Today we bought C&J Energy Services (CJES) at $22.72 a share at 3:15 PM EDT in our Real-Time Alerts. C&J Energy Services has been Hedgeye Energy Analyst Kevin Kaiser's Best Idea since his presentation on it on November 16th, 2012. Buying it on red.
Takeaway: Hedgeye gets a rare look into the UK retail market and its implications for US companies.
On today’s Retail expert call, we were joined by retail expert Stacey Widlitz, head of SW Retail Advisors. Stacey is a recognized expert on retail trends with a unique perspective on both the US and the UK markets. Operating from her base in London, Stacey provided our clients valuable insights on some key retail names last quarter. In today’s conference call she shared her insights on the Christmas season and the changing face of UK retail.
Stacey saw the Christmas season and the fourth quarter generally flat year-over-year in terms of sales. November was a disappointment in the UK and retailers started discounting both early, and aggressively. A key takeaway is that the UK consumer has generally been used to much higher price points than we see in the US, and there has not been a broad culture of discounting in the UK. Stacey believes that is changing and this Christmas season looked a lot like the US season in terms of promotions. One point that worked in favor of the UK retailers was that they came into the final quarter with tightly controlled inventories. Nonetheless, what Widlitz calls the “Americanization of the UK consumer” forced many stores to run US-style holiday promotions.
Widlitz noted heavy promotions at many leading department stores, with fragrance and cosmetics giveaways, and 20%-50% discounts common across the sector – she says Gap ran their discounts as high as 75%. Retailers were taken by surprise as customers stayed away from early season discounts, coming back Yankee-style to scoop up bargains, many of them waiting until the day after Christmas – in the UK it’s called “Boxing Day” and is a separate occasion for gift giving. Widlitz says the UK consumer has figured out the waiting game, and retailers have to play along with the new rules.
Another key theme is the pricing disparity of international brands which often are priced the same in pounds sterling as in US dollars. Widlitz says Kors handbags are significantly more expensive in the UK – a bag that costs US$ 400 in New York costs 400 pounds sterling in London – equivalent to US$ 630. UK customers have figured this out and some now buy expensive fashion items on-line in dollars and have them shipped to friends in the US. London retailers have to figure out how to compete in this environment, and Kors, for example, discounted earlier, and more heavily than in the past.
Widlitz says Hilfiger was among the more successful stores, running “some of the leanest promotions around,” discounting only large sizes and left-over odd pieces. The higher price point and the cachet appear to still hold appeal for local fashinistas.
Widlitz was most positive on Victoria’s Secret, whose London flagship store appears to be one of the most successful major retail apparel outlets. Traffic continues strong and with a high conversion rate – folks who come to look, then stay to buy. Widlitz believes VS is hitting a real void in the retail market, as the only competition for lingerie is either low-market department store lines, or very high-end boutiques.
A major theme that will determine the future of retail is the strength of the Asian tourist trade. High-end accessory retailers look to Chinese consumers to provide demand. They will need it. One of the stark differences this year was the lines waiting to get into boutiques such as Prada and Louis Vuitton: there weren’t any. Last year there were lines out the door at these upscale shops. Retailers are counting on Asian tourist trade to bolster sales at their highest-end outlets, amidst concerns the domestic accessories market may be close to saturation. Luxury brands view London as the bridge to bringing Asian tourist demand to the US, so these sales figures will be closely watched.
Widlitz believes the biggest new opportunity may be in off-price retailing. The UK does not have malls, and with the “high street” retail mentality, most operators appear not to be aware of the attraction of this segment. Widlitz singled out TJX as doing “phenomenally well” with an off-price strategy. The outlet village concept is catching on, she says, and could be huge.
We are pleased to have access to Stacey Widlitz’ unique coverage and analysis. The Hedgeye Retail team will continue to monitor overseas developments for their impact on the domestic market, and for their implications for stock prices in their segment.
Takeaway: The Americanization of the European consumer is the key trend in Europe today. No promotions = no revenue.
We hosted a call today with Stacey Widlitz from SW Advisors to review the state of retail in the UK heading into earnings. Stacey specializes in monitoring promotional cadence and relative brand positioning for US brands that sell in Europe. Here’s a brief review of our notes from the call. Please note that while we agree with most of her comments, these thoughts represent her unaltered views. We're simply downloading to you in an easily-digestible format.
