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WRC: Costs Cuts -- Could vs. Should

Let the debate begin on WRC. The company beat the Street by $0.27 and our model by $0.32.  The quality is not what headline suggests, but a beat is a beat, so I won't ignore that.  But pulling forward $25mm in revenue from 2Q while printing a massive 14% decline in SG&A has its clear leverage pressure points.  This says nothing about whether WRC SHOULD cut SG&A to this magnitude. The fact is, it did.  The $30mm decline in revs y/y was almost entirely offset by a $25mm decline in SG&A dollars. Yes, WRC has big Int'l exposure (i.e. FX helped SG&A), but it's so rare to see such variability in SG&A. The sustainability here and impact '10 will be THE question (i.e. is mgmt cutting off the third leg of a bar stool?).  This smells punk to me.

 

This name is setting up as a nice 'whack-a-mole.' Stay tuned....

 

On the bull side, if you like a wholesaler that is transforming into a growing retailer, driven by aggressive square footage growth and the associated mix benefit from high direct-to-consumer operating margins (20% Four Wall for CK retail) while real-estate costs serve as a tailwind, then WRC should continue to work for a while.  But, watch out for the very first instance that the rate of store growth slows and overall margin growth trends reverse. 

 

MAJOR CALL OUTS

  • Same store sales are slowing (meaningfully) for CK retail:
  • o April: -4%
  • o 1Q09: +5%
  • o 4Q08: +12% (+17% December)
  • o 3Q08: +13%
  • o 2Q08: +20%
  • o 1Q08: +11%

 

  • Raising square footage growth from 20% to 24% for the year. This looks like a classic case of opening stores to drive same store sales to keep overall momentum alive. You can't bet against this for now, but look out when new store growth slows.
  • Spent some time discussing a retail strategy for CK accessories. Clearly another lever here to drive DTC growth. Accessories currently has one free standing retail location and the total division is currently producing $100mm. This was the first mention of an opportunity to double the business over the next 3 years, driven primarily by square footage growth.
  • CEO quotes on store growth: ""If we could do more we would", "current softness in comps is a momentary aberration", we are pursuing "aggressive growth" in retail

 

  • Despite retail square footage going higher, Capex is going lower. Took Capex down to $35mm from just under $40mm. A nice positive.

 

  • Total SG&A dollars now guided to down $100mm year over year. This is a combination of the $70mm in cost cuts plus the benefit of a larger than originally expected F/X impact. The specificity around cost-cutting on the part of management was light. That's surprising given that we're only talking about a $715mm base in total SG&A for WRC.

 

  • Warehouse Clubs saved the day
  • Approximately $25mm in sportswear shipments were pushed into Q1 from Q2 at an above average operating margin. The impact added 5% to total revenues and approximately $0.06 to the quarter (assuming an above avg. 16% operating margin for this piece of business).
  • CK intimates also saved by shipment to the clubs at an above average margin.

 WRC: Costs Cuts -- Could vs. Should - WRC S 5 09

 

 


BANDWAGONEERING

 

Research Edge Position: Long Chinese Equities via CAF

China's exports declined over 22% year-over-year in April, a sequential decline from March, significantly worse than consensus estimates with shipments to the EU and the US off by 24% and 17% respectively. While the external demand picture remains grim, the internal demand picture continues to demonstrate strength in the wake of Beijing's stimulus transfusion. Key data point takeaways released in recent days that underscore this are:

  • Motor Vehicle sales exceeded 1.15 million in April, a 25% Y/Y increase
  • Urban Fixed Investments up 30.5% Y/Y for April
  • Housing sales up 35.4% in the first 4 months of 09 Y/Y
  • Iron Ore imports up 33% Y/Y to 57 million metric tons

 

Tonight Industrial Output numbers will be released by the National Bureau of Statistics, with consensus estimates hovering at 9% Y/Y. Any upside surprise in output  could well put fire in the belly of China bulls looking for final confirmation that the demand story here is real, while Retail Sales data slated for this evening could provide assurance that that the ox is hungry for more than just iron ore and scrap copper. As we said yesterday, electronics exporters have already seen an uptick in mainland order flow as rural Chinese shoppers take advantage of government rebates and we will look for confirmation that the cash register is ringing in coastal cities as well.

 

BANDWAGONEERING - aprilch

 

 

We are long CAF and will be holding it into tonight's news.  All data points lead us to believe that the momentum of China's internal demand growth is accelerating.

 

 

Andrew Barber

Director

 


The Suckerpool Chart

 

My first job on the buy side was as a US Retail analyst. That was 9 years ago, and I think my boss gave me that group because it's the easiest one to analyze - I'm one of them Canadian hockey players, eh!

 

I started trading my own US Consumer "carve-out" of the fund within a few years, and effectively had to learn the art of job stability via not losing money. Losing money in the hedge fund business generally equates to losing one's job - as it should.

 

Making money on the long side isn't that hard to do. Not getting squeezed on the short side is. If the chart below had an audio clip, it would have a massive sucking sound - from now on I am going to refer to it as The Suckerpool Chart (this one will be really hard for Cramer to say is his - he hasn't used Squeezy yet either).

