We see an asymmetric setup for Jack in the Box over the next three years. For any clients looking for ideas on the long side, here is our favorite one on the three year duration.
The price of oil declining has moved some investors to look more closely at the consumer discretionary sector for long ideas. Jack in the Box is one name that we like here and now. The next catalyst for this stock is when 2QFY12 earnings are reported on May 15th. We expect same-restaurant sales to beat expectations at Jack in the Box. In addition, we believe that management will provide incrementally positive commentary on Qdoba, its growth prospects, and its operating margins.
Following the investor day, much of the skepticism was based on Qdoba’s restaurant operating margin trending at 13.5%. As the asset base matures we expect margins to rise. In its Investor Day materials management highlighted that, for Qdoba restaurants open more than three years, restaurant operating margins are at 18.5%. We see an asymmetric risk setup for JACK at this point given the margin expansion that should follow as the Qdoba unit base matures. The leverage in this stock, as we see it, lies almost entirely with Qdoba. The company unit base is projected to double by 2015. If growth targets can be reached and unit economics improve, we see as much as 60% of upside in this name over the next three years.
Sum of the Parts – FY2012
How high margins can go is largely a function of how successful the company will be in increasing same-store sales. Our sum of the part analysis, below, outlines our fundamental view on the stock over the next 6-9 months. We believe that there is 8.5% of upside at current levels. That view is predicated primarily on growth from Qdoba and the investment community awarding the stock a higher multiple, something that we think is overdue. Wendy’s and Sonic include some of the names that are trading at higher multiples than JACK. Given that Jack in the Box has completed a reimaging program of its main concept and is set to generate free cash flow of ~$75mm this year while driving the Qdoba growth story forward, it seems incongruous that Wendy’s, which is facing some serious issues over the next several years, would trade at a premium to Jack in the Box.
Sum of the Parts – FY2015
It is always difficult to forecast what the future holds but, in the case of Jack in the Box, we see much more upside than downside. Management is planning on growing the company-owned base of Qdoba stores to grow by 15-20% per year through 2015. Franchisees are expected to add 30-40 units per year over the same time period. Qdoba’s growth and expanding margins are the primary components of the long-term TAIL story. The margin expansion that we show in the sum-of-the-parts analysis, below, can be attributed to what we expect to be a maturing store base, stronger sales trends, and opportunistic acquisitions of franchise restaurants.
Even assuming an enterprise value of Jack in the Box level with what it is today, we believe that Qdoba’s growing and maturing store base can deliver outsized returns to shareholders. Given that, according to Bloomberg, the sell side is currently divided on the stock – 3 Buys, 7 Holds, 3 Sells – there are plenty of skeptics to be won over if management can hit targets over the next few quarters.
Keith bought JACK today in the Hedgeye Virtual Portfolio as his model was indicating that the stock was immediate-term TRADE oversold. Given Keith’s quantitative view of the stock along with our fundamental view on the stock, we believe that Jack in the Box is the most attractive stock in QSR over the longer term TAIL duration.
Conclusion: FOSL results this morning are the latest to reflect slowing demand out of Europe, but are also one of the more bearish we’ve seen quarter-to-date. While FOSL is considered a fringe player in luxury accessories at best, lackluster jewelry sales were highlighted as a key drag on European wholesale putting other luxury players on notice. This is inconsistent with continued strength through Q1 out of mainstream European luxury brands (Hermes, PPR, Burberrry, etc.), but noteworthy nonetheless.
What Drove the Miss?
Although FOSL reported a head line beat ($0.93 vs. $0.92E), adjusted 1Q12 EPS was actually $0.84 after accounting for a $0.09 discreet tax benefit. As such, the miss was due primarily to the top line growing only 10% vs. +15E with Europe (27% of sales) accounting for 3pts of FOSL’s 5pt top-line shortfall. While performance in France and the UK were strong in Q1, Germany was flat with Spain & Italy down double digits resulting in total European wholesale revenues +1% vs. +12E. It’s worth noting that Europe is also FOSL’s most profitable region (see table below). Although Inventory growth improved sequentially down 4 points to +27%, the slowing top line drove the SIGMA further into the danger zone. Despite management pointing to trends in Germany improving slightly in April, 9 weeks remain in Q2 and continued weakness in Spain and Italy resulted in management reducing expectations in Europe to +LSD-MSD growth in F12 from the prior low to mid teen outlook. With GM and SG&A assumptions largely unchanged, full year organic EPS expectations (ex Skagen) are now $5.23-$5.33, down $0.17 vs. prior $5.40-$5.50. FOSL expects Skagen to add a net $0.07 to earnings in 2012.
