Hedgeye CEO Keith McCullough breaks down the Real-Time Alerts positions as of 1:00PM ET and fields subscriber questions.
Takeaway: Mgmt gave us zero comfort that this can be a ‘big idea’ in the $60s. It needs to shake the etch-a-sketch on its business model.
On Tuesday we took LULU off Hedgeye’s Best Ideas list, and today we’re taking it off our Retail Long list altogether. We’re out.
In our BlackBook on Tuesday (Link: CLICK HERE) we said that there’s $4.00 in earnings power hidden in there, but we need the conviction that management could find it. After today’s call, we we’re far from convinced – even farther than we thought we’d be just a few days ago. In order to justify a 30x p/e and give anyone hope of something in the $70s or $80s (presumably what you’re playing for in buying it today) we think that the company needs to completely reset its business model.
By ‘reset’ we think it has to stop focusing so much on a) improving gross margin and b) building out its North American real estate market.
a) First off, we’re hard pressed to think we’ll get much pushback from people saying that they’ll pay up for a higher margin. That might be the case for KATE (6% on its way to 19%) and RH (9% going to 16%), but not for LULU, which is 21% down from 29% -- and probably belongs in the high teens – which is NOT a bad thing. Management made it clear that a key area of focus remains driving Gross Margins. That’s a #mistake – from both a tactical and a communications standpoint. Laurent noted how “we don’t drive our business with markdowns.” Well, unfortunately he competes with brands that do. As long as this team hangs onto this mentality, there’s a greater risk of an unexpected slowdown in quarterly revenue.
b) As for real estate, we outlined in our Black Book on Tuesday why moving into so many new markets in the US will prove to be dilutive to both productivity and comps. But that’s exactly what LULU double downed on. Management discussed adding another 100 stores in NA (US, mostly), some of which will be larger-format stores that will deleverage occupancy costs (and are untested)
Is Lululemon a great global brand? Absolutely. But Lululemon Athletica, Inc is not a great global company. It’s not even a good global company. Let’s be clear, it absolutely can get there. But it has to break out of this North American owned retail-centric model and follow companies like Kate Spade, Kors, Nike, Ralph Lauren, and Under Armour (KATE AND UA are the most appropriate comps for many reasons). That means aggressively building out its international model – not by adding a token store in Dubai or ‘doubling’ its presence in Singapore by adding one more store. It needs to own the customer relationship by producing different product for different customers at multiple price points and distribute where the consumers shop. It’s not enough anymore to build up stores in new markets (or fill-in markets) and expect consumers to come shop. They need to be where the consumer shops. That means selling at Retail (which they do), e-tail (they’re getting there), and importantly – wholesale (zero presence).
It was pretty clear that this team collectively is focused on doing the same thing it’s done all along – just better. That’s not enough for us. We need it to think bigger. The brand can handle it, and stockholders deserve it.
The other key factor was new CFO Stuart Haselden, who has only been on the job for about six weeks. There are a lot of puts and takes here.
- The guy sounded like he’s been at the company for six years, not six weeks. He had an extremely strong control of the numbers for someone who was put in front of shareholders for the first time.
- As he reviewed the numbers, I scratched my head wondering how he could sound so comfortable in such a short time. Then it hit me…he was literally reading the script that former ‘cfo’ John Currie used for years.
- He sounded more convincing than Currie, which is a plus. But we wonder what kind of mandate he has to illicit change and build a finance culture inside a company that was built specifically to box out any kind of ‘finance culture’. (NOTE, both UA and KATE have one).
- The Q&A was a bit redeeming, in that Stuart answered 75% of the questions. He literally took over from Laurent, and it was difficult to tell who was running the show. Either a) he’s the more dominant personality, b) Laurent – who is naturally uncomfortable with analysts after his disastrous first outing last year – asked Haselden to take the lead, or c) The Board – who we think is Haselden’s REAL boss, told him to dominate the call.
- Either way, the dynamic was very notable. We can only hope that this results in a material change in the decision making at LULU. That has yet to happen. But in fairness, it is way too soon to happen. We’re inclined to think we’ll be looking at more meaningful changes in the functionality of this leadership team later this year. But again – we need draconian changes in the model as outlined above to make this a great stock. We’re comfortable revisiting it when the research suggests that’s happening.
