The ‘emotion factor’ is coming back to this stock after a year’s vacation. Duration is very important here, and our views differ based on near vs. intermediate vs. long-term.
HBI is an interesting name right here. It has historically been a ‘love it or hate it stock” with not a whole lot of sentiment resting between. That high-emotion factor deflated over the past year, and it fell on to the ‘who cares’ list – based purely on investor requests to us on the name. Now we’re we’re seeing the emotion build up again on both sides. We view Duration on this one almost as a barbell.
We like it a lot near term – for the next two quarters, that is. The company has the top-line in the bag, cotton costs locked 30% below current prices, moderate channel restocking, and channel fill as a key customer – Dollar General – is back in rapid growth mode and will need HBI product to fill its shelves. Over the longer term, HBI is the last company left in the industry that can capture such a major margin delta through sourcing savings and use it as an offensive weapon to gain share the same way Gildan did in the early 2000’s. We only need 2-3% growth to make that happen longer term, which would drive margins up and debt down.
But can the company sustain a 5-8% top line growth rate? No way. This is an underwear company, folks. Units grow at about the rate of population (ie 1%) and there’s no real pricing power to speak of. The channel fill is important and undeniable. But just because the channel is refilled (and perhaps overfilled) does that mean that the end consumer will wear more underwear? Nah… I don’t think so.
So what’s our concern? It’s that after we pass by these 2 slam-dunk quarters, then we have to bank on 1) sell through, 2) an improving consumer, 3) rational behavior by Wal-Mart in the wake of channel fill at other retailers, 4) that the Asian factory transaction goes as planned, and that either cotton prices come off, or HBI can offset them with pricing power.
Can all of these things happen? Yes. But our point is that they HAVE TO happen.
Our conclusion? Be mindful of your duration here. Over the next 2 quarters, it’s going to be tough not to like HBI – 3-4 quarters out is a different story. Once that risk passes, $3 in earnings share is a complete reality here.
Key Highlights from 2010 Analyst Day:
Int'l Growth Strategy:
- Can leverage the Int'l business by integrating local business into global supply chain - overhead on par with local competition, but sourcing a distinct advantage.
- Expansion in Mexico since 2008 has been a very positive model that HBI can follow in other markets - expect to introduce outerwear in Mexico now that innerwear/essentials business is established.
- #1 in Canada, Mexico, and Brazil, but significant gain potential in both China and India
- China and India only markets with a double-digit growth profile versus low-to-mid single digit growth for other regions
- Focused on core apparel categories
- Not diversifying
- New channels
- New platform/geography
- Min integration risk
- Fund from FCF/ reduce leverage
- Accretive Yr1
- $200mm deal size
Multifaceted Savings Strategy:
- Expect $150mm in savings over the next 3yrs
- Network = $45mm
- Distribution/Logistics = $30mm
- Start-up & Rest. Eliminations = $20-25mm
- Purchasing = $30mm
- Optimization Initiatives = $20-25mm
- These savings will drive 50-100bps in annual operating margin expansion
Detail on $150mm in savings:
- Slightly more in 2010 compared to 2011
- 60% in GM; 40% in SG&A
- Cost of goods improvements driven largely by maturing supply chain network
- more indirect purchasing and distribution savings
Cost inflation out of Asia - what's built into HBI's assumptions:
- Have built in some wage inflation
- If cotton up another 10% will take more costs out
- Locked for Q1 = $0.52; Q2 = $0.59; Q3 = $0.73
- Assume $80 oil (Q1-Q3)
Revenue growth organic vs. acquisitions:
- 2-4% long-term growth excluding acquisitions
- Domestic opp'y is first choice for acquisitions
- $100mm goal for media spend annually
- Plan is to reinvest - may hamper 35%+ growth in EPS in order to drive growth
Shelf space gains update:
- Ahead of internal sell-through plans to date
- Finished by summer
Sales/ft. versus current productivity?
- Gains at WMT = 4ft.
