Hedgeye CEO Keith McCullough answers an important question from a subscriber during The Macro Show this morning.
Takeaway: Golf clap to M CEO for transparency at GS. BUT, it highlighted so many challenges inherent to his successor, AND the KSS/JWN’s of the world.
Macy’s is always salient when the company presents at a conference – especially when it sends Terry Lundgren, who rarely makes Wall Street appearances unless he has fires to extinguish (like when he had to jump on the 3Q15 (Nov) conference call to tell activist investors that he wasn’t going to do a REIT deal). No big bombshells from today’s GS conference, but we had a few takeaways [in italics].
-America has too much real estate - way out of proportion on real estate per capita [Not exactly a NEWSFLASH, but nice when CEOs admit it. Note to Kohl’s and Nordstrom.]
-some rationalization has to happen, and M is taking the first step in getting ahead of the curve. [Our sense is that he’s further defending his decision not to pursue the REIT structure. Note though, that Macy’s progress is slower than he’s intimating as it relates to impact on the P&L]
-others will probably follow [But not fast enough. Let’s be clear, KSS needs to close 400 stores and shrink box size by 30%. Not close 5 stores at a time].
-all of the 100 stores closing are cash flow positive. [This might be the most interesting factoid of all. Traditional standards for anchor tenants has been to keep money-losing stores open so long as they are cash flow positive. Kudos to Macy’s here].
-refocus talent and capital on smaller base [Definitely things we like to hear. Too bad this is not a company in an industry that is investable. But if they follow through on this, it could be a good long – espec at the start of the next eco cycle].
-restart Macy's all over again - where stores are critical to omni-channel retail [While omni-channel is a buzzword that has to go away, we get the point. Nothing new, but nice to note.]
-amalgamation of deals over time, companies had overlapping real estate [Terry, this was clear in 2005 when you bought May Department stores].
-don't need density of current foot print, need to drive dot.com sales, which he seems confident he can do. [Nicely said. But he’s leaving. Promises are easy to make when left for successors. Karen likely not far behind. #accountability].
-misperception that e-commerce not profitable [No, but there’s a misperception about the capital structure/allocation needed to succeed and take share in this day and age. Also – it is definitely dilutive to margins. We don’t think people assume it is unprofitable.]
-can no longer ‘meaningfully’ leverage store-level fixed expenses. [Obvious, but a big statement from CEO. Golf Clap on his clarity and transparency].
-on the flip side, variable cost structure of online doesn't provide that risk Macy’s sees at retail [Not sure we agree. That’s only true under the current cost structure, which is not right in order to compete and win. The right cost structure will be harder to leverage, but in fairness, should result in higher revenue].
Takeaway: Rolex is evolving. We’re not so sure it should.
We always pick up on anecdotes of private brands, as do most retail analysts. But here’s our take on an interesting one as it relates to Rolex (private) that we think serves as a good brand study.
Rolex is evolving. We’re not so sure it should.
1) We’re seeing a number of developments with the brand. Specifically, the styling is very updated, but starting to look very much unlike the traditional Rolex that is the mainstay for a $20,000 anniversary gift that is ultimately passed down through generations.
2) We’re not suggesting that Rolex is coming out with a ‘me too’ iWatch, but simply that a brand like this with such an amazing cache has to be careful about changing it up too quickly. Check out the images below. The first image looks more like a Tag-Heuer 1990s knockoff than a Rolex.
3) Oh any by the way, distribution is evolving too. These things are selling in the secondary market in flash sales on sites like ‘Touch of Modern’ (which is admittedly a wicked site for men who have cash to burn and like toys – like a desk Jellyfish aquarium or a tactical Damascus Blade knifes handcrafted in Brazil).
4) Brand evolutions are not all created equal. For example – Kohl’s and Nordstrom have failed to allocate capital in a manner that allowed them to evolve. Now they’re as close to perma shorts as you can find in retail – barring a big capital infusion to dig out of the hole. That in itself is a negative stock event.
5) But then on the high end, there’s validity to not changing up a design. The best parallel to Rolex, we think, is the BMW 3-series. Check out a 3.25i from 2006. Then check out a 3.25xi from 2016. The styling is remarkably similar to the extent that non-owners probably cant tell the difference from a distance, which boosts aftermarket value. The same goes for a car like the Lexus RH300/450. Slight evolution, but no sudden movements. If it ain’t broke, don’t fix it.
