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LULU – Still Cautiously Bullish

Takeaway: Gnarly print, but the reality is trends are bottoming. We’re concerned about margins, but not sure it matters now. Still Cautiously Bullish.

 

Conclusion: No surprises for us with the LULU 4Q print after what we laid out in our Black Book on Monday (see our excerpt note below LULU: Why We’re Pulling the Plug on the Bear) where we reversed our bearish stance and turned cautiously bullish. The quarter in itself was hardly anything to celebrate – flat EPS on 7% top line and 20% inventory growth – that’s not exactly an algorithm of excellence . Yes, the company beat, but it beat horrible expectations. The good news for us is that the upside came from the top line, which is something that our research suggests has found a bottom. We think that over time, top line expectations are meaningfully too low – the catch is that margin expectations are about 600bp too high. That might seem like a push (good sales vs bad margins), but with the stock (and sentiment) where it is today, we view the better top line equation as bullish.  

 

Our only real disappointment is that we were looking for an opportunity to take our recent reversal a step further and get outright bullish. The fundamentals didn’t present the ammo for us, and the stock price certainly is not giving us a ‘buy on the freak out’ opportunity. For now, we’re still ‘cautiously bullish’. The stock is trading at about 22x 2015 earnings, and 11x EBITDA, and is on the cheaper side of retail peers when sized against its total addressable market size (EV/TAM). How we’re doing the math, we don’t get more concerned about margins until either a) we’re proved wrong on top line or b) the stock is well into the $60s.

 

 

LULU – Still Cautiously Bullish - LULU financials

 

LULU – Still Cautiously Bullish - EVTAM

 

Here are just a few thoughts on some of the themes that came from the call.

 

Seasonal product – Easily the most talked about topic on today’s call. LULU has used the scarcity model when making seasonal buying decisions to keep demand high and limit discounting. New management emphasized the investments in processes that would  allow for deeper buying in these categories and noted that the current 50% core/ 50% seasonal mix would start to favor seasonal. There are puts and takes for both strategies, but it’s inevitable for the brand if it wants to grow up. 

  • It’s interesting how they stress ‘seasonal’ and don’t acknowledge the word ‘fashion’. Call it what you want, but seasonal product carries more fashion risk. That means higher discounts. We think LULU needs to go there. But let’s call it what it is.
  • Deeper seasonal collections will help drive the top-line. This is especially true in mature markets where the comp is driven by seasonal merchandise. A long replacement cycle means that core can’t carry the comp.

 

Mens – Thankfully it appears that the previously announced standalone Men’s doors won’t be happening. We think there is opportunity in men’s. Now it accounts for about 15% of revenues and that penetration should grow higher in the coming years. New doors with a greater male footprint is great, but we were never fans of the standalone men’s concept. Capital should be channeled towards proven concepts, international, and product/infrastructure improvements.

 

55/25 Margin Targets – Management didn’t say much when asked directly about the company’s long term 55% gross margin/ 25% EBIT margin targets other than to note that in the near term margins would be under pressure due to investments. We’re thinking we’ll get more detail at the coming analyst meeting. We don’t think that LULU will take down the targets materially at the meeting. It will more likely be a slow bleed as LULU pumps more sales dollars through the system.

 

 

03/25/14

LULU: Why We're Pulling the Plug on the Bear

 

Takeaway: We pulled the plug on our LULU Bear call. Our work clearly shows that things are improving. If the qtr is weak, we may get outright bullish.

 

 

Conclusion: After being extremely bearish on LULU since the fall, we're changing our position on the name. While we are not outright bulls at this point -- and while we believe there are extreme challenges for LULU from here -- we do not think that the bear case carries meaningful merit. If the quarter is sloppy and the stock trades down, we may get outright bullish. 

