R3: WSM - Contemplating Post Peak Upside


March 23, 2010


With many retailers nearing or exceeding peak EBIT margins following a year of incredibly tight inventory management, cost cutting, curtailed store growth, and capital preservation, there are few companies that standout as candidates for moving beyond prior margin highs.  One such name that stands out in this camp is Williams-Sonoma. 




With many retailers nearing or exceeding peak EBIT margins following a year of incredibly tight inventory management, cost cutting, curtailed store growth, and capital preservation, there are few companies that standout as candidates for moving beyond prior margin highs. One such name that comes to mind is Williams-Sonoma. After reporting another strong quarter of upside across the top and bottom lines, one key item stood out to us. Management explained how it believed the company could achieve prior peak margins and ultimately exceed them. We agree.


The formula to achieve EBIT margins of 10-12% (vs. peak of 10.2%) is the by-product of a few key variables.


  • For perspective, 2009 reported EBIT margin was 5.2%, or 500 bps below 2005 peak levels. The bulk of the decline is confined to gross margins, of which 415 bps has been negatively impacted by occupancy expense. Within occupancy expense, 50% of the impact is due to escalating costs and 50% due to sales deleverage. The remaining gross margin degradation is the result of a 225 bps hit on selling gross margins offset by 140 bps of supply chain efficiencies.
  • Leverage on central infrastructure, which has seen capacity reduced by 1.2 million square foot in 2009 should continue to drive supply chain efficiency/gross margin improvement. At the very least, leverage should continue through the first half of the year given that capacity reductions have not been fully anniversaried. After that, modest sales growth on a substantially reduced distribution network will continue to yield gross margin gains.
  • Recognize that advertising costs reductions are permanent. Recall that the company substantially reduced catalog circulation over the past year and is in favor of lower cost, higher return digital marketing. It is clear that the ecommerce business is the most profitable growth vehicle the company has and the legacy costs associated with catalog distribution are a way of the past. Circulation was down 20% for the year, representing a permanent cut to costs.
  • Close marginal stores that are saddled with rent escalations that would otherwise pose a drag on overall margins. This is a 150-200 bps opportunity alone. Clearly the current real estate environment affords flexibility and opportunity to reduce costs. Furthermore, growth opportunities in the highly profitable direct business takes pressure off of management to grow retail for the sake of growth. Management is focused on closing stores and we expect this to continue over the next 1-2 years, at least.
  • SG&A is not really a key variable here, provided it remains consistently well managed. Over the past 5 years, SG&A is actually down 10 bps as a % of sales, despite the major decline in total topline sales.
  • Positive mix shift towards higher margin, higher turning home furnishings vs. a more traditional reliance on furniture. While still early in this process, this should be gross margin accretive vs. the historical mix which was more in favor of lower margin furniture.
  • Importantly, on a lower cost structure (primarily supply chain and advertising), topline assumptions do not need to be heroic to continue to drive margin expansion. A low single digit increase in sales over the next three years would allow margins to expand to near peak levels. Clearly momentum is stronger at the current time (and compares are still easy), which suggests the ramp should be steeper in the near-term (even after the huge move off the bottom).

 R3: WSM - Contemplating Post Peak Upside - WSM SIGMA 





  • Tiffany noted that it will launch its collection of leather accessories and handbags later this year. Recall that the line is being designed by Richard Lambertson and is the first line to be brought to market since TIF acquired Lambertson’s company out of bankruptcy just about one year ago. The line will launch with limited distribution in the US stores as well as online.
  • Wal-Mart is adding back some SKU’s it recently cut as part of its effort to rationalize underperforming brands, reduce clutter, and improve profits. Apparently consumers have lashed back, and have expressed their displeasure with the company’s efforts to eliminate SKU’s. Interestingly, Hefty’s One-Zip sandwich bags are on the list of items to make their way back onto the shelves. Recall that we originally flagged the company’s decision to narrow the bag assortment to one national brand (Ziploc) and their own Great Value offering.
  • An interview with J Crew’s creative director, Jenna Lyons, revealed that the company is focused on developing a partnership with a beauty brand. She went on to note that she is seeing “an insatiable appetite for nail polish”. While no deal or strategic partnership is imminent, it won’t be surprising if we begin to see some limited beauty products making their way into the stores. Importantly, if done properly, beauty can be a high margin, traffic driving business.





