TGT/Retail - Another Step Towards 'Free Shipping'

Takeaway: There are a few key considerations as it relates to Target's rather bold move to go toe-to-toe with Amazon with free shipping.


1. First off...Historically, retailers in this space have been lemmings. Prior to TGT announcement (taking shipping threshold down from $50 to $25) there were 5 retailers in the space who set the free shipping threshold at $99 (JCP, M, TJX, BELK, Lord & Taylor) and 4 who sat at the $50 hurdle rate (TGT, WMT, Gap, Old Navy). TGT's move shifts the balance of power in the industry and we think that means there are more dominos to fall. 

2. Free Shipping is Inevitable. This is just the first market share grab by a big player which will inevitably lead to free shipping across the board. That's fine if you're a retailer who has a basket size big enough to absorb the incremental cost for both fulfillment and returns a la JWN. But the problem is that the TGT, WMT, JCP, and KSS do not have that luxury and it has profitability implications. Here's the math…

TGT/Retail - Another Step Towards 'Free Shipping'   - TGT   Shipping


3. If we assume that TGT online sales grow at a 23% CAGR through 2019, taking e-comm as a % of sales from 3.5% in 2013 to 12.5%, that equates to 20bps of gross margin pressure per year or $0.15 in earnings. To get there we assume that TGT sales come in at a gross margin rate 1000bps below brick and mortar sales. We've seen similar numbers out of KSS who you may argue is less efficient. But, when we pair that up with AMZN -- where shipping expense is 10% of total direct sales we think that's a fair estimate.


It's not likely that we will see any impact on profitability in the quarter the company will report tomorrow, because the data breach induced discounting in 2013 will more than offset the effect of free shipping. The same is true for 1Q and 2Q where the company invested heavily to drive traffic. But over a longer duration, you have a zero square foot growth retailer trading near peak multiples with cost pressures accelerating.





Yesterday, DRI announced that interim CEO Gene Lee will become the new CEO of Darden.  Once the company finds a new CFO, the transition to the new management team will be complete.


Next comes the hard part – fixing Olive Garden.


It’s been 2 years, 7 months, and 11 days since we first said DRI needed major changes, when it was evident the CEO’s reckless growth strategy was destroying shareholder value.  What followed was an amazing story of sloppy corporate governance, blatant disregard of shareholder returns, and a level of mismanagement that we’ve never seen in the casual dining industry.  In the end, it’s truly amazing that the failed strategies lasted so long without more shareholder outrage.  What’s more amazing, however, is that one of the key players that contributed to those failed strategies is now the new CEO of the company.  Maybe his knowledge of, and first-hand experience in, the failed strategies of the past will make him a better CEO than COO.  Time will tell.


Either way, it seems counterintuitive that, following the historic unraveling of the Darden Board in October 2014, the new Chairman of the Board, Jeff Smith, would choose a Darden insider as a new CEO.  Given how long it took to name a CEO, one thing is clear: it was not an easy decision.  Our sentiment about the qualifications of the new CEO was reflected in the lack of conviction in yesterday’s press release.  It seemed obvious, to us, that Jeff Smith struggled to accurately frame why Gene Lee was chosen as the new CEO.  The endorsement of Mr. Lee was not only generic, but also failed to cite what he has accomplished at Darden that would position him as the new CEO – outside of being the last man standing.


The contradictions between the Chairman of the Board and the new CEO are apparent.  Consider the following:

  1. Jeff Smith and the current Board of Directors trashed Gene Lee and Dave George’s Olive Garden “Renaissance Plan.”
  2. The Olive Garden remodels show a lack of discipline for ROI.
  3. Under Gene Lee, Seasons 52 opened a significant number of underperforming units – further showing little concern for ROI.
  4. The overall profitability of the Specialty Restaurant Group, run by Gene Lee for six years, is not significant enough spin it off as a separate company.


It will be interesting to see how they’ve solved these contradictions in the coming months.


Having said that, appointing Gene Lee as the new CEO is the safe choice, especially with the stock above $62 and improving industry trends.  We won’t truly know if this was the best choice for the company until we begin to lap the improvements made six months ago.


We suspect there will be structural changes made within the company before we see any sustained improvement in operating trends.  Given the industry backdrop, DRI will likely report strong comps when they release earnings on March 20th.  However, it will be difficult to tell whether these reported comps are the result of improved industry trends or improved operations.  We suspect it will be the former.


