KSS | Much More Downside To Go

Takeaway: Even on the 2Q blow-up, expectations are too high, and KSS is still a short.

Conclusion: Overall, a weaker quarter than even we expected for our top Short in retail. While few people would argue that Kohl’s is a great business, we remain convinced that there are underappreciated risks (even to most bears) to this model that will keep the company’s realized earnings power below $4.00 – pretty much forever. That’s notable when the Street is building up to a $6.00+ EPS number over three years. That’s not going to happen from where we sit.


Specifically, KSS has reached a pivotal point in its maturation cycle where it has already captured 75%-80% of all customers that could potentially shop in a Kohl’s store (see analysis below). Strip malls were once an alternative to Regional Malls, which is how and why KSS was born. Now there’s this thing called the internet that’s a better alternative for consumers to go direct for premium brands. Online growth for KSS is 1,000bp margin dilutive as its basket size is too small to absorb shipping costs, which is increasingly used by competitors as an offensive weapon. So the company is fighting hard – to its credit – to battle this trend. But it is a fight it cannot win. As such, growth is getting expensive. The company had to launch its Y2Y rewards program because neither Chase nor CapitalOne would flex FICO standards any more to go further down the consumer food chain to win new KSS customers. With Gross Margins in a secular decline due to e-commerce, and SG&A climbing steadily due to less credit income (which serves as an offset to SG&A, and is 25% of EBIT), we need to see the revenue line consistently grow in the mid-single digits to make the financial model work. That’s unlikely to happen even in the best economy. There might be flashes of brilliance from time to time, as all retailers have, but by and large, this model is a flat-out fade. And unlike other retailers like Macy’s, there’s no real estate value to speak of.


KSS  |  Much More Downside To Go - KSS market penetration by customers

KSS  |  Much More Downside To Go - KSS market penetration by household B


Here are some of the things on the quarter that concerned us (we’d list positives too, but there really weren’t any).

  • Credit penetration was down 171 basis points vs last year, with sales from Kohl’s card members down LSD in the quarter. This is one of the major risks we highlighted with new customer acquisition under the Y2Y program, in that a person can get the same benefits as a KSS card holder, but buy merchandise and pay for it with their Amex, Visa, or whatever card instead of being required to use the KSS card. KSS will still get the sales, but will forego the credit income. Again, that’s 25% of EBIT at risk.
  • At the same time, KSS’ guidance for 2H suggests that SG&A is trending at the higher end of its range. Note that as credit income slows, it exposes the real growth in underlying cost structure.
  • On one hand, KSS comped positive, which is well above the -1.5% we saw from Macy’s. On the flip side, it was only +0.1%, and it needs to be on a ramp (with a very short slope) to 2% in the back half. That includes 4Q, where KSS is going up an un-KSS-like comp of 3.7% (the number that started the rally from $56 to $79). Comping against this will be extremely difficult for KSS.
  • If there’s any way KSS gets the comp, it is because it is sitting on too much inventory – which was up 9% for the quarter on only a 1% sales increase, marking its second consecutive erosion in the SIGMA trajectory (below). The company tried to explain away its oversized position with $120mm in early deliveries making up 5% of the 8% unit jump. But management admitted a portion being due to lower than expected sales and also having higher clearance inventory.

 KSS  |  Much More Downside To Go - KSS sigma 8 13 15



Below is our previous note on KSS note from 8/11


KSS | Comfortable with Short Into Results

Takeaway: Headline may be benign, but a lot in this print should support our Short. We maintain our view that annual EPS likely to never grow again.

Conclusion: KSS remains our top short. Do we think that the wheels will completely fall off the story with this Thursday’s print? No. But we don’t think we’ll see any notable upside, and we expect to see key metrics erode in support of our bigger call on the name that annual earnings are likely to never grow again. To put that into context, we’ve got numbers between $3.50-$3.75 from 2016-18. That’s 40% below the consensus, which has earnings marching over $6.00. The stock may appear cheap to some at an 11% FCF Yield (the most common bull case we hear). But we’d argue two things…1) while numbers are coming down, department store yields have gone well above 20% (just ask Dillard’s), and 2) our model has a lot less margin and cash flow, and only a 6.5% FCF Yield at $3.75 in earnings. Lastly, unlike with Macy’s and Dillard’s, there is absolutely no real estate play with KSS. So when all is said and done, we’d be short KSS into this print, and if the company throws the bulls a bone – as it does from time to time – then we’d get heavier on it. This is as much of a ‘core short’ as we can find in this market.


