JCP: Our Take On The K

Takeaway: The good outweighs the bad in JCP’s 10K disclosure.

The good outweighs the bad in JCP’s 10K disclosure. Here are some key points.

  1. Commented that the letter it received from bondholders (that one the people speculated was from Icahn to back Ackman into a corner) claiming JCP had defaulted on its commitment has been rescinded. A default would have caused a chain reaction with other tranches of debt, and potentially caused a major liquidity event. That risk is now mitigated.
  2. Capex for 2013 is coming down to levels on par with 2012. That frees up about $200mm in our model, and of course, in JCP’s liquidity. We like this change, because quite frankly – JCP spending $1bn (even with its remodel program) borders on ridiculous.
  3. Pension expense (non-cash) to decline in 2013 by about 40%. On top of that, expected rate of return is down to 7% from 7.5%.
  4. On the negative side, JCP added risk factors of chance of non-cash asset impairment charges, and potential limited use of NOL carryforwards. Not good, and we’re curious as to why there would be a limit in the ability to use NOLs. But the end result is that this not a disaster.  
  5. There was also a comment on change in strategy could take longer. JCP had to do that given that a) it is starting to be promotional again and does not know the full impact. And 2) the Martha Stewart trial is in limbo, and JCP might have to change to alter the scope of the product in the event of an adverse outcome.
  6. One credibility point is that the company noted that it ended the year at 116,000 employees, that’s 27%, or below a year ago. On one hand, that represents major progress in JCP's restructuring.  On the flip side, it’s more than 2x the number of people Ron Johnson said had lost their job when he testified under oath earlier this month at the JCP/M/MSO trial. The year-ago number was likely inflated due to a higher number of seasonal employees on the books on the final day of the prior year – so the figures could likely be dissected many different ways. But either way, Johnson haters will use this as a knock on his credibility.
  7. There was no commentary on 1Q performance, but we caution that we still need to get past what will likely be an abysmal 1Q performance (25% of square footage will be under construction) before we start to see improved productivity from the new shops that get put in place in May.


When all is said and done, we think the good outweighs the bad. We still think anyone with an immediate-term investing horizon shouldn’t look at JCP as a long, but that it will turn in 2H13.


Takeaway: Labor conditions continue to chug ahead. This is both causing, and being caused by, housing's rally.

Labor Market Strength Shows No Signs of Deterioration

The optical (i.e. SA) claims number was slightly better than expected in spite of rising nominally WoW. Our focus is on the trends in the NSA data, where we saw further acceleration in improvement in the latest week. This past week, the rolling NSA (non-seasonally adjusted) initial jobless claims improved by -7.5% YoY as compared with improvement of -5.6% in the previous week. What this signals is that the real labor market is experiencing accelerating improvement, and this has been the case for the last six weeks. Refer to the second chart in this note for additional perspective. We think it's also worth noting that the trajectory of 2013 is now mirroring 2012 with a nearly identical slope of +16 bps (vs +14 bps in 2012). This is the strongest leading indicator for housing trends, lender credit quality trends and loan growth trends. Moreover, it raises expectations of the Fed backing off, which pushes the long end higher, alleviating pressure on margins.


On the SA (seasonally-adjusted) front, the numbers also looked good. This is what the market is paying attention to. As a reminder, the SA data is now facing a small, but growing headwind over the coming six months. The first chart in the note tells the story well. 


The Data 

Prior to revision, initial jobless claims rose 4k to 336k from 332k WoW, as the prior week's number was revised up by 2k to 334k.


The headline (unrevised) number shows claims were higher by 2k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -7.5k WoW to 339.75k.


The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -7.5% lower YoY, which is a sequential improvement versus the previous week's YoY change of -5.6%






























Yield Spreads

The 2-10 spread fell -5.0 basis points WoW to 171 bps. 1Q13TD, the 2-10 spread is averaging 168 bps, which is higher by 25 bps relative to 4Q12.







Joshua Steiner, CFA

Monster Beverage: Drink it Up?

Takeaway: Monster is changing how it classifies one of its products. That doesn't change our opinion on the stock.

Monster Beverage Corp (MNST) announced Wednesday they will market their caffeine-laced product as a “beverage,” not as a “dietary supplement.”  This does nothing to alter our bearish take on the company.  Additionally, our estimates for first-half earnings remain below Street consensus.   


Dietary supplements are regulated by the FDA.  But so are foods? you ask, and you are right.  Because of the way the FDA categories are drawn, makers of energy drinks have flexibility to define their products as either “supplement” or “food.”  One perceived benefit of being a Food is that makers of Supplements are required to report adverse consequences of product use to the Agency.  Such notification is purely voluntary for makers of Foods.


