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JNY: We Want Mgmt To Take The Other Route

Takeaway: The leverage in this model is nothing short of extreme. We want JNY to be the next LIZ/FNP. But until management agrees with us, it won't.

Given how 'out of favor' JNY perennially is we’re tempted to want to go the other way – and today’s beat certainly supports that point. During the quarter, both Domestic Wholesale Jeanswear and Domestic Wholesale Footwear & Accessories confirmed not only the turn we saw last quarter, but a reacceleration in both sales and profitability in these key segments (accounting for 65% of total EBIT). At the same time, despite further revenue deceleration, incremental losses slowed in Domestic Wholesale Sportswear arresting the contracting profit trend reported in each of last four quarters. Not bad at all.


The leverage in this model – both operational and financial – is nothing short of extreme. If only a few things go right, this company can print $2 in earnings power – which makes a $12 stock look like a seriously mispriced asset. But there are two ways to get to the earnings power in question. A) improve the entire portfolio of 30+ brands under the JNY banner, or B) take a draconian stab at this portfolio and do to it something akin to what LIZ/FNP did over the past two years.


Despite the glaring evidence that things are getting better, the reality is that the risk/reward is still not good enough for us to get involved here. Why? Simply put, management is gunning for option ‘A’. For a portfolio that is simply ‘average’, we can’t bank on broad-based improvement in the macro environment to unleash the earnings, and we don’t have the confidence yet that JNY possesses the tools to keep the recent momentum going. We want option ‘B’.


We think that JNY needs to go the way of FNP. It needs to focus its portfolio into the brands the matter most, and dispose of/sell the rest. JNY has over 30 brands, and our sense is that the average investor can’t name the brands representing over a third of JNY’s revenue base.


Realistically, the best way to monetize this content will be for department stores to strike exclusive deals with the company for 100% wholesale distribution, or the brands should be sold to the retailer (like FNP did with JCP and the Liz Claiborne Brand).


When all is said and done, we think that this will prove to be a more valuable strategy for shareholders than to try to continue to run this company as a multi-brand portfolio.


The problem is that management seems to have zero desire to go down this path. They seem to be comfortable running the ship much like it has been run for the past 20 years. Are there call options in footwear and International? Yes. And they’re making great strides today in US Wholesale. Both of these things are great. But they require too many leaps of faith for us at this point, and we don’t like investing based on faith. 

Hedgeye’s Best Consumer Ideas: Short BKW

Takeaway: We remain bearish on Burger King (BKW) as the company was never properly "fixed" when it went private.

Howard Penney – Restaurants: SHORT Burger King (BKW)

BKW was taken private in 2010, then IPO’d again in 2012 after only 18 months, in what Penney calls “one of the best charades put over on restaurant investors in 2012.”  Penney says there are issues in BKW’s North American operation that have persisted since before the company went private in 2010 and have still not been addressed, and the private owners appear to have starved BKW of cash, deferring much needed capital expenditures.


Sentiment on BKW is very high in the investing community, with analysts championing it as a successful turnaround and a play on global consumer growth.  But Penney says the building blocks of a successful business are just not in place.  BKW made a big deal over cost cutting – one executive said the management team in Miami were “sitting on pickle buckets” rather than spend corporate cash on office furniture – but a company doesn’t cut its way to sustainable profitability and, says Penney, the revenue side is simply not there.  There has been significant deterioration in same store sales (SSS) across the US and Canada.  Penney thinks SSS declined 4%, versus the consensus of analysts covering the company of only around a 2% decline, and he expects sales growth for the last quarter to be only 2%, short of the 3.4% average expectation.


Calling BKW “the turnaround that failed to turn around,” Penney says the company could significantly disappoint when it reports earnings this Friday.  He acknowledges that the stock has drifted lower in recent weeks, but he expects disappointing numbers that could rattle largely positive sentiment in the near term as folks realize BKW is not the global growth vehicle its boosters say it is.  If negative surprises lead to downgrades, Penney thinks the stock could drop by as much as $4-$5 in the near term.  





