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RH - Cheap, With Catalysts

Takeaway: If RH didn’t have a shift in Source Book timing, the stock would be up $10 on this print.

The minute we saw the RH numbers, we were shocked, to say the least. Good EPS ($0.67 vs $0.64E consensus), but nowhere near where it should have been, and revenue well below our model (and just about everyone else’s). That didn’t sit well with us, a high-growth, high-multiple name like RH does not have the luxury of missing on the top line. That’s particularly true for us given that such a big part of our thesis is predicated on outsized revenue growth over time. Our concern lasted about 15 minutes, until we a) realized precisely what drove the sales miss, b) determined that it is not symptomatic of an underlying problem, and c) quantified the impact. How we’re doing the math, the 7-week shift in the timing of RH’s Source Book drop cost between $12-$18mm in sales, or about $0.07-$0.10 per share in earnings.  In other words, excluding this event, the company would have printed a number of $0.74-$0.77. Our estimate for the quarter was $0.77 compared to the Street at $0.64. That’s big by any stretch. The stock is trading off moderately on this, but we think it will be very short lived. If RH didn’t have a shift in Source Book timing, the stock would be up $10 on this print.

 

All of that said, we clearly can’t ‘exclude’ this event. It happened, and there’s no taking it back. Some sales will be lost forever. But will there be a revenue push into 3Q? Yes. Did the company play down the impact it will have on the top line in 3Q? We think so.

 

Are we concerned about any management ‘execution issues’? Absolutely not. Let’s be clear, we think that it is management’s responsibility to anticipate timing shifts like this and communicate them to its constituents accordingly (including all of us). But this is a company that a) is pulling off one of the biggest real estate transformations the Retail landscape has seen in a decade, b) has reduced its mailings from 10 to 1 over two years, and c) doubled its product assortment from a year-ago (while simultaneously redesigning floorsets in all its stores). Think of any other retailer or brand. Nike, Kors, Lululemon, whatever… Now think of that company doubling its product assortment over two quarters. The complexity is staggering. All-in, we’re willing to give RH management a seven-week slide with revenue planning on this one, particularly given that Merchandise Margins are stellar and SG&A is so well-controlled.  

 

In fact, Gary Friedman’s and Karen Boone’s poise and confidence came across as being in the top 5% of the 100+ names we tracked over this past earnings season. These guys are in control of the business. Period. Did we walk away thinking that there might be more quarter-to-quarter revenue oscillations as the company grows up? Yes, we did. But again, for a company that is going to add $3bn in revenue and another $8 per share in earnings, we’re pretty much OK with that. We’re probably even OK with an occasional Gary s-bomb. Maybe we give it a slightly lower multiple to account for the revenue volatility. But the aggregate value that should be created here is still astonishing. We’d buy this on the sell-off. We’d buy it without a sell-off.

 

We’re making minimal changes to our model. See our overview below why we think RH is a double over 12-18 months, and is likely to double again. RH is still our top idea, by a long shot.

 

RH - Cheap, With Catalysts - RH chart4 financials

 

09/07/14 09:39 PM EDT

RH – Key Thoughts Ahead of The Print

 

Takeaway: RH remains our highest-conviction long term idea, and the model checks out into this qtr. In this note we flush out where we could be wrong.


Conclusion: We think that people are missing the magnitude of earnings growth at RH, the sustainability of that trajectory over a long period of time, and ultimately the degree to which that will accrue to equity holders. The question is not whether the stock will go to $90 vs $100 (where we see most price targets), but whether it will get to $200 vs $300. Even the best stories, however, are not linear. There will be bumps along the road. But this print should not be one of them.  We’re well above the Street in Sales, Margins and EPS, and we flush out in this note where we could be wrong.

