Incremental Thoughts On Key Retail Ideas

Takeaway: Some feedback we’ve gotten recently on our ideas – as well as where we’re incrementally leaning. RH, KATE, KSS, TGT, FL, HIBB, LULU.

Feedback we’ve gotten recently on a few of our ideas – as well as where we’re incrementally leaning.

 

RH: After the 3Q14 release, incoming call volume in the name dropped by a good 90%. The consensus was that ‘the idea worked, and there’s no major controversy to buy into.” Then RH uncharacteristically pre-announced – when the quarter was otherwise in line. Two different people called asking if there was another convert about to hit the tape, and we can’t count the number of calls asking why such a strong (24%) comp but only 22% EPS growth. The bifurcation between comp and revenue is largely related to stores being pulled out of the comp base due to the real estate plan. Keep in mind that RH will have grown revenue 20% and EPS 37% for the year, and is on track to grow revenue by 30% and EPS by 50% in ’15.  From here, the catalyst calendar is robust. The company’s 4Q earnings release in March begins a significant ramp where there’s a different catalyst about every 6 weeks through Jan (call for details).  We like this one a lot in 2015.

 

KATE: People will always find a reason to hate this name – most of it is management-related (Black Book: CLICK HERE). But consider this… Kate is closing its dog divisions (Saturday and Jack) and just put up a 28% comp in its core business for the quarter, you got to hand it to the team. Also, with Ralph Lauren comping -2% and blowing up in the worst way, Kors decelerating to a 9% comp and taking down guidance slightly, and Coach struggling to eek out a -22% comp for the quarter, KATE is even more of a standout. What we like about the KATE story is that unlike the others, there’s a square footage story here – and a big one at that. Kate has 237 stores globally, which will more than double. With margins expanding from about 10% to the high teens over 2-3 years, we think that this name has $3.00/sh in earnings power written all over it (earned $0.30 last year). We know that management does a good job of sticking several feet in their mouths at once. But focus on what they do and how they execute, not on what they say.

 

KSS: This is the first time in years where we can recall KSS not being a consensus short. The 3.7% comp reported last week was big, no doubt, and the sentiment we’re getting sounds something like “KSS just printed a sequentially improving number, and the co is about to go against its easiest comp of the year in 1Q. If the fundamental short call is right, you won’t know until July earnings at the earliest. If anything, I’d be long here.” We can’t argue with a single part of that logic. But should the stock trade near a peak 15x multiple ever, even if you assume that it beats the Street’s $4.50 and puts up a $4.75? But we still believe that earnings for the year will come in below $4.00 due to all the factors we outlined in our Black Book (CLICK HERE) as well as the impact of the new rewards program, which we think poses a risk to SG&A (ALL IN ON THE KOHLS SHORT: CLICK HERE). It’s rare you get an opportunity to short such a damaged asset at an inflated price. It’s our job to help navigate timing over the next 3-6 months.     

 

TGT: First off, investors’ appetite to short this name is very low (SI as % of float sitting at 3%) due to the concoction of a) new CEO, b) no more Canada distraction, c) lower gas prices (like w KSS), an d) continuing recovery from the data breach. All these things are fine, but the Street is looking for TGT to earn $4.45 this year (Jan ‘16), in the first year where earnings are not muddied by Canada. But that’s 35% above what TGT earned before it decided to go to Canada in the first place. Remember that it went to the Great White North because of the struggles it encountered in its core US market. Cornell made the tough call and closed down Canada, which was a swift and decisive move. But the next moves – to make TGT more competitive in the US – are likely to be much more capital intensive and costly to earnings before they help.  We like TGT Short side.

 

FL: We think we laid out a convincing short case in our FL Black Book (CLICK HERE), in that the cross currents that came together perfectly over the past 6 years are beginning to unwind. But nearly everyone we speak with on the name -- whether they agree with our call or not (few disagree) -- asks the same questions “when?”, or “what’s the near-term roadmap?”. They are very valid questions. And there’s no doubt that FL could eek out 1 or 2 quarters before this story unwinds. But what we know is this. The Athletic industry is going through a sourcing and selling paradigm shift for the first time in 40 years, and the benefits are accruing to the brands as opposed to retailers. FL is the dominant retailer sitting at peak valuation on peak margins. We don’t need FL’s model to implode for this call to work, we simply need it to stop growing. We think that happens this year. LBO rumors are pervasive, but Nike (68% of sales) has a vested interest in FL remaining public.

 

HIBB: Nobody wants to hear about this short idea (Black Book: CLICK HERE). And that’s exactly why we want to keep talking about it. Similar dynamics as FL, but it’s traditional growth model is over, forcing it to grow its footprint more aggressively into territory dominated by DKS, Sports Authority and Academy. In addition, HIBB is the only retailer we know of in the US that does not have an e-commerce business. We’re not saying it has a bad dot.com biz, but that it has ZERO presence online. You can go to Hibbet.com to buy a pair of Nike’s and it redirects you to Nike.com. Building an e-comm platform would likely cost 3 points in margin. If there was a perma short in retail, we think this is it. The consensus is modeling $4.80- in 2018. We’ve got HIBB at $1.30. That’s the biggest miss we’ve ever called for in retail.

 

LULU: We wake up every day asking why we still have this on our Best Idea list as a long after a 75% run. At $37 – and even $47 – we didn’t have to worry about the base business. It was all about changing up the corporate and ownership structure with a call option on LULU comping up a point (even if by accident). There’s one reason we’re hanging in there with this one, and that’s LULU’s new CFO (Stuart Haselden), who started a week ago. We rarely get excited about a single individual’s ability to change a company’s fortunes. But the reality is that Lululemon has not had anything remotely resembling a finance culture since it’s inception. It’s actually borderline miraculous that LULU has grown to nearly $2bn in sales with such a weak financial influence. There’s no tangible strat plan, little recognition of competitive threats, no identification of highest ROI revenue opportunities, etc...  To be clear, this will take a long time to fix. But we can’t imagine that the stock will sell off in the early days of Haselden formulating his plan. We’ll be coming out with a Black Book before the company reports earnings that we think will help Haselden build his game plan. After assessing the opportunities and the capital costs that need to go against them, we’ll know if we should hang in there or cut bait.

 

More feedback to come. 


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