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KATE – Chump Change

Takeaway: By the time KATE approaches year 3-4 of our model, yesterday’s stock action should look like chump change.

The 17.9% pop in KATE’s stock yesterday leaves little for us to add regarding the event itself. But we want to make one thing crystal clear, by the time KATE approaches year 3-4 of our model, yesterday’s stock action should look like chump change. We think there’s $3bn in revenue for this brand (at the consolidated P&L level -- $4.8bn in aggregate brand sales at retail), a high teens margin, and $3+ in EPS power. The 50-60% CAGR (depending on base year) makes us more than comfortable with a 30x+ multiple in the out years (much higher near-term), and a roadmap to a $90-$100 stock.  We hosted a call on Wednesday where we outlined our thesis in a 40-page slide deck. Here’s the replay info and link to the presentation materials in case you missed it.

 

Materials Link: CLICK HERE

Replay Link: CLICK HERE

 

As for the quarter, the biggest positive for us (and probably for the stock) was the dramatic change in management’s tone. Again, this is a team that inadvertently evaporated $1.7bn in equity value during the 2Q call in the face of otherwise stellar results due to an odd mix of way too much information in the face of insufficient disclosure, and no real command of its future. But fast forward 13 weeks, and this time it was as if we literally heard a different management team.

 

1) First off, the call was tight – less than an hour. It is the shortest call on record for KATE, FNP, or LIZ back to at least 1998. The company has always drowned the Street with way too much information that ultimately does not matter.  But this time the message was concise, and the company prevented a situation where the 20th analyst in the queue from a no-name shop could pester the CEO about why the store in Mercedes, TX was out of inventory of chambray totes.

 

2) The overall tone, cadence, and command of the business and message – especially from Craig Leavitt – was at least as good as one would expect from a company twice the size of KATE. In fact, when we juxtapose Leavitt with KORS CEO John Idol on their respective calls this quarter, KATE definitely gets the nod. (Now all Leavitt needs to do is execute like Idol has).

 

3) A definite tonal change on the part of management is that there appears to be zero tolerance for sustaining the existence of dilutive businesses – most notably Jack Spade and Kate Spade Saturday. Though KATE will move forward with its plan to invest in these businesses, it sounds like they are both on a short leash. At best, they only account for 5% of total sales for now. We’d rather see the real estate converted to KSNY, which would probably double the revenue contribution of those real estate assets. But 3 months ago, it seemed like the company would let these brands be dilutive forever. That’s clearly no longer the case (truth be told, it probably never was the case – but the public perception is that it was, which drained KATE’s multiple).   

 

 

Guidance:

  1. Resetting the base: 2016 targets now call for Kate Spade & Co. EBITDA margins to be in the range of 18%-20% on a sales number that is tracking well ahead of plan. Two small changes in the language here: 1)  Corporate expenses are now fully allocated in that target (which we knew was coming), and 2)  it is now looking at the consolidated company which includes Adelingtion for the time being. If we pin Corporate at 5% and add that to the new targets that equates to about 23-25% on an apples-to-apples basis with the old reporting structure. To add context, it's important to note that corporate was 7%-8% of sales in FY 13 depending on which number you look at (Comparable Adjusted vs. plain old Adjusted).
  2. Comp: Guidance for the year (19%-21%) looks beatable to us. It assumes a window for 4Q between 8% and 14%. We're at 18%. Given the moving parts in 3Q, 4th of July and Semi-Annual sale moved into 2Q, we should see a sequential acceleration heading into Holiday. The elimination of 'Surprise Sales' is a bit of a headwind, but we are not overly concerned. Assuming that dot.com now accounts for 25% of sales (up from 18% in 3Q13), that implies a 21% growth rate in the quarter.  At a 20% penetration number it’s 23%.
  3. EBITDA: KATE (and its predecessors) is not known for taking up guidance – it’s been the opposite historically more often than not. The company guided the range up $10mm for the year from $120m to $130m on an in line print. The lion share of that beat comes from upside in Gross Margin targets though we still see upside given the run rate over the past two quarters. -75bps in 2Q (ex. 240bps Kate Spade Saturday dilution) and +144bps in 3Q. To get to the high end of guidance which calls for 125bps of dilution we'd have to see a 300bps sequential declaration on the 1 year trend line and 150bps on the 2yr.

