RTA Live: March 30, 2016

RH | Zegna and Wal-Mart Don’t Mix

Takeaway: 4Q was a hot mess. But let’s not lose sight of the oppty for RH, the capital being deployed to get there, and the weakening competitive set.

This RH quarter was the equivalent of accessorizing a Zegna suit with a tie from Wal-Mart – it simply does not work.  The metrics up and down the P&L and balance sheet were simply bad. We won’t rehash them here. We all know the numbers, and if anybody does not, then rest assured that a 100-day stock price decline from $105 to $38 most certainly does. We think another thing is for certain…RH will look meaningfully different in 12-months than it does today. We also happen to believe that we’ll see tangible evidence – both quantitative and qualitative in each quarter as we go. We like that a lot with the stock trading at a new trough valuation on what we think is the equivalent of a recessionary earnings number (Contact for our Black Book) and when we’re being pinged more than ever incrementally by value investors instead of the typical growth/garp hedge fund crowd.  We can complain about the current valuation, or simply respect it for what it is and act accordingly. This is one of the few transformational growth stories we’ve ever seen in retail (in 20+ years). This is like an UnderArmour, an Ulta, or a Chipotle (sans the e. coli). But not a single one of these – or any transformational story in any industry, for that matter – is a linear progression. There’s usually several stages in any transformational business for reassessing the competitive landscape, identifying the best growth, putting the appropriate capital behind those initiatives (even if shareholders don’t understand it at the time), and…on occasion…screwing up. Well, RH just had such an occasion, and we flat-out reject the premise that the long-term growth vision RH has had along has been smoke and mirrors.


As it relates to the stock, we’ve laid out a path to $300 over the course of three years. Does the latest turn of events change our analysis? Actually, the answer is No – it does not. We still think that RH will realize over $10 in EPS power, and Yes, there will likely be many hiccups as we get there. Does the magnitude of this quarter’s disappointment mean that we should take down our multiple for RH? Over the near-term, yes. But longer-term, absolutely not. When the company achieves our targets – you can rest assured that the Street will forget all about these past three months – just as it has with RH on several occasions since the company went public.  Will we ignore the guideposts along the way? No. We’ll scrutinize the P&L and balance sheet six ways til Sunday every quarter as the story plays out. That’s our job, or part of it at least.


But the market does not offer up too many gifts to the investment community. RH with a $3 (4, or 5) handle, is definitely one of them.

RH | Zegna and Wal-Mart Don’t Mix - 3 30 2016 RH Earnings



1) Inventory: A negative sales to inventory spread is nothing new to RH given its business model, but it’s definitely a red flag in the quarter -- especially given that the revenue miss was associated with a lack of vendor ability to meet demand. To us that means either a) the core product significantly underperformed expectations, or b) RH bought heavily in Modern/Teen categories that didn’t sell. Management all but confirmed choice ‘a)’ on the call, but we think that inexperience in buying Modern/Teen also played a part in the $65mm revenue miss in the quarter. Inventory growth was 30% at years end and DIH was up 24 days into a slowing top line growth equation. We’d be more concerned if expectations weren’t for flat to down earnings growth. But the way we see it, RH now has a low enough margin bar to clear out excess inventory in slow turning core SKUs, which will allow the company to find the right mix between ‘newness’ and core and free up a tremendous amount of working capital – up to $140mm by our math.  

RH | Zegna and Wal-Mart Don’t Mix - 3 30 2016 RH SIGMA

2) Incremental margin math: RH is guiding to a $0.22 hit from ‘elevating the customer experience’ in 2016 most of which is loaded into 1H. That is composed of a $15mm reduction in revenue to try to mitigate cancellations, but the $0.22 EPS hit implies a $24mm hit to the P&L. Put another way, that’s an incremental margin of -160%. That means that there are certain other costs loaded into the revenue hit, which we think are both recoverable as we anniversary this headwind next year and will help set RH for the next leg of growth.


3) Design Gallery Performance: Qualitative commentary on the performance of the next generation Full Line Design Galleries has been extremely positive, but we haven’t seen the hard numbers like we saw in the early days of Beverley Boulevard or Houston as proof of concept. Nor should we, as that type of disclosure sets a tough precedent as the number of Design Galleries compounds. But, based on our math the instore performance looks to be at or above the $650/sq.ft. plan the company has spoken to. A few additional details…

  1. In 3Q and 4Q the company comped 10.5%-11% in its full price retail doors, with DTC averaging the total down to a 7% and 9% brand comp in 3Q and 4Q, respectively.
  2. Non-comp Design Gallery square footage amounted to 24% of total square footage in each of the past two quarters, and should (according to management commentary) when fully mature operate at a productivity level of $650/sq.ft. (about 44% of what the company currently does in its existing fleet).
  3. Yet, the company reported sales/average sq. ft. growth of 2.4% in 3Q and -3.3% in 4Q15. Mathematically that doesn’t work unless the new square footage is tracking ahead of plan. Based on our math, sales/sq. ft. (not average sq. ft.) should have been in the $340-$350 range in each of the past two quarters assuming non-comp Design Gallery sq. ft. peaks out at $650 and comes in at a productivity rate of 70%. Instead we saw $363 in 3Q and $373 in 4Q.

