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DKS: Value Trap -- Even After Getting Lanced

Takeaway: DKS is entering a period where margins will tread water while asset turns back-peddle. That's not a recipe for the stock to go up.

This note was originally published March 11, 2013 at 15:40 in Retail

 


A few people have asked us today as to whether we think that the DKS stock price reaction is overblown. If anything, we think it’s underblown (if that’s not a real word, now it is).

 

This has nothing to do with missing the flow of cold weather patterns or getting ‘Lanced’ by its stagnant inventory of Livestrong treadmills. But rather, it is a company in a mediocre business that is running at peak margins at a time when the outlook for comps (low single digits) is below the rate needed to leverage occupancy, deferred investments on the P&L are eating up an incremental 5% of earnings this year, and capex is trending up an incremental 20%.

 

Furthermore, let’s not forget that DKS falls into the bucket of names that has high risk of share loss to dot.com competitors and brands’ direct growth initiatives, and at the same time we see the company openly admit that it has underinvested in the infrastructure needed to take its ecommerce platform to the next level.

 

We get the whole point about DKS being a ‘best in breed’ retailer. But this is not necessarily a breed that needs to be owned.

 

We think that the crux of where DKS is in its cycle can be summed up in the Profitability Roadmap below, which shows the progression of margins vs. asset turns. Retailers, as we all know, can improve either one of those at any given point in time, but it’s when they improve simultaneously that real value is created and the stocks outperform materially (0.92 performance correlation). This is exactly what DKS did from 2009 through 2011, and it accounted for a 4-bagger in the stock.

 

But today, we think that we’re stuck at a point where margins will tread water, and it will be on an incrementally larger operating asset base. That is the ultimate recipe for a value trap.  

 

DKS: Value Trap -- Even After Getting Lanced - dksprrdmp


Beautiful Rage

Client Talking Points

Watch the Dollar

There are a lot of folks out there who simply hate this market, but the reality is that if you are raging against this market, you’re missing one of the most impressive four-month changes in Asian and US growth prospects that we’ve seen in nearly a decade. A strong currency, if sustained, is a pro-growth signal. So the key here is to watch whether or not the dollar remains strong.

Asset Allocation

CASH 32% US EQUITIES 20%
INTL EQUITIES 24% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 24%

Top Long Ideas

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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

“The question is (in my prime) who looked better in cutoff jean shorts – me or @KimKardashian?” -- @KeithMcCullough

QUOTE OF THE DAY

“…fraught with arbitrary and capricious consequences.” – Manhattan Supreme Court Justice Milton Tingling on striking down New York city’s soda ban

STAT OF THE DAY

$6 million, the salary the Baltimore Ravens wouldn’t pay receiver Anquan Boldin, who they traded to San Francisco


MCD GLOBAL SLOWDOWN TEMPORARY?

Takeaway: McDonald’s same store sales growth slowed last month. Will this trend last?

This note was originally published March 11, 2013 at 12:08 in Restaurants

 


MCD reported February global same-restaurant sales growth of -1.5% versus consensus of -1.6% (not adjusting for the calendar shift).  While calendar shifts are material for monthly headline numbers, the trend in McDonald’s comparable sales growth is unmistakably negative.  In five of the last eight months, McDonald’s has reported flat or down same-restaurants sales growth.  This is the longest sustained slowdown in sales trends since the company’s historic “plan-to-win” turnaround. 


This begs the question: can McDonald’s maintain its long term system-wide sales and operating income growth targets of 3-5% and 6-7%, respectively?

 

We remain skeptical that this slowdown is macro-driven; it seems evident that there are company-specific issues that are yet to be addressed by management.   Below, we update our thoughts on the various geographies.

 

 

Conclusion

 

There is nothing in the currents sales trends or in management communicated turnaround strategies that would cause us to reverse our negative stance on MCD.  We still believe MCD will see flat-to-low single digit EPS growth in 2013.  The emphasis on value has boosted MCD SRS growth in recent months, but history has shown that this strategy is not effective over the long term.  In fact, it externalities of this approach can impede sustainable earnings growth over time as operational complexity increases. 

 

The macro environment is challenging for a number of companies but the changes in McDonald’s long-term trends suggest that there are company-specific issues at play.  The current guidance for food inflation suggests that 2013 will not be as big an issue for MCD as in 2012, but the risk of upward revisions remains high.  Operating margins around the world are likely to continue to be pressured by sales deleveraging and incremental development costs.   

 

Our macro team retains its bullish view on the USD which would be a headwind for MCD Earnings, given its FX exposure.

 

 

MCD U.S.

 

February comparable sales growth for the domestic market was -3.3%, or flat excluding the segment’s calendar shift, versus consensus of -3.6%.  Sales were better than expected despite choppiness in consumer spending trends.   February represented the most difficult comparison for MCD in the U.S.

