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JCP: The Bear Case Lacks Intellectual Integrity

Takeaway: We're surprised at how many people are hanging on to the stale bear case on JCP. Seriously, at least acknowledge that things are improving.

Great news out of JC Penney this evening, as the company reported a 10.1% comp in November.  We admit that it's only a partial window into the quarter. But, this validates three core parts of our JCP thesis.

 

  1. There are so many things at JCP that are broken, but  absolutely none of them are beyond repair. Consensus won't acknowledge the concept of JCP earning money, while we think that $1.50  in earnings power is within reach (that's up from our recent $1.30 estimate).  Once people internalize this eventuality, we think we're looking at a $20 stock (low teens multiple, though we could argue higher).
  2. Even though Wall Streeters may not be big JC Penney shoppers, the fact of the matter is that the average American consumer genuinely wants JCP to exist.  Tough for Wall Street to believe, but our work suggests that it's 100% true.
  3. JCP is absolutely gaining share -- when it comps 10% -- 3-5x its average competitor -- it's tough to argue otherwise.

 

*Our research is based in part on our survey work -- which suggested last month (before KSS missed and JCP beat 3Q) that JCP was regaining share, and that KSS was likely the biggest donor.  We've updated our survey, and will be ready to share our insight (and incremental trends from our last survey) early next week. Please contact sales@hedgeye.com if you are interested in the results.

 

BEARS ARE STILL GROWLING

 

We've gotten a lot of feedback from bears this evening -- including 1) 'they were up against an easy comp' and 2) 'we don't know inventory levels or gross margins.' The latter point is true. We don't know margins. But we have a rather strong sense that they were better than last year.  We still think that a return to the  mid-high 30s Gross Margin is likely -- from the depths of the 22% where Johnson forced them. We need to keep in mind that Gross Margin is one of the easiest lines to destroy on the P&L over a short period of time (i.e. Ron Jon eliminating $2.5bn of 48% GM private label). But unlike other industries, in retail it is also the one line where you can shake the etch-a-sketch clean and return to meaningfully higher levels over a 12-18 month time period.

 

As it relates to the bears' 'it's irrelevant -- it was an easy comp' argument, we think that's an absolutely ridiculous point. The reality is that last year JCP lost a tremendous amount of market share -- $4.3bn to be exact.  And now it's taking it back. When they take it back from KSS -- who we estimate stole $800mm in sales -- is KSS going to say…'that's ok, we took a lot of share last year, so it's ok if our sales are down.' Yes, we know how ridiculous that sounds. But the reality is that JCP is growing 3-5x ahead of its competitors. And that can't be glossed over.

 

Here's A Chart That Shows Us Who Took The Most Share From JCP. As Noted, Our Updated Survey Hits Next Week and We Will Be Able To See Incremental Trends

 

JCP: The Bear Case Lacks Intellectual Integrity - JCP

 

HERE'S ONE OF THE MOST IMPORTANT CONSIDERATIONS AS IT RELATES TO OUR BULL CASE

 

First, as a precursor, we need to reiterate that we are in no way perma bulls on JCP (we're not 'perma' on anything). We were short this name at $42 when Ackman was parading around his $12 in earnings thesis. We turned positive earlier this year when we thought perception of fundamentals as well as sentiment had overshot on the downside.

 

As it relates to earnings power, let’s keep an important factor in mind…JCP is operating at $100 per square foot. That’s embarrassing. Kohl’s, which we think has structural issues and has been at the top of our short list – is running close to $210/sq ft. Before Johnson worked his magic, JCP peaked at $190 per foot.

 

Our point here is that we don’t have to assume that JCP becomes a great retailer. We don’t have to even believe that it will be an average retailer.  It can remain in the lower quartile – a notch above Sears even – and operate at $140/square foot. And it can get there by simply fixing some of the factors that Johnson damaged during his triumphant reign.