 

If you think being short the US Consumer Discretionary sector is a unique thought, think again. This sector, quantified, has the highest bottoms up short interest in the US market. It also now sports none other than Meredith Whitney as the latest doomsayer (yesterday she said short the group on CNBC). I thought she was a bank analyst? Maybe she's moving from the MEGA squeeze in her stocks on over to this one - who knows - but now she's in my sandbox this game probably won't end the way she thinks.

 

I sold my XLY (Consumer Discretionary ETF) on 4/29/09 at $23.18, so I haven't had to deal with the stresses associated with this sector's recent week of underperformance. Today, I am buying it back.

 

The Pain Trade that remains in this market is one that's really been a great story in 2009 - squeezing the US Consumer Depressionista shorts. Are they still out there? You tell me... how many people in your investment meetings are ragingly bullish and "long of" US Consumer Discretionary stocks?

 

I have painted the lines of support (green) and resistance (red) in The Suckerpool Chart below.

KM

 

Keith R. McCullough
Chief Executive Officer

 

The Suckerpool Chart - cd


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Is the Republican Party A Distressed Asset?

 

"Is Michael Steele here? Michael, I don't care how many times you ask, the Republican Party does not qualify for bailout.  Rush Limbaugh is not a troubled asset."

                                                                -President Obama, White House Correspondents' Dinner, May 9th 2009

 

President Obama hosted his first White House Correspondents' Dinner this past weekend to much fanfare.  While much of the dialogue seemed to be fairly predictable, the line above actually garnered a great deal of applause and is a very insightful point. 

 

In fact, the Republican party is currently in trouble and does have a bit of a Rush Limbaugh problem.  While Rush may not be a troubled asset, the Republican Party does need a bailout, or at least a massive makeover.  We recently heard from a contact of ours who is a major conservative fundraiser and he wrote us the following:

 

"I was on the Hill this past Thursday. Very discouraging. Republicans seem exhausted. The party will take years to recover."

 

Installing Michael Steele as the Head of the RNC and the recently completed listening tour by Jeb Bush, Mitt Romney, and various other Republican leaders are certainly steps in the right direction in reinventing the face and energy of the Republican party, yet this process is in its early days.  In the meantime, the Democrats are consolidating power and President Obama's polling numbers continue to improve, while the Republican Party is trading at cents on the dollar.

 

In the past, we have quoted the Rasmussen presidential approval rating as a proxy for how President Obama is doing in terms of popularity.  We use this poll for consistency purposes and also because Rasmussen has been rated as one of the most accurate pollsters over the last decade. For the last five days, Obama's approval index has been in the +7 to +9 range (this is the difference between Strongly Approve and Strongly Disapprove), this range is at its highest since the first week in April.

 

While that poll is interesting and indicates a shift up in approval for President Obama, an even more interesting poll is the right direction / wrong direction poll.  Currently, 38% of likely voters believe the country is headed in the right direction.  While this does not seem like a large number, it is a five year high and is the highest number of the Obama Presidency.  In fact, it is up 11 points from his inauguration and 17 points from when he was elected.  President Obama has inspired a view among likely voters that he is getting this country back on track and with this popular support will come even more political capital.

 

On April 28th we wrote the following in a note about Senator Specter's decision to change parties:

 

"Make no mistake about it, the balance of power in the United States has officially swung to the left and as a result we should analyze both risk and reward accordingly with this new geo-political input."

 

In that note we made the call out that one way in which we could see this power shift manifest itself was on unionization and the potential that Senator Specter would reverse his view on Employee Free Choice, which relates to voting on union representation.  This shift in national political influence with the consolidation of Democratic power in the Senate and increasing popularity of President Obama, combined with the view that he is leading the country in the right direction, will also manifest itself in more subtle ways.

 

Specifically, the recent capitulation of bondholders in the Chrysler bankruptcy has the appearance of a situation whereby the bondholders are deferring to the strengthening power of President Obama and the Democratic Party.  According to the Boston Globe, "The group eventually came to the conclusion that there wasn't enough of them to withstand the enormous pressure and machinery of the US government." 

 

Obviously the bondholders are likely attempting to promote their own interest to the media, so the quote must be taken in context.  Nonetheless, the context is concerning.  Bondholders have rights and fiduciaries responsibilities, and in this situation chose to acquiesce to the government rather than aggressively pursue those rights.  Clearly, part of the decision making process on the side of the bondholders was that they were not only facing off with the U.S. government, but one that has a popular executive branch combined with a consolidated legislative branch - so would be difficult to beat.  

 

While this was a loss for the bondholders of Chrysler, it was also likely a leading indicator of future events.  These capitalists had clearly weighed the risk / reward and decided that based on the potential for future interactions with the government, according to simple game theory analysis, the best outcome was to acquiesce on their position quickly and quietly.  That said, not all  investment managers have walked away from this situation quietly.  In fact, Cliff Asness wrote the following in an open letter:

 

"Here's a shock. When hedge funds, pension funds, mutual funds, and individuals, including very sweet grandmothers, lend their money they expect to get it back. However, they know, or should know, they take the risk of not being paid back. But if such a bad event happens it usually does not result in a complete loss. A firm in bankruptcy still has assets. It's not always a pretty process . . .the above is how it works in America, or how it's supposed to work."

