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RH | Lost in Translation

Takeaway: What should be a victory lap is now an oppty to buy RH on sale. Ultimately, the outsized earnings trajectory will make Longs lots of coin.

Conclusion: This RH quarter is going to draw a Mason Dixon line between the Bulls and the Bears. On one hand, the key factors that the Bulls (including us) need to see were profoundly present – giving us confidence that revenue will double, that we’ll see a 16% operating margin, and $11 in earnings power. In addition, RH beat the quarter, delivered 33% EPS growth in what should be the slowest growth quarter of the year, and it took up 4Q revenue guidance based on what it’s seeing so far this quarter (to 20%+). On the flip side, the Bears got a nice little gift in the form of weaker Gross Margins due to promotional activity, and renewed concerns about management. The reality is that this is a transformational growth story that will change on the margin more often than it doesn’t. Even though the 30% short interest already captures a whole lot of bad news, this print won’t make people cover – and probably validates the pressure the stock came under earlier this week. We’ll respect it for what it is, but based on our confidence in the earnings power at play here, we’d use any weakness as an opportunity to buy. The market combined with noise around the evolution of this story gives you a shot at buying it on the cheap every six months or so. We’re thinking that this is one of those times.

 

DETAILS

This is a pretty good timeline of how we viewed the RH 3Q print.

4:05pm – Press Release: Solid print. Beats the consensus by $0.02 (4%), and takes UP 4Q revenue by $10mm. It’s pretty tough to find anyone who takes up revenue expectations, most companies would simply keep estimates in-line, and upside in their back pocket.  Overall, total revenue guidance and implied EPS of 20-23%, and 40%, respectively. That comes on the heels of an impressive 33% earnings growth in what is widely viewed to be the lightest revenue quarter of the year.

 

Stock up 5% after hours as the EPS beat and top line guide trump the fear that people had headed into the print earlier this week.

 

4:30pm – RH Video: Now we’re feeling really good about this event. The video was targeted, on point, and Gary Friedman appeared to be more focused and grounded than in any other earnings video presentation.  Furthermore, there are basically two things you need to believe to own this story long term. 1) That the large format stores are both working and are scalable, and 2) that RH can successfully scale the brand into new categories and brand-relevant concepts.

 

Well, both of those were answered, with Atlanta continuing to accelerate from the Nov 2014 launch, and 2) RH Modern blowing the doors off expectations just one month after launch. Consider this, the Beverly RH Modern store is already doing $1,800/foot after just one month. This is unheard of. The store was previously a traditional RH Gallery, and over the course of two years it climbed from about $1,000 to $2,300/foot, making it one of the most productive stores in the entire chain until it moved to Melrose (larger format) a year ago. And yet Modern got all the way up to a $1,800 per sq. ft. run rate in 30 days? That’s surreal.

 

The bottom line…we were looking to check two major boxes that the long-term story is on track, and both got a major stamp of approval.

 

 

5:30pm -- Q&A With Management: Recall the comment above about how focused and grounded Friedman was on the video? Yeah…about that…

This was definitely not Gary’s best Q&A. In fact – let’s keep it real -- it was probably his worst from the perspective of the average investor. Unfortunately, it’s that average investor who is probably driving the incremental demand for the stock.

 

What happened? Knowing that the market clipped $300mm in equity value out of RH over the past three days due to an otherwise unplanned Friends & Family sale, we think that IR probably went on offense and asked Gary to make a 3-5 minute statement mitigating concern about promotional activity, and keeping people focused on long-term value drivers. Unfortunately he answered the first question in a 14 minute 20 second monologue which included some statements that prompted a $9 reversal in the stock, flat-out scared the market, and even concerned us (until we got clarity on what’s really going on).

 

These Are Some Soundbytes That Came From The Q&A:  1) “When we look at the data internally, it is the most promotional environment we've seen, meaningfully so.” 2) “You can't ignore someone like Wayfair today. They're doing big volume.” 3) “The last thing you want to do is you want to let yourself get Amazoned by somebody.” 4) “It makes me think, hey, you know, should we be calling Yellen and saying ‘let us tell you what we're seeing’, because, you know, those things, from my point of view — and I don't mean to make anybody panic, but it's important how we look at those.” 5) “RH, you know, ran a big promotion. Got it. We weren't trying to be shy about that, by the way.” 6) “At holiday time, if you've got stores in retail districts or retail malls and there's thousands of people in those malls and you're not doing something to maximize share, then you're a spectator.” 7) “Taking share is important. There's a reason why Amazon launched Black Friday before everybody else in the world, right? There's a reason why we launched the promotion we did last weekend. You know, it was to take share.“

 

We’re Pretty Darn Sure That The Intended Message Sounded Like This: “We’re exceptionally pumped about the success of our key initiatives, such as the new large-format Design Galleries, RH Teen, and especially RH Modern – all of which set us up for a breakout 2016 (after a breakout 2015). While we’re winning with our core initiatives, it pisses us off quite frankly, to see fringe competitors go so aggressively after market share. Wayfair put up a 130% comp around Black Friday, and though we don’t compete with them directly, I see the promotional activity in the rest of retail, and don’t want to be the loser when the holiday season ends. Our brand and our business is so strong such that I made the call to pull forward a sale from January to be sure that if anyone is gaining share out there, it is RH. The plan is, that the plan will change. That’s who we are, it’s makes us great, and we’re not going to apologize for it. We’ve never felt better about where we are, and where we’re headed.”  

