Lululemon: In Search of TAIL | $LULU

Takeaway: This quarter was a mess due to factors far beyond financials. LULU isn’t articulating a cogent plan – because it probably doesn’t have one.

This unlocked research note was originally published September 10, 2015 by Retail Sector Head Brian McGough and his team. For the record, McGough's team added Lululemon (LULU) to its Best Ideas list on 6/15/14 at $37.61 and removed it on 3/24/15 at $63.30 for a 68.3% gain. If you are an institutional investor interested in learning more about how you can subscribe to our research please email

There’s one major reason why we think this LULU quarter was a huge let down -- and it’s not that inventories were up 23 days while Gross Margins missed by 200bps. Nor is it that LULU added $62mm in revenue year over year, but generated $1mm less in EBIT.  It’s the reality that this company does not know what it wants to be. Virtually every statement out of management on the call had to do with near-term tactical branding, marketing and product plans. All that is fine. It matters on some level – and definitely matters to small scale moves in the stock in the coming quarters. But that’s what we call TREND (in HedgeyeSpeak that translates to 2-3 quarters out – the near-term modeling horizon). This is where LULU lives, unfortunately.


But LULU needs a change of address. This is an extremely powerful brand in a solid, yet increasingly competitive, space. LULU needs to not only be a great brand, but a great company. Then and only then will it be a great stock. We think management is coasting on the power of the brand, by tweaking a legacy operating plan, blindly opening stores, and hoping that nothing else goes wrong. Hope, however, is not a profitable growth process.


LULU needs to live in the TAIL (which we define as 1-3 years). What we need for real wealth creation with this stock is for a clear, concise strategy that insiders rally around and are paid handsomely to implement. People need to look to $4.00 in earnings power, and believe in it. It’s that same strategy that would result in its CEO standing up and saying things that will make Nike, UnderArmour and Athleta quake in their boots (which used to be the case) – not that they are using ‘Sports Psychology on the Pant wall’.  Unfortunately, we truly think that LULU does not have a proactive process to grow its business.


Does The Company Have A Long Term Plan?

Somebody, please, ask virtually anyone in the company if they know their market share in stores and online within an hour’s drive of each store. [Note: our math shows it ranges from 2.5% (Long Island) to 26.7% (Burlington Vt) -- ping us if you want the data]. We don’t think they’ll tell you – because they probably don’t know.


How can a CEO stand up and give credible growth and profitability targets without knowing these basic building blocks?  How can they articulate why they don’t have a wholesale model – something that could be a home run for LULU (i.e. sell where the consumer shops)?  Even the CFO, who we have/had high hopes for, hasn’t created his own identity with the Street – as he’s following the same script of his predecessor who was pushed out.


All we get from the company as it relates to strategic initiatives are 1) Brand, 2) Community, 3) Innovation, and 4) Guest Experience.  The only quantified metric is that LULU will return to a 55% gross margin – something that we don’t think is realistic without meaningful backing by the balance sheet (i.e. more capex to boost profitability). But more importantly, the market is highly unlikely to pay for a passive goal to return to peak profitability when LULU is in a different stage of its growth cycle.


This is a great Brand, for the time being. We really want to get behind this story due to the potential that can be unlocked. But without the backing of a great company – we think this stock is going anywhere but up. We’re glad we pulled the plug in March.


Lululemon: In Search of TAIL | $LULU - z brian lulu

FMHQ (Friday Morning Housing Quant)

Takeaway: Construction jobs are getting harder to fill. Homebuilder stocks are in-line QTD performers. And we've added 3 new tickers to our tracker.

Our FMHQ (Friday Morning Housing Quant) tables present the state of the publicly traded homebuilders in a visually-friendly, quantitative format that takes about 60 seconds to consume. 


Quick Quant Takeaways: 

