Takeaway: McComb might be moving on, but this story remains a rarity in retail. We liked it at $4 and like it at $34. Price targets are way too low.
Conclusion: KATE remains one of our top ideas. We continue to believe that earnings power will rise from just $(0.15) in this (investment) year, to better than $3 per share over 3-5 years as the Kate Spade brand fills out its footprint, grows productivity, and takes up margins. We think that this story is unique in that it’s not just about a company that’s adding a bunch of stores, or a brand that found a niche and is growing it accordingly. This is brand that built a strategy around selling product across multiple categories (handbags, accessories and apparel, etc…), to multiple affluent consumers (Kate Spade, KS Saturday, and Jack Spade) in several channels of distribution (wholesale, retail, dot.com, and concessions) in several regions of the world. These characteristics might be expected from a multi-billion dollar company. But keep in mind that KATE is less than $800mm in sales. Never in 20 years have we seen a consumer brand be so broad in its reach and yet so concentrated in its focus. We’ve been fans of KATE/FNP/LIZ since it was at $4. We’re often asked when we’re going to get off the story. The simple answer is…not yet. Not until the financial model ceases to work for us. Based on everything we see, this will be a name to stick with for some time to come. Revenue streams that go from $800mm to $3bn are tough to find.
A FITTING CURTAIN CALL
This was a solid quarter – though the market is already making that point clear. We think it was a fitting curtain call for outgoing CEO Bill McComb. Let’s face it, the guy was arguably one of the least popular CEOs in retail 2-3 years ago. The Street couldn’t stand the guy. But the reality is that behind the scenes, he was doing all the heavy lifting that ultimately created so much value for some of the very people who criticized him. He sold Mexx – easily the worst Paul Charron (former CEO) acquisition we’ve seen – and there were many. He punted the stodgy department store Brands, got rid of Juicy, and finished off with a sale of Lucky. Maybe not the best economic terms for all of the deals, but he got it done. Period. And all while growing the crown jewel. Congrats Bill. We wish there were more like you.
TRANSITION IS BIGGEST RISK, BUT NOT REALLY
All that said, we put back on our analyst hat and wonder what could go wrong now that McComb is gone. Regardless of our high opinion of the ‘new’ management team, we need to respect the reality that whenever there’s change in a complex organization, things can go wrong. We can’t point to any obvious stress points right now, however. The reality is that Craig Leavitt was being groomed to be the next CEO for the past 18 months. They kept it quiet, but it’s the truth. Any major business planning meetings (even for non Kate brands) – Craig was there. CEO-level customer calls – Bill and Craig. Organizational decisions – you guessed it…he was part of them. On top of that, the fact that George Carerra – who has always been a very operational-focused CFO – was elevated to COO makes perfect sense. George will prove to be a big crutch for Craig in key areas where Craig quite frankly should not be focusing his time. The punchline is that this whole management transition started long before anyone thought it did, and we think that the company covered most of its bases.
SOME THINGS THAT STOOD OUT FOR US ON THE CALL
The reality is that there’s really no change to our thesis. This quarter gave us further ammo supporting our bull thesis. But there were a few things that stood out…
- We’re seeing an acceleration in store openings, and the quality is high. Out of Juicy’s 120 stores, about 30 will make their way into KATE’s fleet. They’re only converting the highest quality properties. The company has about 215 stores today, and will add about 90 in 2014 – that’s about 42% growth in units.
- In addition to the unit growth, we’re starting to see a far greater proportion of units come into the comp base. Only 60% of the current fleet is in the comp base today, or about 130 stores. We should see another 100 added by the end of 2015 – something that we think will be weighted toward 1H15.
- Let’s address the comp guidance of 10-13% for the year. The reality is that in his new role, Leavitt does not want to miss a comp – ever. We think that 10-13% is a slam dunk for a few reasons. First off, as noted in the point above, as we see more stores added to the comp base, it is a natural lift to y/y sales comps. More specifically, as the stores start to approach the ‘sweet spot’ of the comp curve of roughly 3-4 years, it provides an added lift – which bolsters our model in 2015 and 2016. Lastly, productivity at Kate was only $1265 this quarter, and while impressive, it’s still a far cry from the high teens and $2000+ rate being realized by US luxury competitors.
- Kate’s EBITDA margins were up for the first time this year, despite investment in Kate Spade Saturday. The company did its best to keep margin expectations grounded for 2014, and they probably succeeded in keeping them up no more than 100bp. Our numbers assume twice that rate.
- Adelington: The division isn’t really worthy of real estate in a research note, but there were a few notables that relate to other retailers. A) the QVC license is underperforming, which hurt revenue, B) The conclusion of the Dana Buchman/KSS partnership dinged the top line, but on the flip side C) Since the change in JCP’s promotional strategy, KATE has seen more positive trends in its Jewelry business.
BLMN remains on the Hedgeye Best Ideas list as a SHORT.