 

What’s done is done, and the people out there that don’t like Gary now have 14 minutes of ammo. But they’d better hope that will make the stock go down…because the sheer earnings growth story here should make this one of the top performing stocks in Consumer in 2016.


Cartoon of the Day: Over The Cliff?

Cartoon of the Day: Over The Cliff? - rate hike cartoon 12.10.2015

 

The Fed is fighting economic gravity with Janet Yellen hell-bent on raising rates into a slowdown.


Peak M&A Is A Classic Late Cycle Indicator | $DD $DOW

Takeaway: We've been highlighting the late cycle nature of M&A for a while now.

Peak M&A Is A Classic Late Cycle Indicator | $DD $DOW - late cycle

Need more evidence that the U.S. is in a late cycle slowdown?

 

Look no further than the proposed merger of Dow Chemical (DOW) and DuPont (DD). If the deal goes through, it would create a massive $130 billion behemoth. Management would ultimately divvy it up into three separate businesses.

 

Why does that matter? Here's our analysis from a note sent to subscribers this morning: 

 

"... A multi-quarter acceleration into peak capital markets activity has historically been a harbinger of an economic downturn. Yesterday, multiple reports claimed DD and DOW are in advanced talks to merge, with the combination to then split into three separate companies; both stocks finished ~12% higher on the day.

 

The WSJ recently noted that worldwide M&A, excluding buyouts, has totaled $3.7T this year, beating the previous record set in 2007. This is exactly the kind of frothy, head-scratching headline you’d expect to see to confirm the forward outlook that global economic growth is as bad as we think it is. 

 

M&A usually peaks when company insiders agree to sell and that’s exactly what you’re seeing in insider transaction reports. At $7.6B, November 2015 was the fourth-highest month of insider selling on record.

 

This comes amid record share buyback activity, which has averaged $3.9B/day since the beginning of earnings season in October. Data firm Trim Tabs observes that this is the highest pace since the bull market began in March 2009.

 

Companies are doing everything they can to arrest the gravity weighing on peak margins. It has become increasingly difficult to protect earnings amid #GlobalDeflation which has perpetuated the ongoing global industrial recession – including right here in the U.S. All told, there is a ton of risk to forward estimates for GDP and EPS growth if we’re right on the economic cycle."

 

We've been talking about the late cycle nature of M&A for a while now. This is a slide from our 73-page Q4 Macro Themes presentation released in October:

 

Peak M&A Is A Classic Late Cycle Indicator | $DD $DOW - macro themes manda 

 

Say it with us now, the U.S. economy is "Super Late Cycle."

 


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Macro Meets Micro: Will Gaming Stocks Get Hit In An Economic Slowdown?

 

On The Macro Show this morning, Hedgeye Gaming Lodging & Leisure analyst Todd Jordan explains why he is bullish on Boyd Gaming (BYD) and responds to a subscriber's question about how our Macro team's #GrowthSlowing theme might impact gaming stocks.

 

 

Subscribe to The Macro Show today for access to this and all other episodes. 

 

Subscribe to Hedgeye on YouTube for all of our free video content.


Style Factors, #LateCycle and Europe

Client Talking Points

STYLE FACTORS

Low Debt, Low SI, Low Beta, Large Cap, Growth has been the winning style factor constellation across every duration YTD.  While yesterday saw the opposite factor cocktail outperform alongside the -1.15% retreat in the $USD, 1-day does not a trend make and we continue to like larger cap liquidity with relative growth (& a catalyst) in a growth slowing, rising credit risk environment.  

#LATECYCLE

A multi-quarter acceleration into peak capital markets activity has historically been a harbinger of economic downturn. Yesterday, multiple reports claimed DD and DOW are in advanced talks to merge, with the combination to then split into three separate companies; both stocks finished ~12% higher on the day. This is exactly the kind of frothy, head-scratching headline you’d like to see to confirm the forward outlook for global economic growth is as bad as we think it is. The WSJ recently noted that worldwide M&A, excluding buyouts, has totaled $3.7T this year, beating the previous record set in 2007. M&A peaks when sellers agree to sell and that’s exactly what you’re seeing amid insider transaction reports. At $7.6B, November 2015 was the fourth-highest month of insider selling on record. This comes amid record share buyback activity, which has averaged $3.9B/day since the beginning of earnings season in October. Data firm Trim Tabs observes that this is the highest pace since the bull market began in March 2009. Companies are doing everything they can to arrest the gravity weighing on peak margins and protect earnings amid #GlobalDeflation which has perpetuated the ongoing global industrial recession – including right here in the U.S. All told, there is a ton of risk to forward estimates for GDP and EPS growth if we’re right on the economic cycle.