  • This week we're adding Taylor Morrison (TMHC), TRI Pointe Group (TPH) and Standard Pacific (SPF) to our list of builders.
  • Housing Macro: “Jobs Hard to Fill” | The domestic macro calendar was relatively light this week but we did get the NFIB small business confidence data for August.  As a reminder, Small Businesses represent over 99% of total U.S. Employer firms and >60% of net private sector hiring on a monthly basis – and sentiment around the current and forward prospects for business activity are discretely related to hiring activity and labor compensation trends.  Notably, the NFIB’s “Jobs Hard to Fill” sub-index rose +4pts sequentially to match its highest level in the post-crisis period.  In the housing sector, as we highlighted last week, with both resi  construction employment and hourly wages growing at approximately 2x the broader averages, tight labor conditions in the sector continue to manifest.  The latest survey data from the Associated General Contractors (see AGC/WSJ figure below) lends further support to the tight supply view as a majority of firms are reporting difficultly in hiring employees across all the principal trades.  
  • Performance Roundup: The mean/median QTD returns for the 14 homebuilders in the tables below are -5.3% and -4.9%, respectively. This compares with the S&P 500 being down -5.4% QTD, so roughly in-line. The broader Housing complex, however, is flat to up +2.6% QTD based on the ITB, XHB and S15 Home Index. We think this comports with our call to de-emphasize the builders on a relative basis for 3Q in order to sidestep their seasonally weakest period. The best performance QTD continues to come from NVR (+15.5%) - one of the two builders we favored for 3Q15. The other was Toll Brothers, which is down -3.2% for the QTD. Hovnanian remains the worst performing builder this quarter (-24.4%), but has seen a big bounce in the last 5 days, rising +16.2% on earnings.  
  • Valuation: The cheapest names in the group currently are Meritage Homes (MTH) at 9.2x NTM earnings, Taylor Morrison (TMHC) at 9.6x and TRI Pointe Group (TPH) at 9.7x.   


FMHQ (Friday Morning Housing Quant) - BQ 1



FMHQ (Friday Morning Housing Quant) - BQ 2



FMHQ (Friday Morning Housing Quant) - BQ 3



FMHQ (Friday Morning Housing Quant) - BQ 4



FMHQ (Friday Morning Housing Quant) - Compendium 090915



FMHQ (Friday Morning Housing Quant) - Construction Labor Shortage



FMHQ (Friday Morning Housing Quant) - Confidence Summary



FMHQ (Friday Morning Housing Quant) - US Eco Summary Table



Joshua Steiner, CFA


Christian B. Drake


Takeaway: The title insurers have been and remain our go to Housing longs in 3Q. FAF remains compelling on its still bombed out sentiment (17).

This morning we are publishing our updated Hedgeye Financials Sentiment Scoreboard in conjunction with the release of the latest short interest data last night. Our Scoreboard now evaluates over 300 companies across the Financials complex.


The Scoreboard combines buyside and sell-side sentiment measures. It standardizes those measures to an index of 0-100, where 100 is the best possible sentiment ranking and 0 is the worst. Our analysis shows that a contrarian strategy can be employed successfully by taking the other side of stocks with extreme readings in sentiment, either bullish or bearish. Once sentiment reaches these extreme levels, it becomes a very asymmetric setup wherein expectations become too high or too low.  


We’ve quantified the tipping points for high and low sentiment. Specifically, we've found that scores of 20 or lower have a positive, average expected return while scores of 90 or greater are more likely to underperform.


Specifically, our backtest of 10,400 observations over a 10-year period found that stocks with scores of 0-10 went on to produce an average absolute return of +23.9% over the following 12-month period. Scores of 10-20 produced an average absolute return of +11.9%. At the other end of the spectrum, stocks with sentiment scores of 90-100 produced average negative absolute returns of -10.3% over the following 12-months.


The first table below breaks the 300 companies into a few major categories and ranks all the components on a relative basis. The second table breaks the group into smaller subsectors and again gives them relative rankings within those subsectors. 


This week we're flagging First American (FAF - Score: 17) as a long as our 3Q15 call to "hide out" in Housing favors the title insurers.








The following is an excerpt from our 90 page black book entitled “Betting Against the Herd: Generating Alpha From Sentiment Extremes Across Financials.”


Let us know if you would like to receive a copy of our black book, which explains this system and its applications.


BUYS / LONGS: Financials with extremely low sentiment readings of 20 and below on our index (0-100) show strong average outperformance in absolute and relative terms across 3, 6 and 12 month subsequent durations.  Stocks with sentiment ratings of 20 or lower rise an average of +15.1% over the next 12 months in absolute terms.   


SELLS / SHORTS: Financials with extremely high sentiment readings of 90 and above on our proprietary sentiment index (0-100) demonstrate a marked tendency to underperform in absolute and relative terms across 3, 6 and 12 month subsequent durations.  Stocks with sentiment ratings of 90 or greater fall in value an average of -10.3% over the next 12 months in absolute terms. 



FINANCIALS SENTIMENT SCOREBOARD - First American (FAF) - Absolute 12 mo



Joshua Steiner, CFA


Jonathan Casteleyn, CFA, CMT


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Kospi, Oil and Spain

Client Talking Points


One-day bounces in developing bear markets are becoming the norm now. The KOSPI has failed (again) at all lines of resistance, closing -1.1% overnight has been as good a leading indicator of the pace of Global #GrowthSlowing as anything real-time indicator.