Hedgeye CEO Keith McCullough shares the top three things in his macro notebook this morning.
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Client Talking Points
Obviously we didn’t have air strikes into Tikrit in our model, but that’s what moves the oil market in very short order here. We are seeing a 4.8 standard deviation move on our immediate term trade duration which puts oil up at the top of the risk range. The risk range for WTI Oil is now $10 wide, this will just perpetuate more volatility. The immediate term risk range for WTI Oil is $42.39-52.29. This is a great selling opportunity for oil.
Probing the lows here the bottom end of the risk range for the USD is just north of $96, the trend line of support is closer to $93. We are not changing our bullish view on the USD or our bullish view on holding a lot of cash. The USD risk range is almost being as asymmetric to the upside as oil is to the downside, we see no resistance for the USD until $99.65 and the upside down to that is that we have no support for the EUR/USD to $1.04.
2,046 is support and 2,084 is resistance for the S&P 500, what was support has now become immediate term resistance. What is even more interesting, is that the trend line that is very much in play, is pretty much right where the S&P 500 started the year. The futures have you below the trend line and below the trade line and again that’s obviously a very bad thing if it were to hold. Now what would be the catalyst...EARNINGS SEASON. The music will stop once the economic gravity hits the tape so again watch out for this, these phase transitions can happen quickly. If the S&P 500 can’t get back above 2,058 this will likely turn into a bearish trend for the S&P 500.
|FIXED INCOME||26%||INTL CURRENCIES||15%|
Top Long Ideas
Manitowoc (MTW) is splitting the business into two companies. Given the valuation differential between the sum-of-the-parts and the current enterprise value of the company, the break-up should be a substantial positive. Recent nonresidential and nonbuilding construction data remains firm for 2015, which suggests that MTW’s crane sales should see a pickup in the first half of the year. The Architecture Billings Index (a survey of architects) typically leads nonresidential and residential construction spending by approximately 9-12 months. More importantly, the ABI Index leads MTW Crane Orders by 2 quarters.
iShares U.S. Home Construction ETF (ITB) is a great way to play our long housing call, U.S. #HousingAccelerating remains 1 of the Top 3 Global Macro Themes in the Hedgeye Institutional Themes deck right now. Builder Confidence retreated for a 3rd consecutive month in March and New Home Starts in February saw their biggest month-over-month decline since January 2007. We think the underlying reality is more sanguine with the preponderance of the weakness in the reported February data largely attributable to weather.
While labor supply constraints may serve as a drag to builder confidence, presumably it is rising demand trends that are driving tighter conditions in the resi employment market. All else equal, we’d view improving demand as a net positive. On the New Construction side, while the sharp drop in Housing Starts captured most of the headlines, we believe the real story was in the 3% gain in permits. We'd expect to see a big rebound in the next two months in housing starts as the data plays catch-up to the thaw.
Low-volatility Long Bonds (TLT) have plenty of room to run. Late-Cycle Economic Indicators are still deteriorating on a TRENDING Basis (Manufacturing, CapEX, inflation) while consumption driven numbers have improved. Most of the #Deflation trades bounced to something less-than-terrible (both absolute and relative) for 2015, whereas the real alpha trending in macro markets continues to play to the lower-rates-for-longer camp’s advantage.
Three for the Road
TWEET OF THE DAY
Nice beat by $LULU. But guidance looks like death.
QUOTE OF THE DAY
The more time you spend contemplating what you should've done ... You lose valuable time planning what you can and will do.
STAT OF THE DAY
40% of content viewed on YouTube is in the music video genre.
TICKERS: SGMS, CCL
- March 26: Macau Legend 4Q conf call 8:30-9:30pm (EST)
- March 27: CCL F1Q, 10am -
SGMS - currently holds the West Virginia contract to provide the central monitoring system. That six-year, $6.2 million was originally awarded in 2006 and was extended when the six-year term expired. The current contract is set to expire in 2017.
WV Lottery director John Musgrave said the Lottery would like to have the bidding process complete a year before the current contract expires to allow for any transition period that might be needed should a different vendor win the contract.
