Takeaway: Here's Cliffs Notes of our JCP/KSS Real Estate Call. Punchline - expect more JCP store closures. Not the good event for KSS you might think.
Today we hosted a call to discuss our short thesis on KSS, and why JCP is both the biggest opportunity and threat to the thesis. While we presented the results of our third department store consumer survey and our e-commerce analysis (both very insightful), we think that the meat of our presentation was in our analysis of the real estate and demographics for every single one of the stores for JCP and KSS. The conclusions are significant. We outlined our research in a 47-page slide deck, and can’t possibly encapsulate all of that here. But here are some of the more salient points. For the full deck and audio presentation, click the link below.
Here are a few select highlights…
1. Real Estate Approach: We think that the biggest threat to a KSS short is JCP announcing a significant number of store closures, which would presumably help KSS longer term as it relates to market share. In order to properly assess this risk, we analyzed every JCP market to see where the most likely closures are, and whether or not they overlap with KSS. For starters, we did not simply map out store locations (a feat in itself) and draw a circle around each point on the map to gauge overlap by market. We mapped out a 15-minute driving radius around every store, which as you can see by the chart below is very different for every single store location in the country. This shows Tallahassee, FL, which has two locations where JCP and KSS overlap perfectly, and another location where JCP exists without KSS as a competitor. We did this in every market in the US.
2. Productivity Analysis. This next chart shows us what the implied sales per square foot range is for JCP’s 1089 stores. What we know is that in the US, JCP has 0.47% share of wallet in apparel, home furnishings and other relevant retail goods across its portfolio in aggregate – again, we’re looking at all expenditures within a 15 minute drive of its stores. If we apply that ratio to each market, we get implied sales/square foot levels ranging from $8 to nearly $1,000 (Manhattan). We know that share is likely to vary by market, so we’re not trying to say that these are the exact productivity levels of each store. But directionally, we think we’re right. And that direction tells us that 782 stores, or nearly 72% of JCP locations, are running below the system average of $98/square foot.
3. 300 Store Closures: We think that JCP needs to close 300 locations, at a minimum. We know that the demographic profile in the surrounding area of JCP stores in aggregate is about $66k in annual household income. We also know that JCP just identified 33 stores that it is closing. We analyzed those locations, and the demographic profile is $54k annually – that’s 18% lower than the portfolio average. So we looked throughout the system of JCP stores and looked to see how many other stores fit that profile. There are 300. If these stores are closed, the average income statistic goes up for the whole portfolio by 7% to $70k. The 300 stores closed have implied sales/square foot of less than $38 annually. There are still almost 500 stores above $38 and yet still below the system average.
4. Revenue Impact of Closures. Our math suggests that these stores would only result in about $550mm-$600mm in revenue loss to JCP. Importantly, KSS only overlaps in 42% of these markets. Our research shows that KSS took about 19% of the $5.4bn in sales JCP hemorrhaged over the past three years. If we apply a 20% share gain level to this analysis for KSS, it suggests about $73mm, or less than 0.4% to KSS in comp. If you want to get more aggressive and assume that KSS takes 100% of that revenue (which WMT won’t allow) you’re looking at about 1.9% in comp to KSS. We think something far below 1% is closer to reality. Here’s the sensitivity analysis below.
5. No Growth KSS. This analysis suggests to us that KSS can only add stores in lower demographic areas. We fully recognize that there are few people running around touting KSS as a unit growth story. But this math is definitely worth sharing. The numbers on the horizontal axis refer to JCP’s entire store base. The bucket to the far left is represents the most attractive demographic locations. The bucket to the far right represents the least attractive locations. The columns show the percent overlap KSS has in each bucket of those JCP stores. The point is that in the top 600 locations, KSS has near 100% overlap with JCP. Then it begins to tail down slightly – with the only real opportunity for growth in JCP’s worst 300-400 markets.
6. KSS Has The Greatest Exposure to JCP Prior (Not Future) Share Loss. Every time we conduct a survey, we look at the dispersion of the of the lost JCP business by retailer. We had a lot of people argue with us over the past two quarters when we presented our 18-19% share stat – but this time around, it was validated yet again. The numbers suggest that KSS captured about $1bn of the $5.4bn JCP gave away. WMT is slightly higher, but as it relates to percent of each retailer’s sales, no one even comes close to KSS at 5.3% of total sales.
7. Shopping Trend Getting Better On The Margin for JCP. There’s half a dozen slides in our deck outlining results of our consumer survey. In this one we ask people if they are buying more or less vs. a year ago at each store. Now with three surveys under our belt to an identical demographic group each time, we can at least compare the retailer sentiment to prior surveys to game the incremental change. Bottom line is that JCP is showing steady improvement, while KSS is not.
Please see the link to the presentation materials above for all of our analysis on these and other topics.
Takeaway: A deteriorating GIP outlook and an increasingly clear status-quo policy outlook leave us negative on China w/ respect to the TREND duration.