Down -2% on Dollar Up and Goldman’s Bear call this morning – we think this sets up interesting on the net long side into the Fed meeting (much more interesting than chasing SPY on decelerating volume bounces); if it can hold $42.03, we think you can squeeze out $48-49 on a Dovish Fed move.


Getting uglier, faster (both equity and credit) with IBEX leading European losers this morning (testing lower-lows) -1% (down -12.4% month-over-month and -18% from the everyone U.S. is “long Europe” top in April. Here’s how sovereign yields are moving m/m vs. UST (Mario Draghi needs more #cowbell).


**Tune into The Macro Show with Hedgeye CEO Keith McCullough and Retail Sector Head Brian McGough at 9:00AM ET - CLICK HERE

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

The franchisees voted YES on the proposal to launch All Day Breakfast nationwide at all 14,318 U.S. locations. This is a very important, monumental move by CEO Steve Easterbrook. It will define his legacy as the CEO that changed McDonald's (and the rest of the industry) for many years to come. In 2016, if MCD (with all day breakfast and an improved value message) can drive same-store sales up by 5%, the system will generate $1.9bn in incremental system-wide sales. 


As noted in our survey we released on July 27th, it is evident that All Day Breakfast (ADB) will be a game changer for the company. Breakfast is the single most requested item by McDonald’s customers. Listening to the customer is a tried and true way to succeed.


Following our recent visit to Plainridge and meetings with senior management, we reiterate our positive Penn National Gaming thesis.  Stability in regional markets provides good earnings visibility while expected strong contributions from Plainridge and Jamul next year should provide a nice 2 year growth story.


Regional gaming likely cooled off in August following a strong July.  While that could provide some consternation as the states begin releasing August gaming revenues later this week, the YoY slowdown is more related to quantitative factors rather than the health of the regional gaming customer.  September should quickly provide evidence of that.


The labor market peaks late cycle and the trend in key employment data suggest things are going from great to good (marginal changes matter). The ADP employment report showed a sequential acceleration, printing +190K vs. +185K in July. But to be clear, this series peaked at over +200K additions in the first couple of months of 2015. Initial jobless claims bottomed about six weeks ago. The trend in that series is moving back to the all-important 300K level. While the headline NFP number was a bomb on Friday, printing +173K for Aug. vs. estimates for +215K, the trend is also turning. This series also peaked back in February on a YoY rate-of-change basis.


Why do we point to all of this growth-slowing data? Because it’s meaningful.

  • As we have mentioned repeatedly Central Banks take a reactionary policy response to the data. The market is becoming more efficient at getting in front of policy the longer we venture into this modern-day central policy experiment
  • When forward-looking growth expectations are taken down, the back end of the Treasury curve flattens (this is good for TLT and EDV)
  • In reaction to more dovish policy monetary policy measures, the market likes gold over dollars coming out of central policy events

Three for the Road


REPLAY | Healthcare Q&A | #ACATaper, Jobs Report & Top Stock Ideas… via @hedgeye



Genius is one percent inspiration, and ninety-nine percent perspiration.

Thomas Edison


“The Late Show with Stephen Colbert” is off to a solid start, with 6.6 million people tuning in to the first show.

CHART OF THE DAY: Current Valuations Richer Than Any Point Except Nose-Bleed Tech Bubble Highs

Editor's Note: Below is a special excerpt and chart from today's Early Look written by Hedgeye U.S. Macro analyst Christian Drake. (Yes, we think you should seriously consider subscribing to the Early Look. A dollar a day to stay ahead of consensus? Best deal around)


CHART OF THE DAY: Current Valuations Richer Than Any Point Except Nose-Bleed Tech Bubble Highs - z d7


CHART OF THE DAY: Current Valuations Richer Than Any Point Except Nose-Bleed Tech Bubble Highs - z CoD 2


"[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


A little bit of a #TepperTantrum yesterday from the Appaloosa Management founder and stalwart bull. 


Advocating higher cash allocations, highlighting higher volatility and increasingly challenged corporate fundamentals, voicing concerns over current multiples and pervasive over-optimism around forward growth prospects.   


Sound familiar?


Tepper’s fundamental and valuation concerns are really just manifestations of our current late-cycle reality and a recapitulation of our 2Q15 #LateCycle Macro Theme.   