Today we covered our short position in Darden Restaurants (DRI) at $45.78 a share at 10:31 AM EDT in our Real-Time Alerts. Solid alpha day for us in Darden. We'll book Hedgeye Restaurants Sector Head Howard Penney's 13th gain in 15 tries at immediate-term TRADE oversold. We remain bearish on the fundamentals. 


TRADE OF THE DAY: DRI - image001

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FNP: Getting Closer To A Solution

Takeaway: The mgmt shuffle at Juicy is great news, but not unexpected. It's clear that CEO McComb supports the part of the business that matters most.

FNP announced after the close that LeAnn Nealz, President and Chief Creative Officer at Juicy Coture, is leaving the company effective March 1st.  This is absolutely positive news, but comes as no surprise to us as noted in our comments as recent as last month (see below). One of Juicy’s problems is that it has been run by a creative person as opposed to a business person. We’ve seen that strategy too many times in this business, and it always fails.


The reality is that in early December CEO Bill McComb inserted a business and operationally-focused leader (Paul Blum) between himself and Nealz – not exactly a great vote of confidence. It was clear that the two would gel and endure, or would disagree and she would leave. There was no question that Blum had McComb’s full support.


We continue to think that Juicy will be monetized to help pay down debt and allow investors to focus on Kate Spade – one of the fastest growing assets in retail.  To be clear, we’re not saying that getting rid of Kate is a catalyst. Everyone is expecting that – and in fact, if it does not happen then the price will take a hit (unless the brand is immediately returned back to profitability under FNP’s banner). But very few people call us asking about Kate, believe it or not. It’s all about Juicy. When people understand the sales and margin upside at Kate from what we see today, we think that we see the next leg of upside from where we are today.  







Takeaway: Getting closer to a sale of Juicy? Regardless of the decision, we think the team has focus. Only good can come from that.

Reuters just noted that FNP is exploring alternatives, including a sale, of Juicy Coture. It says that the company has been having discussions, but has not yet made a decision.


This is completely in-line with our thesis on the company, that Juicy has gotten to a point where disposing the asset and paying off debt will allow FNP to focus on its crown jewel – Kate Spade – which is one of the fastest-growing assets in retail. At the same time, it will have Lucky Brand to continue its role as the annuity in the portfolio to help fund Kate’s growth prospects.


It’s easy to get hung up on internalizing near-term growth and margin performance – a hundred million in revenue here or there, or margins plus or minus a point or two. That seems like a lot in a given reporting period.


But with Kate, the company is en route to adding another $1bn+ in revenue and doubling margins. Will COH or KORS double margins? Not when they’re sitting at 31% and 20%, respectively. In fact, we’d argue that COH and KORS margins will converge closer to 25% over the next 2-3 years.  Kate should get close as well from its current margin rate of around 12% (fully loaded).


Kate is doing it right. The company has been investing capital consistently back into building the operating platform to aggressively gain share. Some of that base investment tapers off as the company moves into adolescence. Our point is that in looking at what the company is capable of, think big. This is not about a few points of comp here or there.


We know that we sound like a broken record with our bull call on FNP. But quite frankly, it is a great story worthy of being a bull.


The company is hosting an analyst meeting for Kate Spade in 1Q where the growth opportunity should be more apparent to the investment community.


As for Juicy, we’re often asked “is it really worth anything?”, our answer is ‘definitely’. Think of all the times people chalked up certain consumer brands as being dead. It happened at FNP, actually, when the company owned Mexx – which was a far bigger dog than Juicy. We hate to pick a multiple out of the air in valuing assets, but does 0.5x sales sound in the ‘fair’ category? Sure, it's consistent with past transactions in retail. We wouldn’t be shocked by more. That suggests about $250mm, which could repay 65% of FNP’s debt.


(If the table below is tough to read, let us know and we'll send the file).


FNP: Getting Closer To A Solution - lizsop





Takeaway: We expect FNP to undergo meaningful structural change in 2013 that will continue to unlock shareholder value.

Dinner with a management team rarely (if ever) shifts ones’ investment thesis on a stock, and our’s with FNP last night was no exception. But we definitely walked away with confirmation that the management team is deploying assets to the areas that will fuel growth, and will do what it needs to do in order to purge parts of the portfolio that are simply not working. The bottom-line is that we expect FNP to undergo meaningful structural change in 2013 that will continue to unlock shareholder value.     


