Watch the replay of this presentation below.
As we stated a few weeks ago in a note, we added UNFI to our LONG bench (NOTE HERE). Now, after doing more work we are very confident in the longevity of this company and as a result are upgrading it to a LONG. UNFI has been battered down this year by ~35% due to significant worries stemming from the loss of the Albertsons contract as well as the competitive landscape. Although increased competition (KeHE) and the potential of the captive systems are some of the biggest risks, we feel that this loss is an isolated incident and the company should not be penalized to this extent.
On August 20th, UNFI pre-announced 4Q15 and FY16 outlook and provided some positive color about the future for UNFI. Management provided positive commentary about the performance in the first two weeks of 1Q16, although only two weeks, it’s a marked sequential improvement and suggests that the core business remains strong. Following the loss of the Albertsons contract, the notion that UNFI will continue to lose customers is overblown and not very realistic in our minds. UNFI provides a value added proposition (a high level service to retailers), offering a wide variety of over 80,000 products at industry leading prices. The industry is seeing continued growth in natural & organic, specialty, ethnic gourmet and fresh, all of which UNFI offers and can package together to provide retailers great value.
Following the disappointing end to FY15 UNFI is in a great position to leverage the strong asset base it has built. Over the past two years, UNFI has gone through a period of significant investment in capacity to take advantage of the growth in the fresh, natural and organic market place. With this investment in the past, capex will be declining to more modest levels, about 0.6% - 0.7% of net sales. As a result, free cash flow is going to start to ramp up significantly and coupled with an underleveraged balance sheet M&A will become a bigger part of the story going forward.
The topics we will cover in today's presentation will be:
- The strong competitive position of UNFI
- The significant growth opportunity
- The strong financial position
- Our estimate of +40% upside in the name
Confirmation Number: 13618360
Materials: CLICK HERE
Video Link: CLICK HERE
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Takeaway: This story is inflecting. Now. Growth in revenue/margins accelerates meaningfully in 2H. So should the multiple and stock. Headed to $300.
This was a textbook print from RH – or for any company, for that matter. RH put up the best comp in all of US retail this quarter with 16% brand comp and 19% store comp. That drove 26% EBIT growth and 27% EPS growth. RH beat by a penny, but took up the lower end of the year by $0.03 more than the 2Q beat. That upside is coming entirely in the fourth quarter, and as we suspected (see below) this all allowed RH to set the bar low for 3Q as revenue from new businesses will not be booked until 3Q closes in October. We think all of this sets up for a beat in another 90 days, at the same time square footage growth is accelerating to 29% vs 7% in 2Q, new concepts (RH Modern/RH Teen) are in full swing, and EPS is growing 40%+. This is going to be a rough time for the bears – especially with 25% of the float short.
Transformational stories like RH are not linear, and this one certainly has not been. The stock chart over three years certainly proves that. But it also proves that the people who bought on quarterly noise have made money almost without fail. If the market decides to sell off based on lower guidance in 3Q (i.e. if the after-market gains reverse), then consider it a gift. Fundamentally and financially, we’re about to see growth at RH go on a multi-year tear. We think this stock is headed to $300 over the next 2-3 years. We’ve been patient for the catalyst calendar to begin, and the waiting is finally over.
For a full rundown of our thesis see our latest Black Book published in July.
RH: Road to $300 (Link: CLICK HERE)
09/09/15 05:48 AM EDT
RH | What Could Go Wrong?
Takeaway: We’re confident in RH across durations. But when asked about the ‘worst that could [realistically] happen’ on Thurs, here’s our answer.
We think that the core long-term call on RH is as clear as ever, as is the catalyst calendar over the next six months. We outlined all of this in our two recent Black Books 1) Road to $300 (Link: CLICK HERE), 2) Home Furnishings Deep Dive (Link: CLICK HERE).We also think that the numbers RH will report on Thursday will be spot-on with the type of model we expect to see from RH going forward (comp 14%, Revenue 18%, EBIT growth 25%, Cash Flow 30%+).
