KATE – Buy The Guidance Gauntlet

Takeaway: KATE should be bought on the latest guidance freak-out. We review why we think the company will outperform the expectations traded on today.

Conclusion: We think that KATE should be bought on Thursday’s sell-off, which was spurred by concerns about 1Q comp trends after KATE hosted a meeting with investors. This company has all the credibility in the world executing on its business model, but not in guiding the Street. Quite frankly (and perhaps over optimistically) we’d have thought the market would start to see through the KATE guidance gauntlet. We think its guidance is conservative, and the Street’s interpretation even more so. More often than not, these communication bubbles create a great opportunity to buy a fantastic long-term story. This is one of those opportunities. Though this note focuses almost entirely on the 1Q comp number, the real call (including 1Q) is a roadmap to a $75 stock.




Today KATE did what KATE does, traded down significantly on information that we think is misleading. Specifically, a group of investors visited management, which resulted in a broker issuing a 1Q comp forecast of +3.5%. We don’t think anyone fabricated information out of thin air. Chances are (and we spoke with several people in attendance) the company gave tangible reasons why comps will start of the year soft, and we think that the ensuing report took an even more cautious posture on management’s assertions.  We simply don’t believe either of them.


We hate to play the guidance game – and most people who know us know we usually look through most of it as noise. But let’s strap the accountability pants on for KATE management…

  • At the beginning of 2014 it guided to 10-13% comp, and ultimately came in at 24% for the full year.
  • KATE said it would start out last year comping in the high-teens, and it printed 29% six weeks later in 1Q.
  • In 4Q KATE guided to 8-14%, and put up a 28%.


We’re going to go through the puts and takes below, but keep in mind that this is a company where you have to watch what they do, not what they say. They don’t have the communication thing down pat, but the company can execute on a world class business plan with the best of ‘em. That’s what matters.


Also… let’s keep one thing in mind – it was just last week that KATE printed the best comp in all of retail – or 28% on top of a 30% comp in the prior year.  And now it is going to slow to 3.5%? Heck, e-commerce alone should get the brand above a 6% comp (it’s about 20% of the business and grew in 4Q at better than 50%). If the company is going to put up a 2,500bp deceleration on the 1 and 2-year comp, then the stock SHOULD sell off – probably a lot more than it did today – and doesn’t deserve its current valuation.


But we think KATE definitely deserves it, and then some. We’re modeling 10% in the upcoming quarter, and 18% for the full year. We’re getting plenty of hate mail for ‘disagreeing with the company’ and setting an unrealistic hurdle rate. But we didn’t just pick 10% out of the air. Below we go through all the puts and takes on factors including e-commerce, flash sales, Japan, FX, Saturday/Jack Spade, and inventory positioning. 


Despite all the real estate in this note dedicated to a singular comp number in the seasonally least important revenue quarter of the year, the focus for us is still on the BIG call, which is $3 in earnings power as the brand footprint doubles over 3-4 years and EBIT margins go from 11% to 19% -- and that story plays out starting today.


What’s It Worth? So that begs the question as to what we should pay for KATE. By the end of this year, we’ll be eyeing about $345mm in EBITDA and $1.30 in EPS.  When looking at the 50% and 100% growth rates in EBITDA and EPS, respectively, we could definitely argue a big multiple. On the flip side, this is a fashion business, and there will almost certainly be a time (like KORS is experiencing now) where it will see multiple compression as it matures.   But keep in mind that KORS has a brand footprint of $6.4bn and EBIT margins of 30%. KATE has a $1.4bn footprint (smaller that Tory Burch at $1.9bn) and margins of only 11%. It will be a long time before we have to ask the ‘is it over’ question. Until then, we think the multiple will continue to defy gravity in the eyes of anyone that’s not a growth investor.


For argument’s sake, let’s keep the forward multiples in place that KATE has today – 50x earnings and 19x EBITDA. We think that there’s upside this year as the company beats. But on 2016 numbers we’re looking at 50x $1.32 = $66, or 19x EBITDA in the mid 50s. Roll ‘em to ’17 and you get to over $2+ in earnings power, or around a $75 stock.


KATE – Buy The Guidance Gauntlet - kate financials





The company cites a reduction in flash sales as the main driver of the sales pullback in the year. For the record, management said the same thing last year during the 4th quarter where they turned a flash sale into a theme sale, and comps were up 45%-55% in the quarter.

We checked the e-mail archives and counted 6 major promotional campaigns during the first quarter of last year. 3 were flash sales, which occurred on: 1/22, 3/18, and 4/4. With one 3 day ‘Friends and Family’ event that kicked off on the 2nd to last day of the quarter.


