More Capacity Comes Out of Home Furnishings Industry
thought of dot.com as both a big risk and a big opportunity for the likes of
Bed, Bath and Beyond. On one hand, virtually every item at a home goods store
can be purchased online with little to no risk of getting the wrong size. In
contrast, an apparel company can do dot.com to a lesser degree as there is
some, but not massive, variability in sizing. At the extreme is footwear, where
one SKU x 3 colors x 28 different sizes = massive complexity. This gives BBBY
an edge vs. these other categories.
But within the
home goods category the edge is less clear. Specifically, the barriers to entry
are extremely low, as just about everything at a Bed Bath can otherwise be
ordered at any of hundreds of sites, and shoppers can price shop using shopping
bots. The key here for BBBY is to exploit its leverage and be sharp on price
points while upselling the consumer on impulse-purchase items.
This is working to
a degree, as Home Décor Products Inc, an on-line retailer and operator of nine
sites that sell home furnishings, ceased operations. The company is one of the
largest online home products retailers ranking number 143 in the Internet
Retailer Top 500 Guide and generated sales just shy of $100mm. This is only a
drop in the bucket to BBBY (BBBY’s revs are $7.2bn in a $110bn category), but
it is still capacity removed from the industry.On the margin, a good thing for BBBY.
Chart Of The Week: Queen Mary, Pray For Us!
This past December one of the Investment Themes that I outlined for the 2nd half of 2009 was “The Queen Mary Turning”…
My macro “call” for 2009 has had 2 parts – with two different durations:
1. Re-flation = 1H09’ (vs. Q408 prices) 2. Increasing Cost Capital = 2H09’ (on an absolute basis)
The first part of this call has to play out in order for the second part to – that’s why I made it a two part call. With the price of oil up for the last 6 weeks, consecutively, taking it +42% over that time period and +15% for 2009 YTD, we are already getting what we were looking for.
Obviously copper prices being +25% for 2009 to-date supports the same. As does the SP500 trading +8% so far for March to-date, reflating +5% from the November 20th low, and +18% from the March 9th low.
A lot of market pundits confuse the terms reflation and inflation – they are not the same thing. Reflation can occur on a day-over-day and/or a month-over-month basis. All reflation means is a sequential acceleration in the price of whatever you are measuring. I measure inflation on a year-over-year price change basis.
Issuing massive liquidity like the US Government has, in the end, will be inflationary. In between now and whenever we see inflation pick up on year-over-year basis (I think we could see that more obviously in Q1 of 2010), we’ll see 2-year yields on US Treasuries rise. They should effectively start discounting what it is that we are going to see on the inflation front, no matter how many Treasury bonds Bernanke says he’s going to buy.
At ZERO percent, rates in the USA are as low as they can go. The only place they can go from here (provided that we don’t turn this place into a Japan) is UP. Rates on 2-year Treasuries are already moving to higher intermediate term highs. An important line in the sand for 2-year yields is the intermediate TREND line at 0.88%. Trading above that line is where I’ll start to concede that reflation is running higher/faster. Trading below that line is where we should all be worried about deflation.
Queen Mary better turn higher, or deflation will have us all resorting to the unenviable investment position of having to pray. Reflation is the only way out of this mess.
Keith R. McCullough CEO / Chief Investment Officer
CROX: The Cash Flow Keeps Drawing Me To This Name
With a maturity date of April 2, this Thursday, the deadline for Crocs to amend its credit facility is looming. Under the current agreement, the company has $22.4mm in borrowings, which is due Thursday if the company is unable to secure a new facility. It ended the year with $52mm in cash, so CROX will have had to burn through more than half of this during the quarter to risk not having enough cash on hand to fund its debt service. (Note: I wonder if the Bill and Melinda Gates Foundation – which owns at least 3.6% of shares outstanding – will let the company go under due to a near-term inability to fund short-term debt?)
Here’s how I look at it. I’m not saying that Crocs is a growth company. In fact, let’s assume the opposite. Let’s say that either the new CEO or a strategic buyer scoops up this company, takes the top line from the $847mm peak down to a core of $400mm and runs at a 10% margin (I can defend this rate six ways til Sunday). That suggests about $42mm in EBITDA. With no store openings, Crocs can sustain itself on $10-15mm/yr in capex – so we’re looking at about $25-$30mm in free cash.
