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.
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.
LEVINE'S LOW DOWN
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. <bloomberg.com>
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. <fashionnetasia.com>
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. <wwd.com>
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. <wwd.com>
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. <wwd.com>
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. <sportsonesource.com>
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%. <fashionnetasia.com>
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. <retail-week.com>
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 www.jcpnewstores.com/manhattan. The two-level, 153,000-square-foot store will be located in the Manhattan Mall at Herald Square. <licensemag.com>