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October 27, 2014

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BULLISH TRENDS

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BEARISH TRENDS

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THE HEDGEYE MACRO PLAYBOOK

Takeaway: Our Macro Playbook is a daily 1-page summary of our core ETF recommendations, investment themes and proprietary quantitative market context.

CLICK HERE to view the document. In today’s edition, we highlight:

 

  1. The rotation out of international Fixed Income and Yield Chasing exposures and into their domestic counterparts
  2. How divergences in momentum between pockets of domestic Fixed Income & Yield Chasing exposures continue to suggest #Quad4 is a highly probable event
  3. The shortable head-fake in homebuilder stocks

 

Best of luck out there,

 

Darius Dale

Associate: Macro Team


KSS – Key Questions for Kevin and Wes

Takeaway: Don’t waste time on the CMO or 4Q comp. We’d dig into levers behind whether KSS will ever earn $4.00+ again after ’14

Here are some questions we’d ask at Kohl’s Investor Day on Wednesday. We’re giving these questions to you, because we won’t have the chance to ask them directly. In the spirit of full disclosure we sent management our 61-page slide deck outlining why we think the stock is a short. They didn’t like it very much, apparently. We're fine with that.

 

We’ll just sit back, listen to the webcast and see how the company’s disclosure about its business challenges or supports our thesis, and will act accordingly. But shy of some massive strategic or financial engineering announcement, we don’t see how the financial community walks away with a whole lot of ammo to think that this company can grow again after 2014 – ever. Our thesis is outlined in the comments below. Also see the link to the replay of our conference call, and the full 60-page slide deck detailing our view.

 

Here Are A Few Key Questions We’d Have For KSS Management

 

1. Q: What percent of Kohl’s brands/content do you think the Consumer would be genuinely upset to see go away forever?

 

Context: No, this question is not a joke. We always ask this of companies that don’t own their own content. Macy’s would probably have a very good answer for this – probably between 80-90%. But its merchants are good enough to fill that void with other content that the consumer wants. For Kohl’s, we have no idea what management would say, but we think it’s as low as 20-30%. That means that 70-80% of its sales could go away forever, and the Consumer would not miss a beat. The irony is that the brands the consumer wants – Nike, Levis, Columbia, Carter’s, Vans – could all be bought at other retailers. Or better yet, online from the brands themselves.

 

2. Q: Why should the current Kohl’s business model exit?

 

Context: Maybe you could think of a more articulate way to ask this one, but think about the history here. In the mid-1990s when KSS first roared onto the scene (as THE growth name in Retail), the bankers and analysts all pitched it as ‘an alternative to the mall’. That’s when the concept of mall traffic being in a secular decline found its way into Wall Street Retail lore, and KSS was viewed as the offset. Lower-rent off-mall property that’s much closer to home, providing an extremely attractive alternative to someone that did not want to battle the crowds in overcrowded malls. Back then, even sophisticated consumers did not know about this thing called on-line shopping (KSS IPO was three years before Netscape). Now, the alternative to the mall is something called ‘your living room’ where you shop on your laptop while binge-watching Sons of Anarchy on Netflix.

 

3. Q: Your e-commerce margins are about 1,200bp below company average. That’s not because you are inefficient, or the model needs to be ‘fixed’, but simply that KSS’ average basket size is too small to accommodate shipping and merchandise handling costs. The real question here is “What happens if your competition moves to free shipping and free returns? If you match that, won’t it crush your margins? If you don’t, won’t it hurt traffic/volume? How is this not lose/lose?”

 

Context: The evolution toward free shipping is not a function of “If” but “When”. Target is offering free shipping on even the tiniest of basket sizes over the holidays – literally, you can buy a pencil online and TGT ships it for free. AMZN will have to ultimately respond. JWN already offers free shipping both ways. Retailers won’t match each other all at once, but the trend is headed there. In that context – particularly with a weak brand portfolio – how can KSS compete at an acceptable margin?

 

4. Q: How many square feet of department store square footage exists today? How many should there be?

 

Context: A seemingly stupid question to ask a CEO. But we’re not so sure that KSS management knows the answer (or many other department store CEOs for that matter). But when 169mm square feet exists today in the department store space – down from 772mm 15 years ago – it’s a perfectly fair question to ask how many the company thinks will exist in another five years. We think we’ll see another 93mm square feet exit the industry. That’s almost as big as KSS is today. We don’t think KSS will be the casualty this time around. But it will hurt – a lot – while it happens.

