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McCullough on Gold: Respect the "Force Majeure" of Dollar Up

Before helping celebrate Maria Bartiromo's one year anniversary hosting Opening Bell on Fox Business Network this morning, Hedgeye CEO Keith McCullough dialed in to Hedgeye's Morning Macro Call to provide his daily dose of market insight. 


In today's Q&A session, Keith gives his longer-term thoughts on gold and breaks down the difference between Bayesian and Frequentist probability theories in relation to analyzing labor market data.


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 dot.com 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.

 

 

 


DRI: THE TRANSITION IS NEARLY COMPLETE

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.


Early Look

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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.


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.

EVENTS TO WATCH

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

 

 

COMPANY HIGHLIGHTS

 

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

 

 

OTHER NEWS

 

TGT - Report: Target expands app functionality

(http://www.chainstoreage.com/article/report-target-expands-app-functionality)

 

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

(http://www.wwd.com/business-news/government-trade/converse-settles-with-hm-zulilys-8223619?module=Business-latest)

 

BBY - Best Buy opening tech center in Seattle

(http://www.chainstoreage.com/article/best-buy-opening-tech-center-seattle)

 

AMZN - Amazon wears Prada

(http://www.chainstoreage.com/article/amazon-wears-prada)

 

GPS - Intermix Taps Former Saks Chief Merchant

(http://www.wwd.com/retail-news/people/intermix-taps-former-saks-chief-merchant-8222575?module=Retail-latest)

 

APP - American Apparel Further Strengthens its Management Team

(http://investors.americanapparel.net/releasedetail.cfm?ReleaseID=897790)

 

URBN - Anthropologie expands in France

(http://www.fierceretail.com/story/anthropologie-expands-france/2015-02-23)


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


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