Health Concerns


But MNST can’t get itself out of the crosshairs just by changing category.  The national Drug Abuse Warning Network (DAWN) gathers hospital statistics on adverse reactions to substances, regardless of FDA classification.  DAWN statistics around caffeine-based products – not to mention lawsuits against the manufacturers – present an ongoing image problem for MNST.  The decision to become a Food doesn’t address this.


What Can MNST Do?


We would like to see MNST get out in front of regulatory developments by taking two steps: disclosing caffeine content, and staying away from advertising that is targeted at consumers under 18 years old.  We believe both of these are likely to be mandated soon, and voluntary action now could give MNST a leading voice in the debate surrounding this segment.




We don’t like MNST any better than before this announcement, and we’re not convinced this move raises their profile.  If the company follows up by putting itself at the head of the debate, they will have accomplished something concrete – though perhaps still not enough for us to turn bullish, given our dim view of near-term earnings.




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GES: No Process, No Multiple

Takeaway: Fashion companies that blame misses on the economy don’t get big multiples. Even with a sell-off, this is a value trap,

This note was originally published March 20, 2013 at 21:31 in Retail

Conclusion: We’re not at all surprised by the big guide-down at Guess (GES), as it’s been on our short list for the better part of a year. We knew this one was overearning, and guidance around margins was like a balloon being held underwater while interim management manufactured earnings sufficient to keep the stock afloat. That said, we wish we’d been louder about this potentially being the quarter where the balloon bursts. The good news is that management has not yet capitulated with its guidance. Earning the lower end of the $1.70-$1.90 guidance is optimistic at best, and if it gets there it will be through cutting costs that arguably should be reallocated to other areas of the business. Our point is that even with the stock trading down, we still like it on the short side. We think GES has 2 to 1 downside/upside.


The way we look at it, the Guess? brand is stalling in all but a few markets, the executive suite has a revolving door (losing 3 key executives in 5 months – two on the same day), and the only real bull case revolves around this being cheap on a more ‘normal’ earnings base of $3+ that it earned over each of the past two years. At $26, we might concur with the ‘cheap’ part, but unfortunately, the premise that GES can ever earn $3 again without significant capital investment (i.e. taking earnings down first) is wishful thinking. Carlos Alberini – the best thing that ever happened to GES -- left for greener pastures (Restoration Hardware) knowing that he was leaving peak earnings power in the dust.


We think that $3 will prove about elusive as Bigfoot, and until then you’re left with an annuity earnings stream of something closer to $1.50-$1.60. What’s a zero-growth earnings stream worth? Whether we use a no-growth retail multiple of 10-12x, or capitalize by a 10% cost of equity (we hate arbitrarily picking cost of equity, but 10% is probably close). Either way a mid-teens stock is not out of the question.


Not only would we argue that it is currently expensive on the real earnings power of the company (16-17x the $1.50 we think GES should earn), but there is literally nothing in place to get the brand momentum moving upward again.


One thing that’s important to consider is that it's 2/3 of GES’ business that is causing the problem – and that’s North America Retail, and Europe. Unfortunately, the company is blaming the economy – again. GES needs to understand – as we do – that investors absolutely have zero tolerance for a management team that does not have a process to drive its business in the face of a downturn in the economy.  Is Ralph Lauren complaining about the economy? No. It’s growing its top and bottom line by driving its brand across product, channel and customer categories in a synchronized way. Guess, on the flip side, is really good at making excuses.   


In the end, we think we’ll need to see new blood in the executive rank at GES who will then need to fight for – and win – the right to reinvest capital into the business to better stratify the brand and build an omnichannel strategy accordingly. We’d definitely put GES in the bottom quartile with its abilities in those areas. Until then, it’s a value-trap in the mid-$20s. We think best case upside is $30 on manufactured earnings upside through misplaced cost cuts. On the downside we think you've got $15 based on math above.  



GES: No Process, No Multiple - gessinga

Mixed Messages

Client Talking Points

Mixed Signals from Asia

Two major markets in Asia went in distinctly different directions overnight. In China, flash PMI for March, an indication of overall manufacturing conditions, strengthened and the Shanghai Composite index remained bullish on TRADE and TREND durations. In South Korea, though, the Kospi is now bearish on TRADE and TREND durations.

Mixed Signals from Europe, Too

In Germany, manufacturing PMI for March slowed to 48.9 from February’s reading of 50.3, but the Dax held its TRADE and TREND support levels. Meanwhile, France’s March PMI plunged, and that snapped our TRADE support level.



Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Darden stands to be a beneficiary from a housing recovery and an improved employment picture, which boosts casual dining trends. Also, another earnings guide down could lead to management or strategy change, which is bullish for the stock.



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.


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.

Three for the Road


“Math is a beautiful thing.” -- @codertrader





“The greatest obstacle to discovery is not ignorance – it is the illusion of knowledge,” – Daniel J. Boorstin


27, the number of points that the Miami Heat trailed the Cleveland Cavaliers last night before storming back and winning their 24th straight game

Stomping Tom

This note was originally published at 8am on March 07, 2013 for Hedgeye subscribers.