 

DETAILS

We still think that RH is the best idea in Retail today. We think that most parts of the thesis are at least acknowledged by the market (category growth, real estate expansion), but people are absolutely missing how all the pieces are coming together to drive such outsized earnings growth over an extremely long duration. The consensus is looking for long-term earnings growth of 28% -- we’re at 45%.  That equates to $11 in earnings power by 2018. At a 45% earnings CAGR, what kind of multiple does this kind of earnings growth deserve? 25x? 30x? 40x? UnderArmour has a 30% CAGR and it trades at 65x earnings. Our point here is that if the consensus is as wrong as we think it is on the earnings trajectory, then it will be equally wrong on the multiple. 25x = $275. 30x = $330. 40x (which seems like a stretch) = $440. Yes, that’s 4.5 yrs out, but even discounted [30x $11 = $330) back by 15% over 4-years and you get about $190 today.  You want to use an earnings number closer in? We’re at $6.25 in 2016. The Street is at $3.76. Let’s keep the current 30x multiple, though we’d argue that we’ll see multiple expansion if numbers are going up that high. That suggests a $188 price in about a year and a half.  This stock is headed a lot higher.

 

All of that said, we fully acknowledge that the slope of a multi-year earnings growth story is not linear – especially for an early-cycle transformational story like this.  There will definitely be some bumps in the road along the way, but we simply don’t think that the quarter to be reported after the close on September 10 will be one of those bumps. The way we see it, RH is in an enviable position in that it could print a number as high as $0.77 if it so chooses (compared to the Street at $0.64) without borrowing from investment dollars that should otherwise be spent to fuel the long-term plan. 

 

Here’s a look at some key line items – and a little stress-test on where we could be wrong.

 

Revenue: We are at $468 for the quarter, ~3.5% above the top end of guidance and consensus. There’s a few important factors to consider here.

1) First off, remember that two points of growth were pulled forward into 1Q. That’s in our estimates.

2) This is the first full quarter where the Flatiron store in NYC will be pulled out of the comp base. That’s meaningless as it relates to Sales contribution. In fact, the store is a positive for the top line because the newly renovated store can begin to boost revenue. But it is the most productive store in the whole fleet (we think it accounts for 5-7% of sales) and it will no longer be part of the reported ‘comp’.  We think we have this accounted for properly, but if our 21% comp proves wrong, we think this is the most likely factor.

3) The late source book launch this year, shallow inventory buy to support the product refresh, and extended fulfillment windows could push revenue for orders booked in 2Q into 3Q. Similar to last year where the 2Q brand comp of 29% was bookended by a 40% brand comp in 1Q and 38% brand comp in 3Q. We think we have this factored into our model appropriately, but it is a part of the model where we could revenue shift between 2Q and 3Q.

4) We think that the on-line business looks solid. Based on the strength we’ve seen in our e-commerce index over the past few months, it is clear that RH is drawing a lot of incremental interest to its web site. This synchs with the timing of its sourcebook, so it is to be expected from where we sit. But the company is clearly executing well in driving its online strategy in conjunction with selling product in physical stores.

 

RH - Cheap, With Catalysts - RH chart1 MUV

RH - Cheap, With Catalysts - RH chart2 QUV 

 

Gross Margin: This is the area where we’re probably the most aggressive in our model, with a 200bp improvement vs last year. A couple points…

1) Last year margins were down 250bp due to significant pricing actions, and we don’t think RH is anywhere near as aggressive this year.

2) A quick point on Order Fulfilment:  RH does not get paid by customers until the product is delivered. As such, Fulfillment is the key to revenue recognition. We think the company is in a much better position this year to fulfill orders than LY for two reasons. a) Inventories are in a much better position to meet demand headed in to 2Q. The sales to inventory spread (sales growth – inventory growth) was -11% in 1Q14 compared to +3% in 1Q13. b) The company has added over 1.2mm sq. ft. in DC square footage, an increase of over 30% since 2Q13. That should help alleviate some of the shipping bottlenecks attributed to the once per year product refresh.

3) Dead Rent will start to be an issue. It should not start to deleverage occupancy until 3Q, but these deals are definitely in constant flux. We wouldn’t be shocked in the least to see it opportunistically take control of certain properties earlier than expected to give it room with construction. This shows up entirely in COGS. But to illustrate, a property line Denver/Cherry Creek will be about $2mm in rent per year. An extra quarter is $500k, or about a penny a share.

