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Trading Off Inventories for Margins

This note was originally published November 15, 2012 at 14:28 in Retail


Apparel retailers are reverting to a margin mean this quarter to an extent that we have not seen in years. As our SIGMA analysis shows, we’re seeing margins revert to zero barrier for many of the larger players oferall, with resulting in flex in the level of inventory relative to sales. The ups the ante for the level of sell-through that is necessary headed into the holiday season.


Our SIGMA charts below will look familiar to most, but for those new to this representation of fundamentals it triangulates the sales/inventory spread (i.e. sales growth minus inventory growth) on the x-axis as well as the year-over-year change in operating margin on the y-axis. Company’s want to be in the upper right (sales outpacing inventory growth with expanding margins) not the bottom right though directional moves within the same quadrant are often more important indicators for future outcomes and when stocks often have the most meaningful moves.


Consider the following:

  1. Mid-tier companies are at a collective inflection point re margins headed into 4Q. In fact, with all but JCP posting less than a +/- 40bps delta, variation in the yy change in margins is the tightest we’ve seen in over 4-years suggesting the likelihood for increased EPS volatility this holiday season particularly in light of top-line compression, or margin give up to support the sales gain.
  2. Our thesis on GPS and M is that the second JCP stops hemorrhaging sales at its current run-rate, it will put incremental pressure on these companies that have been gaining share. If JCP fails to recover – ever (which we think is unlikely) – then that’s bullish for M and GPS. We think in 1-2 quarters JCP’s delta will improve on the margin, and while still bad for JCP, will hurt its peers.

In light of this setup within this mid-tier(ish) space, we like M, GPS, and KSS (post 4Q) on the short-side and WMT long. In other segments of retail, we continue to favor the athletic space (NKE, FINL, FL) as it has such a positive tailwind in the form of a company R&D driven product and marketing cycle.


Trading Off Inventories for Margins - MidTier EPS Surprise History

 

Trading Off Inventories for Margins - MidTier SIGMAs

 

Trading Off Inventories for Margins - MidTier wJCP SIGMAs

 


 

 


Trading Off Inventories for Margins

Apparel retailers are reverting to a margin mean this quarter to an extent that we have not seen in years. As our SIGMA analysis shows, we’re seeing margins revert to zero barrier for many of the larger players oferall, with resulting in flex in the level of inventory relative to sales. The ups the ante for the level of sell-through that is necessary headed into the holiday season.


Our SIGMA charts below will look familiar to most, but for those new to this representation of fundamentals it triangulates the sales/inventory spread (i.e. sales growth minus inventory growth) on the x-axis as well as the year-over-year change in operating margin on the y-axis. Company’s want to be in the upper right (sales outpacing inventory growth with expanding margins) not the bottom right though directional moves within the same quadrant are often more important indicators for future outcomes and when stocks often have the most meaningful moves.


Consider the following:

  1. Mid-tier companies are at a collective inflection point re margins headed into 4Q. In fact, with all but JCP posting less than a +/- 40bps delta, variation in the yy change in margins is the tightest we’ve seen in over 4-years suggesting the likelihood for increased EPS volatility this holiday season particularly in light of top-line compression, or margin give up to support the sales gain.
  2. Our thesis on GPS and M is that the second JCP stops hemorrhaging sales at its current run-rate, it will put incremental pressure on these companies that have been gaining share. If JCP fails to recover – ever (which we think is unlikely) – then that’s bullish for M and GPS. We think in 1-2 quarters JCP’s delta will improve on the margin, and while still bad for JCP, will hurt its peers.

In light of this setup within this mid-tier(ish) space, we like M, GPS, and KSS (post 4Q) on the short-side and WMT long. In other segments of retail, we continue to favor the athletic space (NKE, FINL, FL) as it has such a positive tailwind in the form of a company R&D driven product and marketing cycle.


