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JNY: The Legacy Returns

Do yourself a favor and employ a process that includes something more than looking back only 3 years in analyzing Jones Apparel Group. History is repeating itself. And history pretty much stinks.



Daryl Jones – one of the senior leaders at Hedgeye – often reminds us to “never bet against a Jones.” I’ve got to take exception to that, DJ. Here’s some historical context as to why.


I’ve been covering JNY for about 13 years. How ironic that both revenue and the stock price today are at the same levels as when I first plugged the ticker onto my stock screen. What’s different? Well…management changed a little, but the culture did not. EBIT has been cut by nearly 80%, or $400mm, as the company lost its most profitable assets (a billion+ worth of 20%+ margin Ralph Lauren biz), and no longer has the macro and industry-specific tailwinds to mask its strategy to financially engineer acquisitions while starving its existing brands.


The architect of said strategy was Peter Boneparth, a banker turned CEO of an apparel company called Norton McNaughton. And yes, Boneparth ultimately became CEO of JNY. What I’ll refer to as his ‘buy and starve’ model (starve brands of capital, but buy new ones to give the illusion of growth) worked – until it didn’t. Remember when JNY blew up in 2007? Yeah… That was the end. Or so I thought.


Wes Card was elevated to the role of CEO and has done the best he could with the mess he was left. He’s cleaned up some underperforming company retail assets, and has strengthened parts of the wholesale business. Has he benefitted at 9 West from a strong boot cycle? Yes. But overall, he seemed focused on improving the core.  Until now.

Enter JNY’s announcement to buy Stuart Weitzman.


I’ve got several thoughts on the deal.


1. Is it a good brand? Yes. JNY needs as much higher-end exposure as it can get.


2. Is the $180mm price tag for 55% of the company a good deal? On today’s cash flow stream, it probably is. How I’m doing the math, we’re looking at about 2-3% accretion in 2010 based on my assumption of 12% margins at SW (no disclosure there yet). I don’t dismiss the potential for mid-high teens margins.  If that’s where they are, then that’s super. But then, as with all companies we analyze, we’d also need to get confidence that we did not see margins shoot up recently due to unhealthy costs cuts to dress the company for sale.


3. Now here’s the kicker…The two main sellers are Mr. Weitzman and Irving Place Capital.


a) Mr. Weitzman will stay with the company, but is in print (Friday) as saying ”This is my hobby, I love it and never want to stop.” That’s actually nice to hear how passionate he is about the business. Passion is good. But the ‘hobby’ thing kinda scared me.


b) The REAL notable point here is that Peter Boneparth joined Irving Place last year as a Senior Advisor. I repeat…  Peter Boneparth joined Irving Place last year as a Senior Advisor.


So let me get this straight…If this is such a great company (I do not dispute that it is a solid brand), with margin upside and a growth trajectory that has been properly invested in over the past 2 years during the downturn, why is Irving Place selling? 


Moreover, isn’t it a little ironic that it is being placed at JNY – the place where a Senior Advisor created a culture of paying top dollar at peak margins for acquisitions just to give the illusion of growth?


Maybe we give the seller the benefit of the doubt and assume that – like many of the $550bn in levered loans out there associated with deals struck over the past 7 years – Irving Place simply needs to raise the cash, and is taking advantage of a window when it can do just that.


Regardless of the seller’s motives, I want to understand the level of diligence existing JNY management did on this deal, instead of relying on their former boss as validation. The key for me will be to see how much JNY invests to grow this brand without simply robbing capital from other areas of its portfolio. Management can say whatever it wants about its intentions, but a few quarters of action will tell the story far better.


As it relates to the stock, my sense is that JNY’s strategic shift will likely result in one of two things…


1)      Acceleration in both organic and acquisition-related growth while improving margins, or


2)      Increasing erosion in the profitability of its current core while it chases deals, and a subsequent miss/guide down/write off as the current base – as has been the case with JNY (and coincided with Mr. Boneparth’s departure in 2007).