EUROPE

The Bank of England and Swiss National Bank both kept their interest rates on hold today, a noteworthy decision given the great easing pressure expected from the ECB. The BOE’s main rate was held steady at 0.50% while the SNB’s 3-Month Libor lower target remained anchored at -0.25% and the deposit rate was unchanged at -0.75%.  We continue to expect Currency Wars (a term coined by our good friend Jim Rickards) to heat up – we’re waiting for the Fed decision next week and expect the ECB to go dovish in 1Q 2016 in response to growth and inflation data the missing expectations. 

Asset Allocation

CASH 70% US EQUITIES 3%
INTL EQUITIES 6% COMMODITIES 0%
FIXED INCOME 15% INTL CURRENCIES 6%

Top Long Ideas

Company Ticker Sector Duration
MCD

Restaurants Sector Head Howard Penney had no material update on McDonald's (MCD) this week. However, here is what Penney wrote around when we added MCD to Investing Ideas. It's worth reiterating our high conviction in the stock:

 

"We continue to get more bullish every time we talk to the company, franchisees and/or customers which we have polled via conducting surveys. We are going to be looking at a much different company 1-3 years from now." 

 

"Urgency has been instilled from the top down by new CEO Steve Easterbrook," according to Penney. "This ship is in gear and headed north. 2015 will be the last time this stock is below $100."

RH

A lot has happened in 13 weeks... not the least of which is that Restoration Hardware (RH) is underperforming not only the market by 16%, but Retail as well (by 7%) – despite RH being more insulated from some of the issues that are clipping earnings today for retailers more broadly.

 

Over this time period, however, RH meaningfully accelerated square footage growth, launched two new concepts. Some say it’s bad timing. We disagree. RH is our favorite name in the retail space, and we like it across all three durations. Trade, Trend, and Tail.

TLT

On went the game of slowing last week with a little central planning un-secretive sauce. Despite the ECB’s move to cut the deposit rate to -0.30%, Draghi didn’t ring the cowbell loud enough. Meanwhile, Friday’s jobs report might have been just enough for Janet to hike rates into a late cycle slowdown. The consensus long USD crowd was crushed on the ECB news. The dollar lost over 2% on Thursday and rates were pushed higher.

 

If growth is going to continue to slow, with a rate hike on the horizon, a relative fixed income spread play (long TLT, short JNK) is exactly what you want on.

Three for the Road

TWEET OF THE DAY

NEW VIDEO: Disconcerting Global Macro Developments https://app.hedgeye.com/insights/47987-new-video-disconcerting-global-macro-developments… cc @KeithMcCullough #Deflation $USD

@Hedgeye

QUOTE OF THE DAY

Things won are done; joy's soul lies in the doing.

William Shakespeare

STAT OF THE DAY

Gallup's November update of Americans' 2015 holiday spending intentions finds U.S. adults planning to spend $830 on Christmas gifts this year, on average.


INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK

Takeaway: Energy state labor conditions are decoupling further from the trends in the broader US in the latest week's data. We expect this to persist.

INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK - oil cartoon

 

The main takeaway on the labor front this week is that while the US more broadly muddles further along, the energy economy is hemmorhaging. The chart below shows the spread continuing to widen between our energy state basket and the rest of the US. For reference, we use 8 states: AK, LA, NM, ND, OK, TX, WV & WY to derive our energy state basket. The gap between our two indexed series widened another 4 points to 46 for the week ended November 28th. The most recent dip in energy prices has yet to be reflected in the numbers.

Company's with material exposures to energy hubs such as Houston and Calgary will see headwinds grow for some time. This is why we remain short the Canadian Banking complex. Western Canadian companies with outsized exposure to this phenomenon include Canadian Western Bank (CWB-TSE), Genworth MI Canada (MIC-TSE), CIBC (CM) and Royal Bank of Canada (RY). For reference, initial claims trends in Alberta are similar to those in our 8-State US energy basket.

INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK - Claims18

 

The Data

Initial jobless claims rose 13k to 282k from 269k WoW. The prior week's number was unrevised. Meanwhile, the 4-week rolling average of seasonally-adjusted claims rose 1.5k WoW to 270.75k.

 

The 4-week rolling average of NSA claims, another way of evaluating the data, was -8.3% lower YoY, which is a sequential slow down versus the previous week's -9.9% rate of change.

 

INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK - Claims2

 

INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK - Claims3

 

INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK - Claims4

 

INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK - Claims5

 

INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK - Claims6

 

INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK - Claims7

 

INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK - Claims8

 

INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK - Claims9

 

INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK - Claims10

 

INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK - Claims11

 

<chart19>

 

Yield Spreads

The 2-10 spread rose 6 basis points WoW to 130 bps. 4Q15TD, the 2-10 spread is averaging 139 bps, which is lower by -14 bps relative to 3Q15.

 

INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK - Claims15

 

INITIAL JOBLESS CLAIMS | ENERGY LABOR CONTINUES TO TANK - Claims16

 

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


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