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COH - Broken Brand NOT = Broken Stock

Takeaway: Big bifurcation between the brand and stock. This shouldn’t be a public company, and it likely won’t be for long. Can’t short COH anymore.

Conclusion: After being bearish on the name for nearly three-years, we’re taking Coach off our Retail Short List. To be clear, the fundamental story is absolutely broken, and the financial model is not far behind. Our numbers 2-3 years out are 20%+ below consensus, and we truly don’t think that this company will earn $2.00 again until close to 2020.  But as broken as this model may be, the stock, unfortunately, is not. We think that the absolute best-case downside on a short at these levels is about $5, which is hardly enough on a $36 stock. And the truth is that we’d need to see the company face-plant on its recently-announced Brand repositioning, and there are no expectations for any meaningful results for another 1-2 years. Until then, the company probably has a hall pass to be sub-par, and the stock will probably be rewarded if the company hits a quarter even if by accident.

 

We’ve been struggling with valuation support on Coach given that we expect Gross Margins to cough up another 300bp, and EBIT margins should stay stagnant in the mid-high teens for years to come. But the flip side is that the dividend currently sits at 3.72%, which is reasonably attractive. The key here, unlike other higher yielding retailers is that the dividend is safe – even on our beared-up numbers. In fact, we’d need to see about a 700bp hit to Gross Margins in order to threaten the dividend. That would equate to a 13% EBIT margin. As much as we think that Coach has been relegated to an Outlet brand, it’s extraordinarily unlikely that it will ever see a 13% margin level again. At a 13% margin, we’re looking at about $1.33 in EPS. If we generously give it a 15x multiple, it suggests $20, or a 6.8% yield. That’s probably not going to happen.

 

In fact, Coach is on the short list (no pun intended) of names we think could, should, and probably will be acquired over the next 1-2 years. The brand just lost the team that took COH from $500mm to $4bn (Krakoff, Stritzke, Tucci, Frankfort) and has as much instability in the executive ranks as it does with its brand. A strategic or financial buyer could shield the management team from the near-term expectations associated with the capital markets, and focus strictly on revitalizing the brand – like it did the last time it grew stale and Sara Lee spun out Coach in 2000.

 

LBO: Makes more sense that one might think. The cash flow here is extremely compelling. The public market is getting a 3.72% yield, but a private buyer could take that up to the teens and not miss a beat. The transaction at $36 is on the rich side (a $30 stock with a 20% premium), gets us a 17.2% IRR with 6.9x debt/EBITDA. The leverage is on the high end of deals done to-date. But not out of the realm of what we’d consider doable. Again, this is based on zero margin recovery, and assumes a 10x exit multiple (equal to entry). Let us know if you’d like our LBO model.

 

Strategic Buyers: We think that the three most likely are Fast Retailing (Japan), Kering  (the former PPR/Gucci -- France), and LVMH (France). These companies could all digest COH in a heartbeat – from a leverage and dilution standpoint – at a price as high as $45. Fast could actually do the deal as high as $60 and it would be accretive. Same goes for Richemont and Inditex, though Coach would be further outside their respective cores.

 

COH Acquisition Accretion

COH - Broken Brand NOT = Broken Stock - coh1

Source: Hedgeye and Factset

 

Leverage Pre and Post COH Acquisition

COH - Broken Brand NOT = Broken Stock - coh2

Source: Hedgeye and Factset


Cartoon of the Day: When Doves Cry

Takeaway: All eyes on Janet Yellen in Jackson Hole later this week.

Cartoon of the Day: When Doves Cry - Yellen cartoon 08.18.2014



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Hedgeye In the News: Kinder Morgan, MLPs and the Sell Case

Takeaway: Take a few minutes to read Izabella Kaminska's article on Kinder Morgan and MLPs.

An excellent, must-read piece on Kinder Morgan (KMI) by Izabella Kaminska on FT Alphaville today. She writes:

 

The $44bn self-acquisition of Kinder Morgan has been heralded by some as a great deal for shareholders.


