Target: Temporary "Free Shipping" is a Very Bad Precedent For All

Takeaway: Don’t let this ‘free shipping’ promo sneak under the radar. It ushers Retail to a place where few can be profitable. TGT is not one of them.

This note was originally published October 23, 2014 at 07:18 in Retail

Conclusion: Target offering free shipping over the holidays accelerates a trend that we think will play out over two years -- which is that almost all retailers offer free shipping and free returns. Only those with the highest basket size (Nordstrom) can win at this game. Other retailers are likely to follow TGT over the near term. The math does not look good.




Every year there seems to be a new strategy the retailers embrace to gain share of wallet as the Holiday's approach.  With many stores now open all day on Thanksgiving and staying open 24/7 in the final stretch in December, there's not much more (aside from price) that the retailers can do to get more people to shop at the stores. But Target has an interesting, albeit costly, idea.


TGT is offering free shipping on all items in the store for online customers beginning yesterday, and lasting through Dec 20th. This is a huge event for retail -- at least how we see it.  And it does not result in profitability going up, unfortunately.


Common perception is that e-commerce margins are higher than brick & mortar. That might be true for content owners like Ralph Lauren, Nike and UnderArmour -- who can side step a wholesaler and capture 100% of the margin. But for retailers like Target, Macy's, Kohl's and JC Penney, e-commerce is not margin accretive.


Take KSS, for example. It's e-commerce gross margins are about 25% -- 1,200 basis points below the company average. The big culprit is the triangulation of lower-value (commodity) product, low basket size, and fixed shipping costs.


In the example below, you can see that a company like Nordstrom, which is the only retailer that offers free shipping and free returns, has a big enough basket size due to very defendable brands and price/points such that it can still print a superior e-commerce gross margin. Other retailers -- even Macy's, which is known for being a trailblazer in e-commerce (we don't particularly agree) has an extremely high threshold for free shipping ($99), and still does not have a superior e-commerce margin.

Target: Temporary "Free Shipping" is a Very Bad Precedent For All  - TGT 10 23 chart1



Our concern about this move by TGT is that it currently has a $50 'free shipping' threshold. Over the next two months, if you want to buy a package of q-tips for $3.89, or a package of pacifiers for $5.89, you get them delivered for free.   Unfortunately, the shipping cost on those items is about double the gross profit that Target would otherwise record.

Target: Temporary "Free Shipping" is a Very Bad Precedent For All  - TGT 10 23 chart2



Another angle on shipping costs is that a by-product of a 'free shipping' threshold is that it causes many consumers with a low basket size to come in to the store to pick up the product to avoid a $5-$10 shipping charge. According to Target, 14% of its digital sales are picked up in stores, and then about 20% of those customers buy additional items. What happens now that shipping is free?


We're not as concerned about this event as a negative for Target, but we are definitely concerned that (almost) all retailers are gravitating to a very unprofitable place -- that's free shipping and free returns. Free shipping is kind of like a dividend -- once you give it, you really can't take it away without severe repercussions.

Target: Temporary "Free Shipping" is a Very Bad Precedent For All  - TGT 10 23 chart3

LEISURE LETTER (10/24/2014)

Tickers: WYNN, HLT, PEB, CCL


  • Oct 24:
    • WYN Q3 earnings 8:30 am "wyndham"
    • PEB Q3 earnings 9 am
    • CHH Q3 earnings 10 am , code 86921299
  • Oct 28:
    • GLPI Q3 earnings 10 am
    • HOT Q3 earnings 11:30 am , code "10325720"
    • WYNN Q3 earnings 4:30 pm
    • MAR Q3 earnings 5 pm , ID "59390131"
  • Oct 29: H Q3 earnings 11:30 am code "95150754"
  • Oct 30:
    • HST Q3 earnings 10 am
    • MGM Q3 earnings 11 am , pw "6307991"
    • BYD Q3 earnings 5 pm , pw "8021592"



WYNN (LVRJ) is redesigning its proposed $1.6 billion resort casino in Everett and has scheduled a public meeting to discuss its cleanup plan for the heavily polluted former chemical plant site. The Las Vegas gambling giant said the environmental cleanup meeting will take place Tuesday at Tufts University in Medford. The updates were part of Wynn’s first status report to state regulators since besting Mohegan Sun for the lucrative Boston-area casino license last month.

