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R3: BBBY: Biggest Baddest Blowout Yet

R3: REQUIRED RETAIL READING

January 7, 2009

 

If there’s one thing we can be rightfully accused of when it comes to our positive stance on BBBY since early this Summer, it is that our above-consensus numbers were not bullish enough.

 

 

TODAY’S CALL OUT

 

We’ve taken a bit of heat over the past six months on our positive BBBY call – surprising for such a high quality name.  If there’s one thing we can be rightfully accused of when it comes to our call, it is that our above-consensus numbers were not bullish enough. On the flip side, if we had to point to the most out-of-consensus part of this call that we got right, it is our argument that the trajectory of fundamentals will trump what many argued was ‘too lofty a valuation’ as the stock ‘had already had its big run.’ . 

 

The irony is that the same bears are still likely to look at this quarter, and say that it has finally ended, the story has run its course, and valuation is too toppy. We see a name with the following attributes a) store productivity and operating margins that still have meaningful upside without accounting for any potential relief from the economic cycle; b) its largest competitor closing its doors; and c) no debt, with cash building to over $1.2bn, and increasing likelihood of significant stock repo.  We like that setup in ’10.

 

The key to this story is not the past couple of quarters of upside (Wednesday’s 3Q blowout included) but rather in understanding the 12-18 month opportunity that lies ahead.  With sales improving and a multi-year period of aggressive couponing being unwound, even the solid 3Q results are likely to be just part of a string of upside that is still in the early innings.  We’re not going to rehash all of the finer points to the story (see our notes from 1/4/10, 9/24/09, 7/14/2009, and 6/24/09 for the thesis, which remains unchanged by the way) but rather point to the actual data.  This quarter again proved that a rational competitive environment, less capacity in the marketplace (no more Linens as a start), tight inventories (up 1.9% vs. sales up 10.8%), and the beginnings of deferred maintenance spending in the home furnishings space are all key factors in driving BBBY’s 7.3% increase in same-store sales and 71% increase in EPS.  Now to be fair, 3Q was comparing against the worst sales and margin performance in company history, but the consistency and magnitude of profitable improvement is noteworthy. 

 

While we’ve been correct in identifying BBBY as one of the better earnings revisions stories in retail, we’ve been a bit off the mark with our underestimation of how truly conservative management is.  The company ended the quarter yet again with $1.2 billion in cash and equivalents on the balance sheet.  A $900 million share repurchase remains in place and management only repurchased a paltry $34 million worth of stock in the quarter.  We’ll keep waiting for an announcement on this which we’re confident is to come.  It’s just not clear when the status of the backdrop, characterized by management as “an uncertain macroeconomic environment” will be upgraded and ultimately provide a catalyst to put some cash to work.

 

In the meantime, we’ll stick to the more tangible drivers of earnings.  With square footage growth steady at 5% (powder is dry for opportunistic additions) and same-store sales now guided to 3-5% for 4Q, again we believe even management’s increased guidance is conservative.  Not to be repetitive, but gross margin expansion has now occurred for just 2 quarters in a row after 10 quarters of declines.  Sales comparisons remain easy, but share gains, 5% square footage growth, and constant store remodeling are also key drivers of the topline as the home furnishings sector continues its recovery.  And, cash is king.  Share repurchase would be even better, but for now that surprise is still yet to come. 

 

BBBY remains one of our favorite names, with the biggest risk lying in “taking the trade”.  It’s too early to bail on the momentum that is still building and it’s not too late to recognize the opportunity that still lies ahead.

 

This remains one of the best looking SIGMA charts in all of retail (if you’re confused, call us):

 

R3: BBBY: Biggest Baddest Blowout Yet - 1 

 

 

EVENT REMINDER

We are hosting a conference call on Friday,  January 8th  at 11AM (EST) to discuss our Top 10 Retail Predictable Unpredictables in 2010.  Simply put, these are 10 ideas that we assess at better than 60% chance of happening, but today's Wizards of Wall Street either: A) do not acknowledge that such ideas exist, OR B) see them as so unlikely, they do not bake them into their investment process.  Please contact or reply to this email to request dial-in information.

