Keeping European Retail On Life Support

JJB Sports announced this morning that it averted Administration (bankruptcy) by pushing through a Company Voluntary Arrangement (CVA).  While they have been around since the 1970s, CVAs are growing in popularity, which is very notable for landlord/tenant relations in Europe. The punchline is that they can keep alive a business that otherwise would/should go bust in this bankruptcy cycle - prolonging the inevitable. If we see many more of these in European retail, we could see the business cycle take meaningfully longer to recover when compared to the US. 


What is a CVA?


A CVA is a contract between the insolvent business and creditors to repay some or all of their debts with future profits. It's an answer for those companies who don't want to go completely bankrupt and a solution for creditors to at least receive some of the money they are owed.


A CVA does not just consist of two sides coming up with an agreement to pay back money. It goes much deeper than that. To start with the CVA process, one must believe that their business can come back and be profitable, and come up with a convincing enough argument such that the creditors believe it. The managers and owners still remain in control of the company, but open up the strategic plan and allow the creditors in to make suggestions. A 75% approval rate is needed at the creditor level, and it must be fully vetted and endorsed by the country court.


Anyone who has been following our teams' collective work at Research Edge has heard us refer to this bankruptcy cycle as a game of Survivor. The last one to get voted off the island is going to come out on top as it relates to market share, and likely get the highest multiple along the way.  The irony with these 'CVAs' is that they could prolong the inevitable (and prolong the pain) for European retailers.


JNY: A 5-Year Downward Spiral Ends?

JNY is closing 225 of its 1000+ store base over the next 18 months.  Did anyone even realize that JNY is one of the largest specialty retailers by door count?  Even if you were aware that JNY is a retailer is disguise, it's very positive to see that they are no longer growing for the sake of growth.  It's also positive to see management cutting its losses and moving on.  We applaud the move to close over 20% of the store base for a few reasons:


1) Closing unproductive, loss producing stores has an immediate and positive impact on the P&L.  In aggregate, JNY will save $37mm in losses and costs from closing these stores from '09-'11.  This equates to $0.29 per share.  Off of our new estimate of $0.65, this is substantial opportunity to help rebuild the earnings base


2) The cash cost to execute the store closing plan is only $5mm!  That seems incredibly low and should make any rational person wonder why they didn't close store more aggressively in the recent past.  Think about it, JNY gets to over half of the 20% number almost entirely by letting existing leases run off without renewing.  Seems simple - but prior management has never made anything simple.  Regardless of prior decisions or lack thereof, the net benefit of this effort is a no brainer.


3) Approximately 60% of the stores are mall-based, which leaves the base with a higher concentration of outlet stores.  The outlet stores have recently been comping down only a few points while the mall based stores have been tracking down 20%.  Outlets are a good compliment to a better distribution and inventory clearance strategy.  Leave the mall-based selling to the department stores.


4) Inventories will come down further as the chain shrinks, freeing up additional working capital.  This should be about a $30-$35mm reduction in working capital annually.


In JNY's case, addition by subtraction is not a cure-all for general market share loss and declining brand relevancy.  However, we believe there is still upside in the nearer term as the business shrinks and expenses are once again leveraged.  Of course, must of this is already in the shares which have now tripled from the March lows.  Gains from here will have to come from measurable EPS improvement. But check out the estimate revision chart below. This company has faced 5-years of downward revisions (for good reason). The downside has stabilized, and my strong sense is that any recovery will last more than just a quarter or two. Don't get me wrong, I would not touch this name here. I'd much rather play LIZ for so many reasons. But if you're looking at jumping on the shorty bandwagon now on this perennially hated name - beware.


JNY: A 5-Year Downward Spiral Ends?   - jnyeps

Eric Levine

Research Edge

Revisions Rule The Day


Another week passes where revisions are trending better, and the group is following suit. The major call-out, however, is that we're now sitting at peak valuations based on NTM consensus EPS estimates (17x).


The major question here for me is whether or not estimates are real. Has the sell-side finally overshot on the downside and what appears to be 17x earnings is actually something in the low teens?