 

Alongside $140/square ft., our other key assumption is that Gross Margins get back to 37%, which we think is very doable – despite the severe pushback we get on this assumption. Ron Johnson decimated JCP’s private label brands, which cost the company about $1bn in gross profit – that’s what happens when you remove $2.5bn in sales at a 48% gross margin and substitute that with $900mm at a 33% gross margin.  

  

Here are some of our recent clips from HedgeyeTV. Comments are welcome, as always.

 

http://app.hedgeye.com/media/704-video-jcp-mcgough-remains-optimistic

 

http://www.youtube.com/watch?v=nfMU0ggmJ1U&feature=share&list=UUkDxvN-bcxsKkvJ3yyiGSVQ

 

Here's Our Note After JCP Surprised on the Upside With 3Q Results Last Month

11/21/13

JCP: The Bear Case Just Shrunk

 

Takeaway: This is going to be the Q where people look back and say “yeah, that was the point where I should have realized JCP is a viable entity.”

 

The list of ‘what’s changed’ to our thesis on JCP in the wake of its print is a very short one. In fact, it’s nonexistent. Were there questions that emerged that we need to get answered? Of course there were. That’s what happens when a company loses $1.94 per share. But far more questions were answered than were raised. Here’s some of our thoughts.

 

  1. EPS of ($1.94) missed the Street’s ($1.70) but the reported number includes a $0.73 loss associated with a tax valuation allowance. We don’t think EPS was the most relevant statistic this quarter as share count estimates were all over the place given the mid-quarter equity offering. Nonetheless, on an adjusted basis, we’d say that they probably beat.
  2. By now everyone knows that JCP voluntarily repaid $200mm on its revolver. It’s worth reiterating as that’s not behavior one would expect from a company about to file Chapter 11.
  3. Guidance for 4Q includes; a) additional sequential improvement in top line and gross margin – and both positive vs last year, b) DOWN sg&a versus last year, and liquidity to be in excess of $2bn. We don’t think that down SG&A is sustainable for any extended period of time – nor do we want it to be. But for now, we’ll take it.
  4. That point on liquidity guidance is the most important. The big bears out there had estimates for year-end liquidity of $1.5bn to $1.8bn. Again, companies with stocks going to zero don’t take up liquidity expectations.
  5. One of the biggest factors we had to rectify is the fact that gross margins were weak at the same time the company brought back higher-margin private label. But what we did not consider is the fact that JCP is still dealing with merchandise that was ordered under Johnson’s regime – brands that the consumer simply does not want. This is product that is going out at a gross margin in the 15-20% range. That’s seriously offsetting the high-40% GM JCP realizes on private brands like Arizona, Worthington, and St. John’s Bay. We did extensive consumer survey work around these brands – and although most people reading this note might not want them, the average American definitely does.

 

In the end, this is going to be the quarter where people look back and say “yeah, that was the point where I realized JCP wasn’t going under”.  We know that this isn’t a major bullish statement, but it certainly removes the most bearish case being throw around – and that’s the case that nearly every short is banking on (and yes, JCP remains one of the most heavily shorted stocks in the S&P). People are still going to have to buy in to the premise that this company can see an acceleration in sales/square foot to a level that can sustain a respectable earnings level. We think JCP pierces through $120/ft in 2015 – which will mark its break-even year. That might not sound too enticing – after all, we all like for companies to make money instead of simply not lose money. But the consensus is at a loss of $1.18 that year, and we think that estimates will need to come up materially.


#CyberMonday Goes Mobile

Takeaway: Department stores crushed it with 70% growth.

Editor's note: Hedgeye Retail Sector Head Brian McGough shares some of his thoughts on Cyber Monday.