 

 

LEVINE’S LOW DOWN 

  • Family Dollar management noted that food stamp usage continues to increase at a steady pace. This increase is in addition to the company’s efforts to expand food stamp acceptance across the chain (with the implementation of new POS systems) . In stores that have recently begun accepting food stamps, traffic is measurably improved.
  • H&M just revealed a fashionable line of women’s apparel using only sustainable, organic, and recycled (soda bottles, textile waste) materials. The fashion forward line is priced aggressively with not item topping out above $60. Leave it to the fast fashion leader to also close the price gap on “green” products…
  • According to a BIGresearch December survey, 33.1% of adults over 18 say they shop Best Buy most often for electronics. Wal-Mart is second, with a 20.6% share. Both companies showed substantial year over year increases, with BBY adding 3.3% and WMT adding 3.7% since last December. Interestingly Amazon, Target, and Sears round out the top five, but with substantially less preference by consumers for their electronics purchases. AMZN tops out at 3.6%, while Target is 2.8%, and Sears at 2.0%. All five retailers added to their preference share, most likely due to the disappearance of Circuit City.

 

MORNING NEWS 

 

Gucci, Richemont Units Near Deal with Bank of China - Bank of China appears ready to pay $300,000 to Gucci America Inc. and Compagnie Financière Richemont brands Chloé and Alfred Dunhill to end their inquest into its handling of a counterfeiter’s financial records. Lawyers for the luxury firms and the bank submitted a proposed settlement order to U.S. District Court Judge John Koeltl in Manhattan Wednesday. According to court documents, the bank would pay the $300,000 settlement in exchange for an agreement that keeps it out of any future judgments or collection efforts stemming from a 2007 trademark suit against Kelvin Cho, a native of Malaysia who sold knockoff goods online and received payment through a Bank of China account. In March 2008, Gucci and the Richemont brands won a $4.3 million judgment against Cho. After the judgment, the firms said Cho still owed $4 million and accused Bank of China of allowing him to drain his account despite a court ordered freeze. Later that year, the state-owned bank agreed to release Cho’s records and pay $190,952, but the brands said it failed to abide by the deal. <wwd.com>

 

True Religion Names Koplin to COO Role - Koplin will oversee many of the denim firm’s day-to-day operations and will report to Jeffrey Lubell, founder, chairman and chief executive officer. Koplin was most recently president of the Tommy Bahama women’s division at Oxford Industries Inc., a position she held since July 2005. Before that, she was president and ceo of Apparel Ventures Inc. “This is an important hire for our company as we are committed to continue to invest in and build our management team in order to continue to grow our business domestically and internationally,” Lubell said. “During her tenure within the apparel industry, [Koplin] has managed all aspects of branded apparel operations and we are confident that her hands-on industry experience will prove invaluable as we look to build upon True Religion’s position as a fast-growing global apparel brand.” <wwd.com>

 

Gilt Groupe Promotes Christian Leone - Formerly vice president of marketing and communications for the company, Leone is now vice president of brand relations, a new position. He reports to founder and chief merchandising officer Alexandra Wilkis Wilson. “It’s a very creative role, brainstorming with brands and making sure the brands view us as a true strategic partner, which we’ve certainly become for hundreds of brands at this point,” said Wilkis Wilson. Leone has wide contacts in the industry, having previously handled communications at Giorgio Armani, Alberta Ferretti and Halston, she said. “Our relationship with brands has become increasingly more strategic as we partner with them and grow our business,” she continued. “We are actively seeking partnerships with our key vendors and looking at a number of ways to support their full-price business.”  <wwd.com>

 

