JCP - Taking Off Our Long Bench

Takeaway: After having a long bias on JCP, we now think the upside/downside is symmetric - from $15 to $0. Not the risk/reward we like on either side.

Conclusion: We’re taking JCP off of our ‘Long Bench’ and are making some meaningful downward revisions to our model. This is not all about the 3Q print, but rather our confidence in the company’s ability to drive its top line in conditions that are anything other than optimal. Modeling ‘optimal’ conditions for the next four years hardly seems realistic, and irresponsible considering JCP’s debt maturity schedule. To be clear, we’re not making a short call. But now, we think that the likelihood of the stock going to $15 is equally offset by the chance of it going to zero (something we previously assigned a very low probability). That’s hardly a palatable risk/reward with the stock at $7.50.



It’s extremely rare that a quarterly earnings print will sway our opinion meaningfully on a stock. But this is definitely one of those times. While we did not have JCP on our list of top longs we definitely had a positive bias in our view on the company’s recovery and earnings potential.  Based on our view of where the department store space is headed, and where JCP’s market share and cost structure are both likely to shake out – we now don’t have JCP turning a profit on the P&L until 2019 vs our previous model of break-even by 2016. If our numbers are right, that means that JCP will have to go through another economic cycle losing money, which matters with the stock trading at 14.5x EBITDA and 6.5x an EBITDA number that’s five years out.


Liquidity is something to consider as it’s no longer a key point of the debate today (nor should it be based on current conditions).  To be fair, if we’re going to assume that the economy grows at a normal clip every year for the rest of this decade, then it shouldn’t be part of the debate, as JCP will be just fine. But not having a very bad sales/margin event at some point over the next four years would make this latest expansion one for the record books. We know it’s ‘out there’ to be so focused on what could happen as far as 2018, but the company faces a very big maturity in ’18 – $2.2bn to be exact. If it had to refi that today, it would probably not have a major problem.


But what happens if the company has to do so defensively in the event of a recession/bad economic event in 2016/17? The loan is secured by JCP real estate. It would be backed into having to either a) refinance at a grossly unfavorable rate, b) issue some equity-linked security, or c) surrender the property and then pay market rents if it wants to retain the business. None of those outcomes is attractive. In fact, they’d all send the stock a lot lower from where it is today. This did not matter as much for us with the company growing sales in the mid-high single digits. But our previous assumption seems far too aggressive based on what we’re seeing right now.


Are we making the ‘bagel’ call? No. We are not. We want to be clear about that. But in stress testing the model, we think that a double from here is just as likely as the stock going to $0. That’s not a risk/reward we like to see. We’d simply stay away at this price.


Why Such A Dramatic Change?


Business Changed Very Quickly. Just five weeks ago, JCP lowered guidance to a ‘low single digit’ comp versus previous guidance of ‘mid-single’. That’s usually interpreted as a 2-3% comp, which we think the company implied. But for the quarter, comps came in flat versus a year ago. That means that October must have been an unmitigated disaster. But yet JCP said that September was the worst month of the quarter. Sounds to us like the company was missing materially a month ago, and threw out a ‘low-single’ target with its fingers crossed along with a healthy dose of hope that October would improve. That’s extremely poor risk management.


Gaining Share? JCP only comped 140bps ahead of Macy’s (and KSS based on its preannouncement).  Let’s be clear, for this story to even approach something that is palatable, it needs to gain significant share on a reasonably consistent basis without buying it.  The problem with this quarter is JCP did not have a merchandising miss, didn’t stumble in a specific category, or suffer anything else that is company-specific other than a 30% decrease in liquidation sales. But that was known when the company provided guidance. It was because of the same old reasons we hear from all the other mediocre retailers – weather, competition, promotional climate, and overall ‘tough retail environment’. Note: Great companies – or even mediocre ones with solid revenue plans – don’t talk about these factors.