But is it? Is it really? At least for the ordinary investors?


We’ve already wondered about the motivation for the deal.

 

Hedgeye In the News: Kinder Morgan, MLPs and the Sell Case - km9

 

Kaminska goes granular questioning the ongoing spectacle with MLPs, CEO Rich Kinder’s financial alchemy and more.

 

As you may have already guessed, Hedgeye energy analyst Kevin Kaiser figures prominently in the story.

 

Hedgeye In the News: Kinder Morgan, MLPs and the Sell Case - kaiser

 

Click here to read on FT.


MIDWEST MOJO - AUGUST BUILDER CONFIDENCE

Takeaway: Builder confidence hits its highest level in 7 months with "optimism" and the largest MoM increase ever in the Midwest driving the upside.

Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume.

 

MIDWEST MOJO - AUGUST BUILDER CONFIDENCE  - Compendium 081814

 

Today's Focus: August NAHB HMI (Builder Confidence Survey)

This month (August), the NAHB’s HMI, which measures builder confidence, rose to 55, a gain of two points from July’s print of 53 (which was not subject to any revision), marking the highest reading in seven months and the second month above the improvement demarcation line of 50 on the Index.

  • Sub-Indices:  All 3 sub-indices increased MoM for a 3rd consecutive month with balanced gains across Current Sales (+2pts), 6M expectations (+2pts) and Current Traffic (+3pts)  
  • Mid-West Mojo: Builder Confidence declined modestly in the West and South while rising modestly in the Northeast.  Notably, the Midwest region saw its largest MoM increase ever, increasing +13 pts from July to August

 

Prognostic or Pollyanna? Last month’s gain in Builder Confidence was led by rising optimism with the forward expectations component registering a disproportionate increase.  This month saw a commensurate increase in current sales and forward expectations, leaving the “optimism spread” at its highest level since 3Q12.   

 

Perhaps the modest, ongoing improvement in the labor market is buoying stakeholder confidence in the housing market but, in relation to the preponderance of demand and HPI data (purchase apps, new home sales/start, pending home sales), builder confidence continues to decouple from the reality of actual new construction activity.  

 

We’ll get the housing starts/permits data for July tomorrow, but with permits running largely flat with flagging Starts figures YTD (& declining in the latest month) the upside for single family construction over 2H appears somewhat constrained.

 

COMMENTARY:  After recurrent flip-flopping on the chosen spin the last few months, the August commentary was expectedly balanced and largely canned:

 

NAHB Chairman Kevin Kelly had this to say on the August reading: 

 

“As the employment picture brightens, builders are seeing a noticeable increase in the number of serious buyers entering the market...However, builders still face a number of challenges, including tight credit conditions for borrowers and shortages of finished lots and labor.”

 

NAHB's Chief Economist, David Crowe, added this:  

 

“Each of the three components of the HMI registered consecutive gains for the past three months, which is a positive sign that builder confidence appears to be firming following an uneven spring…Factors contributing to this rise include sustained job growth, historically low mortgage rates and affordable home prices, which are helping to unleash pent-up demand.”

 

MIDWEST MOJO - AUGUST BUILDER CONFIDENCE  - Midwest  MoM

 

MIDWEST MOJO - AUGUST BUILDER CONFIDENCE  - NAHB LT

 

MIDWEST MOJO - AUGUST BUILDER CONFIDENCE  - NAHB Subindices

 

MIDWEST MOJO - AUGUST BUILDER CONFIDENCE  - NAHB Regional

 

MIDWEST MOJO - AUGUST BUILDER CONFIDENCE  - NAHB Optimism Spread 

 

MIDWEST MOJO - AUGUST BUILDER CONFIDENCE  - NAHB vs SF Starts

 

MIDWEST MOJO - AUGUST BUILDER CONFIDENCE  - NAHB vs New Home Sales

 

 

About the NAHB HMI:

The Housing Market Index (HMI) is based on a monthly survey of NAHB members designed to take the pulse of the single-family housing market. The monthly survey has been conducted for 30 years. The survey asks respondents to rate market conditions for the sale of new homes at the present time and in the next 6 months as well as the traffic of prospective buyers of new homes. The HMI is a weighted average of separate diffusion indices for these three key single-family series. The HMI can range from 0 to 100, where a value over 50 implies conditions are, on average, improving, a value below 50 implies conditions are worsening, and an index value of 50 indicates that the housing market is neither improving nor worsening.

