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RH - Three Key Questions

Takeaway: If we had five minutes or less with RH’s CEO, here’s what we’d ask.

The setup -- you have a five minute meeting with the Gary Friedman, CEO of RH. Here are the key critical uncertainties that we think are relevant to the investment thesis today. We did this earlier this week with Target­ -- one of our top shorts. So let’s keep it balanced and do the same for our top long, RH which we think should triple over 3 to 5 years.

 

1. Logistics Network -- Today vs. Tomorrow. One of the biggest Bear arguments against RH is its inability to ship product on time and in the right quantity (i.e. a 6-piece living room order could be delivered in 3 shipments over 12-weeks). That not only delays when the company can collect revenue, but could also impact customer attitude towards the brand and its ability to meet delivery expectations. We have no doubt that RH could work through these issues today, especially with its newly upgraded fleet of DCs. But the reality is that RH has been shrinking its square footage base for the past six years. Starting next month, it goes on an explosive run of growth in square footage – from 800k square feet to nearly 3x that amount over a five-year period. So the question here is this…If you are having challenges now as a $1.5bn business over 70 stores and 800k sq feet, how can we be confident that the company can deliver product under a competitive time frame when it is three times the size? Does that mean that instead of having 5 DCs and 7 hubs, it needs to open another 5 mega-regional DCs in the top MSAs? Or another 25 facilities throughout the country? What’s the right answer?

 

[Note: Though we cannot yet articulate the answer to this question, in our model we assign a capital cost to both the SG&A and Capex lines to account for future capital needed to improve shipping capabilities. We give RH about an extra $80mm per year in capex, while we add an incremental $800mm over 5-years in SG&A – both of which are well North of what is expected for RH to continue on its growth ramp).

 

2. What’s the Optimal Store Size?  The size range in RH’s fleet is daunting. It has Legacy stores at 8,000 feet, Design Galleries at 25,000, and the Next Gen Design Galleries as large as 60-70,000 sq. feet (Atlanta, Vegas). So far, the company has learned that ‘bigger is better’ meaning that the store productivity on a large box eclipsed the Legacy productivity.  The math is such that there are 8,000 foot stores operating at $700/sq ft, or $5.6mm annually. But then there are stores like Houston at 22,000 feet that are doing about $2,500 per foot. Yes, that’s about $55mm per store. And that’s not a pipe dream…that’s proven.

 

The questions then, are a) is it realistic for some of these Next Gen Design Galleries to be running at over $100mm per box? b) at what size do you think you hit a point of diminishing returns with box size? c) you have 65 Legacy stores in the fleet, that you indicated you’ll chop away one by one over time. But the reality is that many of these are solid real estate locations, and your rent terms are better there today than if you were to find new space on your own. Why not keep most of these stores open, and use them to focus on a single category – RH Kitchen, RH Baby & Child, RH Furnishings, RH Whatever…
    

3. Dot.Com Ratio Shrinking? Today RH has the highest ratio of e-commerce as a percent of total sales (47%) out of any retailer shy of Amazon and Williams-Sonoma (48%), but then the competitive landscape craters from there. Pier 1, for example is about 4%.  That’s a pretty huge competitive advantage for RH, in that it has achieved so much success reaching customers who live nowhere near a RH store.  But now that square footage will begin to accelerate so meaningfully, the dot.com ratio almost has to come down. If it does not, then it will likely be due to productivity of the new mega-stores coming in at levels we’d find disappointing. We don’t think that will be the case. We’re modeling that e-commerce comes down to 40% over a four-year time period (while still tripling to a $2bn e-comm revenue stream). Our question to Gary would be ‘how small will you let dot.com get as a percent of the total.’ Our sense is that he’d come back with an answer that sounds something like “I could care less where the sale originates – in a store, or online – as long as we book the sale.” We’re cool with that, and largely agree. But it’s a key question to ask nonetheless.

 

Bonus Question (for those times you get an extra few minutes to sneak in another question)

Fashion Risk. Even your average non-fashionista type with no sense of design could walk blindfolded into a RH-themed room and know within about 3 seconds that it is RH. It just has that ‘RH look’. It’s a look that has been very relevant for three years now. The question is whether a) RH just happens to consistently nail the current trend, or b) it leads consumer trends by sourcing the product it thinks consumers will want, and then merchandises and markets it in a way that the consumer will want to buy it. Our opinion is that RH is an example of ‘B’ – much like what Ralph Lauren has become in the apparel space (seriously, when is the last time Ralph missed a fashion trend? Answer – never). Though we’re kind of answering this question before we ask it, we would like to know more about Gary’s process for driving demand around a given assortment. He alone can offer the best insight on this one for RH.