KATE – Chump Change - kate financials


They Can't Fix This

This note was originally published at 8am on October 24, 2014 for Hedgeye subscribers.

“The problem with the big focus on making capital cheaper… is it’s akin to fighting fire with fire.”

-Dan Alpert

 

That’s a quote from the beginning of chapter 6 of The Age of Oversupply, by Dan Alpert. The chapter was a good one titled “The Empty Toolbox” and it focuses on why central planners “can’t fix the economy.” #agreed

 

Whether you are looking at the US economy or global one slowing right now, it’s important to keep these v-bottom moves in equity markets in context. Where are they v-bottoming from? Oh, and why did they go down so hard so that they could v-bottom to begin with?

 

Our call throughout the year has been very consistent on the why – growth is slowing. And when early-cycle growth slows from multi-year highs, you short the most illiquid form of beta chasing (small cap stocks) and you buy the Long Bond.

 

They Can't Fix This - EL chart 2 

 

Back to the Global Macro Grind

 

I was at a dinner meeting in Maine last night and an entrepreneurial CEO asked me a question I’ve been asked by hundreds of non-Wall Street people in 2014: “What do you think I should do with my money right now?”

 

I’m not the beat-around-the-bush-type, so I told her exactly what I have been telling people all year:

 

  1. Sell stocks
  2. Buy bonds
  3. Raise Cash

 

As basic as this advice has been is as hard as it’s been for people to just execute on it. But, with the total return of the Long Bond (TLT) at almost +19% for 2014 (vs. the Russell 2000 down -4%), why is that?

 

A: It’s not what “everyone” is saying people should be doing.

 

That’s it. From New Hampshire to California and everywhere I’ve been this year in between. That pretty much sums it up. The response is always the same: “but can’t interest rates go up? Aren’t bonds expensive?”

 

What’s been really expensive is believing that central planners can bend gravity and deliver +3-4% economic growth. If they deliver 0-2%, “expensive” bonds are going to get more expensive, and really expensive growth stocks (think Amazon at 112x earnings) are going to continue to crash.

 

But, but… “Keith, this bounce is crazy – why can’t it keep going…”

 

If I have some iteration of that in my inbox 100x in the last 3-4 market days, I have it 1,000x. And all I do is shake my head wondering why so many refuse to take a lesson from the risk management exercise learned as the Russell  was having a -15% draw-down and the 10yr broke 2% only a week ago.

 

To review the #Quad4 deflation case that Mr. Market is effectively yelling right now:

 

  1. Bond Yields (10-30yr) in the US are crashing
  2. Oil prices are crashing
  3. Over 60% of stocks in the Russell 2000 are crashing

 

To be fair, if you didn’t have a view that all of these things would go down, you blamed ebola (and Canada) and wore them the whole way down anyway. But, if you did, you are killing it YTD and in a position to re-ramp every position you’ve had throughout the last 6 weeks of macro market volatility.

 

We’re deep into 2014 and at this stage of the season playing this game from a position of strength is entirely different than playing it from a position of weakness. If you’ve been winning, you don’t have to spend your entire day worrying about why the stock market is bouncing and bonds correcting.

 

You’ve realized that the Fed, Bank of Japan, and European Central bank have all cut to zero. You’ve also reminded yourself that 0 + 0 doesn’t equal something greater than zero – and that they can’t solve for #GrowthSlowing again.

 

In other words, they can’t fix this. Unfortunately, only a deflationary reset can.

