Retail First Look: But How Was The Show Mrs. Lincoln?

Here's some meaty lease accounting considerations that the WSJ article forgot to consider. This is a big deal - and one of the key margin drivers (and killers) in 2010.


This WSJ article touting rent concessions for retailers for invoking 'cotenancy clauses' is the biggest crock of hindsight analysis I've seen in at least a few weeks. Yes, it is accurate in claiming that rents are coming down as the pendulum shifts form Landlord to lessee. But it's missing the point that the retailers have already baked this in to their internal plans, and their communication to the Street. In addition, some retailers' rents are coming down because they COULD, others are doing so because they SHOULD. What we need to be focused on is three factors... 1) What each retailer's lease portfolio looks like, 2) how it has changed in recent years, and 3) who has the greatest opportunity to improve vs. who is largely tapped out. 


Remember that reported operating margins for retailers remain meaningfully misunderstood given different accounting for operating leases. Some retailers have aggressive terms (unfavorable leases) to prop operating margins - this is usually in the form of lower rent payments today at the cost of longer duration, a higher step-up factor, or weaker 'out' clauses. 


In simple terms, this is not unlike home ownership. Do you want to be someone who borrowed $1mm through a 5-year interest-only ARM on a $1.5mm home 3-years ago when housing values are at peak? Guess what? Now your house is underwater, your loan needs to be refinanced at a higher rate, and lending standards are ridiculously more constrictive.  Or would you rather be that person who only bought an $800k home, and has been paying off principal and interest on a smaller ($300k) longer-term, safer facility?  That's kind of a rhetorical question. If you answer the former, then I definitely do not want you managing my money. I have a hard time accepting the fact that most CEOs in retail think of proactively managing this fiduciary responsibility for the benefit of shareholders.


We analyze this by looking at the total duration of lease portfolios for different retailers, which we calculate using disclosure of minimum obligations by year on off balance sheet assets (Y Axis). Then on the X axis, we plot the 2-year change in portfolio's duration. It other words, what is the duration, and are recent actions by management extending or shortening that duration.


Retail First Look: But How Was The Show Mrs. Lincoln? - 7 9 2009 6 43 08 AM


Making sweeping statements based on the analysis would be intellectually dishonest, as there's no right or wrong place to exist on this chart. This is really more of a tool to ask management teams the right questions regarding growth philosophy, where such investments are being accounted for, and how they are funded. But at face value, I'm drawn to companies in the lower half of the chart (low forward obligations/portfolio duration), as well as those to the left of the vertical axis (have been proactively taking obligations lower - even if at the expense of margins). Not that I'm encouraging it, but it opens up the opportunity for these companies to go the other way by upping forward obligations and taking down current rents to a greater degree (hence boosting operating margins). Companies in the upper right have less flexibility. 


I could type for an hour about this. But will save your valuable time to deal with the obligatory barrage of sales datapoints today.


Let me know if you'd like any additional info on any companies in question.



Some Notable Call Outs


  • After meeting with a long-time former executive from Columbia Sportswear, it is clear that a sale of the company is not unheard of or unlikely. There is nothing to speak of at the moment and no deal is imminent, but the long held belief that the Boyle's would never sell is likely unfounded given the change in the company's competitive dynamics over the past few years. Other insights from the meeting included a call-out on Marmot becoming an urban brand of choice (remember North Face?) as well as a reminder that sporting goods retailers are still very focused on exclusive distribution. Product destined for Macy's or Kohl's is very unlikely to make its way into Dicks or The Sports Authority.


  • In a rare but notable move, appliance and electronics retailer HH Gregg announced that it is substantially increasing its store growth plans to take advantage of the favorable real estate market and the exit of Circuit City. The growth plans go from 16-18 stores, to 20-22 for this year and will double to 40-45 next year. This is the most aggressive example we've seen across the entire retail space of a company going on offense in an otherwise challenging environment. Additionally, these moves will bring the company into new territories and trade areas beyond its current regional footprint. This could be the beginning of a widening in the bifurcation between those companies that are well capitalized to take advantage of operational leverage and those that are limited by financial leverage and operational deficiencies...


