R3: REQUIRED RETAIL READING
March 8, 2010
JNY continues to rip. The fundamental negative call is unchanged, but rather the entry price is better. The biggest pushback is on margin opportunity. Here’s our rebuttal.
TODAY’S CALL OUT
JNY is perplexing me. I originally highlighted this one back on Feb 10th as a name that was looking fundamentally broken – again. The market could care less, apparently, as the stock has continued to be a champ. Yeah, retail has been ripping, with the S&P up 6.5% and retail (measured by the MVR) is up 11.2%. But JNY is up nearly 18%.
As I step back and revisit the thesis, my confidence is unchanged. The price is simply better.
One element that has changed is that now I have a few weeks’ worth of feedback on the call, and I fundamentally disagree with one of the most common bits of feedback. That is “At 5% margins, JNY is at only a third of historical peak margins. There’s got to be levers that this team can pull in order to take margins higher. Whether they should be pulling these levers is irrelevant.”
I think that all the moving parts over time have gotten lost here. First off, those former peak margins were simply false. The company was underspending across the board to print unsustainably high margins. It had a pre-tax margin on its Ralph Lauren licensed business (20% of total) of 25%. Do the math on that. It makes a mid-single digit margin all the more realistic on the base business. Well, that’s not here anymore. RL took it back because JNY was doing what it does best – underinvesting in brands. What else has changed? Barney’s is sold. The consumer is no longer strong, and there’s no more juice in the one-time benefit of import quotas being removed to pad JNY’s margin structure. Add that together, and my math suggests that the 7.4% consensus margin estimate out to 2012 is setting a new peak.
As evidenced in the chart below, there’s a meaningful divergence in our margin expectations and the consensus. That is effective immediately.
What does the incremental buyer need to bank on? I think the right multiple to use as a starting point is about 12x EPS and 5x EBITDA. That’s the mid-point of where it’s been in the past (when it was a seemingly better company). I’m not in the business of pegging a multiple and arguing that a stock will get there. The market is smarter than that (and me). But using these multiples it is telling me that at current prices we need to back into about $1.55 in EPS this year. Mind you, the Street is at $1.30 and we’re at $1.13. I think at best JNY gets to $1.55 in 2012. That’s a loooong time to wait.
What Concerns Me?
The upcoming quarter is the easiest year/year comparison of the year. There is still the residual impact of selling in to a sparsely inventoried channel (both wholesale and retail alike), and the pressure will not mount for markdown dollars and increased margin volatility until 2Q. On the flip side, the balance sheet setup is horrible – and that is effective immediately. In addition, sentiment remains quite positive on this name – as measured by its mid-single-digit short interest. So the Street is still playing the near-term momentum on this. But the risk of being a quarter early still eats away at me.
Reminder on Some Core Modeling Assumptions:
1. Wholesale Better Apparel (29% of Revenue and 55% of cash flow): Printed an 11.2% margin in ‘09 – up 128bps from a year-ago. This margin absolutely HAS TO hold, which is a stretch. With so-called ‘bad business’ already having been pruned (i.e. lost), the natural mix shift to a better book is not going to recur. JNY will get about a 3% top line boost due to its Rodriguez acquisition and from jump ball business created by LIZ hopping in the sack with JCP. But on the same token, with LIZ no longer at Macy’s whim, JNY will see added pressure for markdown dollars at quarters’ end by the 900lb gorilla – even if it is not JNY product that is not selling through. This also holds true for Jeanswear and Footwear.
2. Wholesale Jeanswear (24% of revenue and 35% of cash flow): Let’s face an ugly reality. This business just printed a +3.5% top line in 2009, but a 385bp improvement in segment margins, and it just highlighted a major roll over this quarter in top line due to anniversarying a big push last year with l.e.i., and increased competitive pressure. This was also the source of JNY’s asset write down. Margins in ’10 are not looking good here.
3. Wholesale Footwear (26% of Revenue and 30% of cash flow): This business is the poster child for a wholesale business that benefitted from the boot cycle. Could it last another quarter? Maybe. Another year (of sequential improvement in trajectory of boot sales)? Not likely – by a long shot. The company is guiding for 4-9% top line growth for ’10. This looks like a stretch without meaningful margin erosion.
4. Retail: (21% of revenue and -20% hit to cash flow): Here’s where I’m most concerned. JNY is in store closing mode, and 1Q alone should see a double digit revenue hit due to 50 fewer stores, and that should accelerate to 165 stores by end the of the year (it closed 96 in 2009). Also, retail has been a beneficiary of the boot cycle – something that’s not likely to recur in 2010. Management is on record as saying that it will break-even at retail this year. That might seem impressive in looking at the $41mm loss JNY just printed at retail. But read the fine print – that is ‘before corporate allocation.’ We estimate about $40mm in corporate expenses, or about $12mm at retail. So ‘breaking even’ actually equates to losing a double-digit number in what is reported to the Street. You can’t cut a business to profitability long-term. Ultimately you need to sell stuff that the consumer wants.