KATE – Buy The Guidance Gauntlet - Kate flash


To date KATE has done one flash sale on 2/10/15, right in line with when it appeared last year. It didn’t repeat the first 1-day bag specific event of the year, but as you can see later, it didn’t have a negative impact on traffic flow. We’ll be tracking each promotional event as the quarter progresses to see if they follow the same March playbook. The thing we don’t know is the velocity or overall product availability. That could cause some fluctuation in overall sales, but we don’t suspect a big divergence from last year.

Lastly, KATE launched its e-comm operation in England during the 4th quarter. That should have positive implications as the business builds and awareness grows into 1Q.



The first chart below shows the year over year change in traffic rank. Directionally we’ve found it to be a very good indicator of the overall health of a company’s online business. It takes into account 2 metrics (unique visitation and page views/user) and tracks each URL in relation the internet in aggregate. KATE’s rank has pulled back over the past few weeks, which is what we expected (as business slows seasonally after holiday and before Easter), but still sits +38% YY. For reference the trough in the chart below corresponded with 3Q when put up its lowest growth rate of the year at 21%.


KATE – Buy The Guidance Gauntlet - kate traffic rank


If we look at visitation at a much more granular level, we see the same type of trend. Chart below looks at the reach spread and attention spread from 12/31/14-2/28/15. Here reach is defined as the percent of total users on the internet visiting a site on a given day and attention is the amount of time spent on the internet dedicated to a specific URL on a given day. The spread is calculated by taking this year’s reading minus last years, each day corresponds with the appropriate calendar day from LY.  Anything North of the x-axis is positive. Anything south is negative. Overall the trend has been decidedly positive. With the big spike in February corresponding with the ‘Flash Sale’.


KATE – Buy The Guidance Gauntlet - kate spread 1Q


If we compare that to what we saw during the 4th quarter where there was 2 ‘Flash Sales’ and 1 ‘Theme Sale’ the trend looks very healthy.


KATE – Buy The Guidance Gauntlet - kate spread 4Q




Japan is one of the moving parts to the comp story here. Overall it is about $135mm-$165mm in revenue, or 12-15% of total. There are some puts and takes as it relates to the impact on comp that should be considered.


Japan was added to the comp base in the 1st quarter of last year. And it came out of the gates hot comping +37% (44% if you include the impact of the extra week). Some of that was driven in part by the nation-wide hike in consumption tax from 5-8%. But if we look at the trend in that business, comps accelerated to +25% in the 4th quarter on top of a +19% last year.  Currency could be a headwind, but management noted on the call that the a) inventory is 75%-80% hedged for the year, and b) the Yen has only deprecated 200bps since the end of last quarter.


  • Let’s say that comps in quarter are flat, which would imply a 300bps deceleration on the 2yr trend line, and sales growth for the rest of the company was 20%. We are looking at 360bps of headwind to the company average. Or, bear case, Japan is down 10% we are looking at 540bps of dilution.
  • Realistically, let’s assume that the 2-year run rate stays even with 4Q levels – even though it is actually trending higher. A 6% Japan comp would imply a 22% 2-year trend. That suggests 250bps of sequential headwind on a consolidated basis.


KATE – Buy The Guidance Gauntlet - jpn comp


Kate Spade Saturday could cause a slight disruption, but guidance doesn’t assume any effect from the closure. Relative to the size of distribution in the country (KSS and Jack Spade represent about 15% of the distribution in Japan assuming wholesale and retail doors increased by 15% this year) Saturday could curb some demand. But we think it’s important to remember a) these stores are in their infancy with the majority of doors still within a year of the open date, b) brand recognition is still extremely low, and c) there is a reason management shuttered the retail operation.



KATE inventory was up 16% to end the year compared to +46% last year. The consolidated balance sheets don’t reflect that because of the divestitures of Juicy and Lucky. But, a lot of that was due to excess inventory in the Jack/Saturday lines. The company took a 240 basis point hit to liquidate the 2013 Kate Spade Saturday launch year inventory in the 2nd quarter and cost the company ~$6.4mm. And it took another $8.6 million hit in 4Q from. Adjusting for that, inventories should be in-line to support the top-line growth we are modeling. Port closures are an issue, but KATE who will do just north of $250mm in the quarter should be nimble enough to accommodate.



