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Takeaway: 1) Even when LULU beats 2Q, algorithm will be bad, w returns declining. 2) JCP R.E. event shows oppty for those that deserve ‘A’ malls.


RH - Roadmap Into Thursday's Print  -  To see our full note CLICK HERE

LULU - Not Much to Get Excited About

We exited our long position on 3/26 with a view that at that $65, you have to really believe that the current operating plan that LULU management has in place is the right one to double the size of this company. We're by no means bearish on this name, but there's absolutely nothing  that came from yesterday's print that causes us to second-guess our logic.

  1. As close to a $0.01 beat as LULU could conceivably get with a 2% share reduction giving LULU the extra juice.  Comps slowed sequentially on a C$ basis continuing the downward trend on a 2yr basis. Store sales were underwhelming, down 400bps sequentially, but e-comm picked up the slack (up 27%) reaccelerating on a 1yr & 2yr -- inline with what we've seen from online traffic/visitation metrics.
  2. We're surprised that the earnings algorithm hasn't come under more scrutiny. In the quarter earnings were down 2% on 22% sq. ft. growth and mid-single digit constant currency comps. The 2Q guidance implies more of the same -- 25% sq. ft. growth, HSD constant currency comps and earnings down -7.5% to -1.5%. This creates a bit of a mixed dynamic; a) on one hand, the company is likely to beat its guidance -- even if EPS growth is flat to down. b) declining returns as unit growth is up, productivity is down and costs can't (and shouldn't in LULU's [underinvested] case) make up the difference. So a beat is likely to trump anything else, but it is in the context of a horrible algorithm and return profile.
  3. This is the 9th straight quarter where sales have grown ahead earnings, as gross margins were down another 230 bps -- off 10 percentage points from 2011 1Q peaks. With more headwinds on this line over the near term as inventories grew 33% on 10% sales growth taking cash flow from ops down $50mm YY. The one positive being merchandise margins were up 100bps,but were against a 310bps decline last year. Management's plan for GM improvement next year is largely comprised of benefits that are out of its control.
  4. As we look at the growth drivers for FY16 on the gross margin line -- we're not overly excited about a couple bps from reduced fabric expense and air freight cost (the two main drivers of GM expansion CFO Haselden called out). If management is going to make mid-20's operating margins a priority then we need to see more meat on the bone.
  5. No change to our thesis here. We still see $4.00 in earnings power locked away in this brand, but right now the slow drip and lack of an articulated plan by management isn’t enough for us to get excited about. Guidance came up by $0.01 in line with the beat. 2Q guidance isn't heroic with -7% to -2% earnings growth on HSD C$ comps. The questions we have is what are people looking at for an earnings number in ’16? Unless we can build to a number well above the consensus number of $2.34 for FY16, with the stock in the mid $60's at 28x it looks flat out expensive.

RH, JCP, M, Dept. Stores - JCP Lease Termination a Blessing?


Takeaway: If you're curious about where the square footage for RH's expansion plans is coming from and why the deal economics are so attractive, look no farther than the commentary from Kemper Freeman. The Bellevue Collection property just replaced an existing JCP location with a Zara, Uniqlo, and an 'Urban Grocery'. “It took 12 years to get Penney’s out...It took 30 days to find tenants to replace it.” We're not surprised that these conversations are taking place, JCP still has over 130 locations in  'A' malls where it flat out doesn't belong. By our math (in the example below we use an RH, Cheesecake Factory, and a Whole Foods) the income generated from anchor tenant pads increases by 134%. And, it has the potential to complete gentrify the entire wing of the mall. It's likely we'll see more of these types of deals moving forward -- especially in the 'A' malls.

Retail Callouts (6/10): LULU, RH Real Estate, JCP/M - 6 10 chart1


FRAN - 1Q15 Earnings

Retail Callouts (6/10): LULU, RH Real Estate, JCP/M - 6 10 chart2

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