We don’t always agree with Tepper but, when we do, we like to do it 3-months and 150 SPX handles ago.

Problems - buzz the tower NEW 09.05.2014

(The prescient cartoon above was published one year ago this month.)


Back to the Global Macro Grind


Since 2 & 20 sourced soundbites still grab more headlines than Hedgeye’s #BlueCollarMacro mouthpiece, Tepper’s comments yesterday offer a worthwhile opportunity to review some of the fundamental market data and contextualize the current expansion within the historical late-cycle experience. 


First, The Cycle:  Let’s take a quick step back to re-remember the archetypical economic cycle – from the perspective of the current cadre of policy makers. 


Macro cycles, left to themselves, follow a pattern that largely resembles the circular, counter-clockwise flow captured in the inflation-output loop depicted in the 1st Chart of the Day below.    


The conventional view is that the level of output drives inflation which, in turn, drives the policy response. These output-inflation cycles were the prevailing macro reality when the present global policy making oligopoly was coming of age and conventional monetary policy is designed to function within the context of this naturally evolving cycle.  


The broader goal of current policy efforts is to both jump-start and subsequently smooth such a cycle in the face of persistent cyclical challenges and glacial secular shiftings.  


Problems - z CoD1

Policy = Lost in Transmission

The Phillips Curve and the aforementioned output-inflation cycle on which conventional monetary policy is based has been so loose over the last 2 cycles (& the present one) as to be non-existent.


Meanwhile, the empirics on Janet’s hoped for policy flow through to Main Street remain dismal.  Labor’s Share of National Income – which, historically, only rises at the tail end of an expansion and after growth and profits have been strong for a protracted period – remains at a multi-decade trough.   Even if we follow the pattern of gains in the late innings of expansion it won’t close the gap – and, if it does, it will likely come alongside a step function move lower in corporate profitability and EPS growth.  


The other side of rising inequality and top-heavy income distributions is lower highs and lower lows for labor income.    


Valuation = An Anchor, Not a catalyst

Valuation is not a catalyst and from a short-to-medium term risk management perspective, it sits somewhere near the middle-bottom of our consideration hierarchy.


That said, over the longer-term, valuation certainly matters in anchoring return expectations and we don’t discount it as a factor completely, particularly as it moves towards extremes in either direction. Underneath the technicals, acute policy catalysts, and reflexivity that drives immediate and intermediate term price trends sits the steady drumbeat of fundamentals and an accordion-like tether to ‘fair value’. 


Because investor’s maintain varying proclivities for particular multiples and conceptual valuation frameworks, one measure we track is a 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.  


We review each in turn below but the broader conclusion is straightforward:  current valuations are richer than at any point except the nose-bleed tech bubble highs.  As we’ve highlighted, lower neutral policy rates and perma central bank interventionism may indeed be supportive of higher mean valuations but that only modestly dilutes the conclusion.  When valuations are in the top decile of LT historical averages, subsequent returns over medium and longer-term periods are just not that compelling.   

  • 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.   Historically, at extremes, it has served as a solid lead signal for subsequent market performance.  Currently, the q-ratio sits at ~1.06 and greater than 1.3 standard deviations 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.  


The Chart of the Day below shows the valuation composite using the most recent data for the respective metrics. 



Earnings, Corporate Margins and collective SPX profitability all peak mid-to-late-cycle and the last few quarters of data suggest we’re probably past peak in the current cycle (ping sales@hedgeye if you’d like to review our 2Q/3Q Macro Themes decks). 


In a low-to-no growth environment where the pie size stays the same, peak margins are good until they aren’t and are probably a symptom of policy ineffectiveness (in terms of flow thought to Main St.) more than not.  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:  As Keith highlighted yesterday, 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 this year’s 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.   


Our immediate-term risk Global Macro Risk Ranges (with our intermediate-term TREND call in brackets)


UST 10yr Yield 2.12-2.24% (bearish)

SPX 1 (bearish)

VIX 21.70-30.93 (bullish)
Oil (WTI) 42.43-48.17 (bearish)

Gold 1101-1147 (bullish)


Turning away from the market myopia for a moment before closing. 


Today is Patriot Day.  To those who serve(d) in the military and those, more broadly, who go underpaid and underappreciated in service of our greater good, your selflessness does not go unnoticed and your sacrifice will not be forgotten.  We are sincerely grateful for your effort.


To hope & humanism, doing the right thing when no one is looking and blue collar alpha,


Christian B. Drake

U.S. Macro Analyst


Problems - z CoD 2

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