Due to the calendar last year, Easter was pushed back to 4/20/14, compared to 3/31/13. It’s likely that some of the sales that would have been pushed into 2Q of last year were pulled forward due to targeted promotions. We think that’s extremely hard to quantify, but we’ll give them the benefit of the doubt. This year’s Easter falls on 4/5/14. One day after the quarter closes and should be good for a point or two of comp.

Axler: Two ‘Significantly Overvalued’ Stocks Investors Should Short


Looking for solid short candidates? Activist short-seller and forensic financial researcher Ben Axler, founder of Spruce Point Capital Management, highlights two stocks ripe for a big fall and his reasoning why with Hedgeye Industrials Sector Head Jay Van Sciver.


Cartoon of the Day: La Lemmings di Draghi

Cartoon of the Day: La Lemmings di Draghi - Draghi cartoon 03.05.2015

Apologies Signor Draghi, but try as you may, you can't stop economic gravity.

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McCullough: Alibaba Arguably “Biggest IPO Bubble In World History" | $BABA


Hedgeye CEO Keith McCullough appeared on Fox Business’ “Opening Bell with Maria Bartiromo” this morning to weigh in on the growing bubble in technology stocks like Alibaba (BABA).

Two Structural Reasons For More Downside In Commodities

Takeaway: Longer-term trends, the current position in the business cycle, and the outlook for the U.S. Dollar all line-up for more downside risk.

There is one thing we can be sure of with regards to long-term commodity prices over the long run:


They will continue to go up and down, falling just as far as they rose in real-terms, from cycle to cycle.


In the shorter run, which is where we all make our tactical investing returns, we think there are two key reasons commodity prices, especially in the raw material and metals space, could move lower from here:


1)      The Hedgeye macro view is that the U.S. dollar, WHICH HAS ALWAYS LED THE BIG TURNS IN CYCLES ACROSS DURATIONS, looks like it will continue to strengthen over the intermediate to longer-term even if we briefly transition from QUAD 4 to QUAD 1 and back again; and

2)      There is a cap-ex cycle in the commodities space which lasts longer than the normal business cycle on average, and we are now on the back-end of BOTH cycles.


The table below is separated into 6 periods of large inflections in dollar and inflation adjusted growth, spanning across 8 business cycles. In this period of time we’ve experienced 2 longer resources-related capital investment cycles (back-end of the 2nd currently):


1.       1970s inflation (Bretton Woods)


2.       Early 1980s recession and contractionary policy


3.       Mid-1980s-mid-1990s expansion


4.       Clinton – tight policy, strong dollar deleveraging


5.       Greenspan de-regulation, low interest rate era (post tech-bubble through 08’ and still currently a part of the commodities bubble)


6.       Great recession-to-present (commodity prices down from 2010 bubble but still room to run)


There is a clear pattern that emerges, which seems to be very similar to our current cycle:


USD/Growth Inflection --> inflection in metals (early cycle materials) --> inflection in Ags. And Energy  (consumer-based)  


Two Structural Reasons For More Downside In Commodities  - chart USD Inflection Table


Two Structural Reasons For More Downside In Commodities  - Chart supercycle commodities lag


Clearly, as the dollar goes, so too goes the price of many key commodities.  Not to view the dollar as the only factor to consider, but certainly getting the direction of the USD right will enable us to get the price direction of many of these commodities right.


The existence of “super-cycles” as some call it, are longer than business cycles because of the capital intensive nature of bringing product online.


We thought the following quote from Otaviano Canuto of the World Bank was a good description of the normal chain of events:


“Reports on previous cycles and price volatility have been more convergent. These works tend to agree on the localization of at least three super-cycles of commodities since the 19th century, as well as one initiated at the end of the 1990s. Typically 20-year boom periods have reflected strong demand associated with moments of rapid industrialisation and urbanisation – as in the case of the US in the 1890s, or China in the 2000s – in which supply takes a long while before matching that demand. When this happens, periods of much lower commodity prices follow.”

Now that iron ore capacity has matched that demand, we have observed the end result several years after the demand picture turns sour. In other resource-heavy areas, this downside is just beginning.


Simply put, the amount of time elapsed between making an investment decision (capital spent), bringing production online, and getting those top-line revenue streams often spans over multiple business cycles.  Supply does in fact take longer to match the demand and investment decisions tend to be made at times when the spread between the cash cost of production and per/unit selling price are the widest (that NPV picture looks most attractive).