 

Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets – which you can get in our Daily Trading Range product as well) are now:

 

UST 10yr Yield 2.11-2.32% (bearish)

SPX 1835-1963 (bearish)

RUT 1040-1127 (bearish)

Nikkei 14503-15449 (bearish)

VIX 15.06-28.49 (bullish)

USD 85.01-86.20 (bullish)

EUR/USD 1.26-1.28 (bearish)

Yen 105.36-108.31 (neutral)

WTI Oil 79.75-82.62 (bearish)

Natural Gas 3.51-3.74 (bearish)

Gold 1226-1251 (bullish)

Copper 2.95-3.05 (bearish)

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

They Can't Fix This - Chart of the Day


Oil Finally Catches a Bid! (Okay, Maybe Not)

Takeaway: The reality of #Quad4 deflation is sinking in.

Well, that was quick. Oil had a brief, one-day bounce and then went straight back down again. 

Oil Finally Catches a Bid! (Okay, Maybe Not) - chart 2

 

It’s down -14% over the last month and currently down -1.50% to $77.50 today. Right now, the reality of #Quad4 deflation is sinking into the fragile psyche of those who‘ve been net long of oil carry trading since The Bernanke introduced it in 2008. The times, they are a-changin’...

 

The intermediate-term risk range is now $64-84.


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CLAIMS QUICK READ & THOUGHTS AHEAD OF NFP

Takeaway: NFP has a 2/3 chance of being up, not down as expected. Meanwhile, claims continue to move lower.

Handicapping Tomorrow

Two months ago we published a report (link) in conjunction with our Macro Team that looked at the predictive power of the ADP report at handicapping the NFP report. In a nutshell, roughly two-thirds of the time the directional move in ADP (i.e. better or worse sequentially) predicts the directional move in NFP. This creates an interesting opportunity in months when ADP goes one way and expectations are for NFP to go the other way. Tomorrow's NFP report represents such a set-up. ADP rose to 230k this month from 213k last month. Meanwhile, expectations are for NFP to shrink from 248k last month to 240k this month. Given that the move in ADP wasn't huge and the expectations for sequential deceleration in NFP aren't profound we wouldn't make too much of the divergence, but given how sensitive Financials are to labor figures, we feel it's worth pointing out.

 

In other news, initial jobless claims remains a juggernaut of sorts. Claims continue to put in new lows and are now at levels below those seen at the apex of the 2005/2006 economic expansion.

 

We'll leave you with the chart below, which shows both how strong the environment is today but also how risky.  

 

CLAIMS QUICK READ & THOUGHTS AHEAD OF NFP - 9

 

The Data

Prior to revision, initial jobless claims fell 9k to 278k from 287k WoW, as the prior week's number was revised up by 1k to 288k.

 

The headline (unrevised) number shows claims were lower by 10k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -2.25k WoW to 279k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -19.8% lower YoY, which is a sequential deterioration versus the previous week's YoY change of -20.6%

 

CLAIMS QUICK READ & THOUGHTS AHEAD OF NFP - 2 2

 

CLAIMS QUICK READ & THOUGHTS AHEAD OF NFP - 3

 

CLAIMS QUICK READ & THOUGHTS AHEAD OF NFP - 4

 

CLAIMS QUICK READ & THOUGHTS AHEAD OF NFP - 5

 

CLAIMS QUICK READ & THOUGHTS AHEAD OF NFP - 6

 

CLAIMS QUICK READ & THOUGHTS AHEAD OF NFP - 7

 

CLAIMS QUICK READ & THOUGHTS AHEAD OF NFP - 8

 

CLAIMS QUICK READ & THOUGHTS AHEAD OF NFP - 10

 

CLAIMS QUICK READ & THOUGHTS AHEAD OF NFP - 11

 

CLAIMS QUICK READ & THOUGHTS AHEAD OF NFP - 19

 

Yield Spreads

The 2-10 spread fell -1 basis points WoW to 182 bps. 4Q14TD, the 2-10 spread is averaging 185 bps, which is lower by -14 bps relative to 3Q14.

