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KSS – 1Q Gives Us Greater Confidence in our Short

Takeaway: Not much in 1Q to challenge our Short call. We're taking down our estimates, which are already well below consensus. We'd press it.

Conclusion

No change to our KSS Short Thesis. If anything, the lack of conviction and strategic thought process from management on the conference call reaffirmed our view that the problems at this company go far beyond a singular quarterly report.  The weak comp (-3.4%) was not a major surprise given what we’ve seen out of other retailers, but even we didn’t think we’d see anything worse than -2.5%. What’s surprising is that the company held its full year EPS guidance constant despite the $0.03 miss.

 

We get the favorable impact of a lower tax rate and lower share count. But KSS is taking down D&A – which helps by $0.15 (or 3.7% EPS growth). Companies don’t make a decision to change depreciation rates so early in the year if they’re confident about where they’re headed. Also, KSS didn’t disclose its dot.com growth for the first time in at least three years. KSS has had the best growth rate in e-commerce out of any major retailer over the past eight years (38.9% CAGR) and it has served as a pillar of support for KSS’ growth algorithm. That’s clearly weakening.

 

And of course, JC Penney as an emerging competitive threat was not mentioned even once on the call. We think the Macro and industry cross currents are going to smack KSS from every direction, and we don’t think it sees it coming. We’re lowering our already below-consensus estimate for this FY by a nickel to $3.84. We don’t see how sales or margins are up for the year. In the outer years, we remain 20-30% below the consensus.

 

KSS – 1Q Gives Us Greater Confidence in our Short - kss financials

 

 

Here’s a few points relevant to KSS from our revenue overlap study from earlier this week regarding JCP and KSS. The punchline – based on a detailed analysis – is that JCP has about 300 stores to close. We overlapped each of those locations with every KSS store market by market to gauge the potential revenue windfall for KSS, as we viewed a meaningful revenue shift from JCP closures as one of the few risks to a KSS short. In the end, it was far less than we suspected.

 

1.   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.

 

KSS – 1Q Gives Us Greater Confidence in our Short - kss2

 

2.   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.

 

KSS – 1Q Gives Us Greater Confidence in our Short - kss3

 

3.   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. 

 

KSS – 1Q Gives Us Greater Confidence in our Short - kss4 


BOBE: Asset-Light Is Right

Ron Ruggless of Nation’s Restaurant News published a relevant and timely article yesterday afternoon, highlighting the wave of private equity activity that hit the restaurant industry last year.  David L. Epstein, principal with the Chapman Group, was particularly complimentary of the refranchising efforts of Applebee’s (DIN) and Wendy’s (WEN) in 2013.  Similar to us, Epstein is surprised by the lack of transactions in 2014:

 

I thought the huge success Wendy’s and Applebee’s have had in selling their corporate units to franchisees that a lot of other restaurants would see that and embark upon the same thing, but we haven’t seen that.”

 

As you know, we’ve been strong advocates of a potential refranchising effort at Bob Evans Farms (BOBE), suggesting that the transition to an asset-light model would benefit the company greatly.  We typically point to the successful restructuring Jack in the Box (JACK) has undergone over the past few years, but Applebee’s is another reminder of the significant value that can be created under such a scenario. 

 

We continue to believe BOBE would benefit from a reliable, diversified revenue stream and lower-risk business.  Suggestions that refranchising is merely a financial engineering event are heavily misleading.  In fact, franchisees have been known to run better restaurants than the franchisors running the brand, which would hypothetically lead to improved sales, traffic and brand perception.  BOBE would benefit greatly from finding a few franchisee partners to address the operational issues plaguing the company and recent history suggests there is significant appetite for these types of deals. 

 

We surmise the appetite on Wall Street would be as strong – investors tend to favor asset-light operators, often awarding these companies with premium multiples.  In our view, it’s a win-win.

 

BOBE: Asset-Light Is Right - chart1

 

BOBE: Asset-Light Is Right - chart2

 

Howard Penney

Managing Director

 

Fred Masotta

Analyst


Sell Growth: SP500 Levels, Refreshed

Takeaway: The weather turned, but the consumption data that matters most didn’t.