Look no further than this current cap-ex cycle. Investments that were made before the Great Recession are just now being finished:


Mid-cycle commodity bubble investment decisions --> Great Recession --> investment goes on through the next cycle to the 2010 bubble highs and beyond --> the over-investment is now unraveling in some areas, (iron ore and copper) with others to follow


The aftermath will bring more pain:

  1. How much further can the Fed lower interest rates to “fight deflation”? Rates are already near zero yet we are in a deflationary environment and the dollar is getting stronger (we believe it will get even stronger). Can the Fed out-Ease the BOJ and ECB? Nevermind lowering rates. The question consensus is asking is WHEN will a rate HIKE occur? Could a surprise "kicking-of-the-can" crush the dollar? Probably not for any more than a short-term correction.
  2. Projects that were implemented at the commodity bubble highs circa 2006-10 are still being brought online. Just look at the fertilizer space (which is a monopolized industry in some products)

Two Structural Reasons For More Downside In Commodities  - Nitrogen Cap ex


Like iron ore and copper, fertilizer is a mature industry that pivots on a number of very accessible and very abundant resources, and the demand for fertilizer (both nitrogen, phosphate, and potash-based) has followed a slow and steady climb for a long period of time. Given this dynamic, the above table tells the picture of “supply coming late” to meet demand. However the question we would ask is:


Were low-interest policies inflating commodities prices circa Greenspan deregulation (selling vs. cash cost) or was there as long period of under-investment lagging a demand increase for some of the most abundant resources on earth?


There is quite a bit of evidence for the former... 


The charts re-purposed below, and sourced from the World Bank and OECD, also provide support for the existence of this longer-cycle with the previous two evidenced in the tables above.


Pulling back the magnifying glass gives a peek at where we are in the longer cycle. There are a few key takeaways we would like to point out:


1)      Commodity prices go down over the long-term driven by a surplus of investment in inflationary periods  (Oil is the only commodity that has appreciated in real-terms over the long-term)

2)      Not surprisingly the metals (early-cycle materials specifically) segment tracks global GDP pretty closely


Two Structural Reasons For More Downside In Commodities  - chart10 supercycles chart


Two Structural Reasons For More Downside In Commodities  - chart11


Two Structural Reasons For More Downside In Commodities  - chart9 metals vs. gdp


Two Structural Reasons For More Downside In Commodities  - chart7 oil chart


Two Structural Reasons For More Downside In Commodities  - chart8 ag. chart


A risk management strategy molded by predicting how long the current cycles will last is not something we subscribe to, but we acknowledge that longer cap-ex cycles do exist in the industrials, materials, and mining space and they take longer to manifest than a business cycle.


Considering we’re on the back-end of both of these longer-term cycles, we remain bearish on the space in a QUAD 4 set-up where both growth and inflation are decelerating. The fundamental matches our bearish quantitative view which is what we want to see for picking good shorts in the commodity and commodity related space. 


We have been in and out of copper on the short-side over the last couple of weeks (ETF: JJC) in Real-Time Alerts and continue to expect downside in the commodities complex over the intermediate to longer-term.


Two Structural Reasons For More Downside In Commodities  - USD Levels


Two Structural Reasons For More Downside In Commodities  - Copper Levels


Two Structural Reasons For More Downside In Commodities  - WTI Levels


Ben Ryan 




Consistent with our short thesis, MCD gave an uneventful presentation this morning at the UBS Global Consumer Conference.  Despite the stock being bid up since the announcement of former CEO Don Thompson’s retirement, there has been little incremental news suggesting radical change.  With the stock well ahead of the fundamentals, we think it offers an attractive short-term trading opportunity.  MCD is currently trading at a seven-year peak multiple of 20x P/E, despite the numerous challenges the business continues to face across the globe.


While we do understand the hype, we believe it is misplaced.  We don’t see any near-term catalysts on the horizon; a belief that, in our view, was validated during today’s conference by the following:

  • MCD continues to face challenges in important markets, such as the US, France, Russia, China, and Japan
  • MCD will take a while to turn around and results will remain volatile
  • MCD still has an image problem
  • MCD will continue to expand the Create Your Taste platform
  • MCD is facing a lot of pressure to raise wages
  • MCD is playing “catch up” on the technology front (digital, mobile, loyalty, etc.)
  • MCD’s owner operators are still struggling
  • MCD is unlikely to increase its leverage
  • MCD is unlikely to pursue an “OpCo-PropCo” split (at least in the near-term)


The business is facing too many headwinds for the stock to be trading at such a premium multiple.  Given the lack of major news flow we see coming out of McDonald’s in the near-term, we believe the stock is ripe for a trade on the short side.  Considering high expectations, those hoping for a major strategic announcement are likely to be disappointed. 



