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RH: #confidence

Takeaway: Several near-term risks were mitigated this qtr. In addition, we're taking up our 'already high' long-term growth forecast. 2 yrs = $60.

RH’s $0.02 ps beat far understates the significance of the company’s earnings report. After running the numbers and listening to the call, we walked away with the following thoughts:


1)      Confirmation that this management team is executing on one of the most intriguing business opportunities in retail. Comping 26% on top of a 22% in the same quarter last year, and that’s before the launch of new businesses like Tableware and Objects of Curiosity.


2)      Not only is the Design Gallery pipeline robust, but management seemed to have a (borderline odd) epiphany that it could open significantly larger stores with far more favorable rent structures than previously anticipated. Given that increased furniture sales will put a natural damper on margins over time, lower occupancy hurdles are a nice offset.


3)      We made a rather significant change to our model, in that we took the average size of a Design Gallery up from 25,000 square feet to nearly 35,000 over the next three years. The Boston store, for example, is nearly 50,000 square feet. With a weighted average of 35k sq feet and our estimate of 15 Galleries by the end of 2015, it gets us to weighted average square footage growth of 15% by that time period. The interesting element here is that bears (and even common logic) will say that current comp trends will roll, and over 2-3 years we’ll be looking at a stabilization in sales/square foot trends. With that being the case, the acceleration in square footage still drives 15-20% top line growth through this model. We think that’s the biggest part of this story that people are missing.  


4)      Find us a company that is taking UP expectations for both revenue and earnings for the upcoming quarter and year. It would have been easy enough for them to give initial guidance right in line with existing estimates. #confidence.


5)      De-risking Sentiment. Like it or not, sentiment is a major factor with this stock. We’ve been positive on the name since the IPO, and when we bring it up with investors it’s pretty clear to us that it’s not too far from JCP as it relates to being hated. The two most common reasons. 1) There’s not enough float. 2) The company is probably going to do a secondary (that probably explains why 1.4mm shares of the 4.2mm float is short). That’s ironic when you think about it. Half the people don’t like the lack of float, and the other half don’t like the one event that could fix the ‘small float’ problem.

Regardless, there are three things that happened this quarter that we think de-risk sentiment and improves ownership characteristics for RH.

  1. First, simple as it may be, the fact that RH finally ended what may be the longest quiet period in modern retail history is a positive. Other retailers are getting ready to report 1Q in 3-4 weeks, and RH is just getting out its 4Q numbers. It’s been a black hole of info, and it has not helped sentiment one bit. That’s over.
  2. IPO-related charges are out finally known, booked, and out of the way.  They made financial modeling a bear – and now that’s no longer an issue.  
  3. While we usually could care less about company guidance, the fact that RH issued quarterly and annual guidance is a massive positive for a levered and newly public company like this.

The reality is that so many people have had zero appetite for the name given such little float, funky accounting, no guidance, and such a huge delay in the earnings report.  The 4Q print ameliorated many of these concerns.


In the end, this remains one of our favorite longs. Its so rare to find a defendable high-end brand with such an obvious, yet fixable, distribution problem. Having stores that are only large enough to showcase 20-25% of the company’s product is like having a fleet of Ferraris and only a two-car garage. This is the one instance in retail where bigger stores is not only a positive, but it is a necessity. As these stores grow, the company can scale into new categories (kitchen, kids, art, flooring, art, collectibles, textiles, etc…), and subdivide existing ones  to drive productivity.


We think that the earnings guidance of $1.29-$1.37 for the year will prove conservative by at least 10%, and ultimately this is a company with $3 in earnings power over 3-years.  If that’s right, we’re looking at over a 20% CAGR in EPS, which makes 20x $3 in the realm of possibility. Granted, that is by the end of 2014, so there’s some time to go. But until people start to realize this potential, we’re not concerned about the stock being expensive. 

FDX: Is Canada Always on Top or Just America’s Hat?

Takeaway: Today's move shows an strong grasp of old news. Valuing Ground & Express separately shows the restructuring call option in FDX shares.

FDX:  Is Canada Always on Top or Just America’s Hat?



The FDX downgrade this morning shows an excellent grasp of old news.  In mature, cyclical industries, if one is buying on good news and strong data, one is probably making a mistake from a longer-term perspective.  It is precisely the weak margins at FedEx Express that got us interested in the shares last November. 


We think FDX can improve its Express margin over the next few years, in much the way DHL recently did and to a level near what UPS has.  We also think that investors will price the expectation for continued margin improvement into FDX shares should the restructuring show progress.  We believe FDX’s market price currently reflects only the value of FedEx Ground.  Each FDX share provides a free call option on the success of the FedEx Express restructuring, in our view.  That is an option we want. If we are wrong, and we could be, the downside looks limited from current levels.