 

Q: We’re at the back end of the current industry margin expansion cycle (we’re in year 6). As we transition into the next cycle, whenever that may be, what is the mid-cycle earnings power for this company?

 

Context: After 2014 passes, we don’t think KSS will ever see $4 in earnings power again. Traffic = down. Basket = deflationary. E-commerce = Up, but at a dilutive margin. No meaningful store closure or cost cutting opportunity. The only growth we see is from stock buyback – at least while the cash flow supports it. We think that KSS EPS eases into an annuity of $3.50 per share over the next five years.  

 

 

September 29, 2014

KSS – WHY WE THINK IT’S A SHORT

 

Takeaway: Here are some of the more controversial slides from our 60-slide deck from last week on why we think KSS is a structural short. 

Last week we hosted a conference call to review our 60-page slide deck as to why we think KSS is a short. If you’d like to listen to a replay of the call and download the full materials, please click the link below. We picked out eight slides below that are among the more controversial.

 

Replay Link: CLICK HERE

Materials: CLICK HERE

 

Point #1: Expectations Too High

Yes, near-term numbers look doable given several tailwinds facing all retailers. But one we get past this year (only four months away) we think KSS numbers will start to come down materially. The consensus has earnings growing 10% next year, while we think they will be down nearly 10%. Then they’ll be down again, and again, and again. Ultimately, once we’re past 2014, we don’t think that KSS will earn $4 again until the tail end of the next economic cycle.

KSS – Key Questions for Kevin and Wes - kss1

 

Point 2: Losing Share At A Faster Rate

It’s no secret that department stores are losing share of wallet (3.5% of Retail Sales vs 10% a decade ago), but KSS is losing share within that context. The blue line in the chart below shows KSS’ share gain of the department store space. The first big bubble – from 1Q09 to 4Q10 – came about 3-years after a meaningful square footage growth spurt. That’s when the stores began to hit the sweet spot of the maturation curve. Then the next bubble came a little over a year later when KSS gained what we think (based on our surveys) is $1bn in share from JCP. Our latest survey shows that about $150mm has shifted back to JCP – but that still leaves $850mm at risk for KSS. The punchline is that after gaining share of this space every single quarter since its inception, KSS is now a net share loser.

KSS – Key Questions for Kevin and Wes - kss2

 

Point 3: This Model Is Broken

There’s no square footage growth – at all. Productivity of $210/ft in brick and mortar stores is trending down. E-commerce is the only growth engine, but unfortunately it is the lowest margin business at KSS by a country mile. As such, gross margins are structurally headed lower. SG&A can’t be cut in line with the gross profit erosion. D&A was just lowered from $950mm to $900mm – which is stunning in itself. That’s not likely to go down much further. Cash flow still remains healthy enough to buy back 7% of the stock this year. Buy with lower net income, we think that repo/financial engineering gets cut by better than 50% for the duration of the model. EBIT should be down 5-8% each year, with share count making up about 3% of the gap. Net/net = EPS declining every year.  

KSS – Key Questions for Kevin and Wes - kss3 

 

Point 4: Store Productivity Bifurcation

Sales per square foot have been flat for the past four years, but that is only if you include e-commerce. Brick & Mortar productivity is $210, and is at the lowest rate we have ever seen it. There is absolutely no valid argument we can find that this turns around – particularly given that JCP is sitting at just $108 in productivity and has KSS right in its sights. We think those two will converge over time.

KSS – Key Questions for Kevin and Wes - kss4

 

Point 5: New Brands – Juicy and Izod

This topic absolutely dominates the information flow around KSS. We all know that Juicy Couture and Izod are now available at KSS. That said, our consumer survey shows Kohl’s purchase intent is down year/year, while retailers like JC Penney and Macy’s are up meaningfully. So we know about the brands – but consumers might not know, or might not care. Nonetheless, let’s keep in mind that there’s noise around new brands EVERY year at Kohl’s. Take a look at the graphic below.  Could this years’ additions be better than last years? Possibly. But keep in mind that Izod and Juicy are not exclusive. Izod is all over Macy’s and JC Penney’s. Juicy is in the process of growing distribution through new owner Authentic Brands.  To get a good read you need to quantify the impact (see next exhibit).