At $1.19 we’re looking at an EV of $69.2mm. Do the math…the midpoint of the implied free cash flow ($27.5mm) suggests that internally generated cash flow can pay for the company in 2.5 years.
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"I'm aware if I'm playing at my best I'm tough to beat. And I enjoy that." -Tiger Woods
the sun was setting at Bay Hill in Orlando, Florida last night, one of
America's finest leaders reminded us that winning is ultimately born
out of adversity. After reconstructive knee surgery and a 16 foot
birdie putt sinking on the 18th, Tiger Woods is already back with a PGA
Tour win. Leaning on his bad knee, Woods didn't ask for a bailout of
that 17th hole bunker - he's an American who proactively prepares - and
man is he tough to beat!
Unfortunately, the young men on the
Yale Hockey team weren't so fortunate, but they learned an important
life lesson in Bridgeport, CT on Friday night - if you want to win at
the highest level, you have to be playing at your best. That's what
this globally interconnected marketplace is demanding from us every day
- these markets wait for no one. Winners and losers emerge every day.
US stock market has proven that risk managers and traders alike have
had ample opportunity to prove themselves to their investors in the
last 2 months. At +11% for March to-date, the SP500 is UP as much as it
was DOWN in February. Who has the winning strategy that can earn an
absolute return in both up and down markets? The YouTubes are on, and
we will most certainly see...
Friday's US stock market weakness
was mostly price driven. This is no surprise - this market trades on
price, not valuation. On a day-over-day basis, volume was down -32%
versus that which we saw trade into Thursday's 3-week highs. After a
+23% trough-to-peak squeezing of the Depressionistas temples, there was
(and continues to be) plenty of room for US stock prices to deflate.
Inclusive of Friday's -2% loss, the SP500 is still up a very relevant
+20.6% from its March 9th low of 676.
Where are we headed next?
Lower. While the Nasdaq is still trading +3% above what I call the
intermediate TREND line (I am long QQQQ), the SP500 failed to hold its
head above hers (827). With the Dow (I am short DIA) and the US
Financials (XLF) broken from a TREND perspective, Tech and Consumer
Discretionary can only carry this market on their backs for so long.
sold most of our Tech names in our virtual portfolio into Goldman
getting amped up on the semis on Thursday. Some of what Rebecca Runkle
calls "Tech Spec" was re-flating too expeditiously (Monster Worldwide
(MWW), Red Hat (RHT), etc...), so we sold those as well. No, there are
no rules against buying them back! While the XLK (Tech) is +3% for 2009
to-date, and we are still long the ETF in our Asset Allocation
Portfolio, it's not going to be a winner every day. Everything has a
time and a price.
There are 3 out of 9 sectors in the S&P
that are bullish on both an immediate term TRADE and longer term TREND
basis: Consumer Discretionary (XLY), Basic Materials (XLB), and Tech
(XLK). No these aren't themes - these are quantifiable TRENDs that
story tellers start to build investment themes around. The most obvious
one that all of three of these sectors have in common is that they are
what most investors recognize as "Early Cycle" stocks.
2009 global market battle, being early is a heck of a lot better than
being late. The old "event driven" momentum model of the levered long
days has rendered the Fast Money strategy of buying high to "sell
higha" somewhat useless. What we want to be doing here in a Bear market
is simply buying low (early), and selling high (late). The strategy has
been around for centuries, it's actually not that complicated.
is complicated is understanding why President Obama let Timmy Geithner
out of this room yesterday. On a busy market day, it's hard enough to
trust his mug while it's on television, never mind when thought leaders
in this country can actually take the time on a Sunday to listen to
what this man is actually saying. I'll let the media get you up to
speed on what he said specifically, but I can assure you of this - the
world doesn't trust this guy as far as Rick Wagoner can throw him.
from Obama throwing out the embattled CEO of GM overnight, the global
economic community seems perfectly happy to toss whatever they owned
for a Bear market TRADE right back under the bus this morning. As
Geithner moves to try selling Americans on "Cash for Trash", most of us
are cool with tucking our very own hard earned cash under our beds and
hoping that his days leading this country out of this financial mess
are soon over...