The only negative point we could really think of is that with a ~20% hit to EBITDA guidance (Juicy plus general conservatism) and a resulting 12% increase in the stock price, it would be flat-out dishonest of us to not admit that this latest update started the clock and set expectations that something strategic will, in fact, happen this year. Fortunately, we think it will happen, and when it does the path to a $20 stock will be apparent.

In the process of reflecting on his current “State of the Industry,” CEO Bill McComb highlighted that apparel is becoming increasingly commoditized requiring brands to become more differentiated in a consumer-direct format with a focus in part on accessories to shape how he runs each of his portfolio brands for tomorrow. In listening to McComb talk strategyvabout the future of the business, he most similarly sounds like Dick Hayne of URBN. Not a bad stock chart overvthe past year to follow.


Here are a few musings from last night:      

  • As for branded commentary, while Kate continues to be the fastest growing, Juicy remains the most dynamic. McComb put new Juicy CEO Paul Blum in place to set a path for the brand’s approach to market and its product allocation/mix across categories. This leadership has been sorely missed in recent years, which has lead the brand to run astray under Chief Creative Officer Leann Nealz in 2012. Simply put, a creative designer has been running the brand, and our opinion is that she had too much latitude to skew the brand up and down in price point and age. The brand needs a business person to instill a process to methodically target a consumer and procure product accordingly. We’re not declaring victory for Juicy. But we think that it has more going for it today as it relates to touting leadership to make it salable.
  • The upshot is that Paul is setting the course, but that’s just the start. In order to execute effectively, 1) the role of Chief Merchant still needs to be filled, and 2) the chief creative visionary has to be onboard and willing to follow the course set before her. Any deviation there would likely result in a replacement.
  • At Lucky, it’s clear that the focus beyond core denim (i.e. more fashion product) is critical to driving store productivity from $460 up to and beyond management’s $650 per sq. ft. target. In addition, e-commerce will be the primary driver of comp over the next 12-months as the team integrates successful initiatives at both Kate and Juicy.
  • As for Kate, there’s a ton of moving parts over the next year or two that drive brand growth, but McComb remains focused on the bigger picture – investing to ensure the Kate Spade business achieves a critical mass not necessarily managing to profitability. We’re not talking about a $460mm brand at 10% margins getting to 12% overtime, but a path and vision for sub $500mm brand to ultimately achieve $3Bn in revenues at margins over 20%+. We don’t think that investors are looking at the big picture here with what this brand can become. Focusing on the baby steps is an opportunity cost.


As we look ahead to the upcoming catalyst calendar, we expect confirmation shortly that a Kate Spade analyst day will take place over the next 3-months. Given the transformation and multitude of moving pieces underlying Kate’s growth trajectory, the added detail and visibility will be a net positive in light of the discounted multiple the market assigns to this brand.

Prior to then, we wouldn’t be surprised to see the addition of a Head Merchant at Juicy. Beyond 3-months is when we suspect more significant divestiture events are most likely. Among the assets likely to be monetized first are the Adelington Group and then Juicy.

The impact of these events on the balance sheet and P&L would be substantial and set free FNP’s most important asset i.e. Kate Spade. Keep in mind that a 0.5x sales multiple on Juicy Cotoure would net $250mm, which would eliminate 65% of debt, and leave FNP with debt to total capital of under 15%. That’s definitely consistent with what investors want to see from an early cycle high growth story. A better informed market following a 1H analyst day is more likely to reward the remaining business with an appropriate market multiple, which could in turn reward investors with a 40%-65%+ return from current levels and a stock worth $20-$24 per share. FNP remains one of our top longs for 2013.



Bloomin’ Brands shares could be a good short at this price. 





Sell-side ratings on Bloomin’ Brands shares indicate a strong, bullish bias with 73% of analysts recommending buying the shares.  With casual dining sales trends deteriorating, we believe BLMN is a good candidate for investors looking for short ideas as earnings expectations are unlikely to rise from here.


The consensus Price Target, illustrated in the chart below, is below the price of the shares and we do not expect sentiment to rise much further.  Both the multiple (>1.5 turns above casual dining average) and the earnings estimate are not likely to have much upside. 


