Ok…here’s a look into our process as to how names get on our idea list, how they move around, and/or become high conviction ideas – or get booted.
Vetting Level 1 (VL1): We start with 300+ tickers in the retail supply chain globally. Every morning grind away at all the data, company insights, etc that exists. And based on research – or price, we put a name through VL1. This is basically McGough putting through his (my) screening process built over 20+ years. VL1 takes less than 10 min. Then it gets moved to VL2 or gets canned.
VL2: We look at changes in the business model over time – revs, margins and asset turns. What is real underlying earnings power – high level (80/20 rule). We put through Hedgeye’s TREND analysis. This is about a 3-hour exercise. No call here. Just a gauge of whether it moves to VL3 or gets fired.
VL3: We fish through all our sources – proprietary and otherwise – to build to a prospective TREND/TAIL model that we think is defendable. This is about 9-hours. But we know about as much as the average investor. In other words – not enough for us to have a defined edge, or a call.
VL4: NOW we have a call. If a name passes this level – which takes about 30-hours of cumulative vetting, then I think we know more than the average investor – and earnings estimates that are at least 10% above/below consensus. We’ll have a call, long or short. Not a Best Idea, but a candidate for one.
VL5: This is a Best Idea. I’m pretty damn sure that we have a meaningful edge on this one. This is at least 3 months of heavy analysis. This is NKE, HBI, COH, KSS, UA…(see full list below). Basically, if I think I know more about an earnings/cash flow stream than the company’s strategic planners do, then I’m there like white on rice.
VL6: This is what I’ll call ‘world domination’. I know that’s arrogant at face value. But it’s how we talk about things on my team. It is the product of 20+years of work. This is the entire Nike eco-system, AMZN ecosystem, apparel and footwear brands/retailers, and retail supply chain. Biggest is #retail5.0 – which is how the new retail landscape will likely evolve – and who wins/loses. I’ll go to the mat with anyone anytime in these areas. I won't always be right, but I'm proud of our batting average.
IDEA LIST MOVES
We debate these ideas as a team all day, every day. In addition, every Friday, Jeremy, Daniel and Jordan sit in our White Room (it has a huge white board – if you know me you know I can’t go an hour without drawing or storyboarding some idea or theory) and debate the ideas on their own. This is invariably without me being present. The boys tackle things in a different way when I’m not there – and I both like and encourage that.
One of them will email me the team’s view on where we stand on certain ideas by mid-day Sunday, and then I review/debate/confirm/refute accordingly. Then we make appropriate changes to our idea list of 45 names – until we do it again. #RinseAndRepeat
FL
Team: – Nike announcement of consumer direct is a clear negative for Foot Locker. Stock has fallen about 30% since its 1Q print. After another gap down since the Nike Amazon announcement, should this move lower on short list?
BM: No. I appreciate the price action. But Yes. But "it’s so cheap.” It won’t be cheaper at a lower price when it misses ntm EPS by 10-15%, guides down, and deleverages SG&A due to a decade’s worth of milking Nike.
W
Team: Amazon/WFM deal means Wayfair could be a target for Target, or possible other underinvested in ecom B&M retailers (BBBY?). Should this be moved down on short list due to takeout risk?
BM: Never say never about a deal…but if we’re wrong on W due to TGT deal, then we’ve even more right on TGT short. A company that will never grow again buying a company that will never make money – ever -- and trades at an infinite EPS/Cash Flow multiple? That simply does not end well. Cornell likely loses his job either way. I’m comfortable staying Short W, and keeping it high on our list. The competitive landscape deteriorated for W since the AMZN deal w ETH.
CRI
Team: Bullish trade set up from KM. Stock dropped to $80 then rallied to $88 in last 4 weeks. Currently modeling a 2Q beat. Should we take down on short list?
BM: Yes, let’s do it. With all the junk out there that’s still very shortable, the reality is that CRI is a defendable business. But let’s not completely back off this by any means. Eroding share gains, tapped store growth, inability to comp, and cost pressures rising is hardly a concoction to make a 17x pe/11x EBITDA name go up. There will be a time, but maybe this particular print ain’t it.
JWN
Team: Founding family LBO is tough mathematically. Could the downside on a short be limited since the stock has moved? Look at SPLS as a comparison. Do we manage headline risk during the shopping period and move lower on the list until later in the sale process?
BM: Good point on SPLS. But SPLS was not over-earning like JWN is. Unlike KSS/HBI we can’t model a dividend cut at JWN. That’s bullish (or un-bearish). But the earnings trajectory is simply bad, TAIL and TREND. My only concern w a buyout is that if the family wants this done, it’ll get it done. Why won’t a pe firm lend the company capital with a 20% unsubordinated dividend? A good management team would never take that, But this is Nordstrom. When you have the ugly red headed stepchild as ‘Chief of Janitorial Services’, the family culture is pervasive – and in this instance that’s bad (I made up the re-headed stepchild point – but you get the drift).
FINL
Team: On long vetting list. Why? The Nike re-org is likely just as bad for FINL as it is for FL. FINL has 71% of COGS from Nike as well. I think this should be shifted to short vetting bench or punted to the vault for now.
BM: Yeah…punt it altogether. On one hand, I like the fact, and it is a fact, that Nike can absolutely make FINL comp for the first time this whole cycle bc it needs wholesale distro so badly. FINL is 71% Nike – why can’t it get to 85%? Why not 100%? I’m serious…Nike can turn this company into its best off-balance sheet asset. I see no evidence of this yet, but if you want to take a flier on the Long side at 0.25x sales (lower than ANF) than why not? My ‘why not?’ is that this management is worse than KSS. I don’t like betting long on that…but if you like high risk/reward w bad style factors, then go nuts.