  • Family Dollar's stellar 3Q results speak for themselves and don't need to be rehashed. However, the conference call revealed some interesting trends. First, consumables continue to drive the company's same store sales, increasing 11% on a comp basis. The growth in consumables has resulted in a 600 bps increase in penetration, taking the consumables mix to 64%. Discount stores, clubs, and dollar stores are all reporting substantial gains in consumables vs. only modest gains for supermarkets. The market share shift is undeniable at this point and will likely remain a headwind for the traditional grocers. On the discretionary side, home products continue to strengthen along with slight improvements in apparel. Interestingly, management cited consumer research which suggests middle-income customers are finding their way into the stores more frequently. The widening of the customer income demographic is occurring at the same time food stamp redemption continues to increase. There are now 15 million Americans on food stamps, up 19% y/y in March.




Fast Retailing Co., operator of Japan's biggest casual clothing chain Uniqlo, raised its full- year profit forecast for the third time, as recession-hit consumers buy more of its T-shirts, skirts and bra tops.  Net income is forecast at 52 billion yen ($558 million) for the year ending Aug. 31, up 4 percent from an April estimate of 50 billion yen. It posted profit of 43.5 billion yen last year.  Chief Executive Officer Tadashi Yanai, who owns a 27 percent stake, is benefiting as Japan's five-year-high jobless rate and 12 straight months of wage declines drive consumers to discount retailers. The company tripled shipments of bra tops, which are camisoles and tank tops with fitted bra cups, to about 9 million this year.  "Fast Retailing is shining in this economic environment," Koichi Ogawa, chief portfolio manager at Tokyo-based Daiwa SB Investments Ltd., said before the announcement. "Consumers like Uniqlo for its quality and price."  Full-year sales may rise 16 percent to 682 billion yen, and operating profit may rise 23 percent to 108 billion yen, Fast Retailing said. The company also raised its full-year dividend plan by 10 yen to 160 yen a share.  Sales at Uniqlo stores open at least a year in Japan gained for the eighth straight month, rising 6.4 percent in June. The Yamaguchi, western Japan-based company had 777 stores, including 20 franchise shops, in the country as of May 31. Same-store sales strip out the effect of outlets that have recently opened or closed. Uniqlo - The company today raised its forecast for same-store sales in the six months ending Aug. 31 to a gain of 9.3 percent from its previous estimate of a 2.3 percent increase.  <>


Indonesia's Industry Ministry announced nine footwear manufacturers eligible for the government aids to mondernise their industrial machinery for enhanced efficiency and productivity. While the Ministry is offering over Rp. 4.2 billion to these nine shoe companies, the government has allocated a total of Rp. 55 billion for the year, financing 10% of the manufacturers' new machinery purchases. Over 15 companies have so far applied for this aid but this number is below the government's target to assist at least 30 companies. As the government wants each applicant to invest minimum Rp. 500 million for the purchase of new machineries, the number of applicants is less than expected due to the fact that most manufacturers are small and medium enterprises.  The application of the aid will still be opened until the end of July if the companies prove that they have already purchased new machines. Total footwear exports of Indonesia are expected to reach $1.8 billion in 2009 with a slight decline of US$50 million compared to the previous year. <>


The French might soon be enjoying what Michelle Obama did on her trip to Paris last month: shopping for clothes on a Sunday.  Lawmakers here this week are debating a proposed bill that, if approved, would lift restrictions on Sunday trading that date back to 1906, overcoming the resistance of opposition parties and trade unions.  "Is it normal that on a Sunday, when Madame Obama wants to go to the Paris shops with her daughters, I have to make phone calls to have them open?" President Nicolas Sarkozy recently complained.  Unlike the U.S. and U.K., where Sunday trading is the norm, French shops are required by law to stay closed, unless they sell food, or are located in tourist areas and are deemed to have "recreational" or "cultural" value, such as bookstores.  When compared with other European Union countries, France has the most restrictive rules when it comes to Sunday trading. In neighboring Italy, for example, shops in tourist areas can elect to stay open on Sundays and holidays 10 months a year. In Madrid, the Spanish capital, stores are open every Sunday from midday until 8 p.m., while in Berlin they are allowed to open 10 Sundays every year.  In a bid to stimulate trade, the French government is proposing to loosen its tight rules and allow stores to open on Sunday by widening the tourist designation to more municipalities and allowing all types of retailers in these areas to open for business. If the bill is passed in its current form, the number of municipalities designated as tourist areas could increase from the current 500 to 5,000.  <>