Deltas in Forward Looking Commentary?
In order to properly measure performance relative to original expectations, we look at management’s 2012 guidance headed into the quarter as well as the key deltas in Q1 results vs. expectations. Comments in red reflect any changes to future outlook:
First Quarter Guidance:
- Revenue expected to grow 15% (slightly higher constant currency) MISS: Revenues came in +10% vs +15E with shortcomings in Europe (+1% vs +12E) contributing 3 points to the 5 points top line growth miss
- 1Q12 EPS expected to be $0.90-$0.92 MISS: Although headline EPS was $0.93 vs $0.92E, adjusted for the $0.09 tax benefit, EPS was $0.84 vs. $0.92
Full Year Guidance:
- EPS $5.40-$5.50 (ex Skagen) REDUCED: now $5.23 to $5.33 ex Skagen (FOSL guided to $5.30-5.40 incl $0.07 net benefit from Skagen)
- Revenues: +15% (constant currency higher, ex Skagen) REDUCED: organic growth expected to be +11% overall (guided to +16% with 5% contribution from Skagen) driven primarily by softness in Europe
- Europe Revenues: +low to mid teens REDUCED: now LSD-MSD
- Gross margin to be slightly below last year’s 56.1% UNCHANGED
- Expecting FX to impact GM most severely in Q2 & Q3 UNCHANGED
- Expect slight Operating expense deleverage UNCHANGED
- Expect to open 70-75 stores with equal distribution in the US and International UNCHANGED
- Plan to close ~18 stores INCREASED: Planning 18 closures in addition to 5 in 1Q12
- Focus on opening accessory stores, outlet stores and watch station stores UNCHANGED
- Currently committed to 49 locations in 2012 with 21 signed leases ON TRACK: 65 lease commitments to date
Highlights from the Call:
Fossil Brand watches +11%
- Missed some business due to lack of spring color in watch/accessory offering
Jewelry comp'd negative due to repositioning especially in Europe
Eyewear negative resulting from pullback on distribution to US Dept stores and frames biz in Europe
Direct to Consumer: +18% (+18.7% ex FX)
- Comps: +8%
- Asia Comp +18%
- North America comp +11%
- Europe comp (-5%) driven largely by repositioning of jewelry where Europe is the most penetrated in that business
North America Wholesale: +9%
- Watches: +14%
- Men's Leather: +14%
- Partially offset by decline in women's leather & eyewear
Asia-Pacific Wholesale: +20% (+18.8% ex FX)
- China drove growth +57%
- Korea +14%
- Japan: soft economic conditions resulted in 6% decline in shipments- significant opportunity remains to increase concessions in Japan
- Overall concession comps (-1%) due to 6% comp decline in Korea
Europe Wholesale: +1% (+4.7% ex FX)
- UK: DD Growth
- Softness in Germany and continued weakening environment in Italy & Spain
Overall Watch Business: +14% Globally
- Fossil +11%
- Licensed watches +20% (Michael Kors +48%, Marc by Marc Jacobs +67%, Armani Exchange +46%, Diesel +23%, Burberry +14%)
Overall Leather Business: +14.9% (+15.8% ex FX)
Overall Jewelry Business: (-7.1%) (-4.8% ex FX)
- KORS added $4mm to jewelry which was offset by Fossil Jewelry decline
Overall Eyewear Business: (-26.8%) (-25.6% ex FX)
Gross Margin: -40 bps
- Principally driven by an increase in the cost of factory labor and certain watch components and a higher percentage of sales to third-party distributors
- Foreign currency rate changes negatively impacted gross profit margin by approximately 20 basis points for the quarter
- Partially offset by the sales mix of higher margin watch products, direct consumer sales in Asia Pacific wholesale sales in comparison with Q1 last year.