BLMN SHORT OPPORTUNITY - blmn target price



Private Equity Profit-Taking


Given that 66% of the company, or $2.5 billion in stock, is owned by private equity firms, it is unlikely that there will be a sea-change in sell-side ratings any time soon.  However, we would think that a private equity firm considering current sales trends would be glad to offload shares at $18, or 9.3x cash flow.


BLMN SHORT OPPORTUNITY - blmn valuation comp



Howard Penney

Managing Director


Rory Green

Senior Analyst

Slouching Towards Wall Street: Courting Trouble

Courting Trouble

"There is such a feeling among people, among regulators, among the political system all over the world, against the banking system, and I don’t think that’s going to change so soon."
- Sanford Weill

A fish stinks from its head – but it swims from its tail.

The markets need leadership from the political class, but they will only thrive once they regain the confidence of their weakest participants. When the small retail investor trusts the market, the world trusts the market. This is something even Sandy Weill understands.

So why doesn’t Washington?

This nation continues to suffer a twin crisis of leadership in Washington, and of confidence on Main Street. Congress and President Obama both deserve a sound thrashing for their refusal to introduce sanity to the financial markets. Six years into the Financial Crisis (and counting…) we are no nearer to a level playing field, to a powerful and effective regulator, to actively extricating Bad Actors from the industry or to creating transparency in the markets. Like so much else on your television screen today, this will not end well.

In a legal case that may determine the future of capitalism, a federal appeals court in Manhattan was the scene of a hearing last Friday which produced the bizarre spectacle of a government regulator coming to the succor of a company it has just charged with a billion-dollar fraud.

Our recent book, Fixing A Broken Wall Street (http://tinyurl.com/cqgter9) lays out the history of Citibank and its current SEC case in lurid and angry detail, and spells out its implications for America’s credibility. As the next chapter in this nasty saga is played out, the future of capitalism hangs in the balance.

Judge Jed Rakoff (pronounced RAKE-off) of the Federal District Court in Manhattan has criticized the SEC. In 2009 he refused to approve a settlement between the SEC and Bank of America over alleged misleading proxy disclosures when BofA acquired Merrill Lynch. Judge Rakoff argued that the settlement did not disclose who was responsible for the misinformation, that the settlement did not cure the problems the SEC claimed existed at BofA, and that the amount of the fine was miniscule, compared to the financial damage suffered. Adding insult to injury, the Judge observed that the fine was to be paid by the shareholders – the putative injured party.

In November 2011, Judge Rakoff rejected a proposed $285 million settlement of SEC charges that Citigroup had committed a $1 billion fraud. Rakoff complained that the settlement provided no details of the alleged behavior, no indication of the profits Citi earned from the transaction in question – and thus no measure of reasonableness of the settlement amount – no indication of which Citi employees or executives were implicated, and no provision for a cure of underlying problems that gave rise to the SEC case.

Judge Rakoff ordered the SEC and Citi to prepare for trial, saying it was in the public interest that the case be heard in full. No sooner was the ink dry on the Order, than the parties filed for injunctive relief. The SEC and Citi joined forces seeking a court order to require him to stand down. On Friday they had their day in court – literally.

The SEC argued that Rakoff’s rejection of the settlement “conflicted with a century of judicial practice” (NY Times, 9 February, “Judge’s Rejection of Citigroup Deal Is Heard on Appeal”) and that “The court failed to give the SEC any deference.”

Regulatory agencies obtain court orders so they can enforce the terms of a settlement in the event of repeat infractions, and courts routinely sign off on settlements. In practice, though settlements contain language prohibiting repeat violations, those terms are never enforced. Firms can repeat the same violations and only have to pay another settlement. Since they settle “without admitting or denying” the allegations, you cannot say legally that a firm “committed fraud” and you especially can’t say they “committed the same fraud again.”

The theory behind settlements is judicial economy: court hearings drain taxpayer money and lengthy proceedings tie up critical legal resources. Outgoing SEC enforcement chief Robert Khuzami came to the Commission vowing to obtain more, and bigger settlements. Khuzami has won lots of settlements – and headlines. But the willy-nilly settling of every fraud case has gotten to the point where, far from preventing fraud or punishing crime, the government has become a partner in the questionable dealings of the world’s largest financial institutions.