Barneys Opens Revamped Prada Men's Shop - Right before Christmas, Barneys unveiled a completely transformed and enlarged shop for the designer brand on the second floor of its Madison Avenue flagship. The new shop is the only one of its kind in the U.S. and spans nearly 1,800 square feet. It is located next to the Giorgio Armani boutique. “There had been a discussion between Mr. Bertelli [Patrizio Bertelli, chief executive officer of Prada SpA] and Barneys about how to vastly improve the presentation of the shops both in terms of ambiance and sophistication,” said Tom Kalenderian, executive vice president and general merchandise manager of men’s wear for Barneys.  <wwd.com>

 

Jos. A. Bank to expand into tuxedo rentals - Men's apparel store Jos. A. Bank Clothiers said Wednesday that it is expanding into the tuxedo rental business. It will try the concept out in 5 percent of its stores this month and, if successful, roll it out to more than half of its stores in the spring. The company, which already sells tuxedos, was responding from demand from its customers. The rental component would "complete our formal assortment," R. Neal Black, president and CEO of the Hampstead retailer, said in a statement. The company has partnered with a national distributor who will own the inventory and deliver the tuxedos to stores, reducing the risk and investment with starting the venture, the company said <baltimoresun.com>

 

CBX expands into specialty retail, department store design - CBX, a strategic branding and retail design consulting company, has expanded its Retail Division into specialty retail and department store design.

The company has recruited a team of experienced retail designers, project managers and business development executives - including a former partner in Grid2 International, which does design work in the furniture industry - "to create solution-driven concepts for apparel and lifestyle merchants and brands," CBX said in a release.  Our expansion into specialty retail leverages the many strategic and design capabilities within the firm in order to serve retailers in the fashion apparel and lifestyle sectors," said Joseph Bona, President of CBX's Retail Division. CBX offers architecture, interior design, merchandise and store planning, identity and branding, graphics and environmental graphic design, media design, product design, master planning, construction detailing, and consumer research. It will exhibit here next week at the National Retail Federation's Annual Conference and Expo. <furnituretoday.com>

 

Seven & I Net Falls as Japan’s Lower Wages Cut Sales -  Seven & I Holdings Co., the world’s biggest convenience-store operator, said nine-month profit slumped 32 percent as lower wages sapped demand for clothes and food in Japan. Net income totaled 69.3 billion yen ($752 million) for the nine months ended November, compared with 101.7 billion yen a year earlier, the Tokyo-based owner of the 7-Eleven brand said in a statement today. Aeon Co., Japan’s second-largest retailer, had a net loss of 9.93 billion yen in the same period, it said separately today. Seven & I and Aeon are introducing instant noodles, jeans and other products under their private brands to offer lower prices and lure customers. Salaries have dropped for 18 straight months and the nation’s retail sales are down for the last 15 months as Japan emerges from its worst post-war recession.  <bloomberg.com>

 

Shoebuy.com Breaks the 1,000 Brand Mark - Shoebuy.com announced that it has launched its 1,000th brand. Brands recently made available via Shoebuy.com include: Diesel, Yellow Box, Lucky Brand, BCBG Max Azria, Vince Camuto, Reef, Jack Rogers and Converse. The cite now has over $3.5 Billion of inventory available to purchase. The website also said it was experiencing over 6,500,000 visitors a month with nearly 65% of sales from repeat buyers. <sportsonesource.com>

 

John Lewis retail director exits - John Lewis retail director Gareth Thomas has taken early retirement from the department store group after 30 years at the retailer. In a statement John Lewis said: “After 30 years at John Lewis, 10 of those as a member of the John Lewis management board, Gareth has decided that it is now time for him to have a complete change. “He intends to take a break from working full time and devote more of his life to his family and outside interests, one of which is his work for Save The Children, a charity which is close to his heart.” John Lewis managing director Andy Street said he wished Gareth “every happiness and success in the future”. He said: “We will miss his leadership and insight enormously, and value the strong legacy he leaves behind him.” <drapersonline.com>