03/02/15 03:06 PM EST


We’re confident MCD will return to being a great company one day.  But right now, it’s too early to call that turn – there’s a significant amount of work to do.  More important, it’s yet to be determined if the new CEO is willing to make the difficult decisions necessary to move forward.


With that being said, we are adding MCD to our Investment Ideas list as a short.


MCD has risen ~11% since Steve Easterbrook was named the new CEO on January 28th, 2015.  This week, he’ll be communicating his vision for the future of MCD at the “Turnaround Summit” in Las Vegas.  Importantly, Mr. Easterbrook has only had ~32 days to circle the wagons and come up with a plan that will convey change and layout a vision for the future.


We suspect we won’t see the radical changes needed to set MCD on a better path anytime soon and, as a result, believe the stock is way ahead of itself. 


Below is a laundry list of issues, or questions, the company is facing:

  1. The Board, similar to the menu, needs to be overhauled.
  2. Franchisees are clearly disgruntled – will they support the new CEO?
  3. Over the past 10 years, MCD has systematically and regularly added costs to the franchisees’ P&L without considering the long-term impact of these costs.  These expenses are over and above rising wage rates, beef inflation, etc.
  4. Wage inflation for MCD and all quick service peers will accelerate for at least the next two years.
  5. MCD has the highest AUVs in the quick service space – why do they have issues with franchisee profitability?
  6. MCD could sell company-owned stores, but will it have an impact on profitability?  Will they actually do it?  Should they be closing stores instead?
  7. MCD has an image problem.
  8. MCD’s direct competitors (both traditional quick service and new fast casual upstarts) are well managed, well capitalized, and growing.


Recent action in the market appears to be signaling high expectations for the MCD “Turnaround Summit” in Las Vegas this week.  We suspect the news flow exiting this event will be lacking the detail needed to support the current move in the stock. 


In our view, the news needed to support the stock move would be:

  1. Leveraging the balance sheet to recapitalize the company.
  2. Intent to significantly selloff a significant number of company-operated stores.
  3. A new product silver bullet.
  4. A significant cut in G&A and downsizing of the home office.


We don’t think any of these are a real possibility in the coming weeks.  Instead, we believe we’re likely to hear something closer to the following:

  1. A revamping of McCafe – exiting the business of selling espressos.
  2. Ending the Create Your Taste test.
  3. Slowing unit growth – which has already been announced.


The real issues the company needs to address will likely not be addressed anytime soon:


Board of Directors

For the most part, MCD’s board has served the company well, but significant change is long overdue.  Andy McKenna, the current executive chairman, is 84 years old.  While Mr. McKenna has served the company very well over the years, it is time for him to pass the torch to the next generation.  Once the board is reconfigured with new thinking, it then must decide what the McDonald’s brand represents to consumers – and aggressively go after it.


As soon as MCD begun feeling pressure from SBUX, the brand has lost its focus and evolved into trying to be all things to all people.  Therefore, many of MCD’s wounds today were self-inflicted and, in fact, many are reminiscent of the issues the company faced 10 years.  How did this board let history repeat itself?


McDonald’s Image Problem

The perception of the McDonald’s brand is worse now than ever before.  This perception cannot be fixed quickly and will likely be very expensive.  The question some are asking is: is MCD to fast food what IBM is to technology?  For the past five to six years, there has been no clear direction coming from the executive suite, leaving the business in a hole that will be very costly to dig out of.

The biggest “public perception” problem the brand faces has been from over-indexing the brand on discounting and selling cheap fast food.  The $1 menu has been very destructive to the company and will be difficult to change.  This suggests the company may need to put part of its past behind it.  Does MCD need to move on from the Ray Kroc era of selling cheap food fast?


Owner Operators

The owner operators are the key to a potential McDonald’s turnaround.  Currently, a majority of owner operators are in a difficult position thanks in large part to increased debt levels.  It’s clear to use that when the owner operators are making money and growing their business, shareholders are rewarded.  Owner operators are struggling mightily in the current environment; morale is at historically low levels as increased rent, wages, etc. are increasingly difficult to pay. 


Higher wages, which are inevitable, will only erode franchisee profitability.  Ironically, at the same time, it will benefit McDonald’s profitability, since franchisees will be forced to raise prices.  But franchisees must be very prudent with their price increases, because a significant percentage of McDonald’s employees are value conscious and will adjust their spending patterns accordingly.  Owner operators are the best brand ambassadors and their lack of enthusiasm will make a turnaround very difficult to achieve.

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.52%
  • SHORT SIGNALS 78.70%