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JCP: Sweet Emotion

Takeaway: We think JCP has big support at its pre-market range of $18-$19. It’s not for the faint of heart, but we think it’s in the high $20s in a yr

Conclusion: There's a tremendous amount of emotion in this one (almost all negative), and we think that JCP has tremendous support at its pre-market range of $18-$19.  As surprised as we might be to the market’s reaction, we’re not going to argue with it – the same way we didn’t argue with the 24% peak-to-trough squeeze over the past 4-weeks. What we will do is prepare for an opportunity to get heavier in an name where our conviction is growing. Regardless of what the consensus thinks, the metrics that matter (cash, internet, eps) came in at or better than our model, and we remain confident in the cadence of shop rollouts needed to make this model work. This is definitely a ‘hold your breath’ name over the near-term. But we think it is in the high $20s in 12 months.

 

We’ve gotta say up front that we’re surprised to see the stock trading at the same level after hours that it was when we were seeing liquidity-fueled downgrades, $12-15 price targets on supposed equity offerings, and story-telling about Icahn buying JCP bonds as a backdoor way to push Ackman’s second-largest holding into bankruptcy.

 

 

Yes, the results were bad. But the comp was right in line with the -30%+ speculation that was widespread before the quarter. The only thing that was unexpected was the atrocious -640+bp decline in gross margins during the quarter. But let’s actually give RJ some credit (we have not given him any yet). He did what he had to in order to clean inventories to be ready for what will be a very big year for the company. Being heavy on legacy product while shops are being converted would be the end for him.

 

Also, as an aside, we liked the element of humility that Johnson brought to the equation (“last year’s pricing mistakes were all my fault”), which is a stark contrast to the hubris we painstakingly observed last year.   

 

As it relates to shop rollout plans, he reiterated plans for 20 Home shops in over 500 (of the 700 being converted) stores by May. He highlighted what we already knew…that Home-related dollars in JCP stores are 25% of where they used to be (10% of square footage down from 20%, and productivity down below $100/ft vs prior levels nearing $200.) We’d only been modeling 30 shops added in 2013, and still come out bullish – now we’re thinking that they probably beat that (see our shop/comp algorithm math below).

 

Lastly, let’s not forget about the cash. That’s the first number we looked at when JCP printed. Despite management’s original goal of $1bn, we’d have been content (based on our liquidity math) with $500-$700mm. We got $850mm. On top of that, the company built up to a liquidity cache of $3.1bn. By our math, that will fund 2013’s operating loss, working capital, and 2 years of capex.

 

Could This Really Happen?

While we model all our names out 3-5 years in full detail (3-years is our TAIL duration), we never make an investment case based entirely on something that is likely to happen 5-years down the road. But for a name that looks so egregiously overpriced today on a negative earnings and cash flow base, we think it’s a must to at least understand the margin trajectory.

 

In the end, our model (which we’re happy to provide) gets JCP up to $3.15 per share in earnings (keeping in mind that JCP lost over $2 per share in 2012). Initially, that sounds outrageous to our ears. But we assume the following…

a)      JCP adds 100 shops per our models in the tables below.

b)      Sales per square foot only need to hit $166

c)      Revenue gets to $18.7bn, a level it saw in 2008.

d)      Gross Margins stay below 37% -- despite management’s 40% target.

e)      SG&A gets to 26% of revenue. It starts growing again in 2014, but is leveraged by comps in ‘14-‘17

f)       No financial deleverage.

g)      No NOL carryforward usage.

 

What kind of multiple is fair on those results – keeping in mind that it will be on a parabolic margin and earnings recovery. Perhaps 15x earnings, or maybe 6-7x EBITDA? That suggests a stock price of about $47. Yes..we know. 2017 is an eternity away. But let’s discount that back annually by 15% and we get to a price of $27 in a year, and then $31, $36, $41, and $47 for 2014-17, respectively. We know that’s trying to get real cute with price scenarios. But we want to illustrate what this company could look like if management executes on the shop rollouts and regains share that it handed off to competitors like Macy’s Kohl’s, Gap, Target, and off price apparel retailers.   

