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Stock Report: Restoration Hardware (RH)

Stock Report: Restoration Hardware (RH) - HE II RH boxes 9 6 13

THE HEDGEYE EDGE

We think that RH is to home furnishings what Ralph Lauren is to Apparel and what Nike is to Athletic Shoes. It's the preeminent brand in the space, and sets/leads consumer style trends/wants/needs but with very little fashion risk. From a maturity perspective, we think that RH is 5-10 years behind RL, and 10-15 years behind NKE. Its got the runway. And even though it has such minimal market share across its categories, the competitive set is actually not very strong, and it is creating high competitive barriers.

TIMESPAN

INTERMEDIATE TERM (TREND) (the next 3 months or more)

There are some intermediate-term trends worth noting.

  1. RH announced last quarter that it is launching two new businesses -- again.  Does this sound familiar? In RH's first quarter out of the IPO gate it announced the launch of RH Tableware, RH Objects of Curiosity, and RH Fine Art. Now we've got RH Kitchen and Tableware and RH Antiquities. Both of these are massively fragmented businesses and present huge opportunities for RH. These are in addition to RH Leather and RH Rugs, two new catalogue drops this fall. #growthaccellerating
  2. RH managed to snag Richard Harvey from Williams-Sonoma to be CMO for RH Kitchens and Tableware. The simple fact that RH's share of this category is close to zero today, and they went ahead and hired the person with the best track record in the world in brand-building, sourcing and merchandising in the kitchen space….that's just huge.
  3. RH is fresh off the ICSC conference in Vegas and it proved to be a game-changer for the company. They not only had far better success in finding landlords/properties to fit their new Design Galleries. But they found that there are more opportunities for larger properties (as large at 50k square feet) at far lower prices than their business model originally called for. Not only does it take up the number of Galleries we're likely to see over time (over 50), but we think it also takes up the average size per store. These two factors are a critical on a combined basis as it relates to our margin of safety on the RH growth algorithm (see below). With more favorable availability of sites comes more favorable rents and cap rates -- it's economics 101.

LONG-TERM (TAIL) (the next 3 years or less)

One thing that makes the RH model stand out is the growth algorithm over the next 5-years. Specifically…

  1. Square footage has not grown for five years. But RH should finally start to report square footage growth starting in 3Q13 – at which point it should start to climb aggressively.
  2. But our point is that today it is the comp that's driving the model. We can clearly see where that's coming from.  We can map out additional sales as new businesses come on line, and we can draw out the comp curves for new higher productivity entering the comp base and hitting more mature productivity levels. We're modeling sales per square foot going from $846 last year to just shy of $1,500 in year 5.
  3. Ultimately, comps will slow. It's a mathematical certainty. But at the time comps slow we're likely to see square footage growth accelerating to peak rates of growth. Square footage is shrinking slightly today, and should be up at a rate near 20% by year 3.
  4. So you see…we can safely model the comp today due to reasons discussed above. Then as that starts to level off, we have square footage ramping up. We can safely model that too. As the second chart shows, that gets us to just over 20% annual revenue growth with comp and square footage flip-flopping their importance to the model as time passes.

ONE-YEAR TRAILING CHART

Stock Report: Restoration Hardware (RH) - HE II RH chart 9 6 13


BNNY - Bullish on Annie’s

There’s lots to like about Annie’s, even with a rich valuation. Highlights include:

  • Q1 results were disappointing, but typically Q1 is its weakest quarter of the year; management reaffirmed its FY revenue growth guidance of 18-20% and adjusted diluted EPS range of $0.97 to $1.01
  • We believe that BNNY’s premium valuation is justified by higher growth rates across organic offerings, of which Annie’s is a leader, especially as it increasingly moves its products to the mainstream aisle from the organic aisle
  • BNNY is in a bullish breakout, with the stock price trading above our immediate term TRADE and intermediate term TREND levels (see chart directly below)
  • The company remains ahead of health and wellness trends in its product offerings
  • BNNY’s innovation is focused on taking everyday foods that people like to eat (ex. mac & cheese and cheddar snacks) and making healthier and better tasting products than its competitors; we think this strategy should be advantageous and sustain long-term growth versus traditional CPG innovation focused on new and “different” SKUs that may miss consumer interest
  • The company caters to a higher income client who can afford or trade up to the premium pricing of organic, despite swings in the macroeconomic landscape
  • It is poised to take a greater share across mac & cheese, crackers and fruit snacks; the introduction of frozen pizza early in the year and last month’s release of four new frozen meals offer excitement to the category. It is yet to be seen if BNNY can buck the trend of low profitability in the frozen section

BNNY - Bullish on Annie’s  - zz. bnny

 

 

Performance Outlook


Annie’s reported Q1 pro forma EPS of $0.13 on (8/8), one cent below Bloomberg consensus and revenues underperformed expectations (13.8% versus consensus 17.1%). Despite the softness in the top-line, management reiterated its FY guidance and we expect with its increased advertising spend slated for 2H (especially on pizza), a rebound in top-line in the coming quarters.  Note too that Q1 is typically its lowest revenue quarter of the year.

