RH – Best Growth in 4Q = Gary

Takeaway: Great print from our highest conviction idea. The biggest surprise for us, however, was how the CEO is stepping up his game.

Conclusion: RH remains our highest conviction long idea in the Retail space, with ultimate earnings power of $11 per share and a stock price in excess of $200. The company’s 4Q print supported our thesis in many ways. But despite all the positives around revenue outlook, store growth, and margin upside, the biggest growth in the quarter from our perspective was not found in a line item…it was in the CEO.


When we talk to investors about RH, almost every single critic lists Gary Friedman as a chief concern now that (former Co-CEO) Carlos Alberini has left the picture. In investors’ minds, Gary was the product guy, and Carlos did everything else. That’s an incorrect view, but like it or not, that’s the perception. Well, this quarter Gary literally sounded like a different person. He spent more time talking about ROI, capital deployment and managing risk in the business as he did talking about product and merchandising. The only question to be answered is whether this is just a temporary Gary we’re seeing in the immediate wake of Carlos’ departure, or if this marks a structural change to how he approaches his role. Critics will claim the former. We think it’s the latter. Time will tell, but there’s no disputing the change as it appears today.


We’re not making any material changes to our estimates. We still think that the company will have a far better year than it’s guiding. As much as that should make the stock continue to grind higher, the real upside comes from earnings expansion as this growth story plays out – which literally begins in April/May with the redesign of its product line, launch of its Sourcebook (all 3,200 pages of it), and the opening of the new store in Greenwich (which kicks off a mini-burst of square footage growth).


As for valuation, the name seems expensive at face value, but is it? This is a 45% EPS grower that’s trading at 22.7x our 2014 estimate (Nike trades at a higher multiple and earnings are shrinking). That translates to about 10.5x EBITDA. By the end of our model we’re looking at less than 6x earnings and 3x EBITDA. If you care to look at it a different way, let’s look at the EV to total addressable market value. Not a perfect metric, we agree. But it gives a sense as to the value of the company relative to the underlying business opportunity. We chart that stat for a host of retailers and it’s pretty clear that RH is the cheapest of the bunch – by a long shot.


RH – Best Growth in 4Q = Gary - pe ev


Here’s a few things from the quarter that we found notable.


1. We need to address the hiring of Doug Diemoz as the Chief Development Officer. While we’ve never quite heard of that title before, that doesn’t mean that it can’t be effective for RH. As focused as Gary is in steering the ship, the reality is that there are a lot of areas for growth where Gary simply does not have the bandwidth to pursue. Now he’ll have someone who reports directly to him that can explore these opportunities. And of course, Diemoz is part of the Williams-Sonoma alum club – along with Gary, Richard Harvey (Kitchens), and Ken Dunaj (COO). (We’d put CFO Karen Boone in there too from her Deloitte audit days).


2. ‘Always Innovating’ One thing we particularly liked was when Gary noted that people who are going to nit pick over timing of costs and revenue by quarter will perennially be disappointed with RH because “we will always be innovating.” There are other companies that have that same mindset – such as Nike and Ralph Lauren. Both have a dominant founder/leader who sets the tone inside the organization, and both have never been afraid to invest in the business even when it was not popular at the time by Wall Street. Both companies have emerged as superb stewards of capital over time. RH has the exact same feel to us as those other companies. 


3. Holiday: One thing that we underappreciated in the quarter was the company’s reliance on Holiday. It’s markedly less than WSM, but some of the weakness on the top line was driven by the company’s gifting categories. Those weaknesses were attributed to a medley of weather and self-inflicted wounds the latter of which was focused on the company’s decision to send Holiday Source Books to only 20-30% of its mailing list. The source book strategy in total is still a work in progress (more on that below), but what strikes us is how data dependent the company is. There are still some wrinkles to iron out in the system, but the company is working through different strategies in order to maximize return on ad dollar spend.


4. Source Book Strategy: This spring’s 3200pg Source Book is exactly 2x what it shipped last Spring. The raw page count seems excessive, but it makes sense when you consider the breadth of the company’s product assortment in 2014. Add to the existing categories RH Rugs, RH Leather, and one unknown and you have the real core of RH’s product offerings – the one exception being Kitchens which isn’t scheduled for rollout until 2015. We estimated that the company saved about $40mm by eliminating the Fall Source Book. Some of those costs will be transferred to the Spring book, but when you consider cost savings from production and shipping, net-net the company is coming out ahead on this one. The reality is that the company won’t be mailing out the full assortment to all of its customers. When you look at the numbers from 2013, customers received about 40% of the assortment. That number will probably be even less as the company tries to leverage the shopper data it has collected over the past few years to target specific consumers with specific assortments. On top of all that you have UPS delivering the mailers this year which may increase shipping costs, but will ensure a targeted and on-time roll out of the books in 2014, with better data for the company to analyze.


