“Panic! Dow Plunges Through Floor”
The 1980s were awesome. From big hair bands to Boesky getting bagged, there was a lot going on. A straight up stock market went straight down. The Dow dropped -22.61% in a day (October 19th, 1987)… but, if you ask the perma bulls, “the market was flat that year.”
It’s already August and the Russell 2000 is still trying to get back to flat for the year. With the 10yr Bond Yield having crashed alongside fanciful 1980s like +3-4% US GDP growth expectations, in Greenwich meetings yesterday I was told that GDP “doesn’t matter anymore anyway.”
Yep. This time is different. Roger that.
Back to the Global Macro Grind…
The rate of change in US economic growth may not matter to long-short stock pickers, but it matters, big time, to both the bond market and the sector asset allocations that are driving performance in the US stock market. As growth slows, big-cap-slow-growth #YieldChasing stocks & sectors outperform.
They didn’t yesterday though. My Connecticut investor meetings were great, but my recommended positioning sucked:
The only thing that has sucked more than having that short position yesterday, has been having it as a long position all year.
BREAKING: “Wall St Rallies on M&A Blitz and Home Builder Data” –Yahoo
Yahoooo! Everyone is going to buy everyone as US growth slows. Why not? And I’m not being sarcastic about that either. That said, there’s also a greater chance of Big Alberta Cows jumping over the moon than the US economy accelerating as US Housing and consumption slows.
Another US equity only manager told me yesterday that if I was right on #Q3Slowing (and that Janet Yellen gets more dovish, in kind), that “oh, the stock market is going to go higher on that.”
In other words:
It’s a good thing everyone is going to be a winner under any scenario with Global Macro volatility (across Equities, Currencies, Commodities, and Fixed income – ping for our Q3 Macro Theme of #VolatilityAsymmetry) at all-time lows.
That hasn’t happened before, but neither did 1987.
Q: How many US equity only PMs live in fear of missing the last 3% of a 5 year rally in the US stock market? A: lots
Or at least a lot more than there are PMs, strategists, and (god forbid) economists, who are in print like this Canadian mutt writing about the US economic cycle similarities between Q3 of 2007 and 2014.
Enough of the ranting – here are some #timestamped short ideas for this morning’s “futures are up” to sell into:
Yep. On the no-volume bounce (Total US Equity Market Volume was -15% and -39% vs. its 3 month and YTD averages yesterday), I’m going right back to the wood (i.e. the SELL calls that worked for me in both 2007 and 2014). They are early-cycle slowdown housing and consumption shorts.
And no, I don’t think that what’s going on in Ferguson, Missouri right now is a bullish catalyst for the 80% of this country being smoked by the all-time highs in Fed-inflated cost of living. Neither would I be surprised if the US stock market had a 3-6% down day in the next 3 months. Then you’ll see panic.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.34-2.42
MIB Index 186
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Galaxy in line with Street and us for Q2. More chatter regarding higher rebates in the QA and while Galaxy wouldn't deny it is happening in the market, they are not participating.
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
Source: Hedgeye and Factset
Leverage Pre and Post COH Acquisition
Source: Hedgeye and Factset
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