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RH | Catalyst Calendar Begins

Takeaway: RH Teen is a plus, but its importance will be dwarfed by how well RH is likely to execute this growth plan over the next four months.

This announcement about the launch of RH Teen is not groundbreaking by any means, but it is a positive one nonetheless, and is absolutely consistent with the path that RH needs to take in order to double its revenue by 2018 and reach $11 in earnings – a number that is $5, or ~80% above the consensus. If we’re right on our numbers – which we think we are – then that suggests a long-term CAGR in earnings and cash flow better than 40%. If that’s the case, then the current 28x forward multiple looks flat-out cheap given the growth profile.  Higher multiple on higher earnings = $140 in six months, $200 by the end of next year, and then $300 in 2017.  We detailed our math recently in our latest RH Black Book “RH | Road To $300” which outlines the longer-term, but what we think is interesting is how RH’s catalyst calendar is shaping up.  

 

RH | Road to $300 Black Book

Video Link: CLICK HERE

Materials: CLICK HERE

 

RH | Catalyst Calendar Begins - RH fin table c 

 

Importantly, we think that the catalyst calendar is just starting to pick up, and should be the best that RH has seen – perhaps ever. Here’s the roadmap…

1) Earnings on September 10. We’re looking for a strong, consistent quarter out of RH, with 18% revenue leveraging to 25% EPS growth. Our number is only a penny ahead of consensus, keeping in mind that management was on its convert roadshow in the final month of the quarter. It already disclosed and telegraphed everything about this quarter that we need. If there’s any surprise, it should be on the plus side. But all-in, this quarter should have the lowest volatility out of any we’ve seen in a while.

2) RH Teen -- launch on September 18, with subsequent mailing of 200-page sourcebook and dedicated space inside future design galleries.

3) RH Modern – launches within a week of RH Teen. This will have a 370-page sourcebook with a simultaneous opening of a stand-alone store on Beverly Blvd.

4) Starting Late Sept/Early Oct, Successive Design Gallery Openings In

  • Chicago (62,000 feet in the most elite part of Chicago’s Gold Coast  -- but at a non-elite cost).
  • Denver (another anchor property -- using 53,000 feet of the 90,000 left vacant by Saks at Cherry Creek).
  • Tampa (47,000 feet, which is spot on with what our real estate analysis suggests is appropriate for 10% market share and $1,200/ft).
  • Austin (47,000 feet at The Domain – likely to replace one of the two small-format stores in the area, one is just 4-miles away. That makes sense given that our math suggests that Austin could support 50-60k feet for RH).

5) Square Footage Growth Returns. Add up the four stores in the point above and we’re looking at about 210k square feet. That alone represents about 25% growth in square footage (and that’s not counting Atlanta). Keep in mind that this company went from over 100 stores pre-recession (and before having a defendable merchandise, real estate strategy, and actual management team) to 67 in the latest quarter as it culled bad locations. Square footage grew on occasion over that period in a given quarter, but has settled in around 850k. Starting in 3Q, we should see square footage growth ramp from a mid-single digit rate in 2Q to a number ~20%, then steadily march towards 35%+ in FY16. Then we’ve got 20%+ square footage growth every year thereafter for at least five years based on our real estate analysis.

 

So all in, there’s two new and significant merchandising initiatives, which are solid on their own. But to pair them with the square footage growth acceleration seems almost like a fantastic coincidence. But it’s not. This has been in the plan all along. There’ll be many more new concepts and classifications – though we’d argue that the company can go deep and add $2bn in revenue with what it has.

 

To be clear, there’s much more to this story than just square footage growth – like the ability to consistently merchandise product people want in quantities they need.  Without the ability to deliver on that requirement, a retailer could have the greatest store in the hottest location with the best demographics, and it will still be nothing but a liability (regardless of how low the rent might be). That’s why square footage growth is grinding to a halt for other US retailers. That’s also why the growth profile at RH is so powerful, and unmatchable by anyone we see in Retail today.

RH | Catalyst Calendar Begins - RH Chicago then now


Cartoon of the Day: Lonely George...

Cartoon of the Day: Lonely George... - Dollar cartoon 08.13.2015

 

Excerpt from a recent Hedgeye Investing Ideas newsletter:

 

From the perspective of foreign exchange market participants, the U.S. remains the “best house in a bad neighborhood” and we remain bullish on the U.S. dollar (UUP) as a result.


Why 266,300 Jobless Claims May Be a Recessionary Harbinger

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.

Why 266,300 Jobless Claims May Be a Recessionary Harbinger - z rec4444

 

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.