Takeaway: Moving forward in the process, but awaiting the results of the referendum.


HLT – Waldorf Astoria Hotels & Resorts announced the launch a global gastronomy-focused program in partnership with the James Beard Foundation (JBF).  The JBF chefs will visit their selected property for one week, spending time with the Waldorf Astoria master chef inside and outside the kitchen. At the end of the week, each chef pairing will have devised a unique recipe. The winning Taste will be included on the menus of Waldorf Astoria's 28 hotels and resorts worldwide.

Takeaway: Hilton attempting to improve the quality of food and guest experience while creating a buzz.


PEB – announced very strong Q3 results with same-property RevPAR was 11.4%, well above the high end of guidance +7 to +8% with ADR up 8.5% while occupancy increased 2.6%.  Comparable hotel margins rose 350 bps versus guidance of +175 to +225 bps. New full year RevPAR guidance is now 8.25% to 8.75%, up from 7.25% to 8.0%. 

Takeaway: Another strong Q3 beat for the lodging REIT group as well as results that out performed Smith Travel Research RevPAR. The strong results bode well for Lodging REIT HST as well as BEE and SHO.


CCL(Cruise Critic) Princess Cruises canceled calls to West Africa due to the Ebola epidemic. The line has cancelled port calls in Cotonou, Benin; Lome, Togo; Tema, Ghana; and Dakar, Senegal on Ocean Princess' 30-day West Africa Adventure cruise departing May 5, 2015 from Cape Town to Dover. The ship will instead call at Luanda, Angola; Madeira (Funchal), Portugal; Malaga (for Grenada), Spain; and Lisbon, Portugal.


Princess Cruises also axed two Ukraine ports of call from 12 Mediterranean cruises. Scheduled port calls to Yalta and Odessa on a Mediterranean cruise scheduled for August were canceled and replaced with calls to Khios, Greece, and Constanta, Romania. Since March, seven other cruise lines -- including Azamara Club Cruises, Oceania, Regent Seven Seas, Siloversea and Windstar -- have cancelled Ukraine port stops. 

Takeaway:  More itinerary reconfigurations given Ukraine unrest and Ebola risk


Macau Smoking Ban Enforcement(GGR Asia) The Macau Gaming Enterprises Staff Association, affiliated with the influential Macau Federation of Trade Unions, has asked the government to have full-time inspectors inside casinos to enforce the full smoking ban on mass floors that was introduced on October 6. Local media this week quoted Leong Sun Iok, deputy director of the association, claiming that some gamblers ignore the no smoking signs and verbal warnings from casino staff if government inspectors are not present.

Takeaway: We've heard of punters ignoring the smoking ban and openly smoking in corridors, restrooms as well as stairwells.


Macau GGR Recovery (Macau Daily Times) Francis Tam forecast the city’s drop in casino revenue will worsen this month and a recovery will come in the second half of next year. A new bridge connecting Macau, Zhuhai and Hong Kong, coupled with the new casinos opening next year, will increase the city’s capacity to handle tourists, the official was also cited as saying.

Takeaway: Not exactly stepping out on a limb with that prediction.


Macau Boarder Opening(Macau Business) A mainland official has said he is confident that the border between Hengqin Island and Macau will open around the clock this year. The director-general of the Hengqin Administrative Committee, Niu Jing, said the mainland authorities were busy getting the facilities on their side of the border ready.

Takeaway: Long anticipated and anxiously desired, and while a positive event, the border crossing is not likely to meaningfully impact GGR growth.