 

DETAILS

As background, we had been long-term bulls of LULU, but last fall turned bearish as LULU's well-publicized gaffes started to come about. Then we conducted a detailed consumer survey of 500 female Yoga shoppers (80% of whom were LULU customers) across appropriate demographic groups. That survey -- conducted three months ago -- told us to press our short, and it was right to suggest we do so. 

 

But yesterday we released an update to our survey, which asks the same detailed questions (and then some) to the same demographic group. The punchline is that things are unquestionably getting better on the margin. We outline all of the reasons why, and then some, in our 52-page slide deck, the link to which is below. Also, if you care to listen to the accompanying presentation, that audio link is below as well. 

 

One slide we'll highlight is #12, which shows the 'Brand recommendation factor' now versus when we first ran the survey at the beginning of the year.   The question asks the extent to which consumers would recommend each of 18 brands to their friends. At the start of the year, LULU ranked embarrassingly low. But today, it is right in line with peers. There's definitely room for improvement. But things have gotten better on the margin, and that's what matters most to us.

 

LULU – Still Cautiously Bullish - lulu then now

 

By no means is the change in our opinion based on one simple question. But many of the questions that we asked -- especially those where we could compare today's results versus those from the start of the year, simply suggest that anyone playing on the short side for things to materially worsen from here has a pretty tough risk/reward on their hands.

 

Are their challenges? Sure. Athleta (GPS) is emerging as a major threat to LULU's business, and Nike is strengthening on the margin. Also, based on our results we think that there is a problem with perception of value for LULU's product, which suggests to us that the company will have to start a more meaningful discounting strategy.

 

In the end, we come out much higher on the top line over our 3-5 year modeling period, but we have margins going from 24.5% to just under 19% (see Exhibit below). While multiples rarely expand when margins are coming down, we think that with the stock having a 4-handle, better top line will probably win over margin degradation.

 

If the company gives weak guidance on the quarter, based on what we see we'd likely look to get more aggressive on the name. 

 

 

HERE'S A LINK TO OUR FULL SURVEY AS WELL AS THE AUDIO PORTION OF THE PRESENTATION

 

 

MATERIALS: CLICK HERE

AUDIO REPLAY: CLICK HERE 

 


Cartoon of the Day: The Thief

Takeaway: But the certain fact about inflation is that, sooner or later, it must come to an end. It is a policy that cannot last. -Ludwig von Mises

Cartoon of the Day: The Thief - Inflation

 

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INITIAL CLAIMS: FINALLY, SOME GOOD NEWS

Takeaway: YTD, labor data has shown signs of steadily decelerating improvement, but this week the data went in a new direction.

Playing the Inflection

The labor market could be characterized as showing decelerating improvement since the start of January this year. This week marks an inflection from that trend. The year-over-year change in NSA initial claims came in at -13.4% this week, the strongest print since January 3, 2014 and a moonshot compared with the -5.0% print last week. This week was so strong, in fact, that it brought the rolling NSA y/y to -7.1%, up from -3.5% last week. We'll see in the weeks ahead whether the trend is beginning to reverse. One of the arguments put forward in support of the generally weak 1QTD data has been weather. If weather is playing a role in suppressing the strength of the data then one would expect that as we move from the winter to the spring months we could reasonably expect to see improvement in the data. The next few weeks of data should be important in this regard, as they may serve to answer this fundamental question. 

 

It's important to note that one of our favorite intermediate-term trade ideas on the long side is Capital One (COF). We initiated that call in late January on the basis that seemingly every year Cap One misses 4Q and crushes 1Q. We argued for buying it post the 4Q wash-out, holding it through 1Q14 results and exiting ahead of 2Q results. The claims data this morning is certainly supportive of that call. Almost all new loss content comes from newly unemployed people with the balance coming from divorce and illness (major medical expenses). Unsecured lenders like Capital One are hugely correlated with initial claims data, and claims tend to lead the fundamentals by ~13 weeks giving some visibility into what's coming down the pike. It didn't hurt, either, that COF got the Fed's stamp approval for its robust capital return program last night through CCAR.