The luxury goods sector is heading for one of its worst years on record, with a predicted drop in expenditures of 6 percent to 211 billion euros, or $294.7 billion, according to a new report. The study by London-based retail analysts Verdict said Japan and the U.S. are expected to bear the brunt of the 2009 slump, with sharp declines in sales of 14.6 percent and 12.1 percent, respectively. A far different luxury retail sector will emerge once the global economy recovers. Customers, who are now favoring understatement rather than fashionability, are likely to demand fewer, but more exclusive, items of outstanding quality, the report said. And the Internet will be a major sales conduit for luxury goods, helping to widen their reach and bring costs down.  <business-news>


Chief executive officers ended the second quarter with a renewed sense of confidence about their own industries and the economy at large. Adding to gains registered in the first quarter, The Conference Board Measure of CEO Confidence surged to 55 from 30 in the first quarter. A level of more than 50 indicates more positive than negative responses. The index reached 40 in the third quarter of last year and slumped to 24 in the final three months of 2009. The percentage of business leaders expecting improvement in economic conditions more than tripled to almost 55 percent in the second quarter from about 17 percent three months ago. Executives in the durable goods industry were the most optimistic, with 77 percent anticipating higher profits. Executives in the nondurable goods sector were second in profit expectations, with 64 percent anticipating a rise, the Conference Board said. While 56 percent of ceo's surveyed believe cost reductions will drive up profits, 33 percent cited market/demand growth as the source of improvement. Ranking third at 7 percent was the belief that new technology will be the driver of growth. The remaining 4 percent cited price increases as the anticipated source of increased profitability.  <business-news>


Rocky Brands Inc. has entered into a new multiyear distribution agreement with U.K.-based Garlands, a distributor of hunting apparel and sporting goods.  According to Mike Brooks, chairman and CEO of Nelsonville, Ohio-based Rocky, the move is part of the company's ongoing initiative to distribute its outdoor footwear, sporting goods and apparel throughout Europe. Beginning this fall, Rocky will ship product to Garlands, which distributes products to more than 1,000 retailers in England, Scotland, Wales, Ireland and Northern Ireland. <>


Two years after introducing women's casualwear adorned with words from songs by The Beatles and David Bowie, Lyric Culture is singing a different tune with a new line of men's T-shirts, hoodies and scarves.  Launching this summer through an exclusive four-month distribution deal with Bloomingdale's, Lyric Culture is offering $75 scarves twisted from slub terry and $162 double-faced cotton hoodies enhanced with pockets for iPods and metal trims shaped like treble clefs. There also are more than two dozen styles of short-sleeve crewneck T-shirts accentuated with rope-stitching embroidery, retailing from $63 to $79.  All garments will feature lyrics from 25 songs by Bob Dylan, Johnny Cash, The Beach Boys, the Rolling Stones and Queen, among others. In addition to the men's line, which Bloomingdale's will sell exclusively through September, Lyric Culture will launch a grouping for toddlers in August at the department store chain. Schmieder aims to later offer the men's line to other retailers and eventually expand to women's jewelry, handbags, footwear and swimwear.  <>


Coleman, a division of Jarden Corp., acquired the Esky coolers brand from Nylex Ltd and plans to expand the iconic Australian brand internationally. Terms were not disclosed. Nylex is currently in receivership. Coleman Asia Pacific president Simon Traynor told The Australian that he expected the brand to be profitable from day one."As an organization we were well aware that Nylex was suffering some difficulty and for some time we've been watching the business and the brand and knew it was an iconic opportunity if it fell over," he told the newspaper, adding that Coleman was executing expansion plans immediately. <>