Meanwhile, the state’s various lottery games generated nearly $94.7 million in revenue in February, about $2.2 million better than the $92.5 million forecast for the month. However, it was about $4.2 million less than the $98.9 million generated in February 2014. Better than expected revenue from video lottery games at the state’s four racetrack casinos, along with a boost in online games thanks to the $564.1 million Powerball jackpot during the month, helped offset a sluggish performance in limited video lottery revenue during the month.
Musgrave said the casinos are seeing a slight increase in consumer spending. He hoped that the improving spring weather combined with improvements in the regional economy will have positive effect on casino revenue in the next few months. “We would like to think we’re seeing an increase in disposable income,” he said.
Takeaway: Can SGMS hold on to the WV contract? In addition, WV casino revenues haven't seen a growth month since June 2012 due to stifling new competition. The decline will continue in March.
CCL - Carnival is ready to order 10 new ships and to sign a construction contract with the two biggest shipyards in Europe, Fincantieri in Italy and the German giant Meyer Werft.
The announcement with the details of the ships, the shipyards involved and the total figure for the agreement are expected by the end of this week, perhaps by Friday. The commission from the American company will be divided equally between Fincantieri and Meyer Werft.
The market price for these units would be between $700 and $800 million each, a figure that would bring the total value of the commission for Fincantieri to $4 billion. Other sources confirm that the order, when announced, should include a new class of ship for the Costa Cruise fleet: a 170,000-tonne prototype that could be ordered with a twin ship.
The other ships should be divided between the American giant’s various brands, Carnival in particular urgently needing a renewal of its fleet. New ships for Aida are also at stake: the group’s German brand, after the complicated construction of its latest ship in Japan, the “AidaPrima”, Aida decided to build its next ships in Europe.
Takeaway: Build it and they will come.... CCL hopes that is the case.
CY Foundation - CY Foundation Group Ltd, the parent of Macau-based casino services provider CY Management Ltd, said its plans to expand slot machine operations have to be extended beyond the original deadlines.
“Given the recent changes in market environment in Macau, the group has not been able to achieve its target to expand the number of gaming machines in operation to 1,000 by the end of this financial year [on March 31, 2015],” the company said in a filing this week.
CY Foundation identified the market changes affecting Macau’s gaming industry as “the enforcement of non-smoking policy in casinos, mainland China’s policies on restricting frequency of visitation to Macau and the anti-corruption drive within mainland China”.
The company had said in its interim report in December that its goal was to expand the number of gaming machines in operation to 1,000 by the end of the current financial year, and to 3,000 by the end of the financial year ending March 31, 2017.
CY Foundation said it would continue to explore potential sites in Macau and Southeast Asia.
Niraku Holdings - Japanese pachinko operator Niraku Holdings is IPOing in Hong Kong to raise US$49.5 million. Niraku is selling 30 million shares at HK$1 to HK$1.28 each in the IPO, which closes Friday. The money will be used to build five pachinko halls in northeastern Japan.
The $49.5 million is significantly less than the $100 million to $200 million Niraku originally expected to raise.
Niraku is one of four pachinko operators expected to go public this year.
Philippines - SM Investments is considering construction of a casino resort in the southern city of Cebu.
Barry Sternlicht- announced the launch of the new mission-driven luxury lifestyle brand 1 Hotels. The first property debuts in South Beach today, followed by Central Park in late spring and Brooklyn Bridge Park at the end of 2015. 1 Hotels celebrates nature while encouraging sophisticated travelers to live well, do better, and connect with the world around them.
Hedgeye Macro Team remains negative Europe, their bottom-up, qualitative analysis (Growth/Inflation/Policy framework) indicates that the Eurozone is setting up to enter the ugly Quad4 in Q4 (equating to growth decelerates and inflation decelerates) = Europe Slowing.
Takeaway: European pricing has been a tailwind for CCL and RCL but a negative pivot here looks increasingly likely in 2015.
This is a complimentary look at Daily Trading Ranges - our proprietary buy and sell levels on major markets, commodities and currencies sent to subscribers weekday mornings by CEO Keith McCullough. It was originally published March 26, 2015 at 07:56. Click here to learn more and subscribe.
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