 

SG&A: Not a ton of moving parts here. We have SG&A growing at 20% this quarter, a rate that we have accelerating throughout the year as the real estate plan plays out and the company laps its change in Source Book strategy. Our math suggests that RH will spend an extra $52mm this year on its 3,200 page Source Book, but that will be amortized over a 12-month time period. Most of the year-over-year increase will be recognized in the back half of the year. One thing that’s worth noting is that we’re only modeling 54bps of SG&A leverage. That’s the smallest SG&A leverage rate RH will have achieved since 3Q11. In other words, we think our estimate is on the conservative side.

 

Sentiment Considerations

We think that sentiment factors are checking out for RH. Consider that the stock popped on the last earnings print but has actually traded down 12.2% since the June 30 peak, compared to a 2.4% gain for the S&P. In fact, our Sentiment Monitor looks abysmal for RH. This combines both sell side ratings and short interest, and the simple fact is that Sentiment for RH has never been worse. It is almost entirely driven by elevated short interest, which stands at 7.4mm shares – an all-time high. It’s up modestly since RH priced its convert, which makes sense as people buy the convertible and simultaneously short the equity. But the fact remains that 20.7% of the float is currently short. We’ll take the other side of that. In addition…

  • When Williams-Sonoma guided down for 2H, it definitely sucked some of the air out of the momentum sail for RH. RH lost 6.8% since the WSM miss – even though most of the factors were WSM-specific.
  • Though not a traditional peer, RH traded down when Kate Spade put up an otherwise spectacular quarter, but the stock was crushed due to a poorly communicated message regarding long-term outlook. Our sense is that from a PM’s perspective, these names are pretty much in the same bucket. Consumer discretionary, momentum, significant operational leverage, high multiple. We had several calls that week from people afraid that RH was going to be the next KATE.

 

RH - Cheap, With Catalysts - RH chart3 sentiment 


Hedgeye on Fortune: Why Vladimir Putin Is More Chuck Norris 'Judo Master' Than Chess Player

This is an excerpt from a Fortune article written by Hedgeye analyst Matt Hedrick.

Hedgeye on Fortune: Why Vladimir Putin Is More Chuck Norris 'Judo Master' Than Chess Player - 123

 

It’s no secret to any student of Russian President Vladimir Putin. The man loves Judo.

 

Putin started practicing Judo when he was 11 years old and Nikita Khrushchev was still at the top of the Soviet totem pole. He holds a black belt in the sport, is an honorary president of the European Judo Union and has even written a book on the subject, “Judo: History, Theory, Practice.” Last year he was ceremoniously awarded a ninth “Dan” (out of 10) in Taekwondo (for comparison’s sake, that’s higher than Chuck Norris’ eight Dan achievement), and recently attended the World Judo Championship in the southern Urals to view the Russian men’s team take second place to Japan.

 

Oftentimes, when commentators try to size up state actors and their influence on geopolitics, the discussion quickly turns to the metaphor of a “chess game” – and the current Russia vs. Ukraine (and the West) conflict appears no different (witness this week’s cover of The Economist with Putin standing on a giant chessboard).

 

The metaphor of a chess match misses the mark in Putin’s case. The metaphor of a Judo fighter is more apt in capturing the essence and approach of Putin since he joined the KGB in 1975...

 

Click here to continue reading on Fortune.


Cartoon of the Day: Will They or Won't They?

Takeaway: The epic global macro struggle du jour? Scottish independence.

Cartoon of the Day: Will They or Won't They? - Scotland cartoon 09.10.2014

Will the Scots decide to leave the United Kingdom, or not? A few weeks ago, no one was even considering this as a potential global macro issue, but after a recent YouGov.Com poll that showed a slight majority of Scots voting Yes (51%) to independence versus No (49%), the British pound was sold dramatically and Scottish independence became a hot topic with the manic media.


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.33%
  • SHORT SIGNALS 78.51%

McCullough: Housing “Train Wreck Within a Train Wreck”


Q&A: McCullough Answers Questions on the Fed, Bubbles and What to Do Right Now

In the Q&A portion of today's Morning Macro Call, Hedgeye CEO Keith McCullough answers three critical questions from institutional subscribers.