Editor's Note: This research note was originally sent to subscribers on May 13, 2014 at 10:04 a.m. EST by Hedgeye CEO Keith McCullough. Follow Keith on Twitter @KeithMcCullough.

  

POSITION: 8 LONGS, 7 SHORTS

 

But whatever you do, don’t call falling bond yields (do not sell bonds here!) on today’s #ConsumerSlowing (Retail Sales +0.1%) print a US growth slowing confirmation. The weather turned, but the consumption data that matters most didn’t.

 

Across our core risk management durations, here are the lines that matter to me most:

 

  1. Immediate-term TRADE overbought = 1901
  2. Immediate-term TRADE support = 1866
  3. Intermediate-term TREND support = 1845

 

In other words, you have -1.8% and -2.9% immediate (TRADE) and intermediate-term (TREND) risk to the downside if you get plugged chasing the all-time SPY high here. So don’t do that.

 

Both the Russell2000 and UST 10yr yields remain bearish, because growth is slowing.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Sell Growth: SP500 Levels, Refreshed  - SPX large

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Hedgeye Retail: Wal-Mart Plays Right Into #GrowthSlowing | $WMT

Takeaway: Not a great start for new CEO Doug McMillon.

Hedgeye Retail: Wal-Mart Plays Right Into #GrowthSlowing | $WMT - 2

 

The chart below shows what everybody already knows: Walmart comps disappointed. The company cited weather for 20 basis points of the decline. And if there's any retailer who's data we trust, it's Wal-Mart's.

 

But the two-year trend, which we place much heavier weight on as it relates to drilling down the real underlying trend, is nothing to write home about. This plays right into Hedgeye's #GrowthSlowing theme as it relates to the US Consumer.

 

Hedgeye Retail: Wal-Mart Plays Right Into #GrowthSlowing | $WMT - wmt comps large

 

The more telling visual is the earnings per share (EPS) miss. In 11 years, Wal-Mart has only missed 12 times, and nine of those were by a penny. Today it missed by a nickel. That's only happened once before – in 2007.

 

The blue bars in this chart show the absolute EPS variance to consensus for each quarter. The dots refer to the right axis showing the percent beat or miss in each period. Not a good way to start things off in the first quarter for new CEO Doug McMillon.

 

Hedgeye Retail: Wal-Mart Plays Right Into #GrowthSlowing | $WMT - wmt2 

 

*     *     *     *     *     *

 

Editor's Note: This research note was originally sent to subscribers on May 15, 2014 at 8:36 a.m. EST by Hedgeye Retail sector head Brian McGough. Follow Brian on Twitter @HedgeyeRetail.

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ICI Fund Flow Survey - Best Week All Year For Bonds Versus Very Light Week For Equities

Takeaway: Last week the combination of taxable and tax-free bond fund flow had the best week all year versus very light equity fund flows

Investment Company Institute Mutual Fund Data and ETF Money Flow:

 

In the most recent 5 day period, the combination of taxable and tax-free bond funds had the best week all year with $5.5 billion in inflow, well above the running year-to-date average of $1.9 billion. Conversely, equity funds had a very light inflow of just $754 million, well below the year-to-date average of $3.3 billion

 

It was an anemic week for equity mutual fund and ETF trends. Total equity mutual fund flows experienced slight relief w/w, improving sequentially from a net outflow last week, but still producing a tally well below the 2014 year-to-date weekly average. The $754 million that flowed into all equity mutual funds during the most recent 5 day period ending May 7th was split between a $2.0 billion outflow from domestic equity funds and $2.7 billion inflow into international equity funds. This outperformance from foreign equity products has been consistent over the past two years; international stock fund inflow has averaged $2.6 billion per week thus far this year, on par with 2013's $2.6 billion inflow, while domestic fund trends have averaged an inflow of just $770 million thus far in '14 and $451 million inflow in '13. The 2014 running weekly average inflow for all equity mutual funds is now $3.3 billion, only a slight improvement from the $3.1 billion weekly average inflow from 2013. 

