May 8, 2015

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KSS – New Black Book. Putting Our Credit Thesis To The Test

Takeaway: Our new Black Book/consumer survey will test our thesis that 25% of KSS’ EBIT is at risk of going away – contrary to management’s guidance.

Please join us on Tuesday May 12 at 1pm for a call in conjunction with our latest Black Book on Kohl’s, which is a Best Idea Short. Note that the call will be two days before KSS 1Q results. Despite the obvious strength in the stock and the business year to date, we think that earnings growth will decelerate sharply as the year progresses, and that earnings power will prove to have peaked at $4.26 last year. We think consensus estimates are high by 15% this year (after we pass 1Q), and by 30-40% over the following two years. Ultimately we think that KSS will shift from trading at a peak multiple on peak earnings, to more of a mid-cycle multiple on something closer to $3.50. That suggests a stock in the low $40s, or about 45% downside from here.


The key issue as we see it links back to the company’s credit card and rewards program. Specifically, we think that the rationale behind the recent change in KSS Rewards is evidence that KSS is in the 10th inning as it relates to finding new customers. About 85% of profits are linked to the credit card, and we think that 25% of EBIT is at risk due to the recent changes implemented by KSS management.


In order to put our thesis to the test, we are in the process of completing a very detailed consumer survey of 1,000 KSS shoppers who either hold a Kohl’s credit card or the new Yes2You rewards program. The results (which we have not yet seen and might well prove us wrong!) should give us an accurate picture as to who is shopping, how much they are spending, and how much of a customer’s incremental purchases are flowing through KSS Card or some other Third Party Card (Visa, MC, etc).


Participant Dialing Instructions (We’ll Also Have  A Live Streaming Presentation in Conjunction with the Call)

US Toll Free:

US Toll:

Confirmation Number: 39610531

REPLAY: The Macro Show - Special Jobs Report Edition

You don't want to miss today's LIVE special edition of The Macro Show featuring Hedgeye CEO Keith McCullough and special guest, U.S. Macro Analyst, Christian Drake. The show will also feature a live play-by-play breakdown of April's all-important jobs report, what it means, and how investors should position themselves.





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KATE – Happy Mother’s Day

Takeaway: Nevermind the Kate Spade bag this Mother’s Day – buy her the stock instead.

Fact: KATE is consistently one of the most volatile ‘earnings day’ stocks, moving an average of 12.7% (usually down) on the day of the print.


Fact: There is usually a very good reason for the move – either due to poor communication about guidance, or sloppy results as the high-growth model either invests in, or closes non-core divisions.


Fact: KATE’s communication misfires are a thing of the past. The company nailed it this quarter. Even when an analyst asked an inciteful question about participating in the industry’s ‘promotional cadence’ (which could have had a bad outcome), CEO Leavitt proverbially stuffed the question right back at the Analyst, and showed how KATE is on offense as it relates to creating its own destiny as opposed to being hostage to an industry that few on Wall Street really understand.   


Fact: This was a great quarter. Sales were up 24%, margins looked healthy across the board (gross margins up 80bps, EBITDA mgns +400bps), and inventories were very much in check (up 12% vs 24% sales growth).


Fact: Comps came in at 9%, and management said that comps should accelerate throughout the year (implying something in the teens). But guidance still calls for high-single digit comps for the year (#conservative – i.e. 9% is already at the highest end of that range).


Fact: We can find absolutely no good reason for the sell-off today. When we saw the print, we checked the box and assumed that the stock would be up modestly.  We can usually pin an outsized move on something. But in this rare instance, we don’t get it. That’s probably the only concern that we have about the print – the fact that someone might know something that we don’t (that said, the company does not know it either).


KATE remains one of our top ideas. As outlined below, we think that there’s a roadmap to a $75 stock over 2-years.


KATE – Happy Mother’s Day - KATE financials 5 7


Some Details on the Numbers

Comps came in 250bps above the street’s expectations at 9% with Japan down 4% and e-comm in the high teens, low DD. But, due to the 14th week LY, SE Asia JV, and closure of Jack/Saturday sales we’re a little lighter than expected. Year-over-year unit growth slowed from 30% to 7% as the brunt of the store closures fell in this quarter. There are a lot of moving parts on the revenue line now due to the factors mentioned above with the Brazil transition announcement added to the mix.


Despite the noise on the top line, let’s stick to what we know.

1) Sales grew in the quarter on a pro-forma constant currency basis by 28% (24% excluding the currency impact).

2) E-commerce comp in the high-teens, low-20’s assuming a weight of 25% on the low end and 20% on the high end. Even with the pull-back in ‘Flash Sales’ this side of the business continues to outperform.