For more details, or to connect with Stacey directly, please contact your Hedgeye salesperson.
Same store sales growth in the UK still running below inflation. Inventories are finally clean (with few exceptions – like GPS) but are squarely driven by increased promotional activity. The ‘Americanization’ of UK retail, where consumers are trained to wait for discounts, seems to be a trend that is more relevant than ever.
In 4Q, November was a disappointment and retailers got promotional very early relative to last year. ‘Hitting the panic button too early in the quarter’.
Retailers that did not have 20-50% signs up (or ‘free fragrance’ or other promo) by the 1st week of December saw a meaningful slowdown in traffic and/or conversion. Mid-December was ‘eerily quiet’.
Majority of retailers noting that consumers are waiting til after the holidays bc they have figured out the markdown game.
Here are callouts by company/brand:
After stabilizing in 3Q (something that Stacey had called out when we did this call a quarter ago), ANF got incrementally worse on the margin.
The company did not promote until after holiday, which made it stand out like a sore thumb. Consumers walked into the flagship looking for deals and could not find any overtly stated promos.
The new Hollister store is around the corner from Abercrombie. There is a 35% price discount between the two, but the consumer does not respect it.
The company simply did not pull the pricing lever like it needed to.
Gap and Banana were early with promotions. Perhaps too early.
30% off 1st weekend
75% off by end of month
Even now stores look heavily clearance. Other retailers are bringing in new product, but GPS seems mired in the excess inventory of holiday.
Gap is competing against Top Shop where conversion rates are double. GPS price points are too high and there’s not enough units. GPS has Fast Fashion at one end, and Primark at the other end (single digit opening price points). Biggest risk to Gap is that Top Shop accelerates expansion.
Went on sale mid Dec this year, which is earlier than last year.
Harrods and dept store discounts were deeper in percentage terms
This weekend the stores are being cleared and freshened up.
KORS' aspirational aspect is much more significant in the UK vs US.
Priced 40-50% higher in UK than US. Kors has the highest price spread out of any brand vs the US.
Retail stores decided to promote, which helped them – as did a blast of snow in Jan.
Surprised how long it took to bring out the 50% signs.
After Christmas the 50% off inventory was 2x what it was mid month.
GES seems to be unable to nail down who their consumer really is and what drives shopping behavior.
VICTORIA’S SECRET FLAGSHIP
One of SW's favorites.
Very high conversion rate in store.
Lingerie market is very department store focused in the UK.
There is a specialty-store void that is filled by VS.
Opened a 2nd flagship on oxford street. Absolutely amazing environment.
Conversion rates are also some of the highest in the market at first flagship. Very solid brand opportunity.
2 flagships in London. There’s quite a bit of promos going on, which is unusual for flagships. Seeing the 30-50% off in bags, trenches, footwear. This is a new phenomena for COH
RL had not been getting the boost from Chinese tourism over the past few years like the rest of the luxury market has been.
Part of this is because the tourists have wanted logo product like LV and Coach.
Now those preferences are waning as Chinese consumer wants non-logo product, which opens up a new consumer opportunity for RL.
In answer to recent concerns out there about RL, Stacey sees all brands following the promotional cadence set by the department stores, and that RL is not necessarily losing share in that context.
Hilfiger is 25% cheaper than RL. Some shirts are 15%. Definitely not enough of a gap to threaten RL.
That said, TH is running some of the most successful promotions, with only discounted odd-sizes left over for sale.
Brand appetite is high. Sweaty Betty is the only athletic game in town outside of the traditional brands (adidas, nike, puma) and they cannot particularly compete with LULU – even at a 30-40% discount. $275 for two tops and a pair of leggings is steep by our standards, but for a UK consumer it works.
H&M was the only fast-fashion retailer to be early in pulling the promotional trigger. The others did not need to. Forever21, Top Shop had extremely strong traffic trends.
Pricing Spreads (who are the highest and lowest spreads)
KORS is 40-50% higher priced in the US.
ANF – priced in dollars – paying 50% more. Especially high given that Hollister is a block away at 35% less.
VS is the outlier on the other end. Only 15% premium to the US. Not a surprised that it is performing so well.