6) Maybe this is why the late-model Rolex designs are selling for a 50-70% discount in the secondary market.
Short the rich. The best play here is Tiffany – though that call goes far beyond this Brand Study (it’s only the 446th ranked keyword on Tiffany.com). Sales should still slow, as its traditional customer gradually shifts away from the brand, sales per square foot weakens, and margins compress as the inability to sell successfully online while maintaining brand cache plagues the long-term story. Numbers remain too high.
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Takeaway: This is why Reporters should not pose as Analysts. Highly unlikely that VFC touches HBI for so many reasons.
If you saw that Bloomberg story about HBI being a good strategic fit for VFC, you should ignore it. The logic is very flawed. This is why reporters should not try to be analysts. Here’s why…
- True, it’s been a while – five years to be exact – since VFC (a serial acquirer) has done it’s last deal. That was Timberland for $2bn.
- But there’s a reason why it’s been 5 years. VFC is extremely valuation-focused. Multiples have been inflated in the 3 years since it integrated Timberland, so it’s been out of the game. Whether we’re at the end of an economic cycle or not (we probably are), the reality is that VFC THINKS we are. It won’t step up deal flow at these multiples with earnings at risk.
- There’s another key consideration. Circa 2007 with the sale of Vanity Fair, VFC sold out of the last of its intimate apparel brands at a 4x EBITDA multiple. It wanted out of the commodity-priced brands that owned its own manufacturing assets. Why in the world would it acquire HBI, which is exactly what it exited (but on a much larger scale)? HBI bought Maidenform in 2013 at 9.5x EBITDA. VFC did not want it then (at that price) and it almost certainly does not want it now.
- Does VFC want to acquire its way into Wal-Mart and Target? Seriously?
- HBI itself has been on an acquisition tear – buying underwear assets for up to 12.5x EBITDA. They’re doing this all while the CEO (otherwise young at 58) is exiting the business.
- It bought Pacific Brands in Australia – a big deal at $800mm. Our view on Australia is that the economy is at considerable risk of a consumer collapse as the ability to tap into home equity evaporates. The average underwear replacement cycle for dudes is about 7-years. As gross as that may be, in a consumer downturn it can stretch to an even nastier 10 years. That means sales and margins come down for anyone selling the stuff. HBI could prove, in the end, to have paid 20x or higher for this asset – one that we don’t think is scalable beyond Australia.
- We think Pacific Brands management knew this. It was shopped and sold well before it was bought. HBI was the highest bidder. VFC knows this. HBI knows this. That is one reason why the CEO is stepping away.
- Bottom line – not going to happen.
- We’ll present our HBI thesis in a detailed slide deck on September 14th.
Takeaway: The Pershing investment does not change my Chipotle thesis for the time being, but I have been put on notice.
Editor's Note: The following note written by Hedgeye Managing Director Howard Penney (originally entitled CMG | This Is Why I Play) was sent to our institutional subscribers yesterday. It was written in response to news that activist investor Bill Ackman's Pershing Square has taken a 9.9% stake in Chipotle. Email email@example.com for more info on Penney's research.
Chipotle (CMG) is on the Hedgeye Best Ideas list a as a SHORT.
Obviously, the fact that Pershing filed a position in CMG does not change my short thesis overnight. Should I try to understand their bull case? Absolutely! I hope one day we can meet to talk about what they see that I don’t.
I have a good track record in sniffing out when activists are going to get involved in a restaurant name, but I clearly missed this one. As I see it, CMG does not have the common traits of an activist name.
First, there is no real estate to sell or significant non-core assets to sell like in Darden. The G&A is fairly lean given it’s a growth restaurant company and management is loved by shareholders. According to the proxy vote, Chipotle's co-CEOs, including founder Steve Ells, were reelected and received more than 95% of the shareholders' votes.
CMG has no funded debt, so we could see him push to leverage the company and buy back stock, but that is just financial engineering and will not get anyone very excited. The company has previously announced they are looking for a new board member so I’m sure the new shareholder will be happy to help in that regard and maybe a few other corporate governance issues.
Pershing’s big wins in the restaurant space were WEN, MCD, and QSR. In the case of WEN, at the time of the investment the Tim Horton business represented the entire vale of the company so you were getting the Wendy’s business for free. The MCD story was to refranchise the company store base and spin it out as a separate business. The deal never happened but the stock worked any way (the turnaround was well underway). QSR story was a straight sell all company stores and become an asset light model. This was a home run!
