Here’s a step back and post mortem on LIZ. Relative to the underlying fundamentals, this is overdone. But the company has not yet earned the benefit of the doubt from anyone. The irony is that the stock has changed more than the story has.
This LIZ blow-up today requires a big step back and post mortem for us. While not in the Hedgeye Virtual Portfolio, I (McGough) have definitely been a bull on LIZ with the stock as a single-digit midget despite the magnitude of challenges facing the industry in 2011.
The crux of our case has been that after 4-years of missing numbers (and releasing more earnings miss press releases than there were quarters) the company would finally start to harvest its investments of the past 2-years and would face positive earnings revisions on dramatically reduced working capital needs while the rest of retail went the other way.
The bottom line is that there was definitely a downturn in our expectations at Lucky, and to a lesser degree, Mexx. But the best way I can characterize this event is that it’s a ‘higher quality miss.’ “C’mon McGough, admit you’re wrong and throw in the towel on this dog.” I’ve had 3 such conversations over the past 12 hours where I heard these words.
But let’s tear it down and see what’s changed.
Liz Wholesale/JC Penney:
- It was a painful 2-year build up to the decision to go exclusive with JCP and pull out of other department stores. Leading up to the decision, the company not only lost out on top line, but got beat up on margin and working capital.
- In the 2-years it took to implement, LIZ worked down JCP exposure to Zero. But built up JCP/QVC from Zero.
- The bottom line is that we’re talking a $1bn unprofitable business with high working capital needs. That spells horrible RNOA. Now, they are 1-quarter into a sub $1bn business, but with steady 4-6% margins. That might not seem like much. But msd steady margins on a business with 2-3x operating asset turns is a trade I’ll take any day. The events leading to today’s stock action has Zero bearing on this thesis.
Liz Outlets: The company is nearly out of its 87 money losing Liz Claiborne branded outlet stores in the United States and Puerto Rico. These have been a major earnings and working capital drag. Think about it, with inventory poorly placed by multiple divorces between LIZ and Department Stores, the outlets have borne the brunt. That’s almost over. No change here in thesis.
Consumer Direct Brands:
This is where it gets dicey. I’ve got to check through 12 years of notes to confirm, but I think that this is the first time LIZ has ever called out bad weather as being the key contributing factor. In fact, it’s probably the first time in McComb’s life he’s used it.
Unfortunately, this is impossible for us to validate and/or quantify. What I’ll give ‘em is that all it takes is a simple Google search to find all the videos and news releases discussing the ‘paralyzed’ consumer in Western Europe. I’d argue that even a paralyzed consumer will make sure that they get the best product/value regardless of weather. But changes in consumer confidence rarely occur to a magnitude that would support a 16% negative diversion from one month to another.
The irony here is that in looking at the underlying comp run rate for all Liz concepts, they all improved on the margin, except for Mexx, and Mexx only eroded by 200-300bps. If management is not flat-out lying about the snow factor, then this really is not that bad.
- That aside, Mexx Europe appears to be making progress early in year 2 under Thomas Grote’s direction with comp performance Oct-Nov flat after 3+ years of posting negative comps in addition to spring order book that’s up 14% both of which are positive on the margin.
- Leadership at both Juicy (Leann Nealz 9/10) and Lucky (Dave DeMattei 12/09) has been replaced within the last 12-months and product selling through now is likely to be legacy lines from the prior management. Spring 2011 is when we’ll likely see new product roll out.
- Despite the decline in December comps, Juicy’s comps on a 1yr and 2yr basis have been steadily improving and in addition to moderate store growth the top-line has reaccelerated in Q3 and Q4.
- Lucky continues to be a most significant drag with underperformance actually accelerating to the downside throughout the quarter with women’s product (over 50% of sales) highlighted at the key reason.
The question is whether the company deserves the benefit of the doubt between now and its 4Q call on February 17th at which time management will provide January trends to determine just how much of the shortfall in December was due to weather vs. product?
For a levered small cap stock over such a short duration, the answer is probably ‘No.” But is there enough for us to take this thing out behind the barn an pop a cap in it? Definitely not.
In fact, after the Feb 17 call, we’ll have better disclosure on the size, profitability and return characteristics of the partner brands and exit of the outlet stores – which we think will be a positive surprise.
Keep in mind that 4 out 5 investor conversations I have on Liz include questions around liquidity. People ask about LBOs on JCP, American Eagle, Carter’s and other peaky margin companies. But they don’t breach the topic on LIZ. Are they asking me about the math as to how you get the Liz Claiborne brand for free at the current price? No. This is completely backwards.