 

We continue to state that despite the lofty valuation of Annie’s (P/E of 37.4x vs food peer group average of 18.0x), organic food companies are deserving of a premium over the group due to their outperforming growth profile. BNNY enjoyed revenue growth greater than 20% over the last three years and has grown revenues at an average rate of 17.5% over the last 5 years. These figures are simply not anywhere near the much lower rates of growth for its peers in the food category,  most of whom have recorded average revenue growth south of 10% over the past five years. 

 

For a company that is virtually debt free, investing in cap-ex to grow the business, and increasing its work force, while maintaining a leading position in organic foods as it expands to the mainstream aisle to meet consumer demand for organic, we think BNNY rightly deserves to trade at a premium multiple.

 

For reference, below we show how BNNY stacks up against its competitors in the food category. Admittedly we are comparing BNNY, a small cap, to large cap non-organic companies, yet this snapshot serves as a reference point.

 

While gross margins slipped -190 bps to 37.8% in Q1, and we expect Q2 to be down slightly less (~100-150bps) versus the year ago comp of 38.3%, we expect a slow rebound towards 40% in the back half of the year.

 

BNNY - Bullish on Annie’s  - zz. comp sheet

 

 

On the Annie’s Brand


What’s not to love about a company that has been able to get ahead of the biggest consumer trend of customers better understanding what they’re eating and how what they eat may affect their overall health? 

 

Health and wellness is the industry’s buzzword and has been the focus of all consumer companies over the last 3-4 years. While some portfolios have been challenged to meet this trend (think: PEP, KO, CEE), BNNY is now enjoying the movement of its products from the natural and organic aisle to the mainstream (center of the store) aisle and the opportunity to take share from traditional branded players, especially those without organic offerings.

 

With 47% of its sales from Meals, 39% from Snacks, and 14% from Dressing, Contaminants, and Other, Annie’s sales growth has come from its strategy to take everyday products that consumers love to eat and improve the taste while using all natural and organic ingredients.  We see this as a huge competitive advantage as its innovation is focused on improving what the consumer already likes, rather than innovation for the sake of creating something “new” that may fail with the customer. We think this innovation should equate to increased household penetration.

 

And the movement of its products to the mainstream aisle (Mac & Cheese was first to do so in 2011) has not only met consumer demand for organic but also benefitted retailers (offering in most cases a higher margin structure). Annie’s now enjoys number one share position in national organic products in mac & cheese, snack crackers, gram crackers and fruit snacks.

 

Annie’s has over 135 products in 26,500 stores in the U.S., with initial inroads into Canada, across all major retailers (mass and grocery) and natural and organic stores. Given its nationwide distribution, its focus is on adding SKUs to existing channels and driving products to the mainstream aisle.

 

We like Annie’s ability to maintain and grow its market share as it caters to a higher income customer (typically better educated and more health conscious) that has the discretionary dollars to pay up for the price premium of organic.  Broader U.S. economic trends, with the unemployment rate at 7.6% and record highs in food stamps, suggest that lower income earners remain very price constrained since the economic downturn. Therefore, BNNY is in less competition with its branded rivals that cater to a lower income demographic. (Note: Annie’s products are sold on average at a 25-30% premium to more traditional brands across categories).

 

 

New Product Inroads


In January 2013 Annie’s launched frozen pizza in Whole Foods. In the same month it issued a voluntary recall of its frozen pizza after small metal fragments were identified in the pizza dough from a third-party flour mill it sourced.  Despite the challenges of its launch, frozen pizza is making strides (with build-out in Target and natural retails in particular), and a strong repeat rate of 70% according to the company. The one great challenge for BNNY will remain the value perception within the frozen pizza case, but the company is optimistic that television advertising slated for 2H 2013 will help to drive sales.

