The Economic Data calendar for the week of the 14th of January through the 18th is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.
The drought that has plagued Midwestern America and the rest of the country is far from over. New reports show that corn, wheat and other commodities are low in supply, which accounted for today’s pop in the futures market. Simply put: the Midwest needs snow and lots of it. Several feet will be necessary to equate to the amount of rainwater that will make a material difference. Average snow depth across the Midwest for the first 11 days of January was 0.3 inches and that was covering only about 10.4% of the area. Ouch.
Takeaway: $GES is an admittedly unloved stock, but it should be loved less. Some argue it's cheap, but the real EPS power makes it look expensive.
Guess? Is one of the more interesting names to us heading into ICR. It will undoubtedly be one of those companies where 50 analysts will be crowded around the CEO at the break-out session fighting to glean every last bit of information. But we have no reason to believe that the information will be positive relative to expectations.
To put this into perspective, the stock is up 14% since the trough before the latest quarter and is sitting just 4% (or $1) away from its TAIL line of resistance). On that last print, which was very sloppy to say the least, it was clear that management really has no clue as to why its business is weak. While placing blame on a weak consumer might be accurate, we can point to a host of other companies that are still growing even with a weak consumer.
Also, one notable difference at ICR this year is that GES is without a COO and a CFO – the first time in its history of attending this conference where that will be the case. So let me get this straight…the company just lost two of its best players (with the simultaneous and still mysterious resignation of Prince and Secor), and the remaining bench is left trying to bridge the gap between macro and a micro problems.
In looking at sentiment, one might think that these concerns are already baked into the stock. After all, sentiment (as measured by our Sentiment Monitor) is sitting near a historical low of 20 on a scale of 100. (i.e. this says that sentiment is bearish, which when exaggerated is a contrarian indicator for the stock).
But we don’t think so, and we think it comes down to earnings.
1) We need to assume that every business unit accelerates in order to hit the company’s 4Q guidance – which they issued at a time when they admittedly did not know what was driving their business down.
2) We’re at $1.65 next year versus the consensus at $2.32. Yes, it looks cheap at 10.8x consensus estimates. But it’s at 15.2x our number.
3) Keep the current multiple steady on our estimate, and you get a $17.75 stock – that’s 30% downside from where it is today.
Keep in mind that GES was one of the companies that came out an announced a special dividend for the 2012 calendar year -- $1.20 per share, or $110mm. This was one of the more self-serving moves we’ve seen, as the co-founders own 30% of the stock and drew better than $55mm in dividends for the year. That’d be fine as it pays other shareholders as well, but the reality is that this company is likely to generate free cash flow this year of only $125mm.
Even though the company is not levered, it hardly seems prudent to pay up for a special dividend when you’re looking at an economically cyclical business that depends on hitting fashion trends and the company just lost leadership by way of departures in the COO and CFO ranks. Shareholders probably liked the dividend, but we can’t quite stomach it from a risk management perspective heading into an uncertain 2013.
Of course, the disconnect would be that management does not view 2013 as a year where there is risk to earnings, while we do. Therein lies our comfort level with our short case.
The near term risk to the upside is that the company is one press release away from announcing an external management hire that gets people all excited. We don’t think that one person can immediately make a big difference here – especially given that whomever is brought on will need to prove (as Carlos Alberini did) that he or she can manage both the shareholder and family agendas simultaneously, which is tough to do. But we need to at least acknowledge the risk.
Note: As it relates to earnings, GES is currently sitting in a very bearish part of its SIGMA chart, with inventories and margins both working against the company.
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Not a lot of corn out there right now
Today’s WASDE (World Agricultural Supply and Demand Estimates) didn’t tell us anything that we didn’t already know – yields ticked up a bit from December (123.4 versus 122.3 bushel per acre) and ending stocks were down at 602 MMT versus 647 MMT in the prior report and expectations of 652 MMT. The 602 MMT is a historically tight number as we head into the planting season. I wouldn't read too much into the yield increases, as that number tends to get fudged a bit.
In a bit of a surprise, both Argentinean and Brazilian corn production estimates were raised – we only saw half of that coming and expected a move in the other direction in Argentina.
The bottom line is that there is not a heck of a lot of corn out there versus historically levels, and the snow situation in the Midwest remains unhelpful – average snow depth across the Midwest for the first 11 days of January was 0.3 inches and that was covering only about 10.4% of the area. We need to start getting some snow.