What Happens When Things Aren’t So Good Out There? We understand that there are likely to be quarters where JCP performs closer to the peer group than others. This might be one of them. Also, the company put up a stellar 718bp improvement in Gross Margin. It could have easily forgone some of that margin in favor of a better comp. But management said flat-out that it will do mid-single digits longer term…just not this year. What we don’t understand is that this is a company that is in recovery, and is only putting up comp store sales growth (including e-commerce) of 3-4% in a decent enough economy.


What happens if the consumer cracks? What happens if the current 6-year growth and margin retail expansion cycle comes to an end, and ‘re-cycles’. It’s been known to happen from time to time (about twice a decade for the past 40 years).  So basically – the company all but admitted that it can only comp msd when the economy is extremely healthy and/or the retail climate becomes ‘easy’. That’s just something that we’re not willing to put in our model for ANY company.


No Store Closures: Sounds like store closures are definitely not on the front burner. Not even close. Maybe down the road, but not now. Management admitted the same exact thing that KSS said a few weeks back – virtually all stores operating today are making money, and are cash flow positive. Furthermore, our work suggests that unlike in past cycles, retail CEOs will avoid closing stores that are otherwise considered marginal as retail stores are inextricably linked with e-commerce. Closing stores – even bad ones – risks losing e-commerce revenue. The only line item (aside from SG&A) growing for any department store is revenue, and the companies won’t risk shooting themselves in the foot by shutting down one of the biggest assets that enable e-commerce. The point is…no major store closure/cost cutting plan.


Key Assumptions In Our Model

Sales: We assume store sales grow at a 3% clip, with e-commerce growing closer to 10%. That lands us at around 4% top line growth through 2018. It also suggests that JCP gets back to $130 per square foot. That’s a far cry from its former $195 and KSS $210. But it’s better than the $108 JCP is sitting on today.


Gross Margin: We tempered our assumptions here. Assuming JCP adds 200bp over 5 years to 36.4% -- that’s down about 150bp from our previous model. On one hand, the company has been doing a great job in recovering margin, but on the flip side, a lower comp growth base will mitigate occupancy leverage.


SG&A: Growth of 1-2% per year. This is a company that used to have $5.3bn in SG&A on the same store base we have today. Today SG&A is just below $4bn. It’s probably headed higher. No changes in our modeling assumption here.


Capex: $250mm this year ramping to $400mm by year 5. Yes, the $1bn RonJon cap spending was too high. Now JCP is overshooting on the downside. If it wants to gain share, capex will need to rise. As with SG&A, we did not change anything here.


Free Cash Flow: We have FCF within about $100mm of break-even (usually positive) over the foreseeable future. The challenge is that we’ll need more than that to handle debt maturities which total $600mm over the next five years until the big $2.2bn refi in 2018. 


TWTR: Long on Promise, Short on Detail (Investor Day)

Takeaway: The bigger issue remains: the perverse relationship b/w its user & revenue growth. The Street will not accept weakness on either front


  1. COURT THE PASSIVE VISITOR: TWTR gets a lot more passive traffic than its MAU metrics suggest.  Visitors get routed to twitter when clicking a twitter-related link while on another site, but most of these visitors do not interact with twitter past that point.  TWTR is looking to court the passive user by presenting them with a timeline of tweets when that occurs, hoping it will boost their registrations & MAU metrics.
  2. EXPAND PRODUCT PORTFOLIO: There was a greater emphasis on enhancing private chat options.  TWTR also wants to introduce new products to expand its product portfolio, suggesting a greater emphasis on Vine, but no other detail regarding other potential ideas.
  3. ENHANCE DEVELOPER FUNCTIONALITY: TWTR wants to make it easier for developers to interact with the twitter platform.  The rationales is that if developers can build and monetize their third-party applications, TWTR could reach a broader audience.



