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DKS: Value Trap -- Even After Getting Lanced

Takeaway: DKS is entering a period where margins will tread water while asset turns back-peddle. That's not a recipe for the stock to go up.

This note was originally published March 11, 2013 at 15:40 in Retail


A few people have asked us today as to whether we think that the DKS stock price reaction is overblown. If anything, we think it’s underblown (if that’s not a real word, now it is).


This has nothing to do with missing the flow of cold weather patterns or getting ‘Lanced’ by its stagnant inventory of Livestrong treadmills. But rather, it is a company in a mediocre business that is running at peak margins at a time when the outlook for comps (low single digits) is below the rate needed to leverage occupancy, deferred investments on the P&L are eating up an incremental 5% of earnings this year, and capex is trending up an incremental 20%.


Furthermore, let’s not forget that DKS falls into the bucket of names that has high risk of share loss to competitors and brands’ direct growth initiatives, and at the same time we see the company openly admit that it has underinvested in the infrastructure needed to take its ecommerce platform to the next level.


We get the whole point about DKS being a ‘best in breed’ retailer. But this is not necessarily a breed that needs to be owned.


We think that the crux of where DKS is in its cycle can be summed up in the Profitability Roadmap below, which shows the progression of margins vs. asset turns. Retailers, as we all know, can improve either one of those at any given point in time, but it’s when they improve simultaneously that real value is created and the stocks outperform materially (0.92 performance correlation). This is exactly what DKS did from 2009 through 2011, and it accounted for a 4-bagger in the stock.


But today, we think that we’re stuck at a point where margins will tread water, and it will be on an incrementally larger operating asset base. That is the ultimate recipe for a value trap.  


DKS: Value Trap -- Even After Getting Lanced - dksprrdmp

Beautiful Rage

Client Talking Points

Watch the Dollar

There are a lot of folks out there who simply hate this market, but the reality is that if you are raging against this market, you’re missing one of the most impressive four-month changes in Asian and US growth prospects that we’ve seen in nearly a decade. A strong currency, if sustained, is a pro-growth signal. So the key here is to watch whether or not the dollar remains strong.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

We believe ASCA will receive a higher bid from another gaming competitor. Our valuation puts ASCA’s worth closer to $40.


With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view.


HOLX remains one of our favorite longer-term fundamental growth companies given growing penetration of its 3D Tomo platform and high leverage to the 2014 Insurance Expansion from the Affordable Care Act.

Three for the Road


“The question is (in my prime) who looked better in cutoff jean shorts – me or @KimKardashian?” -- @KeithMcCullough


“…fraught with arbitrary and capricious consequences.” – Manhattan Supreme Court Justice Milton Tingling on striking down New York city’s soda ban


$6 million, the salary the Baltimore Ravens wouldn’t pay receiver Anquan Boldin, who they traded to San Francisco


Takeaway: McDonald’s same store sales growth slowed last month. Will this trend last?

This note was originally published March 11, 2013 at 12:08 in Restaurants


MCD reported February global same-restaurant sales growth of -1.5% versus consensus of -1.6% (not adjusting for the calendar shift).  While calendar shifts are material for monthly headline numbers, the trend in McDonald’s comparable sales growth is unmistakably negative.  In five of the last eight months, McDonald’s has reported flat or down same-restaurants sales growth.  This is the longest sustained slowdown in sales trends since the company’s historic “plan-to-win” turnaround. 

This begs the question: can McDonald’s maintain its long term system-wide sales and operating income growth targets of 3-5% and 6-7%, respectively?


We remain skeptical that this slowdown is macro-driven; it seems evident that there are company-specific issues that are yet to be addressed by management.   Below, we update our thoughts on the various geographies.





There is nothing in the currents sales trends or in management communicated turnaround strategies that would cause us to reverse our negative stance on MCD.  We still believe MCD will see flat-to-low single digit EPS growth in 2013.  The emphasis on value has boosted MCD SRS growth in recent months, but history has shown that this strategy is not effective over the long term.  In fact, it externalities of this approach can impede sustainable earnings growth over time as operational complexity increases. 


The macro environment is challenging for a number of companies but the changes in McDonald’s long-term trends suggest that there are company-specific issues at play.  The current guidance for food inflation suggests that 2013 will not be as big an issue for MCD as in 2012, but the risk of upward revisions remains high.  Operating margins around the world are likely to continue to be pressured by sales deleveraging and incremental development costs.   


Our macro team retains its bullish view on the USD which would be a headwind for MCD Earnings, given its FX exposure.