Have a good weekend,
HEDGEYE RISK MANAGEMENT, LLC
Takeaway: This is the first day in the last 7 trading days that my intraday SPY signal gave me a lower-high.
POSITIONS: 10 LONSG, 9 SHORTS @Hedgeye
Today, both the fundamental research and quantitative risk management signals said the same thing – time for a breather. This is the first day in the last 7 trading days that my intraday SPY signal gave me a lower-high.
Lower-high versus the 1494 I registered on the close last night, that is. We are obviously seeing higher-lows and higher-highs across longer-term durations, and that’s bullish, until it isn’t.
Across our core risk management durations, here are the lines that matter to me most:
In other words, overbought is as overbought does. If all the Financials act the way WFC just did on the “news”, I’ll be surprised; especially if we go into the prints from a lower price. But then again, everyone else would probably be surprised too.
Keep moving out there,
Keith R. McCullough
Chief Executive Officer
Takeaway: The 'short Ackman' trade might be the best angle here. But as we noted, there are definite factors to consider in a short here.
There's a lot of reasons to get on the 'short Ackman' train and be negative on JCP. In light of today's downgrade by one of the big brokers, we want to make our current position clear. Specifically, there are a lot of reasons to eliminate the thought of going long JCP for someone that cares about fundamentals. But we think that a short beyond a near-term trade could prove outright reckless -- at least without considering the factors we outlined in our 12/13/12 note (JCP: Reasons To Reconsider Your JCP Short).
An added factor is our Sentiment Monitor. Currently, JCP is the only retailer that has a Sentiment Score below 10 (on a scale of 100). Mind you, this was calculated before today's downgrade, so the real score is likely 1-2 points lower. The point is that this extreme bearish sentiment is a very bullish signal -- as proven statistically by our models. It's important to note that this sentiment is present as the stock is en route to retesting 12-month lows of $16.28. Mind you, that's also the level where we started to see the largest inside Buy cluster in years.
JCP: Reasons To Reconsider Your Short (12/13/12)
We’ve thought from Day 1 that there’s no shortage of reasons to be bearish on JCP. Structurally, we still think that’s the case. But stocks don’t trade in a vacuum, and on the short side, we would not touch this one with a 20-foot pole in the high teens. Our purpose here is not to convince anyone to buy JCP. But rather to explore as many factors as possible that could prove a short position painfully wrong.
We recently spent two weeks on the road, and JCP name was a topic of discussion in 8 out of 10 meetings. The only one that rivals it in terms of controversy is Nike. The irony here is that despite the overwhelming bearishness – 40% of float short and bulls capitulating with less than 30% recommending JCP as a Buy – the topic we encountered most on the road was “why not buy JCP here, as it seemingly has all the bad news we’re likely to see in the stock, and is discounting zero positive developments?” Out of all the people who raised that question, we could find maybe one who followed through and actually bought the stock here.
We think the reason is that if you buy it here and you’re wrong, it’s an offense that probably poses career risk for some. Buying JCP here is really taking a flier on Johnson getting ANYTHING right next year – even if by accident. Let’s face it, after so many self inflicted black eyes, the guy is due for a win. That blind assumption is hardly a sound investment process in our book. But if you want to stay bearish in the high teens, you should remember the following.
1) The ‘JCP is a Zero’ argument has been made about SHLD since that marriage was formed in the fall of 2004. And since then, the stock has underperformed with a -10% CAGR, but it has been flat for the better part of five years, and has been far from insolvent. We could make a good TAIL call about how JCP will prove to be a failure in 8 years – even sooner than that. But it has no bearing on how the stock trades next year. Initially we feel short sighted in saying that, but the facts are what they are, and we won’t ignore them.
2) Let’s look at the specific stock trading patterns from the week before the Sears/K-Mart deal was announced vs the week before Ron Johnson’s appointment as JCP CEO. They’re different types of events, but we put them both in the ‘hail Mary’ category and therefore comparable. For 10 months, the stocks followed almost the same EXACT trading pattern, until JCP’s egregiously low comp level pushed it down to new cyclical lows. JCP is now down 45% from the announcement, while SHLD was UP 45% at the same corresponding point in time (i.e. 1.5 yrs after announcement). The point is that there was ‘reason to believe’ 2-3 years into the SHLD story. It turned out to be unjustified, as SHLD is sitting at a mere $42 today, down 56% from the announcement of the deal. But if you were a ‘perma-short’ throughout the past 8 years, the early part of it was probably less than comforting. The chart below is self explanatory.