Supply Chain Forum - The recession forced executives to reexamine their supply chains and find new efficiencies. Cutbacks in inventories and the culling of suppliers that brands and retailers engaged in to survive the downturn present a challenge to growth. Today, companies are scrambling for capacity. The industry is in a classic bullwhip effect. Companies have relied heavily on Asian sourcing for decades; however, Asia, and China in particular, are quickly developing into powerhouse consumer markets which has significant ramifications for sourcing. Commodity inflation is a likely result of an economic recovery and a surging Asian consumer population.  “In a world where the source countries are seeing GDP growth at a rapid rate, and the mature countries are having slow to no growth, the pinch point becomes clear,” McBreen said. Companies are focusing on improving its speed to market and implementing product life cycle management techniques that allow it to break away from a seasonal delivery mind-set. Retailers have adjusted by focusing on its supply chain and moving away from areas where deliveries had been unreliable, such as Pakistan. Such thing as reducing time spent unloading containers became critical.  “You may think that you’ve got down to your source and this is the best you can do with your supply chain. I feel there’s still a lot of work to do,” he said. “The U.S. is far behind the Europeans. They’re closer and they have their supply chain rates and percentage much more economical and understandable.” <>


Supply Chain Forum 2: Sourcing Companies - The economic downturn has forced retailers to reevaluate how to utilize the role of the sourcing company, resulting in suppliers being under greater pressure to inject more value into the overall packages they deliver to boost their competitiveness. Rockowitz said manufacturers will have to increase investment in technologies such as automated equipment in production lines, advanced management systems and computerized systems for research and development in order to boost overall capabilities. There also will be a greater push toward connectivity. Li & Fung has developed a wireless system that gives all those involved in the supply chain access to real time information for improved efficiency. Christina Ong, textiles and garments division director at HSBC, believes developing product design capability is essential to survive in the supply chain in the coming years. Bundling design and merchandising services will enable sourcing companies to attain higher profit margins and customer loyalty. This also helps fend off competition as buyers become dependent on the agent for product development. New technologies now have become inextricably linked with sustainability. Ong said consumers are more aware of environmental matters and expect retailers to provide products manufactured by compliant factories and will have to look to reforming highly polluting and resource-consuming industries such as tanning, dyeing and electroplating. <>


China's long term growth plan recovery - China has started to regain momentum in manufacturing and exports this year, both of which were dealt heavy blows by the global financial meltdown. But the longer-term damage of the world economic crash may lie in disrupting the central government’s ambitious plans to transform China’s economy into one based on innovation by 2020. The first two months of this year show a fledgling recovery taking root in China’s manufacturing sector, with renewed growth in exports, according to recent government statistics. The index used to measure manufacturing output held steady, while China’s exports during January and February soared 46 percent from the same months last year. Yet, as Premier Wen Jiabao warned in his annual state of the union address on March 5, the future is littered with mine fields. Amid its drive to balance exports and imports and rebalance the entire economic structure, China faces an uphill road in improving the content and quality of its exported goods. The central government, Wen said, will commit special efforts to 10 key industries in 2010, including textiles. But there’s no denying the downturn somewhat derailed China’s detailed economic development plans, which could mean more of the same in manufacturing. <>


New Leather Tannery Cluster to be Built in Fuxin, China: The China Leather Industry Association (CLIA) has confirmed the country's official policy to locate new tanneries to specialised tanning clusters as it aims to tighten up the regulations to build new sites. China has been promoting the new tanning cluster in Fuxin, Lioning province of Northern China. The Fuxin cluster so far has three or four new tanneries either planned or under construction including the new beamhouse plant for Shanghai Richina Leather. A new central effluent treatment plant is also under construction to cater for the tannery waste. The Lioning cluster is due to be fully operational by 2011 and is close to the shipping ports, which is ideal import and export of goods. The CLIA spokesperson said that in the future it will be more difficult for tanners to obtain permits to build new plants and therefore the tanning clusters offer the best chance to a permit to be granted. The Association also added that the growth of new tannery construction in China is expected to slow down in the future as they focus on improving the environmental performance of existing tanneries. <>