- Dyed underwear & t-shirts not quite as productive as core white tee
- Mexico model gives mgmt confidence
- "trade advantage" - tap into treaties low duty movement
- Key to moving upscale and into newer channels
- Expect ~$90mm spend in 2010 with goal of increasing to $100mm/yr to grow with sales
Acquisitions - "superior returns":
- Focus on cash on cash returns
- Significantlyabove debt reduction + share repurchase
- Not much exposure to Europe
- "in the 1st inning"
- Stores currently ~60% of direct-to-consumer mix, will shrink as internet grows
- Strategy is less location growth than location expansion (footprint) - designed to capture greater $/cust, not necessarily drive increased volume
- Adding brands in existing doors
- Assumption in 2010 - minimal (any increases would be based on Q4 costs at most)
- Beyond 2010 - predicated primarily by cost inflation
- 2-4% top-line outlook for 2011+ assumes very little by way of pricing
Outerwear - Operating Margin growth opportunity:
- Will be primarily driven by supply chain savings as well as mix
- where smaller volume business is brought in-house
- More branded product
- Will be below company average over time
- Was ~12% in 2009 - due to large domestic restructuring charges/ refi
- Expect 20%-25% over next 2-3 years
View on 'commodity business':
- Mgmt is focused on growing branded lines, which are more differentiated and defensible vs. the commodity business
- Does not suggest they will neglect wholesale customers
- Looking to leverage the supply chain to offer branded apparel and build out the screen print channel
Supply Chain - Opportunity to Internalize:
- Currently outsourcing lower run product lines where there is less leverage opportunity
- In the process of internalizing the Champion's C9 line
- Spoke to ideal of $200mm in size
- "some companies acquire as a growth strategy, but that's just not us" - Rich Noll
- Won't lever up for growth via big acq.
Intimate Apparel - Shapewear trend:
- Have plans in place
- See some gains in 2010-2011
- Didn't meaningfully impact the business in 2009
- Less than 20% of the mass market
- Starting to see same trends as in most retail where retailers are focusing on #1 and #2 brands and adding private label to shrink moderate brands
Cotton - regional purchasing:
- Bulk is purchased in the US
- Very small quantities out of China
Chinese facility (Nanjing)- Capacity Utilization:
- Will continue to expand 1st phase through early 2011
- Building can be doubled from current build out plan (essentially 50% utilization)
- Phase 2 of build out will be to develop other 50%
We could debate forever and a day about the viability of the department store business model, and the health of the consumer that shops there. Over the past year, that has not mattered. When capex is being cut by 20%, working capital is coming down by 15%, and SG&A by 5% -- the companies still have enough juice to the model even if sales are punk.
I’m so often hit with the argument that “if sales only bounce back, XYZ Co will see massive leverage on the operating profit line.” Yes, that’s probably true. IF sales bounce back. Some companies get lucky and temporarily realize this sales lift. But others invest in their models to drive it, and to sustain it. Unfortunately the department stores are banking on the former.
What do I mean?
Check out our SIGMA chart below, which layers the past 4 quarters for Macy’s, JC Penney, and Nordstrom on top of one another. As a reminder, the vertical axis measures the sales/inventory growth spread (i.e. 10% sales growth and 2% inventory growth = +8%), while the horizontal axis measures the year over year point change in margins. Observations…
1) All three companies are either in the sweet spot (positive sales/inv spread) or headed in that direction for at least 3 quarters. They’re going to have to start comping this. Nordstrom is the most problematic from my perspective.
2) Note that for EVERY one of them, the latest data point on this chart market a slight downtick. That’s very, very soon relative to other retailers who traced this path. We call that a negative divergence.
Also, can anyone explain to me why Macy’s and JC Penney are at their highest free cash flow margins in almost a decade. Yes, cash flow and working capital are at historic lows. This actually is not much of a problem overall for most companies. They simply come up with a proactive plan for taking capital, and allocating it throughout their model (including in SG&A) in a way that will drive the top line without increasing the volatility and risk on the gross margin line.
In other words to invest in these names, we need to value the growth, as opposed to value component.
Good luck with that.
I don’t like any of ‘em (KSS is the exception, and the one outlier that is managing their business right).
Add JWN, JCP, and M to the list of names we don’t like – incl DG, FDO, ROST and JNY.
Hedgeye Retail Team
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“Think not those faithful who praise all thy words and actions; but those who kindly reprove thy faults.”
This weekend I read a booked called "Nurture Shock", which outlines some new theories relating to raising children. The first question one might ask, is why a 36-year old bachelor is spending weekends reading child psychology? That is actually a pretty good question and I’m not sure I have an answer. Regardless, the studies in the book appeal more broadly than to just parenting. Specifically, there is one chapter that discusses praise and how to effectively use praise. As I will outline, the insights from this chapter are broadly applicable to the work force and other interpersonal relationships. Not to mention, quite interesting to a 36-year old bachelor!
To some extent, Socrates hit the proverbial nail on the head in his quote above, which is that we need to be very careful with praise. Not only because there may be ulterior motives behind praise, but also because praise itself may be much less effective than we realize. In "Nurture Shock", the authors open this chapter, which is called “The Inverse Power of Praise”, with the following quote:
“Sure, he’s special. But new research suggests if you tell him that, you’ll ruin him. It’s a neurobiological fact.”
To this point, a survey conducted by Columbia University indicated that 85 percent of American parents think it is important to tell their kids they are smart. Ironically, a number of recent studies suggest just the opposite, which is that telling your kid he or she is smart may be actually leading to underperformance.