“Hello out there, we're on the air, it's 'Hockey Night' tonight.
Tension grows, the whistle blows, and the puck goes down the ice.
The goalie jumps, and the players bump, and the fans all go insane.
Someone roars, "Bobby Scores!" at the good old Hockey Game.”

-Stomping Tom Connors


It is a sad day back in my home country of Canada.  Iconic Canadian singer Stomping Tom Connors passed away from natural causes.  For those that were born south of the 49th parallel, his name is probably not all that familiar, but in Canada his songs are unofficial national anthems.


I know, I know only Canadians would idolize a singer that called himself Stomping and sang about hockey.  To be fair, Connors also sang about more complex topics like potatoes (Bud the Spud) and Saturday evenings in small Canadian outposts (Sudbury Saturday Night).  On some level this simplicity is the beauty of Canada, although one does have to wonder what would be worse – listening to Stomping Tom on repeat for 12 hours or a 12 hour Rand Paul filibuster.


As many of you know, one of Canada’s most significant industries is mining.  Our Industrials Sector Head Jay Van Sciver will be presenting his in-depth view of the global mining and construction sector on March 27th in a black book presentation.  We will circulate the information closer to the date.  The most controversial name in this sector is Caterpillar Tractor (CAT).


A primary reason we are negative on the global mining sector, and CAT in particular, is simply reversion to the mean.  Mining companies have dramatically over spent for the last decade, as highlighted in the Chart of the Day, and as much as some sell side bankers would have you believe otherwise - mining is not a growth industry.  Margins will revert to the mean, spending will revert to the mean, and so too will capital investment.  After all, cyclicals are cyclical.


Switching gears, between Keith and myself, we have been on the road for the better part of the last month from London to San Francisco, and most spots in between.  If there is one consistent theme, it is that most large investors are still very cautious as it relates to equities.  Now I realize this is anecdotal, but it has been a striking observation for us. 


In that vein, as I was reviewing the New Tape (aka Twitter) this morning, I noticed this tweet from Ralph Acampora:


“This is still the “most hated” bull market I have ever seen in my close to 50 years in this business.  This disbelief is very bullish.”


I don’t know enough about Ralph’s history to know whether he has a good record of forecasting stock market direction, but I do think that tweet was apropos and consistent with what we are seeing and hearing.


A key theme underscoring our relatively bullish call on the U.S. economy and U.S. equities has been what we call #HousingsHammer.  In effect, this is the idea that home prices will improve not at a linear pace, but at a parabolic rate.  This was a thesis developed by our Financials Sector Head Josh Steiner and we continued to see support in this week’s Core Logic numbers.


Corelogic released its January home price data Tuesday morning as well as its early look at February 2013. The data was very strong. January 2013 saw home prices rise +9.7% YoY, which was upwardly revised from the preliminary estimate for January one month prior of +7.9%. The preliminary estimate for February is that prices rose +9.7% YoY, unchanged vs. January.


Excluding the distressed segment of the market, the story is more bullish. January prices for the non-distressed market rose +9.0%, which was up materially from the +6.7% increase in December 2012. Interestingly, the early read on February prices shows the non-distressed market up +11.3%, a sequential acceleration of 230 bps. So in two months, the rate of appreciation on non-distressed homes has accelerated 460 bps.  This is what we call a parabolic recovery.


In our models, housing is a critical variable to the U.S. economy because more than 70% of the U.S. economy is driven by consumption.  In a paper last year, Charles Calomiris, Stanley Longhofer, and William Miles found that the wealth effects from housing “vary depending on whether the homeowner is old or young, poor or rich—but their overall estimate is that a dollar of extra housing wealth triggers five to eight cents in additional spending.”


On a high level, the math is compelling in terms of the housing benefit to GDP.  If we assume there are 75 million owned homes in the U.S. and the average price is $175,000, then that is a total housing stock value of $13.1 trillion.   That value of that housing stock would increase by $1.3 trillion if home prices are up 10% this year.  Assuming the midpoint ($0.065) in the study above is accurate, the appreciation in home value at 10% this year will lead to an incremental $85 billion in consumer spending. On a GDP base of $15 trillion this is an incremental tailwind tail wind of 0.6% growth.


Clearly, these are all rough numbers and estimates, but we do feel very good about the fact that the home price appreciation will continue to accelerate and this will be additive to consumer spending.  Given that Bloomberg consensus for 2013 U.S. GDP growth is 1.8%, an additional 0.6% could very well lead to an actual GDP number that “stomps” the consensus estimates.


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1559-1589, $109.01-111.98, $81.88-82.66, 91.89-94.69, 1.91-1.97%, 11.91-15.18, and 1519-1551, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Stomping Tom - Will MIners stomp capex


Stomping Tom - vp 7

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