 KSS – Key Questions for Kevin and Wes - kss5

 

Point 5b: Quantifying Juicy and Izod

We know that these brands occupy 525 sq ft and 700 sq ft, respectively, inside the average KSS box. That’s 1.42% of KSS’ total square footage. Now…it can’t just create space out of nowhere, which means that it needs to take out product that is underperforming – but is still productive. Assuming that these brands generate $225/ft in productivity, and that it is replacing private label brands that are doing $110 per foot in the same space, we build up to about $250mm in incremental sales in another two years. That’s about 1.3% accretion to sales, but it comes at a lower margin as these national brands carry lower profitability than the portfolio as a whole. The bottom line = it’s going to take a lot more than a couple of mediocre brands to salvage KSS’ top line.

KSS – Key Questions for Kevin and Wes - kss6 

 

Point 6: Structural Margin Decline

Gross margins on KSS’ e-commerce business run about 1,200bp below the store-level margins. Some people are hoping/banking on a margin rebound as KSS did not seemingly benefit from the same tailwind the rest of the group has over the past five years. The truth is that it has. Without that tailwind we’d be looking at KSS with margins near 5-6% today. The industry tailwind was masked by the massive growth in KSS’ e-commerce business. In fact, from ’05-’13 KSS put up the highest growth rate of any ecommerce business in the US throughout all of retail. But as this business continues to grow 15-20% annually (the only line item to grow aside from SG&A) it naturally depresses aggregate GM% by 30bps per year. Those are margin points that this model can’t afford to lose.

KSS – Key Questions for Kevin and Wes - kss7 

 

Point 7: Keep An Eye On KSS Credit

Many retailers have, or maintain, credit cards. It’s a solid tool to keep customers and incentivize them to spend more. But our consumer survey suggests that 18% of KSS shoppers have a rewards card. But more importantly, we know that 57% of purchases are made by that card. That is a simply staggering figure from where we sit. Three years ago KSS shifted its partnership from Chase to Capital One. But median credit scores for Chase customers range between 700-750, which are optimal for a mid-tier retailer. But the 700bps in card penetration that KSS saw under Capital One came at a median credit score of 600-650. Basically, this tells us that incremental sales growth is likely coming from more marginal consumers. This is not exactly a smoking gun on the short side, but taken in context with the other pressures we see to the model, it certainly does not bode well.

KSS – Key Questions for Kevin and Wes - kss8


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INVITE | EBOLA FORECASTING & CONTAINMENT CALL WITH DR. JEFFREY SHARMAN

Takeaway: Our Healthcare team is hosting a call on Ebola this Tues. The threat has obvious implications for consumer behavior, and therefore Retail.

INVITE | EBOLA FORECASTING & CONTAINMENT CALL WITH DR. JEFFREY SHARMAN - ebola

 

Hedgeye will be hosting a specialist call with Dr. Jeffrey Sharman on Tuesday, October 28th at 1:00pm EDT to learn more about  the real and perceived risks of the current ebola virus situation.

 

Dr. Sharman will provide his informed perspective to better understand recent developments, including the global response in Africa, the handling of confirmed cases in the U.S., as well as what we should expect in the immediate future.

 

We will discuss Dr. Sharman's research on forecasting and containment of the ongoing ebola outbreak in Africa, the probability of a significant outbreak outside of Africa, and the timeline for bringing the disease under control, which Dr. Shaman estimates will take another 12 to 18 months.   

 

 

CALL DETAILS

  • Date/TIme: Tuesday, October 28th 1:00pm EDT
  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 651216#
  • Materials: CLICK HERE

 

ABOUT JEFFREY SHARMAN, PhD

Dr.Sharman is an Associate Professor in the Department of Environmental Health Sciences, a junior faculty fellow of the Earth Institute, a faculty fellow of the Institute for Social and Economic Research and Policy, and a member of the Center for Environmental Health in Northern Manhattan. He is also affiliated with the International Research Institute for Climate and Society.  Dr.Shaman received a BA in biology from the University of Pennsylvania,and an MA,M.Ph.and PhD in climate science from Columbia University.  He was a NOAA post-­-doctoral fellow in climate and global change at Harvard University.