  

JCP: Sweet Emotion - chart1jcp1

 

JCP: Sweet Emotion - chart2jcp2

 

JCP: Sweet Emotion - chart3jcp3


MNST Q4 – Where do we go from here?

Coming into this evening’s earnings release, we had concerns that the company would disappoint versus consensus – those concerns were validated.  We like the category and we like the company, and we want to like the stock, but we still need to see 1H ’13 consensus come down a shade(2%).  Ultimately, we continue to believe that MNST’s superior growth profile isn’t being appropriately valued, in part because of ongoing regulatory overhang and in part because of weakness in the energy drink category in the U.S.



MNST reported Q4 results this evening, falling short of consensus on both the top and bottom line.  Revenue growth was 15.0% (versus 17.6% contemplated by consensus) while reported EPS of $0.39 was $0.02 light of consensus.

 

What we liked in the quarter (the good)

  • Sequential improvement in revenue growth versus a more difficult (420 bps) one year comp
  • Sequential improvement in EPS growth versus a more difficult (930 bps) one year comp
  • Sequential mitigation in gross margin declines against a marginally easier comp
  • Continued share gains by MNST in the energy drink category
  • Sustained strength in international sales (+29.6%)
  • Aggressive share repurchase by the company in the quarter

What we didn’t like in the quarter (the bad)

  • Continued year over year declines in the price per case (fourth consecutive quarter)
  • Weakness in the broader energy drink category

What else (the ugly)

  • Very difficult one and two year comps in 1H 2013
  • Pending adjustments coming out of this release, we remain below consensus for 1H ‘13

We continue to like the longer-term prospects for the energy drink category in general and MNST specifically, but this quarter’s results are precisely the reason we haven’t been as vocal as we have been in other situations – we prefer to see a clear path to EPS upside before we get excited about a name.

 

Call with questions,

 

Rob

 




Best Ideas: Bank of America

Bank of America (BAC) has substantially cleaned up its legacy mortgage exposures and the remaining costs associated with its housing exposure are finally quantifiable .  As housing improves at an accelerating rate, the bank’s credit quality will continue to improve, adding to the bottom line.  Finally, risks emanating from the housing bubble and the financial crisis are largely either behind the company, or baked into the stock price.  Steiner sees BAC as the best play on strong housing among the major financial institutions. 

 

As the financials sector emerges from crisis mode, BAC stock remains highly  volatile.  Investors tend to use price volatility as an indicator of a company’s fundamental stability.  Steiner believes observers are discounting key ratios that are standard factors in the analysis of financial companies, based on a fundamental misunderstanding of current risks.

The banks hold more tangible capital today than they have in many years – in some cases, more than they ever held.  Paradoxically, the market is using historical cost-of-capital calculations at a time when the whole risk profile of the sector has changed.  Banks – BAC in particular – hold lots of capital.  Tangible equity capital – not “risk-weighted capital” – is hard to manipulate.  

 

Investors remain focused on the risks of leverage – the excesses that brought down the system.  But Steiner points out, capital is the inverse of leverage.  High levels of capital equals low levels of risk.  Steiner says the market continues to charge a high-risk cost of capital at a time when risk is lower than it has been in many years.

 

Steiner believes the decline in volatility will dramatically reduce BAC’s cost of capital computation.  Investors should also see a significant improvement in the bank’s margins and, as volatility declines, will change the way they account for risk.  Steiner thinks this Best Idea has the potential to return 100% over the next one to two years.


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TRADE OF THE DAY: ITB

Today we sold our iShares Dow Jones US Home Construction ETF (ITB) position at $22.55 a share at 10:48 AM EDT in our Real-Time Alerts. We originally bought ITB at $22.17 a share on February 20, 2013. After an outstanding week of US Housing data, booking our 6th consecutive gain on the long side in ITB on an immediate-term TRADE overbought signal. We remain Bullish on #HousingsHammer.