5. Balance Sheet: Lastly, let’s consider this thing called the balance sheet. On the plus side, JNY printed a commendable 18 point spread between sales growth and inventory growth. But how much longer is that sustainable for? Working capital should be helped by store closures, but keep in mind that in 2009 working capital was accretive to cash flow from operations to the tune of 29%. That’s the SAME year when capex as a percent of sales came down to 0.9%. Yes, boys and girls, that’s 0.9%. Can someone find me any company that touches this industry that can sustain a capex rate below 1%. Thanks in advance. In fact, JNY already guided that capex is going up to 1.5%, or about 55-60%.
6. Buy, Buy Buy. Another note on cash. JNY did not buy back stock this quarter, and in fact it issued a small amount. The company said flat-out that it is in full-on deal mode. No stock repo, no debt paydown. They’re gonna buy something. Let’s look back at JNY’s track record of acquisitions. Actually, let’s not. It’s too depressing. Just take a quick glimpse at long-term return on capital.
The bottom line here is that JNY is easing back into the ‘old Jones’ mindset. Cut when you should invest, and acquire when you can, not when you should. Let’s not forget that this is a company that historically traded as low as 3-4x EBITDA and 9-10x EPS, and had up to 35% short interest. Today it is at 6x EBITDA, 14.5x earnings, and has a paltry 6% short interest. Some might argue that 6x EBITDA is not expensive. And overall, it’s probably not – IF they believe in the stability of cash flow. I’ll go to the mat with them on that one!
LEVINE’S LOW DOWN
- The latest trend at the box office is clearly the proliferation of 3D movies. In 2009, 3D movies took in $2 billion in revenues, nearly seven times the amount recorded in 2008. Keep an eye on the development of “in-home” 3D technology, which is sure to follow as the studios work to boost revenues outside of the traditional box office. Now if only we didn’t have to wear those silly glasses to experience the excitement….
- A MasterCard Spending Pulse report for the month of February reported that the spending on luxury goods (ex jewelry) increased by 15% for the month. This marks a substantial increase from January, which increased by 8.1%. However, the increase also comes during a month when almost all retailers showed a measurable increase in momentum and across all price points.
- Over half (55%) of mobile social networkers were found to be women - not teens, who are more likely to use their devices to text. In fact, teenagers and college students combined account for less mobile social network traffic than their parents. And it's not women from the younger end of the age scale using their mobile deivecs to socialize. The largest segment (36%) consists of 35 to 54 year olds followed by those aged 25 to 34 (34%).
Payless to Launch Beauty Line - Payless ShoeSource will soon find out if customers have the same passion for lipstick and body sprays as they do for shoes and accessories. The footwear and accessories mammoth, with 4,500 stores, is gearing up to launch a beauty component to the business this fall through an alliance with Maesa Group. Terms of the deal were not disclosed, but the firm called it a “multiyear arrangement.” Payless Stores, with 1,500 units, will introduce, starting Sept. 1, bath and body products under the names Zoe & Zac and Unforgettable Moments, linking back to proprietary shoe and accessory brands of the same names. Beauty products will include a collection of up to 60 items such as lotions, creams, fragrances and color for eyes, lips and nails. Prices will range from $2.99 to $19.99. Via said the beauty lines are geared to please women of all demographics. Payless traditionally targets mothers and daughters. It has not been decided if the firm’s designer collaborators in shoes and accessories such as Alice & Olivia, Christian Siriano and Lela Rose would take part in the new category. While Via declined to offer sales projections, she expects the new initiative to be “a significant business” for the firm and that beauty will eventually be rolled out to the remaining 3,000 stores. <wwd.com>
Wal-Mart Brings Back Goods as Shoppers Turn to Lowe’s, Walgreen - Wal-Mart Stores Inc., the world’s biggest retailer, is bringing back some products it had removed from shelves last year as shoppers turn to competitors for a wider selection of merchandise. The company met with suppliers about reinstating items to keep customers from going to other stores, said Leon Nicholas, a director at consulting firm Kantar Retail who has spoken with manufacturers about the move. Wal-Mart, based in Bentonville, Arkansas, said it frequently assesses product assortment. Wal-Mart is returning some health and beauty supplies, cereal, pet treats, soda and laundry detergent, Nicholas said. The retailer said last month its U.S. stores recorded a drop in sales and had a “slight decrease” in customer traffic in the quarter that ended in January. “Wal-Mart cut too deep and now they’re going back to manufacturers,” Michael Kantor, chief executive officer of the Promotion Optimization Institute, said in a telephone interview. The organization trains retailers and producers, including Wal- Mart suppliers, to work together on marketing and merchandising. Kantor is based in New York. Last year, Wal-Mart reduced the number of merchandise varieties, known as stock keeping units, or SKUs, sold in the U.S. in categories such as laundry detergent and bedding. U.S. stores cut inventories by 7.6 percent while increasing sales by 1.1 percent. Gross margin, or the proportion of sales left after accounting for the cost of goods sold, advanced 73 basis points. <bloomberg.com>