 

RH - Three Key Questions - RH Financials


FLASHBACK: #GrowthSlowing (Lots of Charts)

Takeaway: We are getting increasingly negative on the slope of domestic economic growth.

This note was originally published December 12, 2013 at 17:45 in Macro

FLASHBACK: #GrowthSlowing (Lots of Charts) - turtlecrossingroad

Yesterday, Keith and I did a full slate of meetings with funds in NYC; without violating any confidentiality by getting bogged down in the details, here are the key takeaways we were effectively pounding the table on:

  1. We still like our #EuroBulls theme (CLICK HERE to launch our @HedgeyeTV video) and continue to see opportunities on the long side of European growth equities. We continue to like the UK and GBP then Germany and EUR in that order.
  2. Based on early warning signals, we think 3Q13 is a cycle-peak in the sequential rate of US economic growth. If we were mandated to allocate capital to US equities, it would be in high yield, slow growth, low short interest and/or commodity-linked stocks, at the margins – basically a return to the 2011-12 playbook. The UST 10Y yield has probable downside to 2.5% in this scenario.
  3. A potential 1H14 macro theme we see developing is inflation-hedge/consensus yield chasing plays continuing to make higher-lows alongside US equity volatility (CLICK HERE to launch today’s @HedgeyeTV video on a potential breakout in the VIX). That list would include gold, commodities, emerging markets, TIPS and REITs. The Abenomics trade (i.e. short JPY/long Japanese equities) would make lower-highs in this scenario.
  4. Fund flows have the opportunity to buoy the US equity market well into 1Q14, though we’d expect growth data to be decidedly cooler by then if the Fed does NOT taper. We are very differentiated from consensus in that we think that a return to prudent monetary policy is the only way to promote sustainably faster rates of domestic economic growth. We don’t buy into the consensus fear-based whining about deleveraging and the perceived risk of higher rates in the housing sector.
  5. If the Fed tapers or signals imminent tapering, we’d abandon each of the aforementioned views and would be buyers of any subsequent US equity pullback. If the Fed does NOT taper (as we expect), we’d be sellers of any subsequent US equity strength.

 

Today, we received a great follow-up question from a very sharp client in the fixed income space: “What is the data you’re looking at to support your view that GDP growth will slow down?”

 

As with any inflection-based call on growth and/or inflation, we start with the market’s risk management signals – which tend to lead the reported data. The USD is decidedly broken from a quantitative perspective and long-term interest rates are making lower-highs vs. the YTD peak in both growth data and #GrowthAccelerating expectations.

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - dale1

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - UST 10Y

 

Moreover, both are declining on a QoQ average basis, which is historically something you’d see during periods of marginal stagflation (i.e. Quad #3 of our GIP model = Growth Slows as Inflation Accelerates).

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - GIP Model Backtest

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - Quad  1 vs. Quad  3

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - USD  UST Rates and GDP

 

That reflexive relationship is something we’ve seen throughout the YTD:

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - 4

 

As it relates to early warning signals, the ISM data appears have materially inflected here, which confirms what we’ve already seen with respect to the respective trends in consumer and business confidence.

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - 5

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - 1

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - 2

 

Recall that inventories juiced the 3Q GDP print – which we’ve argued is a healthy, pro-cyclical response to increased business confidence. Well, now said business confidence has inflected to the downside here in 4Q and we anticipate inventories will follow suit when 4Q13 GDP is reported.

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - 3

 

Again, our call for an inflection in growth is in the very early innings so you won’t see it in the broad swath reported data just yet – much like you didn’t see a ton of data to support our #GrowthStabilizing and #GrowthAccelerating calls at the start of the year.

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - US QoQ

 

I’m guessing to the naked ear we sound about as crazy as we sounded roughly one year ago when we were pounding the table on long side of US equities and on the short side of anti-growth assets (e.g. gold, EMs, commodities, etc.) as the biggest US growth bulls on the street. For now, that’s a position we feel comfortable taking in the absence of a change of heart at the Fed.