Hope, of course, is not an investment process.
Neither is betting against the true American leaders in this country,
like Tiger Woods. In a world where everyone who won't exist without a
bailout is whining for more easy money leverage - it's time to start
looking in the mirror and focusing on winning without the foot wedge.
Play by gentleman's rules and do whatever it is that you need to do to
get that win on the tape - because no matter where you go out there
today, there those marked-to-market scores will be.
at your best - stay hedged - and always make your portfolio structure
tough for Big Government to beat. My downside support levels for the
SP500 are 801, then 760. Manage risk (or trade) around those levels
Best of luck out there fighting the good fight today, KM
RSX - Market Vectors Russia-The
Russian macro fundamentals line up with our quantitative view on a
TREND duration. Oil has benefited from the breakdown of the USD, which
has buoyed the commodity levered economy. We're seeing the Ruble
stabilize and are bullish Russia's decision to mark prices to market,
which has allowed it to purge its ills earlier in the financial crisis
cycle via a quicker decline in asset prices. Russia recognizes the
important of THE client, China, and its oil agreement in February with
China in return for a loan of $25 Billion will help recapitalize two of
the country's important energy producers and suppliers.
QQQQ - PowerShares NASDAQ 100 -
We bought QQQQ on Wednesday (3/25) on the pullback. We believe the
NASDAQ has moved into a very bullish tradable range and is breaking out
from an intermediate TREND perspective alongside the more Tech specific
USO - Oil Fund-
We bought oil on Wednesday (3/25) for a TRADE and are positive on the
commodity from a TREND perspective. With the uptick of volatility in
the contango, we're buying the curve with USO rather than the front
EWC - iShares Canada-We
bought Canada on Friday (3/20) into the selloff. We want to own what
THE client (China) needs, namely commodities, as China builds out its
infrastructure. Canada will benefit from commodity reflation,
especially as the USD breaks down. We're net positive Harper's
leadership, which diverges from Canada's large government recent
history, and believe next year's Olympics in resource rich Vancouver
should provide a positive catalyst for investors to get long the
DJP - iPath Dow Jones-AIG Commodity -With
the USD breaking down we want to be long commodity re-flation. DJP
broadens our asset class allocation beyond oil and gold.
XLK - SPDR Technology-Technology
looks positive on a TRADE and TREND basis. Fundamentally, the sector
has shown signs of stabilization over the last several weeks.
Semiconductor stocks, which are early cycle, have provided numerous
positive data points on the back of destocking in the channel and
overall end demand appears to be stabilizing. Software earnings from
ADBE and ORCL were less than toxic this week and point to a "less bad"
environment. As the world stabilizes, M&A should pick up given
cash rich balance sheets in this sector and an IBM/JAVA transaction may
well prove the catalyst to get things going.
EWA - iShares Australia-EWA
has a nice dividend yield of 7.54% on the trailing 12-months. With
interest rates at 3.25% (further room to stimulate) and a $26.5BN
stimulus package in place, plus a commodity based economy with
proximity to China's H1 reacceleration, there are a lot of ways to win
being long Australia.
GLD - SPDR Gold- We bought gold on a down day. We believe gold will re-assert its bullish TREND.
DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.
UUP - U.S. Dollar Index -
We believe that the US Dollar is the leading indicator for the US stock
market. In the immediate term, what is bad for the US Dollar should be
good for the stock market. The Euro is down versus the USD at $1.3169.
The USD is down versus the Yen at 96.7600 and up versus the Pound at
$1.4119 as of 6am today.
XLI - SPDR Industrials- We shorted it on 3/26; industrials remain broken on a TREND basis.
EWL - iShares Switzerland -
We shorted Switzerland for a TRADE on an up move Wednesday (3/25) and
believe the country offers a good opportunity to get in on the short
side of Western Europe, and in particular European financials.
Switzerland has nearly run out of room to cut its interest rate and due
to the country's reliance on the financial sector is in a favorable
trading range. Increasingly Swiss banks are being forced by governments
to reveal their customers, thereby reducing the incentive of
Switzerland as a tax-free haven.
