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Rolex | Short the Rich

Takeaway: Rolex is evolving. We’re not so sure it should.

Editor's Note: This is a recent research note written by our Retail team. Email sales@hedgeye.com for more information.

 

Rolex | Short the Rich - z ro ro

 

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.

 

Rolex | Short the Rich - 2 ro


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CHART OF THE DAY: #ACATaper Likely = #NFPTaper

Editor's Note: Below is an excerpt and chart from today's Early Look written by Hedgeye U.S. Macro Analyst Christian Drake. Click here to learn more.

 

ACA has proven effective as a jobs and consumption stimulus program.  It served to augment employment growth over the last two years and has helped support headline payroll gains in the face of ex-healthcare softening in 2016. 

 

However, as the #ACATaper theme plays out and the benefit decays, the support to NFP will similarly diminish. 

 

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Pershing Has Stepped In Front of a Ticking Time Bomb | $CMG

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 sales@hedgeye.com for more info on Penney's research.

 

Pershing Has Stepped In Front of a Ticking Time Bomb | $CMG - z cmg

 

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:

  1. 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. 
  2. 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.
  3. 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.
  4. 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. 

 

Game On! 

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 


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