RH – Best Growth in 4Q = Gary - RH Financials




Takeaway: There will be puts & takes on the 4Q print. But the multi-year catalyst calendar starts in April. Beware getting beared-up over 1Q guidance


Conclusion: They’ll be puts and takes on the 4Q print. But the multi-year catalyst calendar starts in April. Beware getting beared-up over 1Q guidance. We stand by our positioning on RH that we presented in our last update conference call/deck in early February. Specifically, we laid out how we’re thinking about the name across multiple durations. See the links below to both the slide deck and audio presentation. Our general view by duration is as follows.


TAIL Duration (long-term): One of the most powerful growth algorithms in all of Consumer. The company should earn around $1.70 this year, and we think that over 5-years that number approaches $11. Common perception is that RH is building a bunch of palaces and hoping that people will show up to shop. We think about it the other way around…they are creating assortments of product across multiple categories in the home space, and are subsequently taking a massive piece of a category where they only have 2-3% share. Yes, bigger stores are a part of this, which is critical to support the kind of product extensions we’ll see from RH. Currently, the Legacy 9,000 sq ft stores only house 20% of the SKUs and run at about $750/sq ft. The 25,000 Design Galleries highlight closer to 50% of the product, and they average an ‘per foot productivity’ rate that is 2x the existing core. People often ask us about why RH has the right to expand into new categories of Home. People asked that same question about Ralph Lauren in the 1980s when he expanded beyond neckties and polo shirts. Our full modeling assumptions are in the Deck (link below), but the key is to measure the success by product and design creation and sourcing, not by simply building stores.


TREND Duration (next 3-4 quarters): The trends should accelerate dramatically over the course of this year for RH. First and foremost, the product line is being meaningfully changed for the Spring. With that will come an updated Sourcebook – which the company has not released in the better part of a year. At the same time, after a full year of not adding a single square foot of space, RH will be adding four new stores throughout this year. In April/May we’ll see the much anticipated opening of Greenwich, CT, the store in the Flatiron District in NYC, then in the Fall we’ll see Los Angeles and Atlanta. As noted above, the actual stores are not as important to us as the product that goes behind them. But this year, the calendar is lining up nicely with a product refresh in the Spring and then four large stores immediately following, That’s about 12% growth in square footage. That might not sound huge for a company that will be looking at a 30%+ growth rate in square footage within two years. But it matters to us given that it has not grown square footage since before 2008.


TRADE Duration (Immediate-term): The TRADE duration was a slam dunk when the stock was in the $50s. The reality is the Street got beared up because just about every retailer was missing numbers due to weather and whatever else is going on out there in the economy. But with RH, 47% of it’s sales are, which are weather proof, and the category in itself is not very ‘at-risk’ due to snow. Think about it…if you want to go shopping for clothes, you might pick up a pair of jeans. If it’s snowing, that purchase is probably dead. But if your kids need new bunk beds, are you going to bag the purchase just because it’s snowing? No. We have some useful stats on the topic in the Deck. We’re not very worried about the actual number that RH reports. The company has extremely good visibility with its top line. The same factor that the Street beats this company up so often for – the long lead times in its shipping window – also gives the company great visibility into its top line for an extended time period.


The big question is around comp guidance for the first quarter. The company already noted that the first quarter would be its weakest comp of the year – due to the timing of the product refresh and catalog drop. The Street knows that. The consensus is printed at 11%, and we think that the whisper is for something in the high-single digits. Could guidance for 1Q be in the single digits? Yes – with no product refresh, a 41% compare vs last year, and the strong possibility that some 1Q purchases were pushed into 2Q,the upcoming quarter will be the weakest of the year – as management already indicated. What we can say is that with the tremendous delta in our estimates versus the Street over our modeling horizon – and with how good the TAIL and TREND calls are lining up, we’re not going to get too bent out of shape figuring out if people are going to freak out over guidance that was already largely given.