 

Please feel free to email us with any follow-up questions or if you’d like us to forward you the analyses supporting the conclusions laid out at the start of this note.

 

Have a wonderful evening,

 

DD

 

Darius Dale

Associate: Macro Team


Poll of the Day Recap: Majority Says US Housing Market Slowing

Recent reports of declining mortgage applications could be the first sign of a #HousingSlowdown – one of Hedgeye’s new quarterly macro themes.
 

We wanted to know where you stood on this issue, so we asked in today’s poll: Do you see that the US housing market is indeed slowing?


At the time of this post, most people feel the US housing market is slowing with 69% responding YES; 31% saying NO.


Some who voted YES said they felt it so much that they (and friends) were once looking to upsize but have now backed off. Others saw slowing especially in low-end homes.

 

Hedgeye CEO Keith McCullough voted YES noting, “Given rates have been falling since their December highs, the MBA mortgage purchase application data is flat out scary.”

 

Other noteworthy YES comments included:

  • “Prices [are] far outpacing capacity for first time home buyers to purchase.  When funds cease to be the marginal buyer of existing homes, they may turn into a marginal seller.  That would leave a vacuum of demand until the price adjusts to levels at which first time home buyers, 24-30 year olds, can afford to be owners via their incomes.”
     
  • “Banks aren't interested in lending at these rates and they also are scared of the future economic collapse that is coming.”
     
  • “Pent up demand and investor buying is flattening out. Wage and job growth stagnating, baby boomers trying to retire (so paying off debt, reducing RE assets & saving money) and 1st homebuyers saddled with 60 month car payments & student loans. Getting into and out of a mortgage costs have risen due to loan fees & taxes. It now costs 10% or higher just to buy/sell.”
     
  • “[Yes] because of year over year reduced housing prices. Lack of demand is the culprit due to growth slowing in income, etc.”
     
  • “The fundamentals of housing (demand and supply) turn well in advance of price. Demand has been rolling over for ~9 months now and prices are just beginning to show signs of deceleration. QM is a significant and underappreciated headwind for housing.”

Interestingly, one YES commenter said the US housing market’s slow growth was old news, while another said it wouldn't be a media issue for another 9-12 months “meaning most consumers and investors won't have a clue until it's too late.”

 

NO voters, however, said that they hadn’t specifically experienced a slowdown where they lived, further explaining why they felt it was simply location dependent.

 

One NO voter felt a slower housing market wouldn’t happen for another year, and a few others hoped it would benefit them when they looked for a house in terms of lower pricing. (One responder even said that because rental rates continue to go up they’re being practically forced to look for a place to buy.)

 

Maybe Keith can sum it up for us:  “Housing $ITB -0.9% today leads losers again = US #HousingSlowdown.”

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Nike Jacking Up Jersey Prices: Will Consumers Rebel? | $NKE

Takeaway: Nike has total control over this market; they can essentially do whatever they want.

Nike Jacking Up Jersey Prices: Will Consumers Rebel? | $NKE - SP14 AT SB Jersey 001

 

Nike raises NFL jersey prices

  • "Nike, which makes the official league uniform, has decided to raise prices on two of the three types of jerseys it sells. Nike did not announce the increase in price, but retailers, including the official league online store, started charging more on April 1."
     
  • "The Game jersey, which is the cheapest replica, will still cost $100. But the price of the Limited jersey, which has embroidered twill numbers and letters in place of the silicon printing on the Game jersey, has jumped from $135 to $150. The Elite jersey, which is the closest to what the players wear on the field and boasts being water repellent and has a tighter, tailored fit to the body, went up nearly 20 percent to $295, up from $250."
     
  • "NFL spokesman Brian McCarthy said that Nike and the retailers, not the league, determine the prices. But sources told ESPN.com that it was Nike executives alone who made the decision, implementing the new prices as the minimum prices retailers could sell the different style of jerseys for."

Takeaway From McGough:

Nike has a monopoly over this market. It can raise prices at its own discretion -- presuming that  consumers don’t rebel. (If only it was that simple for its footwear and apparel business!) Nike has successfully raised prices over the past couple years as input costs moderated. Now, with commodity costs switching from a headwind to tailwind, and very little pricing power left to exercise, we think that the next move on the gross margin line is down. $295 for a jersey?

