It’s always nice to find a solid multi-year story that actually has near-term earnings juice. PSS is one of the few.
There’s been increasing evidence to suggest that Payless’ Performance Lifestyle Group along with core retail stores are likely having a solid first quarter. In fact, our above-consensus estimate for the quarter of $0.88 vs. Street at $0.74 may be looking a bit conservative given some mid-quarter data points. Additionally, though sourcing is less of a driver that it has been, it should still fuel GM% to come in 2x expectations. The key variable is how aggressively the company reinvests in SG&A during the quarter – we’re modeling 5% growth yy. With rent and DC savings offset by growth investments in PLG there could be some variability in opex, but the bottom line here is that the two most important lines of the P&L are tracking nicely.
Here are a few facts to consider:
- First, as it pertains to Saucony. It’s no secret that performance running has been and still is one of the strongest performing sub-categories of athletic footwear. Last month we addressed the strength vis-a-vis, Brooks - a direct competitor to Saucony as well as another of the niche “running only” brands. Brooks CEO recently noted that after a mid-single digit increase last year, the company’s U.S sales are tracking up 25% through April with a double digit positive backlog through the Fall. Keep in mind this is also consistent with commentary from FL and HIBB last week, both of which highlighted performance running as a leading category.
- Secondly, the NPD monthly brand data is directionally accurate. While in no way does the data capture all U.S sales of the Performance Lifestyle Group’s big brands, it has still proven to track closely with reported trends. The charts below include trends through the end of April. Despite an Easter induced spike in March, trends turned positive across all major brands on a sequential basis during the quarter (bottom chart).
- What about the backlog? Unbeknownst to most investors and analysts, PSS began reporting a backlog number for the wholesale division at the end of its fiscal year with the filing of its 10-K. Perhaps last year’s data point was lost in the shuffle during the market meltdown, which is why not many people are focusing on this year’s version. According to the filing, PSS’ Performance Lifestyle Group backlog (for orders delivered this year) was up 36%. Now keep in mind the order book does not include or account for cancelations or shipment delays, but this is impressive growth nonetheless. In taking a look at the past 2-years, approximately 88%-90% of year-end backlog has been realized in Q1 revenues. With a backlog of $222mm at year-end, if we assume only 80% is realized (which we have) that suggests 20% growth yy, or 3.5% to the top-line alone.
- Finally, the overall health of the family footwear channel suggests our 3% same store sales estimate for the core retail business may prove conservative. Recall that 4Q same store sales were light given lack of inventory support for key trends including boots as well as the post-Oprah hangover. Continued strength in mall traffic as indicated by Q1 retail sales along with a conservative forecast for a flat ticket, we further believe a 3% comp may indeed be too low. Consider the following charts as a proxy for PSS’ historical same store sales results as well as the charts illustrating relative comp trajectories including preannouncements from both DSW and SCVL.
R3: REQUIRED RETAIL READING
May 27, 2010
TODAY’S CALL OUT
With mixed datapoints out of retail earnings this week as it relates to demand headed into the end of May, we want to put this into context as it relates to the athletic space. The bottom line is that after 2-years of fairly extreme volatility in the athletic space relative to retail – which we best capture by measuring the rate of change in the weekly ICSC index vs. other data series such as NPD and SportscanINFO – the Athletic space is performing right in line with the rest of the world.
One thing worth noting is that we have just ended nearly a month-long period of tough compares as last year’s spread contracting by 16 points in 3 weeks. We’re now into a period where compares are increasingly easy through through Thanksgiving.
Note that this is the same time period over which we think the product cycle will start to kick up more meaningfully (as we’ve been very vocal about), and we get a little bump due to a little event called World Cup.
The bottom line is that the data started to support our thesis earlier this spring when the sector’s top line accelerated meaningfully. Now we’re in a holding pattern. That does not concern me one bit. If it concerns the market, then it’s a great opportunity to scoop up more UA, FL and NKE – our core three calls.
LEVINE’S LOW DOWN
-American Eagle noted that the company overbought in the knit tops category, despite the positive customer response to the company’s value pricing strategy. Overall, management simply bought too many units. As a result, the company expects to make less unit buys in 3Q, with an emphasis on higher AUR’s. Interestingly, AEO still remains one of the few specialty retailers that is not chasing inventory, but rather placing more aggressive “bets” that don’t seem to be fully accepted by its customer.
- 99 Cents Only management noted that the company continues to experiment with creative pricing schemes as a means to address potential inflation down the road. While the company is not seeing any signs at the current time, inflation creates challenges for the company which historically has remained true to its $0.99 pricing on everything. Test pricing includes efforts to price items on a per unit or per lb basis as well as to sell a gallon of milk at a market driven price (above $0.99).
