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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.

This note was originally published February 13, 2013 at 21:25 in Retail


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. 


IDEA ALERT: BUYING IGT

Keith recently added IGT to our Real-time Alerts at $16.26.

 

 

With a cheap valuation of 11x forward, rising ship share, improving visibility and strong EPS growth, and better capital deployment away from acquisitions and towards stock buyback, IGT looks attractive.  IGT is clearly a show me stock and we believe that 2013 will be a year of performance.  Aggressive share repurchases should keep a floor on the stock while shareholder activism and a potentially large order from Oregon represent near-term catalysts.  The Oregon Lottery is considering submitting an RFP to refresh its all the units in its 20,000 VLT market.  We don't believe that order is reflected in the estimates or the stock.


Ketchup Comes Off the Table

This morning, Berkshire Hathaway announced that it was acquiring Heinz (HNZ) for $72.50 per share - approximately a 20% premium to yesterday’s close - 13.2x EV/EBITDA.



HNZ wasn’t our favorite stock or our favorite management team, but the transaction does make sense within the context of Warren Buffett’s (Berkshire Hathaway) preferred investing style of being involved in iconic brands.  At various times, Berkshire has owned share of KFT (old Kraft Foods), BUD and KO – HNZ certainly fits the profile.



What we didn’t like about HNZ is largely irrelevant at this point – EPS growth driven by a lower tax rate and declining brand investment.  Good luck to Mr. Buffett.



Importantly, we don’t see this as a harbinger of a consolidation wave in packaged food, though obviously all of the “deal” names get a bid this morning – POST, for example.  CPB also has a bid, though some of the move is likely short covering into earnings as well as this news.  We wouldn’t be doing anything into the CPB print, but might look to short on any strength.



One off deals aside, we prefer to stick with our preferred long in the space, CAG, as recently highlighted on Hedgeye’s Consumer Best Ideas calls.

 

-Rob

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

E:

P:

 

Matt Hedrick

Senior Analyst


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ELASTICITY OF RESTAURANT DEMAND

Price elasticity of demand is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price.  We think there are a few companies within the restaurant industry that are depending on price inelasticity of demand among their consumers to hit FY13 guidance.  There are some indications that, in casual dining at least, demand may be more elastic than operators would like.

 

The recent deterioration in same-restaurant sales growth can be attributed to many different factors like the payroll tax increase, delayed tax returns, and higher gas prices year-over-year.  It seems that operators increasing prices may also be playing a role.  Black Box Intelligence data, illustrated in the chart below, suggests that traffic growth in the lower-margin casual dining industry has been decelerating of late as prices have been moving higher. 

 

Some points on specific companies:

  • BWLD traffic is down mid-to-high single digits, depending on where mix is tracking, in the early innings of 1Q13.  Is the company seeing a negative “multiplier effect” in its traffic trends as it takes price?
  • CMG has indicated that it will likely raise prices later this year.  We are skeptical of the concept’s ability to raise prices further in FY13
  • PNRA has been increasingly dependent on price and mix to drive its comp.  With traffic possibly negative in 2013, the company’s ability to push new menu items will be crucial to its success in 2013.
  • Concepts that have heavy exposure to red meat prices may experience the most margin pressure if the consumer begins to push back on pricing.  Insiders in the beef industry are anticipating another record year for beef prices in 2013 as the US herd has been cut to its smallest size since 1952.

ELASTICITY OF RESTAURANT DEMAND - blackbox elasticity

 

While some management teams tell us that they are not feeling any pushback on price increases in their restaurants, is this chart indicating that operators within casual dining are seeing it?

 

ELASTICITY OF RESTAURANT DEMAND - restaurant employment

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst


Hedgeye's Best Consumer Ideas: Long IGT

Takeaway: IGT is set to reap the benefits of a three to five year bull market in the slots business.

Todd Jordan – Gaming, Lodging & Leisure: LONG International Game Technology (IGT)


The previous management team spent heavily on acquisitions anticipating a boom in Server-Based Gaming (SBG).  But SBG failed to take off, and by 2009 IGT stock went into a steep decline.  With new management focused on developing gaming content, we think the company is done with acquisitions.  This frees up substantial cash flow, and management has made it clear they intend to use this to benefit shareholders.  The stock now trades at the low end of its earnings multiple range (11X forward P/E) management’s stated goal of increasing leverage should make as much as $450 million available each year for share repurchases, while leaving room for multiple expansion to drive higher share prices.

 

Jordan says the company is at an inflection point as company and sector fundamentals have turned.  IGT’s market share has stabilized and is now on the upswing.  If we are right, and the company is done with acquisitions, this should lead to rapidly rising Return On Investment – faster than today’s stock price would imply.

 

IGT is seeing both profitability and cash flow increase.  As interactive gaming starts to build momentum, earlier acquisitions are finally starting to pay off.  Meanwhile the stock price is stuck on the idea that “previous management made a bunch of lousy acquisitions.”  Jordan says these acquisitions aren’t “lousy” any more, which should be reflected in 2013 earnings and ROI performance.  Jordan sees the industry moving into what should be a 3-5 year bull market as replacement demand improves and new jurisdictions look to increase tax revenues.   ON-line gaming proposals are under discussion in a number of US states, but there is also plenty of room for expansion internationally as countries such as Japan, Taiwan, the Philippines and South Korea explore the potential of gaming as a revenue generator.


On Notice

Client Talking Points

Hit The Brakes

Having transitioned from #GrowthSlowing to #GrowthStabilizing in mid-November back in 2012, we’ve since enjoyed a run up in the US equity market of epic proportions. The bears have been slaughtered, with their heads proudly displayed above the mantle in the House of Bulls. As much as the global recovery is exciting, it can be stopped in its tracks right now by two things: oil and Japan. Should Brent crude oil hit $130 a barrel and high gas prices come back into play, that will affect the consumer and when consumption slows, growth slows. As for Japan, their insistence on destroying the Yen while trying to save their own economy leaves much to be desired. After all, the Yen has been “Taro Aso’d” for some time now now. Just remember that the market only goes up until it doesn’t.

Valentine's Day

I wouldn't be able to pen today's RIA Daily Playbook without mentioning the single most important holiday of the year for couples. So with that being said, here's a random tidbit for you: it is estimated that $13.19 billion will be spent on Valentine's Day between the chocolates, the flowers, the dates, the jewelry, etc. That's nothing to sneeze at and is a positive for consumption which is a driver of global growth. If you are not participating in today's festivities for whatever reason, may we suggest enjoying a nice bottle of wine and the first season of the critically acclaimed HBO series The Wire ?

Asset Allocation

CASH 55% US EQUITIES 10%
INTL EQUITIES 15% COMMODITIES 0%
FIXED INCOME 5% INTL CURRENCIES 15%

Top Long Ideas

Company Ticker Sector Duration
ASCA

We believe ASCA will receive a higher bid from another gaming competitor. Our valuation puts ASCA’s worth closer to $40.

FDX

With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view.

HOLX

HOLX remains one of our favorite longer-term fundamental growth companies given growing penetration of its 3D Tomo platform and high leverage to the 2014 Insurance Expansion from the Affordable Care Act.

Three for the Road

TWEET OF THE DAY

“Holy heck...$HNZ going away...didn't see that one coming...god speed to Warren Buffett” -@HedgeyeStaples

QUOTE OF THE DAY

“The squeaking wheel doesn't always get the grease. Sometimes it gets replaced.” -Vic Gold

STAT OF THE DAY

U.S. weekly jobless claims drop 27,000 to 341,000 in the week ended Feb. 9.


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