The next 25 days will be the most important of the new CEO’s career.  That’s how long he has to write a script that shows the investment community he can make difficult decisions that will lead to a multi-year improvement in the fundamentals of the business.


The plan should include:

  1. A new strategic direction for Olive Garden’s menu.
  2. A new look and feel for Olive Garden’s asset base.
  3. A plan to improve LongHorn’s relatively low AUV’s and below average returns.
  4. Significant changes to capital allocation strategies, including limiting new unit growth and the potential sale of real estate and other non-core assets.
  5. Franchising – including selling stores – of non-core brands.
  6. Strategic priorities for improving the cost structure of the enterprise.
  7. Setting a timeline for restoring EBIT margins to 10% or better.


We look forward to seeing how the new CEO presents the future opportunities at DRI.  We’re confident there is significant low hanging fruit, but we need to see how these opportunities manifest themselves for the benefit of shareholders.


In the short-run, this stock is way ahead of a turn in the fundamentals.

Keith's Macro Notebook 2/24: #Deflation | USD | UST 10YR


Hedgeye CEO Keith McCullough shares the top three things in his macro notebook this morning.

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Retail Callouts (2/24): KSS, DDS, M, Chain Store Sales

Takeaway: KSS positive sales performance does not look company specific with strong DDS, BONT, BLKIA results. ICSC sales feel the chill.


Retail Callouts (2/24): KSS, DDS, M, Chain Store Sales - 2 23 chart2





KSS Callout

Takeaway: DDS put up a very good 4Q, leveraging a 3% comp into 17% EPS growth. This should help put the 3.7% KSS comp into perspective. Since KSS released its sales results for the quarter, we've been barraged with concerns that the company's new strategies like Beauty, National Brands, and new Rewards program will create a 1-2 year period where KSS meaningfully outperforms the group. We simply don't think that's true. We think the results from DDS, and what we saw over the holiday (and should see in upcoming EPS) from fellow mid-tier department stores like Belk and Bon-Ton will show that the lion's share of KSS' strength was definitely not company specific.  It remains one of our top shorts, and we think that earnings are ultimately headed closer to $3.00, while the consensus (and current valuation) is eyeing something closer to $6.

Retail Callouts (2/24): KSS, DDS, M, Chain Store Sales - 2 24 chart1



ICSC RETAIL SALES (80 General Merchandise Stores)


Takeaway: As brutal as the weather was last year during the polar vortex, this year is not far behind. And it's gotten sequentially worse as the year has progressed which we think helps explain the 2yr trend in the ICSC numbers. It's still to early in this year's first fiscal quarter (3 weeks in) to make sweeping generalizations about impacts from weather, but to date it's been less than an easy compare.

Retail Callouts (2/24): KSS, DDS, M, Chain Store Sales - 2 24 chart3

Retail Callouts (2/24): KSS, DDS, M, Chain Store Sales - 2 24 chart4





TGT - Report: Target expands app functionality



NKE, ZU - Converse Settles With H&M, Zulilys



BBY - Best Buy opening tech center in Seattle



AMZN - Amazon wears Prada



GPS - Intermix Taps Former Saks Chief Merchant



APP - American Apparel Further Strengthens its Management Team



URBN - Anthropologie expands in France


Stick With The Deflation Playbook

This is an excerpt from Hedgeye morning research. Click here to learn more about our products and how you can become a subscriber today.


Stick With The Deflation Playbook - 36


Despite the 3-week counter-TREND reflation move in February, #deflation remains our Top Global Macro Theme right now. The Eurozone just reported lower-lows in CPI at -0.6% year-over-year and the U.S. is going to print another CPI miss on Thursday. Will Janet Yellen be as dovish as this data is going to get come June?


Stay tuned. Her forecasts are the problem.


On a related note, UST 10YR Yields finally backed off @Hedgeye resistance and remains bearish TREND ahead of both the Yellen comments and slowing CPI and GDP data on Thursday and Friday. The immediate-term risk range is now 1.85-2.16% and that made REITS the best sub-sector yesterday +0.7% vs. Oil & Gas stocks (XOP) -0.9%. 


Stick With The Deflation Playbook - 46

ICI Fund Flow Survey: Bond Bulls Continue to Rule 2015

Takeaway: Make it 6 for 6 or all weekly periods in 2015 as having higher demand for fixed income than equities

This note was originally published February 19, 2015 at 07:14 in Financials. Click here for more information on how you can become a subscriber to Hedgeye.