#CyberMonday Goes Mobile  - cybmon

 

Cyber Monday Goes Mobile With 55 Percent Sales Growth, Reports IBM

  • "U.S. shoppers made Cyber Monday the biggest online shopping day in history with a 20.6 percent increase in online sales, according to the latest cloud-based analytics findings from IBM. Mobile sales led the way, exceeding 17 percent of total online sales, an increase of 55.4 percent year-over-year."
  • "Cyber Monday also capped the highest five-day online sales period on record – from Thanksgiving Day through Cyber Monday – which grew 16.5 percent over the same period in 2012."
  • "Department Stores: Cyber Monday total online sales grew by 70.3 percent over 2012, with mobile sales growing 52 percent year-over-year. Average order value was $161.83, up 18.7 percent year-over-year." 
  • "Health and Beauty: Cyber Monday total online sales grew by 65.1 percent over 2012, with mobile sales growing 84 percent year-over-year. Average order value was $60.22, an increase of 6.8 percent year-over-year."
  • "Home Goods: Cyber Monday total online sales grew by 26.5 percent over 2012, with mobile sales growing 40.5 percent year-over-year. Average order value was $182.19, an increase of 9.2 percent year-over-year."
  • "Apparel: Cyber Monday total online sales grew by 22.5 percent over 2012, with mobile sales growing by 58.3 percent year-over-year. Average order value was $102.83, a decrease of 6.9 percent year-over-year."

Takeaway: Some interesting color here by IBM. Department stores crushed it with 70% growth, which is great, because they fell flat on their face as it relates to in-store shopping. Let's also put the dot.com spend into perspective…most stores are coming off an fairly low level of spending online. About 10% of total retail sales originate on-line, but department stores are only about 7% (despite the fact that virtually everything they sell is e-commerce friendly). Big sign of failure to capitalize on an opportunity, but also a big opportunity from here. JC Penney, for example, lost about $500mm in dot.com sales over the past two years (thanks RonJon), or about a third of its internet business. We think it gets it back within 2-3 years.  

 

#CyberMonday Goes Mobile  - nnn7

 

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ISM: Nice Upside Surprise

Takeaway: ISM of 57.3 for November surprised on the upside.

Yesterday's headline ISM reading for November improved +0.9 month-over-month to 57.3, marking another year-to-date high and the highest reading since April of 2011. 

 

Strength was pervasive across the sub-indices as the New Orders and Employment series hit their highest levels since April 2011 and April 2012.  Supplier Deliveries remained unremarkable at a middling 53 while inventory levels improved to 50.5 in November from 52.5 prior.   Reported respondent commentary was generally positive as well (Here)

 

ISM: Nice Upside Surprise - gm5

 

Whether incremental strength in November could be partially attributed to deferred demand coming back online post the government shutdown resolution in October remains equivocal.  While October durable goods data showed a discrete deceleration, headline ISM advanced in October with Business Production, New Orders and Employment declining only modestly. 

 

Notably, in the ancillary index aggregates, backlogs continued to rise and the export index advanced for a third straight month (highest since Feb 2012) as demand from outside the U.S. continues to support domestic manufacturing activity. 

 

It’s not particularly surprising to see manufacturing gains outpace services gains domestically with household personal income and spending growth still constrained (largely stemming from sequestration and ongoing negative government employment growth) and European growth accelerating.  

 

While any reading >60 is solid, we’ll be interested to see if New Orders can make a higher high in December or if we get a repeat of August and another short cycle top as we head into the 2014 iteration of the budget/debt ceiling tragicomedy.   

 

In the more immediate term, with the dollar correlation to equities holding moderately negative, the market remains largely myopic in its focus on the implications of the macro data for prospective policy adjustments.  

 

ISM: Nice Upside Surprise - ism1

 

* * * * * * * 

 

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Just Charts - #EuroBulls

Our Top Q413 Global Macro Theme remains #EuroBulls.