 

Kenneth Cole Productions, Inc. Announces Upcoming Investment Conference Participation - Kenneth Cole Productions, Inc. (NYSE: KCP) announced today that it will present at the ICR XChange conference next week. Management will deliver a presentation on behalf of the Company at The 12th Annual ICR XChange Conference held at the St. Regis Monarch Beach Resort in Dana Point, CA. The Kenneth Cole Productions investor presentation will be webcast live at 1:45 p.m. Eastern Standard Time on Thursday, January 14, 2010 at: http://investor.shareholder.com/icr/2010/eventdetail.cfm?eventid=76224. <prnewswire.com>

 

Fashion's M&A Scene Heating Up - Fashion’s game of deal or no deal is heating up for 2010 and it seems almost everyone is looking to play a part. And although no one is predicting a return to the go-go days of 2006 and 2007 when buyers bid hot properties up into the stratosphere, experts said a steadier economy, easing credit markets and more realistic price tags could bring some sizzle to fashion’s mergers and acquisitions scene this year. The tenor of the market will recall the dealmaking of the earlier part of the last decade, said Pellegrini, pointing to such strategic buys as VF Corp.’s acquisitions of The North Face and then Vans and Nike Inc.’s purchase of Converse. And many of those same companies — with cash, cash equivalents and short-term investments on their balance sheets or the ability to borrow enough for a purchase — are headed back out on the hunt. Among the companies publicly scouting or said to be on the prowl with at least some capital to be put to use are Nike ($3.63 billion in cash, cash equivalents and short-term investments on hand), PPR (1.27 billion euros, or $1.83 billion at current exchange), Li & Fung Ltd. ($1 billion), VF ($379.1 million), Phillips-Van Heusen Corp. ($356.6 million), Iconix Brand Group Inc. ($233.4 million), The Warnaco Group Inc. ($229.3 million) and Jones Apparel Group Inc. ($156.9 million). <wwd.com>

 

 

Luxe Labels Raise the Bar on Quality in Men's Wear - If luxury goods were distinguished by price prior to the recession, they will be defined by quality after it is over, according to senior executives at leading European luxury goods firms who are gearing up for the new men’s wear season. The new reality is that consumers want value for their money and are turning to brands they can trust. This means an even greater attention to detail, a focus on craftsmanship and, in the short term at least, a new way of communicating that will reinforce a brand’s savoir faire credentials. “The luxury consumer has always been, by definition, a client who is attentive and demanding when it comes to buying a product,” said Cristiana Ruella, group managing director and board member of Dolce & Gabbana. “They are even more so today and, different from the past, they are much more informed and sensitive to the relationship between quality and price.” <wwd.com>

 

Mobile consumers flock to top m-commerce sites and apps, Nielsen says - Traffic to Top 500 mobile commerce web sites and through mobile apps continues to soar as more consumers become comfortable researching and shopping on mobile devices and more adopt smartphones offering rich features and high performance. Of the top 10 m-commerce merchants based on unique monthly visitors measured by The Nielsen Co., eBay Inc. remains on top: 5.03 million consumers visited its site or used its app in October 2009, up 26.7% from 3.97 million in October 2008. Amazon.com Inc. came in a strong second with 3.51 million visitors, up 42.6% from 2.46 million in the same period the previous year. And GameSpot wound up in third with 2.58 million visitors, up 33.6% from 1.93 million in October 2008. Amazon is No. 1 in the Internet Retailer Top 500 Guide (a PDF version of the company’s financial and operating profile can be ordered by clicking on its name).  <internetretailer.com>

 