Until I get strong evidence otherwise, I am assuming #2 -- this company's culture of shareholder is too strong to give the benefit of the doubt for anything else.  My earnings estimates for JNY are $1.30 for 2010, and $1.40 next – which are below the Street by 15% and 20%, respectively.


Let’s simply look at what a rational investor needs to believe in order to buy the stock at $20.  I’ll work under the assumption that an investor at this price needs to be looking to sell at something at least $25. JNY, and others with similar models have traded between 10-14x pe over time. I’ll assume 13x. That suggests EPS just shy of $2.00. The bottom line is that we need to get to 9.5% operating margins to support these assumptions. The last time JNY had margins over 9% it was being fueled by its Ralph Lauren licenses – which simply are no longer part of the equation.


Unless they know something pretty material that they aren’t telling us, this looks to me like JNY is reverting back to its value-destroying days of old. So…with earnings compares getting tougher, high earnings expectations, and short interest near 3-year lows, can someone tell me who the incremental buyer is of JNY here?”

Correction or Contagion, What’s Next for Equity Markets?

As stock market operators, a strong stomach and preparedness for the unknown are critical traits.  Yesterday’s action in the U.S. equity markets tested even the most savvy of investors.  But, as Robert Frost famously said, “In three words I can sum up everything I’ve learned about life: it goes on.”  Indeed it does.


While the intraday move is quickly being dismissed by the CNBC punditry as a “fat finger”, or human error, and to some extent that is accurate, it is critical to remember that markets are interconnected.  The current catch phase in stock market parlance is contagion.  A contagion in medical terms is a contagious disease, and in this scenario, cotagion implies that the whole world is going to catch the Greek sovereign debt flu.


Esteemed investor George Soros had a more apt description for contagion, he calls it reflexivity.  Specifically, market events aren’t random, but they are influenced by other events.  Taken a step further, actual fundamentals are influenced by market events, so the market and prices in effect are leading indicators.


In isolation, yesterday’s event was an isolated event and was likely some Middle Aged White Guy, or MAWG has my colleague Howard Penney called him today, on a trading desk at a major financial institution who ran the wrong algorithm or sold shares when he should have been buying, albeit on a massive scale.  But the reality is that this event, which was the largest intraday drop for the Dow in stock market history, occurred on a day and in a period when the market and investors were incredibly skittish and schizophrenic due to accelerating sovereign debt concerns.  Even if this was a simple “error”, the timing was far from random.


In fact, this event is likely a catalyst for more market volatility in the coming weeks, rather than a return to complacency and the upward trend in the market.  This view is based on signals from a number of the key factors that we monitor in our risk management model, which include: credit spreads, volatility and sovereign debt credit default swaps, which are outline in the attached chart.  Collectively these factors had been signaling to us the potential for an equity market correction, and continue to signal further turbulence ahead.


Credit spreads widening in conjunction with a declining stock market typically indicate a dramatic shift away from any type of risk by institutional investors.  More specifically, they also signal bond investors getting increasingly concerned about fundamentals and cash flow.   Over the course of the past few days, corporate high yield yields widened dramatically from 8.2% to 8.6%.  This morning yields continue to climb.


The VIX is one of a few measures of volatility that we use, and it has been accurately called the fear index.  As investors get scared and sell assets, volatility spikes, which increases the potential intraday moves of asset classes.  Similar to credit spreads, equity volatility had been increasing over the past few weeks and is up another 14% this morning, signaling increasing fear and volatility ahead.


On the final point, credit default swap spreads widened for many European countries over night.  In fact, many are approaching all time highs, specifically Greece's five-year CDS rose 10 basis points to 950 basis points, while those of Portugal rose 60 basis points to 495 basis points, and Spanish CDS rose 17 basis points to 290 basis points.  If this market action is telling us anything, it is that any proposed bailout that is on the table is insufficient and there are more European sovereign debt issues ahead of us.