3) 9% is at the top end of HSD, and comps will accelerate from here. Management again was extremely conservative with its guide but we didn’t hear any reason why we shouldn’t still expect the sequential acceleration management initially guided to…


a) 2Q -- The company moved it’s ‘Friends and Family’ event into 2Q15 this year and will repeat the Semi-Annual sale in 2Q again this year. Also lapping the pull-back in Japanese consumption following the tax hike.

b) 3Q – KATE is lapping the lost Semi-Annual Sale from a year ago, and will be adding back the Juicy re-lo’s which should add a ‘couple hundred bps’ to comps.

c) 4Q – Lastly, the company is lapping the first real pull-back in ‘Flash Sale’ events in the quarter when it took down its events from 3 to 2 in 4Q14.


4) US store productivity flat. The majority of the KATE’s store base (about 60% on our math) is in the 1-3 year old band. Meaning that they should continue to ramp meaningfully on the productivity curve. Our sense is that this helps explain a large part of the stagnant US comp door productivity.



Margins across the board looked really strong. As the company shed the Jack/Saturday anchor. Most of the beat on the gross margin line was attributed to timing and plenty of reasons were given why margins should be flat YY excluding the 4Q14 Jack/Saturday inventory write down. But in 2Q14 Kate Spade Saturday alone accounted for 240bps of the 315bps of dilution on the Gross Margin line (about $6.5mm), and the company will be lapping that when it reports numbers in 3 months.


For the year, the top end of guidance assumes a 15.7% EBITDA margin rate. On par with what the company printed LY when excluding the $29mm in losses from Jack/Saturday in 4Q and the $6.5mm inventory write down charge booked in 2Q14. With Int’l KSNY EBITDA margins guided to HSD from flat last year and Adelington margin neutral there is room to outperform especially if sales come in ahead of guided expectations.



05/05/15 10:29 PM EDT

KATE – We Feel Good About The Print


Takeaway: We think that the long-term call is absolutely on track, and that KATE’s 1Q results should be another milestone on the way to $75


We think that the long-term call is absolutely on track, and that KATE’s 1Q results on Thursday should be another milestone on the way to $75. As the company doubles its sales base over the next three years while taking margins from 11% to 19%, generating $3+ in earnings power. Sales and margins trends look in-tact over the near term as the US e-comm trends looked solid even with the pullback in Flash events. And, margins stand to benefit from the elimination of stand-alone Jack/Saturday stores and the shift of the ‘Friends and Family’ from 1Q14 into 2Q this year.  


We’re Above Consensus. We think that management was being overly cautious with its targets for 2015. There are so many levers in this model, and our sense is that the company downplayed them. KATE guided to $185mm-$200mm in EBITDA for the year – assuming the top end of revenue guidance, that’s 15.7%, or about flat on a year/year basis (adjusting for the Jack/Saturday dilution). But we’re modeling $237mm, or about 110bp higher than last year. That’s about 65% EBITDA growth for the year, a number we expect to moderate only slightly to 50% the year after.


Quite frankly, we like the company’s conservatism, as it will keep expectations grounded, and mitigate the likelihood of an earnings day sell-off, which happens too often for KATE to call it a coincidence.


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.





1) This is perhaps the most polarizing number we will see during the print on Thursday. While we usually don’t play the near-term comp game, let’s strap the accountability pants on for KATE management. It guided 1Q14 high-teens, 4Q at 8-14% and the full year at 10-13%, and printed 29%, 28% and 24% for each quarter and the year respectively. The company’s initial guidance for the year calls for HSD comps improving sequentially throughout the year. We should see a typical KATE print, sales coming in ahead of expectations followed by a guidance raise.


2) For the quarter we are at a 10% comp, and will be very surprised if we see anything in the single digits. More details on the math behind our assumption and the two controversial areas below…


a) E-Comm The company continued on its planned pull back on ‘Flash Sales’. Similar to 4Q14, the company hosted 2 ‘Flash Sales’ compared to 3 in the prior year’s quarter. In 4Q14 the company posted sales growth of ~45%-55% depending on the aggregate weight of the segment. In the quarter, e-comm alone would support 5% comp growth assuming it is a) 25% of the business in 1Q, b) grows at 20%, and c) Brick and Mortar comps are flat. If we ratchet e-comm comps up to 25% holding all other assumptions the same, it would get us to a 6.3% comp for the quarter.


b) Japan – Due to the 37% comp KATE Japan posted in 1Q14 ahead of the country’s consumption tax hike from 5%-8%, management cited this as one of the main reasons for the guided sequential slowdown in comp trends. But given the size of the business (12% - 15% of total revenue) we’re not overly concerned about the potential headwind. 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 (flat sequentially). That suggests 250bps of sequential headwind on a consolidated basis.


c) Our algorithm consists of a few parts. Organic growth ex. Japan and Jack/Saturday of 13.5%. Japan down 3%. Which gets us to 10% comp growth. That’s broken into e-comm growth of 20% (~25% of the consolidated revenue base) and B&M comps of 6.7% down from the 21% we saw in 4Q14.