 

Indeed.

 

Daryl G. Jones
Managing Director


GAS PRICES – ON THE RADAR SCREEN AGAIN

 

When gas prices at the pump hit $4 a gallon last summer, the pain felt by restaurant operators was severe.  While we are miles away from that level, the surge in oil prices and subsequent move in gas prices should not be overlooked. 

 

Last week pump prices increased to a new national average of $2.17 a gallon and are up $0.12 over the past month.  The good news is that prices are still $1.47 a gallon cheaper than last year.

 

GAS PRICES – ON THE RADAR SCREEN AGAIN - gas prices

 

There is a view that oil could have a meaningful upside as the re-flation trade continues to play out, especially with a weakening dollar.  In early trading today, Oil prices traded above $59 a barrel to set a new six-month high, mainly in response to the positive tone to equities and a weaker dollar.

 

At some point, the sequential rate of change (week to week and month to month) will begin to impact the consumer somewhat more than the absolute year-over-year decline. 


Currently, the psychological behavior associated with the rate of change has not been evident is sales trends at Wal Mart, which is a proxy for consumer behavior as its sales trends have a high R-squared to changes in gas prices.  Although, it should be noted that the Consumer Discretionary (XLY) has now begun to underperform and appears to be in a correction phase; over the past week the XLY is up 0.3% versus 2.4% for the S&P 500.

 

With Full Service valuations surging over the past two months, sales trends that remains under pressure, and higher gas prices, it’s not the right time to be a Full Service BULL!

 


GOOD TO GREAT CANADIAN GAMING

Wow!  We knew management was making progress on the cost side but this exceeded our expectations by a wide margin.  Should the stock go up on this?  Absolutely.  Will it?  Yes, but probably not enough.  Even with a big move up today, the stock will likely still trade around 6-6.5x 2010 EV/EBITDA versus the US regional comp group at 7-7.5x.  An argument can be made that GC's business model is more attractive than the US guys (see our 4/5/09 note for the thesis, "GC:  GOOD CANADIAN GAMING").  GC is definitely a "show me" stock, but Q1 is definitely a start.

 

Revenues were a little below expectations but EBITDA bested our projection by 19% and the Street by 27%.  EBITDA margin increased 370bps YoY to 30.5% despite an 4% revenue decline.  The good news?  Most of these cost cuts appear sustainable.  Numbers are going higher, despite the revenue decline.  Here are the property details.

 

GOOD TO GREAT CANADIAN GAMING - GC Q1 EBITDA TABLE

 

 

For those of you who like details, the following are the conference call and property highlights:

 

RiverRock:

  • Gaming revenues in line with our expectation, normal hold
  • Hospitality & other revenues came in a little light, caused by the construction disruption which led to the temporary relocation of several food & beverage outlets and reduction in room capacity to 195 room from 202
  • Costs came in 1.9MM lower than our estimate, and were down 13% Y-O-Y due to reduced staffing levels and reduced variable costs

 

Boulevard:

  • Gaming revenues were 1% better than our estimate
    • Table drop was better than we expected, up 7% y-o-y, but hold was weak at 18.3% vs our 19.15% estimate, costing GC 300k of revenues
    • Slot handle was weaker than we expected though, down 11% y-o-y, but had slightly better win %
  • F&B and other was 26% better than our estimate
  • Costs were 8% lower than 1Q08 and 1.1MM below our estimate
  • EBITDA was up 11% and margins increased 460bps to 46%

 

Vancouver Island:

  • Gaming revenues came in 1.4% better than our estimate
    • Table drop was very weak, coming in 15% below our estimate, hold was 1% above our estimate. However, table revenues are only 1.3MM at these 2 properties so the hold differential was de minimis
    • Slot handle was a little better than our estimate down 4%, win % was normal
  • Hospitality and Other was materially lower than our estimate down 27% y-o-y (again very small number to begin with)
    • There was some construction disruption
  • Costs were down 20% y-o-y, much better than our estimate
  • EBITDA was up 2% and margins were up 6.2% to 57.6%

 

Nova Scotia:

  • Gaming revenues came in 5% below our estimate
    • Table drop a little better than we expected, hold was normal
    • Slot handle 2% below our expectation, win % was normal
  • Hospitality & other came in 200k above our estimate and 21% better y-o-y
  • Costs were in line with our estimate (remember that cost reductions at this property began in 2Q08)
  • EBITDA was up 133% and margins were 20.2% vs 8.4% last year - this is the last quarter of easy comps

 

Racinos:

  • Table drop increased 17% y-o-y, although hold was 2.2% below normal levels, impacting revenues by 600k
  • Hospitality and other came in 150k better than our expectations
  • EBITDA came in 22% better and margins came in 330bps better
  • In CAD dollars revenues increased 29% and EBITDA increased 44%
  • CAD dollar decline 20% in value vs USD at the end of 1Q09, if spot rates stay constant the decline should be closer to 13% for 2Q

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