February comparable sales growth for the domestic market was -3.3%, or flat excluding the segment’s calendar shift, versus consensus of -3.6%.  Sales were better than expected despite choppiness in consumer spending trends.   February represented the most difficult comparison for MCD in the U.S.



  • Fish McBites were introduced
  • Heavy focus on the Dollar Menu continued
  • Several lower-performing items were dropped from the menu, including the Fruit  & Walnut Salad and Chicken Selects.  We expect McDonald’s to drop the Angus Burger in the near future
  • Monthly SRS have held up on the back of incremental value message promotion, but this is not a sustainable trend
  • Extended hours are not driving incremental sales
  • The $6-7 casual dining lunch price point of $6-7 is competitive with MCD core menu items at lunch



MCD Europe

Europe comparable sales growth came in at -0.5%, or +2.7% excluding the calendar shift, versus -0.4% consensus. 



  • Russia and the UK continue to generate positive same-restaurant sales on the back of extended day parts and it appears that the horsemeat scandal may not have significantly impacted UK trends
  • German and France continue to experience declining sales and traffic trends, despite continuing messaging around value platforms
  • Margins in Europe are under pressure and will likely Margins in Europe are under pressure and will likely continue to contract in FY13 as sales growth remains under pressure in the region
  • The boost from reimaging is likely to diminish over time as almost all of the interiors and half of exteriors in the region have been completed





Asia/Pacific, Middle East and Africa (APMEA) February comparable sales growth decreased -1.6%, or +1.5% including the segment’s calendar shift, versus consensus of  -1.5%.



  • Australia continues to deliver positive SRS growth, while China benefited from the timing of Chinese New Year
  • Japan trends remain soft with February SRS trends of -12.1%
  • Average check at MCD Japan improved but traffic continued to decelerate, declining -10.9% year-over-year, versus the -8.1% decline in January.
  • Given the seemingly secular deceleration in Japan and the difficult environment in China, APMEA is also likely seeing continued margin pressure
  • What ideas, beyond value, are being put forward to improve the APMEA business?
  • Almost 2/3 of markets offer extended hours of some form and over half are open 24 hours.  This spigot is slowly closing from an incremental sales growth perspective.



Howard Penney

Managing Director



Rory Green

Senior Analyst




Morning Reads from Our Sector Heads

Takeaway: Here are some items that caught our analysts’ attention today.

Consumer Staples sector Rob Campagnino looks at the weighty issue of the soda ban in New York.



Our gaming, lodging and leisure team is reading about some management issues potentially affecting one casino.



Our energy team is reading about Southern Pacific.


February comparable sales grew +2% in Yum!’s China division.  Consensus was expecting -8.8%.  This release is spurring optimism that the worst of the fallout from the chicken supply scandal in YUM’s largest market may be in the rear view mirror.



Sequential Improvement


Yum! Brands reported 1Q China comps of -20% versus consensus -24%, including KFC -24% and Pizza Hut -2%.  February was a driver of sales growth with comps growing 2% versus consensus -8.8%, suggesting sequential improvement through the quarter.  A timing shift related to the Chinese New Year had a positive impact in the mid-teens.  KFC comps were flat in February while Pizza Hut comps grew 13%.



Full-Year View

We stepped back from our bullish stance on the immediate- and intermediate-term durations on February 4th, publishing a note titled, “YUM GUIDE DOWN A GAME CHANGER”, citing a lack of visibility on same-restaurant sales growth.  The long-term growth story has remained intact through all of the volatility.  Yesterday’s release suggests that the fallout from the chicken supply scandal may be abating with time as YUM’s PR machine has gone into overdrive to regain consumer trust.  We will wait for further confirmation on the near-term duration, but this gives us confidence that the long-term upside for YUM shares represents an attractive opportunity for investors willing to look through near-term issues.


Our Sum-of-the-Parts valuation that we published late last year, as part of our Black Book titled, “YUM: BEST LARGE CAP OUTLOOK FOR 2013”, suggested a twelve month upside to the 11/29/12 share price of 20% to $89.  While not for the faint of heart, we believe that YUM still represents compelling value over the long-term TAIL duration.


Please reply to this email for a copy of this Black Book.



Quantitative Setup


Our CEO, Keith McCullough, sees the stock as breaking out of an important base.  Intermediate-term TREND and long-term TAIL levels of support are at $66.41 and $65.07, respectively. 





Howard Penney

Managing Director


Rory Green

Senior Analyst

Early Look

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