 

Editor's Note: This is a complimentary research excerpt from Hedgeye Retail Sector Head Brian McGough. Follow McGough on Twitter @HedgeyeRetail

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Cartoon of the Day: Dollar Down!

Takeaway: The USD Index at $79.78 remains well below our long-term TAIL risk line of $81.17 — yes taxing US Consumption.

Cartoon of the Day: Dollar Down! - Fallen dollar

 

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Retail Callouts (4/9): AMZN, EBAY, NKE, APP, VFC, GES, CHS, GPS

Takeaway: EBAY/AMZN strong March. NKE NFL price hike. No Americans want to save APP. VFC mgmt gets stronger. But not GES. Greene dips toe in CHS.

EVENTS TO WATCH

  • BBBY - Earnings Call: Wednesday 4/9, 5:00pm

 

COMPANY NEWS

 

EBAY, AMZN - March 2014 ChannelAdvisor Same Store Sales (SSS) for eBay, Amazon, Search and CSE

(http://ebaystrategies.blogs.com/ebay_strategies/2014/04/march-2014-channeladvisor-same-store-sales-sss-for-ebay-amazon-search-and-cse.html)

 

  • March 2014 SSS Results 
    • Amazon - "Amazon's March SSS came in at 26.2% compared to February’s 23.0%, a strong m/m increase we believe due to the improvement in weather conditions."
    • eBay -  "eBay's March came in at 17.8% up from January’s 15.0%."

 

Retail Callouts (4/9): AMZN, EBAY, NKE, APP, VFC, GES, CHS, GPS - chart2 4 9

 

Takeaway: Agreed…good uptick for AMZN, and continued strength for eBay, which shows the healthiest trend of the bunch. But the comment about AMZN sales picking up because of a weather recovery borders on ridiculous. A brick & mortar store MIGHT have a case in arguing that sales were weak in 1Q due to weather. But someone who generates 100% of sales online ? We have a really tough time believing that one.

 

NKE - Nike raises NFL jersey prices

(http://espn.go.com/nfl/story/_/id/10752520/nike-raises-prices-two-types-nfl-jerseys)

 

  • "Nike, which makes the official league uniform, has decided to raise prices on two of the three types of jerseys it sells. Nike did not announce the increase in price, but retailers, including the official league online store, started charging more on April 1."
  • "The Game jersey, which is the cheapest replica, will still cost $100. But the price of the Limited jersey, which has embroidered twill numbers and letters in place of the silicon printing on the Game jersey, has jumped from $135 to $150. The Elite jersey, which is the closest to what the players wear on the field and boasts being water repellent and has a tighter, tailored fit to the body, went up nearly 20 percent to $295, up from $250."
  • "NFL spokesman Brian McCarthy said that Nike and the retailers, not the league, determine the prices. But sources told ESPN.com that it was Nike executives alone who made the decision, implementing the new prices as the minimum prices retailers could sell the different style of jerseys for."

 

Takeaway: NKE has a monopoly over this market so it can raise prices at its discretion -- presuming that the consumer does not rebel. If only it was that simple for its footwear and apparel business. NKE has successfully taken up price over the past couple years while input costs moderated. Now with commodity costs switching from a headwind to tailwind and very little pricing power left to exercise, we think that the next move on the Gross Margin line is down.

 

VFC - VF Announces Strategic Leadership Changes to Align Business for Continued Long-Term Growth

(http://phx.corporate-ir.net/phoenix.zhtml?c=61559&p=irol-newsArticle&ID=1916737&highlight=)

 

  • "VF Corporation today announced the appointment of Steve Rendle to the newly created role of Senior Vice President, Americas."
  • "Since 2011, Rendle has served as Vice President & Group President – Outdoor & Action Sports Americas. His new responsibilities in the Americas will include leadership of the Outdoor & Action Sports, Jeanswear, Imagewear, Sportswear and Contemporary Brands coalitions."
  • "The company also announced the following senior management changes: Patrik Frisk, currently Timberland® brand President, has been promoted to Coalition President, Outdoor Americas, with responsibility for The North Face®Timberland®, JanSport®, lucy® and SmartWool® brands. A successor to Frisk to lead the Timberland® brand in the Americas will be announced in the coming months."
  • "Kevin Bailey, who is currently Vans® brand President, Americas, has been promoted to Coalition President, Action Sports Americas and Vans. In addition to the Vans® brand, Bailey will oversee the Reef® and Eagle Creek® brands."

