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Cartoon of the Day: Crude Realities

Cartoon of the Day: Crude Realities - Freeze and hike cartoon 09.06.2016


Talk is ... how shall we put it ... cheap.


Takeaway: 2 key callouts from last week’s LULU print. Both mean margins and returns headed lower.

We hope your long Labor Day weekends were filled with plenty of beach time. The ‘break’ (if such a thing exists in the summer for a retail analyst) gave us some time to dig through the LULU 2Q16 transcript and subsequent 10-Q filing.


There were plenty of items to pick through, most of which we hit on in our note titled LULU | RUBBER HITS ROAD, ROAD HITS BACK (full note below) after the print. But there are two new pieces of disclosure that we think are important to the long-term margin structure and returns for LULU – both of which we think are headed lower.


1) Int’l more expensive. Might seem like a no-brainer, but we think it’s an underappreciated risk to the story. Even after the company gets past the initial investment needed in order to scale up an international operation across multiple borders/languages/cultures. The new data point is that the international doors operate on a 4-wall basis 300-500bps below the core US/Canada business. That might not sound like a big deal today with 12% of the store portfolio outside of the US/Canada – but fast forward another 5 years and that number will 2x at 24%. Tack on lululemon’s stepchild operation in ivivva, and we are looking at 42% of the store portfolio consisting of operations we consider to be ‘non-core’. That compares to 24% where the company ended 2015, and 14% in 2011 when the company printed a peak EBIT margin of 29%.



2) SG&A Levers @ HSD Comp. Well and good if we were to dial the clock back 4/5 years – but we think a sustained HSD comp is in the rearview. That’s not to say there won’t be quarters where LULU surprises to the upside, but we think that the trend from here on out will be well below that needed hurdle rate. Primarily because… a) sq.ft. benefit to comp growth peaked out in 2015, b) men’s won’t put up UA-esque growth rates needed to hit the $1bn sales growth, c) e-comm growth has been less than impressive in 2016 to-date, and d) Int’l will fail to produce the type of top-line buffer the company expects.


Ultimately, we think the GM tailwinds will be understated by the need to take expenses up to keep market share in the US and fund ‘non-core growth’. That translates to a steady state margin in the mid-to-high teens vs. the street approaching 20%.

LULU | UN-HAPPY RETURNS - LULU business dynamics



Below is our previous note from 9/1/16


09/01/16 07:15 PM EDT



Takeaway: This print had one or two redeeming factors, but overwhelmingly reinforced our short call. There’s another $20+ downside over 12-18 months.


This quarter was not a disaster by any means, but with slightly weaker revenue and a tempered outlook, it’s certainly not what a $76 stock at a 35x multiple needs to see.  The aftermarket sell-off shows that clear as day. But the reality from where we sit is that there is much more downside from here. Our call was to press the short on the print. In hindsight, we’d have stuck with the same call from a risk management perspective. The reason is that even though the stock is selling off after market, we think there’s a good $20+ in downside left in this name. Our major concern is that numbers, and the rising capital costs to capture incrementally lower margin growth, do not synch with elevated expectations, and the company will need to guide down in 3-6 months, or flat out miss by 10% or better in 2017.


The TTM incremental margin in this quarter was under 4%, and expectations – even after weaker guidance -- are calling for that to accelerate to a whopping 24% over the next three quarters.  We think that LULU will flat-out miss this target. Even if we’re wrong, the incremental buyer needs to ask if there is any potential upside from these aggressive targets? We think No. We would love to engage in that debate, and we’re pretty sure we’d win (see note below for details).

LULU | UN-HAPPY RETURNS - 9 1 2016 LULU inc margin


To be fair, LULU put up absolute EPS growth of 12% -- which is actually good for a retailer in this day and age (though not worthy of nearly a 3x PEG ratio). In addition, it just put up the best Gross Margin improvement since 2Q 2011 on top of a downright impressive move in the SIGMA – that is nearly a lock for some level of gross margin improvement in the coming quarter. That’s the biggest, and perhaps only real positive from this print.

LULU | UN-HAPPY RETURNS - 9 1 2016 LULU sigma


But the whole thing does not sit well with us, for several reasons…


1) Management is hinging this story on a long-term comp of at least 9% -- the level needed to leverage SG&A, but it admits that customer traffic continues to be a problem (in 3Q to date as well), and is banking on higher Average Unit Retail (AUR -- i.e. price/mix per item) and Units per Transaction (UPT).  We don’t see how anyone can rely on this given the longer-term competitive pressures from solid brands with far better strategic visions, management teams and Boards.