The ‘Americanization of the UK’ plays right into TJX’s efforts to grow international presence. They are the only game in town. This is seemingly a great secular opportunity given where the market is headed.
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Takeaway: Japanese policymakers’ gross misinterpretation of economic history portends negatively for the ailing yen.
The Japanese yen, which is down roughly -16% since we initially outlined our bearish bias back on 9/27, continues to get Taro Aso’d.
The latest developmental jawboning on this front has come in the form of Finance Minster Aso’s recent remarks that the Japanese government is taking a page out of its own historical playbook by pursuing strong anti-deflation policies:
“There is no one in the government, the bureaucracy or the BOJ who has experience in anti-deflation policy. We can only learn from history.”
-Taro Aso, 2/3/13
The history lesson Mr. Aso is referring to is Depression-era Japanese Finance Minster Korekiyo Takahashi’s mandating of the BOJ to directly monetize Japanese sovereign debt (as opposed to open-market operations), which began in 1932 and continued for the next 14 years.
During this era, the ratio of JGB issuance financed directly by the BOJ peaked at 89.6% in 1933 and remained elevated throughout the program. This monetization strategy assisted in doubling JGB issuance and boosting Japanese public expenditures by a whopping +34% in 1932 alone.
What is conveniently left out of Aso’s commentary is the fact that Japanese CPI readings peaked at rates north of +40% YoY throughout the 1930s during the aforementioned episode of aggressive sovereign debt monetization.
We’re not sure where this fits in the context of this note, but it’s probably worth mentioning that Takahashi was literally assassinated for trying reign in public expenditures in 1936…
Phillips curve in hand(s), western economists and those schooled in western academia continue see little-to-no-harm in perpetuating inflation for the sake of achieving nominal GDP growth target(s). We’re not sure how the deflation-addicted JGB market will respond to all of this, but preliminary indications suggests not well:
The key question as it relates to any potential Japanese sovereign debt crisis is whether or not this is 2003-06 all over again in Japan, with that occurrence demonstrating that a melt-down in JGB prices could perpetuate a sustained melt-up in Japanese equities.
Could, however, this time be different with all three of Japan’s major financial markets (currency, equities and bonds) eventually being lit on fire all at once? That remains the critical tail risk embedded in Japan’s aggressive Policies To Inflate over the long-term TAIL.
For now, stay short the yen and long JPY-funded carry trades (email us if you’re interested in specific ideas). Let Mitani’s woes continue to help get you paid on the long side of emerging market equities and FX. Key policy catalysts are outlined in the list below.
Takeaway: Long China, Hong Kong and Singapore continues to be our top idea across Asian equities with respect to the TREND duration.
Over the weekend we received more JAN PMI data out of China on the Non-Manufacturing front and we also received Singapore’s JAN Manufacturing PMI data this morning. The indicators all showed sequential strength, which is incrementally supportive of our broader regional #GrowthStabilizing theme – which itself is underpinned by our fundamental call for continued improvement in the Chinese economy.
On the strength of the aforementioned investment theme(s), we’re seeing continued strength across the associated financial market indicators we have liked and continue to like on the long side with respect to the intermediate term.
The MSCI China Consumer Discretionary Index is up +9%, Hong Kong’s Hang Seng Index is up +11.9% and Singapore’s FTSE Straits Times Index is up +4.2% since we turned the corner on each – which was on 12/10, 11/16 and 12/21, respectively. That compares to +7.1%, +10.7% and +3.4% for the MSCI China Index, the MSCI AC Asia Pacific Index and the MSCI AC Asia Pacific Index, respectively, over the associated durations.
We expect these ideas to continue generating absolute gains and relative outperformance over the intermediate term. Our quantitative risk management overlay suggests the same.
We’ll get Hong Kong’s JAN Manufacturing PMI data tonight and China’s JAN Social Financing, Money Supply and Trade Data on Thursday. We expect continued improvements – particularly in all the YoY figures, as the timing of the China’s Lunar New Year celebration is favorable for the JAN ‘13 figures. Specifically, China’s Lunar New Year festivities begin FEB 10 this year vs. JAN 23 in 2012.