Here’s a summary of the key things we’re looking for in this quarter…

  1. The only way we expect to see the recent positive trend in store traffic to continue is if KSS gives it all back in lower merchandise margins.
  2. The only comp we’re likely to see will come by way of e-commerce, which is GM% dilutive by 1,000bp.
  3. Combining those two factors, we can’t reconcile how the Street could be looking for a 20bp improvement in GM% y/y.
  4. We’re also looking for growth in credit income (25% of EBIT) to continue to slow due to cannibalization from its Y2Y Rewards program, which should lead to contraction in its biggest profit center by year-end (without having to make a call on the credit cycle).
  5. There’s no real guidance one way or another with KSS, so it will be interesting to see how management handles Revenue expectations for 2H. The consensus is looking for an implied underlying comp acceleration from -1% to +3% over just two more quarters. That’s BIG for a company like KSS.



Comps Get Tougher. The sales line should be the biggest ‘driver’ of this print on Thursday (with the caveat that earnings are really not growing). Expectations have come down considerably since 1Q where the buy side was looking for 4%+, and Consensus has walked numbers down from 2% (10bps lower then where it sat before the 1Q print) to 1.5% over the past month which helps explain the 5% sell off. The 1.5% seems achievable from where we sit, but assumes a positive 2yr comp -- something KSS has only printed once in the past 9 quarters (4Q14).


Then, comps get much tougher for the company with current consensus estimates assuming that the company accelerates sales sequentially on a 2yr run rate from the -0.9% number reported in the first quarter to 2.8% in the 4th quarter. We don’t believe that KSS’ current arsenal of sales drivers: personalization, loyalty, beauty, BOPIS is enough to reverse the 3yr trend of negative store comps.


KSS  |  Much More Downside To Go - KSS sales trend 


If KSS has anything going for it this quarter, it’s that e-comm comps were extremely easy in the months of May and June (at 15% vs 30% in July). But, the company lapped the same benefit in the first quarter where comps were 12.4% and failed to realize the benefit. Traffic rank numbers which take into account both unique visits and page visits per user ended the quarter up in the mid 40% range, a slight acceleration from what we saw in 1Q. But, what we think is more notable is a) the accelerated ramp of JCP which is a big deal considering our works suggests that KSS was the biggest beneficiary of the JCP market share hemorrhage, and b) the relative underperformance of M compared to the group.


KSS  |  Much More Downside To Go - KSS ecomm


Gross Margin

Management’s bull case for this year was predicated on improving merch margins due to tight inventory management. That was well and good when the company entered FY15 with a sales to inventory at a favorable 5% (the first positive spread in over 3 years), but the SIGMA trajectory inflected in a meaningful way to the downside headed out of 1Q against the easiest comp of the year. That almost never equates to a positive gross margin event. Management tried to downplay the margin headwind of 5% inventory growth by calling out the growth in National brands which carry a higher AUR (units per store were up 1% vs. last year), but that also comes with its own margin pressure.


On the DTC front, e-comm caused 42bps of dilution in the first quarter, and assuming a 20%+ growth rate in the DTC channel (which the company no longer discloses) that amounts to 30bps of headwind for the year assuming of course that there is no further deterioration in e-comm gross margins. That’s a big hit for a company like KSS to handle especially when you consider that the company started this new rewards programs which equates to 5% cash back, National Brand penetration growing (a conservative 4bps to 7bps of headwind for every 100bps of mix shift), and the current inventory position of the company.


KSS  |  Much More Downside To Go - KSS Sigma


SG&A Comps

It’s tough to reconcile the company’s guidance of 3-4% growth for the quarter after management guided to 4%-5% growth in 1Q and printed 1.6%. But what we do know is that…

  1. Credit was a 13mm (70% of the dollar decrease) benefit in 2nd quarter of last year, that’s slowed over the past two quarters to 1mm and 2mm, respectively. We think that continues to march lower as the Yes2You rewards program continues to curb credit portfolio growth.
  2. 2Q14 was just the 2nd time in the past eight years that the company leveraged SG&A expense on a negative sales number.
  1. Employment costs are headed nowhere but higher. KSS management seems to be in denial about the added pressure from two of largest players in the retail space raising wages to $9, but the way we are doing the math by extrapolating the guided WMT cost pressure to the relevant number of KSS employees we get to 60bps of margin pressure and a $0.35 (8% hit) to earnings. That hasn’t manifested itself yet, and probably won’t until the retail hiring season kicks up in 3Q for BTS.