 

The heart our #EuroBulls call is a bullish position on the GBP and EUR versus the USD and a bullish position on UK and German equities, built on a few central factors:

  • Central Bank Intervention: we expect Janet Yellen to remain the ueber dove on policy and push out any QE taper expectations to at least late in Q1 2014, which should burn the Greenback lower (etf UUP). 
  • BOE “Hawks”: we expect Mark Carney and the BOE to remain on hold with interest rates and the asset purchase target, built on improving UK fundamentals, which should encourage the British Pound higher (etf FXB).
  • Draghi’s Back Pocket: we were surprised (and off-sides) with the ECB’s decision to cut the interest rate 25bps on 11/7. The cross has since corrected and we like the set-up on the long side. Twisting an expression, we don’t think it pays to ‘Fight the ECB’: Draghi has balance sheet flexibility with LTRO repayments to unlock additional sovereign and banking bailouts, if needed (etf FXE).
  • Island Insulation: the UK was the first country to issue austerity in Europe -- we’re seeing the threw-put of that decision with fundamentals improving ahead of its European peers. We maintain a bullish bias on UK equities (etf EWU).
  • German Leadership: Chancellor Merkel is formalizing coalition talks with the SPD; alongside her Finance Minister Schaeuble we see strong continuity of policy vis-à-vis the EU with the new coalition. We’re seeing strong domestic economic health from Eurozone’s largest economy and we expect the country to benefit as the region recovers off a low base. We’re buyers of Germany’s stability (etf EWG).

Just Charts - Below we show the data we’re seeing that is supportive of our #EuroBulls call:

  • GDP Taking the Turn: before we highlight the economies of Germany and the UK, we’ll note that we’re seeing a broader improvement from the Eurozone region. In the next charts, the turn (to the positive) is underway!

Just Charts - #EuroBulls  - zz. eurozone imports and exports

 

Just Charts - #EuroBulls  - zz. eurozone IP and REtail

  • Confidence Ramping: From economic to business and consumer, the improvement in confidence readings is hard to ignore.

Just Charts - #EuroBulls  - zzz. .eurozone business conf

  • Even Autos are getting a bounce: Any increase in big ticket items is a signal of confidence to us.

Just Charts - #EuroBulls  - zz. EU clunkers

  • PMIs Popping: the improvement in confidence is backed by stronger Services and Manufacturing PMIs.  Despite underperformance from France, we expect the Eurozone aggregate to cruise about the 50 line (expansionary), and the UK and Germany to outperform.

Just Charts - #EuroBulls  - zz. pmis

  • Risks Abates: an additional positive signal comes from tightening credit spreads, approaching levels last seen when Europe’s sovereign ‘crisis’ began.  While risk is not completely off the table, either on the sovereign or banking sides, we’re seeing compelling improvements. All European sovereign CDS are down on the month and, on average, European Financials have tightened by 46 bps or roughly 21% on the month. 

 Just Charts - #EuroBulls  - zzz. credit spreads

  • Deflating the Inflation: we view deflation of the inflation as a lower consumption tax that will boost real inflation adjusted growth. Clearly the ECB has failed to meet its mandate of CPI at or below 2%, however CPI at its current 0.9% is not a “threat” of deflation in our opinion.  Despite the ECB’s surprise cut to the interest rate on 11/7, we see no need for the central bank to cut further as fundamentals are showing improvements.       

Just Charts - #EuroBulls  - zz. Eurozone inflation

  • Draghi’s Back Pocket: Our new mantra is don’t ‘Fight the ECB’ because 1). Time and time again it has not paid to, and 2). Draghi has even more balance sheet flexibility now with LTRO repayments coming in. Don’t forget our central position has been that Eurocrats want to keep the Eurozone experiment alive – this includes at all costs, be it for additional sovereign and/or banking support. 

Just Charts - #EuroBulls  - zz. ECB and LTRO

  • Credit Thin: This chart remains a thorn in Draghi’s side. Getting credit to flow into the system to households and non-financial corporations has been a great challenge. We don’t expect the ECB to issue another round of LTRO, given its shortcomings in this respect, but we could foresee an alternative to the LTRO with more outlined lending requirements. 

 Just Charts - #EuroBulls  - zz. ecb loans to households

  • The TREND is Your Friend: our quantitative lines in the sand on the EUR/USD have not moved much in Q4. The currency crashed on Draghi’s unexpected rate cut on 11/7. It has since rebalanced and we like it on the long side as fundamentals improve and the EUR marginally wins out versus the USD in the #CurrencyWars (etf FXE). 