Conclusion: We continue to see supportive data points that growth is slowing and inflation is accelerating on a GLOBAL basis in 1H11.
While we may have been early, our view that global inflation would lead to tighter monetary policy and slower global growth is beginning to play out in spades. In aggregate, global inflation is being driven by the Fed’s experiment with Quantitative Guessing. Numerous “insignificant” countries ranging from China, to Brazil, to India have explicitly pointed to monetary easing in the U.S. as a key contributor to their own inflation headwinds, as the weak U.S. dollar from July to November drove up commodity prices and accelerating inflation expectations carried them higher alongside the marginally stronger dollar of the last two months. We suggest you avoid buying the one-factor model of “accelerating US growth” as the reason global bond yields have ticked up over the last two month.
Now, we’re entering a period in which many countries will actually have to accelerate tightening measures, which may put additional upward pressure on US Treasury yields, as well as put downward pressure on global growth (email us for recent reports pertaining to the topic). We’d be remiss to forget how good 4Q09 and 1Q10 were from a global growth perspective. Those be some tough comps in the face of accelerating inflation, tighter monetary policy and higher interest rates.
Seemingly every day, we get a global macro data point(s) that fit into each of the three buckets of the equation. From today’s run we wanted to highlight the following:
Accelerating Inflation: Brazil CPI accelerated to a 25-month high of +5.91% YoY in December.
Monetary Policy Tightening: Indian Finance Ministry’s Chief Economic Adviser, Kaushik Basu, said India’s inflation rate is “too high” and needs to be addressed.
Slowing Growth: China’s Vice Premier Li Keqiang estimated that the Chinese economy grew about ~10% in 2010. Assuming he knows the numbers ahead of time, using his full year estimate, we can back into China’s GDP growth rate from 4Q10: +8.2% YoY. For reference, the Bloomberg consensus estimate for Chinese growth is +9% YoY in 4Q10 and +8.4% YoY in 1Q11. In a report yesterday, we explored the possibility of a hard(er) landing in China relative to consensus expectations, with the conclusion being that it is likely not priced into global equity markets (email us if you need a copy).
All told, the direction of global bond yields tells us one thing: inflation is a problem GLOBALLY. And because of that, there will be unintended consequences as struggling PIIGS and State & Municipal bond issuers come to the market to refinance throughout the year:
- According to some estimates, Italy and Spain (two of our favorite global macro shorts since 2Q10) need to raise €317B ($412B) this year – a sum equivalent to roughly 13.3% of their combined GDPs; and
- House Budget Committee Chairman Paul Ryan (R. WI) yesterday ruled out bailing out any US State in budget trouble. This explicitly translates to a higher risk premium for muni bond issuers as they accelerate tax-free muni bond issuance in the face of waning federal support to patch budget gaps totaling $140B starting in FY12 (which begins on July 1 for all but four states).
Of course, none of this matters to AAPL’s earnings…
The US equity market has been cruising along for the most part, but all is not well under the hood. Have a great weekend,
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The momentum in gold is lower, but is it just taking a break before rocketing higher? Keith McCullough, Hedgeye Risk Mgmt. CEO, and Frank Holmes, US Global Investors CEO, discuss.
POSITION: Short SPY
Suffice to say, it’s been an interesting week to start off the New Year. Almost every global macro data point that I measure as a very immediate-term leading indicator has all of a sudden flashed an either amber or red flashing light. I said almost.
US small caps, which everyone and their brother was hot and heavy for after a boomer of a 2010, are now down for 2011 YTD. Barely down, but down doesn’t register as a green light in my model.
The SP500, however, isn’t flashing amber or red yet…
For that to occur, I’d need to see the SP500 breakdown and close through the 1265 level outlined in the chart below. That’s the immediate-term TRADE line of support. If it holds, God bless my longs – if it breaks, God help the perma-bulls.
If we’ve learned anything in the last 3 years about markets, it’s that they subscribe to mean reversion. Just when you think all of your short ideas are stupid, they become the only thing that works. A TRADE line breakdown through 1265 puts the intermediate-term TREND line of support down at 1190 back in play.
Now I fully realize that it’s been a while – since we had a mean reversion oriented correction that is… and that’s exactly why the probabilities are climbing of one occurring. This is actually the 1st time that the SP500 will close down on back to back days since November 29th-30th …
It’s been a while, indeed.
