Takeaway: We made 10 changes to our Idea List – 7 Shorts/3 Long – and outlined duration for each. NKE, FL, M, DDS, COH, DKS, AMZN, DG, HBI, URBN.
This week, we made several changes to our Retail Ideas list. We also changed the format to address how we see each of these names playing out by duration. In case you’re unfamiliar with how we approach duration…
A) TRADE = 3-weeks or less. This is largely near-term catalyst-driven. Not where we spend the bulk of our time, but need to be aware of what’s coming down the pike nonetheless.
B) TREND = 3 months or more. This is primarily driven by quarterly modeling assumptions 2-3 quarters out.
C) TAIL = 3 years or less. This is the long-term call about market share, margins, and the capital needed to get there. For all names we recommend, we actually go out 5 years.
1) We added Foot Locker to the Short Bench. Trends look fine for FL today, especially in Europe, which is about 25% of sales. Nike and UA are fueling its momentum in the US as well. But the company is putting up a 10%+ EBIT margin on productivity of over $500/ft – 25% higher than historical peak. On top of that we’ve got a 15x p/e (close to peak), and are staring at sentiment scores that are among the highest in retail.
2) We added Macy’s to our Bench, and put it right alongside Nordstrom as names we’ll opportunistically look to get louder on as the research becomes more conclusive, or the price heads higher.
3) We removed Dillard’s from our bench. We originally were cautious on the name as we thought (and still think) that the $100+ real estate values being thrown around the Street were overstated by 3x. What we did not appreciate is the free cash flow story behind DDS. We won’t buy that FCF story here, but we definitely won’t short it.
4) We removed COH from our Top Three shorts. The punchline is that we think that there is at best $5 downside for this name, which is not enough for us given the risk to the upside. As much as we think that this Brand and Financial model are broken, we think COH makes a lousy short here. Here’s the link to our note on the name. (Link: CLICK HERE)
5) We moved DKS in place of COH on the top three. It’ll stay there unless the price corrects or estimates post-quarter come out to be too conservative.
6) We pulled Nike out of the Short side of the ledger and put it on the Long Bench. The name remains ridiculously expensive, but the fact of the matter is that in recent weeks Nike has made some moves that are incredibly rational on the cost side – like passing on Kevin Durant (to UA) and letting Manchester United go to Adidas. Both of those alone save Nike about $100mm/year. Combine that with easier SG&A comps in another 2-3 quarters, and Nike will likely have consensus numbers in the bag – and then some.
7) We added Amazon to the Short Bench. We’re long term believers in the model, but every incredible story has a price. We can’t believe that 300x earnings and 35x EBITDA is the right one for AMZN.
8) We removed DG from the Bench. But then about 30 seconds later we put it back on. We get the excitement around synergies of a deal with FDO. But we think that this bidding war is far from over. It’s already rich at 11.6x EBITDA, but we think it ultimately will have to pay somewhere in the mid-$80s for FDO – or about 13x EBITDA. When it is looking to pay that much for such a poor quality asset, we need to really ask ourselves about the prospects management sees in its core.
1) Added Nike, as noted above.
2) Added URBN. This is a name we want to be bullish on, but have been wading in slowly. We think the management team is exceptional, we like the unit growth and e-commerce platform, and the problems at the core UO concept are definitely not terminal. The only thing holding us back is that having such highly productive concepts like Urban and Anthropologie that are doing $700/ft and $1,000, respectively are a double edged sword. They’re highly profitable, and very defendable. But turns in the business – both on the upside and downside – take an extremely long time to play out. Our point is that we could be sitting here in a year and people might still be complaining about weakness at UO. At some point it won’t matter, and that time might be now. But we need to do more research to get the answer.
3) Added HBI. Let’s be clear…we don’t like this company or the business. This is a classic example of a company with a growth-challenged base business that is obfuscating its core by acquiring other companies. It’s track record is amazing…just as one acquisition approaches its 12th month, it goes ahead and buys something else. But whether we like it or not, HBI has a great 12-months ahead. It has year 2 synergies of Maidenform plus a full year of DB Apparel. Growth will look solid, HBI will beat conservative expectations, and investors will get paid with stock repo and dividends in the interim. As a kicker, lower cotton prices start to accrue to HBI in about another two quarters. We think this stock works from here.
Hedgeye Macro is hosting an expert call this Thursday, August 21st at 11:00 a.m. EDT to better understand the developing risks to Brazilian coffee production capacity next year and beyond. Brazil accounts for more than 1/3rd of global coffee production, and the damage from an unprecedented drought in the first three months of 2014 may have caused irreparable damage to a much larger portion of the 2015-16 crop than believed by consensus.
Our expert speaker will be Judith Ganes-Chase, founder and president of Ganes Consulting, an independent agricultural softs commodities research and consultancy firm. Judy worked on the sell-side for 20 years before founding J. Ganes Consulting in 2001.