 

CLAIMS QUICK READ & THOUGHTS AHEAD OF NFP - 15

 

CLAIMS QUICK READ & THOUGHTS AHEAD OF NFP - 16

 

 

Joshua Steiner, CFA


Jonathan Casteleyn, CFA, CMT

 


ICI Fund Flow Survey - Taxable Bond Bleeding Stops...Damage is $36 Billion in Motion

Takeaway: Taxable bond fund outflows slowed to a trickle with just over $200 million redeemed this week. This has put $36 billion up for grabs.

Investment Company Institute Mutual Fund Data and ETF Money Flow:

 

The most recent ICI mutual fund survey showed a reprieve from the drastic taxable bond fund outflows of the past 5 weeks set into motion with the portfolio manager change at PIMCO. Taxable bond redemptions slowed to just $295 million in the most recent 5 days, a far cry from the past 4 weeks where the sequence of redemptions was $21.0 billion, $4.6 billion, $5.1 billion, and $4.9 billion. The total money set into motion however tallies $36 billion, which is keeping a strong bid for BlackRock (BLK) and Legg Mason (LM) and the obvious beneficiary Janus Capital (JNS). Looking at the similar analog in 2010 of Jeff Gundlach leaving TCW, the TCW Total Return Fund shed 55% of its assets-under-management (AUM) over an 18 month period, which could put a fairly long tail on taxable bond fund money in motion in the upcoming year. The PIMCO Total Return Fund prior to the Bill Gross departure had $220 billion in AUM. Thus if the TCW/Gundlach analog were to exactly play out for PIMCO, this would put over $100 billion out into the bond sphere up for grabs with Janus having the chance to capture over $70 billion (or 70% of that redemption). We think the situation is slightly different this time with PIMCO Total Return having been managed "by committee" to begin with and the fund having put up bottom decile returns over the past 18 months. Thus with lagging performance, the recapture by Gross of his prior AUM may be problematic. In the case of TCW, we assumed that Gundlach captured 70% of the TCW outflow (with money having left to other managers as well), which puts the total net capture of his existing AUM at 39 cents on the dollar.  

 

ICI Fund Flow Survey - Taxable Bond Bleeding Stops...Damage is $36 Billion in Motion - Gundlack chart 12

 

In other survey data, U.S. equity mutual funds had another slight inflow at $1.1 billion in the most recent week, although the intermediate term trend is still very soft with outflows in 24 of the past 27 weeks. Passive fund flows via ETFs were robust again with both total equity ETFs and total bond ETFs taking in substantial new assets. One call out in the sector ETFs is that the Materials Sector SPDR (XLB), lost a whopping $1.4 billion in AUM last week. That reduced total AUM by 31% in just 5 days alone.

 

ICI Fund Flow Survey - Taxable Bond Bleeding Stops...Damage is $36 Billion in Motion - new recap

 

 

In the most recent 5 day period ending October 29th, total equity mutual funds put up inflows with $2.3 billion coming into the category according to the Investment Company Institute. The composition of the inflow was balanced with Domestic stock funds taking in a $1.1 billion subscription which matched the $1.2 billion which came into International stock funds. The two equity categories have been a tale of two cities all year however with International stock funds having had inflow in 42 of the past 43 weeks. Conversely, domestic trends have been very soft with inflow in just 15 weeks of the 43 weeks thus far year-to-date and have been drastically negative the past 6 months with just 3 weeks of inflow in the past 27 weeks. The running year-to-date weekly average for all equity fund flow continues to decline and now settles at a $1.1 billion inflow, now well below the $3.0 billion weekly average inflow from 2013. 

