In this excerpt from a recent institutional presentation, Hedgeye Demography Sector Head Neil Howe explains why the fertility rate is the biggest leading indicator of immigration trends.
Takeaway: DKS went from greatness, to mediocrity, to uninvestable. Not a clear path back to awesomeness with this capital structure.
This DKS earnings event was perplexing. On one hand, the company gave every reason for just about any type of investor to never look at owning it again – at least until we emerge from the next economic recession. On the other hand – the stock actually traded up on the print. Yes, up. And we’re not talking a good ‘ol fashioned squeeze on a crowded short that is down and out. This is a name that was already up 28% for the year-to-date heading into the print and had only 7% of its float held short (below 10-yr avg of 9.7%). Now we’re left with a company that has underinvested in any effort to capitalize on the changing way that consumers are incrementally buying product in this corner of retail. Management’s answer? Aggressively buy Sports Authority stores as a key competitor goes bankrupt. NOT a good idea. Based on what we see today, we’d be on the short side of this name.
Here Are Some of Our Concerns
1) The earnings algorithm was horrible. DKS de-leveraged 4% sales growth into a 17% and 13% decline in EBIT and earnings, respectively.
2) Comp missed, and came in at -2.5%, but keep in mind that this INCLUDES e-commerce. On a store-only basis, DKS comped -4.4%, which was the worst performance since 4Q08 – when we were in a significantly more perilous environment.
3) New Store Productivity weakened at a greater rate than we can calculate – ever.
4) DKS SIGMA looks really really bad. Simply put, whenever a company puts up such a bad gross margin reading (-200bp), you want to at least see that its sales/inventory spread improved on the margin. That was not the case with DKS, and the market looked right through it.
5) Store Funk [was Mike Tyson in a ‘funk’ at the end of his career, or did he just get old and tired]
The performance of Dick's B&M stores remains poor. Stores comped down 4.4%, the 6th negative comp in a row, slowing 180 bps on a 2 year basis. For the first time since 2009 we saw a sequential decline in number of stores at -3, the biggest drop ever. New store productivity is trending down as well, yet the company still has plans to open 45 stores this year, and then another 60 stores next year to hit its 2017 target. If the stores are comping negative, new doors coming in at lower productivity, returns are declining rapidly on the incremental store investments. We think at this point the store targets are a pipe dream.
6) What Gives with e-commerce? If there was only one statistic we can look at to gauge the health of a brand, it would be e-comm growth. That’s unfortunate for DKS, as e-comm slowed sequentially for three consecutive quarters, and is growing today at a mere 13%. That level of growth for a company with such an immature e-comm business is simply unacceptable. Interestingly, Dick's online business grew below the rate of online retail as a whole, which grew 14.7% in 4Q15. In fairness, DKS should see an acceleration when it takes full control of its e-comm business in 2017. But unfortunately, hundreds of competitors will have advanced by then.
7) Sports Authority. DKS is aggressively going after TSA stores as its long-time competitor goes under. As backdrop, Sports Authority does about $3.5bn in sales in its ~465 stores. If we academically assume that the stores being closed operate at a 20% productivity discount, we get to $820mm in sales. DKS management indicated 90 to 100 (68%) of the 140 closing stores overlap with their stores, which looks like a fair number given our overlap analysis below shows 75% overlap (less than 15mi apart) for Dick's stores with all of Sports Authority. Therefore the total opportunity for DKS is ~$550mm or 7.5% in growth if they can take ALL of the revenue from closed Sports Authority stores. Claiming a more plausible 20% of sales – which will come at a significant capital cost - would mean a 1.5% growth tailwind.
Let’s be clear about something…in the past when DKS has acquired competitors and then subsequently rebranded them, it’s been at a point when the industry was in its adolescence. Today it is extremely mature – at least in the form that Wall Street knows it. It’s no longer about acquiring Sporting Goods stores, but rather about building a defendable brand that will own the consumer in all channels of distribution. That does not appear to be what DKS has in mind, which is unfortunate, as that would be a story worth getting behind.
Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Director of Research Daryl Jones. Click here to learn more.
"... So while traders may continue to chase the “wabbit” on the long side of oil, the data tells a different story. In fact, as highlighted in the Chart of the Day, oil supply continues to reach new highs in the U.S. at an accelerated rate. Currently, supply in the U.S. is running up +20% y-o-y!"
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“Family quarrels are bitter things. They don't go according to any rules. They're not like aches or wounds, they're more like splits in the skin that won't heal because there's not enough material.”
-F. Scott Fitzgerald
The quote from Fitzgerald above seems an apt way to describe the current state of the Republican Party. No doubt with Donald Trump’s wins last night in the Michigan and Mississippi, the fissures in the “family” are only widening.
In Michigan, Trump took 39% of the vote and in Mississippi he took 50% of the vote to strengthen his delegate count to 458, which is a 99 delegate lead over second place Senator Ted Cruz. Despite this lead, Trump still only has 45% of the delegates and is a long way from locking down the 1,237 delegates he will need to claim the Republican nomination.
So, what happens from here?
The next two major catalysts are the Ohio and Florida primaries in six days. Ohio is a must win for Governor John Kasich and Florida is a must win for Senator Marco Rubio. Currently, Trump has a wide lead in the most recent poll aggregates with a 16 point lead in Florida and a 4 point lead in Ohio.
For the Republican family elders, though, there is probably some solace in the volatility and unpredictability of these state level polls as exemplified in the Michigan primary on the Democratic side. Going into last night, Secretary Clinton was up by some +21 points and lost. So much for all that money spent on polling!
The Florida and Ohio primaries on March 15th are critical because they are likely to decide the fates of Kasich and Rubio, but they are also the beginning of the winner takes all primaries. On March 15th, there are 367 delegates up for grabs across 5 states and 1 territory and they are all in winner take all primaries.