Call Participant Instructions:
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Conference Code: 998836#
Materials: CLICK HERE
About Judith-Ganes Chase:
Judy has over 25 years of experience covering the agricultural softs space. Prior to founding Ganes Consulting in 2001, she spent most of her career as a senior softs analyst at Merrill Lynch and Shearson Lehman. Her most recent post was as the Director of News and Research at InterCommercial Markets.
Ms. Ganes-Chase is a contributing member to Elliott Associates, Gerson-Lehrman Groups Council, and Coleman Research Group. She is also a participant in the ICE (Intercontinental Exchange) research program and makes regular contributions to several industry-specific publications: Specialty Coffee Association of America, National Coffee Association, and the International Women’s Coffee Alliance (IWCA).
Hedgeye Macro Team
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Takeaway: There're puts/takes w the qtr…but bigger picture, there’s more bad news to come. We think 5-6% margins are more likely than recent 9% peak.
Conclusion: ‘Better than expected’ does not equate to a good quarter. Yes, we liked the 3.2% comp, 96% new store productivity, and $100mm repo – the second highest ever for DKS in a single quarter. It’s rare that DKS beats a quarter – we’ll give a golf clap when it’s due. But when all is said and done, depending on how you adjust for special charges, earnings were down between 5-10% on +10% sales growth. Not exactly a good quality number. On top of that, inventories remain elevated, margins are under pressure, and e-commerce grew at its lowest rate in 11 quarters. None of these factors get us particularly excited about owning this name – over any duration. Most importantly, to us at least, while people will obviously be talking about Golf due to the horrible trends and restructuring, we think there are bigger takeaways; a) looked at over a longer time period, this Golf Galaxy deal was simply horrendous. DKS bought at the top of a golf cycle, and is downsizing at the bottom of one. Textbook example of how not to deploy capital. B) we think that there’s a bifurcation in the golf market that is making it structurally unable for DKS/Golf Galaxy to compete. The company is taking its presence from 20% of sales to 15% and ultimately to 10%. Maybe the right answer is zero. The bigger question is whether or not this is an example that might apply to the rest of the Dick’s business as well. We’re modeling mid-single digit EPS growth – 200-300bp below the rate of store growth – over the next 5 years. We think that this stock is flat-out expensive.
GOLF: BUY HIGH, SELL LOW
There are a few things that don’t sit right with us about the Golf business, and the downsizing effort that the company is taking. Clearly, the golf equipment business is under severe pressure. That’s nothing new. This started six quarters ago for Dick’s, and has manifested itself in financial results for virtually every other retailer and brand that participates heavily in the Golf business. But what we don’t understand is that Dick’s bought Golf Galaxy in 2006 – right at the top of a golf cycle -- as a way to strategically double down on a category that it viewed as a long-term value creator. Now we’re sitting here at what is arguably the bottom of the golf cycle, DKS is cutting costs from the model outright, and it’s even talking about how 63% of its Golf Galaxy leases come up within 3-years and will be candidates for closure. We’re not necessarily saying that golf is a good investment now. But with retailers under pressure and OEM’s cutting capital allocation to golf equipment, this strikes us as an opportunity to take share and reposition for the next upturn, if nothing else. Buying High, and Selling Low is rarely a winning strategy. Unless of course, the company has reason to think that it simply won’t be a part of any upturn in the market.
Based on the monthly sales trends for Amazon and eBay, we’re inclined to think that DKS is right in that it will simply not participate in any eventual upside in the golf space. In other words, we can simply write this off as a deal gone bad. Consider this. The time of year where most golf equipment is bought at full price is in April and May. Then discounts pick up in June, and accelerate meaningfully as the Summer progresses. Amazon’s numbers, in particular, show a simply staggering acceleration from -5% in April/May to 43% as we entered the key discounting period in July.
What we think is happening is that there’s an increasing bifurcation in the golf market. Dick’s sells primarily to the ‘Occasional’ golfer, which accounts for about 44% of the golfing population. ‘Avid’ and ‘Core’ golfers are about 26% and 30%, respectively, and tend to shop in much higher-end golf specialty stores. One might think that this is not too bad, as it leaves 44% of the market for Dick’s. But that ‘Occasional’ player is also the lightest spender, and only accounts for about 19% of the market. That’s the same consumer that is more inclined to shop on Amazon or eBay for equipment at a heavy discount. An Avid golfer (45% of total spending) is not buying new gear on Amazon in August because it’s cheaper. They don’t care about price – and they have a favorite local store with high-end service where they buy equipment. Dick’s attempted to fill that void by hiring 400 Golf Pros to work in its Golf Galaxy stores. But they were all fired last month. Dick’s can’t compete with the golf specialty shops at the high end, and it’s proving that it can’t compete online with Amazon at the low-end.
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