 

Fixed income mutual fund flow had another drawdown in the most recent ICI data succumbing to more net selling from the dislocation at large bond fund manager PIMCO. Total bond funds lost another $66 million last week with the distribution focused within the taxable bond fund category which lost another $295 million in the most recent 5 days. This brings the "money in motion" or the taxable outflow to over $36 billion in the past 5 weeks. Municipal or tax-free bond funds put up a $299 million inflow, making it 41 of 42 weeks with positive subscriptions. The 2014 weekly average for fixed income mutual funds now stands at a $881 million weekly inflow, an improvement from 2013's weekly average outflow of $1.5 billion, but still a far cry from the $5.8 billion weekly average inflow from 2012 (our view of the blow off top in bond fund inflow). 

 

ETF results were very strong during the week with substantial inflows in equity funds and decent subscriptions into passive fixed income products continuing to mop up the ongoing redemption in taxable bond funds. Equity ETFs put up a $13.0 billion subscription while fixed income ETFs had a $1.3 billion inflow. The 2014 weekly averages are now a $1.8 billion weekly inflow for equity ETFs and a $1.1 billion weekly inflow for fixed income ETFs. 

 

The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a positive $14.0 billion spread for the week ($15.4 billion of total equity inflow versus the $1.3 billion inflow within fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $3.1 billion (more positive money flow to equities), with a 52 week high of $27.2 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week). The 52 week moving average chart displays the declining demand for all equity products (funds and ETFs) for the safety and security of fixed income. 

 

Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.   

 

Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the running weekly year-to-date average for 2014 and the weekly quarter-to-date average for 4Q 2014:

 

ICI Fund Flow Survey - Taxable Bond Bleeding Stops...Damage is $36 Billion in Motion - ICI chart 2

 

ICI Fund Flow Survey - Taxable Bond Bleeding Stops...Damage is $36 Billion in Motion - ICI chart 3

 

ICI Fund Flow Survey - Taxable Bond Bleeding Stops...Damage is $36 Billion in Motion - ICI chart 4

 

ICI Fund Flow Survey - Taxable Bond Bleeding Stops...Damage is $36 Billion in Motion - ICI chart 5

 

ICI Fund Flow Survey - Taxable Bond Bleeding Stops...Damage is $36 Billion in Motion - ICI chart 6

 

 

Most Recent 12 Week Flow Within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI) and the running weekly year-to-date average for 2014 and the weekly quarter-to-date average for 4Q 2014. The third table are the results of the weekly flows into and out of the major market and sector SPDRs:

 

ICI Fund Flow Survey - Taxable Bond Bleeding Stops...Damage is $36 Billion in Motion - ICI chart 7

 

ICI Fund Flow Survey - Taxable Bond Bleeding Stops...Damage is $36 Billion in Motion - ICI chart 8

 

Sector and Asset Class Weekly ETF and Year-to-Date Results: In specific callouts, the Basic Materials ETF (XLB) got hammered in the most recent 5 days losing 31% of its AUM or an outflow of $1.4 billion. In addition, it is interesting that the Energy Sector SPDR has still added 33% to its total AUM thus far in 2014 which could mean the blood letting in that group could continue with oil prices continuing a downward slope.

 

ICI Fund Flow Survey - Taxable Bond Bleeding Stops...Damage is $36 Billion in Motion - ICI chart 9

 

 

Net Results:

 

The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a positive $14.0 billion spread for the week ($15.4 billion of total equity inflow versus the $1.3 billion inflow within fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $3.1 billion (more positive money flow to equities), with a 52 week high of $27.2 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week). The 52 week moving average chart displays the declining demand for all equity products (funds and ETFs) for the safety and security of fixed income.

 

 

ICI Fund Flow Survey - Taxable Bond Bleeding Stops...Damage is $36 Billion in Motion - ICI chart 10

 

Exposures: The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:

 

ICI Fund Flow Survey - Taxable Bond Bleeding Stops...Damage is $36 Billion in Motion - ICI chart 11 

 

 

 

Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA

 


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