But yesterday someone asked us…
Q: “What’s the worst we could hear from RH on Thursday”?
Our answer sounded something like this (actually it sounded exactly like this)...
A: “We’re not worried about the print. RH has never missed a quarter and it’s not going to start now. This will be one of the lighter quarters of the year, and earnings should STILL grow 25-30%. If there’s any bad news, it will likely come in the 3Q comp guide – with earnings potentially shifting into 4Q. There are some legitimate factors that could cause a lull in the top line, and whether or not they materialize, our bet is that the company invokes them to keep expectations grounded.“
Let’s put ‘light guidance’ into perspective. We think that a worst case comp guide is in the high-single digits (we think less than 30% probability). That would leverage to revenue growth in the low dd, and EBIT/EPS 30%+ (the consensus is at 37%). If the worst case scenario were to happen, we’d have to give the revenue/earnings to the fourth quarter. In other words, the year really does not change materially. Also keep in mind that there is little upside baked into the guidance in 2H from the new categories which already calls for the underlying growth rate to accelerate by 350bps. It’s also worth noting that the company would have to guide 3Q comps as low as 5% in order for the 2-year trend to turn down. We put less than a 5% chance on that happening.
What would cause 3Q guidance be light? There are three meaningful business drivers in 2H that move the needle.
1) RH Teen -- launch on September 18, with subsequent mailing of 200-page sourcebook and dedicated space inside future design galleries.
2) 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
3) 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).
Here’s why timing matters.
1) Delivery, Not Order = $. It will take a six months to build mass awareness for the new concepts, but RH should begin to take customer orders at a level that actually matters within 3-4 weeks of launch. Let’s say $50mm combined for both concepts right off the bat. We’re talking about roughly 8 to 9 points of comp in the quarter, which would be an extremely solid start. But the problem is that even if the orders are placed for both concepts by October 1, then we need to count forward by at least six weeks for revenue recognition, as customers only pay for product upon final receipt. That puts the sales into mid-November, which is the first month of the fourth quarter.
2) Ditto for store openings. Chicago and Denver are likely the only stores to impact square footage count for 3Q, but only around 5% of revenue is ‘cash and carry’, meaning that the consumer walks out with the purchase on the same day. The rest of the revenue builds into the fourth quarter P&L.
3) RH Cleared The Deck. In anticipation of its new concepts and stores, RH explicitly noted on the last call and on the recent convert Roadshow that there would be a lull in the summer as it relates to new product. That has, in fact, shown up in the online data that we track for RH, as visits to the site seem to have fallen behind last year for the better part of eight weeks. This week’s reading shows that RH is back on par with last year, and we expect that to head meaningfully higher throughout the third quarter. But again, there’s a good 6-8 week lag between the pick-up in business that we see vs. when RH actually sees it on the P&L.
One other reason why RH might guide lightly. Simply put, because it can. It has never had such a position of strength, yet the shorts are already betting against RH with 25% of the float held short. It has two major initiatives that are stand-alone multi-year growth platforms, and we wouldn’t be surprised to see another announced by the time the year is done. Add up the four stores being added this year 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.
"[I’m] not loving it …I have problems with earnings growth [and] problems with multiples, …So I can't really call myself a bull "
- David Tepper, 9/10/15
Earlier today David Tepper made headlines (HERE) in advocating for higher cash allocations and defensive positioning amidst increasingly challenged fundamentals, concerns over current multiples and pervasive over-optimism around forward growth prospects.
Having authored the 2015 Global #GrowthSlowing thesis, we’d agree.
Tepper’s fundamental and valuation concerns are really just manifestations of our current late-cycle reality. Given that his comments were largely a re-capitulation of our call from July and our 2Q15 Macro theme #LateCycleUSA (Here), today offers an opportune time to update the charts and re-highlight a selection of canonical late-cycle metrics.