LQD - iShares Corporate Bonds-
Corporate bonds have had a huge move off their 2008 lows and we expect
with the eventual rising of interest rates in the back half of 2009
that bonds will give some of that move back. Moody's estimates US
corporate bond default rates to climb to 15.1% in 2009, up from a
previous 2009 estimate of 10.4%.
EWJ - iShares Japan -
Into the strength associated with the recent market squeeze, we
re-shorted the Japanese equity market rally via EWJ. This is a tactical
short; we expect the market there to pull back when reality sinks in
over the coming weeks. Japan has experienced major GDP contraction-it
dropped 3.2% in Q4 '08 on a quarterly basis, and we see no catalyst for
growth to return this year. We believe the BOJ's recent program to
provide $10 Billion in loans to repair banks' capital ratios and a plan
to combat rising yields by buying treasuries are at best a "band aid". EWU - iShares UK
-The UK economy is in its deepest recession since WWII. We're bearish
on the country because of a number of macro factors. From a monetary
standpoint we believe the Central Bank has done "too little too late"
to manage the interest rate and now it is running out of room to cut.
The benchmark currently stands at 0.50% after a 50bps reduction on 3/5.
While the Central Bank is printing money and buying government
Treasuries to help capitalize its increasingly nationalized banks, the
country has a considerable ways to go to attain its 2% inflation
target. Unemployment is on the rise, housing prices continue to fall,
and the trade deficit continues to steepen month-over-month.
DIA -Diamonds Trust-We shorted the DJIA on Friday (3/13) and Tuesday (3/24).
EWW - iShares Mexico-
We're short Mexico due in part to the country's dependence on export
revenues from one monopolistic oil company, PEMEX. Mexican oil exports
contribute significantly to the country's total export revenue and
PEMEX pays a sizable percentage of taxes and royalties to the federal
government's budget. This relationship is unstable due to the
volatility of oil prices, the inability of PEMEX to pay down its debt,
and the fact that PEMEX's crude oil production has been in decline
since 2004 and is down 10% YTD. Additionally, the potential
geo-political risks associated with the burgeoning power of regional
drug lords signals that the country's economy is under serious duress.
IFN -The India Fund-
We have had a consistently negative bias on Indian equities since we
launched the firm early last year. We believe the growth story of
"Chindia" is dead. We contest that the Indian population, grappling
with rampant poverty, a class divide, and poor health and education
services, will not be able to sustain internal consumption levels
sufficient to meet targeted growth level. Other negative trends we've
followed include: the reversal of foreign investment, the decrease in
equity issuance, and a massive national deficit. Trade data for
February paints a grim picture with exports declining by 15.87% Y/Y and
imports sliding by 18.22%.
XLP - SPDR Consumer Staples-Consumer Staples was the best sector on Friday (3/27), showing that low beta can actually work on a down day!
SHY - iShares 1-3 Year Treasury Bonds-
On 2/26 we witnessed 2-Year Treasuries climb 10 bps to 1.09%. Anywhere
north of +0.97% moves the bonds that trade on those yields into a
negative intermediate "Trend." If you pull up a three year chart of
2-Year Treasuries you'll see the massive macro Trend of interest rates
starting to move in the opposite direction. We call this chart the
"Queen Mary" and its new-found positive slope means that America's cost
of capital will start to go up, implying that access to capital will
tighten. Yield is inversely correlated to bond price, so the rising
yield is bearish for Treasuries.
MAR: KEEP A TRADE A TRADE
Lodging is a highly cyclical space and it tends to be an early cyclical mover.Many investors believe that 2009 numbers are “trough” and therefore deserve a higher multiple.For most lodging companies, especially owners of hotels, we would argue that 2010 will be a materially worse year than 2009.However, our EBITDA estimate for MAR is only 5% lower than 2009, mainly due to the following:
MAR should still experience a nice benefit from room growth, as many of the hotels under construction today are already financed and will open
MAR owns/leases few hotels – so there is less of the flow-through issue
Over 50% of the rooms in MAR’s system are limited service, which is more “defensive” than Upper Upscale and Luxury segments.Ritz Carlton represents only 4% of MAR’s system rooms
Only $850M or so MAR’s debt is getting refinanced in the next 3 years, with only the credit facility being likely renegotiated by YE 2010, so the mark-up on interest won’t be as painful for MAR as many other companies in the space
MAR is trading at 10.5x 2009 and 2010 EBITDA.Consistent with the last year, we are still below the Street consensus EBITDA estimates, by 4% and 10% for 2009 and 2010, respectively.On a P/E basis I have them at roughly 19-20x.To put current valuation in context we looked at where MAR has traded over this last decade based on actual forward results.See the charts below.