India's textiles minister Dayanidhi Maran has announced he would take up concerns with the finance minister and described the new Budget as full of "growth-spurring initiatives" in response to disappointment from the industry over the Budget. "The finance minister has accepted more than 90% of the recommendations of the Textiles Ministry, which were based on the suggestions of the industry. If there are any anomalies or suggestions for further improvement, I will take it up with the finance minister, " said Maran.He also said the government was keen to increase the success of the textile industry and was aiming for a growth rate of 7-8%. <>


Sir David Jones, the beleaguered JJB Sports chairman at the centre of a controversy over a £1.5m loan from rival Mike Ashley, has put his £2.2m home in West Yorkshire up for sale. <>


On July 31, JCPenney will open its first Manhattan store, joining its other New York City borough stores in the Bronx, Queens and Staten Island.  JCPenney is reported to be spending approximately $1 million on its advertising campaign, according to The New York Times. The retailer is promoting the opening through special ads, touting "NYC style. JCP prices," as well as exclusively designed shopping bags, a new logo, celebrity events and a Web site at The two-level, 153,000-square-foot store will be located in the Manhattan Mall at Herald Square. <>


Retail First Look: But How Was The Show Mrs. Lincoln? - 7 9 2009 7 32 19 AM



Macau reported six newly confirmed cases of flu A/H1N1 yesterday, bringing the total to sixty-eight.  Two of the newly confirmed cases were imported while the other four were locally infected, according to the Health Bureau. 

According to the statistics from the Health Bureau, the 26 patients who tested positive for the A/H1N1 flu virus were still receiving medical treatments at local hospitals and they were all in stable health conditions.


The overriding theme for the 6% market correction is largely focused on the pace of the recovery and now more investors are focused on the ability of Q2 earnings guidance to sustain the rebound seen in Q1.  Additionally, the impact of rising unemployment on the consumers' ability to make mortgage payment and overall disposable income is creating fresh concerns for weak consumer-related trends.   

We learned this morning that mortgage applications in the U.S. rose last week while refinancing applications jumped the most since March. Additionally purchases climbed to the highest level in three months.   This week's results include an adjustment to account for the July 4th holiday.

The Market Composite Index (a measure of mortgage loan application volume) was 493.1, an increase of 10.9% week-over-week on a seasonally-adjusted basis.  While this news is good, the twelve-week moving average fell 6.4% from the previous week's reading of 752.3.

The refinance share of mortgage activity increased to 48.4% of total applications from 46.4% the previous week. Meanwhile, the adjustable-rate mortgage (ARM) share of activity increased to 4.4% from 4.3% of total applications from the previous week.  The average interest rate for 30-year fixed-rate mortgages remained unchanged at 5.34%. 

Undoubtedly the decline in home prices has brought more homes within reach of more buyers. Incrementally this creation of new demand appears positive, yet with  unemployment at a 26 year high and borrowing costs edging back up, any further improvement in housing will be further down the road. As always, we return to our mantra: "less bad" is not the same thing as "good".

Howard Penney

Managing Director


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UA: The Duration Bifurcation

The BIG call is that sales/EPS will double over 3 yrs. No one owns it for blow-out EPS today, and nothing will come out of 2Q to either rattle the long-term call, or to make the 28% of float that is already short press its bet. My sense is that a beat will boost the stock more than a miss would hurt, and 2H call options are under appreciated. I remain positive.


Negative sentiment is building again on UA in advance of earnings. Duration is a major factor here - perhaps more so than with any story I can find. Why?


Core apparel sales are flattish, footwear is performing 'fine' (i.e. not stellar), management has been selling stock, key internal positions have turned over, prior guidance is vague, 2Q just closed after it rained for 80% of the most important month of the quarter, and at 26x earnings it is one of the most expensive stocks in retail.  I never ignore the facts, and they're particularly important when the stock is resting right on top of $21 TREND support in Keith's model.  I can't say that I blame the bears...


So how in the world could anyone justify being bullish? Well first off, the simple fact that this question is being asked is notable.


But there is a massively more important consideration... NO ONE who owns UA does so because they think that the company will smoke the upcoming quarter or year. It's generally accepted - and probably correct - that UA will print somewhere in the ballpark of $175mm in footwear sales this year, and that apparel revenue will be flat-to-down organically.