Where’s the political will to force change? Look at another recent example and cringe.

HSBC bank is the third-largest publicly-traded bank, and the sixth-largest public company in the world (Forbes, 2012.) The bank recently agreed to pay a $1.9 billion fine and acknowledged that for years it permitted “narcotics traffickers and others to launder millions of dollars” throughout its global system. “Millions” is an understatement.

The Justice Department says HSBC took in more than $ 15 billion in unexplained cash deposits “in Mexico, Russia and other countries. In some branches the boxzes of cash being deposited were so big the tellets’ windows had to be enlarged” (The Guardian, 14 December 2012, “HSBC Money Laundering Fine.”) Entities for which HSBC is reported to have laundered funds include Colombian and Mexican drug gangs, and the Iranian Revolutionary Guard – the backers of Hezbollah (see our Screed of 23 July 2012, “50,000 Dead Mexicans Can’t Be Wrong.”)

The $ 1.9 billion settlement represents about 25% of HSBC’s annual profits, so it will have little effect on the bank’s operation. Senior HSBC executives said they were “profoundly sorry.”

There is a high likelihood that HSBC’s money laundering activities were implicated in the murder of US citizens. Mexican and Colombian drug gangs have killed tens of thousands of Mexicans and Colombians, but they also kill US citizens. Since the drug money in question originated in street sales in the US, there is an inevitable link, not merely to the killing of the odd DEA agent or border

police officer – and not only to Mexican-American gang members in Los Angeles – but to street violence here at home. We wonder why the politicians who are challenging the President’s drone memo are not calling for harsh measures against HSBC.

Oh – silly us! Now we remember.

Assistant US attorney general Lanny Breuer said the consequences of criminally prosecuting HSBC would be “dire” – it would cost jobs and risked destabilizing the global banking system.

As to the jobs issue, we are confident the FDIC could figure out a way to keep HSBC’s domestic US business humming – a perfect opportunity to bring Sheila Bair back as Treasury Secretary. As to the global piece, we are not sure how the government defines “destabilize,” when the global banking system is already the prime conduit for funneling cash to Iranian-funded terrorists and Mexican drug lords. This is no doubt a highly specialized use of the term, a degree of nuance known only to legal minds on the level of Mr. Breuer’s. What practitioners call “a term of art.” Where’s the political will to do something about failures in the system?

In 1998, Citigroup sprang whole into glorious, robust life, born from the mind of Sanford Weill like Botticelli’s Venus. It was ably midwived by Alan Greenspan and Robert Rubin, while the slap that started it breathing was administered by President Clinton. This entailed revoking the Glass Steagall Act and ultimately led to the Commodity Futures Modernization Act, making it illegal for the government to regulate the futures markets. It’s been Off To The Races ever since.

The judicial economy argument for settling cases is to keep court resources available for really important matters. Under this rubric, there can be no more important use of judicial resources than to determine whether Citigroup committed financial fraud. This is the entity for which major laws were uprooted, new laws brought into existence, and the entire structure of the marketplace and the economy turned on its head. The Citi case is a veritable laboratory of 21st-Century American Capitalism. The transaction that laid the foundation for the contemporary financial marketplace – and for the crisis that continues to plague us.

We say America is entitled to the full story on Citi. A full hearing should determine whether such an entity should – or even can – exist; whether it is possible to implement sufficient internal controls; how such an entity should be regulated – or whether it is ultimately not possible to oversee a marketplace dominated by behemoths. It would also reveal weaknesses in the current regulatory regime and help create a roadmap to restructuring the SEC. No wonder the unholy alliance of Citi and the SEC are desperate for a court-ordered stay.

Folks, it doesn’t get more important than this.

A strong decision in favor of Judge Rakoff will lay the groundwork for the incoming SEC chairman to get serious about restoring credibility to the markets, and should send the same signal to Congress. A decision against Judge Rakoff will be clear abdication – the regulatory equivalent of the Lehman bankruptcy.

Our lawyer friends think we’re overreacting. They say it will be tough to convince a court to push back against a federal judge. We hope they’re right. Until then, we seek in vain for a policy of Zero Tolerance.

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