Kohl’s heads west to open a new e-commerce distribution center - Kohl’s Corp. wants to get closer to its online shoppers, especially on the West Coast. To expedite picking, packing and shipping to online shoppers in California and other Western states, Kohl’s is opening a new distribution center near San Bernardino, CA. Initially the new center, which will occupy almost one million square feet, will fulfill Kohls.com orders in all 50 states, but in 2011 will be dedicated strictly for packing and shipping West Coast orders. Kohl’s now has 11 distribution centers that ship merchandise to its stores and a dedicated e-commerce fulfillment hub in Monroe, OH. The new facility, which could employ as many as 500 workers, is needed to support a growing e-commerce business, the retailer says. Annual web sales at Kohl’s increased 38.1% to $491.5 million from $356.0 million in 2008. “We're making a major new investment in capital and infrastructure in our e-commerce business to fuel future growth,” CEO Kevin Mansell told Wall Street analysts on the chain retailer’s year-end earnings call. “Based on our research and our own results, it appears that our opportunity in this business is substantially larger than we originally envisioned.” <internetretailer.com>
Nike/Cole Haan to Bann Exotic Skins from Shoes - Nike and its affiliate Cole Haan announced that they will stop selling products that are made from exotic skins like lizard, snake and alligator. People for the Ethical Treatment of Animals (PETA) said Cole Haan is the first maker of high-end accessories and shoes to ban exotic skins. Cole Haan defines exotic as including alligator, crocodile, lizard, snake and ostrich. A Nike spokesman told the Associated Press that products using those materials will be eliminated across the entire Nike line after the summer retail season. According to Nike's revised company policy, "Animal Skins must not be any species considered to be exotic. Examples include, but are not limited to alligator, crocodile, lizard, snake, ostrich, fish, marine mammals, etc." "Every snakeskin bag, shoe, or jacket sold in a trendy boutique comes with a high price--and it's paid by animals who are torn away from their jungle homes and cruelly killed," said PETA Executive Vice President Tracy Reiman, in a statement. "We're asking retailers worldwide to follow Nike's lead and step away from cruelty to animals by giving exotic leather the boot." <sportsonesource.com>
Billabong to License Skate Brand Plan B - Billabong International Limited today announced it has entered an exclusive 10-year agreement to license the California-based skateboard brand Plan B. The partnership, which covers all territories globally, will see Plan B continue under its current management structure and leverage the backend distribution and general business support of the Billabong group. Billabong North America president Paul Naude said the licensing arrangement would allow Plan B to maintain its focus on the creation of premium skateboarding products and the promotion of skateboarding. <sportsonesource.com>
CircuitCity.com launches a new payment option - CircuitCity.com has launched a new payment option, the CircuitCity Preferred Account, that seeks to build customer loyalty by allowing customers to finance their purchases and offering account-specific offers and promotions. CircuitCity.com is promoting the option on its web site and e-mails by offering preferred account holders $20 off a purchase of $100 or more when they use the account. A shopper can apply for the account at checkout. After answering two security questions, the shopper receives a credit check. Account holders pay no interest for up to 12 months on orders of $1,000 or more and up to six months for orders of $250 or more. “We think there is a loyalty factor here,” says Bruce Leeds, vice chairman of CircuitCity.com parent company Systemax Inc. “The people who apply are likely to come back more often and use the card. That’s a big positive.” <internetretailer.com>
Cornell Activists Protest Nike over Plant Closings - Cornell University's chapter of Students Against Sweatshops (CSAS) launched a new campaign dubbed, 'Just Pay It,' to protest events surrounding the closing of two factories in Honduras that had been operated by Nike subcontractors. As reported, activists at the University of Wisconsin-Madison as well as Purdue University have also protested alleged illegal wage practices following the closure of the Hugger de Honduras and Vision Tex factories in January 2009. Late last month, Cornell's chapter of Students Against Sweatshops met with University administrators and then issued a statement claiming Nike stopped sourcing from the Honduran factories, forcing a liquidation, according to a report in the Cornell Daily Sun. The group then claimed Nike refused to pay their workers approximately $2.1 of $2.5 million in severance pay legally mandated by the Honduran Government. The group said the nonpayment represents a breach of university clothing codes of conduct as well as the Designated Suppliers Program regulations that Cornell endorses. "Nike is trying to skirt its obligations by claiming there are legal loopholes that excuse their behavior," Casey Sweeney, President of Cornell Organization for Labor Action, said in a statement. "But both legally and morally, they are required to pay their workers." The Nike protests come after workers rights groups celebrated a landmark victory when Russell Athletic last November decided to rehire the 1,200 Honduran workers who had lost their jobs in a factory closing after student protests led to nearly 100 universities to cancel their Russell contracts. <sportsonesource.com>