RH | Zegna and Wal-Mart Don’t Mix - 3 30 2016 RH spsqft

CHART OF THE DAY: The Final Tally Is In! Earnings Season Sucked

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye CEO Keith McCullough. Click here to learn more.


"... Shifting gears, not that profit or credit cycles matter when the Janet waives her “dovish” day-trader wand, but Earnings Season officially ended yesterday and here’s the summary:

  1. SP500 (500 of 500 companies have reported) aggregate SALES down -4.0%
  2. SP500 aggregate EPS down -6.9%
  3. SP500 Sectors saw 6 of 10 report NEGATIVE earnings growth
  4. “Ex-Energy” (i.e. 40 of the 500 companies), there are still 460 companies!
  5. Industrials (65 companies) and Financials (90) companies had EPS of -5.9% and -5.4%, respectively"


CHART OF THE DAY: The Final Tally Is In! Earnings Season Sucked - 03.30.16 chart

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Janet, We're Up!

“These ideas are entirely imaginary, but if everyone shares them, we can all play the game.”

-Yuval Noah Harari


Imagine US GDP wasn’t tracking towards 1% with most of the cyclical/industrial sectors of the economy in #recession and corporate profits running down -11% year-over-year? Wow. Mind blowing. How would we play the “she’s dovish” game then?


Janet, with 2 trading days left until we send out our quarterly performance reports, we’re up, baby! Oh yeah – you go girl! Forget SP500 +0.5%, if we’re long the Long Bond (TLT +9% YTD), Utilities (XLU +14.3% YTD), and Gold (GLD +16.9% YTD), we’re really up!


Fascinating and brilliant, this complex market system is, isn’t it? As Harari astutely points out in Sapiens, “in order to establish such complex organizations it is necessary to convince many strangers to cooperate with one another…” (pg 118)


Back to the Global Macro Grind


It’s almost like 1987 out there right now. Heck, if you asked a perma bull what the US stock market did that year – “it was flat.” After the worst 6-week start to the SP500 ever (which is still, in the non-imagined-world, a very long time), it’s back to “flat”, baby!


Janet, We're Up! - Bull market 03.24.2016


If only every portfolio manager’s performance was flat.


As one of the best performing long-only PM’s we work with pinged me yesterday, “bad is good and good is good, but it all sucks.” And since he’s not heartless about how a +1% US “growth” (heading toward 0% in Q2) economy ends for a lot of Americans, he’s right about the sucking part. Once we get through the last of this no-volume-month-end markup, I think bad is going to be bad again.


If you’re long something that is in line with both the Fed and Consensus Macro’s forecast of +3% US GDP growth (some of them used to be at 4%) like say, The Financials, yesterday really sucked too (XLF was only +0.18% on the day to -5.92% YTD).


But, if you were long the real Slower (GDP) and Lower (rates) for Longer stuff, like:


  1. Utilities (XLU) +1.5% on the day
  2. Gold (GLD) +3.0% on the day


Wow, did you have an awesome day. Those returns were 2-4 baggers versus the SPY, bros!


Shifting gears, not that profit or credit cycles matter when the Janet waives her “dovish” day-trader wand, but Earnings Season officially ended yesterday and here’s the summary:


  1. SP500 (500 of 500 companies have reported) aggregate SALES down -4.0%
  2. SP500 aggregate EPS down -6.9%
  3. SP500 Sectors saw 6 of 10 report NEGATIVE earnings growth
  4. “Ex-Energy” (i.e. 40 of the 500 companies), there are still 460 companies!
  5. Industrials (65 companies) and Financials (90) companies had EPS of -5.9% and -5.4%, respectively


To give Janet her “fair share” of air time, some of this weakness in the Financials (XLF) “reflected Financial developments since December”, like:


  1. The Fed hiking into a slow-down = December Policy Mistake
  2. The BOJ going for “negative yields” and ECB “buying corporate bonds”
  3. Then the Fed un-hiking the hikes, in their latest attempt to “ease” their SP500 dependent view


You know what all of this did for the credit cycle?


High Yield Spreads (up for 5 of the last 6 days btw) simply made another higher-low within a nasty cyclical breakout (well above the AUG-SEP level). And the rates move all but ensured that bank earnings are going to get hammered in the next Earnings Season.