  1. LONG ON PROMISE, SHORT ON DETAIL: The only real detail came on its efforts to court the passive user.  Outside of that, nothing material.  Remember that FB also experimented with private chat options (Facebook Messenger), then wound up acquiring WhatsApp.  In terms of additional products, we suspect that means acquisitions (TWTR just raised $1.7B in new capital).  Expanding third-party application efforts could have the perverse effect of routing TWTR users away from the platform (same as Tweetdeck did before TWTR acquired it).  In short, we wouldn’t get too excited.
  2. THE BIGGER ISSUES REMAIN: TWTR’s strength over the LTM has been driven primarily by monetization, which we estimate has been driven by surging ad load more than anything else.  We suspect there is a perverse relationship between ad engagements (monetization) and user growth, which suggests that its surging ad load strategy is pressuring user retention.  This relationship creates a tug of war between user and revenue growth; if TWTR experiences any weakness on either front, the street will hammer the stock for it.


TWTR: Long on Promise, Short on Detail (Investor Day) - TWTR   Ad Engagement vs. Pricing 3Q14

TWTR: Long on Promise, Short on Detail (Investor Day) - TWTR   Ad Load vs. US MAUs 3Q14

TWTR: Long on Promise, Short on Detail (Investor Day) - TWTR   HRM vs. Consensus 3Q14


For more detail on our short thesis, see link to our most recent note below.  Let us know if you have any questions, or would like to discuss in more detail.


TWTR: The Story Has Changed

10/28/14 07:13 AM EDT



Hesham Shaaban, CFA



Cartoon of the Day: On the One Hand...

On the one hand, gas prices have dropped for 46 straight days to their lowest level in four years.


On the other hand...


Cartoon of the Day: On the One Hand... - gas price cartoon 11.12.2014

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Retail Callouts (11/12): FOSL, KORS, WMT, DKS, AMZN, EBAY

Takeaway: FOSL hits trifecta–beat, algorithm, KORS – with big ROE kicker. WMT’s employee problem is bigger than grocery. Golf sales still in the tank.



Retail Callouts (11/12): FOSL, KORS, WMT, DKS, AMZN, EBAY - 11 12 chart2





FOSL - 3Q14 Earnings


Takeaway - Fossil hit the earnings trifecta this quarter. Not only did it beat the quarter by 8%, but did so by putting up a clean algorithm of +10% sales, +15% net income, and +25% net income. Its SIGMA trajectory swung towards the upper right hand quadrant, which is bullish for gross margins in the upcoming quarter. One thing we particularly liked was how we're starting to see a meaningful diversion between ROE and ROIC for this company. Too many companies that tout improving ROIC trends leave out the fact that they're letting cash build on their balance sheets. FOSL is doing the inverse. When we see ROE trending above an upward-sloping ROIC curve, we definitely take notice.  Oh, and by the way, the Michael Kors agreement -- which accounts for 22% of FOSL sales -- was renegotiated until 2024.


Retail Callouts (11/12): FOSL, KORS, WMT, DKS, AMZN, EBAY - 11 12 chart4


Retail Callouts (11/12): FOSL, KORS, WMT, DKS, AMZN, EBAY - 11 12 chart5


AMZN, EBAY - Sequential slowing for both AMZN and EBAY in ChannelAdvisor Comp Sales

Takeaway: The noticeable spread between the two companies in 2014 held in October.  Sales growth slowed for both companies slowed on a 1 and 2 year trend.  Ebay's +4.4% is the worst month since early 2011.


Retail Callouts (11/12): FOSL, KORS, WMT, DKS, AMZN, EBAY - 11 12 chart1


AMZN, EBAY, DKS - Golf Comps

Takeaway: Amazon golf comps put up yet another strong month.  The delta between  Amazon and eBay can partially be explained by the fact that eBay implemented a defect rate as part of its seller profile earlier this year, thus pressuring used product sellers to be more selective in their inventory.  At the same time Amazon has added features to expand the used category.  Either way, strong sales in this channel -- which is the bottom of the food chain for golf sales -- does not bode well for the category in general. The malaise that became apparent earlier this year (plaguing DKS and others) is still alive and well. 