  • #ItsNot2013:  Growth estimates globally continue to get marked down.  Slowing topline (GDP) and compressing margins (rising inflation) is not the stuff of market multiple expansion or macro P&L dynamics to remain lazy long of.
  • RISING INEQUALITY:  Corporate Profits - measured as the % of National Income or GDP -  made another new high in 4Q13.  The other side of that, of course, is a lower low in labor’s share of income.  Latent risks can remain latent.
  • CAPEX RESURGENCE?  General acknowledgement that assets are aging and businesses have under-invested isn’t a catalyst.
  • PAY-ME-NOW:  Productively continues to grow at a positive spread to unit costs and investors continue to reward the ‘pay-me-now’ corporate capital strategy. 
  • DURABLE DISAPPOINTMENT:  New Orders for Capital Goods non-Defense Ex-Air have been negative on a month-over-month basis for four of the last six months.
  • INITIAL JOBLESS CLAIMS:  A positive week of data…finally.  The next few weeks of data should be important



We summarily re-hashed our 1Q14 macro view along with our current thinking from a strategy perspective in a note late last week - #PROCESS: SUMMARIZING OUR CURRENT VIEW


Below we highlight the notable trends across this morning’s GDP & Initial Claims data




In short, with inflation estimates unchanged, the +0.2 positive revision to 4Q13 GDP resulted as the net of a +0.49 revision to consumption (driven by services) and -0.31 revision to investment (driven by downward revision to nonresidential investment).  


The table below provides the detail on the final estimate and the complexion of the final revision.  




Domestic growth expectations, meanwhile, continue to come in with the 1-month and 3-month change in 1Q14 GDP estimates down -30bps and -80bps, respectively. 


Looking globally, the story is similar with growth estimates for 1Q14 and full year 2014 getting marked lower across both developed and emerging economies while inflation expectation, particularly across emerging markets, are beginning to flash some upside


(Note: we can email the tables below for a cleaner visual if you're interested) 




As we’ve highlighted repeatedly QTD, slowing topline (GDP) and compressing margins (rising inflation) is not the stuff of market multiple expansion or macro P&L dynamics to remain lazy long of.   #ItsNot2013 





Corporate Profits - measured as the % of National Income or GDP -  made another new high in 4Q13.  The other side of higher highs in corporate profitability, of course, is that labor’s share of national income made another lower low.  


The un-sustainability of that trend and the associated mean revision risk to peak margins remains perhaps the broadest, and most obvious, latent risk to investors.    


The bureaucratic prescription for a (largely) policy driven rise in inequality, as we’ve seen with the recent statutory wage increases, is more policy aimed at legislating spread compression in the division of income via a de-facto income transfer from owners of capital to labor. 


Please see our note LOSE-LOSE? WAGE INFLATION & LABOR'S BAD BANK for a fuller discussion of the impact of wage controls on labor economics. 


With the income spread expanding and the goal of monetary policy effectively amounting to a hope for the ultimate trickle down/trickle around wealth effect, expect more populist rhetoric out of the beltway to help further churn existing populace angst.   








Expectations for resurgent corporate capex have been fairly pervasive of late.  Indeed, varying iterations of that same narrative/expectation have ebbed and flowed for the better part of 4 years now.    


From a growth perspective, real gross private nonresidential investment growth extended the broader deceleration trend in 4Q13, slowing 90bps sequentially to +2.6% YoY. 




Fairly, net private investment as a % of GDP continues to recover and the average age of the aggregate capital stock may be above historical triggers for accelerated capex spending, but that’s been true for a while now and general acknowledgement of that reality doesn’t make it a catalyst. 




As it stands currently, productively continues to grow at a positive spread to unit costs and investors continue to reward the ‘pay-me-now’ corporate strategy.   


There are some inflationary wage pressures percolating but they are far from acute and, with a little leverage & planned repo in the model,  peak margins can stay peaked and EPS can continue to grow at a premium to topline over the intermediate term. 


So, on balance, fundamentals aren’t signaling an immediate need to shift strategy and the prevailing corporate capital policy – which continues to reward both investors and management teams - has nearly a decade of inertial momo behind it. 


Necessity may drive an ongoing, gradual shift towards rising capex but data supporting an imminent and significant inflection in business investment isn’t particularly compelling.





Yesterday’s preliminary Markit PMI data for March was positive but the February Durable Goods figures were decidedly disappointing with the -1.3% MoM decline in core capex orders the notable, negative outlier.   


Indeed, New Orders for Capital Goods non-Defense Ex-Air have been negative on a month over month basis for four of the last six months.  


Weather distortion or not, measures of business investment and activity (Durable goods, Industrial Production, ISM, rising sales-to-inventory ratio’s) have to see a material, sustained acceleration from here for the resurgent corporate investment thesis to regain credibility.   








In contrast to the accelerating improvement in jobless claims that characterized most of 2013, the 2014 trend has been one of discrete deceleration. 