 

Conversely, fixed income mutual fund flows accelerated notably on a w/w basis. For the five day period ending May 7th, $5.5 billion flowed into all fixed income funds, as opposed to last week's much weaker $931 million inflow. The improvement in bond fund flow this week was the result of $4.4 billion that flowed into taxable products and $1.1 billion that flowed into tax-free or municipal products. The inflow into taxable products this week was the 13th consecutive week of positive flow and the inflow into municipal or tax-free products was the 17th consecutive week of positive subscriptions. The 2014 weekly average for fixed income mutual funds now stands at a $1.9 billion weekly inflow, a vast improvement from 2013's weekly average outflow of $1.5 billion, but still a far cry from the $5.8 billion weekly average inflow from 2012 (our view of the blow off top in bond fund inflow). 

 

ETFs had polarized trends this week, with a substantial weekly redemption in equity ETFs and a solid week for bond ETFs. Equity ETFs experienced an $8.7 billion outflow w/w, while Fixed Income ETFs experienced $3.0 billion in inflows. The previous week saw a $4 billion inflow into stock ETFs and a $818 million inflow into bond ETFs. The 2014 weekly averages are now a $385 million weekly inflow for equity ETFs and a $1.0 billion weekly inflow for fixed income ETFs. 

 

The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a negative $16.4 billion spread for the week ($8.0 billion of total equity outflow versus the $8.5 billion inflow within fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $7.4 billion (more positive money flow to equities), with a 52 week high of $31.0 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week). 

 

Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.   

 

ICI Fund Flow Survey - Best Week All Year For Bonds Versus Very Light Week For Equities - chart11

ICI Fund Flow Survey - Best Week All Year For Bonds Versus Very Light Week For Equities - chart12

 

 

Most Recent 12 Week Flow in Millions by Mutual Fund Product:

 

ICI Fund Flow Survey - Best Week All Year For Bonds Versus Very Light Week For Equities - 2

 

ICI Fund Flow Survey - Best Week All Year For Bonds Versus Very Light Week For Equities - 3

 

ICI Fund Flow Survey - Best Week All Year For Bonds Versus Very Light Week For Equities - 4

 

ICI Fund Flow Survey - Best Week All Year For Bonds Versus Very Light Week For Equities - 5

 

ICI Fund Flow Survey - Best Week All Year For Bonds Versus Very Light Week For Equities - 6

 

 

Most Recent 12 Week Flow Within Equity and Fixed Income Exchange Traded Funds:

 

ICI Fund Flow Survey - Best Week All Year For Bonds Versus Very Light Week For Equities - 7

 

ICI Fund Flow Survey - Best Week All Year For Bonds Versus Very Light Week For Equities - 8

 

 

Net Results:

 

The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a negative $16.4 billion spread for the week ($8.0 billion of total equity outflow versus the $8.5 billion inflow within fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $7.4 billion (more positive money flow to equities), with a 52 week high of $31.0 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week). 

 

ICI Fund Flow Survey - Best Week All Year For Bonds Versus Very Light Week For Equities - 9.2 

 

 

 

Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA

 


Scary WMT Visual ***Correction

Takeaway: The comp miss is obvious. But the EPS miss is startling given historical context. Not a great start for new CEO McMillon.

Chart 1 shows what everybody already knows, that WMT comps disappointed. The company cited weather for 20bps of the decline. If there's any retailer who's data we trust, it's Wal-Mart's. But the 2-year trend, which we place much heavier weight on as it relates to drilling down the real underlying trend, is nothing to write home about. This plays right into Hedgeye's #growthslowing theme as it relates to the US Consumer.

 

Scary WMT Visual ***Correction - wmt comps

 

The more telling visual is the EPS miss. In 11 years, WMT has only missed 12 times, and nine of those were by a penny. Today it missed by a nickel. That's only happened once before -- in 2007. The blue bars in this chart show the absolute EPS variance to consensus for each quarter. The dots refer to the right axis showing the percent beat or miss in each period.   Not a good way to start things off in the first quarter for new CEO Doug McMillon.

 

Scary WMT Visual ***Correction - eps variance 


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