 

subscribe to Hedgeye TV on YouTube


Retail Callouts (9/10): AMZN, EBAY, TGT, UA, KSS, URBN, DG, FDO, DLTR

Takeaway: AMZN monthly comps rip, EBAY lowest growth rate in 3.5yrs. TGT emphasizes 3 key departments, food big omission. UA re-ups with U of MD.

EVENTS TO WATCH

 

Wenesday (9/10)

FIVE - Earnings Call: 4:30pm

WTSL - Earnings Call: 4:30pm

RH - Earnings Call: 5:00pm

 

Thursday (9/11)

LULU - Earnings Call: 9:00am

KR - Earnings Call: 10:00am

ULTA - Earnings Call: 5:00pm

 

 

COMPANY HIGHLIGHTS

 

AMZN, EBAY - ChannelAdvisor August Comparable Store Sales

 

Retail Callouts (9/10): AMZN, EBAY, TGT, UA, KSS, URBN, DG, FDO, DLTR - 9 10 chart4

 

Takeaway: ChannelAdvisor works with a host of 3rd party sellers who use the AMZN and EBAY marketplaces and uses the sales results from its clientele to back into these monthly comp numbers. Directionally it’s a very good indication of how the two businesses are tracking. AMZN has been on an absolute tear since April, and the divergence between the two is noteworthy. At 5.9% this is the lowest comp for EBAY in over 3.5 years.

 

TGT- Target Narrows the Bull's-Eye, With Emphasis on Signature Products

(http://online.wsj.com/articles/target-narrows-the-bullseye-with-emphasis-on-signature-products-1410293111)

 

  • "Target Corp.'s new CEO plans to double down on just a handful of departments like baby products and fashion, a strategic shift as the discounter works to bring shoppers back to its stores and better compete with online rivals."
  • "Just a month into his job, Chief Executive Brian Cornell is seeking to bolster a small number of categories that could help the chain stand out."
  • "'We've got to major in these signature categories and make some bold changes to re-energize those businesses,' Mr. Cornell said in an interview. 'All categories can't be prioritized the same.'"

 

Takeaway: We don't disagree with Mr. Cornell's approach on this one. The problem is that over 70% of the company's US store base has an expanded grocery department and that was willfully omitted from the list. The company can't hop into the DeLorean and undo the P-Fresh decision. Over a 5yr time frame, TGT went from cool, edgy ‘Tarjay’ where it was the envy of most of its peers, with a relatively defendable customer and would actually compete on the fringes with the likes of H&M, to being the place where a person who cares about nothing but price, or shops there simply because they hate going to WalMart. It went from having a peer group where it had a notable competitive advantage, to putting itself right in the middle of four unique competitors – 1) WalMart, 2) Department Stores, 3) Dollar Stores, and 4) Supermarkets. As a bonus, it has Amazon.com hovering over its head plucking away every last sales dollar it can. Differentiating TGT from the competition is going to take more than mannequins and health conscious cleaning supplies.

 

UA - Maryland’s helmets and uniforms will feature the lyrics to ‘The Star-Spangled Banner’

(http://www.washingtonpost.com/blogs/dc-sports-bog/wp/2014/09/09/marylands-helmets-and-uniforms-will-feature-the-lyrics-to-the-star-spangled-banner/)

 

Retail Callouts (9/10): AMZN, EBAY, TGT, UA, KSS, URBN, DG, FDO, DLTR - 9 10 chart 1

Retail Callouts (9/10): AMZN, EBAY, TGT, UA, KSS, URBN, DG, FDO, DLTR - 9 10 chart2

 

Takeaway: We're all for patriotism but these new UA unis for the University of Maryland are an eye sore. We take NKE and Oregon's aesthetics over UA and Maryland any day. On another note - UA re-upped its deal with the University yesterday at essentially the same terms as before, $3.4mm per year. Like Nike and Oregon this negotiation was a formality.

