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JWN | Time vs. Price

Takeaway: When we finally get a glance of JWN’s sales numbers–they need to be truly horrendous. We’d actually look to buy it on a sell-off tomorrow.

Conclusion: This is a multi-duration call. Bearish over the near-term as macro headwinds put earnings at risk. But, levers are there once the consumer stabilizes/recovers. The reality is that this is the only department store that really needs to exist.

 

We assembled a rather hefty slide deck on JWN as it emerged as a battleground stock ahead of this week’s print.  Initially, we were very bearish. The precipitous increase in short interest from 6% to recession levels of 20% over the past month means that when we finally get a glance of JWN’s sales numbers – they need to be truly horrendous. By the look of its e-commerce business, that’s precisely what we’ll get. Sometimes, the consensus is right, and this time, it probably is.

 

Unfortunately, it’s still the consensus. And while we think that this quarter will be terrible. The rate of change on the sales, gross margin, sg&a, and capex lines will change on the margin in JWN’s favor by mid-year. At that point, we might actually look to go long this one. After all, it’s the only department store that really needs to exist, and it’s trading at less than 7x a doable EBITDA number.

 

In the end, we’d actually look to buy it on a sell-off on tomorrow’s numbers – something in the low-mid $40s sounds about right. Otherwise we might be interested in buying with a $5-handle later this year when the Macro environment is de-risked and JWN emerges from ‘investment mode.’

 

JWN | Time vs. Price - 2 17 16 JWN earn table

 

Additional details…

 

Trade (3 weeks or less): JWN is the only name amongst its peer group that has been radio silent throughout the holiday season that saw M and KSS pre-announce earnings growth rates of -20% (-30% ex. the Brooklyn asset sale) and -15%, respectively. Management lowered the 4Q bar by 9% post the 3Q print, and then the Street came down by another 7% over the past three months. Sales expectations still look too high given the general softness in the retail space (especially at the high end) over the holiday period and the fact that JWN is up against its toughest comp since 4Q12. E-commerce traffic trends have been soft across all of JWN’s concepts as it laps the launch year of the Rack website, while Full Price and Hautelook continued to weaken into quarter close. We’re about $100mm, or 2%, below the street.

 

These Traffic Trends Look Terrible

JWN | Time vs. Price - JWN Traffic

 

On the margin side, JWN likely took the biggest hit of any of the department store players in the quarter with gross margins down 160bps in 3Q, as it proactively managed its inventory position. Warm weather and weak demand will still be an issue in 1Q, and we expect inventory growth ahead of sales for the 16th time in the past 18 quarters. Canada and Trunk dilution is starting to roll off now that the sales base North of the border is forming a critical mass and the acquisition of Trunk Club is annualized. The company pulled a few SG&A levers last quarter by cutting its investment in its loyalty program (bullish for credit income). All in we’re modeling a 200bps hit to EBIT, broken out into 110bps of deleverage in the core, another 40bps from non-core investments, and the remainder allocated to the sale of the credit card receivables.

 

3Q15 SIGMA Chart 

JWN | Time vs. Price - DEPT SIGMA

 

Trend (3 months or more): Not unlike the rest of the retail space, the street is looking for a snap back on the top line as we enter 1H16, chalking up most of the demand issues we saw in the back half of 2015 to just weather. We’re not buying it. And, after what we think will be another sales miss in the 4th quarter we expect the guide for 2016 to be conservative on the top line. Or, at least it should be given the price action on the stock over the past 3 months and the fact that short interest is at 5 year highs at 19% (up from just 6% in late November).

JWN | Time vs. Price - 2 17 16 JWN vs Retail

 

Here’s where we come out on each of the lines on the P&L in the first half of 2016…