At a minimum, if Trump wins Florida and Ohio, the math becomes very difficult for anyone else to get the nomination. If he doesn't, then it is very likely a contested convention is in play. In this scenario, the nominee will be decided on the convention floor by rules set by the RNC’s Rules Committee. Those rules, like most rules in family feuds, can be changed and will be set shortly before the convention. In this scenario, the proverbial family feud is likely only just beginning!
Back to the Global Macro Grind…
Back in the real world of data and asset prices, there is far less drama and intrigue. (Or is there?) On the oil front, the EIA indicated that it expects oil supply to grow more than previously expected due to production staying at high levels. Meanwhile, API is expecting a crude oil build of some 4MM barrels. Certainly, while oil and oil related assets (like the Loonie) have had a nice rally over the last few weeks, the data continues to fall solidly on the side of oversupply.
The next major catalyst for oil from a policy perspective is likely to be a proposed OPEC meeting in Russia on March 20th to discuss an output freeze. As our colleague Joe McMonigle at Potomac Research has noted, next to nothing will come out of this meeting (if it even occurs) and really the major harbinger for those that are bullish on the price of oil is the fact that Iran’s sole focus is to ramp product and take back share. We think Iran will continue to beat expectations on its ability to increase production and is likely to get to 700,000+ barrels a day of exports this year.
So while traders may continue to chase the “wabbit” on the long side of oil, the data tells a different story. In fact, as highlighted in the Chart of the Day, oil supply continues to reach new highs in the U.S. at an accelerated rate. Currently, supply in the U.S. is running up +20% y-o-y!
The broader issue with oil and natural gas staying at low levels for extended periods is the financial deleveraging that will have to occur in the sector. According to Moody’s, in the year-to-date there have been 18 defaults with half in the energy sector. Last year at this point, there were 11 defaults with 1 in the energy sector. So as year-over-year change goes...
Setting the volatility of oil aside, the most significant event on the macro horizon is tomorrow’s ECB rate decision. Our expectation, which isn’t necessarily out of consensus, is that Draghi and the ECB are going further into unchartered waters (see carton above for the analogy) to fight the shark that is deflation. The key reasons we see the ECB easing further:
- CPI has held below +0.5% for the last 20 months and is currently in negative territory
- PPI was reported in January at -2.9%; and
- Growth by almost any measure in Europe is anemic, which was highlighted this morning by the Bank of France taking its growth estimate to +0.3% on the back of manufacturing confidence falling to 3-year lows.
So with their likely move to more negative rates and a possible -0.4% on overnight deposits, the ECB continues to re-write the rules on monetary policy. Who knows though, perhaps after more than 600+ interest rate globally this will be the one that does the trick.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.67-1.94%
Oil (WTI) 30.65-38.18
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Client Talking Points
The #BeliefSystem (of central-market-planning) continues to break-down as the BOJ is now rumored to “hold off next week due to unstable bond markets” – wow – weren’t negative yields supposed to save equities from the profit cycle? The Yen remains bullish TREND and the Nikkei which is down -0.8% overnight remains bearish TREND.
Chase the wabbit – U.S. equity futures whipping around on what Oil does and that isn’t going to do anything for the economy obviously (volatility = bad). The immediate-term risk range for WTI is 30.65-38.18 so the way we would deal with this is fade Oil related beta moves at the top end of that range.
No matter what oil does, our favorite S&P Sector remains Utilities (XLU) which ramped another +1.0% yesterday to immediate-term TRADE overbought at +10.5% year-to-date as our favorite Sector to be short remains Financials (XLF) which led “ex-Energy” losers yesterday -1.6% to -8.1% year-to-date.
*Tune into The Macro Show with Gaming, Lodging & Leisure Sector Head Todd Jordan live in the studio at 9:00AM ET - CLICK HERE.
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Top Long Ideas
If you were long energy over utilities last week, nice trade! We'd remind you that Utilities (XLU) are outperforming the S&P 500 by +10% year-to-date. And that’s with the bounce. By contrast, Energy (XLE) was up 6.5% on the week but is up only 1% year-to-date.
General Mills (GIS) faces some headwinds across their portfolio, and although the 1H of FY16 was a challenge, the company has robust merchandising and consumer plans in the 2H that should improve results.
GIS has embarked on a mission to drive their top 450 SKUs, which represent 75-85% of their volume. Calling it their ‘Power 450’, surprisingly these 450 SKUs aren’t even in all retail locations and formats, broadening the distribution footprint of these top SKUs is priority number one for GIS’s sales team. The organization is also looking at the bottom 450, representing 1-2% of volume and making critical decisions on what products can be discontinued.
We continue to believe GIS is one of the best positioned consumer packaged foods companies due to its strong brands and best-in-class people and organization.
We can’t emphasize enough the bigger picture from both a data and top-down market signaling perspective. To contextualize the relief rallies and short squeezes in asset classes and instruments that are counter to our more longer-term view. Here’s what how we think the macro environment plays out from here:
Once the policy catalysts are out of the way in the next few weeks, our expectation is a return to outperformance in growth slowing asset classes (TLT and XLU). If you’re in for the TAIL and the TREND call, focus on the data, not the desperate attempts of central planners to arrest economic gravity. A brief reminder: ECB chief Mario Draghi will attempt to walk on water today.
Three for the Road
TWEET OF THE DAY
An Update On Howard Penney's SHORT #ShakeShack Call | $SHAK https://app.hedgeye.com/insights/49610-hedgeye-s-howard-penney-nails-shake-shack-short-call-again-shak… @KeithMcCullough
QUOTE OF THE DAY
It's kind of fun to do the impossible.
STAT OF THE DAY
Today in 1796, Napoleon married his 1st wife, Josephine.
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