KSS  |  Much More Downside To Go - KSS SGA Leverage 

No Change To Guidance

No matter what the company prints on Thursday, it’s pretty clear that the company won’t make any material changes to its FY guidance. The company updated its guidance policy last year, and noted that it would only update its Fiscal year numbers once in the 3rd quarter.



There hasn’t been a lot to like on the Management front at KSS over the past few months.


First, KSS ended its 14 month search for a new Chief Merchant when it decided to add responsibility to the plate of Michele Gass current Chief Customer Officer. With the entire global retail industry  as a talent pool to source this position, Mansell picked the person who said very explicitly at the Analyst Day in October that 'love' would drive the business -- not once, or twice, but 19 times. Also, being a Chief Customer Officer (something that has no P&L responsibility or accountability) has nothing to do with being a Chief Merchant. This one will be hard for the bulls to defend.


And more recently, the company’s CIO, Janet Schalk, ended her 4 year tenure as CIO and jumped ship to Hudson's Bay citing a ‘great deal of uncertainty’ over the management transition taking place within the company centered around the hiring of a new yet to be named COO.



Stay Short the Euro

Stay Short the Euro - Euro cartoon 05.18.2015

We remain the EUR/USD bears.


On Tuesday, Hedgeye CEO Keith McCullough issued another short signal in the EUR/USD (via the etf FXE) in our Real Time Alerts product. Here’s a portion of what he wrote:


If the Chinese think Draghi is going to sit idle and not devalue-back, they have another thing coming. As growth and inflation continue to slow, globally, I fully expect this central-planning FX War to continue.


Notably, the next days will bring parliamentary votes on Greece’s third bailout.  Make no mistake, the top Eurocrats (ECB’s Mario Draghi & Germany’s Angela Merkel) are incentivized to plug Greece’s credit hole. So, expect ‘debt relief’ in some form, but no great solution to Greece’s larger, leviathan structural issues. (Never mind the flawed nature of a currency union regulating uneven economies with one monetary policy.)


We continue to expect slower growth in the region from here. This should put increased pressure on Draghi to issue more QE.  As Hedgeye Europe analyst Matthew Hedrick wrote in this morning’s Early Look: 


Look to Jackson Hole at the end of the month (Aug. 27-29) as an opportunity for Draghi to talk down the Euro. An increase in his QE target would send the Euro falling.


Takeaway: After rolling SA claims hit 266.3k in April 2000, it took exactly one year for the economy to enter recession. This week's reading: 266.3k.

With spot SA claims having hit a 42-year low four weeks ago, the rolling 4-week number has hit its own low of 266.3k this week. The last time rolling SA claims were at this level was the week ending April 15, 2000. Aside from that one week in 2000, this is the lowest level of rolling SA claims since December 1973.


For perspective, back in the late '90s, early '00s cycle, 266.3k was the lowest rolling SA claims would go. The following chart shows that from April 15, 2000 claims began to rise; the economy entered recession exactly one year later.




In energy states, the spread versus the U.S. as a whole rose to 9 in the week ending August 1, coinciding with the July Challenger report that showed Energy sector cuts rising to 9k from 0k in June.




The Data

Prior to revision, initial jobless claims rose 4k to 274k from 270k WoW, as the prior week's number was revised down by -1k to 269k.


The headline (unrevised) number shows claims were higher by 5k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -1.75k WoW to 266.25k.


The 4-week rolling average of NSA claims, another way of evaluating the data, was -9.9% lower YoY, which is a sequential improvement versus the previous week's YoY change of -8.7%






















Yield Spreads

The 2-10 spread fell -5 basis points WoW to 148 bps. 3Q15TD, the 2-10 spread is averaging 161 bps, which is higher by 3 bps relative to 2Q15.







Joshua Steiner, CFA


Jonathan Casteleyn, CFA, CMT


LEISURE LETTER (08/13/2015) - WYNN, MPEL, Airbnb





August 28: 10:00am: PENN - Meeting with Management at Plainridge Park  


WYNN - Global casino giant Wynn Resorts may be contemplating a push into New South Wales, Australia (NSW) after its representatives met with Deputy Premier and gaming minister Troy Grant to discuss investment opportunities.  According to the latest NSW government ministerial diary summaries, representatives from Wynn Resorts met Mr Grant on May 13. The purpose is recorded as an "introductory meeting" to discuss "investment in NSW".
Takeaway: Worth pursuing...