However, with headline rolling claims declining -9.5K WoW to 317K and the rate of improvement in the rolling average of non-seasonally adjusted claims improving 360bps sequentially, this week’s data was decidedly better.  


Josh Steiner, our head of Financials research, provided the following context: 


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








Christian B. Drake


Get McGough. The Guy Knows Lululemon | $LULU

Veteran Retail analyst Brian McGough and his team put out a Lululemon Black Book three months ago (and nailed the drop in the stock.)


He and his team worked like Alaskan sled dogs this past weekend and delivered a granular, deep-dive follow-up Black Book for Hedgeye subscribers. They nailed the inflection – for all the right reasons.


McGough remains "cautiously bullish" on LULU.


Here's his video earlier this week.





Subscribe to Hedgeye.

The Absurd Way the U.S. Measures Inflation

Takeaway: This is, quite possibly, the most absurd way to calculate inflation.

Editor's Note: This article was originally published on Fortune earlier today.


FORTUNE -- "If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished, and without utilities?"


The Absurd Way the U.S. Measures Inflation - 89


Believe it or not, the government asks ordinary American homeowners that perfectly imprecise and highly subjective question every single month as part of the Bureau of Labor Statistic's monthly price survey process. The answers determine the calculation of "Owner's Equivalent Rent," which represents almost 25% of the index used to calculate consumer price index inflation in the United States.


It is, quite possibly, the most absurd way to calculate inflation.


The answers have a profound effect on U.S. monetary policy and influence how much you ultimately pay for groceries, gasoline, and much more. If you answered that question in the last month or so, your response appeared in the latest Consumer Price Index report and influenced Fed Chair Janet Yellen's debut speech.


The head-scratching bottom line? Pie-in-the-sky guesses of homeowners, overwhelmingly lacking both economic training and policy experience, are the tail wagging the Federal Open Market Committee dog.


Click here to continue reading.


CAT, JOY: Pent-Up Demand In Mining Equipment Aftermarket? Call With Michael Currie

Takeaway: Please join us for an in-depth discussion of the mining equipment aftermarket with former Finning manager Michael Currie Wednesday @ 11AM

CAT, JOY: Pent-Up Demand In Mining Equipment Aftermarket? Call With Michael Currie - cat call



“You can do that for a while, but remember, in an industry like mining, the most important thing to the customer is the cost per ton of what they get extracted in uptime. How much of the day a machine is actually running is a big piece of that, and you can't defer maintenance forever. So it appears like that's happened some. I think as the year has gone on that has moderated a bit. We certainly don't think that kind of thing is going to continue in perpetuity.” – Michael L. DeWalt 12/4/2013




Several mining equipment OEMs have indicated that they believe current levels of aftermarket spending are unsustainably low. Many investors are also betting on a bounce-back in aftermarket revenue as deferred maintenance catches up with mining companies.


Is the current level of spending on mining equipment aftermarket and service sustainable? What are the pricing trends for aftermarket parts and services?  How do OEM aftermarket relationships differ from dealer networks?


We will discuss these questions and other key topics on Wednesday, April 2 at 11:00am EDT during an in-depth conversation with recognized Industrials thought leader Michael Currie. We will also discuss the relationship between CAT and its dealer network in selling aftermarket parts and services.




  • Is the currently unsustainable maintenance deferral? If so, in which equipment categories?
  • What strategies are miners using when negotiating to purchase aftermarket parts and services?
  • How relevant are non-OEM parts and how does quality vary?
  • How is pricing for aftermarket parts and services currently trending?
  • Is CAT mistaken in using its dealer network for aftermarket parts and services and how is revenue typically split?

Please feel free to send additional anonymous question ahead of or during the call.




Participant Dialing Instructions

  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 996391#
  • Materials: CLICK HERE




Michael Currie provides strategic advice to clients that wish to optimize investments in industrial assets and in the technologies that support them. He is a recognized leader in applying life cycle cost (LCC) analysis to mobile mining equipment and provides products and services based on LCC principles to clients operating around the world, including Anglo American, Total Energy, URS, Barrick Gold and North American Construction Group.


In addition, Mr. Currie has experience developing an asset management consulting practice with PricewaterhouseCoopers LLP and as a senior manager with Finning Canada, a Caterpillar dealer. He has a degree in Civil Engineering from the University of British Columbia and an MBA from the University of Western Ontario.


CAT, JOY: Pent-Up Demand In Mining Equipment Aftermarket? Call With Michael Currie - cat 2


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.




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. 



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. 









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