China: Li Ning bullish on the mainland sportswear retail market - Chinese sportswear retail giant Li Ning reported an impressivley strong 2009 performance and said the market also looks strong for 2010. The company expects to increase sales by more than 16% this year with a 10% rise in same-store sales as the company produced an impressive set of fiscal 2009 figures, with group revenue increasing by 25.4% to RMB 8,386.9m for the year ended December 31.  "2009 was an extremely challenging year with economies around the world swept by the global financial crisis. China was also impacted by this crisis in 2009, especially in the first half of the year. In addition, the post-Beijing Olympics effect impacted the pace of growth of the sporting goods industry during the year," said Li Ning, Chairman of the Group. "Against the backdrop of a challenging operating environment, the Group, under the excellent leadership of the management and relentless efforts of our staff, reinforced its financial strength and boosted its competitiveness in key areas including its brands, products and new sports category, thus achieving solid business and financial growth." As the Group's core brand, LI-NING brand sales accounted for 91.7% of the total revenue, grew by 21.1% to RMB 7.69 billion. Sales of LI-NING brand footwear products, apparel products and accessories grew by 19.1%, 22.3% and 27.4% respectively.  <>


Japan Fashion Week: Two factors are working in local designers’ favor — a growing contingency of buyers and consumers from other Asian countries and Japanese department stores’ newfound willingness to place orders and decrease their dependency on European luxury labels. "Every single store carries the same names, the same merchandise, and the customers and the buyers are a little bit tired of seeing the same,” he said. “The market condition is terrible, but it’s in a good condition for the young designers.” About 40 runway shows, along with dozens of presentations and other related events, will take place this week around the city. Like in seasons past, small home-grown brands with names such as Somarta, Mint Designs and Motonari Ono dominate the lineup. But a growing number of men’s labels, such as Discovered, Factotum, Phenomenon and Yoshio Kubo, also is joining JFW’s ranks, underscoring a widely held belief that men’s designers here are overshadowing their women’s wear counterparts, both in terms of buzz and commercial success. <>


REI Profits - REI (Recreational Equipment, Inc.) released its audited 2009 financial results showing it earned net income of $29.8 million, up 106% from $14.5 million in 2009. The company's direct sales channel, which includes online and catalog sales, grew by nearly 5%, while comp store sales declined by 3.5%, outperforming an expected 5% decline. <>


NRF Makes Statement on Health Care Legislation - The National Retail Federation in a statement expressed extreme disappointment at the House's passage of sweeping health care reform legislation over the weekend, saying added labor costs under the bill will cost many retail workers their jobs.  <>


Dick's Sporting Goods has declared May as Dick's Sporting Goods National Runners' Month with the sponsorship of ten major running-event sponsorships.   <>


Protests Against Nike - Maryland University became the latest college to see campus protests erupt against Nike over the closing of two factories in Honduras that had been operated by Nike subcontractors. Activists at the University of Wisconsin-Madison, Cornell University and Purdue University have also protested alleged illegal wage practices following the closure of the Hugger de Honduras and Vision Tex factories in January 2009.  <>


UK Retail Sales Grow 2nd Month in a Row - Retail sales have grown for the second consecutive month, and growth is expected to continue at a similar pace through Easter, according to the CBI Distributive Trades Survey. <>


Zappos’ customer service draws raves in a new report - The online shoes, clothing and accessories retailer had the top-ranked customer service in a new study commissioned by customer service ratings agency StellaService. <>


Tiger Woods and Sponsors - Tiger Woods may have lost a few key sponsors since his November car accident and the resulting fallout, but he continues to draw attention for those that have stood by him. Woods, who granted five-minute interviews to ESPN and Golf Channel, wore a Tiger Woods hat, Nike sweater and Tag Heuer watch during the interviews. Eric Wright of Joyce Julius & Associates claimed the branding exposure for the combined Nike brands is worth an estimated $2.4 million. Tag Heuer, which received a four second close-up as Woods modeled his new Buddhist bracelet, received $5,000 worth of exposure. <>


Google Cleared of Trademark Infringement in Vuitton Case - Google Inc. did not violate trademark law by allowing advertisers to buy keywords corresponding to registered names such as Louis Vuitton, the European Union’s highest court has ruled. However, the court said advertisers who use such keywords must make patently clear to Internet users where the goods they are selling originate, a victory for luxury goods makers vying to stamp out counterfeits online. <>


Rapper T.I. Sued Over Apparel Line - An Illinois media firm has brought a trademark lawsuit against rapper T.I. over the name of his apparel line, Akoo. Akoo International Inc. says it has used the name since 1999 and trademarked it in 2007. The company, based in the Chicago suburb of Elmwood Park, provides music video programming to public spaces such as malls, restaurants and college campuses. TI launched his clothing line under the moniker — short for A King of Oneself — in 2008. <>