 

Detail:

  • Fish McBites were introduced
  • Heavy focus on the Dollar Menu continued
  • Several lower-performing items were dropped from the menu, including the Fruit  & Walnut Salad and Chicken Selects.  We expect McDonald’s to drop the Angus Burger in the near future
  • Monthly SRS have held up on the back of incremental value message promotion, but this is not a sustainable trend
  • Extended hours are not driving incremental sales
  • The $6-7 casual dining lunch price point of $6-7 is competitive with MCD core menu items at lunch

MCD GLOBAL SLOWDOWN TEMPORARY? - mcd long term SRS US

 

MCD Europe


Europe comparable sales growth came in at -0.5%, or +2.7% excluding the calendar shift, versus -0.4% consensus. 

 

Detail:

  • Russia and the UK continue to generate positive same-restaurant sales on the back of extended day parts and it appears that the horsemeat scandal may not have significantly impacted UK trends
  • German and France continue to experience declining sales and traffic trends, despite continuing messaging around value platforms
  • Margins in Europe are under pressure and will likely Margins in Europe are under pressure and will likely continue to contract in FY13 as sales growth remains under pressure in the region
  • The boost from reimaging is likely to diminish over time as almost all of the interiors and half of exteriors in the region have been completed

MCD GLOBAL SLOWDOWN TEMPORARY? - MCD long term SRS EU

 

 

MCD APMEA


Asia/Pacific, Middle East and Africa (APMEA) February comparable sales growth decreased -1.6%, or +1.5% including the segment’s calendar shift, versus consensus of  -1.5%.

 

Detail:

  • Australia continues to deliver positive SRS growth, while China benefited from the timing of Chinese New Year
  • Japan trends remain soft with February SRS trends of -12.1%
  • Average check at MCD Japan improved but traffic continued to decelerate, declining -10.9% year-over-year, versus the -8.1% decline in January.
  • Given the seemingly secular deceleration in Japan and the difficult environment in China, APMEA is also likely seeing continued margin pressure
  • What ideas, beyond value, are being put forward to improve the APMEA business?
  • Almost 2/3 of markets offer extended hours of some form and over half are open 24 hours.  This spigot is slowly closing from an incremental sales growth perspective.

MCD GLOBAL SLOWDOWN TEMPORARY? - MCD long term SRS APMEA

 

Howard Penney

Managing Director

HPenney@hedgeye.com

862.217.9429

 

Rory Green

Senior Analyst

RGreen@hedgeye.com

 

 

 


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Morning Reads from Our Sector Heads

Takeaway: Here are some items that caught our analysts’ attention today.

Consumer Staples sector Rob Campagnino looks at the weighty issue of the soda ban in New York.

http://online.wsj.com/article/SB10001424127887323826704578354543929974394.html

 

 

Our gaming, lodging and leisure team is reading about some management issues potentially affecting one casino.

http://online.wsj.com/article/SB10001424127887324096404578354613754829562.html

 

 

Our energy team is reading about Southern Pacific.

http://shpacific.com/en/news/stp-2013-03-11.pdf


YUM CHINA BETTER THAN FEARED

February comparable sales grew +2% in Yum!’s China division.  Consensus was expecting -8.8%.  This release is spurring optimism that the worst of the fallout from the chicken supply scandal in YUM’s largest market may be in the rear view mirror.

 

 

Sequential Improvement

 

Yum! Brands reported 1Q China comps of -20% versus consensus -24%, including KFC -24% and Pizza Hut -2%.  February was a driver of sales growth with comps growing 2% versus consensus -8.8%, suggesting sequential improvement through the quarter.  A timing shift related to the Chinese New Year had a positive impact in the mid-teens.  KFC comps were flat in February while Pizza Hut comps grew 13%.

 

 

Full-Year View


We stepped back from our bullish stance on the immediate- and intermediate-term durations on February 4th, publishing a note titled, “YUM GUIDE DOWN A GAME CHANGER”, citing a lack of visibility on same-restaurant sales growth.  The long-term growth story has remained intact through all of the volatility.  Yesterday’s release suggests that the fallout from the chicken supply scandal may be abating with time as YUM’s PR machine has gone into overdrive to regain consumer trust.  We will wait for further confirmation on the near-term duration, but this gives us confidence that the long-term upside for YUM shares represents an attractive opportunity for investors willing to look through near-term issues.

 

Our Sum-of-the-Parts valuation that we published late last year, as part of our Black Book titled, “YUM: BEST LARGE CAP OUTLOOK FOR 2013”, suggested a twelve month upside to the 11/29/12 share price of 20% to $89.  While not for the faint of heart, we believe that YUM still represents compelling value over the long-term TAIL duration.

 

Please reply to this email for a copy of this Black Book.

 

 

Quantitative Setup

 

Our CEO, Keith McCullough, sees the stock as breaking out of an important base.  Intermediate-term TREND and long-term TAIL levels of support are at $66.41 and $65.07, respectively. 

