Takeaway: We're weighing in on JCP liquidity -- an issue that's quickly racing to the forefront of key risks, and opportunities.
JCP issued a release this evening vehemently defending against a letter it received suggesting that JCP is in violation of terms on 11% of the company’s debt. The letter came from a firm claiming representation of over 50% of holders of the 7.4% debenture due 2037 (one of 11 tranches of debt). JCP argues that this is ‘completely without merit and intended to create self-interested trading opportunities in the market’. It’s impossible for us to know one way or another. But right or wrong there’s only one thing that’s certain – liquidity will be talked about more as a key issue with JCP. With that being a near certainty, we thought we’d stress-test our model to see where the risks are to this story.
Before going into the model, here's a few thoughts...
We think that the key is to do a simple assessment of JCP’s cash, and cash flow needs under a bear-case scenario, and then do a simple check as to the company’s liquidity. Consider the following as it relates to sources of cash.
USES: Assumptions for uses of cash gets a bit more dicey, but let’s start with our P&L and Cash Flow modeling assumptions…
The punchline is that we can absolutely see why there’s all the concern about JCP’s liquidity – a $500mm-$1bn pad is not as much as we’d like to see for a retailer this size. But we don’t think that the concern should be the result of this evening's announced claim.
We think we’d need to see a cash balance at year-end below $600-$700mm to get concerned about JCP’s cadence of shop in shop rollouts for 2013. That would lead to either a) a slowdown in the rate of shop-in-shop additions, or b) the need to sell equity to keep the storytelling alive. We’d prefer the former, but due to management’s ego regarding growing the business, we can’t rule out the latter. For now we’re sticking with our modeling assumptions that shouldn’t require either.
As the facts change so will we. For now, we're comfortable with the facts.
Yum! Brands announced FY12 EPS and gave game-changing guidance on FY13 that is leading us to capitulate on our long YUM idea.
Stepping Back From YUM
In advance of tomorrow’s earnings call, we are stepping back from our long YUM thesis. While our initial analysis, released in November 2013 as a Black Book, was sound, the chicken supplier issue was clearly unforeseeable. With hindsight, our mistake was defending the stock at that point, rather than taking a more prudent approach. The reasoning behind our decision was that the government’s investigation had ceased, the stock price had declined quite dramatically, and sentiment seemed to be setting up for a strong contrarian position on the long side over the long-term TAIL duration.
Growth Story Intact, Comp Sales the Big Issue in 2013
The important component of the YUM press release was the commentary from David Novak, the Chairman and CEO. Important points regarding China:
That the company is not revising its growth targets could mean that management’s confidence in the long-term prospects of its China business is high but, given the data in the press release, we think that the bottoming process could take several quarters.
Our Black Book, which was published the week before YUM’s analyst day, included a sum-of-the-parts-analysis suggested a value of $88 per share. On December 6th, during the analyst day presentation, management suggested a value of between $80-90. As of now, it is much more difficult to value this stock. Following the call tomorrow, we expect to have a better idea of how the business should fare over the coming quarters and years.
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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