Tod's SpA Gains in 2009 Driven by Footwear and Asia - Tod’s SpA noted performance of its footwear division and growth in Italy and Asia as drivers behind revenue and profitability growth. Approached 2009 with rigorous control of discount sales and a more and more selective wholesale distribution. Shoes, the group’s core business, continued to grow, with sales rising 4.2% percent to $506.1 mm in 2009 while leather goods and accessories showed a 12% drop to $154.8 million, sales of apparel inched up 0.5% to $132 mm. Geographically, sales in Italy gained 5.5%, while Europe fell 6.4%. Revenues in North America declined 21.7%, Asia saw sales rise 7.5%. <>



The Macau Metro Monitor, March 23rd, 2010



According to an anonymous source, gambling  revenue in Macau soared close to HK$13 billion ($1.68 billion) for the first three weeks of March, similar to the levels achieved in February. SJM Holdings retained the biggest share of the market, at around 30%, while Sands China was second with around 20%.


Macau GDP grew 1.3% in 2009. Secretary for Economy and Finance, Francis Tam Pak Yuen, attributed the better than expected GDP performance to a substantial increase in gaming receipts in the last quarter of 2009. Tam believes a gaming revenue recovery and a growth in both private investment and consumption will boost GDP further this year. However, he added that it is not expected that the casino industry growth will be as sharp in the future as it has been in the last years, with the exception of 2009.



"The government is preparing to outlaw slot-machine parlors in residential areas--existing venues will have to move," said Secretary Tam, on the first day of the debate of the 2010 Policy Address for Economy and Finance areas. Other gaming controls under consideration include raising minimum age to 21, money laundering and terrorism financing at the local casinos, and an audit of gaming operators at year end.



Total visitor arrivals to Macau surged 24.4% YoY to 2.06 million in February, attributable to the long Lunar New Year holidays, the Statistics and Census Service said on Tuesday. Surging 38.1% annually to 1.15 million, mainland China visitors accounted for 55% of all visitor arrivals.



''About'' 50,000 people obtained their right to temporary residency in Macau through the property investment scheme, according to the Macau Trade and Investment Promotion Institute (IPIM).  CEO Chui said last week that the property investment scheme had already achieved its goals. He added the government will study an overall makeover on the population and immigration policies.

Seeing The Forrest Through The Trees

Seeing The Forrest Through The Trees

“It’s there if no one else has told you.”

-          Forrest Chang, Hedgeye Risk Management


No, I didn’t spell Forrest wrong in the title.  Granted some days we have the odd typo in our research, today Forrest - with two RRs - is actually the name of my colleague, Forrest Chang.  Not only does Mr. Chang, an MIT graduate, run our Oceanside, California office, but he also has a Budha-esque quality to him.


Yesterday I emailed our Operations Team to inquire as to whether the MP3 for our sovereign debt call was on the portal for our subscribers.  His response was the quote above: “It’s there if no one else has told you.”  As I read his email response, I thought that’s logical.


Like most deep simplicity, his statement has a much deeper meaning.  One would expect nothing less from a computer scientist of Mr. Chang’s genius.  As you know by now, Keith and I like to apply many analogies, and more often than not sports analogies, to our business and to global macro investing.   In this instance, do your own work, DJ go to the site and look yourself, was what Forrest was telling me.


So, as we survey the global macro landscape today, what “is there because no one had told us”?  Well, I would say a few things:

  1. Bank of China earnings – The Bank of China reported earnings over night.  Not surprisingly, the Bank of China posted a fourfold jump in profit based on loan growth and lower write downs.  Now the first part was to be expected given massive loan growth in China, but fewer write downs?  What of the mystical empty Chinese cities that these loans are supposedly underwriting?  Despite conspiracy theories, Chinese loans still appear to be money good for the most part.
  2. Iron Ore Prices –Vale is the second largest mining company in the world, so when Vale speaks, our commodities team listens.  Last night Vale sent a document to its customers saying it was raising iron ore prices to $122.20 per tonne, versus $57 per tonne year last year.  That is a 114% increase.  I don’t need a degree from MIT to know that is inflationary. 

Incidentally, if you are looking for a market with duopoly pricing power, Vale and its competitor Rio Tinto Group control roughly2/3rds of the global iron ore market.  So, yes, they have pricing power.  And yes, when they raise price by 114% year-over-year that is inflationary for all things steel.

  1. U.K. Inflation – A common debate in economic circles these days is whether we are in an inflationary or a deflationary environment.  I’m not sure if anyone has told me, but it appears that inflation is here based on data out of the U.K. this morning. 

