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RESTORATION HARDWARE: MORE CONFIDENCE

Takeaway: Restoration Hardware raised its first quarter revenue and earnings forecast on Friday. Here's our take on the company.

This note was originally published May 10, 2013 at 15:32 in Retail

It's pretty safe  to assume that the few analysts that actually like Restoration Hardware (RH) just saw the stock blow through their price targets. We, however, still think that this is at least a $60+ stock over two years. Our note from a few weeks ago was titled #CONFIDENCE (see below), and today's (Friday May 10) positive pre-announcement -- and 41% comp (WHAT?!?) certainly support our view. In short...

 

"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 three years.  If that’s right, we’re looking at over a 20% CAGR in EPS, which makes 20 times $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."

 

The biggest obstacle at this point is timing.  With over one million shares short at the same time we're seeing decreased opacity in the model, an equity offering that cures one of the biggest points of pushback we've gotten on the name (sparse liquidity), and such a material step-up in business levels (comps going from +26% in 4Q to +41% in 1Q) -- it's no shocker that the stock is behaving like it is today (Friday).

 

That said, we would not chase it right here, right now.  We'd treat this one like a fine wine -- simply let it breathe for a little while. At a minimum, we'd wait to see how it reacts when another 4 to 4.5 million shares enter the float with the company's secondary. If the stock trades down, then we'd look to get involved. If it holds current levels, then we'd buy it anyway.

 

 

(Our Note from April 18, 2013)

RH: # CONFIDENCE

Takeaway: Several near-term risks were mitigated this qtr. In addition, we're taking up our 'already high' long-term growth forecast. two years = $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 20 times $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.


European Banking Monitor: Financial Swaps Mostly Wider

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .

 

For our most recent outlook on Europe titled "Where's Europe At?" please see: http://app.hedgeye.com/feed_items/28511  

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European Financial CDS - French, Spanish and Italian banks saw swaps mostly widen last week. Overall, swaps were wider, by a median of 6 bps.

 

European Banking Monitor: Financial Swaps Mostly Wider - y. banks

 

Sovereign CDS – Italy, Portugal and Japan all dropped 6-8 bps WoW. Elsewhere, swaps were flat to down 2 bps. The world remains a calm place for now.

 

European Banking Monitor: Financial Swaps Mostly Wider - y. sov 1

 

European Banking Monitor: Financial Swaps Mostly Wider - y. sov2

 

European Banking Monitor: Financial Swaps Mostly Wider - y. sov3

 

Euribor-OIS Spread – The Euribor-OIS spread was unchanged week-over-week at 13 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. 

 

European Banking Monitor: Financial Swaps Mostly Wider - y. euribor

 

ECB Liquidity Recourse to the Deposit Facility – Deposits declined week over week by 37.6 billion Euros. The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  

 

European Banking Monitor: Financial Swaps Mostly Wider - y. facility

 

 

Matthew Hedrick

Senior Analyst


MACAU NORMALIZES AFTER MAY HOLIDAY

As expected, average daily table revenues slowed from the May holidays but were up strongly over last year.  We’re still projecting 16-20% YoY GGR growth to HK$29.5-30.5 billion for the full month of May.  This past week’s ADTR of $798 million climbed 12% YoY, following up on May’s first week’s 24% YoY increase.  I was in Macau late last week and the operators were overwhelmingly bullish as were other market participants.

 

In terms of market share, MGM and Sands China made big jumps week over week, although LVS remains below trend albeit only slightly.  Thus far, MGM and Wynn are the big winners versus trend.

 

MACAU NORMALIZES AFTER MAY HOLIDAY - macau

 

MACAU NORMALIZES AFTER MAY HOLIDAY - macau2


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.64%
  • SHORT SIGNALS 78.61%

MCDONALD'S NOT GOING TO HIT NUMBERS

Takeaway: If we're right on McDonald's numbers, the underperformance in the stock could become even worse for shareholders.

This note was originally published May 08, 2013 at 11:14 in Restaurants

The upside in McDonald’s stock is not being driven by the company’s fundamentals. The underperformance in the stock since we added it to our Best Ideas list on April 25, is likely to continue and, if we are right on the numbers, could become worse for shareholders.

 

The company has a lot of work to do to turn its operational performance around and we are not seeing any indication that this reversal will transpire any time soon. Management's recital of the (stale) tenets of the current Plan to Win, “optimize our menu, modernize the customer experience and broaden accessibility to brand McDonald's around the world”, as an answer to all ills, does not instill confidence that the current leadership is coming up with new ideas to counteract the company’s current operating headwinds. 

 

 

April SRS vs Consensus (Consensus Metrix)

  • US Beat: +0.7% versus consensus -0.1%
  • Europe Missed: -2.4% versus consensus -1.0%
  • APMEA Missed: -2.9% versus consensus -1.4%
  • Global Missed: -0.6% versus consensus -0.5%

United States: “Premium McWraps, compelling value options and the ongoing popularity of McDonald's breakfast contributed to the month's results.

 

Europe: “positive performance in the U.K. and Russia more than offset by Germany, France and other markets.”

 

APMEA: Results reflected “the impact of Avian influenza, primarily in China, and softer results in Japan and Australia.”

 

 

Without Sales Growth, Earnings Growth Will Be Difficult

 

In 1Q13, McDonald’s posted revenue growth of +0.9% on systemwide sales growth of 0%. One month into the second quarter, MCD systemwide sales have decreased -0.4%.  The Street is expecting 3% revenue growth in the second quarter.