SOLID 4Q13 RESULTS
BLMN reported 4Q13 results mostly in-line with expectations before the open. Total revenues of $1.051 billion and adjusted EPS of $0.27 slightly beat expectations by $3m and $0.01, respectively. Total revenues increased 5.2% YoY, driven by revenues from new restaurants, an increase in comparable sales and the consolidation of one-month of sales generated by Brazil operations. EPS growth was driven by marginally stronger restaurant level margins, due to higher AUVs and productivity savings, and lower corporate and compensation expenses.
Comparable store sales at BLMN’s two biggest brands fell short of street estimates. System-wide, Outback and Carrabba’s comps missed expectations in 4Q13 by 10 bps, 50 bps and 50 bps, respectively. Outback and Carrabba’s disappointed despite growing their lunch business by a large margin in 4Q. At the end of the quarter, weekday lunch was being offered at approximately 35% of Outback locations and 40% of Carrabba’s locations. This is up significantly from the third quarter, when only 26% of Outback locations and 28% of Carrabba’s locations offered weekday lunch. With this degree of daypart expansion, these two concepts should be expected to grow traffic and outperform the industry. Outback only managed to grow traffic 0.5% and management didn’t reveal traffic trends at the Carrabba’s brand. Bonefish and Fleming’s comps beat expectations in 4Q13 by 80 bps and 70 bps, respectively.
Although 4Q13 was a difficult quarter for many casual dining operators, BLMN managed to outperform the Black Box Index by 150 bps. The 1.4% system-wide comp growth was driven by increases in price and traffic, partially offset by a lower mix due to lunch expansion. This number also benefitted 40 bps from a calendar shift in the quarter. Traffic grew by 0.3% in the quarter, consistent with what is to be expected of a company rolling out lunch across multiple brands.
Two-year sales trends remain weak across all four concepts.
GUIDING DOWN FY14
Street estimates for FY14 proved too aggressive as management reigned in guidance and expectations across the board.
FY14 Financial Outlook
*Guidance indicates the low-end of management’s range
There were clearly some positives in the quarter, but there are also several signs that the underlying trends are not as strong as management is portraying. That being said, we will revisit our short case and provide an updated outlook in the coming days.
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Takeaway: Darden management's "strategic plan" could do more harm than good.
Editor's note: What follows below is a brief distillation from Hedgeye Restaurants Analyst Howard Penney's institutional research note yesterday. If you are an individual investor and would like more information on how you can subscribe to Hedgeye click here. Institutional investors, please ping email@example.com.
- We woke up to news today that activist investor Starboard may call a special meeting to halt Red Lobster's spinoff.
- As we wrote in our note, “Clarence’s Legacy, A Half-Baked Plan,” back when the plan was announced, Darden CEO Clarence Otis’ legacy will be defined by his unwillingness to make the changes necessary to create significant value for shareholders.
- The takeaway from stock action (and, in our opinion, sentiment since 12/20/13) is DRI rallies when there is movement toward replacing management and sells off when management publicly digs their heels in.
- All told, the plan presented in December seems reactionary and hastily put together. It fails to address declining traffic, margins and relevance as well as potential solutions to these issues.
- After a series of conversations with industry insiders and some independent thinking, we’ve concluded that Darden’s strategic initiatives could actually end up destroying shareholder value.
- Our plan creates four operating companies focused on: Italian, Seafood, Steak and Growth. This would properly allow for intensive focus on guest targets and specific brand priorities in each respective category.
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Takeaway: As for the fundamental reality of #InflationAccelerating’s impact on growth, I don’t think the market cares until it has to.
Editor's note: This complimentary unlocked research note by CEO Keith McCullough was originally published February 24, 2014 at 13:02 in Macro. For more information on how you can subscribe to Hedgeye click here.
POSITIONS: 5 LONGS, 6 SHORTS @Hedgeye
Why the ramp right back to the all-time SPY highs? Surprisingly, there was a net short position (futures and options contracts) of 93,465 (Index + E-mini) in SPX on Friday’s close. Unwinding some of that happens on green, not red.
As for fundamental reasons, evidently the machines still love the smell of Burning Bucks (Dollar Down again today) as the hyper-mo-mo SPX vs USD inverse correlation (15 days) has moved to -0.94.
As for the fundamental reality of #InflationAccelerating’s impact on growth, like in Q1 of 2011 (when we made the same bearish call on US consumption), I don’t think the market cares, until it has to (which can start from today’s overbought price inasmuch as any other).
Across our core risk management durations, here are the lines that matter to me most:
- Immediate-term TRADE overbought = 1859
- Immediate-term TRADE support = 1816
- Intermediate-term TREND support = 1791
In other words, TREND support is -3.7% versus the price on your screen right now (#RealTimeAlert to short SPY = $186.11 at 12:19PM EST) , and I don’t think it will take this market much (a down day will do) to re-test that level of 1791.
If the US government burns its currency like Venezuela did, the SP500 could be up another +450% from here. But don’t worry about that. I’m sure that would be great for someone - just not for American GDP.
Keith R. McCullough
Chief Executive Officer
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