 

 

Joshua Steiner, CFA

 

Christian B. Drake

 


Retail Callouts (8/18): FDO, DG, DLTR, TGT, WMT

Takeaway: DG will ‘win’ FDO. But at much higher price. Good for FDO. Bad for DG. Neutral for DLTR. Horrible sign for quality of growth in US retail.

EVENTS TO WATCH

 

Monday (8/18)

  • URBN - Earnings Call: 5:00pm

 

Tuesday (8/19)

  • HD - Earnings Call: 9:00am
  • DKS - Earnings Call: 10:00am
  • TJX - Earnings Call: 11:00am

 

Wednesday (8/20)

  • SPLS - Earnings Call: 8:00am
  • LOW - Earnings Call: 9:00am
  • PETM - Earnings Call: 10:00am
  • TGT - Earnings Call: 10:30am
  • AEO - Earnings Call: 11:00am

 

Thursday (8/21)

  • DLTR - Earnings Call: 9:00am
  • BONT - Earnings Call: 10:00am
  • GPS - Earnings Call: 4:00pm
  • GME - Earnings Call: 9:00am

 

Friday (8/22)

  • ANN - Earnings Call: 8:30am
  • FL - Earnings Call: 9:00am
  • HIBB - Earnings Call: 10:00am

  

COMPANY HIGHLIGHTS

 

DG, FDO, DLTR - Dollar General Makes Proposal to Acquire Family Dollar for $78.50 Per Share

(http://investor.shareholder.com/dollar/releasedetail.cfm?ReleaseID=866625)

 

  • "Dollar General today announced it has made a proposal to acquire Family Dollar Stores, Inc. for $78.50 per share in cash, in a transaction valued at $9.7 billion. The proposal was conveyed this morning in a letter to Family Dollar's Board of Directors. This transaction would deliver increased consideration and immediate liquidity to Family Dollar's shareholders and represents a compelling opportunity to create value for Dollar General shareholders."

 

Takeaway: First, before even considering which two companies are a better fit, we think that the most glaring observation is that we're talking about STARTING a bidding war for a company as poor quality as FDO in between 11x-12x EBITDA. Again, let's let this one digest…11.6x EBITDA for a dollar store.  Whether FDO is looking to aggressively sell itself, or DLTR and DG are finding it critical to chase after poor quality growth, it does not send a great signal about the their collective view of the US economy.

 

Second, this is far from over. You (DG) don't go into a bidding process only 5.5% above the prevailing bid -- even if the deal is all cash vs 80% cash/20% stock for DLTR -- expecting to win the deal outright, especially when you're going hostile against an otherwise friendly merger.

 

Third, this deal probably makes more strategic sense for DG even at a slightly higher multiple. The $78.50 price per share implies a 11.6x EV/EBITDA forward multiple. Given the assumed synergies  for a combined DG/FDO at $550mm-$600mm on an annualized basis compared to DLTR/FDO at $300mm. That takes the 2016 multiple down to 6.1x for FDO and 7.5x for DLTR.

 

Our Prediction: DG walks away with this one. But it's going to be expensive. Our bet is that FDO is bought for $85, or nearly 13x EBITDA. That's great for FDO shareholders. Bad for DG. And an even worse sign about how hard it is to find quality growth in US retail today.