 

YUM CHINA BETTER THAN FEARED - LEVELS QUANT YUM

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst


THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – March 12, 2013


As we look at today's setup for the S&P 500, the range is 31 points or 1.43% downside to 1534 and 0.56% upside to 1565.    

                                                                                                                           

SECTOR AND GLOBAL PERFORMANCE


THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

THE HEDGEYE DAILY OUTLOOK - 3

 

THE HEDGEYE DAILY OUTLOOK - 4

 

EQUITY SENTIMENT:


THE HEDGEYE DAILY OUTLOOK - 10


CREDIT/ECONOMIC MARKET LOOK:

  • YIELD CURVE: 1.78 from 1.80
  • VIX  closed at 11.56 1 day percent change of -8.18%

MACRO DATA POINTS (Bloomberg Estimates):

  • 7:30am: NFIB Small Bus. Optimism, Feb., est. 90.0 (prior 88.9)
  • 7:45am: ICSC weekly sales
  • 8:55am: Johnson/Redbook weekly sales
  • 10am: JOLTs Job Openings, Jan. (prior 3.617m)
  • 11am: Fed to purchase $1b-$1.5b TIPS due in 2017-2043 sector
  • 11:30am: U.S. to sell 4W bills
  • 1pm: U.S. to sell $32b 3Y notes
  • 4:30pm: API weekly inventories

GOVERNMENT:

    • House, Senate in session
    • Senate Banking Cmte holds hearing on Cordray, White, 10am
    • House Appropriations panel holds oversight hearing on SEC, 3pm
    • House Appropriations panel hears from Food Safety, Inspection Service Admin. Alfred Almanza at oversight hearing, 10am
    • All FCC commissioners testify at Senate Commerce Cmte’s oversight hearing on FCC, 2:30pm
    • National Transportation Safety Board meets to consider 5 Safety Alerts aimed at reducing number of general aviation incidents, 9:30am
    • Washington Day Ahead

WHAT TO WATCH

  • HP says Serious Fraud Office investigating Autonomy
  • SEC nominee White to face conflict questions at hearing
  • Cordray nomination at stalemate amid wait for court ruling
  • Citigroup added to team advising Dell buyout group: WSJ
  • Costco 2Q revenue $24.87b misses est. of $24.95b
  • GM share sale brought Treasury $489.9m in February
  • Roman Catholic Cardinals to begin election of new pope
  • U.S. accuses China of cyber espionage that threatens ties
  • Greece in talks with creditors to cut 150,000 civil servants
  • Yandex founders, investors to sell up to $607m of shares
  • Goldman among banks to get lower fees for Japan Tobacco sale
  • Galaxy Securities said to pick Goldman, JPMorgan for $1.5b IPO
  • Suntech gets 2-mth forbearance on $541m in bonds

EARNINGS:

    • Stage Stores (SSI) 6am, $1.15
    • FactSet (FDS) 7am, $1.24
    • Empire Co (EMP/A CN) 7:03am, C$1.15
    • Laredo Petroleum Holdings (LPI) 7:26am, $0.10
    • Raven Industries (RAVN) 9am, $0.25
    • Acadia Pharmaceuticals (ACAD) 4:01pm, $(0.09)
    • Dole Food (DOLE) 4:06pm, $(0.02)
    • Investors Real Estate (IRET) 4:30pm, $0.17
    • Kennedy-Wilson Holdings (KW) 4:33pm, $(0.08)
    • PetroBakken Energy (PBN CN) After-mkt C$0.13
    • Black Diamond (BDI CN) After-mkt C$0.31

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

  • WTI Halts Three-Day Advance on Supply; Chinese Refining Declines
  • Gold Sales From Soros Reveal 12-Year Bull Run Decay: Commodities
  • Soybeans Drop on Signs Brazil Is Gaining Market Share From U.S.
  • Gold Futures Advance to Highest This Month on Technical Buying
  • Copper Rises to $7,762 a Ton in London Trading, Erasing Decline
  • Europe Copper Premium Seen Dropping for Second Month by Traders
  • Oil Supplies Climb to Eight-Month High in Survey: Energy Markets
  • Cocoa at 1-Month High as Prices May Have Bottomed; Coffee Slips
  • Gold in India Heading to Lowest Since May: Technical Analysis
  • Ships Reject Unprofitable Cargo to Halt Slump in Rates: Freight
  • Arabica-Coffee Premium Versus Robusta Falls to Lowest Since 2009
  • Europe Gas Carnage Shown by EON Closing 3-Year-Old Plant: Energy
  • Crop Price Ratios Can Foreshadow Crop Planting Decisions
  • Wall Street $100 Million Man Makes Downton Abbey in Vermont Town

THE HEDGEYE DAILY OUTLOOK - 5

 

CURRENCIES


THE HEDGEYE DAILY OUTLOOK - 6

 

EUROPEAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 7

 

ASIAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 8

 

MIDDLE EAST


THE HEDGEYE DAILY OUTLOOK - 9

 

 

The Hedgeye Macro Team

 

 

 

 

 

 


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