 

 

OTHER NEWS

 

KSS - Juicy Couture Now Available Nationwide at Kohl’s Department Stores

(http://phx.corporate-ir.net/phoenix.zhtml?c=60706&p=irol-newsArticle&ID=1965560&highlight=)

 

  • "Kohl’s Department Stores today announced the international lifestyle brand Juicy Couture is now available at Kohl’s stores nationwide and Kohls.com/JuicyCouture."
  • "'Customers across the country will be excited by the newness they find at Kohl’s this fall,' said Kevin Mansell, Kohl's chairman, chief executive officer and president. 'Amazing product is a fundamental pillar of our new Greatness Agenda and the proven casual luxury brand Juicy Couture will offer customers a fun, new fashion and home option in addition to Kohl’s existing portfolio of powerful and well-recognized brands.'"
  • "The cross-category collection includes misses’ and girls’ 7-16 apparel, jewelry, handbags, accessories, watches, footwear, bedding and fragrances. Retailing under $100 for fashion and accessories to under $400 for bedding and watches, Juicy Couture delivers confident, relaxed and feminine style at incredible savings."

 

KSS - Brendan Hoffman Seen on Kohl's Radar

(http://www.wwd.com/retail-news/people/hoffman-seen-on-kohls-radar-7893316?module=Business-latest)

 

  • "Currently, Hoffman is said to be on Kohl’s radar for a top position. Kohl’s, based in Menomonee Falls, Wisc., has its two top merchant slots open, following the departures of chief merchandising officer Donald Brennan last April, and Peggy Eskenasi, senior vice president of product development, last month. Earlier this year, Hoffman was on J.C. Penney Co. Inc.’s radar, as a possible successor to ceo Myron 'Mike' Ullman 3rd, but that didn’t pan out."

 

URBN - 3Q Update (10-Q)

(https://www.sec.gov/Archives/edgar/data/912615/000119312514336729/d765586d10q.htm)

 

  • "Thus far during the third quarter of fiscal 2015, comparable Retail segment net sales are low single-digit negative."

 

DG, FDO, DLTR - Dollar General Commences Cash Tender Offer to Acquire Family Dollar At $80 Per Share

(https://investor.shareholder.com/dollar/releasedetail.cfm?ReleaseID=870068)

 

  • "Dollar General Corporation today announced that it has commenced a tender offer to acquire all outstanding shares of Family Dollar Stores, Inc. for $80.00 per share in cash. The offer is scheduled to expire at 5:00 p.m., New York City time, on October 8, 2014, unless the offer is extended. The full terms, conditions and other details of the tender offer are set forth in the offering documents that Dollar General will file today with the Securities and Exchange Commission. Dollar General also will promptly file for clearance under the Hart-Scott-Rodino Act, which will allow the Company to begin the antitrust approval process with the Federal Trade Commission."

 

RL - Judge Puts Ralph Lauren, USPA Case in Arbitration

(http://www.wwd.com/business-news/legal/arbitration-in-india-for-ralph-lauren-uspa-dispute-7892271?module=Business-latest)

 

  • "The 30-year trademark battle between Ralph Lauren Corp. and the United States Polo Association is headed back to India after Judge Thomas Griesa of the U.S. District Court for the Southern District of New York this week rejected a complaint filed last October by Ralph Lauren Corp. against United States Polo Association Inc. and Arvind, its Indian apparel licensee. The complaint alleged unauthorized use of Polo’s single polo player mark and failure to provide the required disclaimers indicating that USPA isn’t affiliated with Ralph Lauren, as set forth in a settlement agreement reached in 2003."

 

FIVE - Five Below opens new distribution center in NJ to support growth

(http://www.retailingtoday.com/article/five-below-opens-new-distribution-center-nj-support-growth)

 

  • "Five Below has signed a lease for a new distribution center in Oldmans Township, New Jersey. The 1,045,000-sq.-ft. facility, located at 5 Gateway Blvd. in Pedricktown, will replace the company's existing 421,000-sq.-ft. facility located 12 miles away in New Castle, Delaware."

 

 


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