 

OTHER NEWS

 

TGT - Target to Keep Some Stores Open to Midnight in Push for Traffic

(http://online.wsj.com/articles/target-to-keep-some-stores-open-to-midnight-in-push-for-traffic-1408136702)

 

  • "Target Corp. TGT is keeping its doors open later at more than half of its U.S. stores, hoping to snag guests who are putting off shopping until well after dark and might have gone elsewhere."
  • "The chain's nearly 1,800 U.S. stores had typically opened at 8 a.m. and closed at 10 p.m. on weekdays and Saturdays and at 9 p.m. on Sundays. The new hours will keep stores open until 10 p.m. or 11 p.m. on Sundays and until 11 p.m. or midnight on other days."

 

WMT - Wal-Mart makes holiday ‘checkout promise,’ pledges to staff every register

(http://www.chainstoreage.com/article/wal-mart-makes-holiday-%E2%80%98checkout-promise%E2%80%99-pledges-staff-every-register)

 

  • "A day after announcing a disappointing second quarter, Wal-Mart Stores has made an aggressive holiday promise to its customers: the world’s largest retailer says it will staff every cash register from the day after Thanksgiving through the days just before Christmas during peak shopping times."
  • "Wal-Mart’s 'checkout promise' is aimed at addressing lengthy waits in checkout lines."

 

GME - NCAA Legal Controversy Leads to a Slow Summer for Video Games

(http://www.businessweek.com/articles/2014-08-15/video-game-sales-down-after-cancelation-of-ncaa-game)

 

  • "... industrywide revenue from new video game software was down 15 percent in July, to $178 million, compared with a year earlier. Sales of newly launched games were down almost 70 percent, which was almost entirely the result of the lack of a new version of NCAA Football, according to NPD."

 

Jones Group - Exclusive: Shoe retailer Stuart Weitzman to go on auction block - sources

(http://www.reuters.com/article/2014/08/15/us-stuart-weitzman-sale-exclusive-idUSKBN0GF21R20140815)

 

  • "Women's shoe retailer Stuart Weitzman is preparing to launch a sale process and has tapped investment banks Goldman Sachs Group Inc and Citigroup Inc to assist with the effort, people familiar with the matter said."
  • "The New York-based retailer could fetch a price well below $1 billion, two of the people said this week. Others said the ultimate sale price could be around $800 million."
  • "Sycamore Partners, the New York-based private equity owner of Stuart Weitzman, acquired the brand as part of its $2.2 billion purchase of Jones Group Inc earlier this year."
  • ansion into Canada are shoe stores, auto parts stores, and lingerie, swim and bridal stores."

 

JD.com Quarterly Revenue Rises 64%

(http://www.wwd.com/business-news/financial/jdcom-quarterly-revenue-rises-64-7839901?module=Business-latest)

 

  • "JD.com Inc, China's second-largest e-commerce company, reported a 64 percent rise in quarterly revenue as the number of its active customers nearly doubled."
  • "However, net loss widened to 582.5 million yuan ($93.9 million)"

 

AdiBok - Adidas unveils Bayern Munich 2014-15 third official jersey

(http://www.fibre2fashion.com/news/garment-company-news/newsdetails.aspx?news_id=166935)

 

  • "adidas and Bayern Munich are excited to announce the launch of the new official third jersey for the 2014/2015 season, a kit that seeks both to celebrate the club´s extraordinary legacy in the UEFA Champions League and also its unique team spirit."

 

Austria’s Signa buys Karstadt department store chain for just €1

(http://www.ft.com/intl/cms/s/0/c3a248ae-245c-11e4-be8e-00144feabdc0.html?siteedition=intl#axzz3AjuHnKnR)

 

  • "Karstadt, the struggling German department store chain, is being taken over by Austria’s Signa Group, ending weeks of speculation over the company’s future after the shock departure of its chief executive in July.
  • Signa, founded by Austrian investor René Benko, will pay just €1 for the lossmaking chain, whose 83 stores across Germany employ 17,000 people. The Austrian group will also take over the remainder of Karstadt Premium department stores and KarstadtSports, after buying a 75.1 per cent stake in the groups last year."

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