Just Charts - #EuroBulls  - zzz. eur usd levels

  • UK GDP: we expect outperformance versus most of its European peers, built largely on it choking down austerity first during the great recession.  The European Commission in its autumn report recently raised UK GDP expectations, to +1.3% in 2013 from +0.6% and to +2.2% in 2014 versus a previous estimate of +1.7%. We’re buyers of UK equities (etf EWU).

Just Charts - #EuroBulls  - zzz. uk gdp

  • UK CPI Eases: Inflation has moderated to 2.2%. We think this is an added benefit to consumers and expect a #StrongCurrency to increase purchasing power by deflating imported inflation.

Just Charts - #EuroBulls  - zz. uk cpi

  • UK Confidence Confirms the Data, or visa-versa: We see confidence rising alongside high frequency data: Manufacturing PMI for November was the best in in Europe (58.4 versus 56 in October). And Construction PMI shot up to 62.6 vs 59.3 in October.

Just Charts - #EuroBulls  - zz. uk confidence

  • UK Manufacturing and Retail Sales: confidence is a huge piece of the consumption puzzle; we see the trend in manufacturing and retail sales moving positively over the intermediate term. Household spending accounts for 62% of GDP in the UK. 

Just Charts - #EuroBulls  - zz. uk IP vs RETAIL

  • UK Housing May Ease: After taking off like a rocket ship for the balance of the year, the BOE announced on November 28th that it would curtail mortgage lending in its “funding for lending” scheme. 

 Just Charts - #EuroBulls  - zz. uk housing

  • GBP/USD: the cross is trading comfortably above over our intermediate term TREND level of support of $1.59 and long term TAIL line of $1.57 (etf FXB).

Just Charts - #EuroBulls  - zzz. gbp usd

  • Strong Germany: we continue to like the DAX, on a positive correlation to the EUR/USD. Fundamentals remain grounded with a low unemployment rate (6.9% vs 12.1% in the Eurozone), CPI at 1.6% Y/Y, expanding exports, strong PMIs and consumer and business confidence, and an inflection in factory orders to the upside (etf EWG). 

Just Charts - #EuroBulls  - zz. germany factory orders

 

Just Charts - #EuroBulls  - zz. germany ifo

 

Just Charts - #EuroBulls  - zz. germany zew

 

Just Charts - #EuroBulls  - zzz. dax vs eur

 

 

Matthew Hedrick

Associate

 

 

 


KKD: DÉJÀ VU (BUY THE DIP)

Takeaway: DÉJÀ VU - This is a great opportunity to buy the dip. The company's fundamentals are as strong as ever and the growth story is intact.

 

 

Krispy Kreme posted very solid 3QF14 results after the close yesterday and today’s dip offers a nice buying opportunity for those looking to be long the name.  Despite softer than expected top-line growth, the fundamentals of our bullish thesis remain intact.  In our opinion, today’s selloff was largely due to “disappointing” domestic company comps of +3.7%, which missed consensus metrix estimates of +6.7%.  However, domestic franchise comps (+10.7 vs. +6.8% estimate) and international franchise comps (-3.1% vs. -7.9% estimate) both significantly surprised to the upside.  Domestic company and franchise comps continue to grow and international comps are accelerating at a rate much faster than anticipated.  There is a chance that international comps could turn positive next year, which would be far sooner than the street currently expects.

 

While KKD appears to have failed to live up to lofty expectations, the fact of the matter is the company is in great shape.  All four business segments posted higher operating margins than a year ago, traffic was up +1.1% despite lapping a difficult comp of +7.1%, beverage sales were up +4.2%, the growth story is predominantly on track, and the balance sheet is as strong as ever.  Essentially, the growth drivers that made us bullish on the company back in early September are still in place.  Krispy Kreme has tremendous opportunities to drive long-term growth by continuing to refine its freestanding small factory shops, driving higher margin beverage sales, growing its capital light model, and expanding its domestic and international footprint.