LULU
Team: Glenn Murphy may have helped close a deal for WFM. Maybe he does the same for LULU? Trend setup looks negative on the SIGMA. Do we still like being short this?
BM: Yes, short. Not a Best Idea short. But 27x earnings for slowing growth, eroding margins and the weakest strategic plan for a premium brand outside of RL? The Murphy/Larsson bit can’t come to fruition for another three quarters (non-compete). Until then LULU has to deliver. I don’t think it will.
M
Team: Stock down 35% YTD. We’re bullish on opportunity for small real estate deals to sustain EBIT. Short interest at 7 year highs, CEO just bought stock. Starboard is out, so the activist catalyst looks to be gone (until it's not). Should we still be short this, or vetting it long side?
BM: I’d definitely rent this name at a price. I want to fully vet the near-term earnings power. If all cash flow growth is coming from Credit and Asset Sales, I won’t touch it long side. Let’s up this in the queue to tear apart q/q sales/GM/sg&a drivers and revisit. Until then it stays where it is.
KATE
Team: DB’s work indicating chance of another buyer stepping in is very low. Odds of deal not happening increasing. Think take off retail best ideas list?
BM: No way my man. Tender or not, Coach won't let this deal die -- even if they have to pay more. Another $10 per share (54%) and this thing would STILL be accretive to COH. I won’t take KATE off long, just might move COH off Best Ideas list of it has to pay $23 or more.
BBBY
Team: Does this go higher short-side on conviction? It seems consensus, but rev and margin trends only getting worse despite lower free shipping order min and attempt at membership model. Earnings expected flat by street when reality should be down 10-15% annually.
BM: I presume you mean ‘higher’ on Short list. Not a Best Idea Short for me. But only thing that could save it strategically is if a banker engineers a W/BBBY deal. One needs ecomm, other needs stores. It’d be worse than breeding a Great Dane with a Yorkie – the end result would be hideous – but never say never. Some things are worth being short at the bottom, until it finds a new bottom. BBBY is one of them.
ETH
Team: Long vetting, Hgher? Waiting to see the Amazon page launch. It was planned for June, but hasn’t happened yet. SIGMA set-up is positive. I think we move to top of long vetting list and be prepared to move quickly around Amazon launch and earnings coming in a couple weeks.
BM: Move higher, but not to the top. I won’t get greedy on timing here. Not for a company like this. But if/when it works, sales/margins accelerate and operating asset base shrinks. There’s your 2-3-bagger. #patience
AAP/ORLY/AZO
Team: ORLY on long vetting bench. Space gotten crushed YTD both from reports of increasing activity in auto by Amazon and weakening earnings results. We should do the work here to answer what is going on. Is it Amazon? Is it an industry tailwind inflecting? Or is it simply weather factors? I think we add AAP and AZO to long vetting bench as well and do the work to answer those questions. Maybe they end up as shorts, but we should be in the debate on these.
BM: I don’t like shorting after I missed it the first time. But neither does the buy side, so they’re probably not. We have the proprietary data to answer the Amazon call (FICO scores/Prime by category -- incl Auto, MSA spending by channel, locations, overlap, etc…), so let’s do it. These names are in ‘multiple purgatory’. They either need to trade at 25x earnings or 12x earnings. They’re tweeners now. Up the space in the queue. Let’s go.
MIK
Team: On long vetting list. Had an analyst day this past week. What’s the short thesis here? DB says margin opportunity is there, but the company has to comp to realize that margin upside and it hasn’t comped YTD. Management is guiding comp acceleration in 2H, which the Street is betting against. Need confidence in that comp acceleration to make this a long idea.
BM: Model is a survivor. Anything is Amazonable, but this one clearly less-so. I like the guest experience (not me, but you get it). Sounds like a DKS setup as it relates to comp expectations. But w DKS the NSP story is there (ie along w ULTA and RH it is the only one w a better real estate profile). I can defend comp story at DKS too – ie NKE needs it. NKE is 20% of store going to 30%. But the fragmentation and ‘brands don’t matter’ element w MIK give me pause. Let’s take it down on vetting bench. If we can’t get an edge before retail earnings season, let’s punt it entirely.
This is not a team debate…but an example eof our morning process – which results in our Hedgeye RetailDirect (HRD) product. TIF just went from bottom of short list towards the top.
This TIF story is a fluff piece – but it shows that regardless of who TIF hires, the company needs a very expensive change in direction to win back the $500-$4,000 customer. I’d argue that TIF’s problem is almost as big as Ralph Lauren’s. Except TIF is FAR more expensive.
- TIF should be comping now given the Macro tailwinds, but it’s not.
- I think that the strong Macro/High End climate is making TIF comp 300-500bps more than it otherwise should – and management has not a clue that this is happening. In more of a steady-state environment, management would realize there’s far more of a problem as it relates to brand relevance. That’d probably be long-term bullish, bc it would force management to change.
- But the activist changes here are too little too late, and too little again.
- Naturally, the bull case revolves around a take-out. I will NEVER say “XYZ company can’t be bought/sold”. That’s a JV statement that does not respect that major/dilutive deals we see when a cycle turns so severely (though this time clearly not economy-driven’.
- All I can say is that any company that buys TIF at 23x earnings should probably be shorted – or if a P/E firm, then it’s likely to fall in the ‘dumb money that does not do proper diligence’ category. That’s my opinion (no shortage of those).
- We fortuitously backed off our TIF short when our Macro team called the high-end strength earlier this year (21.6% ago – S&P up 7.6%). The multiple expanded, but earnings have not.
- With a 9-handle, TIF is at the ‘un-long-able’ level, and is even more appetizing short side.
