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Retail Productivity Is Worse Than It Appears

Employee Productivity Is Worse Than It Appears

 

I’ve been hammering the US Retail industry for excess SG&A cutting. This analysis suggests that it might not be cutting enough.  

 

It’s easy to look back at the past 5 or 10 years and nitpick the changes in retail employee productivity. But Zach went back to the Johnson administration to see how these trends have ebbed and flowed since the late 1960s through today. The answer? Yes, overall productivity is certainly higher, as it should be given inflation and technology’s impact on productivity. But over 40 years, the year/year trend has only gone negative 3 times before the current recession – and the math adds up in a way such that the erosion in the preceeding 3 periods combined just about equals what we’re looking at today.

 

What does this mean? How does it tie into a stock call? I’m really not YET sure. But I know that I’ve been hammering the US Retail industry for excess SG&A cutting over the past six months. This analysis suggests that either 1) perhaps the industry has not even cut enough SG&A (polar opposite to what I thought), or that 2) the revenue hit was truly more massive and perhaps anomalous than I gave it credit for.

 

I’m gonna stew on this one…but in the interim I figured I’d throw it your way in case you’d like to do the same.  

 

Retail Productivity Is Worse Than It Appears  - Retail Sales Per Employee Historical

 


UA: How Have Expectations Changed?

UA: How Have Expectations Changed?

 

Expectations are growing less apocalyptic, though the fundamental story is shaping up as it should. The one factor that could derail near-term earnings (SG&A spend around footwear) is the biggest revenue catalyst for 2010.

 

 

UA has been one of our favorites for most of 2009. As we do with all of our ideas, we step back daily, re-evaluate the facts, and see how reality does (or does not) synch with expectations. The bottom line is that this is still one of our favorites, and the only thing that has changed since we rolled out our Under Armour Black Book is 1) the price has gone up, and 2) evidence that the story is, in fact, playing out with the company’s fundamentals. As quantified in our report, we still believe that next 2-years’ estimates are low by 15% and 25%, respectively. Looking at this on an EV/Total Addressable Market Value basis, we still think that there’s no cheaper stock in Consumer Discretionary.

 

But looking into the quarter, what we won’t do, however, is turn a blind eye to changes in near-term expectations. Over the last month, consensus 3Q revenue growth forecasts have risen to 6-7%, about in line with our model. Though we still think that the Street is off with margin estimates, now we’re looking at around 7% EPS upside instead of the 10-12% we had after the last print. Also, while this name remains very much hated (only 2 of 20 Analysts have it rated ‘Buy’) short interest has come down to around 20% of the float (still understated, we think given certain long term holders that won’t sell), Is sentiment ugly? Yes. But it has grown somewhat less apocalyptic as the stock has more than doubled off its low.

 

So what could UA do or say on Oct 27th to change the thesis? Over an intermediate-term (and certainly a long-term) duration I don’t think there’s much that can slow this beast down. Over the near-term, we’d have to see either a meaningful slowdown in core apparel, or UA back off of footwear goals. We have 13 weeks of POS data under our belt, and the trends look good for UA. Tack that onto in-line inventories at the end of last quarter, and it smells fine by me – especially with 4Q starting off on a positive note as it relates to apparel growth industrywide.

 

As for footwear, the biggest and baddest thing the company can do is have Gene McCarthy get on the conference call and talk about how he is hiring 50 people to fill out his new footwear organization, which will take up the SG&A base this year.

 

Is this possible? Yes, very (as stated in our Black Book), and will make my EBIT numbers be too high. But the other numbers it will make unrealistic are my 2010 revenue numbers for footwear – they’ll prove too low. You see… this guy ‘gets it.’  How many times have we heard companies like Columbia Sportswear talk about ‘hiring a new footwear guy’ to solve their ills and capitalize on a ‘great brand opportunity’? Something that is consistently ‘a great brand opportunity’ but is never realized is not really an opportunity afterall…

 

McCarthy went in to Plank’s org chart with the understanding that he would build out his talent pool. Note that he started to do this with TBL’s Authentic Youth biz – and it started to work immediately. Then they made him Co-President of the company, did not back fill his efforts in the Authentic Youth segment and pulled resources accordingly in that area. 