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd sales eps leverage1

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd 13 eeg

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd systemwide sales

 

 

May and June will be crucial months for McDonald’s.  A sequential acceleration in two-year average trends of 105 bps is needed to meet May consensus comparable sales growth in the U.S. So far this year, the two-year trend in U.S. comps has decelerated every month by an average of 83 basis points.

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd global comps

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd us comps

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd eu comps

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd apmea comps

 

 

Long-Term Trend Remains Discouraging

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd srs global ttm

 

 


MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE

Takeaway: Risk remains low, though last week's rate of improvement decelerated vs. the past month. U.S. Financials saw exceptional improvement WoW.

Key Takeaways:

 

XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.4% upside to TRADE resistance and 3.3% downside to TRADE support.

 

2-10 Spread – Last week the 2-10 spread widened 9 bps to 156 bps. 

 

High Yield – High Yield rates fell 4.5 bps last week, ending the week at 5.22% versus 5.27% the prior week.

  

Financial Risk Monitor Summary

 • Short-term(WoW): Positive / 3 of 12 improved / 2 out of 12 worsened / 8 of 12 unchanged

 • Intermediate-term(WoW): Positive / 7 of 12 improved / 2 out of 12 worsened / 4 of 12 unchanged

 • Long-term(WoW): Positive / 5 of 12 improved / 0 out of 12 worsened / 8 of 12 unchanged

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 15

 

1. U.S. Financial CDS -  Swaps were sharply tighter for US financials last week. BofA and MS saw swaps tighten 16 and 10 bps, respectively. MTG & RDN dropped another 51 and 38 bps, while MBIA dropped 670 bps on a favorable resolution of their BofA litigation. MBIA swaps are now trading just inside the "Lehman line" at 299 bps. Overall, all 27 major U.S. financials we track saw swaps tighten week-over-week. 

 

Tightened the most WoW: MBI, TRV, XL

Tightened the least WoW: UNM, MET, COF

Tightened the most WoW: MBI, RDN, AXP

Tightened the least MoM: WFC, UNM, JPM

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 1

 

2. European Financial CDS - French, Spanish and Italian banks saw swaps mostly widen last week. Overall, swaps were wider, by a median of 6 bps.

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 2 2

 

3. Asian Financial CDS - Relatively uneventful week for Asian financial swaps.  

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 17

 

4. Sovereign CDS – Italy, Portugal and Japan all dropped 6-8 bps WoW. Elsewhere, swaps were flat to down 2 bps. The world remains a calm place for now.

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 18

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 3

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 4

 

5. High Yield (YTM) Monitor – High Yield rates fell 4.5 bps last week, ending the week at 5.22% versus 5.27% the prior week.

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 5

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 5.3 points last week, ending at 1804.9.

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 6

 

7. TED Spread Monitor – The TED spread rose 0.7 basis points last week, ending the week at 23.4 bps this week versus last week’s print of 22.7 bps.

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 7

 

8. Journal of Commerce Commodity Price Index – The JOC index fell -0.9 points, ending the week at 5.51 versus 6.4 the prior week.

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 8

 

9. Euribor-OIS Spread – The Euribor-OIS spread was unchanged week-over-week at 13 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. 

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 9

 

10. ECB Liquidity Recourse to the Deposit Facility – Deposits declined week over week by 37.6 billion Euros. The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 10

 

11. Markit MCDX Index Monitor – Last week spreads widened from 43 to 61 bps on the 16-v1 series. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states.  

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 11

 

12. Chinese Steel – Steel prices in China rose 0.4% last week, or 13 yuan/ton, to 3584 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 12

 

13. 2-10 Spread – Last week the 2-10 spread widened to 156 bps, 9 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 13

 

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.4% upside to TRADE resistance and 3.3% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: U.S. FINANCIALS SWAPS PLUNGE - 14

 

Joshua Steiner, CFA

 


Gold Bugs Out

Client Talking Points

Gold Not Glittering

Gold has been front-running the Fed since Fed Chief Ben Bernanke said he’d print to infinity and beyond (September 2012). On the heels of John Hilsenrath’s Wall Street Journal article on Friday night, the Gold price is down another -1.3% this morning to $1427/oz. That’s the worst year-to-date start since 1982.

Consumption Growth

Retail sales grew 0.1% in April, beating expectations and confirming Hedgeye’s broad macro theme that US consumption is increasing and that growth is accelerating. Consumption has been strengthening both as the US dollar strengthens, and as a result, commodities prices fall.

Asset Allocation

CASH 33% US EQUITIES 18%
INTL EQUITIES 18% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 31%

Top Long Ideas

Company Ticker Sector Duration
IGT

Decent earnings visibility, stabilized market share, and aggressive share repurchases should keep a floor on the stock.  Near-term earnings, potentially big orders from Oregon and South Dakota, and news of proliferating gaming domestically could provide near term catalysts for a stock that trades at only 11x EPS.  We believe that multiple is unsustainably low – and management likely agrees given the buyback – for a company with the balance sheet and strong cash flow as IGT.  Given private equity’s interest in WMS (they lost out to SGMS) – a company similar to IGT that unlike IGT generates little free cash – we wouldn’t rule out a privatizing transaction to realize the inherent value in this company.  

WWW

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow.  

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.

Three for the Road

TWEET OF THE DAY

“I’ve never been more happy that all my trading algos/models aren’t locked into windows someone could have viewed.”

--@KeithMcCullough

QUOTE OF THE DAY

“All generalizations are false, including this one.” – Mark Twain

STAT OF THE DAY

0.1%, the increase in retail sales for April


investing ideas

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