 

The Data

Prior to revision, initial jobless claims fell 9k to 311k from 320k WoW, as the prior week's number was revised up by 1k to 321k.

 

The headline (unrevised) number shows claims were lower by 10k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -9.5k WoW to 317.75k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -7.1% lower YoY, which is a sequential improvement versus the previous week's YoY change of -3.5%

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 1

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 2

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 3

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 4

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 5

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 6

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 7

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 8

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 9

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 10

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 11

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 12

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 13

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 19

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 14

 

Yield Spreads

The 2-10 spread fell -10 basis points WoW to 225 bps. 1Q14TD, the 2-10 spread is averaging 240 bps, which is lower by -1 bps relative to 4Q13.

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 15

 

INITIAL CLAIMS: FINALLY, SOME GOOD NEWS - 16

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


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Did You Buy Social Media Puts?

When you’re right, you’re right.

 

Hedgeye CEO Keith McCullough pulled no punches during his hour-long conversation on Monday with Fox Business’ Maria Bartiromo where he spelled out his current market and economic concerns, in particular, the growing bubble in social media stocks.

 

The timing was especially prescient given the bubblicious market spectacle that ensued including Candy Crush’s disastrous IPO, Facebook’s $2B purchase of Oculus, and Twitter getting hammered 9% this week.

 

As he told Bartiromo, 74% of the companies that have come public in the last six months do not make any money -- only eclipsed by the dot-com bubble in 2000 when 80% of companies that went public didn’t make any money.

 

“If you’re long the S&P 500, don’t worry,” he joked. “It won’t top for another couple of months.”

 

Take a look at the video beginning at the 4:15 mark where McCullough advised investors:

 

Buy some [social media] protection. While you’re in the rental mode, go buy some protection—bombed out puts,  August and September puts in social media stocks.”

 


He added:

 

“Big social media stocks, don’t forget, are tied to the advertising cycle. The advertising cycle is pro-cyclical. So if we’re at the end of an economic cycle, you’re going to wake up at some point this year—and Twitter looks like it’s already pricing this in—to some kind of a disappointment on revenues from an advertising-based social media stock. That’s what I’d be looking for. I have no idea which one it’s going to be, but you can buy puts on a pretty good basket of those.”

 

As he wrote in today’s Morning Newsletter:

 

I know no one wants to call it a bubble. There’s career risk in calling something what it is. But seriously mo bros, with Facebook (FB) -17% since March 10th (coincided with the all-time-bubble-high in US stocks) and Twitter (TWTR) -30% YTD, what’s the fuss?

 

Indeed.

 

 


VIDEO | Keith's Macro Notebook 3/27: EUROPE US CONSUMER UST10YR


LEISURE LETTER (03/27/2014)

TICKERS: CZR, LVS, MPEL, RCL


EVENTS TO WATCH:  UPCOMING EARNINGS/CONFERENCES/RELEASES 

 Friday, March 28 

  • Nevada gaming revenues release for February 
  • MPEL board meeting
  • Wynn Macau board meeting

Tuesday-Thursday, April 8-10

  • Mid-America Gaming Congress (Columbus, OH)

Wednesday, April 9

  • SHO Investor Day

Thursday, April 10

  • HST Investor Day


COMPANY NEWS

CZR – announced its intention to close Harrah’s Tunica in Mississippi on June 2, resulting in 1,300 job losses.  "There’s just too much supply in that market.  The Harrah's has not been profitable for a while,” said John Payne, president of the company's central markets division. 

TAKEAWAY:  Another sign of the tough times.  Interesting there are no interested buyers for the property...or maybe there is a lack of funding for such acquisitions.

                                  

CZR – the company announced, via an SEC filing, it received correspondence from a law firm representing a group of its bond holders who want the company to shutter Caesars Growth Partners.  The bond holders assert the parent company violated its fiduciary duties to the creditors when the parent company opted to sell certain assets to the Caesars Growth Partners.