Venture Capitalists Turn Positive on Investment Levels and IPOs in 2010, KPMG Study Finds - In contrast to last year, the venture capital community is signaling an uptick in overall venture capital investment in 2010, according to a recent survey by the U.S. audit, tax and advisory firm KPMG LLP. In addition, the KPMG survey found that the venture capital community expects IPO activity and valuations of venture-backed companies to trend upward next year. In polling 100 venture capitalists and entrepreneurs in the U.S., KPMG found that they are much more bullish on venture investment levels, IPO activity and valuations of venture-backed companies. In fact, the 68 percent of respondents say they expect total venture capital investment to increase in the year ahead - a completely different perspective from a year ago when 74 percent said they expected investment levels to decline. Venture capitalists also expect increases in deal volume (66 percent) and venture fundraising (53 percent). <prnewswire.com>




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WHAT DO WE DO WITH THESE PESKY SLOT STOCKS?

A potential short-term cross breeze (earnings reductions) but the long-term wind remains at the tail of the slot sector.

 

 

They’re cute (at least WMS is), safe (well, they should be), fun to own (when they go up), and the long-term story is as attractive as any in consumer land.  Unfortunately, they’re not cheap and analysts keep overestimating slot demand.  Ideally, we’d like to see estimates come down, particularly for the 1H CY2010, and the stocks come in.  This is a space that needs to be on the radar screen.

 

Earnings

I feel like a broken record but unit sales to new casinos and expansions will be down considerably in 2010.  We estimate almost a 50% decline.  See our 11/25/09 post “ONE IN THE HAND IS WORTH TWO IN THE BUSH”.  Replacement demand should accelerate, but will it grow more than the 50% necessary to make the Street’s slot projection?  That’s a tall order.  The first half of calendar 2010 is at risk with March being the most difficult comp of the year.  We project new/expansion units to fall 80% in the March quarter.  Yet, analysts are projecting significant revenue, EBITDA, and EPS growth in the first quarter as shown below.

 

WHAT DO WE DO WITH THESE PESKY SLOT STOCKS? - slot comps q1

 

Needless to say, we are below the Street for IGT and WMS, but in-line for BYI.

 

Valuation

They’re not cheap on a forward earnings basis.  IGT and WMS both trade at 21x consensus 2010 earnings while BYI clocks in around 17x.  Again, we think the IGT/WMS estimates are too high so the valuations may be even more inflated.  However, we think there is approximately 50% upside to the numbers from normalized replacement demand alone.  Combine “regression to the mean” replacements with a significant new market pipeline – domestically and internationally – and the gaming supply segment could generate 20%+ EPS growth over a 5+ year period.  From that perspective, 20x EPS doesn’t seem so expensive although I’d prefer mid-teens.  Maybe they’ll get there.

 

The Mexico Catalyst      

This is one market that could surprise on the upside in 2H 2010.  From what we are hearing, the transition from Class II games to Class III is showing promise.  Operators like the performance.  Class III games are also faster – 11 games per minute versus 8 for Class II.  The Class II market is anywhere from 35k machines to 50k machines so there is a lot of potential for Class III replacements.  Look for some color on the Mexico potential during the earnings conference calls.  Stay tuned for more on Mexico from us as well.

 

The Perfect Storm

We could be at the trough of a huge 5-7 year cycle for slot demand.  In a few years, we may look back on the 2008-2010 period as the perfect storm:  slot customers on the verge of bankruptcy; a dearth of new markets, new casinos, and casino expansions; and the dud that is (was) server based gaming.


RETAIL TOP 10 in 2010: PREDICTABLE UNPREDICTABLES CALL

Please join us as we launch our Black Book:

Top 10 Retail Predictable Unpredictables in 2010

  

Conference call FRIDAY January 8, 2010 -- 11 AM EST 

 

 

Simply put, these are 10 ideas that we assess at better than 60% chance of happening, but today's Wizards of Wall Street either:  

A) do not acknowledge that such ideas exist, OR

B) see them as so unlikely, they do not bake them into their investment process.  

 
Some of our deeper conclusions will come from the following topics...