- Fred’s management noted that while the competitive environment was relatively stable in 1Q, promotional cadence has picked up in 2Q. Fred’s CEO went on to say. “ we anticipate the competition becoming much more aggressive relative to price and promotion as we're seeing today and moving forward and throughout Q2 and potentially beyond.” The comments were primarily focused on Wal-Mart’s rollback efforts, which have intensified over the past couple of weeks.
- After indications of a trend shift to athletic footwear from casual at Foot Locker and vice versa at DSW, Brown Shoe confirmed they are indeed seeing the former with athletic outperforming other categories in both women’s and men’s businesses. It’s also worth noting that comps up 15.5% at Famous Footwear represented the greatest quarterly gain in more than a decade.
WMT's Asda Group buys Netto's UK Discount Supermarkets - Wal-Mart Stores Inc.’s Asda Group Ltd. agreed to buy Netto’s 193 U.K. discount supermarkets for 778 million pounds ($1.13 billion) as it fights to retain its No. 2 position in Britain’s food retailing market. <bloomberg.com/news>
Chinese Consumer Remains Loyal to Luxury Brands - Chinese consumer loyalty to luxury brands remains high despite the economic downturn, according to a report released Wednesday by KPMG. Of the consumers surveyed, 72% said they felt little or no impact from the recession, while 62% said they would continue to maintain their luxury goods spending this year. The 927 luxury consumers surveyed were between the ages of 20 and 44. <wwd.com/business-news>
GSI Commerce Extends and Expands Timberland Ecommerce - GSI Commerce Inc. has extended and expanded a multiyear agreement to provide The Timberland Company with e-commerce technology, order processing and customer care services for their U.S. and European Web stores. <sportsonesource.com>
JJB Sports Will Be Unprofitable For A While - JJB Sports Plc said full-year losses narrowed and recovery won’t be “quick or easy.” JJB had trouble getting merchandise shipped last year as it struggled to avoid falling into bankruptcy. Last September, it said performance wouldn’t improve until late 2010 or early 2011 because inventory levels wouldn’t improve soon enough. One encouraging sign was the 7.5% increase in comps for the 16 weeks ended May 23. <bloomberg.com/news>
J. Crew Bridal Takes Inspiration from a French Salon - Furnished with brass-rimmed vitrines for vintage jewelry, velvet drapes in the window and a graciously spaced showroom downstairs with a crystal chandelier and private suites so family and friends can comfortably witness the fittings, the 4,000-square-foot J. Crew bridal shop opens today on the corner of Madison Avenue and 66th Street. The boutique also retains J. Crew’s signature quirkiness, with an assortment that ranges from a more traditional silk taffeta gown with a floral sash to an offbeat pairing of a delicate Mongolian wool vest with a tricotine skirt with a train. <wwd.com/retail-news>
Hamptons and the Luxury Market - The Hamptons are mellowing out amid the global recession. After last year’s downturn, retail vacancies filled up fast, particularly in East Hampton, where there’s been an infusion of designers and brands — from Hugo Boss to Juicy Couture as well as Chico’s bringing a lower-priced offering to a high-end field. Ater a decade of evolving toward a year-round, spend-with-abandon destination, retailers say there’s contraction. Merchants must grab as much business as they can in July and August, when the real migration eastward occurs. This contrasts with past years, when good traffic could be counted on for a longer stretch, beginning a few weeks before Memorial Day and lasting until a few weeks past Labor Day. <wwd.com/retail-news>
Jimmy Choo Is Going Sporty - The London-based luxury brand, known for its sky-high stilettos, is launching a capsule collection of sneakers for fall ’10. The two-style offering — which comes in white, black, purple and beige — includes one low-top and one high-top style. Embellished with gold details, including a star-shaped eyelet, the sneakers feature patent leather, suede and exotic snakeskin uppers. The styles are set to retail between $495 and $565 at Jimmy Choo boutiques and Jimmychoo.com. <wwd.com/footwear-news>
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Take it as a data point or it may just be speculation, but the Starbucks bloggers are talking about insufficient staffing levels. I would not even highlight this if so much of the margin recovery story at SBUX was not built on cost cutting. To that end, the company continues to surprise to the upside with its cost cutting initiatives.
From a Starbucks blog; “apparently there is such a staffing crisis at the SM (Store Manager) level in the DC area that several SMs in the Mid-Atlantic are being recruited to travel down to DC, all expenses paid, for a period of two months to help run the stores until ASMs and RMTs are ready to assume those positions. One of the SMs I know is going.”