We believe that MAR’s P/E multiple troughed in 2008 at 14x our 2009E EPS estimate of $0.91.Using historical achieved EPS, P/E troughed at 14x in 2003 when the stock hit $14.43.EV/EBITDA multiples also troughed at 7.5x in 2003.The average forward P/E ratio over this time frame was 27x.However, if we exclude 2000, 2007 (peak take-out speculation) and 2008 (Street expectations were massively too high for 2009) the average is closer to 22x. The average forward EV/EBITDA ratio over this time frame was 13x.However, if we exclude the same periods as above the average is 11.5x.
The takeaway here is that current valuations are above trough valuations and are not significantly out of line with historical multiples.The problem though is that the road to recovery from this cycle may be slower and longer than most investors anticipate:
Many of the cost cuts are not permanent
Occupancy needs to stabilize before ADR begins to recover and we are nowhere close to that asQ1 is the first quarter where ADR will take a meaningful hit
Flow through from ADR is much worse than Occupancy
Higher group rates booked in early 2008 and 2007, will roll off the books in 1H09, and be replaced with lower rated AAA, AARP, airline crew, and OTA merchant bookings, which will then take a while to roll-off again when things improve
When most of the 5 yr 2006 & 2007 CMBS financing roll in 2011 & 2012, companies will experience a huge markup on their cost of borrow.Same goes for financings put in place from 2006-1H2008
While MAR looks to be one of the best positioned, i.e. most defensive, lodging companies, the sector has had a huge run.Until occupancy stabilizes, the stocks are unlikely to sustain rallies, at least that’s been the historical precedent (see our 01/29/09 post “A GIRAFFE FROM HEAD TO TAIL”).Given our outlook, this space should be rented for near-term catalysts and not owned.For MAR the catalyst was Capex cuts (which we got) and improving investor sentiment.Now that we’ve achieved a 35% move in the stock since 3/6/09, there appears to be little reason to stay with it.
EPS Revisions Challenge My Call For a Week
I’ve been noting for the past month my view that retail’s
cash flow trajectory will meaningfully improve in 2H.
Last week’s earnings revisions challenged my view, as
outlined in the chart below. This was largely the result of revisions at Nike,
and to a lesser extent Abercrombie, and Ross Stores.
My confidence level remains high, however, as commentary
from these companies are contributing to the factors that I think will cause
cash flow to bounce. Again -- I am NOT making a call on the consumer, but am simply modeling that the delta in the negativity of consumer spending (less toxic
is good in my model) occurs simultaneously with stabilizing gross margins, and a cost-reduction cocktail of absolute SG&A and capex cuts. (See my March
5th note “I’m Getting Fundamentally Bullish” for more
The big question heading into 2010 will be who cut costs
because they could, vs. who cut because they should. We’ll see plenty of weak
companies cutting into bone this year, and they’ll be the next shoe to drop.
I’m drawn to the quality companies today who I know are
investing in the right places for the right reasons, such as Ralph Lauren,
Under Armour Lululemon, Hibbett, and (dare I say) Liz Claiborne. Hanesbrands also fits the bill. I don’t like
those who are cutting in all the wrong places, such as Ross Stores, Iconix,
Sears, Carter’s, Jones and Gildan. The challenge here is that this latter
basket of companies will also show a reversal in cash flow trends, temporarily
masking the damage they are doing to their base business. I’ll be working
closely with Keith to game the sizing and timing on these fundamental ideas when
the group looks more ‘shortable’ and/or when the near-term fundamentals for
each of these names present an opportunity.
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