In aggregate, I think that estimates are largely too low for the next 12-months, as our team has outlined since March 5th (We're Getting Fundamentally Bullish). But back then, it did not matter which names you played, as pretty much the whole group went up in unison.


The sector call still matters (check out Howard Penney's sector strategy work), but now, company-specific revisions matter a lot more than they did a month ago. If you're involved in a name and think that 'a miss is already in the stock,' then I feel for you come earnings day.  There are lesser quality names that have set themselves up to smoke estimates in the upcoming quarters - such as CRI, JNY and SKX. Expectations are now lofty and I'm not convinced the upside is coming in a healthy way (setting up for shorts as '10 nears). Then there are others like UA, RL, HIBB, and HBI where I think the upside is meaningful AND warranted. PSS is another, with my lingering concern being the upcoming quarter. It won't be squeaky clean - which probably matters after double in the share price. I think that 2H estimates need to go up by almost half, so I'd keep that name front and center.


Revisions Rule The Day - 90 day revisions chart


Revisions Rule The Day - NTM and Consensus Chart

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UA: Bottom Up Shoe Math


Having doubled off its lows and trading at 11x EBITDA, UA is admittedly not cheap. But the top line growth is there - esp in shoes as outlined herein. Margin oppty is being realized, and capital intensity is coming down. Don't underestimate this one.


I'm still amazed by Wall Street's myopic nature associated with Under Armour's presence and opportunity with its new footwear initiative. People hear management's comments on the conference calls and conferences and get so hyper-focused around a few hundred thousand pair here or there. Let's put some numbers into perspective.


If we take the running category alone, and assume a rate of daily sell through averages at less than one pair of shoes per day at a conservative list of major retailers, then it gets us to $65mm in annual sales along at a $40 wholesale price point.  This suggests about 8-9% market share for UA in the running category at these retailers. Could I argue 2 pair per day on overage over the course of a 12-month time period? Yes, not unreasonable by any means.


This does not include basketball, outdoor, or any form of casual footwear whatsoever. You could take that $65mm number, and multiply it several times over into new categories. Therein lies my assertion that it is not tough at all to get to $300mm in footwear revenue in 2-3 years (40% growth over today's sales base).  Furthermore, this would put UA at half the market share run-rate of the likes of Adidas, New Balance, and Asics. Ironically, it puts it right in line with Reebok (which is a mess).


If I'm going to place my bet on which brand will pierce the 10% share barrier next, it's going to be UA.


UA: Bottom Up Shoe Math - ua

US Market Performance: Week Ended 5/1/09


Index Performance:


Week Ended 5/1/09: DJ +1.7%, SP500 +1.3%, Nasdaq +1.5%, Russell2000 +1.7%

Q209 To-Date: DJ +7.9%, SP500 +10.0%, Nasdaq +12.5%, Russell2000 +15.2%

2009 Year-To-Date: DJ (6.4%), SP500 (2.9%), Nasdaq +9.0%, Russell2000 (2.5%)


Keith R. McCullough

Chief Executive Officer


HOT management's commentary is in quotes and our responses are bulleted.




"RevPAR declines in the quarter were increasingly driven by declining rates while occupancy appears to have found a plateau"

  • Price changes are very sticky so ADR isn't going up anytime soon. That is why the hoteliers resisted for so long. Now, they are falling off a cliff.


"Our guidance does not include any impact from the recent concerns about swine flu. It is very hard to estimate impact."

  • Providing themselves an out in case business doesn't stabilize?


"Also, the year-over-year comparison is very unfavorable for FX in the first three quarters, but with the dollar at current levels the negative FX impact disappears in Q4 this year.  In short, our second half RevPAR numbers benefit from easier comparisons to last year and the disappearance of the FX hit in Q4."

  • We already take this into account hence the less bad ½ 2009 RevPAR. However, costs won't be falling as much either.