Court backs EU anti-dumping duties on Chinese shoes - A European court has rejected an appeal by a number of Hong Kong and China-based shoemakers against import duties levied by the European Commission on shoes originating form China and Vietnam. "The adoption of anti-dumping duties is not a penalty for earlier behaviour but a protective and preventive measure against unfair competition resulting from dumping practices," the EU's second-highest court ruled. The European Commission imposed the duties in 2006, following a complaint by European manufacturers who argued that they were unable to compete with shoes dumped in the European market by low-cost producers in China and Vietnam. European Union ministers voted in December to extend the import duties for another 15 months, while Beijing launched a dispute at the World Trade Organization last month over the EU tariffs, claiming they were illegal. <sportsonesource.com>
U.S. consumer credit rises for first time in year - In an encouraging sign for the economy, U.S. consumers increased their debt in January for the first time in a year, just the latest hint that household demand may be on an upswing. Although the economy has picked up steam lately, many economists don't believe it will be on a sustainable path unless consumers restart their spending. Total seasonally adjusted consumer credit, a measure of total debt taken on by individuals, increased in January $4.96 billion, or at a 2.4% annual rate, to $2.46 trillion, the Federal Reserve reported Friday. Economists surveyed by MarketWatch expected consumer credit to decline by $6 billion in January. That marks the first increase in consumer debt since January 2009 and the biggest since July 2008. Another positive sign came earlier this week when data showed that U.S. chain store sales posted a very strong 3.7% comparable-store gain in February, the strongest reading since November 2007. After the financial crisis deepened in the fall of 2008, the economy fell into recession and consumers stopped spending. As a result, debt levels have declined. On a year-on-year basis, consumer credit is down 4.2%. The increase in January was led by non-revolving debt, such as auto loans, personal loans and student loans, which rose $6.62 billion or 5%. Credit-card debt fell $1.67 billion, or 2.4%, to $864.4 billion. That's a record 16th straight monthly drop in credit-card debt. <marketwatch.com>
Income and Spending Trends - Over the past many months, the de-leveraging process has provided us details that shows consumer credit coming down like an avalanche. If consumers are continuing to spend via credit, are we starting to see a trend that will return us to an economy that lives and breathes off of credit lines again? Perhaps it is a good sign that consumers are more confident about the future, but that would not match with the latest consumer confidence numbers. Core PCE is also showing a good deal of strength. That showed up in the recent retail same store reports from companies this week, which beat most estimates. Good news and bad news…
- Personal spending in January rose 0.5% after increasing 0.3% in December. The increase matched January’s retail sales numbers and exceeded the consensus estimate by 0.1 percentage points.
- Personal income rose 0.1%, well below the 0.4% increase the consensus expected. Real disposable income fell 0.6%.
- Inflation remained subdued as core prices were unchanged. However, higher energy costs pushed total consumer prices up 0.2%.
- The spending data came in largely as expected. Goods expenditures rose 1.2% as nondurable consumption jumped 1.8%. Services consumption increased a modest 0.2%.
- Personal taxes rose by $59.0 bln as federal net nonwithheld taxes rose by $52.5 bln. The jump in taxes should not carry over into February and growth in disposable income should look strong in response. <seekingalpha.com>
Retail Hires Up in Feb. - The U.S. Labor Department said apparel retailers increased staffing levels in February for the second month in a row, hiring 7,200 workers. Department stores hired 6,200 to employ 1.48 million, while specialty stores expanded payrolls by 1,000 to 1.37 million. In January, apparel stores added 23,600 jobs. The retail uptick was part of a Labor Department employment report issued Friday that was slightly better than expected. Month-to-month jobs data for retailers are difficult to interpret because of seasonal hiring trends, but the long-term trend for the sector “seems to be one of slow additions of jobs since roughly November,” Hoyt said. He cautioned some of the specific retail employment figures for the first few months of 2010 could be distorted because stores hired significantly smaller numbers of seasonal workers for the holidays and consequently had fewer layoffs when the season ended. In the broader economy, employers cut 36,000 jobs, fewer than analysts expected, and the unemployment rate was unchanged at 9.7 percent. Analysts expected the severe winter weather in February to negatively impact employment figures. <wwd.com>