MPEL - Billionaire James Packerstepped to step down as chairman of Australia’s Crown Resorts Ltd. Mr Packer will remain co-chairman both of Asian casino developer Melco Crown Entertainment Ltd and the “Alon Resort” casino-hotel project in Las Vegas, the company said in a filing.



Bloombery - Reported a net loss for the second quarter of 2015. The group’s unaudited results for the three months to June 30 show a net loss of approximately PHP773.54 million ($16.75 million) compared to a net gain of about PHP846.60 million in 2014.

  • Revenues for the three-month period increased by 9.4% YoY to PHP5.99 billion. 
  • Operating costs however jumped 47.2% from a year earlier to PHP5.61 billion in the second quarter of 2015. Including other items, total costs topped PHP6.27 billion, up 58.7% from a year ago.
  • Jump in costs tied to the opening of Solaire’s, Sky Tower and the acquisition of Jeju Sun Hotel and Casino in South Korea. 
  • GGR was PHP7.49 billion for the three months to June 30, up from PHP6.90 billion in the prior-year period
  • Rebates for junket operators and VIP guests however increased by 15.5% YoY to PHP2.01 billion



Airbnb - Reported yesterday that Airbnb acquired apartment rental startup, RentMethod.  This is not a formal acquisition. RentMethod is shutting down and two of its founders have joined Airbnb.  Customers who used RentMethod are being encouraged to port over their data to other solutions, to which the company will provide a list in the future.  



Macau Gaming License Study - The study the government is making in preparation for its forthcoming review of gaming licences is in the pipeline, and officials mean to have the first draft of the study report completed by the end of next month, Chief Executive Fernando Chui Sai On has said. 

  • Mr Chui told the Legislative Assembly that his government expected to begin soliciting public opinion on the findings of the study this year.

  • “The review will focus on eight aspects, including the impact of gaming on the Macau economy, small and medium enterprises, society and the relationship between gaming and the development of non-gaming activities. The review will also study if the current contracts with operators have been fulfilled and if they are assuming their social responsibilities,” he said.



Regional Gaming Revenues


AC - July GGR (SSS): +7.1 YoY 


Highlighted financials 

  • Q2 Gaming Revenue -28% YoY
  • Q2 Non Gaming Revenue -3% YoY 
  • Q2 Adjusted EBITDA - S$296.46 million, -6% YoY
  • Q2 Unadjusted EBITDA - S$107.865 million, -60% YoY
    • (Includes the effects of losses on financial derivatives)
  • Resorts World Sentosa contributed revenue of S$577.8 million, a drop of 23% YoY. Poor VIP business to blame. 
  • No dividend declared for Q2. Dividend of 1 cent was declared for Q1 2015. 
  • Q2 2015 eps - S$(0.14)

Q & A 

Rolling VIP volumes? VIP win rate?

  • Rolling VIP volumes -11% QoQ
  • VIP win rate - 2.1% 

VIP share of total volume? Mass share, Mass GGR?

  • 37% VIP, Mass volume 43% this Q, Mass GGR was 41% 

Overall GGR performance YoY

  • GGR -28% YoY
  • VIP GGR -36% YoY
  • Mass GGR +2% YoY

Accounts Receivable down substantially? Why?

  • They are being a lot more cautious in the VIP space. They are quite concerned with their ability to give credit. They have tightened their collection procedure quite significantly as a result of their lack of confidence in the Chinese economy. 

FX reserves are high because they must pay their customers back in the same currency they came there with. 


What drove the drop in value of your financial derivatives? 

  • The prices derive directly from the price of the public listed equities. The value of those equities has fallen off and therefore the derives have fallen off. 
  • Very limited color on how the values are derived. Would not disclose additional information on these derivatives. 

They do not hedge any of their currency exposure. 


Why is the mass market growing for you guys? 

  • They include mass and premium mass together. Very concerned with the volatility of the currencies in the surrounding countries. They get a lot of business from Malaysia and the Malaysian ringgit has continued to depreciate. This could hurt their mass and premium mass business. 

Cost cutting measures? What have you implemented?

  • Mostly reductions in the VIP business headcount through natural labor attrition. Could see further reductions in headcount. 

Ability to pay dividends and increase dividends?