  • Revenue: No comp growth in the brick and mortar side of the business with negative LSD comps at Full Line and flattish comps at Rack against easy compares last year. That’s offset by low teens growth in the company’s e-commerce business (inclusive of FullLine.com, Rack.com, and Hautelook), about a half a point of growth from Canada and Trunk Club, and 5% square footage growth. That gets us to LSD sales growth in the first half of the year at the retail level (flat revenue growth reported due to the loss of credit revenue).
  • Gross Margin: We’re looking at another 75bps of deleverage as the company continues to invest in its roll out of Rack and Canada stores, which caused about 30bps of deleverage on the gross margin line in 2015. As noted earlier, JWN took it on the chin on the margin side to keep inventories in check headed into 4Q15, but we expect the combination of weak demand and warm weather to lead to a negative move in the sales to inventory spread. That coupled with high inventories across the space = another ‘highly promotional’ environment in 1H15.
  • SG&A: Growth in the mid to low single digit range as the company laps the Trunk Club acquisition, East Coast fulfillment center, and the profitability in the Canada business operation starts to head North. Offset by about $25mm in credit revenue from the TD Bank agreement in each quarter.
  • Earnings: Add that all up and we get to a negative DD earnings growth rate in 1H. 5% and 10% below the Street in 1Q and 2Q, respectively.

Tail (3 years or less): Over a longer duration (3 years or less), we like the setup for JWN. Yes, macro headwinds and category risk are keeping this name on the long bench rather than the core set of names as trend earnings risk still looks likely. But, once we get through the macro reset JWN has the makings of a textbook long. Here’s why…

 

1) For starters, we have to ask the question does JWN need to exist? We think the answer is unequivocally yes. It has arguably the best e-comm operation in all of B&M retail, premium content, a concentrated footprint in the top malls/MSAs outside of the Northeast, and can hit 300 rack doors without skipping a beat. We’re not convinced that the ‘non-core’ (Canada/Trunk) growth drivers are ROIC accretive, but expectations have come down to a level where we think the point is moot.

 

2) JWN is coming off a peak investment year, and while there is still $3.1bn left on the $4.3bn 5 year CapEx plan, 2015 marks the tops of capital investment. Margins are washed out as the company invests in the Rack rollout (27 doors added this year), Canadian entry, new East Coast fulfillment center, credit card receivables sale, and absorbs the Trunk Club acquisition. That should in turn fuel top line growth in the HSD range once we enter the back half of 2016 (consumer environment permitting).

 

3) We don’t have to make wild profitability or sales assumptions for this model to work. By 2017, we assume that Full Line EBIT margins are 100bps off 2014 levels, Rack EBIT margins are 50bps off of 2014 levels, slight improvement in e-comm margins as the business (Rack and Full Line) climbs to ~$4bil, and a profitability donut in the non-core side of the business (Canada/Trunk). At that point Canada will be around a $400mm business, with the entire full line buildout complete, and Trunk (which was break even when JWN acquired it) will have benefited from 3 years of integration. Any improvement in each of the four segments will add additional upside.

 

4) On that math we get to earnings of $4.13 in 2017 on a sales base just north of $16bn. 6% ahead of the street today and likely higher as numbers come down after 2016 expectations are reset. 


JT Taylor: Replacing Justice Scalia & Paul Ryan's Budgetary Balancing Act

Takeaway: Is a standstill in the Senate likely with ensuing search for Justice Scalia's replacement. Can Paul Ryan unite Republicans around a deal?

Editor's Note: Below is a brief excerpt from Potomac Research Group Senior Analyst JT Taylor's Morning Bullets sent to institutional clients each morning. 

SCOTUS SCRAMBLE:

 

JT Taylor: Replacing Justice Scalia & Paul Ryan's Budgetary Balancing Act - scalia

 

Expectations for the Senate's productivity this year were already low, but the looming nomination fight over Justice Scalia's replacement threatens to grind the chamber to a standstill. Majority Leader Mitch McConnell's decree that any Obama nominee to the Supreme Court would be stonewalled all but invites an "obstructionist" tag for the whole party in the coming election (though we're willing to bet that Harry Reid, if in his shoes, would be using the same playbook). He's caught between the stated goal of "regular order," demonstrating his party's ability to govern, and a much-less ephemeral conservative base that will not countenance a nominee from the current president, period. 

 

We wonder, why not just let the process work? There are several major hurdles that a nominee faces under normal circumstances -- the Judiciary Committee, a cloture vote, and finally a floor vote -- and there's opportunity throughout for Leadership to slow or block confirmation, with far less risk to the party brand. Not every Senator seems to be adopting the party's hard line -- Judiciary Chair Chuck Grassley said he would at least withhold judgment until a nominee is named, while fellow Judiciary member Thom Tillis warned about the "obstructionist trap" they risk by blocking a SCOTUS pick sight-unseen.