TAKEAWAY:  Never attempt to run-over your bondholders as they never forget and doing so will jeopardize future borrowing negotiations. 

 

MPEL – unveiled final plans for its newest hotel at City of Dreams. The 40 story hotel will include 780 guestrooms, suites, and villas as well as spa, ultra lounge, and sky pool.  The property will open in early 2017.

TAKEAWAY:  City of Dreams needs the additional hotel capacity.

 

LVS – reduced the payout for blackjack at its Venetian and Palazzo tables from 3:2 to 6:5, resulting in the payout falling from $15 to $12 on a $10 bet. 

TAKEAWAY:  Hold could be higher for the coming quarters. Media contrasting that with Sheldon's "concern" for the average joe who could be duped with on line gaming.

 

LaQuinta – proposed ticker LQ, offering 37.2m shares, IPO Price $18-$21, proceeds of $678 million used to prepay long-term debt.  Post offering Blackstone to own 66.7% or 63.8% if underwriters option exercised.  

TAKEAWAY:  We're favorably inclined on the lodging cycle although near-term revpar may be under pressure.

 

Four Season Hotels – recently has made several announcements regarding leadership appointments at the executive vice president level. 

TAKEAWAY:  While we didn’t take note individually of each appointment/promotion, when viewed in totality, it would appear Four Seasons is getting ready to go public.  

 

RCL –  RCL introduced a more flexible dining program for its newbuilds Quantum of the Seas and Anthem of the Seas. Called Dynamic Dining, the new program will give passengers a choice of 18 restaurants, of which seven will be fee-free for all guests: four full-service and three casual eateries.  A new reservations system also will be used onboard so passengers can decide when, where and with whom they want to eat each night. 

TAKEAWAY:  This innovative change will help onboard spending - an area which RCL had led in growth recently 

  

INDUSTRY NEWS              

US Gaming Industry to vet gamblers funds – the United States Department of Treasury Financial Crimes Enforcement Network (FinCEN) is considering rules which would require US casinos to fully vet the source and origin of a gambler’s funds.  FinCEN is also investigating possible compliance lapses at other Las Vegas casinos.

TAKEAWAY:   The US Treasury efforts are to explicitly regulate casinos like a financial institution in an attempt to crack down on potential money laundering activities.  Political payback to Wynn and Adelson?

 

Las Vegas casinos subject to anti-money laundering probe – the United States Department of Treasury Crimes Enforcement Network is currently investigating un-named Las Vegas Casinos for possible anti-money laundering compliance lapses.  This investigation follows, Las Vegas Sands August 2013 agreement with the Department of Justice to pay $47 million fines for anti-money laundering lapses at LVS’ Venetian and Palazzo properties in Las Vegas.

TAKEAWAY:   Stay tuned, more headlines and fines forth coming...

 

New Jersey Casino Expansion Bill – despite outspoken opposition by various elected officials, legislation was introduced to allow casinos at Meadowlands and Monmouth Park racetracks.   As we noted last week, officials indicated no expansion of gaming would be considered until after 2016, when the Atlantic City revitalization plan expires.

TAKEAWAY:  We doubt this legislation will pass given the Governor's vocal opposition. 

  

Federal Legislation to ban internet gaming – legislation was introduced in the US House of Representatives and the US Senate to reinstate the Wire Act of 1961 regulations which would thus make internet gambling illegal.

TAKEAWAY:  The proposed legislation appears to strictly prohibit all existing  and considered forms of internet gambling including online poker and lottery activities.  No grandfathering provisions were offered. We doubt this passes.

  

MACRO

Hedgeye remains negative on consumer spending and believes in more inflation.  Following  a great call on rising housing prices, the Hedgeye Macro/Financials team is turning decidedly less positive.  

Takeaway:  We’ve found housing prices to be the single most significant factor in driving gaming revenues over the past 20 years in virtually all gaming markets across the US.


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