While we support the adage that the time to buy is when there is blood in the street, that strategy needs to be framed with the understanding that equity markets can stay irrational, and usually do, for longer than investors expect.  In early 2009, very few investors predicted that the market would climb over 75% in the ensuing 15-months.  Conversely, the correction, when it occurs, will likely be of longer duration than the consensus group-thinkers believe as well.  And perhaps the correction is only the beginning.


Daryl G. Jones

Managing Director


Correction or Contagion, What’s Next for Equity Markets? - 1





The Week Ahead

The Economic Data calendar for the week of the 10th of May through the 14th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - cal1

The Week Ahead - cal2

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BBBY: KM Buying – Our Fundamental Backdrop

In the midst of the current correction, Keith continues to look towards quality names with stability in earnings momentum, proactively-driven top line growth, and plenty of cash to boot. In other words, Bed Bath & Beyond.


Here’s a reminder as to why we like this one…


  1. Long-term: Combine a remarkably consistent management team, steady unit growth, outsized market share gains regardless of the economic climate, and you get one of the most predictably efficient growth models in retail. We don’t buy the ‘growth is maxing out’ argument – the fact is that there’s still 85% of this industry that BBBY does not own. Sprinkle on underappreciated/undervalued non-core concepts and call option on putting $1.7bn cash hoard to work, and this is a tough story not to like at face value.
  2. Intermediate-term: Earnings guidance calls for 10-15% growth in 2010. We’re looking for 25% and that may be conservative.  Yes, expectations have risen, but 4Q was just the third quarter in a row (after 10) in which gross margins improved.  Sales are accelerating, as they should when a macro recovery is underway and the company’s biggest direct competitor is now gone for just over a year.
  3. Near-term considerations: The catalyst here should continue to be earnings. BBBY is not scheduled to report until the back half of June, but our degree of confidence in the model is high. Management finally putting the cash hoard to work would be a welcomed bonus.


Valuation: At 8x EBITDA and 15x P/E, we ‘get it’ that it is not exactly the cheapest name in retail. But its been a long time since I’ve seen a name in retail where more people say “it’s too expensive…I missed it.”  That’s a tough argument to stick to when you have a quality name that’s got growth, earnings momentum, market cap, and cash.




March is a tough act to follow.


Mc Donald’s is expected to report its April sales before the market open on Monday.  On a year-over-year basis, April 2010 has one less Wednesday, and one additional Friday, than April 2009.  The impact from the Easter shift in school and business holidays from March 2008 to April 2009 positively impacted Europe’s comparable sales by approximately 2%. 


Below, I am providing my view on comparable sales ranges for each of MCD’s geographic segments as indicators of what I would rate as GOOD, NEUTRAL, or BAD results based largely on 2-year average trends.


To recall, MCD management made the following comments about April trends on its 1Q10 earnings call:

  • “Our momentum is continuing into April with comparable sales trending positive across all of our geographies.”
  • “I think that the consumer is starting to feel a little bit better. We see consumer confidence scores getting better over the last couple of months. We see a little more spending in the marketplace and yet the stubborn unemployment being at 9.7% still is a factor, I think, relative to that overall spending and net confidence.”
  • "For April, what we said in the release was that we expect April to be at least as strong as the quarter on a global basis. So what we’re setting there is a floor, saying that it won’t any lower than 4.2 is what our expectation is.”



U.S. (facing a 6.1% compare, including a calendar shift which impacted results by 0.0% to +0.4%, varying by area of the world):


GOOD:  Any result greater than approximately 4% would be perceived as a good result because it would imply that the company was able to sustain its U.S. sales momentum from the outstanding print in March.   Last month’s number resulted in a 2-year average trend of 4.9% (or 5.4% if you adjust for the negative calendar shift in March 2009), which was the best 2-year number since February 2009.  In order for April’s number to imply a 2-year average trend in line with what was seen in March, the comparable store sales figure will have to be approximately 4%. 


NEUTRAL:  Roughly 3% to 4% implies 2-year average trends that are about even with March to slightly lower, but still remain above prior month trends, confirming a real rebound in MCD’s U.S. business. 