- $120mm in sales in 2011
- OM just above 17%
- Currently 13 locations globally
Capex: $18mm in Q1
- Expect full year Capex of $120mm
- Ended Q1 with 398 stores (190 outside North America) @ 700K square feet
- Opened 5 in 1Q12
- 65 lease commitments to date
- Remain on track to opening 70-75 new stores (outlet & accessory concept, splits between US/overseas)
- Closed 5 stores in Q1, planning additional 18 for remainder of the year
- Targeting to end the year with ~280 concessions based on an additional 65-70 through the remainder of this year
- Revenues to increase 16%, +19% ex FX
- Skagen expected to benefit sales growth by 6% in 2Q
- 2Q EPS (including Skagen) expect to be $0.77-$0.79
- Skagen expected to deliver $0.03 in operational earnings however costs related to the transition are expected to negatively impact EPS by $0.07
- Stronger U.S. dollar is negatively impacting Q2 earnings by about $0.02
- Revenues of +16%, +18% excluding FX
- Skagen expected to contribute 5% to overall growth
- Expect GM to be slightly below 56.1% achieved last year
- Ex Skagen, expecting slight deleverage of operating expenses for the full year
- Expect full year tax rate of 32% for the balance of the year
- Diluted EPS expect to be $5.30-$5.40 (including Skagan)
- Skagen expected to deliver $0.22 in operational activities with a $0.15 impact from transaction related costs
- Stronger U.S. dollar is negatively impacting Q2 earnings by about $0.02 and the full year by $0.07.
- Expect Fossil brand sales to deliver double digit growth for remainder of the year driven by new jewelry offering, strong watch & accessory momentum and expanded retail/concession store base
Miscellaneous Full year Commentary
- Michael Kors Jewelry launch going well and expected to reach $30mm in sales this year
- Expect more than 25% growth from Asia for the remainder of the year driven by multi-brand watch sale growth
- Europe guidance reduced to +LSD-MSD from Low-mid teens
- FX will have biggest impact in Q2 and Q3
- FX will be partially offset by higher sales mix from Asia wholesale and DTC in additional to select price increases
- Expect full year Capex of $120mm
- Previously offered 2 Jewelry assortments (US & Europe)- now consolidating into 1 global assortment
- Greatest impact in Europe bc European sales mix more penetrated in Jewelry vs. other segments
- 1Q is the smallest quarter of the year
- Retail sales of watches and Fossil brand continue to be strong in the US
- Expect to continue to gain US market share- still a big runway for opportunity
- Most of the wholesale business in department stores where sell through statistics are in line with inventory- no imbalance in terms of performance at retail
- Seeing US continue to grow at HSD rate, North America slight better given 20%-30% growth in Canada/Mexico
- Kors does not seem to be cannibalizing in the US, just growing the business
- Korean concession comps -6%
- Believe Korean operational potential to be huge long term
- China comps +17.3%
- Japan comps +18% (18 Fossil stores)
- Refining Japan wholesale business
- Transitioning Japan to be more concession based
- Expecting Asia to increase 25% for the year with additional concessions being added in
- Continue to see the opportunity to double the size of the business over 5-6 years
- Strong growth in both UK and France
- Germany was flattish
- Italy and Spain were down DD
- Expect LSD-MSD growth ex Skagen for the full year in Europe
- Have seen slight improvements in Europe in April though still 9 weeks to go
- Still seeing weakness in Italy and Spain but Germany has recovered slightly with similar results in the rest of the countries in that market
- Planning an increased number of store/concession openings
- Missed Q1 sales expectations by $35mm which resulted in $10mm-$12mm in inventory cost at Q end
- Component inventories +40% creating $5-$6mm in inventory addition
- Continue to open outlet stores to clear inventory going forward
- Skagen inventories: preparing to increase the amount of quantities to the rest of the year in both the US and internationally
- Have seen no change in strategy on that the RELIC business would be going forward
- Expecting business as usual in that environment
- Planning on launching first quarter 2013
- Working on product development
- Price points similar to Michael Kors
- Seeing a lot of interest in Asia and Europe
Store Opening Plan:
- Opened net just over 30 in 2011
- Quarterly cadence expected to be similar to last year
- Expecting a ramp in openings in the back half
- Effected price increases on new and certain core items March 1st (on going)
- Looking to bring back some opening price points in various categories
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Here are some thoughts on the PENN deal to acquire the Harrah’s property in St. Louis
We are moderately positive on the transaction:
- Accretive: With goodwill accounting and low borrowing rates, EPS accretion ain’t what it used to be. However, we calculate about $0.20 in annual EPS accretion from the deal.
- Deferred Capex: This situation could be worse considering it is a Caesar’s property. We think they will need to spend about $50MM over the first few quarters on new slots, renovating the casino, rebranding, and a new IT system. Rooms and restaurants are in pretty good shape.
- Multiple looks ok: The EBITDA multiple looks to be 7.4x – not a steal but not bad.
- Is it better than buying stock? – Not right away since PENN’s multiple is lower (after Ohio opens) but probably over the long term. PENN still needs to add a Strip property to get the cross marketing benefits of a big regional property like this. Given the cash accretion, either option is a positive relative to status quo.