Dr. Carol Dweck studied fifth graders in New York City over a period of 10-years. The kids were taken out of their classes and given a non-verbal IQ test consisting of a series of puzzles. At the end of the IQ test, the kids were given a single line of praise. They were told that they were “very smart at this” or they were told “they worked really hard”. In effect, they were either praised for their innate intelligence, or praised for their effort and process.
In the next round of tests, the kids were given a choice of a set of harder tests or a set of easier tests. They were told that they would learn a lot from the harder tests, but that they were definitely harder. Almost 90% of the students that were complimented on their work ethic and process in the first round, chose the more challenging tests. Conversely, the majority of kids who were complimented for “being smart” chose the easier tests. In effect, the “smart kids” took the easier path.
In the next round of tests, none of the kids had a choice and all the kids were given a more difficult test, which was designed for kids who were two years ahead of their grade level. Not surprisingly, everyone failed the second, but the two groups responded very differently. The group that was praised for their effort, and not their smarts, after the first round “got very involved, willing to try every solution to the puzzles.” Conversely, the group that was praised for their smarts “were sweating and miserable.” The results were astounding. The students that were praised for their effort on the first test improved by ~30% on their first score, while those that were praised for their smarts scored worse by ~20%.
In the follow up interviews, Dweck quickly determined the key variable. Those students that believed success was based on innate intelligence, grossly discounted the impact of effort. The reasoning was in effect, “I’m smart. I don’t need to put out effort.” Dweck repeated this initial experiment and found that the results held true for every socioeconomic class and both males and females.
The irony of the results of this experiment, and many like it, are that its results are totally disregarded by many school systems and have been for years. According to Dwek, since the early 1980s:
“Anything potentially damaging to a kids self esteem was axed. Competition was frowned upon. Soccer coaches stopped counting goals and handed trophies out to everyone. Teachers threw out their red pencils. Criticism was replaced with ubiquitous, even undeserved praise.”
Much of this self esteem movement was actually supported by studies. In fact, from 1970 – 2000, there were over 15,000 scholarly studies on self esteem.
In 2003, the Association for Psychological Research asked Dr. Roy Baumeister to review this body of research. Of the 15,000 studies, Baumeister found that only 200 utilized a scientifically sound way to measure self esteem and its outcomes. After reviewing those 200 studies in greater detail, Baumeister concluded that self esteem didn’t improve grades, career achievement or decrease alcohol usage. Ironically up until that point Dr. Baumeister had been an advocate of the unadultered praise philosophy and called this study the biggest disappointment of his career.
Dweck’s work and others like it calls into question how we encourage our children, motivate our employees, and coach our players. One fact that is increasingly clear, telling someone that they are “smart” or “great” merely to boost their confidence will likely have an adverse impact on their actual performance. The key is to encourage the process or actions that will lead to the successful outcome.
As the old saying goes, “Hard work beats talent when talent doesn’t work hard.” That is of course especially true when the talent is only a mirage created by ill advised attempts to promote self esteem.
Is not being full of praise for your kids tough love? Maybe, but a little tough love may actually going a lot way towards their future success.
Daryl G. Jones
Recently, we have stopped being as critical of Ben Bernanke. This is primarily because he had the political spine to raise the Discount Rate. This is progress, however, this doesn’t mean that we underwrite (or understand) what he talks about real-time. He’s testifying in front of Congress right now – here are my thoughts:
After being chastised by Ron Paul, then supported by Barney “The Republicans Did It” Frank, Ben Bernanke has started to do what the politicians who were paid off to keep him in his seat expect him to do – pander to the political wind of keeping the Fed Funds rate at zero for an “exceptional and extended” period of time.
That, of course, is either a Japanese or unreasonable monetary policy to uphold in perpetuity. I am ok with neither. Nor should you be. The outcome of zero percent returns on your nest egg of savings is implied – its zero – and the output of carry trading on asset prices with easy money is also implied – its inflationary.
Fortunately, Bernanke pandering like this was proactively predictable. This is why we took our allocation to US Equities from 3% to 9% in the last two days of US stock market weakness.
To be clear however, sad is as sad does. I will be the first to admit it, even though we are getting paid by it today. Bernanke is completely politicized and will continue to sponsor a stock market that can rally to lower-highs on easy money speculation.
I suppose that a short term risk management model for America’s manic stock market is what he means by “Macro-Prudential.” He can’t be serious in telling us that this is a long term macro risk management plan.
My immediate term resistance line for the SP500 is now 1120. Ride the Bubble in US Politics while you can. This is like riding a bull - 8 second rallies can be fun in the short term – then one day, the bull runs you right over.