  • Probably able to consider an increase in 2016 depending on how results rebound. 

Buy back to continue?

  • Yes, they have a lot of shares they can buyback, will move forward with the buyback as originally planned. 

Korea, whats the status of getting a gaming license? 

  • Property is well underway and construction is on track. The government is putting together the regulations and they should have the regulations finished by Q12016. Bottom line: They have to wait for the regulations to come out before they can submit their license application. Could be a 6 month wait until the application is processed and approved. 

ADR this Q?

  •  S$275

Market stabilizing?

  • Sentiment is still very negative from their perspective. They still see overall volume and GGR trending downward over the next 12 months. 
  • Currency issues in the surrounding countries remains a major problem and could further hurt visitation and GGR. 

Does the low win rate has to do with the breadth of players, or is it the table mix?

  • Not the table mix. From a statistical standpoint they do not know why their win rate remains so low. They are "praying" for it to get better. 

Slot mkt. share in Q2?

  • 43% for the Q. (for the entire slot business)

What are the derivatives linked to? Which equities? US, AUS, UK?

  • No comment. 









USD, EUR and Commodity Divergences

Client Talking Points


Investors pushed out the dots yesterday as global growth slowing and China’s quasi-acknowledgement of economic reality pushed bets on the probability of a September lift-off back below 50% and pushed the dollar -1.1% lower on the day. With dollar correlations still strong, across durations, ↓ Dollar still  = ↑  (commodity/energy) re-flation and XLE followed the currency correlation playbook gaining +1.86% and leading sector performance  … but the slow-growth rotation remained equally strong with XLU up 1.8% on the session (+2.8% MTD vs SPX -0.85%).  The USD is up modestly this morning and Jackson Hole – the next major currency catalyst – is, on the margin, Euro bearish.  Jackson Hole = Aug 27-29th, September FOMC = Sept 17th.  


We remain the EUR/USD bears. The next days will bring parliamentary votes on Greece’s 3rd bailout.  Make no mistake, the top Eurocrats (Draghi & Merkel) are incentivized to plug Greece’s credit hole. Expect ‘debt relief’ in some form, but no great solution to Greece’s larger structural issues nor the flawed nature of a currency union regulating uneven economies with one monetary policy. We expect slower growth in the region from here, which should put increased pressure on Draghi to issue more QE.  


3-factor price signaling in the commodities complex is sending mixed signals. Relative USD correlations (near-term vs. historical norms) are tracking more positively (less negatively correlated) and price volume signals vs. USD movements are diverging across the space. Nat. Gas and RBOB Gas finished +~3-4% vs. Corn and Soybeans -5-6%, all on heavy volumes. We continue to like base metals, materials, and crude on the short side, but time and price is key. Most look oversold on a near-term duration on our screens. We would look to short on strength.  

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

In an analysis of the demographics of the newly insured, Pap testing, HPV, and mammography were at the top of the list of products that would be positively impacted by the ACA.  As we reach the #ACATaper stage, will HOLX take a hit to their Diagnostic segment? It is possible, in our view, but so far a minor risk. As we learned last week from a lab operator, Qiagen is likely to continue to cede their 14% HPV testing share to HOLX. So while the #ACATaper appears to be finally here, there are offsets. On a disappointing note, our 3D Tomo Tracker update for July came in at 24 facilities. Down sequentially from June, and down from a peak of 54 in May. Our forecast algorithm, which is based on these updates, remains unchanged. While 20 is low, it is probably a blip in the longer term adoption cycle.


PENN has emerged as the first domestic gaming growth story in 10 years with a new casino in Massachusetts this year and one in San Diego next year. Meanwhile, regional gaming trends have stabilized, providing near term earnings visibility and upside. Upcoming catalysts include the monthly release of State gaming revenues for July, including Massachusetts, and positive earnings revisions.


Sometimes the macro rotation and allocation playbook is relatively straightforward. As growth slows and "reflation" deflates, you want to be buying A) Long-term Bonds and B) stocks that look like bonds. Bond proxies and defensive yield consistently outperform alongside the dual deceleration in demand and prices and Utilities and REITS remain the go-to sectors for growth slowing, defensive yield exposure.

Three for the Road


$SHAK announces 4M share offering priced at $60 - someone thinks its a good buy here



One person with passion is better than forty people merely interested.

E. M. Forster


Only 1.9% of Facebook users continue to use the popular 1990s-era acronym LOL to signify their laughter in a post.

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