 

His research interests include: infectious disease, vector and pathogen ecology, health in the indoor and built environment,large-­-scale climate dynamics,the hydrologic cycle, and climate and disease forecast. Much of his present research focuses on developing model-­-inference systems for the forecast of infectious diseases, including influenza, West Nile virus and Ebola. 


INVITE | EBOLA FORECASTING & CONTAINMENT CALL WITH DR. JEFFREY SHAMAN

1 normal

 

Hedgeye will be hosting a specialist call with Dr. Jeffrey Shaman on Tuesday, October 28th at 1:00pm EDT to learn more about  the real and perceived risks of the current Ebola virus situation.

 

Dr. Shaman will provide his informed perspective to better understand recent developments, including the global response in Africa, the handling of confirmed cases in the U.S., as well as what we should expect in the immediate future.

 

We will discuss Dr. Shaman's research on forecasting and containment of the ongoing Ebola outbreak in Africa, the probability of a significant outbreak outside of Africa, and the timeline for bringing the disease under control, which Dr. Shaman estimates will take another 12 to 18 months.   

 

 

CALL DETAILS

  • Date/TIme: Tuesday, October 28th 1:00pm EDT
  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 651216#
  • Materials: CLICK HERE

 

ABOUT JEFFREY SHAMAN, Ph.D.

Dr. Shaman is an Associate Professor in the Department of Environmental Health Sciences, a junior faculty fellow of the Earth Institute, a faculty fellow of the Institute for Social and Economic Research and Policy, and a member of the Center for Environmental Health in Northern Manhattan. He is also affiliated with the International Research Institute for Climate and Society.  Dr.Shaman received a B.A. in Biology from the University of Pennsylvania, and an M.A., M.Ph. and Ph.D. in Climate Science from Columbia University.  He was a NOAA post-­-doctoral fellow in climate and global change at Harvard University.

 

His research interests include: infectious disease, vector and pathogen ecology, health in the indoor and built environment,large-­-scale climate dynamics,the hydrologic cycle, and climate and disease forecast. Much of his present research focuses on developing model-­-inference systems for the forecast of infectious diseases, including influenza, West Nile virus and Ebola.


Investing Ideas Newsletter

Takeaway: Current Investing Ideas: EDV, GLD, RH, TLT, XLP and MUB.

Below are Hedgeye analysts’ latest updates on our five current high-conviction long investing ideas and CEO Keith McCullough’s updated levels for each.

 

*Please note that we added  MUB (iShares Muni Bond ETF) to our Investing Ideas list this week.

 

We also feature two institutional research notes which offer valuable insight into the markets and economy.

 

Investing Ideas Newsletter     - II chart 

 

Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers.

  • "Trade" is a duration of 3 weeks or less
  • "Trend" is a duration of 3 months or more
  • "Tail" is a duration of 3 years or less

CARTOON OF THE WEEK

Absolute Zero

Investing Ideas Newsletter     - 0percent 10.21.14

You can thank your unelected central planners for zero interest rate policy for the foreseeable future.

IDEAS UPDATES

TLT | EDV | XLP | MUB

 

MOVE DOVISH DATA: STAY LONG OF TLT, EDV, MUB & XLP

 

The week ending October 24th, 2014 equities bounced slightly as investors fearing a year-end rally nervously jumped in to buy the pullback.

 

Mixed economic data continues to bolster our anticipation of a reactionary dovish policy response from the Federal Reserve in the coming months:

 

  • U.S. CPI came in flat at +1.7% YoY in SEP, which matched the below-target pace of Core CPI.
  • US Markit flash Manufacturing PMI numbers slowed to 56.2 in OCT compared to a final reading of 57.5 in SEP.

 

In addition to a mixed week of economic data in the U.S. (versus notable strength in the 2nd quarter), we continue to receive confirmation of middling growth abroad:

 

  • OCT flash PMI numbers showed optical strength for both the Eurozone and China. However expansive, Markit noted that new orders and inflows both slowed in the Eurozone, while “backlog of work” fell across both manufacturing and services.
  • France manufacturing numbers slowed posting 47.3 vs. a prior reading of 48.8 and a services number of 54.8 vs. a prior reading of 55.7.
  • In China, new orders, new export orders and output all slowed sequentially, calling into question the efficacy of the headline “beat”.