 

Why 266,300 Jobless Claims May Be a Recessionary Harbinger - z recession Claims9 2 large

 

Why 266,300 Jobless Claims May Be a Recessionary Harbinger - z rolling jobless Claims3 large

 

Editor's Note: This is an excerpt from a research note written this morning. For more information on how you can subscribe to our institutional research, please send an email to sales@hedgeye.com. If you're an individual investor looking to stay a step ahead of consensus, we encourage you to take a look at our wide array of offerings here.


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CRUDE OIL: Quick Check-In With the Market Signals and OutliningUpcoming Catalysts

Takeaway: Book Some Gains on RED Short-side and look for a re-entry point.

With WTI moving in on its oversold signal, we want to book some gains short-side and outline a few upcoming catalysts that could disrupt our view (which hasn’t changed) through the end of the year.

Our intermediate-term view of 1) more deflationary USD strength and 2) Confirming market signals (PRICE, VOLUME, VOLATILITY) drives our bearish view on commodities as an asset class. With that being said, many of the tickers on our screen look oversold (Crude oil included) on the FX catalyst this week and we want to point out a few snap back risks over the next month and a half (think of them as shorter-term risks within an intermediate-term TREND view on the asset class).

With WTI moving to the bottom end of our risk range we like the idea of booking some gains short-side with the intention of re-shorting at a better price. Since the reflation trade unwind (June 10th), the market signaling taking crude lower confirms our intermediate-term TREND bias but these signals haven’t been as strong over the last two weeks.

  • Implied volatility (OVX Index) has moved higher with widening realized ranges. Higher volatility increases the range of probable outcomes near term
  • The healthy volumes and greater price semi-deviation on the down days (Target threshold of “0%”) confirm the bearish momentum over the last month and a half but these signals too, aren’t as strong
  • Consensus now expects more USD strength and pain in commodities as relative USD correlations have broken down over the last month 

CRUDE OIL: Quick Check-In With the Market Signals and OutliningUpcoming Catalysts - Semi deviation Table

 

The table above shows that on days of negative returns since the June 10th highs (which double up down days), we’ve seen healthy volumes and more variance in price momentum (All BEARISH signals) meaning that the downside moves have been much more pronounced on average.

Most importantly, these price signals haven’t been as pronounced over the last two weeks, and currency correlations (both absolute and relative) are breaking down as expected volatility widens out: NON-LINEAR RISK.

 

CRUDE OIL: Quick Check-In With the Market Signals and OutliningUpcoming Catalysts - Relative USD Correls

 

WIDENING RANGES: Realized Ranges and expected volatility stretching out 

 

CRUDE OIL: Quick Check-In With the Market Signals and OutliningUpcoming Catalysts - OVX Index

 

Source: Bloomberg

 

We outlined both of the next two central planning catalysts in the Macro Show this morning:

“$USD:  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.  As a consequence XLE pop +1.86% to lead sector performance. Jackson Hole is the next currency catalyst, and we expect the event to be Euro bearish with Draghi’s presence.  Jackson Hole = Aug 27-29th, September FOMC = Sept 17th.” 

With the 2-step Chinese devaluation and likely Draghi jawboning in Jackson Hole perpetuating a de-facto tightening without a fed funds rate cut, any incrementally dovish move out of the Fed could unwind consensus positioning which is betting on more of the same:

 

CRUDE OIL: Quick Check-In With the Market Signals and OutliningUpcoming Catalysts - CFTC Positioning

 

CRUDE OIL: Quick Check-In With the Market Signals and OutliningUpcoming Catalysts - Crude Oil CFTC Sentiment Monitor

 

The most differentiated part of our GIP model right now for the full year 2015 is our inflation estimates (See below). With the relative central policy measures globally perpetuating more USD strength, expect a pushing of the dots (or an expected pushing of the dots) if the Fed starts to sniff out CPI readings anywhere in our area code ahead of the September meeting. Even so, Draghi is the near-term catalyst (unless we get more from Beijing), but the market is sniffing him out.  

 

CRUDE OIL: Quick Check-In With the Market Signals and OutliningUpcoming Catalysts - GIP model

 

Ben Ryan

Analyst

 

 

 

 

 

 


Housing Hangover Ahead After HUGE Building Permit Numbers in New York

 

In this excerpt from today's edition of The Macro Show, U.S. Macro Analyst Christian Drake explains the absurdly high NYS multi-family permits through June and how that will likely precipitate the first bad housing number in a long time.


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.

 

FULL DETAILS

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.

 

Management

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.

 

 


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