2) Above all that, the fact (and it is a fact) that with the absence of a wholesale model – one that we think LULU is likely not capable of executing alongside its DTC business – and real estate growth outside its core markets, the company is simply not ‘fishing where the fish are’. Of COURSE traffic will be a problem in this scenario. Why should that turn around?

3) LULU took up capex slightly this quarter (2-3%) and moderated its SG&A leverage expectation to spend on the brand – but we need to see a lot more than the ~22% it is spending on the margin. We need at least an incremental $150 million in annual spend, or about another 75bps in margin – and we could even argue something closer to $250mm to meaningfully accelerate top-line growth to the levels needed to grow consistently and profitably. We heard no part of the strategy on the conference call that makes us think otherwise. Potdevin can talk about the ‘Feathered Designs and Technical Silouettes’ all he wants…the fact is that expectations are very high, growth is slowing, and the cost of growth is heading up. That means lower returns – structurally – which hardly synchs with the stratospheric multiple.

Dear Janet, Are You Really "Data Dependent"?

Takeaway: You may want to stop reading now if you're a “data dependent” hawk.

Dear Janet, Are You Really "Data Dependent"? - Yellen data dependent cartoon 11.18.2015


Editor's Note: The excerpt below is from a larger institutional note written by Hedgeye CEO Keith McCullough.

ISM Services prints worst since 2010. 


...Drops -4 pts sequentially with Business Activity and New Orders dropping a remarkable -7.5 pts and -8.9 pts, respectively.  Employment down -0.7 and barely holding positive at 50.7 as well.


From potential overheating to flirting with contraction in a single month with New Orders posting its largest sequential decline in 104 months. To review, if you broadly divide the economy into Services & Goods and do the data dependence math for August:


  1. GOODS = Contraction
  2. SERVICES = worst print since 2010  


If you’re more into data point breadth, here’s a list that “data dependent” hawks should obfuscate or ignore:


  1. Chicago PMI = Worse
  2. ISM Services = Worse
  3. ISM manufacturing = Worse
  4. Markit Manufacturing PMI = Worse
  5. Bloomberg Consumer Confidence = Worse
  6. NFP = Worse
  7. Auto Sales = Worse
  8. Labor Market Conditions = Worse

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.37%
  • SHORT SIGNALS 78.32%

More #Slowing (ISM Services)

Takeaway: ISM Services = worst since 2010. New Orders = largest decline in 104 months. Early August macro data = ↓.

ISM Services printed its worst reading since 2010 in August.  The Headline dropped -4 pts sequentially with Business Activity and New Orders dropping a remarkable -7.5 pts and -8.9 pts, respectively.  Employment dropped -0.7 pts as well and continues to barely hold above the expansion-contraction Mendoza line at 50.7.


Across the leading subindex, New Orders posted its largest sequential decline in 104 months, fully reversing from prospective overheating to flirting with contraction.  


In short, if you broadly divide the economy into Services (~88% of GDP) & Goods (~12%) and do the data dependence math for August:


  1. GOODS = Contraction
  2. SERVICES = worst print since 2010  


If you’re more into data point breadth, here's the sequential scoring just a week into August data reporting - a list that “data dependent” hawks should obfuscate or ignore.


Chicago PMI = Worse

ISM Services = Worse

ISM manufacturing = Worse

Markit Manufacturing PMI = Worse

Bloomberg Consumer Confidence = Worse

NFP = Worse

Auto Sales = Worse

Labor Market Conditions Incex = Worse


USA GDP? We’re now tracking at +1.1% YoY/+1.7% QoQ SAAR for 3Q16, which is down from the previous update of +1.2% YoY/+1.9% QoQ SAAR. For Q4 we’re +1.0% YoY/+0.4% QoQ SAAR. 


More #Slowing (ISM Services) - ISM Services Table


More #Slowing (ISM Services) - ISM Services Aug


More #Slowing (ISM Services) - ISM Mfg


More #Slowing (ISM Services) - ISM Services Headline Employment  New Orders


More #Slowing (ISM Services) - Services ISM vs Markit

RTA Live | September 6, 2016

Poll of the Day: Are Negative Interest Rates Coming to America?

What do you think? Cast your vote. Let us know.


Poll of the Day: Are Negative Interest Rates Coming to America? - z silly




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