 

The company also just launched four varieties of family sized frozen meals, intended for parents who  need a quick dinner option, but still want a “healthy” meal. We acknowledge that BNNY may be competing for a different (higher income) consumer with its frozen meal offerings versus traditional frozen offerings, but we are well aware of how challenged frozen has been for the industry. We’ll have to wait and see how performance plays out.

 

Finally, the company is reporting strong results in snacks, in particular Cheddar Squares, launched two months ago, that target an older aged customer (versus the success of Cheddar Bunnies for kids).

 

 

Matthew Hedrick

Senior Analyst


August Employment: Something For Everyone

Ahead of this morning’s Employment Report, Keith tweeted All that matters in the BLS # is the market reaction to it”.  That seems especially fitting for the August employment data.  There was something for everyone. 

 

Consider the following:  The unemployment rate dropped to 7.3%, but did so on the back of a lower participation rate and negative household employment gains.  Private Payrolls declined sequentially and NFP missed estimates, but on a YoY & 2Y growth basis both measures were actually flat to slightly better sequentially.  The two month revision was negative at -74K, but PT employment for economic reasons declined, U-6 unemployment fell below 14%, weekly hours ticked higher and hourly earnings accelerated sequentially.  The Business Survey (which drives the NFP figure) showed a net gain of +165 but the Household Survey (which drives the Unemployment Rate) showed employment declining by -115K.

 

What do we do with that equivocality?  From a positioning or allocation perspective, not much unless the price signal changes.  

 

The Quantitative Risk Management setup remains positive for equities here and, on balance, today’s data doesn’t materially impact our Trend view of fundamentals – particularly with the initial claims data continuing to show accelerating improvement, the preponderance of domestic macro data in July/Aug strengthening, the seasonal headwind (which impacts the NFP data also) beginning to reverse in September, and a diminishing fiscal drag moving tangibly closer on the timeline.    

 

Maybe there’s a case that today’s data adds some incremental uncertainty to Taper prospects, maybe Putin vs. Obama escalates, maybe Congress delivers a negative policy surprise.  Maybe not.  

 

All in, similar to last month, we wouldn’t view today’s employment data in isolation as a real catalyst in either direction. 

 

We provided a more detailed analysis of the Labor Force Participation Rate in today’s Early Look.  You can link to that here >> Early Look: Cyclical vs. Secular

 

A summary review of the August Employment data below:


NFP:  Net Non-Farm payrolls gained sequentially coming in at +169K - holding flat on a YoY growth basis at +1.65% and accelerating marginally to 1.67% on a 2Y basis

NFP Revision:  The net two month revision was -74K with June revised from +188K to 172K and July revised from +162K to +104K.  

Household Survey:  The net employment gain as measured by the Household Survey was negative at -115K vs. +227K in July

Employment by Age:  Employment growth accelerated for 20-24 yr. olds and 65+ yr olds, decelerated for 55-64 year olds, and held flat for the balance of age cohorts

Unemployment Rate:  The Unemployment Rate dropped to 7.3% from 7.4%  as the total labor force declined -312K alongside a -198K decline in Total Unemployed and -115K decline in Total Employed. 

Labor Force Participation:  A positive +203K change in the working age population alongside a net decline in the labor force pushed the Labor Force Participation Rate down to 63.22% from 63.40%.

Part-time/Temp Employment:  Part-time employment declined by -234K while Temp employment gained +13K, registering its 11th consecutive month of net gains.  

Industry Employment:  Information and Finance were the only losers with employment declining 18K and 5K, respectively in August.  Manufacturing gained +14K on the month, reversing a 5 month run of net job loss.

Ave Weekly Hours for Private Employees:  Hours increased to 34.5 from 34.4 MoM and were up 0.1 vs  year ago levels.

 

August Employment:  Something For Everyone - Employment Summary Table

 

August Employment:  Something For Everyone - Cycle Profile

 

August Employment:  Something For Everyone - NSA Claims 090613

 

August Employment:  Something For Everyone - Employment by Age

 

August Employment:  Something For Everyone - Unemployment Rate 

 

August Employment:  Something For Everyone - CES vs CPS 2Y

 

August Employment:  Something For Everyone - Employment CES vs. CPS

 

August Employment:  Something For Everyone - Unemployment Rate vs LFPR

 

Christian B. Drake

Senior Analyst

 


Early Look

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CHINA GOES BULLISH TREND ON THE ONLY POSITIVE DATA POINT THAT ACTUALLY MATTERS

Takeaway: The Shanghai Composite Index closed above its 2,123 TREND line today on really meaningful – and potentially very positive – news.