Keith R. McCullough
Chief Executive Officer
OEH 4Q09 CONF CALL "NOTES"
“The early signs of stability seen at the end of the third quarter continued through quarter four, with growth in hotel revenues in all regions and overall revenues (pre Real Estate) up 17%. EBITDA margin was ahead of 2008, with the result that adjusted EBITDA (pre Real Estate) grew by $3.3 million to $13.5 million. Whilst we cannot yet celebrate the end of these challenging times, these results, coupled with improved bookings pace, are strong indicators that the revenue and RevPAR declines of 2009 will not be repeated in 2010."
- Paul White, President and Chief Executive Officer
HIGHLIGHTS FROM THE RELEASE
- "Owned Hotels same store RevPAR was down 7% in local currency. However, because of a weakening of the US dollar in the last quarter, RevPAR in US dollars was up 11% compared to the fourth quarter of last year."
- "The principal variances from the fourth quarter of 2008 included results from owned hotels in Italy (up $3.8 million), Grand Hotel Europe, St Petersburg (up $1.8 million), La Samanna, St. Martin (down $1.5 million), Mount Nelson Hotel, Cape Town (down $1.6 million), and Venice Simplon-Orient-Express (up $1.1 million)."
- "Porto Cupecoy enjoyed strong sales in the run-up to completion of the construction, with ten apartment contracts signed during the quarter, and a further five units sold since the end of the year. This means that 99 units or 54% of the total are now sold. The grand opening of the development took place in January 2010."
- Europe: "For the region, the effect of the weakening US dollar in the fourth quarter of 2009 compared to a strengthening US dollar in the fourth quarter of 2008 had a $3.2 million positive impact on EBITDA versus the prior year."
- North America "Excluding EBITDA of $3.2 million from Charleston Place, there was an EBITDA decrease of $1.1 million. Same store RevPAR for the region fell by 18%."
- Weather impacted them in Peru
- Non rooms revenues and trains & cruises had good growth in the quarter
- Increase in Europe was all FX
- Cost reductions implemented in the 1H09 started to flatten out
- Key focus in 2010 will be on the sale of the residential real estate. $68MM of sales to date and $34MM has already been received. The remaining 85 units will be sold free of debt, since the proceeds from the originally sold units will pay down the construction loans
- Last week Madeira was hit with flash flooding, so that may impact their results
- Quarter one bookings are tracking 6% ahead, but pricing is lower given the promotions and discounting
- 2Q2010 is tracking behind, but they expect it to catch up given the recent pick up in volumes
- Trains business is up 23% for 1Q2010
- Charleston is seeing some recovery in group bookings
- Minimal opportunities to cut costs further, now it's all about growing revenues
- Leverage Covenant was 8x
- Term debt maturity : 548MM in 2011, 176MM in 2012, thereafter 1445MM. $60MM due in 2010, but $34MM is related to the construction loans which will be repaid when the units close
- $5MM of Capex in the Q + 11MM in Porto Cupecoy
- Cash tax was $14MM in 2009, $12-14MM expected in 2010
- Plan to refinance maturing 2011 debt by 4Q2010
- Europe will show better RevPAR growth since they all saw huge occupancy drops but only small drop in rate. This is still going to be another tough year
- Booking window in Brazil has always been short. They are 16% up on rooms booked y-o-y or 2010, but that's a small % of the total
- Peru though tends to get booked 8-9 months in advance and because of the train closure they are down 10-15% for on the books business for 2010
- No NY development update
- Tone of refinancing on R/C is good, but the pricing is clearly going to be higher. Think they can get 200ish spread. Think they can roll 75-85% of the commitment with a 3-5 year term
- Why is Copacabana doing so well?
- Domestic demand is very strong - over 1/3 of the travelers are domestic
- Even in Italy the domestic demand has increased dramatically to double digits from 1-2% just a few years ago
- 40% of their customers are from NA, 40% European
- What are the plans with Keswick?
- Have 40 plots left to sell, have been working with Robert Stern on designs. Hope that they will sell the plots over the next 12-24 months
- Outlook for Grand Hotel Europe & Italian portfolio and their pricing strategy
- In the shoulder season months they are much more focused on occupancy
- In the peak season, they are feeling more confident that they don't need to discount as much to get occupancy
- Grand Hotel: pickup is very strong on the room side, but are concerned on the F&B side. Don't think that he 6-7% growth they saw in Jan will continue throughout the year but still expect good results
- Italy: too early to tell. Bookings really just starting coming in at the end of Feb through East period.
- TTM EBITDA at the Copa around $13MM for 2009 and peak was $14.5MM
- Real Estate strategy
- Cupecoy - customers have already paid about 75% of the purchase price, so they are very confident they will close on all the sold units. Just need face to face time with the client to hand the keys over which will take 3-4 months
- Expect to sell the remaining 84 units over the next two years. Demand has been very strong
- If the economy recovers, will they consider starting new projects? Unclear - still far away, question of when and how