 

Simply put, the ‘rock star’ approach does not work here. It takes a team, and McCarthy will build it. If people freak out because of higher spending to get this team built – then this will be a gift for a risk manager.

 

Revenue Analysis

Historically, the correlation between reported UA wholesale apparel revenue and the corresponding Sportscan athletic apparel data (lagged by one full quarter to account for wholesale to retail timing) is 76% based on analysis of the last 12 quarters. 

 

With the benefit of the late 1Q09 launch of running shoes, footwear revenues are forecast to benefit from an incremental $15 million in the quarter.  We’re assuming the legacy footwear base (cleats & trainers) will decline by 30% to ~$9 million due in part to difficult comparisons and insight we’re gleaning from the channel.  On the whole, we are modeling 85% growth in footwear during Q3.  While revenues are still challenging to pinpoint with a high degree of accuracy given the lack of history for running, we believe the directional trends highlighted in the weekly scan data support our estimates. 

 

Furthermore, while running and additional category expansion in footwear remains key to our longer-term thesis, we’ve got to keep in mind that we are still in the very early stages of the footwear maturation curve.  Anecdotally, in a recent meeting with Dick’s management, they candidly discussed their surprise that UA’s footwear launch was met with such mixed reviews, and that it met their launch expectations.

 

Take a look at the chart below depicting the historical relationship (spread) between UA reported results and Sportscan trend data.  It’s important to note that over the last four quarters the spread has been within a +/- 5% range, reflecting a fairly high degree of correlation.

 

UA: How Have Expectations Changed? - UA apparel1

 

UA: How Have Expectations Changed? - UA Footwear1

 

Margin Analysis

 

Despite a smaller portion of lower margin footwear sales compared to the 1H, higher reserves, and increased liquidation activity will weigh on margins, which we are modeling down 200bps in Q3. Offsets will include strong higher margin direct-to-consumer sales that were impacted by ~100bps last year related to IT interruptions as well as fewer discounts in the outlets for apparel liquidation due to tighter inventories and a more stabilized retail environment. In addition, product costs are starting to swing the other way, which could lead to upside.  At the same time while UA will continue to invest in the brand growing SG&A roughly in-line with revenues, we expect modest deleverage of 90bps in the quarter as the company manages costs while the top-line recovers.

 

UA: How Have Expectations Changed? - UA Rev Waterfall

 

UA: How Have Expectations Changed? - UA EBIT Waterfall

 

UA: How Have Expectations Changed? - UA FCF Waterfall


“Weighty” Euro

 

Position: Long Germany via EWG

 

Although rear-view, it’s worth looking at today’s Eurozone trade balance release as a preview of the impact that a strong Euro is having  — exports were down 5.8% in August month-over-month, with imports declining 1.3%, dropping the trade balance to 1 Billion EUR from 6 Billion EUR in the previous month when exports rose 4.7% sequentially.

 

We’ve been hitting on the implications of currency strength in our European posts. With the Euro trading at an increase of +6.3% YTD versus the USD or +15.4% over the last 7 months, the impact on trade will be pronounced. As noted in yesterday’s post, ECB President Trichet has recently signaled his displeasure with a strong Euro, yet has not made explicit comments on raising rates in the near term.  

 

In order of absolute EUR of trade, exports from the Eurozone in the first seven months this year versus a year earlier declined to the UK by 26%, followed by a -20% contraction to the US, and declines of 10% and 4% to Switzerland and China respectively, according to Eurostat.

 

We continue to monitor the Euro versus major currencies. Certainly for Germany’s export-led economy, a strong Euro is a major headwind.  Today’s report shows that from January-July 2009 versus a year prior Germany far exceed any other country in the EU with a trade surplus of 73.4 Bill EUR, followed by Ireland (+23.3 Bill EUR) and the Netherlands (+20.9 Bill EUR). Conversely the UK far exceeded any other country with a trade deficit of -54.4 Bill EUR over the same period, followed by France (-30.4 Bill EUR) and Spain (-26.9 Bill EUR).

 

We’ll have our EYE on the Euro and its impact on trade, especially as it relates to Germany, which we’re currently long in our model portfolio.

 

Matthew Hedrick
Analyst

 

 

“Weighty” Euro - a1

 

 

“Weighty” Euro - a2

 

 


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THE WEEK AHEAD

 

The Economic Data calendar for the week of the 19th of October through the 23rd is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.  