An asset light business model was the common characteristic of all three of Pershing’s previous restaurant investments. The “asset light models” are clearly the safest way to invest in the restaurant space. Obviously, CMG is anything but an asset light model and will likely never become one as it is not in their DNA. Converting CMG to an asset light model would be very expensive and dilutive to EPS.
As with most activist situations, that leaves the Pershing investment in CMG dependent on an operational turnaround as the way to create significant shareholder value. While they are familiar with the industry, rarely can an activist be much help in fixing operations. In most cases, the activist’s ideas are short term in nature to get a pop in the stock and then they are gone.
Putting it all together, this leaves me to conclude they see a big operational turnaround as the way to make money in CMG. This thought process is confirmed by the 13D. According to the 13D "Pershing argues Chipotle has "a strong brand, differentiated offering, enormous growth opportunity, and visionary leadership."
Let’s take these one by one:
- A strong brand – I agree it’s a strong brand and one day it may return to the glory days but that is going to take time and will require an investment in better advertising.
- Differentiated offering – That may have been true 10 years ago, but the rest of the industry is catching up. We made this point in the CMG black book.
- Enormous growth opportunity - Could CMG double its store base from here? Yes! Right now the company needs to slow growth, fix operations and repair the brand. The law of diminishing returns is impacting the numbers. Importantly, there is a lack of great real estate right now and it’s getting too expensive to grow.
- Visionary leadership – I agree that Steve Ells is a visionary, but it ends there. Being a visionary will not get the company out of the problems they are experiencing today. The company needs new management to help get it to a better place. I have no doubt Pershing can help in this regard, but replacing the founder is going to be very difficult!
The Pershing investment does not change my thesis for the time being, but I have been put on notice. As we noted in our CMG deck, the FDA’s Office of Criminal Investigation does not get involved with many companies and when they do its usually a serious situation. I’m very surprised Pershing stepped in front of this ticking time bomb. On the other hand, if criminal charges are brought against some CMG executives, Pershing will have an easier time finding a new management team.
Please call or e-mail with any questions.
Again we repeat our commentary: Is the ECB worried about the low inflation environment? YES! Does it know what else to do from a policy perspective to spur real growth and inflation? NO!
In today’s ECB monetary policy decision meeting, President Draghi underlined a few main points:
- Rates are expected to stay at present or lower levels for an extended period of time, well past the horizon of asset purchases.
- Monthly asset purchases of €80 billion are intended to run until the end of March 2017, or beyond, if necessary.
- If warranted, the ECB will act to use all instruments in its tool belt to support economic conditions.
Our quick read-through:
- Growth and inflation will remain lower and slower for longer than the previous time horizon (see the downgrade in updated ECB staff projections below).
- The ECB will have to extend the scope of its Asset Purchase Program, can you say #HelicopterMoney?!
GIP Flashes Quad 3:
Our proprietary GIP (growth, inflation, policy) model shows the Eurozone stuck in Quad 3 - growth slowing as inflation accelerates - for the remainder of 2H 2016 and into early 2017.
And we reiterate the huge challenge before the ECB to lift inflation: the latest Eurozone CPI for August printed +0.2% Y/Y, unchanged from the prior month and below the 0.30% forecast. CPI has been at or below 0.3% for 22 straight months, and far from the ECB’s medium term 2.0% target!
Today’s Decision: the ECB kept its main interest rates and Asset Purchase Target on hold:
- Main Refinancing Operations unch at 0.00%
- Marginal Lending Facility unch at 0.25%
- Deposit Facility unch at -0.40%.
- Monthly Asset Purchase Target unch at €80B
ECB Staff Projections Downgraded:
- Eurozone GDP Projections at 1.7% in 2016 (vs prior June projection of 1.6%), 1.6% in 2017 (vs 1.7% prior), and 1.6% in 2018 (vs 1.7% prior).
- Eurozone CPI Projections at 0.2% Y/Y in 2016 (unch vs prior), 1.2% in 2017 (vs 1.3% prior), and 1.6% in 2018 (unch vs prior).
Weighing the Euro: We’re playing our trading risk range of $1.11 to $1.13 on the EUR/USD and have a bearish intermediate term TREND bias on the cross.
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