Yep. Roll out the Old Wall’s “Ex-Financials, Buy Stocks On Rising Gas Prices” bull case for the US Economy in Q2!


Admittedly, we’re all trying hard to play this imaginary game of trying to find the next chart to chase (before the machines do). But it is getting harder to keep track of how the rules of the game go.


Following the Fed’s “transparent communication process” can really trip up a Fed follower:


  1. Two weeks ago, Yellen cuts via taking out the rate hikes = #Dovish
  2. Then, for all of last week, her Regional Talking Fed Heads talked up “April and June” rate hikes = #Hawkish
  3. Then she pivots incrementally dovish vs. her teammates’ hawkishness yesterday?


To be fair, I guess A) the SP500 was down last week (on their hawkishness!) and B) the Atlanta Fed GDP forecast dropped to 0.6% for Q1, so I guess she just had to start moving the goal posts a little faster.


Imagined or not, we all have to keep trying to play this game until the #BeliefSystem breaks down. Since it’s already breaking down in Japan and Europe, I think we’re closer to the beginning of the end of the game than we’ve ever been.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.79-1.91%

RUT 1066-1115

VIX 13.24-19.95
USD 94.54-96.50
YEN 111.02-113.88

Gold 1


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Janet, We're Up! - 03.30.16 chart

Reflation Rallies!

Client Talking Points


Isn’t this getting fun? We’re pretty sure Janet Yellen never played team sports, so maybe we shouldn’t be surprised that her Fed forecasting team is all over the place at this point in talking to markets about rate hikes and USD. Massive inverse Correlation Risk continues to drive daily market moves with USD to CRB and SPY running -0.81-0.96 in March.


As opposed to v-bottoms on the SPY short-side, the long side has been easy year-to-date – as #GrowthSlows, Fed Easing has pounded the UST 10YR down to 1.81% (2YR just went from 0.90% to 0.77% in less than a week on Fed Head confusion) and Utilities (XLU) continued to lead the way on yesterday’s Yellen Ramp, closing up another +1.5% = +14.3% year-to-date XLU.


Heck, why buy Utes on Yellen turn-tailing dovish when you can go right to the vein and buy Gold? It was +3% yesterday (vs. Financials barely up at +0.18% XLF #terrible) to +17% year-to-date leading most things in absolute return space which we highly doubt will be trumpeted more than “the S&P is up” (+0.5% year-to-date) all day today (into month-end markups).


*Tune into The Macro Show with Hedgeye CEO Keith McCullough live in the studio at 9:00AM ET - CLICK HERE

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

CME Group (CME) put up a decent fourth quarter earnings print with a slight revenue and earnings beat. Not that we put much weight on what happened last quarter but trends into the new operating period are looking even better. The exchange guided to just a +1% operating expense increase for 2016, guided to slightly lower annual taxes for '16 (with more activity coming from abroad), and again announced that open interest was setting a new record, at over 111 million contracts.


Even assuming some mean reversion to just over 16.5 million contracts (depending on product group), 1Q is running at ~$1.20 per share in earnings, which means the Street will need to perk up its current $1.06 estimate. Simply put, this is one of the few growth stories in the current macro environment within Financials.


We continue to like General Mills (GIS) as one of the best large cap names in the packaged food space. With that being said, the third quarter was not without its noise surrounding the numbers; Green Giant divestiture, Walmart clean store policies, foreign currency exchange, and grain merchandising just to name a few, muddied the waters. But digging through the noise, this is a business that is truly turning a corner. When they set sail on fiscal year 2016 back in June of 2015, we knew this was not going to be an easy ship to turn towards success. Now, with many key product platforms turning (through strong product innovation and renovation) in the right direction and operational improvements implemented through cost savings initiatives, GIS is on the cusp of success. We will be measuring this success by realization of sustained top line growth in the low single digit range.


In our model the second quarter is the toughest compare on both GDP and U.S. corporate profits so we want to be very careful going into that and be positioned defensively. Stay long Long-Term Treasuries (TLT).


While small/mid cap U.S. Equities reverted to their bear market mean last week (Russell 2000 down -2.0% on the week and -16.7% since US Corporate Profits peaked in Q2 of 2015), so did a few other US Equity Market Style Factors that had had a big 1-month bounce:

  1. High Beta stocks were -2.0% on the week
  2. High Leverage (Debt/EBITDA) stocks were -1.9% on the week
  3. High Short Interest stocks were -1.7% on the week

Three for the Road



The #Airbnb Impact On #Hotels & Timeshare… via @HedgeyeSnakeye @KeithMcCullough



Courage is grace under pressure.                               

Ernest Hemingway


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