More important for the Restaurant industry as a whole is the trend in turnover rates if the economy and the job picture gains momentum. In an economy that is creating jobs there is an increased willingness to quit and walk away from a lousy job, and the restaurant industry will pay the price.
For now, however, we don’t have much to worry about. As our Financials Analyst, Josh Steiner, wrote today “Consistent with the trend year to date, claims remain in their ~450k range, too high for unemployment to improve meaningfully. This morning the reported number fell 14k to 460k, down from last week's revised print of 474k, and higher than consensus of 458k. Rolling claims climbed 2k to 457k week over week. Remember, we need to see initial claims fall to a sustained level of 375-400k in order for unemployment to fall meaningfully and, by extension, lenders' net charge-offs to return to normalized levels. We remain well above that level.”
Cutting costs too deeply is a whole different issue. Based on SBUX’s improving same-store sales trends, I had not been under the impression that the company was cutting costs to the extent that it was detrimental to the customer’s experience. In the most recently reported fiscal 2Q10, store operating expenses (including labor costs) as a percentage of retail sales decreased 350 bps YOY in the U.S. Management attributed the YOY decline to “sales leverage, the closure of underperforming stores and the continued application of lean principles in our store labor deployment. Lower benefits expenses related to health and welfare programs, which tend to vary from quarter to quarter also contributed to the improvement. As a result of the lean work to-date, productivity and customer satisfaction have both improved dramatically compared to last year. We continue to refine these important activities as many of them are customer facing. In addition we have other initiatives under way such as a new labor scheduling tool and a new point-of-sales system that we expect will further increase productivity once fully implemented.”
It will be important to monitor whether customer satisfaction scores continue to improve to ensure that the company’s cost cuts are sustainable and not a result of management “pulling the goalie” to improve margins. I don’t think this is the case, however, as management seems focused on improving the customer experience and sequentially better same-store sales and traffic trends seem to reflect that renewed focus, but insufficient staffing levels would be concerning.
Position: Short France (EWQ)
As we spelled out in our Q2 Theme call, the Sovereign Debt Dichotomy will not be isolated to Greece. While the fiscal excesses of the Greek government were first to be exposed, we’ve called for Spain, France, and Italy to follow, with the spotlight reaching the USA in 6-9 months.
Following spending and austerity measures issued in recent days by Spain, Portugal, and the UK, Italian PM Silvio Berlusconi announced a $30 billion plan in spending cuts late yesterday and is vocal today calling the measures “absolutely necessary” to defend the Euro and Italy, saying “defending the euro today means saving Italy’s future.”
Like Greece, Berlusconi’s government has plenty of fat to trim in the form of bloated civil service pay over recent years and room to rein in tax evasion (Italy’s annual tax revenues lost are 2nd only to Greece). While the package is a start, we don’t think the package alone (nor Berlusconi’s confidence) will be enough to deflect the reality of Italy’s fiscal problems. While Italy’s budget deficit of 5.3% of GDP is nearly half of those ‘affectionately’ named the PIIGS or Club Med countries, Italy’s total debt as a percent of GDP is as large as Greece’s at 115%.
Clearly, Berlusconi has seen the repercussions of the media’s frenzy with Greece (the Athex Index is down 28% YTD), and doesn’t want Italy to be next. Don’t forget that Berlusconi also has his own interest in the performance of the country’s capital markets as one of Italy’s wealthiest businessmen.
One initial signal we’re following for heightened fears is CDS price. The chart below shows a recent spike in Italy’s 5YR CDS. While far from a 940bps high in Greek CDS in early May, or the 300bps tipping point for Lehman Brothers and Bear Stearns, this rise could be an early indication of something much bigger: the reality that you cannot kick the can of debt down the road in perpetuity.
Consistent with the trend year to date, claims remain in their ~450k range, too high for unemployment to improve meaningfully. This morning the reported number fell 14k to 460k, down from last week's revised print of 474k, and higher than consensus of 458k. Rolling claims climbed 2k to 457k week over week. Remember, we need to see initial claims fall to a sustained level of 375-400k in order for unemployment to fall meaningfully and, by extension, lenders' net charge-offs to return to normalized levels. We remain well above that level.
As a reminder around the census, May is the expected peak employment month. Starting next week the census will become a headwind for job creation.
The following chart shows the census hiring timeline. If the past two cycles are an appropriate model for this year's census, we should start to see Census employment draw down as we move into June, creating a headwind for employment.
Joshua Steiner, CFA
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