  • Product Trade Down:  The mix shift to lower cost products has been going on for quite some time.  It is good they finally noticed.  As we pointed out in our November 2012 Express & Courier Services deck, the cycle in high value transports relates to economy-wide inventory levels.  Slack inventories slow shipping, since no one pays to express goods that are already sitting in inventory.  Express services peaked in ~2005 amid the tightest inventories of the post-war period, and we believe it is at or near a trough now (hence the title of our deck “When Will Then Be Now? Soon”). 
  • Mix Shift Only Small Part of It:  The reality is that DHL and UPS are more profitable than FedEx in Express sevices with the current mix.  FedEx has company specific issues, which we believe are addressable.  DHL has already completed a successful restructuring from a much worse margin position than FedEx Express is in currently.  We do not see a structural reason that FDX cannot match competitors’ margins.
  • Mix Shift Makes Targets Harder?  Since the $1.7 billion in cost reductions are to be measured against this year’s run rate, mix shifts are in the base for the cost reductions.  Mix shifts probably lower the bar for gains, which everyone already knows, but do not make them harder to achieve.  If mix rebounds, however, it would actually make it easier to achieve the targets.
  • Mix Trend is Here to Stay?  If that is the case, then all packages eventually end up in the SmartPost channel.  That isn’t going to happen and faster delivery does add value.  Extrapolating the mix-shift trend is a facile approach that does not consider the origins of the shift.   Factors like fuel prices and ocean freight rates have actually been abating.  Inventories may well tighten from current levels in North America, where consumption-oriented economic activity appears to be improving.
  • International Express:   It is not news that FedEx Express needs to restructure its aircraft fleet.  It is a key component of the restructuring plan.  Removing excess capacity is a good thing.  There is nothing wrong with redeploying 777s if they are more profitably operated in a different channel.  If the late pick-up service offerings do not make money, they can be put aside until demand supports the product offering. 
  • Domestic Express:  This fixation on FDX’s two networks vs. UPS’ one network is odd to us.  FDX has a separate Ground network, in part so it can use independent contractors to dramatically reduce labor costs and take market share from unionized UPS for 12+ consecutive years.  FedEx Express is flying archaic aircraft and needs to rationalize capacity, facilities and labor.  That is not a 1 vs. 2 network issue, but it is the point of the restructuring and a component of our long thesis.  It is not as though UPS is delivering an overnight package from Boston to Seattle through its ground network and FedEx Express is barred from operating trucks. 
  • Risks in USPS Airlift Contract:  That UPS is bidding against FDX for the USPS air contract has been known for at least several quarters.  We even discussed it with the former head of the Postal Regulatory Commission last November here.  The contract was put out in July of last year, with the bid packages received around October.  UPS already has about 10% of the USPS airlift revenue (see USPS supplier table below).  The intertwining of the postal service and FDX/UPS is complex and there is a history of bad blood between the post office and UPS.  In government contracting, if a supplier is doing a good job, they are likely to keep most or all of a contract.  Otherwise, it can be more work and scrutiny for government employees.  That said, we do expect UPS to get a larger share of the contract and expect margins on the contract to come down.  We also expect an announcement pretty soon.  But the revenue at risk is likely less than 3% of FedEx Express’s total.  We do not think it is worth much attention relative to a prospective $1.7 billion margin expansion opportunity.  