BUDGET BALANCING ACT:

 

JT Taylor: Replacing Justice Scalia & Paul Ryan's Budgetary Balancing Act - paul ryan

 

Speaker Paul Ryan, facing stern opposition from conservatives to the budget caps agreed-upon by his predecessor John Boehner, laid out three options for members of his Caucus on Friday:

 

  1. Re-impose sequestration-level cuts for defense and domestic spending;
  2. Bump up the defense budget, to satisfy hawks, but maintain or lower caps on domestic spending; or
  3. Don't pass a budget at all -- with the budget topline already set for next year, appropriations bulls can still move forward unimpeded.

 

Options 1 and 2, he stated, would result in the one outcome conservatives hate even more than excess spending: a Democratic blockade in the Senate, followed by an Omnibus appropriations bill crammed down their throats at the end of the year. Option 3 would be an embarrassment for Ryan, former chair of the Budget Committee, and give Democrats yet another attack vector on the party's inability to govern -- but "the sky wouldn't fall," according to the Speaker. Partisan rancor over the SCOTUS shake-up increases the odds that House Republicans will take option 3. 


Cartoon of the Day: The Three Little Pigs

Cartoon of the Day: The Three Little Pigs - central bank cartoon 02.17.2016

 

Central bankers have become concerned about recent tumult in financial markets. They should be. Macro markets continue to signal economic growth is slowing.


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BREAKING: Atlanta Fed's Economic Forecast Is Out To Lunch

Takeaway: The U.S. economy is slowing, despite what the Fed says.

BREAKING: Atlanta Fed's Economic Forecast Is Out To Lunch - Fed forecast cartoon 11.13.2015

 

The latest Atlanta Fed GDP reading is a head-scratcher.

 

In case you missed it, their forecast for Q1 2016 came in at 2.6% today.

 

2.6%!

 

That's well above rosey Wall Street consensus estimates of 2.1% and stands in stark contrast to Hedgeye's latest (revised) forecast... 0.6%. 

 

BREAKING: Atlanta Fed's Economic Forecast Is Out To Lunch - gdp fed q1

 

For the record, our Macro team has nailed the last five GDP reports.

 

Then there's the Atlanta Fed's own track record... You'll recall that Q4 2015 GDP came in at 0.7%. Back in October, the Fed's estimate for Q4 2015 GDP was almost 3%. That was ratcheted way back to a final estimate of 1.0%.

 

BREAKING: Atlanta Fed's Economic Forecast Is Out To Lunch - gdp fed q4

 

Part of the inaccuracy of Atlanta Fed's model is methodological. Here's Hedgeye U.S. Macro analyst Christian Drake:  

 

"The GDPNow model is never accurate in the early part of a quarter  - that’s because it’s a tracking model and uses reported data for the quarter to drive the estimate. At the beginning of the quarter it is largely interpolation and estimates, which subsequently get revised as the actual data comes in.

 

We don’t even have January data yet across a number of material series which means the Atlanta Fed model has incorporated zero actual data across many of the expenditure types in the 1Q16 estimate so far."

 

Hedgeye Senior Macro analyst Darius Dale adds even if there is a "sequential acceleration by the time Q1 GDP is reported... that would not be unlike 2Q 2000 and 2Q 2008 (both #SuperLateCycle head-fakes)."

 

The broader point here is that our Macro team reiterates its #GrowthSlowing theme per the preponderance of economic data that is rolling over of late and in spite of the Q1 2016 GDP number.

 

If we're right and historical precedence (per 2Q '00 and 2Q '08) is our guidepost, stay away from equities. As Dale points out, back then "You could've bought all the stocks you wanted en route to peak-trough decline on the order of -49.1% and -56.8%, respectively (S&P 500)."

 

in other words ... Watch out.


INSTANT INSIGHT | Central Planning, Currency Wars, & European Stocks

Takeaway: Europe needs a strong dollar to prop up their stock markets.

INSTANT INSIGHT | Central Planning, Currency Wars, & European Stocks - draghi devalue

 

A few interesting insights via foreign exchange markets. As Hedgeye CEO Keith McCullough pointed out to subscribers this morning:

 

"The strong recovery day for the US Dollar yesterday after holding 94 @Hedgeye TREND support during the 2 week correction – rest of the world’s equities (Europe and Japan in particular need #StrongDollar as their stock markets aren’t working unless their FX weakens) – can Draghi break the Euro down to $1.05 vs USD in March? Doubt it."