SUMMARY BULLETS:

 

  • The Shanghai Composite Index closed above its 2,123 TREND line today. While this move needs to confirm itself on a closing price basis over the next few days and weeks, we’d be remiss not call out this groundbreaking quantitative signal as anything other than that.
  • Perhaps the most important part about China closing above its TREND line today was that it happened amid some really meaningful news:
    • The Politburo plans to speed up the development of the Shanghai free-trade zone (to be launched later this month), with the intention that it will take the lead in financial reform – eventually rivaling Hong Kong as China’s main international financial center with intentions for it to become a global financial center by 2020.
    • In the free-trade zone, 19 commercial sectors are to be liberalized with the banking sector being the most important of the 19, considering the plans for the Shanghai free-trade zone to be at the forefront of interest rate liberalization in China.
    • Additionally, regulators will authorize full capital account conversion on a trial basis, though it remains to be seen how much the exchange rate will be allowed to fluctuate because of it.
  • All in all, this could wind up being extremely positive as it relates to offsetting China’s structural liquidity headwinds with new sources of capital, but we simply need more data to confirm that hypothesis.
  • The one thing we can tell you is that if the market thinks the Shanghai free-trade zone will be meaningful enough to help offset the structural liquidity constraints we see weighing on Chinese economic growth over the long term, then we do as well. Unlike the consensus US equity bears in 2013, we’re not and never will be smarter than the market…
  • We’ll be on the sidelines awaiting more details as it relates to these developments and we suggest you do the same; at the bare minimum, investors should no longer be shorting China here. A small loss on the short side is always better than getting royally squeezed for an even bigger one (NOTE: the MSCI China Financials Index is up +1.3% since we turned bearish on Chinese financials and property developers back on JUN 7).

 

Roughly three weeks ago on AUG 15, we published a note titled, “ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE?” where we thoroughly dissected the confirming and disconfirming evidence underpinning the current rally in the Chinese equity market – particularly with respect to its sustainability on our intermediate-term TREND duration. We greatly expanded upon that analysis on slides 58-72 in our AUG 30 presentation titled, “PADDLING UPSTREAM?: NAVIGATING #EMERGINGOUTFLOWS” and in our SEP 3 note titled, “HUNTING FOR ASIAN EQUITY ALPHA: LONG SOUTH KOREA VS. SHORT CHINA?”.

 

In each piece, we ultimately concluded that the recent recovery in Chinese economic growth was not sustainable; thus, we concluded that the Chinese equity market’s dead-cat bounce off its late-JUN lows was likely beginning to fade. In the interest of brevity, we’ll refer you to the aforementioned slides and research notes for the analysis supporting this economic and financial market call.

 

Needless to say, that was the wrong call to make. Since AUG 15, the Shanghai Composite Index has advanced +2.8%, which is good for the 2nd best gain throughout all of Asia and well ahead of the regional median equity market delta of -0.2% over that time frame. More importantly, the Shanghai Composite Index closed above its 2,123 TREND line today. While this move needs to confirm itself on a closing price basis over the next few days and weeks, we’d be remiss not call out this groundbreaking quantitative signal as anything other than that.

 

CHINA GOES BULLISH TREND ON THE ONLY POSITIVE DATA POINT THAT ACTUALLY MATTERS - China SHCOMP

 

The worst thing we can do as one of your trusted resources in Global Macro Risk Management is pound the table on the short side in light of the aforementioned delta. That would be disingenuous and inconsistent with our proven, repetitive investment idea generation process:

 

CHINA GOES BULLISH TREND ON THE ONLY POSITIVE DATA POINT THAT ACTUALLY MATTERS - 2

 

Perhaps the most important part about China closing above its TREND line today was that it happened amid some really meaningful news:

 

  • The Politburo plans to speed up the development of the Shanghai free-trade zone (to be launched later this month), with the intention that it will take the lead in financial reform – eventually rivaling Hong Kong as China’s main international financial center with intentions for it to become a global financial center by 2020.
  • In the free-trade zone, 19 commercial sectors are to be liberalized with the banking sector being the most important of the 19, considering the plans for the Shanghai free-trade zone to be at the forefront of interest rate liberalization in China.
  • Additionally, regulators will authorize full capital account conversion on a trial basis, though it remains to be seen how much the exchange rate will be allowed to fluctuate because of it.