 

With growth in both Europe and China continuing to decelerate on a trend basis, we continue to expect slowing global growth to weigh on both business and investor confidence and reflexively perpetuate a negative feedback loop in the domestic economy over the intermediate term.

 

In brief, you want to be long/overweight the asset classes and style factors that have weathered recent financial market volatility (i.e. Treasuries, munis, cash, and large-cap/high-yield/liquid equities), while remaining short/underweight its inverse (high beta, small cap illiquidity and early cycle leverage). That means remaining long of TLT, EDV, MUB, and XLP.

GLD  

Gold has grinded higher on the back of Janet Yellen's summary of the minutes from the committee's September 16-17th meeting.

 

Since her commentary on October 8th that the global economy was weaker than expected and that policy members were worried that "FURTHER GAINS IN THE DOLLAR COULD HURT EXPORTS AND DAMP INFLATION," gold is up +2.3% vs. a commodity complex getting beaten down with #QUAD4 deflation (CRB -2.1% over the same period).  

 

Gold will continue to trade in front of the USD, and a CPI print this week below the Fed’s target is bullish for gold, especially when real full year real domestic GDP growth is tracking near 0%:

 

CPI m/m +0.1% Sep. vs. -0.2% prior

CPI y/y +1.7% Sep. vs. +1.7% prior

 

As has been the case throughout the year, the major global economies are all slowing at the same time, and we expect the monetary policy members governing the major currencies to undertake similar measures.

 

With TLTRO underway, and loan growth underwhelming, the ECB reported Friday that 25 banks were set to fail the Asset Quality Review Stress Test with 10 of the 25 banks expected to face capital shortfalls that will “need to be addressed.”

 

The banks that failed will have a short time to make adjustments before the final results are released on October 26th, but the headlines will support the implementation of additional Euro-weakening measures from Mario Draghi. With the currency war heating up, we feel comfortable with the gold allocation for FX diversification. 

     

RH 

RH took two steps forward in redeveloping its real estate strategy this week.

 

1) Opening a new 33,000 sq. ft. (23,000 selling, 10,000 outdoor) store on Melrose Avenue in Los Angeles. The new store will replace the existing 17,200 square foot Design Gallery that opened in June of 2011. At nearly 2x the size, the company will show about 2.5x the assortment.

 

2) Substantiated rumors hit the wire this week reporting that RH had signed a new lease in the Meatpacking district of New York City. The new store will span over 70,000 square feet – time of opening TBD.

 

The company is still in phase 1 of its retail build out. Its Design Gallery count is now up 6 and that will grow at an accelerated pace over the next 5 years – adding an incremental 1.2mm square feet to the company’s footprint.

 

With the buildout comes additional exposure for the company’s newer categories. Since 2011, the company has added eight categories to the mix, and in 2015 we will see the first iteration of the Kitchen business.

 

Those categories have virtually zero presence in the company’s physical retail stores to date. Hence the larger stores. A legacy store can show about 10% of the existing SKUs, first generation Design galleries 20%/25%, and a Full Line Design Gallery closer to 70%.

 

The reason behind the additional presentation at retail is the fact that when a new item is introduced at retail in a marketplace it receives a 50%-150% lift in sales across channels (both in-stores and online). That helps explain the production levels we’ve seen from the company’s first 6 big stores to date.

 

Our math suggests that there are 85 markets in the United States that could support a Full Line Design Gallery. Will the company tap all of those markets, no probably not, but the runway is still wide open.

 

* * * * * * * * * * 

 

Click on each title below to unlock the content.

 

 

China Reiterates Our Call That Global Growth Is Slowing

 

China’s 3Q/SEP economic data confirms our view that global growth is slowing and will likely continue to slow through at least year-end.

 

Investing Ideas Newsletter     - China flag full

 

YELP: Only Gets Worse From Here (3Q14)

The model is broken. Moving forward, it’s going to get tougher for management and the sell-side to make up stories to the contrary.

Investing Ideas Newsletter     - YELP help 10.23.14

 

 


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