FDX:  Is Canada Always on Top or Just America’s Hat? - usps


  • Fixed Cost Reallocation – WTF?   The complete loss of the USPS contract would obviously be a negative, but the full cost of that lost revenue would not be broadly reallocated to the rest of the Express division.  A quick perusal of the FY2002 10K for FedEx should ease any anxiety since 1) profit didn’t jump by a huge quantity as >$1 billion in costs were suddenly spread out over the USPS revenue and 2) the costs are identified as incremental salaries, fuel costs and other, mostly variable, factors.  Sure, there could be a charge associated with a partial or complete contract loss, but, in our view, the notion that there could be an ongoing $1.00 to $3.00/share loss associated with cost reallocation should not be presented and borders on moronic. 
  • Who Cares If They Cut $1.5 Billion Instead of $1.7 Billion?  Currently, FedEx Express’ value is not in the share price at all, in our view, as the FDX valuation can be explained by FedEx Ground alone.  If FedEx Express generated a couple of billion in operating income, shares of FDX would be revalued significantly, in our view.  Not that we value the company this way, but FDX currently trades at an EV/Sales of 0.64 while UPS trades at 1.53.  We believe the primary difference is that UPS’ Express revenue is vastly more profitable than FedEx’s.  That does not have to be so.
  • Why Would FedEx Lower Their Longer-term Guidance Targets?   FedEx has not reported a single quarter since the restructuring was expected to generate cost benefits. Further, restructuring is a multi-year affair. Forecasting a management reduction in targets based on something that has not started, especially from a position of inferior knowledge relative to company insiders and competitors, is, well, pretty aggressive.  The targets seem achievable to us, since DHL just did it and UPS already has it.  A discussion of competitors’ margins is notably excluded.
  • Where Do They Get These Multiples?  Why a 4.5 EV/EBITDA?  Who takes these valuations seriously?  The use of an aggregate, narrative fitting multiple is particularly tedious when a discourse on the disadvantages of FDX’s separate Ground and Express networks is followed by a failure to value them separately.
  • More Noise, Better Opportunity:  There is no new news on FedEx, but the shares are cheaper.  A single post-restructuring quarter has yet to be reported, but the street seems to have already decided the restructuring is a failure.  Will they change their minds if the restructuring is working by year-end, upgrading the shares at higher prices?  Haven't we seen that movie?
  • Our Take:  We think that FDX shares trade for what FedEx Ground is worth, leaving a free option on the upside produced by a successful FedEx Express restructuring imbedded in the shares.  The restructuring is a multi-year process, but one that is likely to succeed since management is focused on it, a competitor just did it and the industry structure supports it.  We think many have misread the Express cycle – loving FDX in 2005 at the peak and shunning it now (at a lower price) near a cycle trough in 2013.  In short, we think FDX is a straight-forward long, but apparently one that requires a strong stomach for both broker research reports and market volatility.



Today we shorted Carnival Cruise Lines (CCL) at $33.52 a share at 10:03 AM EDT in our Real-Time Alerts. Carnival bounced off an oversold low, but remains in a bearish TREND view per our Cruise Line specialist, Felix Wang.



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McDonald’s is set to release March sales, along with 1Q13 earnings, tomorrow before the market open. Expectations are muted for March comparable sales but we believe the back half of the year is where there is most potential for a disconnect versus expectations. The stock has broken higher from $85 with no supporting increase in earnings estimates. The 1Q13 consensus estimate of $1.26 or 3% EPS growth looks aggressive but the company has many levers to manage the number. We will be hosting a call on April 25th to go through our bearish stance on MCD FY13 EPS versus expectations in more detail.


The company reported February sales on March 13th and, since then, MCD has outperformed the market by 340 bps. We continue to believe that the stock is ahead of the company’s fundamentals, with little upside to earnings for 2013 leaving the multiple embedded in the stock stretched.


Specific to the earnings release, we will be focused on the following:

  • Any update to 2013 guidance (sales, costs, reimaging, FX)
  • US comp in April
  • Commentary on competition in the QSR segment and MCD's value push


The charts below illustrate what we believe the investment community will perceive as good, bad and neutral results for the US, Europe, and APMEA March sales.


MCD SALES PREVIEW - mcd us comps


MCD SALES PREVIEW - mcd eu ocmps


MCD SALES PREVIEW - mcd apmea sss



Howard Penney

Managing Director


Rory Green

Senior Analyst


2Q13 Macro Call: Our Process


Hedgeye held its 2Q13 Macro Call for institutional subscribers this week, which covered several themes we think will be big and noteworthy in the second quarter of 2013. We began the call with CEO Keith McCullough outlining his process. We use a combination of fundamental research combined with quantitative risk management.


The quantitative process involves using risk management signals and levels to determine entry and exit points for a stock or index. It involves a multi-duration model that includes: TRADE, TREND and TAIL. The fundamental research utilizes our world-class research team to find ideas that we can apply to our quantitative model.


We look at a combination of politics, monetary policy, economic health and other factors to see where certain companies and countries are at and how to trade them.

BRAZIL: Getting Smoked

Brazil's BOVESPA Index dropped -2.1% yesterday and is down -13.4% year-to-date. One of the worst performing markets on the planet, the country just experienced a 0.25% rate hike to 7.5% on central bank borrowing rates by Alexandre Tombini, the governor of the central bank of Brazil. It's the first rate hike since July 2011 and has given investors plenty to worry about. We like staying short commodities and short Brazil through the iShares MSCI Brazil Index ETF (EWZ).


BRAZIL: Getting Smoked - BOVESPA

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This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.