HedgeyeRetail: I Got An Idea

Takeaway: Here’s a brief summary on our Longs and Shorts. We have another dozen names on our bench, and about 20 in the vetting stage. Stay tuned.

 

TOP IDEAS

LONGS

RH: We’re comfortable owning into earnings in two weeks. We’re ahead of consensus, and the earnings algorithm should show that sales and earnings are accelerating while the broader group is slowing. We should also get some good detail on new categories/concepts, which should fuel growth along with a material square footage ramp in 2H. Still one of the biggest Consumer ideas out there today across durations. We like the fact that there are so many different angles here that are so grossly misunderstood by the investment community. The company will continually innovate, grow, while marginalizing its weaker competitors. We still think that RH being above $200 is more a question of ‘when’ than ‘if’. The story is not linear – no great stories are – and there will be puts and takes by quarter. But this quarter looks good from where we sit.

 

KATE: Our only concern with KATE is that it trades like something is wrong. But fundamentally, this name checks out.  Comps seem to be accelerating from the (slightly weak) 9% number we saw in 1Q, and are torn as to whether the biggest surprise for people will be the sequential acceleration in the business, or the margin gain from last year. Either way, KATE is one of the few high-growth names that should work while the group faces headwinds.

 

NKE: We’re well ahead of the Street for the May quarter. It’s important to remember that last quarter when multinationals were dropping like flies due FX headwinds, NKE uncharacteristically came out just fine. The difference between this and prior FX cycles is that now Nike has an e-commerce offset. Dot.com should accelerate by roughly 1,000 bp to 50%+ as its solid momentum comps against an easy May14.  The math here is clear – an incremental sale online not only carries a 20point margin premium to a wholesale sale, but roughly 4x the Gross Margin Dollars. The same dynamic is at play this time, and the next quarter, and the quarter after that…

 

WWW: We’re comfortable with this one as a sleepy name that has several levers. We think that 1) the PLG brands (40% of the company) are growing outside the US to a far greater extent than is apparent in the GAAP results. That will show to a greater degree in 2H, which should give estimates a lift. Also 2) Merrell (25% of revs) just swapped out its high-profile President, and probably has a free pass for another few quarters while it changes direction. So that’s about 65% of revenue, or 90% of rev that has any element of volatility. Estimates look extremely achievable this year. Also the Street is not accounting for what should be 500bps in financial deleverage. If we don’t see it, it is likely bc WWW goes ahead and does another deal – and it can stomach up to a $1.3bn transaction at current leverage levels. We usually don’t like deals, but in WWW’s case they usually serve as a positive catalyst.

 

SHORTS

KSS:  Even after the recent drop, we still think KSS is a solid short. Expectations are too high in sales and gross margins and cash flow, and too low in SG&A. Wage pressure will build for KSS this summer (lowest paying in the industry) when it flexes its workforce for seasonal employees – then again around holiday. We also think that there’s meaningful risk to KSS’ credit card income (25% of total EBIT) – even in a very healthy credit environment – due to the flawed nature of how the new rewards program intersects with KSS Credit Card. Consensus estimates are marching to $6.00, while we think they’re headed to $3.00.

 

HIBB: We think that HIBB is one of the most structurally challenged retailers out there. Top line trends are decelerating, costs are accelerating, and capital requirements are going nowhere but up. Any form of growth from here on out – in existing stores, new stores, and online, will all come at an incrementally lower margin. Numbers in the current year are coming down, but we think next year’s earnings are too high by 40%. Still one of our top shorts following the 1Q print.

 

FL: There’s no debating the strength of the quarter on Friday, with 2% sales growth leveraging to 18% growth in EPS. But virtually every penny of the EPS upside came from lower SG&A – in fact, Gross Profit was only up 3.7%.  SG&A was down 2.8% vs last year, and came in at 18% of revenue. For the record, it is almost impossible to find a small-format retailer with SG&A below 20% of sales, and FL is sitting at 18%. This is also notable in that FL recently noted that its SG&A goal is 18-19% of sales. The point is…it’s pretty much there.  Remember that this company’s RNOA went from 5% to 28% over six years as it pulled capital out of the model (closing stores/repositioning banners) while boosting productivity and margins to all time highs. At the same time, it’s percent of sales from Nike (traffic driver) went up by 2,500bps to 72% of COGS – and near 80% of sales.  That’s not going any higher. FL’s answer is to become a unit growth story once again and sustain a mid-single digit comp while maintaining the leanest cost structure out of any retailer around. And for all that, the stock is trading at 16x forward earnings – an all-time high. The ‘going private’ angle here is moot given its high Nike exposure. Lastly, the stock is having more muted reactions to good news. 

 

TGT: Out of any idea on our list, this is the one we struggle with the most. On one hand, with the Canada disposal out of the way, there are no more quick and easy fixes for new CEO Cornell to improve profitability. He’s stuck with the result of an extremely poor decision making process by his predecessor that left the company in such bad shape that going to Canada actually seemed like a good idea in the first place. We think that the company needs to materially step up investment to set TGT on a growth trajectory – basically putting the brand once again on offense. That would likely take margins – and potentially sales – lower before they ultimately head much higher. But we can’t shake the Bull Case, which is that Cornell will make subtle tweaks to the model that will be enough to keep earnings slowly grinding higher – without implementing major change that will hurt the stock over the near-term.  We’re going to continue to wait and see into 2H, as we think that the significant EPS deceleration in the group plus increased cost pressure (labor and margins) will step up materially. Risk to TGT in that environment is to the downside.  

 

HedgeyeRetail: I Got An Idea - 5 26 idea list


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