Trading Off Inventories for Margins - MidTier EPS Surprise History

 

Trading Off Inventories for Margins - MidTier SIGMAs

 

Trading Off Inventories for Margins - MidTier wJCP SIGMAs

 


 

 


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WMT: Idea Alert. Buying Again.

Takeaway: $WMT's inquiry into the FCPA will cost money, but not the ~$9billion in market cap WMT lost today.

We’re adding WMT back to the long side of our portfolio on today’s selloff.  The print was in-line with our view for a tepid top line, but SG&A and below-the-line items making up for the difference. But to suggest that the stock is trading off 4% because of a perceived weak earnings quality is just plain silly. The 8-K added that “Inquiries or investigations regarding allegations of potential F.C.P.A. violations have been commenced in a number of foreign markets where we operate, including but not limited to Brazil, China and India.”

 

That’s bad enough news to anyone who knows the story, but it sounds a heck of a lot worse when you read out the acronym FCPA – Foreign Corrupt Practices Act.  Not exactly a confidence-inspiring ring to it.

 

All that said, the company will spend money on these inquiries. Millions…tens of millions. Maybe even a hundred+. But the risk of WMT realizing that it has to pull out of a country or severely limit growth outside the US is not in the realm of what we think is realistic. Today alone, the market dinged WMT’s market value by ~$9billion, and pushed the stock within $2 of its long term TAIL support of $66.12.

 

Downside here is minimal, concerns will blow over, and there’s a big call option on WMT if oil rolls. 

 

WMT: Idea Alert. Buying Again. - WMT TTT

 

Call it financial engineering, and better tax planning. We'll call it better better relative EPS growth on a big liquid name.

 

WMT: Idea Alert. Buying Again. - 22


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INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA

Takeaway: Comparing Hurricanes Sandy and Katrina, their impact was similar on jobless claims. We'll know more once the State-level data is released.

This note was originally published November 15, 2012 at 09:48 in Financials

Hurricane Comparisons

Remain calm. In the chart below we profile the trend in initial jobless claims following hurricanes Katrina and Sandy. If, in fact, this week's enormous surge in initial claims is attributable to Sandy, then we can reasonably expect to see it mean revert along a similar path that we saw following Katrina. That said, it took 8 weeks for Katrina to fully renormalize. 

 

There is in fact a way in which we can test the government claim that the rise in claims is attributable to Sandy. The government releases state-level NSA claims. Total NSA claims rose 104k WoW. We would expect to see a preponderance of that increase represented by New Jersey, New York and other hard-hit East coast states. Unfortunately, the state level data is not yet available on the Labor Dept website. Stay tuned.

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - sandy vs katrina

 

 

Initial Jobless Claims: The Data

Initial claims rose 84k last week to 439k (an increase of 78k after a 6k upward revision to last week's data). The rolling claims series rose 11.75k WoW to 384k. On a non-seasonally adjusted basis claims rose 104k to 466k. The year-over-year rolling NSA change made a dramatic jump to ~0% improvement. Last week the YoY rolling NSA change was -6.5%. 

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - Seasonality

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - rolling claims NSA YoY data

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - Raw

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - Rolling

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - NSA

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - Rolling NSA

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - SPX

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - Fed

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - NSA YoY

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - Recessions

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - Claims Linear

 

 

Yield Spreads

The 2-10 spread fell 3 bps WoW to 133 bps. So far 4QTD, the 2-10 spread is averaging 1.43%, which is up 6 bps relative to 3Q12.  

 

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - 2 10 spread

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - 2 10 QoQ

 

Financial Subsector Performance

The table below shows the stock performance of each Financial subsector over multiple durations.  

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - Subsector performance

 

INITIAL JOBLESS CLAIMS: SANDY vs. KATRINA - Companies

 

Joshua Steiner, CFA

203-562-6500

jsteiner@hedgeye.com

 

Robert Belsky

203-562-6500

rbelsky@hedgeye.com

 


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