"Last year in Q1, our RevPAR growth for company-operated hotels was a positive 8%. This year it was negative 24%.  So on a two year basis, we were down 16%.   FX hurt us to the tune of almost 500 basis points in the first quarter.  So the two-year run rate on a constant dollar basis was down around 11%."

  • They didn't back out the FX from last year as well. North American RevPAR had the benefit of the Canadian dollar being up 17% in 1Q08


"Last year our RevPAR at company-operated hotels was down 12%. With the dollar where it is today, there is only a 200 basis point FX impact. So a two-year run rate on a constant dollar basis of 11% in Q4 this year, i.e. an assumption that things on a two-year basis stay about as bad as they are right now, would imply relatively flat RevPAR in Q4.  We're not suggesting that that is what we are expecting.  In fact, as you can see from our baseline adjustments, we're assuming RevPAR stays materially negative in Q4 which would imply a worsening two-year run rate into Q4."


  • Sorry but we just don't see RevPAR moderating to being flat year over year in the 4Q09. You can "You Tube" us on that one. We have consistently said that we need to see occupancy declines stabilize and improve before we see a real recovery. With occupancies in the 50's industry wide, there is no pricing power since the hotels are trying to fill rooms with low rated discount business to simply cover fixed costs. Therefore, we are sticking with our thesis that ADR will continue to be weak until we get occupancy recovering - and we are seeing no signs of that occurring.





"We're being more active than ever with key travel participants including, for example, double savings with AAA and a 4% credit to the master account for meeting planners. We're also working closely with online travel agencies to drive business through limited time offerings."


"While this is another steep decline, the second quarter would be the first time in six quarters that our RevPAR trend is not expected to worsen. The second derivative is, at worst, becoming less negative."

"We're working on innovative offerings to drive business to our hotels, such as SPG flights which extends our 10-year old, no black-out offer to the airline space. Members can use points to book an airline ticket with the same convenience of a hotel room."


"For every two stays, our members will be rewarded with one free weekend night."

  • This basically amount to a 30% ADR cut





"Our managed and franchised revenues dropped 15.4% in the quarter as our footprint growth offset declining RevPAR.  We're earning new fees from the nearly 200 hotels that we opened between 2006 and 2008."

  • Clearly they are not commenting on incentive fees or fees earned on Bliss & other businesses - those were both down a lot more than 15% as totalfee income fell 21%
  • Incentive fees dropped 32% and fees from Bliss & Miscellaneous dropped 24%.... amortization of gains though stayed pretty constant at $20MM (from $21MM a year ago)





"Close rates and tour flows were in line with our expectations, and for the first time in several quarters we actually saw some trends improve.  Price realization was slightly lower than expected but this was entirely a result of product mix, not price reduction."


"...delinquencies are running at 4.4% versus 2.9% a year ago."


"Also not included in our guidance is any loss we might incur from a securitization. We expect the loss to be small."

  • Of course let's not count the loss but give them credit for the interest income





"We're still on track to achieve overhead savings of over $100 million"


"We also cut our company-wide capital spend by roughly 60% from 2008. Meanwhile we continue to evaluate options for Bal Harbor where we've already significantly reduced costs and slowed our capital spend."


"We expect to offset some of this additional decline by doing better on hotel level costs by $20 million and another $20 million more in SG&A cost reductions. Interest expense will be higher, depreciation and amortization will be lower, as will our tax rate for the year."


" sense is that the majority, something like ¾, I think, are sustainable long-term, maybe more than that."

  • This is fodder for another, more detailed post. We don't believe they will sustain 75% of the cost cuts. Coming out of the lodging downturn of 2001-2003, flow through on the huge RevPAR gains of 2004-2007 was extremely disappointing





"With a high probably of at least one receivable sale, we now expect the gross debt will drop below $3.5 billion and even lower when we execute some of the other initiatives that are currently in the works."

  • We do like the job management has done with the balance sheet. The timing on Friday's $500 million debt offering looks very advantageous to HOT with a yield of only 8.875%. HOT already cured its covenant issue with the recent amendment to its credit facility and now has the liquidity to fund next year's maturity.

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