Is that worth 26x earnings and 11 EBITDA? Probably not -- unless you're banking on meaningful growth in the business in the next 3 years. Here's the key... The question as to whether this will happen will absolutely not be proved or disproved by 2Q results or guidance.


  • Regardless as to whether footwear sales/guidance are +/- $25mm for the year, this says little as to whether UA will succeed or fail in getting footwear market share from >1% to 5% (around $500mm in added sales) over 3 years. Bulls are unlikely to throw in the towel unless the company does. UA will definitely not back off this strategy, and in fact is likely to highlight organizational changes to take the footwear organization to the next level.


  • Similarly, for someone on the short side that is banking on a miss and/or weak 2H top line guidance, the rebuttal is likely to be that orders for fall were placed at a time retailers were choking on product due to weather-impacted comps. I rarely give that free pass, but this is one instance where it's pretty much a no-brainer.


Let's remember that only 14% of analysts have a 'Buy' rating on UA (lowest in history) and the average price target is 6% below current levels. Short interest as a percent of float has stepped up from 23% to 28% over the last three months.

UA: The Duration Bifurcation - 7 8 2009 7 19 14 AM


So it sounds to me like this is going to hinge upon a meaningful negative earnings revision to beat it down. In going through our model, I've got revenue growing about 5% better than consensus for the remainder of the year. Margins are more of a question mark. But keep in mind that we are anniversarying the launch of cross training - which had a negative impact on mix and margins.


Also, starting in 2H there will be a notable favorable change in capacity for footwear production (and prices) in China, which should ease margin compares. Let's also not forget the Foot Locker factor. Brand new CEO coming from JC Penney where he was President and head of merchandising. Every vendor was at his mercy. Now he comes in to a smaller box where one vendor accounts for over 50% of sales. Not a good setup... His first move will be to sit down with every vendor and find ways to optimize his shoe wall. That means more Under Armour as FL will want to be in the pole position for driving starting a partnership not unlike what DKS and UA had in apparel off-mall. I can't imagine that these are consensus ideas.


The bottom line is that we get to UA beating the quarter by a couple pennies, and earning $0.88 for this year in both EPS and FCF/share, and then $1.10 and $1.35 in 2010 and 2011, respectively. A mid-teens grower this year and 20-25% the two years thereafter? Yeah, I'll stomach a multiple starting with a 2-handle for that. Mind you, this is $1.2bn in revs which only represents 3% share of the relevant footwear market (Adi is 6%, Reebok = 4%, Puma = 3%, Asics and New Balance range between 6-8%).  It also assumes very little success driving a women's business and International presence.


As for the quarter, when I add up all the puts and takes on sentiment, my sense is that a beat (or any bit of positive news) will disproportionately boost the stock as opposed to how much a miss would hurt.

Sequential Improvement for Europe’s Workhorse

German Factory Orders and Industrial Output Improve

If you've been following our work you'll know we have a bullish bias on countries with economic leverage and a bearish stance on countries with financial leverage. As it relates to Europe we've seen a number of countries that have underperformed due to the latter, including (but not limited to) Switzerland, the UK, Spain, and Italy in 2009; and we expect this trend to continue well into next year-with budget deficit rising, access to credit should tighten, which will be prohibitive to growth.

Conversely, Germany occupies a spot on a small list of European countries we're incrementally bullish on. The DAX has yet to show signs of real positive returns this year, currently hovering at -3% YTD, yet German Chancellor Angela Merkel and her economic team have shown strong leadership in adequately stimulating the economy while not overextending debt levels. This should be a huge benefit on the TAIL to growth. Approval of her management is confirmed by the most recent Forsa poll that places support for her party, the CDU, at 37%, up one point from the previous week's reading and increasing her party's spread over its rival, the Social Democrats, to 16 percentage points. 

Fundamentally we're starting to see signs that economy is bottoming out. As a leading economic indicator German factory orders increased 4.4% in May on a monthly basis, as reported yesterday by the Economy Ministry in Berlin. The reading was the biggest gain since June 2007 and nine times the 0.5% increase forecasted by surveyed economists. Today the Ministry reported that industrial production rose 3.7% from April; you'll notice from the chart below that industrial production on a year-over-year comparison is bottoming out and showing signs of positive momentum.