(note: This was published before by Lampert's subsequent decision to push out his CEO and assume the role himself)
3) Why does this ultra-long duration matter? Because that’s how Ron Johnson gets paid. Keep in mind that his warrants don’t vest until 2017. We can’t imagine that he did not get the Board’s full support before accepting the job to live through major jolts to the company’s financial nerve center. Without that, there’s no way he’d have taken the risk. Currently, his 50mm warrants are worthless. Above $29, he starts to see the fruits of his labor. His big mistake was not in trying to radically change the store. It was bowing to storytellers in the investment community and issuing near-term guidance around a story that would not play out until the intermediate-term had long passed.
4) One thing to keep in mind is that Johnson is not afraid to miss near-term targets for long-term value creation. That’s painfully apparent to the bulls who suffered through the past three quarters of financial results. But his investments ultimately paid off. We’re the first to highlight how his toolbox at JCP pales in comparison to what he had at Apple. But the guy is not used to losing, and likely won’t go another year wearing that tattoo. Check out his performance at Apple. The retail business missed its guidance to hit break-even target twice in the early days. We’re currently seeing the miss, though obviously on a much greater scale. But he will likely tweak the equation in whatever way he needs in order to keep morale heading higher and fend off share loss.
5) Speaking of share loss, we don’t think its clear exactly how much share JCP has hemorrhaged in year 1. For the first three quarters of this year we’re talking over $2.7bn in share. When 4Q – the seasonally strongest quarter – comes out, we’ll be looking at something closer to $4bn in annual share. This is coming off a base of only $17bn in revenue. Our sense is that the M’s, GPS’, KSS’ and TJX’s of the world are underestimating how much share JCP is handing them. This is not a permanent share shift by any stretch. And given that these other retailers pretty much don’t have a clue as to how much share they are gaining, it’s tough for them to have a clear plan as to how to avoid giving it back.
6) The argument for comp improvement is tough to refute mathematically. Not only is JCP coming off –mid20% comp declines, but it is happening at the same time that an incremental 2-3% of its store base is being remodeled every month. With current sales per square foot sitting at a paltry $112 – yes, you read that right, $112 – and the new stores likely to clock in 30-40% above that level, it is tough for us to not get to a 20%+ positive swing in comps next year. One may wonder (as we do) how much the comp will cost them in terms of higher technology and deferred maintenance costs, we think that it will trade with the comp, not necessarily with profitability. We don’t think that’s appropriate, but we think it’s reality.
7) We think that the big risk here on the long side is simply cash flow. In other words, to be short the stock here, we think that you have to prove the company will run out of cash to fund its growth. That might happen, but not until 2-3 years down the road at the earliest. Before that, we’ll see the comp delta improve.
In the event that cash runs dry the company can follow in the footsteps of Dillards and most recently Loblaw, a Canadian food retailer that is spinning-out 80% its of its property assets and reinvesting the $7bn into its operating business. Yes, JCP would have to pay market rent on this property that is currently largely fully amortized. But again, for the first few years this would not matter. It would have the liquidity for Johnson to evolve the store base according to his plan.
With cash flow from operations YTD down -$655mm and net debt-to-equity at historical highs at 0.67x, the probability of JCP pursuing this option is still low, but increasing on the margin, and most importantly, the optionality is there.
JCP currently owns approximately 39% of its real estate, or 44.6 million sq. ft. Based on current rent and cap rates, we estimate JCP’s potential REIT value at $1.85Bn-$2.55Bn, or $8.25-$11.50 per share. Since the formation of a REIT provides the greatest benefit for retailers that own a substantial percent of their real estate, we’ve looked at the likely candidates (see chart below). Both Macy’s (55%) and Nordstrom (46%) own a greater portion of their store base compared to JCP, but even with 39% of its real estate owned, this is an option for Penney’s to consider.
While forming a REIT is not likely, one thing to keep in mind that Steven Roth is on JCP’s board. While Loblaw’s announcement may have roused speculation in the start of a potential trend, recall that Roth was one of the first to execute such a strategy when he bought Alexander’s out of bankruptcy in 1993 and converted it to a REIT. Roth has “been there and done that” before.