 

As an aside, management did acknowledge that its original goal of 400 domestic shops by January 2017 may aggressive.  This is marginally negative, but isn’t a huge deal.  In fact, management would not completely rule it out and the overall growth story is largely on pace to play out.  Another point of contention is the gap between domestic company (+3.7%) and domestic franchise (+10.7%) comps.  To most, this signals that the company is doing something wrong.  But, to us, this resembles an impressive franchise base and an opportunity to refine company operations.  Seven domestic franchisees grew same-store sales by +20% or greater, while the remaining franchisees grew same-store sales by +7% or greater.  This type of operational execution and performance is what makes us excited about the growth prospects of this company.  KKD announced a development agreement with Dulce Restaurants, LLC, to develop 10 new shops in Houston over the next five years and management indicated that more announcements are likely to follow in the coming weeks and months.

 

The market’s reaction today is emblematic of what we saw last quarter after KKD reported “disappointing” 2QF14 results.  KKD is currently trading at a PE of 27.5x and 17.8x EV/EBITDA on a NTM basis, well below prior valuation levels.  This downward multiple revision represents a strong buying opportunity.

 

What we liked in 3QF14 results:

  • Revenues rose +6.7%, comparable sales rose +3.7%, and operating income rose +27.2%.
  • Domestic franchise and international comps blew away expectations.
  • Operating margins improved across all four business segments.
  • Traffic was up +1.1%, despite lapping a very difficult +7.1% comp.
  • International same-store sales could turn positive next year.
  • Beverage sales grew +4.2%, led by the coffee category which was up +15%.
  • The wholesale channel is growing.  Average weekly sales per door rose in both the grocery and mass merchant and convenient store channels.
  • Long-term opportunity to drive incremental sales and extend the Krispy Kreme brand through packaged ground coffee.
  • The majority of domestic unit growth over the next three years will be franchise.
  • Continue to develop and improve the freestanding small factory shop models.
  • Total franchise commitment for additional international development now stands at roughly 350 shops and the goal of 900 international shops by January 2017 remains achievable.
  • Recently announced two franchise agreements (Alaska and Houston) and plan to announce more in the coming weeks and months.
  • The growth story is intact.  Anticipate opening 10 to 15 domestic company stores, 20 to 25 domestic franchise stores and about 85 international franchise stores in FY15.
  • KKD is now much more attractive from a valuation standpoint.

What we didn’t like in 3QF14 results:

  • Total revenues came in light, driven by disappointing domestic company comps (+3.7% vs. +6.7% estimate).
  • Management sounded unsure that they would be able to hit the original goal of 400 domestic stores by 2017, calling it a “stretch” goal.
  • Facing difficult domestic company and franchise same-store sales comparisons in 1HF15.
  • Preliminary FY15 EPS guidance of $0.71-0.76 came in below expectations of $0.77.

 

KKD: DÉJÀ VU (BUY THE DIP) - KKD company

KKD: DÉJÀ VU (BUY THE DIP) - KKD franchise

KKD: DÉJÀ VU (BUY THE DIP) - kkd international

 

 

Howard Penney

Managing Director

 


$FXB: Don't Mess With The Pound

Takeaway: We remain bullish on the British Pound (via FXB).

After another blockbuster economic data point out of the UK this morning (November Construction PMI 62.6! vs 59.3 in October), the Pound continues to pound the Burning Buck at $1.64 versus the US Dollar.

 

$FXB: Don't Mess With The Pound - uk99

 

Guess what? It can go a lot higher from here.

 

Especially if the Fed engages in open-market storytelling about why the ISM growth data (best in 3 years) isn’t enough to taper.

 

Yes - we remain bullish on the British Pound (via FXB).

 

Incidentally, all of those Keynesian college professors who said austerity would kill the UK (Danny Blanchflower at Dartmouth)?

 

They are eating crow.

 

$FXB: Don't Mess With The Pound - UK Construction PMI


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