- Total Rewards: This is a big wildcard. It is unclear how much the most effective loyalty program out there has contributed to EBITDA and how much goes away without it. History is on the side of a huge impact but there are a few mitigating factors: the closest CZR property is 120 miles away, there are marketing restrictions put in place, and the St. Louis market is well-established. An additional negative: would existing St. Louis customers prefer to cash in rewards benefits at Wynn (from PNK), MGM’s Strip properties (from ASCA), or PENN (M Resort)?
- Cost Savings? Not really a lot here although we would expect to see less promotional activity. With rational competitors ASCA and PNK in the market, there could be some savings.
Stock vs. Asset acquisition
- The acquisition is structured as a purchase of all the stock in the Harrah's St. Louis subsidiary. Contrary to an asset acquisition, this allows them to step into their shoes on day one. However, since both parties agreed, the IRS allows Penn to treat the acquisition as an asset sale, which means that they can depreciate roughly $428MM of the purchase price over 15 years, which results in a $10MM/ annual tax shield. Penn estimates that the present value of this tax shield is worth $79MM.
- In terms of slots, the 300 slots that are leased at the property will be replaced immediately since those are costly and then roughly 200 more will get replaced in short order
- Penn will also reduce the number of games on participation
- After replacing 500 slots off the bat, PENN will likely replace about 1/7th of the slots annually on a go-forward basis, which is in-line with their normal replacement cycle of 7-8 years
- The Maryland Heights property’s margins are in the 29% range. PENN believes that there is an opportunity to improve margins by a few hundred basis points over the course of a few years by removing costly slot leases, lowering the participation percentage, hiring cheaper on-site property management in the fields of accounting, marketing, etc where Harrah’s used a centralized system and then allocated costs to the property, and optimizing marketing spend.
- Margin improvement will take some time to materialize since they need to get their new systems, marketing tools, and people in place. PENN pointed to ASCA’s 37% property margin as an example of being able to achieve better than 29% margins. However, comparisons to ASCA’s 37% are not apples to apples, since ASCA allocates less overhead to the property level than most companies.
- PENN hasn’t even gotten in front of the regulators yet. They are already licensed in the state so that should make it faster. Late 3Q/early 4Q is probably doable.
In preparation for MPEL's FQ1 2012 earnings release Wednesday morning, we’ve put together the recent pertinent forward looking company commentary.
MPEL 4Q CONFERENCE CALL
- "We are optimistic regarding GGR growth for 2012, particularly in relation to the highly profitable mass market segment, which continues to be strong, as evident in the increased visitations and strong mass table growth rate."
- "Total deprecation and amortization expense is expected to be approximately $90 million to $95 million, corporate expense is expected to come in at $18 million to $20 million and net interest expense is expected to be approximately $25 million to $30 million."
- "In the future, couple of months, we have put in place a program to improving, expand our VIP gaming facilities in COD, and we should be able to add another three junket operators in next three months time."
- "As a policy, and it has served us very well over the last few years, we do not intend to compete on price or credit in the rolling chip segment."
- "I think our hypothesis for a 15%, 20% growth in the gross gaming revenue overall in the market for this year is based on around 8% GDP growth. So we are pretty comfortable with the budget that we had set last year and with the current trading rate in Macau."
- "We have to really yield up our table productivity. We allocate quite a lot of tables in Altira because of the history of Altira. Per table productivity, compared to COD or Cotai standard, it's a little bit low."
- "We're hopeful and optimistic that we can stick by the schedule that we had previously guided and so the next official announcement from us regarding Studio City as the designs are all done now would be a restart of construction."
- "Based on our current cash balances and future expected cash flow, we do not envisage a requirement to raise equity capital for Studio City."
- "I think you will start to see mass represent a larger and larger part of our mix of EBITDA."
LIZ remains one of our top longs for 2012. As such, with Trade support broken, we view this morning’s drawdown as a buying opportunity as the stock nears its intermediate term TREND support of $11.58 based on Keith’s quantitative levels.
As a reminder, while LIZ’s 1Q12 earnings came in light, top line strength exceeded expectations with April-to-date comps suggesting an acceleration in underlying demand at Kate Spade and Lucky. In addition, with FOSL results out this morning suggesting accelerated weakness in European jewelry sales, we remind investors that while LIZ has nearly 20% of sales generated in international markets, less than half of that is derived in Europe. No change to our thesis here- LIZ remains on track to double in 2012.
See our 4/26 note "LIZ: On Track to Double Again" for additional detail on our thesis and thoughts headed out of the quarter.
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