I’m having surgery on Monday. So I’ll be out for a few days with no SP500 levels updates. Don’t pray for me – its minor stuff. But while I’m gone, keep the 1265 line in mind. If it cracks, the buy-and-hope-bulls who re-appeared after a +89% rally from the March 2009 lows, may need the prayers.
Cheers and enjoy your weekend,
Keith R. McCullough
Chief Executive Officer
R3: REQUIRED RETAIL READING
January 7, 2010
- Keep an eye on the next evolution of internet exclusivity mixed with fashion. Enter Moda Operandi, an ecommerce site slated to launch in February which will bring the “trunk show” to the masses. Sounds interesting, but the real question will be how many people outside of big cities or luxury area codes actually know what a “trunk show” is. Perhaps “pre-order” is the better term.
- Expect the Jersey Shore product parade to continue unabated, this time with a flurry of licensed goods bearing Snooki’s name. The star of the hit show has signed a deal to license her name on fuzzy slippers, jewelry, and sunglasses. Future products are expected to include denim, sportswear, lingerie, handbags, beauty products, fragrance, swimwear, bedding, and home goods. In other words, every product conceivable may have a Snooki logo on it by year end.
- With Gap sales struggling to materialize, we wonder if the company’s return to the 70’s will offer any help for the Spring season. Gap will roll out its 70’s inspired, high waist denim and bell bottoms over the course of this month in hopes of catching the next trend. Whether this translates into positive same store sales still remains to be seen, although the sharp contrast in silhouette vs. the past couple year’s skinny jean trend is notable.
OUR TAKE ON OVERNIGHT NEWS
New Ebay App Allows Consumers to Try on Product at Home - In what may be a first, eBay has added augmented reality to its fashion app. The new version of the app made its debut Thursday. Now anyone with an iPhone 4 can virtually try on a pair of sunglasses by superimposing an image of the glasses over an image of their face. For now, though, try-on is limited to a few select styles. EBay plans to expand the virtual try-on to other designs and categories later. It is also exploring using augmented reality in other ways, said eBay executives. “Our ‘See It On’ augmented reality feature is truly an innovative way to shop — it allows consumers the option of making their style and spending decisions in a snap, on the go,” said eBay Inc. general manager for fashion Miriam Lahage. “I was questioning how I would look in Wayfarers so I tried a pair on [virtually] and I liked what I saw, they were…placed on my face. Then I could just click and buy.”Although owners of other iPhones won’t be able to try the augmented reality feature because their cameras don’t face the right direction, they can still download the new version of the app, which includes the additional categories of watches, jewelry and bridal.<WWD>
Hedgeye Retail’s Take: Long in the works, it looks like Ebay is the first major platform to utilize augmented reality as way to influence purchasing decisions. Expect this technology to permeate many more fashion sites in the coming year, as the barrier to trying product on when purchasing online is the key factor in e-commerce’s significant return rates.
Fortune Brands Hires Morgan Stanley - Fortune Brands (has hired Morgan Stanley to auction its golf division, a sale that may fetch as much as $1.5 billion, Bloomberg reported. The news agency cited four people with knowledge of the matter. The company's golf segment includes the Titleist and Footjoy brands. Morgan Stanley may approach and Adidas, which owns Taylormade, and Nike as well as private equity firms and Asian companies like Sumitomo Rubber, the owner of the Srixon golf-ball brand, Bloomberg said. Fortune Brands and Morgan Stanley were not available for comment.<SportsOneSource>
Hedgeye Retail’s Take: This is one to watch as the low (no) growth profile of the golf industry will likely limit the pool of potential buyers.
LivingSocial hires former Walmart.com exec as CFO - John Bax Daily deal company LivingSocial has hired a former executive of Walmart.com as chief financial officer. John Bax held a similar job for the e-commerce operation of the world’s largest retailer. LivingSocial, one of the main rivals to Groupon Inc., which also sells online discounts and coupons for local and some national retailers, last month received a boost from the world’s largest Internet retailer, Amazon.com. Amazon, No. 1 in the Internet Retailer Top 500 Guide, invested $175 million in LivingSocial while the e-commerce world waited for confirmation that Google would spend up to $6 billion for Groupon. That deal never materialized. Most recently, Bax worked as chief financial officer for RecycleBank, a New York-based company that operates a merchant-funded rewards program; consumers can earn rewards points by recycling household goods. Before that, Bax was chief financial officer of Sentient, a private travel firm. His experience as Wal-Mart, No. 6 in the Internet Retailer Top 500 Guide, came prior to Sentient. Besides the e-commerce job, he also had worked as vice president of planning and analysis for Wal-Mart Stores.<InternetRetailer>
Hedgeye Retail’s Take: Following Groupon’s recent hire of an AMZN financial executive last week, the discount deal companies are actively adding to the bench strength of their financial teams given heightened investor interest. Our sense is that experience bringing companies public, or at least working for one, is also at play here.