Below is a visual tour of the data. The larger fundamental takeaway is not different than the one we’ve been voicing YTD. Slower for longer remains the call, lower gross and net equity exposure continues to make sense and dynamically trading the risk of the immediate-term range remains the best means of tactically risk managing late-cycle market volatility.
Labor: Best Before the Crest | The employment data always looks best before the crest and the current labor cycle is certainly cresting. As we highlighted in our review of initial jobless claims this morning we are now 19-months into the sub-330K environment (ave over the last 3 cycles = 33months) and within ~a month the year-over-year rate of change will be ~0% as we beginning lapping the floor in the claims data.
With the convergence to zero complete, any trending positive growth in claims activity will offer a low-intensity means of monitoring deterioration in the labor market. There is still some modest runway for ongoing labor strength but the clock tick is getting louder.
Valuation: Stocks Still Hoping It’s the 1990’s | The simple fact that we’re not at peak tech-bubble valuation is not particularly sweet solace.
Below is an updated look at our valuation composite which represents an equal weighted composite of three of the most widely used conventional valuation metrics: Shiller PE, SPX Market Cap-to-GDP and Tobin’s Q.
- Shiller PE: Inclusive of the hundred’s of billions of market cap lost in the recent correction, the Shiller PE remains above 24x and sits just south of the top decile of its historical range. Mapping the Shiller PE by decile vs subsequent market performance suggests return expectations should move systematically lower alongside incremental increases in valuation. Historically, 1Y and 3Y returns progressively decline for each decile change in the Shiller PE.
- Tobin’s Q: Longer-term valuation arguments center on the premise that returns on capital should equalize to cost of capital and market values should normalize to economic value. Tobin’s Q ratio is not a measure we use to tactically manage risk, but we can appreciate the intuition underneath its application – why buy an asset when you can “re-create” it for less and compete away existing, excess profit. Currently, the q-ratio sits at ~1.06 and greater than 1.0 standard deviation above the long-term mean value – a level that has generally not been a harbinger of positive forward returns historically.
- S&P 500 Market Cap-to-GDP: Assuming the collective output of SPX constituents credibly reflects aggregate national production (or serves as a credible proxy for it), the Market Capitalization-to-GDP ratio effectively represents a price-to-sales multiple for the economy. At current levels we are well above both the LT average and the 2007 highs.
PEAK PROFITABILITY: Earnings, Corporate Margins and collective SPX profitability all peak late-cycle and all three appear to be moving past peak in recent quarters. Unless you think peak returns to capital provide a sustainable path to aggregate demand growth in the face of negative trend growth in real earnings, trough returns to labor, middling productivity growth and secularly depressed investment spending, then the mean reversion risk for operating margins remains asymmetrically to the downside.
- 2Q15: With 2Q earning largely rearview for SPX constituents, the final score shows revenues and earnings down -3.5% and -2.2% year-over-year, respectively. Yes, the commodity rout was an outsized impact to energy/industrial’s profitability and that collapse becomes next year’s comp but still, negative top & bottom line growth is not the stuff escape velocity, private-sector handoffs are made of or multi-year tightening cycles anchored on.
Policy = Lost in Transmission | The Phillips Curve and output-inflation cycle on which conventional monetary policy is based looks broken. Meanwhile, the empirics on Janet’s hope for policy flow through to Main Street remain dismal. Labor’s Share of National Income only rises at the tail end of an expansion and after growth and profits have been strong for a protracted period. The cratering in the latest cycle looks like some measure of a structural break and even if we follow the pattern of gains in the late innings of expansion it won’t close the gap. Lower highs & lower lows remains the trend.
Slower for Longer: Underneath the current business cycle oscillation remain the secular realities of over-indebtedness and negative demographics. The combination of voluntary and involuntary deleveraging in the post-crisis period has improved the aggregate household balance sheet, but certainly not enough to jumpstart another credit cycle or drive sustained debt supported consumption growth. And while the Millennials sit as an emergent demographic force, the core consumption demographic of 35-34 year-olds will remain in retreat for the balance of the decade – across all the major DM economies.
Christian B. Drake
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