For those in search of a deeper discussion on the aforementioned investment ideas and themes, please email us and/or refer to the following research notes:
From a top-down factor risk perspective, the key callouts from each of the aforementioned geographies are as follows:
The key idiosyncratic policy risks from each of the aforementioned geographies are as follows:
All in, the balance or risks – both fundamentally and quantitatively speaking – continue to support our bullish biases on Chinese, Hong Kong and Singaporean equities. On absolute tears, it's admittedly tough to run out and buy 'em up here; that said, however, we do support increasing allocations to these asset classes on any pullback(s).
Ahead of Green Mountain Coffee Roasters releasing 1QFY13 earnings on Wednesday, we wanted to highlight an apparent accounting change that may have boosted FY12 free cash flow. We have written in the past of the mounting pressure on sales and margin in GMCR’s core businesses and believe that investors should pay close attention to the reporting conventions being used by the company when releasing earnings.
Green Mountain’s FY12 cash flow seemed surprisingly strong to us when results emerged in November of 2012.
Specifically, we were not expecting the company to generate free cash flow. A closer look at the footnotes, however, shows that in FY12 the company may have used an aggressive accounting practice to produce more attractive cash flow than otherwise may have shown up in the financial statements.
The FY12 10-K makes for some interesting reading; the footnotes, in particular, have raised some important questions in our thinking on the company’s ability to generate cash going forward. FY2012 was the first time that GMCR acquired assets through capital lease obligations. The company’s accounting practices have been scrutinized in the past and it looks like the cloud of suspicion may linger on, despite the appointment of a new CEO. His tenure is still new, so it is far too early to judge, but addressing investor skepticism must be one of his foremost priorities.
The key question, by our thinking, is to learn what was behind the company’s decision to begin acquiring assets through capital leases. Was the switch made to inflate the cash flow numbers or is there another explanation?
The cash flow statement from Green Mountain’s most recent 10-K shows reported “fixed assets acquired under capital lease and financing obligations” of $66.5mm . This figure amounts to 86% of the reported $76.6mm of free cash flow reported for FY12. Some forensic accountants suggest that the acquisition of fixed assets under capital lease and financing obligations can serve as a means to “overstate” a company’s cash flow generation.
The classification of a lease depends on a number of criteria. Specifically, a lease is considered a capital lease if it fulfils any one of the following conditions:
Assets acquired through capital leases are, in terms of their impact on the financial statements, substantially similar to assets purchased and financed through credit.
As a refresher: “When assets are acquired through capital lease transactions, they are reported on the asset side of the balance sheet. The capital lease obligation is shown on the liability side. Depreciation on these assets and interest on the related obligations are represented as expenses. Since cash is not dispensed when the assets are acquired, they are not included with capital expenditures reported in the investing section of the statement of cash flows. Subsequent principal payments made on the capital leases are reported in the financing section of the cash flow statement. Note that while the company acquires the asset for use, cash flows related to the acquisition of the asset are never shown in the investing section of the cash flow statement. Although this is in keeping with the guidelines provided by SAFS No. 95, it can lead to miscalculated amounts of free cash flow.”
Understanding Green Mountain’s reasons for deciding to acquire assets through capital leases is important. One reason the company might have taken this step is that the appearance of strong cash flow generation could succeed in taking some momentum out of the short theses that were dominating the news flow around the company. The most well-known GMCR bear is, of course, Greenlight Capital’s David Einhorn. One of the most important components of his thesis was the idea that the company’s cash flows were unlikely to be sufficient to cover the bloated capital spending plans going forward. One way to help the company’s free cash flow numbers could have been to acquire $66.5mm of fixed assets under capital leases and financing obligations in 2012.
The company expects capital expenditures in the range of $380-430 million in FY13, versus $401mm in FY12. The company also expects free cash flow of $100-150 million in FY13. Our focus will be on the “assets acquired under capital lease and financing obligations line item” this year.
The company is reporting EPS on 2/6. Like other’s following the stock, we are eager to hear the new CEO, Brian Kelley’s, input as the Street develops a more complete picture of his vision for the future of Green Mountain Coffee Roasters. In particular, he will need to assure investors that the SEC investigations and class action lawsuits are in the rear view mirror, and unlikely to command much of his team’s attention going forward. Such issues aside, the company has plenty of competitive issues to address, so Kelly will need all minds focused on GMCR’s profitability rather than worrying about investigations or litigation.
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