 

Takeaway: This is an uncharacteristic management move by VFC. But the reality is that it is probably the best managed company in the business, and we'll think twice (maybe three times) before questioning a reorg of its management rank.

 

GES - Joseph Gromek Appointed to Guess?, Inc. Board of Directors

(http://investors.guess.com/phoenix.zhtml?c=92506&p=irol-newsArticle&ID=1916936&highlight=)

 

  • "Guess?, Inc. today announced that its Board of Directors has appointed Joseph Gromek to its Board, increasing the number of directors to seven and bringing the total number of independent directors to five. Mr. Gromek will also serve on the Compensation and Nominating and Governance Committees of the Board."

 

Takeaway: Our opinion is that WRC was among the worst managed companies in the apparel/retail industry. We didn't have a big problem with Gromek, but the reality is that he was captain of a ship who's only asset belonged to someone else (PVH -- Calvin license).  WRC had extensive operations in Europe, which could help GES -- but that's not where they have a problem. It's in regaining relevance with the North American consumer. Not sure how much help Gromek will be there. 

 

APP - American Apparel CEO Finds New Believer Just in Time

(http://www.bloomberg.com/news/2014-04-08/american-apparel-ceo-finds-new-believer-just-in-time.html)

 

  • "The American Apparel Inc. chief executive officer, facing a looming debt payment, attracted an investment last month from Swiss firm FiveT Capital AG."
  • "FiveT, a Zurich-based firm run by 35-year-old Johannes Minho Roth, bought about half the shares in an American Apparel stock offering, helping the clothing chain pay bills and stave off the risk of default. FiveT is now the American Apparel’s largest outside investor -- second only to Charney -- with an almost 13 percent stake."
  • “'He’s a visionary,' Roth said by phone. 'Dov wants to make it his life goal to make American Apparel into a successful company. I have a very positive view on him.'”
  • “'We can’t believe how cheap it is,' Roth said. Especially since 'it’s a lot further in the restructuring process than people think.'"

 

Takeaway: The irony that the blue-blood American Apparel brand isn't saved by an American company is borderline hilarious. Roth definitely sees something that we don't.

 

CHS - Chico’s Rises After Leonard Green Reports 1.3% Stake

(http://www.bloomberg.com/news/2014-04-08/chico-s-rises-after-leonard-green-reports-1-3-stake.html)

 

  • "Chico’s FAS Inc...rose the most in more than two years after Leonard Green & Partners LP disclosed a 1.3 percent stake in the company."
  • The shares climbed 8.4 percent to $16.97 at the close in New York, the biggest-one day gain Feb. 22, 2012...Leonard Green...purchased 2.05 million shares of the company, according to a filing today."

 

Takeaway: This is probably not the last we hear of Leonard Green with CHS. The reality is that it does not buy 1% of anything -- ever -- without plans to scale meaningfully higher (like 100%). That's what yesterday's 9% move in the stock suggests, at least. 

 

OTHER NEWS

 

PVH - PVH Corp. Announces Minority Investment in Karl Lagerfeld

(http://www.pvh.com/investor_relations_press_release_article.aspx?reqid=1916945)

 

  • "PVH Corp. announced today that it has become a minority shareholder in the parent company of the Karl Lagerfeld brand. Terms of the deal were not disclosed."
  • "This investment will enable PVH to benefit from the growth of this unique brand and includes the right of first offer to license the brand for North America, which has primarily been focused in Europe and Asia."
  • "Karl Lagerfeld was part of the Tommy Hilfiger Group until PVH acquired the Group in 2010, at which time it was spun off to the Group’s former shareholders. Other investors in Karl Lagerfeld include Apax Funds, the Chou Group, Mr. Tommy Hilfiger and Fred Gehring, CEO of Tommy Hilfiger."

 

GPS - Rachel Tipograph Exiting Digital Role at Gap

(http://www.wwd.com/fashion-news/fashion-scoops/exiting-gap-7634495)

 

  • "Rachel Tipograph on Friday is stepping down as Gap Inc.’s director of global digital and social media after nearly three years on the job."

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