BAD:  Any comparable store sales number below 3% would imply a sequential slowing from March on a 2-year average trend basis.  While this would not be a disaster in the context of the trends over the last couple of years, it would fail to confirm the resurgence that was seen in March.  Given that many management teams have been making positive comments on April trends, I think it would be a disappointment to see 2-year average trends slow sequentially (especially given the run that the stock has been on since March trends were reported).



Europe (facing a 8.4% compare due to Easter holiday shift, which positively impacted April ’09 by 2% and a calendar shift which impacted results by 0.0% to +0.4%, varying by area of the world):


GOOD:  Above 4% would signal a sequential improvement in 2-year average trends; despite improving last month, the 2-year average trends are still at historically low levels.  A +4% trend would imply a return to 2-year average trends in the region of +6%.


NEUTRAL:  +3% to +4% would signal that 2-year trends are roughly even with March levels.  While this level is neutral with respect to sequential trends, it would indicate continued softness in the Europe business compared to the most part of 2009 when 2-year average trends were consistently in the 6.0% to 8.0% range.


BAD:  Below +3% would indicate that trends have sequentially deteriorated further from March levels. 



APMEA (facing a 6.5% compare, including a calendar shift which impacted results by 0.0% to +0.4%, varying by area of the world):


GOOD: Better than 6.0% would signal that 2-year average trends have rebounded strongly from last month’s (adjusting for the calendar impact on March) dip after a strong showing in the first two months of the year. 


NEUTRAL:  Roughly 3.0% to 6.0% would indicate that 2 year-trends were stable-to-slightly better on a sequential basis from March. 


BAD: Below 3% would imply 2-year average trends that have either stagnated or slowed further from the level seen in March.  Below 1% would point to trends in line with the trough 2-year average trends indicated in December.




Howard Penney

Managing Director

UK Undertow

Position: Long Germany (EWG)


Per Wikipedia, undertow is defined as “a strong subsurface flow of water returning seaward from shore, often as result of wave action.”  If the strong subsurface flow in the UK is the threat of stagflation as the UK economy is forecast for meek growth alongside expanding inflation and a looming double-digit budget deficit to GDP ratio, more surface waves could result, including those from yesterday’s general election result.


Number 10 Downing Street


Yesterday’s election yielded no clear majority government, or the 326 seats needed (of the 650 seats in the House of Commons) to gain an overall majority in Parliament. Although Cameron won the most seats with 291 versus Gordon Brown (251) and Nick Clegg (51), the inability of one party to form a majority sets the stage for three likely outcomes:

  1. Gordon Brown and his incumbent government may continue to govern because no party won parliamentary majority, perhaps with a hand-shake agreement with another party for support like the Liberal Democrats.
  2. Brown may offer his resignation to the Queen and suggest a new government, likely David Cameron.
  3. The Queen could overthrow Brown’s minority government in her "Queen’s Speech” on May 25th in favor of another party (the Conservatives).

While a hung parliament was largely priced in, the uncertainty on the political and economic direction of the UK could likely put further downward pressure on the Pound, which is down -9.2% versus the USD year-to-date (or flat versus the EUR) and also on the equity market (the FTSE is down 5% YTD).


Inflation Popping


The UK’s Producer Price Index for April was released today and the figures remind us why we want to steer clear of this economy. The Input Price Index jumped 13.1% in April year-over-year and output rose 5.7% versus the previous year and suggest that producers will pass on higher input costs to consumers.  The most current reading of CPI is 3.4% in March Y/Y.


UK Undertow - UK PPI APRIL


Clearly, whoever emerges as the winner in the UK will have the challenge of righting an ailing economy.  The UK has a hefty budget deficit that will likely reach ~13% of GDP this year with gross debt climbing to some 73% of GDP which would force the government into a very difficult position of cutting the deficit (expediently) while not smothering growth (think Greece, Portugal, Spain, USA...).  While the UK debates spewed idealism on the country’s future, the reality of the country’s anemic fundamentals is formidable.


Matthew Hedrick

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