 

1.       M&A Targets
2.       Looming Business Failures
3.       Unionization
4.       The Retail Private Equity Pipeline
5.       dot.com
6.       Asia's Role in Sourcing
7.       Inventory Cycles and Capacity Utilization

8.       Asia Free Trade Agreement Impact

9.       Consumer Retrenchment

10.     Commercial Real Estate’s Next Leg

 
Research Edge institutional strategy calls are available to current and prospective institutional subscribers. Please contact or reply to this email to request call information.

Research Edge Retail Black Books are available to Premium subscribers to our Retail vertical and on an a la carte basis to other qualified institutional investors.

******************************************************
Contact
to request access to the conference call.

 

 

 


FL: Close ‘Em or Suffer

FL: Close ‘Em or Suffer

Our team has roughly 30-years of cumulative experience analyzing this beast. Throughout our tenure, what we have not seen is a respectable analysis showing cannibalization factors by FL concept. Well… here you go. We still like the low-hanging fruit here.

 

 

Here’s an update on Foot Locker – one of our top bench ideas for 2010. Our team has roughly 30-years of cumulative experience analyzing the beast that has become Foot Locker. Throughout our tenure, what we have not seen is a respectable overlap analysis showing likely cannibalization factors by FL concept. Well… here you go.

 

The bottom line is that the overlap stats are quite sad, actually.

 

Here’s the analysis:

 

There are 111 stores or 5.4% of the domestic FL portfolio that suggest self cannibalization.  In other words, 111 units are located within a ½ mile or less of another unit with the exact same nameplate.  Think Foot Locker in a mall and another at the other end of the mall or just down the street.

 

FL: Close ‘Em or Suffer - 1

Source: ESRI; InfoUSA; Research Edge. Note: InfoUSA database represents 90% of the total U.S. store base.  Data not available for Champs.

 

The overlapping stores listed above represent the most obvious candidacy for closure.  Provided the upfront lease termination fees are justifiable, it seems reasonable to assume a productivity boost would result from closing stores that are in close proximity to other locations carrying the same brand name.  As a sidenote, FL’s implied portfolio lease duration is among the lowest in retail. It has not done a whole lot right in its history, but keeping landlords on a short leash has been an area of strength. High lease flexibility is definitely a big positive.  

 

After eliminating some of the more obvious locations, store closures become more strategic.  Our analysis suggests that FL’s domestic store portfolio is 81% self-cannibalizing.  In other words, 81% of all Foot Locker sub-brands have another sub-brand within a ½ mile.  However, we caution not to get overly fixated on this high number.  The majority of the concentration comes from Lady Foot Locker and Kids Foot Locker, both of which were clearly positioned with co-location in mind.  This brings us to our next step in store closures: Lady Foot Lockers.

 

FL: Close ‘Em or Suffer - 2

Source: ESRI; InfoUSA; Research Edge

 

FL: Close ‘Em or Suffer - 3

Source: ESRI; InfoUSA; Research Edge

 

Over time, management established Foot Locker stores as a central hub and then added additional locations in the same mall  with the opening of Lady Foot Lockers and Kids Foot Lockers.  It seemed logical to place Lady Foot Lockers next to or near Kid’s Foot Lockers because they do not compete, but instead complement each other.  That makes sense to us at some level, but with 1.7 Lady Foot Lockers for every Kids Foot Locker, the opportunity to right-size the Lady portfolio appears compelling.  In fact, we wonder why Lady and Kids need to separately exist? A one stop shop for women and children, while leveraging overhead.  After all, ‘kids’ is not a gender.  Kids also could care less where their Mom buys their kicks. Stores should cater to the person holding the cash – not the 4-year old that cannot dress himself in the morning. 

 

We’re still awaiting signs of management’s actual intentions, but for now we’ll continue to explore all options and ideas.  We continue to believe there is ample low hanging fruit here, and real estate may just be the easiest to pick given a 20 point+ margin delta in profitability between the best and worst performing stores.

 

Zachary Brown

Eric Levine


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