EBITDA Margin:


1) Gross Margins: The way we see it, the combination of Jack/Saturday caused 130bps of dilution in FY14 from inventory write off charges alone. The company will get all of that back in ’15. With the additional benefit of shedding free standing Jack/Saturday doors which were operating well below the company average.


a) For the quarter, the company is comping against a 150bps decrease in Gross Margin as the company moved its ‘Friends and Family event’ into 1Q14 to pull forward sales lost to a late-April Easter that fell in 2Q14 last year. The company did not repeat the sale in 1Q15 this year. That should more than offset any headwinds from Fx or occupancy related to the newly converted Juicy outlet doors.


2) In total we get to operating margin expansion of just over 300bps, with the majority driven by SG&A leverage with 100bps of Gross Margin expansion. Add on the $12mm in estimated D&A cost gets us to an adjusted EBITDA margin of 11.3%.


Cartoon of the Day: Entrails

Cartoon of the Day: Entrails - Central planning voodoo cartoon 05.07.2015

Relax. They've got it all under control.


Takeaway: While positive, the $35m increase in synergy target wasn't completely a surprise. It had been in mgmt's back pocket to mask higher costs.







  • 6.7% average increase in beverage prices
  • $1 in net yields translates into $15m in bottom line
  • Market-to-fill strategy:  172 days booked (154 days in Q1 2014).  39% more revenue on the books for 2016 vs 2015 at same time last year
  • Freechoice style promotion resulted in record-breaking Wave demand for Norwegian
  • Every quarter in 2015 higher load factor than 2014.  2016 load factor has doubled what it was in 2015 at same time (Norwegian brand only)
  • German/UK sales offices joined forces in Prestige acquisition
  • "Incremental Reinvestment efforts: crucial to ???? customers
  • Norwegian Escape:  booked better 10x than Getaway.
  • Oceania Siriena: record booking days
  • Lower interest expense:  lower than expected interest rates and better group pricing on credit facilities due to better leverage metrics
  • 1Q higher costs: receipt of technical parts and increased marketing expense
  • NCC:  $9.1m benefit on mark-to-mark contingency (contingent of $50m of Prestige shareholders) 
  • 1Q: $401 at the pump oil price (-39% YoY)
  • Norwegian Star drydock in April - repairs under warranty but lost revenue from canceled 15 day Panama sailing
  • 2015 NCC guidance: unchanged as $20m 'reinvestment' offset better cost synergies
  • Q2 2015 capacity:  29% in Caribbean, 27% in Europe, 12% Alaska, 4% Asia/Africa/Pacific/World Cruise
  • Final tally of synergies will be during Q2 conf call


Q & A

  • Why was net yield FY 2015 guidance not raised?  Combination of things: Star drydock, FX hit later
  • Sees prices/diem going higher in 2016
  • When Q2 integration efforts are done, they will do a China study group and expect to complete by end year.
  • "Incremental reinvestment costs ($20m in 2015, $40m in 2016)" - sales force/marketing efforts 
    • No benefits baked into 2015/2016 guidance
  • By 2017, EPS would hit $5 (had included $50m synergy target in 2016)
    • Now additional $25m net synergies boost 
    • Feel stronger today $5 is achievable
  • Revenue synergies:  2/3 synergies onboard yield, 1/3 ticket synergy.  More opportunities were in ticket.
  • 1Q 2015 synergies:  75% in ticket (more towards Norwegian).  25% in onboard synergies (skewed towards Prestige)
  • Deferred revenue of $21m:  $18-19m remaining for next few quarters.
  • Fuel guidance: MGO fuels costs go up in Q3 but will go back down in Q4
  • Market color:  Pretty steady across all regions.  A little weakness in exotic itineraries in Oceania (Africa/Asia). Alaska doing well. Escape doing well.
  • Increase in beverage prices:  have not seen a decrease in consumption
  • FX sensitivities: $0.003 euro, Canadian $0.003, Australia $0.002 
  • Feel there is more opportunities on synergies
  • $27m headcount reductions (10% of payroll) for 2016 ---pretty much done there in cutting costs
  • Will not eliminate close-in discounting. Applaud RCL for taking that step
  • In Q4 2015, could start to pay down some debt or share repurchase
  • Weighted cost of debt: 3.7%
  • Share repurchase has higher priority than issuing a dividend

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