The improvement can be attributed in part to the stimulus from the eco premium for scrapped cars, which has been so popular it's oversubscribed, and the income-enhancing measures of the stimulus package, including:  cuts in income tax and increases in child benefits. As these benefits work through the system we expect consumer spending to improve. Already we've seen sequential improvement in forward-looking consumer, business, and investor confidence.

Exports still look battered on a year-over-year comparison (May data is out tomorrow), yet the increase in factory orders is decidedly bullish if the trend can continue. The report showed that demand from outside the Eurozone gained 8.2% and domestic demand improved 3.9%. With the Ministry revising April's reading to an increase of 0.1% from unchanged, factory orders have increased over the last three months.

Exports, which make up nearly half of total German GDP, could remain a stumbling block in the near term as global demand is still depressed, yet we believe that Germany's significant industrial capacity gives it a structural advantage over its European peers moving into 2010.

Matthew Hedrick


Sequential Improvement for Europe’s Workhorse - GermanyIndust

RT - Who Knew What When?

RT's stock price moved up 12.5% yesterday prior to the company reporting 4Q09 earnings after the close. And judging by RT's significantly better 4Q performance, someone knew something! Earnings came in at $0.28 per share relative to the street's $0.20 per share estimate. Company same-store sales declined 3.2% in the quarter. This was a surprisingly strong number on many counts. RT easily beat the street's expectation of -5.3%. It showed significant improvement from RT's recent performance (-6.8% in 3Q and -10.8% in 1H). And RT outperformed its casual dining competitors by 2.4% in the quarter as measured by Malcolm Knapp. This last point was the most surprising as RT has underperformed its casual dining peers by 5%-10% for the better part of the last two years.

RT - Who Knew What When? - RT FY09 Gap To Knapp

RT management attributed its relatively strong top-line results to its marketing initiatives that have focused on communicating the concept's compelling value proposition. The increase in same-store sales does not come without cost, however, as RT is driving increased traffic with its value message at the expense of average check and restaurant margins. For reference, RT's 2.4% same-store sales outperformance relative to its casual dining peers stemmed from its 8%-9% traffic outperformance, which points to the company's underperformance on an average check basis. RT's CEO Sandy Beall stated that the company's first priority is to "get bodies in seats." Along those lines, the company has not increased its average check in 2-3 years and is not focused on driving check higher in FY10. Instead, Mr. Beall said RT "will keep pushing value for some time to come until the consumer changes."

This increased focus on value will continue to put pressure on restaurant margins, primarily from the negative impact discounting has on food costs as a percent of sales. Despite declining restaurant margins, another bright spot in the quarter was RT's nearly 250 bp YOY increase in operating margins, which was a continuation of the improvement we saw in 3Q. RT has been able to offset its lower restaurant margins in the back half of FY09 by cutting costs in other parts of the P&L. Specifically, the company reduced its annualized costs by $45-$50 million, with the bulk of these cost savings implemented during 3Q. A big portion of the cost savings stem from reduced labor costs as a result of a more efficient labor-scheduling process and lower supervisory costs as RT expanded control for both regional and area supervisors. The company will continue to see the benefit of these cost reductions, particularly in the first half of fiscal 2010, but taking more costs out of the business going forward will be difficult without impacting the guest experience. I have always said that cutting costs that the guest cannot see, taste or experience makes sense, but reducing area supervision can be risky as it can often impact the overall guest experience. This just means it will become increasingly more difficult for RT to protect its operating margins in this challenging sales environment from increased discounting and lower restaurant margins as a lot of the fat has already been cut from the P&L. The company currently has no plans for company-owned unit development, however, which will provide some operating flexibility going forward.

All of that being said, RT has come a long way. It has gone from being a concept that seemed close to becoming a thing of the past to outperforming its peers from a sales and guest count perspective. It has gone from being a company that was at risk to breaking its debt covenants to one that paid down $112 million of debt in one year, in excess of its initial $80M-90M and revised $90M-$100M targets. And in FY09, RT reversed 4 years of operating margin declines.

RT - Who Knew What When? - RT 4Q09 EBIT


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 80.46%
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