Justin Beiber Nail Polish Sells Out on Christmas - Tween heartthrob Justin Bieber created a holiday sales mania at Wal-Mart, which created a dedicated display of Bieber-themed goods for the Christmas season. Bieber’s nail polish collection with Nicole by OPI — with song-inspired shade names, including One Less Lonely Girl (lavender) and Give Me the First Dance (silver) — completely sold out in the 3,000 doors where it was sold. “The call center in Bentonville was flooded and flooded with calls with people wanting to know where they could get the nail polish. We just couldn’t keep up,” said Carmen Bauza, Wal-Mart Stores Inc.’s vice president and divisional merchandise manager of beauty and personal care. She added, “We thought it would be a stretch since he doesn’t wear nail polish.” Bauza said Bieber’s unisex scented wristbands and dog tags by Etoile Nation also were brisk sellers. <WWD>
Hedgeye Retail’s Take: This may be the first exclusive product to sell out of WMT in years! Unfortunately the unit volume would have to be in the billions to move the comp the needle.
Crocs Hires Senior Creative Director -Crocs Inc. named Becky Gebhardt senior creative director. In the newly created position, Gebhardt will be responsible for concept creation in sales and brand strategy, as well as driving the online and in-store Crocs customer experience. She previously worked as VP of creative, PR and online experience at Avelle Inc., formerly known as Bagborroworsteal.com, and at Land’s End as VP of creative. "Gebhardt has an extraordinary talent for conceptualizing compelling consumer brand marketing solutions that will broaden Crocs awareness, increase sales and enhance customer loyalty,” said John McCarvel, president and CEO for the Niwot, Colo.-based brand. “Her understanding of the brand’s new positioning and expanding product line will help us continue to elevate and evolve the Crocs brand globally.”<WWD>
Hedgeye Retail’s Take: Over a year removed from the AVP partnership stranglehold, it appears that the brand building effort underway continues to gain steam (and investment). For Crocs to continue its recovery, it has to build the brand beyond its “clog” image.
Red Wing Plans Store Roll-Out - Red Wing Shoe Co. is on a retail roll. The company plans to grow its network of retail stores by 20 percent over the next five years. It currently has more than 425 Red Wing stores in the U.S., with close to 70 percent of those independently owned. According to the firm, based in Red Wing, Minn., the 1,200- to 1,500-sq.-ft. stores are generally located in larger metropolitan areas with populations of about 100,000 or more, providing a strong customer base for independent storeowners. Additionally, because the stores are not franchised, no fees are paid to Red Wing.<WWD>
Hedgeye Retail’s Take: Is this a sign of a pick up in industrial production or perhaps validation that the company’s iconic and fashionable Americana boots have reaccelerated growth prospects for the 100 year old brand?
Illinois moves to tax online purchases - Illinois would levy taxes on Internet purchases under a plan that won final General Assembly approval today with an 88-29-0 vote in the state House. The law would make Illinois the latest state to try to squeeze revenue from online retail purchases, though other states have faced court challenges and the threat of lawsuits after trying to collect taxes from web sales. And some online retailers have simply cut off affiliates in states that have passed similar laws. The Illinois law still needs approval from Gov. Pat Quinn, a Democrat. Lawmakers have 30 days to send it to him, and he then has 60 days to act. The tax would start on July 1. The tax is part of an amendment to Illinois House Bill 3659. The tax would subject certain online purchases to the state’s 6.25% use tax. Those taxes resemble sales taxes, but, technically, apply to the right to use products purchased from Internet and catalog merchants that don’t collect sales tax on behalf of that state. <InternetRetailer>
Hedgeye Retail’s Take: Another step towards the inevitable closure of the gap between those collecting tax and those that do not? As a reminder this past summer the same issues were brought to Capitol Hill in an effort to even the playing field between online only players and traditional retailers as well as generate additional state revenues. We continue to believe the tax loophole status will be closed soon.
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