick's needed to promise higher rents in the outer years or sign less favorable terms to secure the locations. The strength in the business more than offset these higher costs, so Wall Street did not know (or care) about the risk. The stock was subsequently revalued from 8x up to 16x EBITDA.

NOW:
1) The consumer took a 180 turn and is on very shaky ground.
2) The Under Armour comp cycle is done like dinner. Still a great brand, and still growing nicely. But the days of 75%+ growth at DKS are long over.
3) Competitors are actually adding stores again, and are starting to step on each others' footprint (Sports Authority in Florida, Academy in Texas, and everyone in California).
4) Private label is close to tapped out without sacrificing margin.
5) I'm convinced that vendor terms will be less accommodating than in prior years bc a) UA growth is slowing and the need for competitive response is not as great, and b) there's no way that vendors can be as generous when they are being faced with 8-10% increase in their cost of goods sold. Let's not forget that 'Dick's Sporting Goods' is largely an apparel and footwear retailer. It is absolutely not immune to higher product costs. Check out recent postings on the topic.

So now we're looking at a situation whereby all the factors that hid high occupancy escalators are ebbing, and the real risk to the P&L is being exposed. Yes, the stock is more fairly valued today than 24 hrs ago. But 9x EBITDA and 16x earnings relative to the rest of retail? I don't get it - especially when DKS is just starting what is likely to be at least a 12 month downward P&L trajectory.

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 80.28%
  • SHORT SIGNALS 78.51%

SBUX - A Few Positive Data Points

Starbucks' announcement yesterday to acquire substantially all of the assets from Coffee Vision, Inc. and Coffee Vision Atlantic, Inc., its licensee in Quebec and Atlantic Canada and transition 40 licensed locations to company-operated locations fits into the company's plan to accelerate its international unit exposure. Along with the 40 stores, the company is gaining full development and operation rights for retail stores in these two provinces. Going forward, the company plans to open more stores internationally than in the U.S. (about 3,500 stores internationally versus less than 1,200 stores in the U.S. over the next three years). The company is guiding to $800 million in capital spending in FY09, which is line with what the company spent in the U.S. alone in FY07 (which was a huge problem from a ROIIC standpoint), so as more of the company's growth capital expenditures are allocated to its international business, we should see returns improve dramatically.

Also, insiders must see good value at these levels. I always view it as a positive when I see insiders buying stock because they are obviously closer to the story than I am. Yesterday, one of Starbucks' directors bought 2,300 shares at $17.26.

Boneparth Swapping JNY for KSS?

Tough to miss the form 4 out of Kohl's today noting that Peter Boneparth picked up 2,500 shares at $48 this week. My initial sense was that this was the token stock purchase to show support as a new Board member. After all, the net cost was $113k. That's a lot of dough to most of us little guys -- but keep in mind that Mr Boneparth was paid $16.7 million (per JNY's proxy) upon his termination from Jones Apparel Group in July 2007. By my math, we've seen a $1.9bn hit to shareholder value as the organization tried to patch itself up post his departure. That's $114 taken from shareholders' wallets for every dollar he made upon exit. I don't get it. Really, I don't.

What I do get is that Mr Boneparth is quite savvy. First a lawyer, then Private Equity investor, then apparel industry magnate. He's bought and sold stock well in the past.

Kohl's is two quarters from lapping tough sales compares and product misses, gross margin squeeze, and SG&A deleverage. Anyone reading my postings knows that I am an uber-bear on the supply chain squeeze coming down the pike. This should absolutely hurt KSS, but perhaps not til '09. Does he see something in the back half that we don't?

EAT - Getting It Right!

I wanted to contrast the direction Brinker is headed with the comments we made about CKR, JBX and SONC.

Brinker's management team has placed a big focus on what's happening within the four walls of each restaurant. In support of that effort, EAT has significantly reduced the number of domestic company-owned restaurant openings. In fiscal 2008, EAT is expected to open around 70 company-owned restaurants and only 15 or less in 2009 and 2010. The slowing of pace of development is driven by the need to improve returns from new units. In FY09 total capital spending will be approximately 185 million, or approximately 5% of sales.

It should be noted that capital spending as a % of sales for CKE, JBX and SONC is approximately 10%.

How much do you want to bet that EAT outperforms those names over the next two years?

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