Editor's note: Hedgeye retail sector head Brian McGough is removing Quiksilver from Investing Ideas. Please see his note below.
Conclusion: There’s only one take-away from this quarter for us – and it’s not about lower revenue out of PSUN or ZUMZ. It’s a serious ding to Team Mooney’s credibility. The company’s cavalier attitude towards pushing out revenue and profit targets, its lack of any clearly articulated building blocks of growth (even though we still think they exist), and what we think is lack of accountability to the financial community make it near impossible to tell our story – that was 50% based on management execution – without serious thesis-morph (which we won’t do). As such, we’re taking the black eye and are removing ZQK from our Best Ideas list. Our sense is that this will be an idea worth coming back to in another year as a) revenue growth reaccelerates (which we still think will happen), b) the company finds a way to actually tell what could be an interesting story, and c) it becomes a take-out candidate. But none of those things will happen in this calendar year. If we get wind that the story is back on track when it is a few bucks higher, then so be it. But we’re not going to change our thesis and narrative just to fit in with where the stock is today.
DETAILS
I’ve been doing this for 21 years, and this is a first for me -- I’m yanking support of a stock AFTER a meaningful blow-up. When a stock I like faces a negative event (it happens to most of us), I like to step away from all the noise, recalibrate long-term earnings power with the stock, and see if it is an opportunity to double down, or best to just walk away. Usually, we stick with the name. But the problem with ZQK is that the research changed as much, if not more than the stock. This goes far beyond #growthslowing. And we’re definitely not talking about weakness in PSUN, TYLYs or the US ‘teen space’ like so many people are talking about. Basing the investment on that would be nonsense, especially given that the US is only 38% of ZQK’s business. But our problem here is that management is simply not as effective as we thought it was.
When we first got involved with this name about six months ago, we were attracted to what we thought was a far better management team than a company the size of Quiksilver probably deserved. With seven of the top eight executives coming from high-profile roles at employers like Disney, Gap, Levis, and Nike, we thought they were worth giving the benefit of the doubt on being able to fix this perennially mis-managed company. We did the digging on the individuals as well, and research came back positive. We also conducted extensive consumer research to see if the brands could still be saved. After all, even the best management team can’t fix a dead portfolio. Fortunately, the brands scored far higher than we expected in our surveys, and when it all came together we built up a model that arrived at over $1.15 over a five year time period.
Now, unfortunately, we struggle to get to $0.75, and our confidence level in that earnings power has all but evaporated. A higher discount rate on a lower earnings number is hardly comforting.
There are several factors that concern us. None of them is a smoking gun, but they add up to be enough when 50% of our thesis hinges on a management team….
1) Lack of clarity surrounding financial plan. We keep hearing about the ‘profit recovery plan’ but there’s so little detail given about how they get there. All we hear about is how the Quiksilver brand is declining, Points of Distribution are shrinking, but yet sales will still accelerate to a high-single digit rate for the next three years. It would be so much easier for us all if they’d step up and say “we think we could add $300mm in revenue in 3-years…a) footwear is $150mm, b) China is $100mm, c) Roxy/Yoga is $50mm, etc…” There’s a problem when we think we can articulate a revenue story better than the CEO of the company (for what it’s worth, China and Footwear combined should account for a $500mm opportunity alone). Clearly, his information is better than ours. So either a) the growth is not there like we think it is, or b) the company will likely never articulate it as such until they hire someone who knows how to run a real IR effort.
2) Very little sense of urgency. We concur that this might be just a personality trait on the part of Andy Mooney, but when most CEOs talk about their business, they sound hell-bent on fixing existing problems as soon as humanly possible. Mooney comes across as way too accepting of certain problems as they are presented to the Street (like pricing pressure, distribution closing, and the eventuality of growing emerging markets ‘over a few years’). Again, this might be part personality, and part lack of being trained by someone who knows investor-talk. But it is what it is.
3) Should Mooney really have been on Mad Money on the final day of the quarter? Do you think that just maybe he knew the general trajectory of his business on the last day of the quarter? Either that was extremely poor judgment to be on financial media to promote his story when there was such a disconnect with expectations, or he simply did not know the numbers and his day-to-day command over the financials are not what they should be. We’d bet that it was poor judgment.
4) Lack of accountability to Wall Street. This goes beyond the fact that it’s easier to get a call returned from President Obama than it is from ZQK management. But they don’t seem to acknowledge or care about what it takes to be a shareholder-friendly company. Maybe Apple and Nike have earned the right to be ‘tough to follow’ but a company like ZQK needs to make it as easy as humanly possible for an investor to cover the company. There appears to be very little humility as it relates to the messages that they send to the investment community about financial targets, and how changing those statements impacts shareholder value.
5) There seems to be a new ‘issue’ every quarter. It was DC two quarters ago, then independent wholesale distribution last quarter. And now it’s wholesale apparel pricing. As it relates to apparel pricing, this means that we won’t see any uptick in this busines until ’15. Our revenue estimates for the back half of ’14 were contingent upon the company’s ability to deliver fast-turn ‘fashion right’ product to wholesale accounts. Those systems, which we were led to believe were in place at the end of 1Q, won’t be ready until at least the 1H ’15. And, management has shown very little confidence in its ability and/or the willingness of retail buyers to invest in the ZQK brands. The company admitted that it was buying shallow into the Fall ’14 and Spring ’15 selling seasons due to fears about sell throughs – which doesn’t help the top line a whole lot.
6) Product is behind schedule. Footwear pricing initiatives that were slated to take hold in the Fall of ’14 before full implementation in Spring of ’15. The changes which were to be part of the product relaunch in Fall of ‘14 were characterized as a ‘band-aid’ operation by Mooney, which is hardly what we were led to believe last quarter. The team would have been given a much better reception had they articulated both the issues facing DC from a pricing perspective and the gigantic opportunity in the $45-$50 price range. Price without product is a no win situation, and we think management failed in communicating this to the street. There still may be tremendous opportunity in the now 200mm canvas vulcanized market – but we had more faith yesterday in ZQK’s ability to deliver than we do today.