We’re probably a bit late with this research note, largely because the last few months of mixed policy signals amid rapidly souring economic data left us in “do nothing” mode with respect to our preferred China exposures. Recall that we’ve been advocating a long “New China”/short “Old China” investment strategy since early December:
That investment strategy has performed modestly well (+577bps on an equal-weighted basis using the CQQQ, CHIQ, CHIX, and CHXX etfs as proxies), though it has certainly given up a lot of performance juice in recent weeks. This narrowing of performance between “New China” plays and “Old China” plays was a key leading indicator of the fundamental outlook we are now modeling in from a GIP perspective – with policy guidance being the other.
Our GIP outlook for China isn’t all that negative from an absolute perspective (I mean, does anyone actually care if Chinese growth is +7.2 or +7.4 percent?), but we now see Chinese #GrowthStabilizing in 2Q (vs. an initial projection of #GrowthAccelerating) amid a likely acceleration in reported inflation (i.e. the GDP deflator – assuming China’s real GDP calculus is, in fact, “real” calculus).
The back half of the year should see the Chinese economy mired in Quad #3 (i.e. growth slowing as inflation accelerates) – largely because the Chinese economy lacks sufficient sequential momentum for us to justify China “comping” increasingly difficult comps as we progress through the year.
Moreover, both credit growth and headline GDP growth tend to be weighted towards the first half of the calendar year, so seasonality is in favor of this research view.
Lastly, now-consistent policy guidance out of key members of the Politburo, State Council and PBoC have severely quashed our expectations of any major fiscal or monetary stimulus over the intermediate term.
Going back to China’s lack of sufficient sequential momentum, the balance of Chinese economic growth data shows a general trend of rather muted MoM improvement – if any – across a number of key indicators. On a trending basis, Chinese growth data remains more-or-less flat – with the exception of Chinese trade data, which has shown marked improvement in recent months.
Looking to China’s property market tells a sharply divergent tale – particularly one of sharp deterioration on a trending basis. Specifically, headline measures of financing, supply, demand and price are all crashing with respect to their trailing 3M, 6M and/or 12M trends. It’s worth noting that the recent collapse in land areas purchased is a headwind for both prospective real estate development and local government finances – the latter of which could limit the scope of any additional targeted fiscal stimulus efforts.
Given that property investment accounts for ~20% of Chinese GDP according to some estimates, this is not good. So much so that the PBoC had to embark on qualitative easing today, urging banks to accelerate residential mortgage lending in order to help curb the sharp deceleration in demand that has spilled over into China’s Tier 1 cities in recent months (residential sales values dropped -31% YoY in APR and are trending -27% YoY in the YTD).
One thing Chinese banks can do is lower mortgage rates; while they are allowed to lend down to 70% of the PBoC’s benchmark 5+ year mortgage rate (currently at 4.5%), they’ve actually kept the cost of capital fairly high in the YTD. The PBoC’s latest Quarterly Monetary Policy Report showed mortgage rates averaging 6.7% in 1Q14, up +17bps QoQ.
The aforementioned maneuver out of the PBoC follows a plethora of piecemeal easing measures in recent months, including but not limited to:
In summary, our call on China is simple: with real GDP growth upside seemingly capped at/near +7.5% for the foreseeable future and asymmetric downside heading into 2015 (e.g. principle due on listed Chinese property developer debt more than doubles to 69.7B CNY next year as funding slows sharply currently; deposit rate deregulation threatens both marginal lenders and borrowers as the cost of capital remains artificially low throughout the Chinese financial system; and capital account deregulation without broad expectations for structural CNY appreciation could be disastrous), we see no reason for investors to get involved in China here other than “valuation”.
Valuation is not a catalyst…
What are catalysts, however, are GIP fundamentals and tail risk. While we continue to believe that both the political resolve and fiscal & monetary firepower will continue to mitigate the latter, neither are currently skewed in favor of being long anything China at the current juncture. At best, investors should remain on the sidelines.
Don’t ever forget that China’s economic reform agenda, while likely structurally positive for the Chinese economy, may not be all that fun for investors in the short term – which is actually something we concluded roughly 2.5 years ago! Dozens of research notes and several conference calls later, what have we really learned?...
Enjoy your respective evenings; feel free to ping us with follow-up questions.
Associate: Macro Team
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Takeaway: 51% said 1,800; 49% said 2,000.
The S&P 500 closed at a record high yesterday and is currently sitting at 1,900. But, as CEO Keith McCullough pointed out this morning, “Calling total US Equity Volume a cricket yesterday wouldn’t be giving it its due credit! On the “all-time-high” CNBC Dow cheers (RUT and QQQ are down -5% to -6% from their year-to-date highs) volume was down -10% and -31% versus one-month and three-month averages, respectively.”
We wanted to know what you thought, so we asked in today’s poll: What’s the next stop for the S&P 500?
At the time of this post, in a very close, neck-and-neck race, 51% said the next stop would be 1,800; 49% said it would be 2,000.
Those who believe it will drop to 1,800 say it’s due to “money flow and volume.” Additionally these voters said:
However, those who said it will go to 2,000 simply believe it’s a bull market:
Takeaway: “Mister Wabbit, before you die, you can have one wast wish.” - Elmer Fudd
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