The Brits printed a Consumer Price Index this morning that was up +3% year-over-year for February.   Yes, that is a February number and it is now March. Yes, that is a deceleration from January’s +3.5%.  And, yes, it is still inflationary.  We expect global inflation numbers to go up in March versus February.


Just as a MIT computer scientist and a Yale hockey player are juxtaposed, so too is the leadership in the global macro markets this morning.


We have been criticized for being too pro-China at times, but when a country and its leadership both do and says the right things, it is hard not to get a little bulled up.  In a speech to major CEOs last night Premier Wen Jiabao said:


“They must not fight a trade war or a currency war because this will not help us in meeting the current difficulties.”


This is an admittedly savvy appeal to the capitalists who run some of the largest companies in the world ahead of Congress’ manipulator meetings tomorrow.


In Europe the continuing debate regarding the PIIGS, namely Greece, rages on with nary a real leader in sight.  Will the IMF provide bail out monies? Will the EU provide bail out monies? Does Germany like Greece, or not?


In our picture of the day today, posted below, we see a perplexed and confused looking European Central Bank President Jean-Claude Trichet, with the caption, “Smells Like a PIIG in Here . . .”   As we stated on our Sovereign Debt Call last week (email us at if you want the replay), sovereign debt issues rarely end with one country. 


Not surprisingly, we continue to favor the Chinese leadership to the European confusion.


On an ending note, we couldn’t help but highlight a quote that we read from CNBC pundit Dennis Gartman yesterday.  Garty wrote:


“We remain long of restaurant chains and other companies that keep making higher highs.”


Setting aside the fact that Dennis has probably never analyzed a restaurant (our own Howard Penney is one of the world best restaurant analysts), what kind of a thesis is being long companies that make higher highs?  Come on Dennis, there is responsibility in recommendation.  This isn’t a game, people depend on us.


Keep your head up and stick on the ice,


Daryl G. Jones

Managing Director


Seeing The Forrest Through The Trees - Trichet


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While the S&P 500 finished higher on significantly lower volume from Friday, the XLU is now broken on TREND.  While the day got off to a shaky start, the Healthcare (XLV) sector provided some early upside leadership following the passage of the Senate's healthcare reform bill in the House; the XLV has increased 5 of the last 6 days


While the Dollar index traded flat on the day, the safe-haven status of the dollar continues to gain momentum amid the uncertainty European leaders will fail to agree on an aid package for Greece.  The Hedgeye Risk Management models have levels for the Dollar Index (DXY) at:  buy Trade (80.36) and sell Trade (80.93); the dollar is in a bullish formation. 


The strong dollar continues to put pressure on the REFLATION trade.  Materials (XLB) ended up putting in one of the best performances of the day, but two key names (PTV and MLM) were higher on takeover speculation.   The Energy underperformed and was one of two sectors down on the day.  While oil and the bulk of the energy commodities were higher on the day, natural gas remains a laggard.  CHK, CNX and EP all significantly underperformed.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (80.11) and Sell Trade (83.64). We are currently long the USO. 


Consumer Discretionary (XLY) and in particular retail was a bright spot on the day, with support coming from earnings and improving consumer spending trends.  The retail S&P Retail Index was up 1.2% on the day; the Department stores (SKS, M, DDS and JWN) were notable outperformers.  Also, WSM rallied after beating on Q4 earnings and raised 2010 guidance.


Semis provided much of the upside leadership for Technology (XLK), with M&A and the semi-cap equipment group leading the way. 


The notable laggard on the day was the Industrials (XLI).  Within the XLI, FDX and UTX gave back some of their gains from last week. 


Yesterday we sold our LONG position in the VXX.  The VIX continues to be broken on all three durations - TRADE, TREND and TAIL.  The Hedgeye Risk Management models have levels for the volatility Index (VIX) at:  buy Trade (16.22) and sell Trade (18.73). 


In early trading, equity futures are trading above fair value, following yesterday's up move.  The US MACRO calendar is void of any significant events.  As we look at today’s set up the range for the S&P 500 is 15 points or 0.8% (1,157) downside and 0.5% (1,172) upside.  Today's MACRO highlight will be February existing home sales. 


In early trading, copper is trading lower as the dollar is higher.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (3.33) and Sell Trade (3.42).


In early trading Gold is trading lower for the third day in a row.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,093) and Sell Trade (1,120).


Howard Penney

Managing Director














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