 

THE WEEK AHEAD - week ahead oct 19

 

 


AMZN and WMT: 1-2 Punch

Did you see what transpired yesterday? If it’s any indication of what’s to come, we will have a highly competitive online market this holiday season. Yesterday alone held a back-and-forth price battle that provided entertaining sport (and a break from earnings). First, Wal-Mart announced it was cutting its online price for bestsellers to $10. Just a few hours later, Amazon cut its own prices to match. By the end of the day, both companies boasted books for a mere $9.00 and whopping discounts of up 70%.

 

AMZN and WMT: 1-2 Punch - 1

 

AMZN and WMT: 1-2 Punch - 2 

 

 

Obviously, this isn’t good for the overall profitability within the publishing industry (unless you believe in massive amounts of elasticity, which I don’t). In fact, moves like this just seem poised to hasten the demise of publishing profits with the digital transition about to shift into high-gear.

 

And in terms of Amazon and Wal-Mart, I won’t rush to any conclusions – other than to flag these moves as ones that I will keep on my radar screen. I can’t imagine that these price cuts will benefit anyone other than the consumers’ wallet, but the breadth and depth of such moves is what will really matter over time.

 

At the very least, to those that are writing off Wal-mart as a threat to Amazon – I say “not so fast”. This strikes at Amazon’s core and with increases in competition across Amazon’s portfolio (as I’ve highlighted in the past), moves like this are (on the margin) a negative.

 

AMZN and WMT: 1-2 Punch - 3

 

Google Trends tracks the rate at which people are searching for given terms (not necessarily visitors to a site). AMZN and WMT both show strong holiday seasonality in search.

 


THE MACAU METRO MONITOR

WHAT BEIJING GIVETH… destination-macau.com

CASINO STOCKS FALL AFTER VISA RULES TIGHETENED scmp.com

The Macao Daily broke the news on Wednesday that visa restrictions have been tightened once again by the authorities in Guangdong.  Shares in Macau casino companies fell yesterday as the news broke.  The frequency with which visitors can apply for visas to travel to Macau has gone from once every three months, to once per month, to the current limit of once every two months.  The reasoning behind this fluctuation is unclear and has caused some confusion. 

 

DM believes that analysts have paid too much attention to the Individual Visit Scheme, both in boom and gloom days, stating that “there has been only two months out of the past 18 when mainland arrivals really plunged, and that was around this time last year, when both IVS arrivals and tour group arrivals fell sharply”.  The recent boom, according to the author, is more influenced by the financial well-being of Macau’s VIP customers than the IVS scheme.

 

 

 

TABLE FOR SIX? destination-macau.com

The recent discussions led by Macau’s government regarding limits on table capacity expansion and raising the minimum age of casino visitors to 21.  DM sees this as positive news for the Big Six.  There is ample supply in the market; The Venetian had more than enough space no its floor during Golden Week. Considering that Lots 5&6 will be started as soon as possible, Galaxy is getting its Cotai resort going again, the government is clearly looking to calm the pace of expansion. If anything, DM believes investors should be concerned with diminishing industry ROI numbers as more projects are brought to completion.  There are many questions that remain to be answered, for instance, if there are unilateral caps or quotas imposed, how will the government decide who gets what?

 

 

 

MGM, HO PLAN MACAU CASINO EXPANSION, MULL ASIAN IPO Bloomberg.com

MGM Mirage and Macau partner Pansy Ho plan on expanding their casino and exploring sites for potential resorts as they consider an initial public offering, according to a report on Bloomberg.com today.  Jim Murren, MGM CEO and Chairman, is quoted saying that MGM is “working on plans” to finish the 70,000 square feet of its casino’s second floor.  As for a possible IPO, Murren says that no decision has been taken but that “both partners have discussed it, and we believe it’s a very viable and attractive option… there’s been a very positive disposition towards it from both partners.”

 

Some commentators believe the indications from MGM that an IPO could be on the cards should be viewed cautiously given the “unclear picture” in light of the recent travel restrictions and the possible implementation of new laws concerning slot machines being banned from residential areas and raising the age for customers and staff at casinos to 21 from18 .


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