Chinese Communist Party Central Committee on Graft – Approved by the central authority, the 18th Central Commission for Discipline Inspection of the Communist Party of China will hold its fourth plenary session on Saturday, October 25th. 

Takeaway: Expect more headlines regarding anti-graft and corruption crackdowns - which in turn are near term headwinds for Macau GGR. 


China New Home Prices decreased 1% month-to-month as compared to down 1.2% during August.


Hedgeye Macro Team remains negative Europe, their bottom-up, qualitative analysis (Growth/Inflation/Policy framework) indicates that the Eurozone is setting up to enter the ugly Quad4 in Q4 (equating to growth decelerates and inflation decelerates) = Europe Slowing.

Takeaway:  We're seeing bottoms up slowing in Europe cruise pricing in our monthly survey. Europe has been a tailwind for CCL and RCL but a negative pivot here looks increasingly likely. Following CCL's earnings release, we recently turned negative on those stocks based on the negative European thesis. 


Hedgeye Macro Team remains negative on consumer spending and believes in muted inflation, a Quad4 set-up.  Following  a great call on rising housing prices, the Hedgeye Macro/Financials team is decidedly less positive. 

Takeaway:  We’ve found housing prices to be the single most significant factor in driving gaming revenues over the past 20 years in virtually all gaming markets across the US.

Macro Notebook 10/24: S&P 500 | Oil | UST 10YR

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Lower Highs

Client Talking Points

S&P 500

The S&P 500 is getting lots of attention as it recaptures the minds of those who think the 200-day moving monkey is a risk management indicator; for us, 1967 remains bearish TREND resistance and there is no immediate-term TRADE support to 1835; volatility’s risk range is wide open too with VIX = 15.06-28.49.


Oil experienced a one-day rally, and failed, again – WTI is down -0.9% this morning to $81.33 with no immediate-term support to $79.75; even after a -5.2% move in energy stocks (XLE) for October to-date, some of the best looking shorts on our screen remains energy and MLP related equities as #Quad4 deflation risk remains.


When they bounce yields to lower-highs, you add to the winning team’s position in 2014 and buy the Long Bond (TLT, EDV, if you are looking at the ETF version); UST 10YR at 2.25% this morning with no support to 2.11% as both global and U.S. growth slows.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). U.S. real GDP growth is unlikely to come in anywhere in the area code of consensus projections of 3-plus percent. And it is becoming clear to us that market participants are interpreting the Fed’s dovish shift as signaling cause for concern with respect to the growth outlook. We remain on other side of Consensus Macro positions (bearish on Oil, bullish on Treasuries, bearish on SPX) and still have high conviction in our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.


We continue to think long-term interest rates are headed in the direction of both reported growth and growth expectations – i.e. lower. In light of that, we encourage you to remain long of the long bond. The performance divergence between Treasuries, stocks and commodities should continue to widen over the next two to three months. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove. We certainly hope you had the Long Bond (TLT) on versus the Russell 2000 (short side) as the performance divergence in being long #GrowthSlowing hit its widest for 2014 YTD (ex-reinvesting interest).


Restoration Hardware remains our Retail Team’s highest-conviction long idea. 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 punchline of our real estate analysis is that a) RH stores could get far bigger than even the RH bulls seem to think, b) Aside from reconfiguring 66 existing markets, there’s another 19 markets we identified where the spending rate on home furnishings by people making over $100k in income suggests that RH should expand to these markets with Design Galleries, and c) the availability and economics on large properties for all these markets are far better than people think. The consensus is looking for long-term earnings growth of 28% -- we’re looking for 45%.  

Three for the Road


Both the FTSE and DAX remain bearish; Portugal down another -0.8% to -19.1% YTD this morning



The creation of a thousand forests is in one acorn.

-Ralph Waldo Emerson


According to a Google 2014 Shopping Intentions Study more than 50% of consumers surveyed said they'll start their research before Thanksgiving, with 26% of shoppers starting before Halloween.