 

That's why European markets are up today. The Euro is weakening.

 

here's a look at Italian stocks...

 

 

and Germany's DAX...

 

 

For the record, the DAX has tumbled -25% from it's 2015 high.

 

the central planning gong show continues...

 

INSTANT INSIGHT | Central Planning, Currency Wars, & European Stocks - Currency wars cartoon 08.12.2015


[UNLOCKED] Fund Flow Survey | Bottom Fishing

Takeaway: Investors made more aggressive allocations last week with domestic equity having its first inflow in 19 weeks.

Editor's Note: This is a complimentary research note which was originally published February 11, 2016 by our Financials team. If you would like more info on how you can access our institutional research please email sales@hedgeye.com.

 

* * *

Investment Company Institute Mutual Fund Data and ETF Money Flow:

In the 5-day period ending February 3rd, investors made more aggressive allocations than they have in recent periods, drawing down -$4 billion of cash and making contributions to domestic and international equity mutual funds. Domestic equity funds experienced their first inflow in 19 weeks with investors contributing +$2.3 billion to U.S. stock funds. Additionally, international equity funds took in +$5.7 billion, their largest weekly subscription since April 2015. Passives continue to be a source of funds however with equity ETFs losing another -$8.8 billion (over $3.0 billion of this redemption was in the S&P 500 SPDR this week). In fixed income, fear abounds with taxable bond funds having its worst week in 5 with -$5.5 billion being withdrawn. Municipal bonds continued their winning streak, taking in +$1.2 billion, making it 18 straight weeks of tax-free inflows. Fixed income ETFs gained +$1.9 billion.


[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI1 large 2 16

 

In the most recent 5-day period ending February 3rd, total equity mutual funds put up net inflows of +$8.1 billion, outpacing the year-to-date weekly average outflow of -$917 million and the 2015 average outflow of -$1.5 billion. The inflow was composed of international stock fund contributions of +$5.7 billion and domestic stock fund contributions of +$2.3 billion. International equity funds have had positive flows in 41 of the last 52 weeks while domestic equity funds have had only 6 weeks of positive flows over the same time period.

 

Fixed income mutual funds put up net outflows of -$4.3 billion, trailing the year-to-date weekly average outflow of -$1.6 billion and the 2015 average outflow of -$463 million. The outflow was composed of tax-free or municipal bond funds contributions of +$1.2 billion and taxable bond funds withdrawals of -$5.5 billion.

 

Equity ETFs had net redemptions of -$8.8 billion, trailing the year-to-date weekly average outflow of -$5.6 billion and the 2015 average inflow of +$2.8 billion. Fixed income ETFs had net inflows of +$1.9 billion, trailing the year-to-date weekly average inflow of +$2.6 billion but outpacing the 2015 average inflow of +$1.0 billion.

 

Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.



Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the weekly average for 2015 and the weekly year-to-date average for 2016:

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI2

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI3

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI4

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI5

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI6



Cumulative Annual Flow in Millions by Mutual Fund Product: Chart data is the cumulative fund flow from the ICI mutual fund survey for each year starting with 2008.

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI12

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI13

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI14

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI15

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI16



Most Recent 12 Week Flow within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI), the weekly average for 2015, and the weekly year-to-date average for 2016. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI7

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI8



Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, investors made large withdrawals from industrials and materials. The industrial XLY ETF lost -$277 million or -5% to redemptions. The materials XLB lost -$113 million or -6%.

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI9 2



Cumulative Annual Flow in Millions within Equity and Fixed Income Exchange Traded Funds: Chart data is the cumulative fund flow from Bloomberg's ETF database for each year starting with 2013.

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI17

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI18



Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a positive +$1.6 billion spread for the week (-$774 million of total equity outflow net of the -$2.4 billion outflow from fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is +$724 million (more positive money flow to equities) with a 52-week high of +$20.5 billion (more positive money flow to equities) and a 52-week low of -$19.0 billion (negative numbers imply more positive money flow to bonds for the week.)

  

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI10

 


Exposures:
The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:

 

[UNLOCKED] Fund Flow Survey | Bottom Fishing - ICI11 


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