 Retail Callouts (11/12): FOSL, KORS, WMT, DKS, AMZN, EBAY - 11 12 chart3



WMT - Walmart Memo Orders Stores to Improve Grocery Performance



Takeaway: The writer here clearly had an agenda from the start. Taking a confidential memo about the need for improvement in the grocery department and dovetailing that with a singular store visit is just flat out irresponsible. For starters, these types of memos get circulated all the time. We're sure if you found a disgruntled Whole Foods employee you could get your hands on something similar. Asking your employees to execute on the 'Would I Buy It?' grocery test isn't egregious. The troubling thing for WMT is the overall discontent from its employee - that's nothing new, we know that, but to have store managers tactically leak information to the press is never a good recipe.  This is an employee-relations problem, not a grocery problem.





WMT - Wal-Mart Stretches Black Friday Deals to Reach Shoppers



  • "The 'New Black Friday' will include five days of sales on and in stores, starting at 12:01 a.m. online on Thanksgiving and running through Cyber Monday, the Bentonville, Arkansas-based company said in a statement today."


JWN - Nordstrom Rolling Out Shoes of Prey In-Store Shops



  • "Nordstrom is rolling out in-store shops for Shoes of Prey, an Australia-based online firm that enables women to design their own shoes."


Cambodia to Increase Minimum Wage



  • "The minimum wage in Cambodia’s garment sector will be raised to $128 beginning in 2015, a 28 percent increase over the current $100 monthly wage."


REI names its first-ever chief creative officer



  • "Outdoor outfitter REI has added a chief creative officer slot, and hired Ben Steele to fill the position, effective Jan. 1. Steele most recently served as executive creative director at global brand firm Hornall Anderson in Seattle."


BBY - Best Buy to open 5 p.m. on Thanksgiving, one hour earlier than last year



Keith's Macro Notebook 11/12: Sentiment | Europe | UST 10YR

Sentiment, Europe and UST 10YR (UPDATED)

Client Talking Points


What isn’t bearish is how people were positioned at the SEP $SPX highs and this morning’s – II Bull Bear Spread (bulls minus bears) is +99% to the bullish side since OCT 13th (14.8% Bears tracking all-time lows).


Saw a lot of “charts” in which people were claiming Europe was “breaking out yesterday” – in other news this morning, Italy leads losers -1.6% - MIB Index, the DAX -0.9%, and Eurostoxx50 -0.9% all confirming bearish TREND @Hedgeye).


UST 10YR Yield is down 3 bps this morning (after falling last week on a bad jobs report) to 2.33%, continues to crash (-23% year-to-date) vs. misplaced U.S. growth expectations of +3-4%; we still see sub 2% for the year when it’s all said and done (Q4 slowing).

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). U.S. real GDP growth is unlikely to come in anywhere in the area code of consensus projections of 3-plus percent. And it is becoming clear to us that market participants are interpreting the Fed’s dovish shift as signaling cause for concern with respect to the growth outlook. We remain on other side of Consensus Macro positions (bearish on Oil, bullish on Treasuries, bearish on SPX) and still have high conviction in our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.


We continue to think long-term interest rates are headed in the direction of both reported growth and growth expectations – i.e. lower. In light of that, we encourage you to remain long of the long bond. The performance divergence between Treasuries, stocks and commodities should continue to widen over the next two to three months. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove. We certainly hope you had the Long Bond (TLT) on versus the Russell 2000 (short side) as the performance divergence in being long #GrowthSlowing hit its widest for 2014 YTD (ex-reinvesting interest).


The U.S. is in Quad #4 on our GIP (Growth/Inflation/Policy) model, which suggests that both economic growth and reported inflation are slowing domestically. As far as the eye can see in a falling interest rate environment, we think you should increase your exposure to slow-growth, yield-chasing trade and remain long of defensive assets like long-term treasuries and Consumer Staples (XLP) – which work decidedly better than Utilities in Quad #4. Consumer Staples is as good as any place to hide as the world clamors for low-beta-big-cap-liquidity.

Three for the Road


BoE growth outlook cut:  2015 GDP at 2.9% vs 3.1% in August and 2016 GDP at 2.6% vs 2.8%. Inflation outlook also revised down #EuropeSlowing



Either write things worth reading or do things worth writing.

-Ben Franklin


Wal-Mart isn’t concerned about slowing growth in China; the Company is sticking by a plan to have around 480 Wal-Mart stores in China by the end of 2016.

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