 

TRADE OF THE DAY: ITB - image001


CRI: Eye On Capital Intensity

Takeaway: We liked the CRI print, but we don’t like the change we’re seeing in capital intensity. The movements are severe and could impact returns.

Conclusion: There were puts and takes in the CRI quarter, but the major standout to us is the change that we’re seeing in the capital intensity of the model. The colossal rise in capex and spike in SG&A ups the ante for the well-telegraphed ‘14% EBIT Margin’ bull case we need to see come to fruition in order to prevent a decline in returns. If this happens we think you’ve got 16-17x $4.25 in EPS in 2015, or a 8-10% annualized return on a number that you have to wait 3-years to see. If our concerns about pricing spreads and high cost/low return of international growth play out, we think CRI has downside to about 13x on $3.00, or $15 downside over the next year. Capital deployment shorts don’t play out overnight, but at a minim we’d avoid the long side of this name. There are far better places to be in our opinion.

 

DETAILS 

Obviously the market doesn’t like the CRI print today, and we agree. But we think we don’t like it for different reasons. The stock started to trade down just as CEO Casey mentioned that 1Q to date showed negative comps in Carter’s stores. While that’s not good, we think a bigger negative was the change in tone regarding capital allocation and margin makeup.

 

Harvesting Is Over: We think CRI is entering a meaningfully different stage in its investment cycle. The way we see it, it just made its second international acquisition in 18 months, it is bringing its product sourcing from 20% of total today to 50% in 5-years, it just took SG&A up 40% in the latest quarter on top of a 14% sales growth rate, and management noted that GM upside (ie pricing better than costs – something it has sparse control over) will need to happen in order to offset higher planned costs. Furthermore, capex in the coming year is slated to be $200mm. As a frame of reference, this is 4x the rate of Carter’s D&A, and it has never spent even half that much in a given year (even as a % of revenue) in all the years it has been public.

 

Don’t get us wrong. We like when companies spend money – at least those who prove to be good stewards of capital and drive returns higher through share subsequent share gain or margin improvement. But CRI is simply unproven in that regard. We’re not saying that it will fail. But rather that you need to believe that it will succeed in order to buy the stock here.

 

The ‘14% margins due to direct sourcing’ bull case is very well telegraphed. If we assume that the company gets there within 3-years, we’re looking at about $4.25 in earnings power. That’s a great lift over the $2.86 it printed last year and $3.28 it is guiding towards in 2013. But with the stock at $55, you’re paying 12-13x a best-case earnings number that may or may not happen in 3-years.

 

In the interim, there are some puts and takes.

International is clearly growing, US Carter’s retail is still putting up mid-teens square footage growth, and dot.com is growing nicely – up to 18% of store sales in this quarter vs 11% last year. The new DC should keep this heading higher.

 

On the flip side, we remain concerned about more normalized product costs and increased competition by both retail partners and competing brands alike. In addition, while International is nice, it’s definitely not a slam dunk.

 

a)      Bonnie Togs comping down only 2-quarters after it is included in the comp base.
 

b)      The new dual-brand stores in Canada are launching, but are not proven yet.  
 

c)       Just after CRI anniversaries the Canada acquisition, it’s investing capital in the last place we want to see incremental money put to work – Japan. For a luxury brand (like Kate Spade, Kors, or Ralph) perhaps that makes sense, but not for a kids mass apparel maker. Also, keep in mind that the dominant brand for CRI in Japan is Osh Kosh, which it has a hard enough time growing in the US nevermind Japan. The opportunity is for the for Carters brand, but Japanese Moms are not US moms. It will cost money to build that opportunity. 


Have Stocks Conquered Commodities?

Since we moved in to #GrowthStabilizing territory in mid-November of 2012, we've been a proponent of the long US stocks/short commodities game plan as the great commodity bubble created by the Federal Reserve deflates. Over the last three months, the S&P 500 has gained +7% while the CRB Commodities Index has dropped -1.1%. 

 

Have Stocks Conquered Commodities? - CRB SPX


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