They Can't Fix This

“The problem with the big focus on making capital cheaper… is it’s akin to fighting fire with fire.”

-Dan Alpert


That’s a quote from the beginning of chapter 6 of The Age of Oversupply, by Dan Alpert. The chapter was a good one titled “The Empty Toolbox” and it focuses on why central planners “can’t fix the economy.” #agreed


Whether you are looking at the US economy or global one slowing right now, it’s important to keep these v-bottom moves in equity markets in context. Where are they v-bottoming from? Oh, and why did they go down so hard so that they could v-bottom to begin with?


Our call throughout the year has been very consistent on the why – growth is slowing. And when early-cycle growth slows from multi-year highs, you short the most illiquid form of beta chasing (small cap stocks) and you buy the Long Bond.


They Can't Fix This - EL chart 2 


Back to the Global Macro Grind


I was at a dinner meeting in Maine last night and an entrepreneurial CEO asked me a question I’ve been asked by hundreds of non-Wall Street people in 2014: “What do you think I should do with my money right now?”


I’m not the beat-around-the-bush-type, so I told her exactly what I have been telling people all year:


  1. Sell stocks
  2. Buy bonds
  3. Raise Cash


As basic as this advice has been is as hard as it’s been for people to just execute on it. But, with the total return of the Long Bond (TLT) at almost +19% for 2014 (vs. the Russell 2000 down -4%), why is that?


A: It’s not what “everyone” is saying people should be doing.


That’s it. From New Hampshire to California and everywhere I’ve been this year in between. That pretty much sums it up. The response is always the same: “but can’t interest rates go up? Aren’t bonds expensive?”


What’s been really expensive is believing that central planners can bend gravity and deliver +3-4% economic growth. If they deliver 0-2%, “expensive” bonds are going to get more expensive, and really expensive growth stocks (think Amazon at 112x earnings) are going to continue to crash.


But, but… “Keith, this bounce is crazy – why can’t it keep going…”


If I have some iteration of that in my inbox 100x in the last 3-4 market days, I have it 1,000x. And all I do is shake my head wondering why so many refuse to take a lesson from the risk management exercise learned as the Russell  was having a -15% draw-down and the 10yr broke 2% only a week ago.


To review the #Quad4 deflation case that Mr. Market is effectively yelling right now:


  1. Bond Yields (10-30yr) in the US are crashing
  2. Oil prices are crashing
  3. Over 60% of stocks in the Russell 2000 are crashing


To be fair, if you didn’t have a view that all of these things would go down, you blamed ebola (and Canada) and wore them the whole way down anyway. But, if you did, you are killing it YTD and in a position to re-ramp every position you’ve had throughout the last 6 weeks of macro market volatility.


We’re deep into 2014 and at this stage of the season playing this game from a position of strength is entirely different than playing it from a position of weakness. If you’ve been winning, you don’t have to spend your entire day worrying about why the stock market is bouncing and bonds correcting.


You’ve realized that the Fed, Bank of Japan, and European Central bank have all cut to zero. You’ve also reminded yourself that 0 + 0 doesn’t equal something greater than zero – and that they can’t solve for #GrowthSlowing again.


In other words, they can’t fix this. Unfortunately, only a deflationary reset can.


Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets – which you can get in our Daily Trading Range product as well) are now:


UST 10yr Yield 2.11-2.32% (bearish)

SPX 1 (bearish)

RUT 1040-1127 (bearish)

Nikkei 149 (bearish)

VIX 15.06-28.49 (bullish)

USD 85.01-86.20 (bullish)

EUR/USD 1.26-1.28 (bearish)

Yen 105.36-108.31 (neutral)

WTI Oil 79.75-82.62 (bearish)

Natural Gas 3.51-3.74 (bearish)

Gold 1 (bullish)

Copper 2.95-3.05 (bearish)


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


They Can't Fix This - Chart of the Day

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