Investment Company Institute Mutual Fund Data and ETF Money Flow:


Investors remained defensive in the most recent mutual fund and ETF money flow survey for the week ending February 11th. The sum of total equity mutual funds and ETFs against total bond mutual funds and ETFs, remained negative (-$2.1 billion) for the sixth straight week which has now totaled -$39.0 billion thus far this year (a $39 billion favoritism by investors for fixed income versus equities). For the equivalent first six weeks of 2014, investors had favored equities over fixed income by a +$31.3 billion spread, highlighting the very risk averse start to the New Year. In addition, investors built up cash positions last week, contributing +$4 billion to money market funds.


Focusing on domestic equity mutual fund flows, even with a quick 3 week positive subscription of +$7.8 billion for the prior 3 weeks, domestic equity mutual funds put up another loss of -$27 million this week and have now lost -$62.4 billion over the past 52 weeks (with outflows in 37 of 52 weeks).  We continue to flag caution for the most directly affected managers in this group with our underweight or short views on T Rowe Price and Janus Capital (see our TROW and JNS research).


ICI Fund Flow Survey: Bond Bulls Continue to Rule 2015 - josh


In the most recent 5 day period, ending February 11th, total equity mutual funds put up net inflows of +$1.3 billion according to the Investment Company Institute, lagging the year-to-date weekly average inflow of +$1.5 billion but outpacing the 2014 average inflow of +$620 million. The inflow was composed of international stock fund contributions of +$1.3 billion and domestic stock fund withdrawals of -$27 million.  International equity funds have had positive flows in 48 of the last 52 weeks while domestic equity funds have had only 15 weeks of positive flows over the same time period.


Fixed income mutual funds put up inflows of +$5.9 billion, outpacing their year-to-date weekly average inflow of +$2.7 billion and their 2014 average inflow of +$929 million. The inflow was composed of +$5.2 billion of contributions to taxable funds and +$693 million of contributions to tax-free or municipal bond funds.  Munis have had a solid run with subscriptions in 51 of the last 52 weeks.


Equity ETFs gained +$4.7 billion in contributions, outpacing both the year-to-date weekly average outflow of -$2.3 billion and the 2014 weekly average inflow of +$3.2 billion. Fixed income ETFs took in +$2.2 billion, trailing the year-to-date weekly average inflow of +$3.0 billion but outpacing the 2014 weekly average inflow of +$1.0 billion.


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 weekly average for 2014 and the weekly quarter-to-date average for 1Q 2015:


ICI Fund Flow Survey: Bond Bulls Continue to Rule 2015 - ICI 2


ICI Fund Flow Survey: Bond Bulls Continue to Rule 2015 - ICI 3


ICI Fund Flow Survey: Bond Bulls Continue to Rule 2015 - ICI 4


ICI Fund Flow Survey: Bond Bulls Continue to Rule 2015 - ICI 5


ICI Fund Flow Survey: Bond Bulls Continue to Rule 2015 - ICI 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), the weekly average for 2014, and the weekly quarter-to-date average for 1Q 2015. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:


ICI Fund Flow Survey: Bond Bulls Continue to Rule 2015 - ICI 7


ICI Fund Flow Survey: Bond Bulls Continue to Rule 2015 - ICI 8


Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR call-outs, energy XLE flows continue to track performance; the XLE returned -0.63% from 2/5 to 2/11 and lost -4% (-$570 million) in withdrawals over the same period.  Separately, investors continue to make defensive sector allocations, contributing +4% (+$302 million) to the utilities exchange traded fund the XLU.


ICI Fund Flow Survey: Bond Bulls Continue to Rule 2015 - ICI 9



Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$2.1 billion spread for the week (+$5.9 billion of total equity inflow outweighed by the +$8.1 billion inflow to 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 +$1.6 billion (more positive money flow to equities), with a 52 week high of +$27.9 billion (more positive money flow to equities) and a 52 week low of -$15.5 billion (negative numbers imply more positive money flow to bonds for the week). 


ICI Fund Flow Survey: Bond Bulls Continue to Rule 2015 - ICI 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: Bond Bulls Continue to Rule 2015 - ICI 11 



Jonathan Casteleyn, CFA, CMT 



Joshua Steiner, CFA




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