 

All in all, this could wind up being extremely positive as it relates to offsetting China’s structural liquidity headwinds with new sources of capital, but we simply need more data to confirm that hypothesis.

 

The one thing we can tell you is that if the market thinks the Shanghai free-trade zone will be meaningful enough to help offset the structural liquidity constraints we see weighing on Chinese economic growth over the long term, then we do as well. Unlike the consensus US equity bears in 2013, we’re not and never will be smarter than the market…

 

We’ll be on the sidelines awaiting more details as it relates to these developments and we suggest you do the same; at the bare minimum, investors should no longer be shorting China here. A small loss on the short side is always better than getting royally squeezed for an even bigger one (NOTE: the MSCI China Financials Index is up +1.3% since we turned bearish on Chinese financials and property developers back on JUN 7).

 

Moreover, to the extent our fears (i.e. the market’s cheers) are confirmed, a positive inflection in China’s structural economic outlook would obviously have meaningful implications for the supply/demand/price dynamics across key commodity markets, broader EM economic growth and investor sentiment surrounding EM capital and currency markets (NOTE: the latest BofA flows data shows a rolling-3M outflow from EM stock and bond funds of $60B, which is the largest rolling 3M outflow since 2008).

 

Sit tight and stay tuned for more clarity is the best advice we can give you at the current juncture. Anything more than that would also be disingenuous, as knowing when and what you don’t know is often times as important as knowing when you’re flat-out wrong.

 

Have a great weekend,

 

Darius Dale

Senior Analyst


Working Women

Takeaway: Here’s why employment among your women is increasing.

Here’s a number from today’s jobs report that most overlook – the employment growth among women aged 20 to 34. As the chart below shows, that year-on-year employment growth among those women is accelerating.

 

Those numbers dovetail with Healthcare Sector Head Tom Tobin’s theme of rising birth rates as employment often comes with health insurance, which is pretty much a necessity before having a child.

 

Working Women  - wecantdoit

 

Working Women  - women


KSS: Risk Of Share Loss Is Greater Than Most People Think

Takeaway: We think KSS stole as much as $800mm in sales from JCP. JCP wants it back. Succeed or not, JCP will inflict damage on KSS as it tries.

Conclusion: We think that KSS stole as much as $800mm in sales from JCP last year. JCP wants it back. Succeed or fail, JCP will inflict damage on KSS that is not appreciated.

 

We’d been assuming for much of the past year that the primary beneficiaries of JCP’s share loss have been Macy’s and GPS (Gap and Old Navy US). At face value, the sheer dollar shift in 2012 supported this thesis. But our recent work has presented us with new data that make us think we’ve been negative on the wrong names. Specifically, we recently conducted an extensive consumer survey to understand why consumers have shifted dollars away from JCP, and where the share has gone. And the big winner (and soon to be loser) turned out to be Kohl’s. Macy’s came in at number two, but by a wide margin. Gap looked surprisingly good.

 

Survey Says: As outlined in the chart below, consumers claim that almost 19% of items that they shifted away from JCP are now being purchased at Kohl’s. The math is pretty simple. $4.3bn in sales lost * 18.6% share shift = $800mm.  But the obvious counter-attack is “That can’t be right. KSS has been putting up horrible numbers – that’s way too high as KSS only gained $475mm in net sales in 2012”. It’s a logical question, and we’d ask the same one.

 

But our sense is that what’s actually happening is that the $475mm sales gain includes upwards of $800mm in sales gains from JCP.  In other words, sales on an organic basis were likely down at JCP last year by several hundred million.

 

We understand that there is sampling error associated with every form of survey – ours included. But we should note that this is not a typical ‘ask a bunch of people at the Garden State Plaza Mall what they think’ kind of survey. We put this up any other one out there.

 

Even if you do want to adjust for sampling error, these numbers are still so high that we can raise a very large red flag for anyone modeling KSS’ comp or Gross Margin out over the next 1-2 years. Customers are never easy to win back, but we surveyed how consumers would respond to pricing, promotions, private label and remodels, and we feel pretty confident that KSS is going to have a problem on its hands.

 

Stores Shopped Instead of JCP (blue column) vs Items Dispersion of Where Items Where Purchased (Gray)

KSS: Risk Of Share Loss Is Greater Than Most People Think  - shareshift

Source: Hedgeye Research

 

Share Gain From JCP By Income

KSS: Risk Of Share Loss Is Greater Than Most People Think  - share2

Source: Hedgeye Research


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