R3: DG: Looking at the Drivers


June 8, 2010


Under the hood of DG’s strong Q2 results are several notable highlights including the willingness of the lower-end consumer to purchase incremental non-consumables.


DG reported another strong quarter, with earnings of $0.42 vs. the Street at $0.34.  Recall that the company was on the road for a secondary in the early part of the quarter, which in some way was probably a big vote of confidence in favor of the company’s underlying trends.  Timing aside, there’s no denying that this was another solid quarter, on top of difficult comparisons with the prior year.  Yes, same store sales were better than forecast (up 6.7% vs. a 4.1% expectation) but gross margins and leverage on SG&A were better too.  In looking below the surface there were a couple of notable changes that stand out:


- DG’s merchandise mix showed one of the more dramatic sequential changes we’ve seen in several quarters, with consumables growth slowing and seasonal and apparel categories picking up.  Notably, apparel posted a 6.7% increase on top a 7.6% increase LY.  This is clearly a win for gross margins over time, if sustainable.  Either way, the conference call will be telling as we wait to see if management takes credit for the changes in mix or if this is simply a byproduct of comparisons with last year.


- Dovetailing on the mix comment, was a very strong performance from the company’s seasonal category.  For the quarter, seasonal increased by 20.6%.   Favorable weather was likely a key contributor, as we have seen across the entire retail space in early Spring.  Nonetheless, the willingness of the lower-end consumer to purchase incremental non-consumables is noteworthy.


- Inventory remains well controlled, but not as stellar in quarters past.  On an 11.9% increase in sales, DG’s inventories increased by 10%.  While this is still a favorable spread, see the SIGMA chart below to see the progression over the past few quarters in the company’s inventory management.


Eric Levine



R3: DG: Looking at the Drivers - DG SIGMA




- GIII’s push to transform outerwear specialist Andrew Marc into a lifestyle brand continues. Management believes category extensions for the brand are “endless”. As such, the company recently announced the license of the brand for Men’s denim and sportswear with Jones New York. The men’s business will be built under three sub-brands, which are expected to be sold through specialty and department store channels. Other recent licenses include men’s small leather goods, luggage, footwear, and women’s accessories.


- Keep an eye on the Boomerangers. Who are these people? Defined as young adults who have moved home with their parents after living away and being independent, this newly defined demographic is growing. Approximately 13% of parents report Boomerang children according to a Luminosity poll. Marketers are becoming more excited about this niche category of consumers due to their ability to influence self-purchases as well as those made by their families living under the same roof.


- Add Crocs to the list of footwear companies looking to capitalize on “barefoot” technology. While toning has certainly received a disproportionate share of attention, let’s not forget the growing belief that we’re all better off walking around barefoot (for health and anatomical reasons). Building on this concept is Crocs ABF, short for “as close to barefoot as it gets”. The new sandals come in a variety of colors and designs, priced from $19.99 to $29.99.





Puma to Consider More Acquisitions - Puma will consider further acquisitions if any potential target complements its offerings. CEO Jochen Zeitz said: "I can well imagine making acquisitions so long as these are complementary to Puma and move it forward." Puma acquired the golf equipment brand Cobra, which it bought in March from US diversified consumer products company Fortune Brands Inc. In terms of Puma's prospective growth, Zeitz said the company still believed it had the long-term potential of generating sales of more than 4 bn euros ($4.88 billion) despite the recession. <fashionnetasia.com>

Hedgeye Retail’s Take: With sales stalled at ~€2.5Bn over each of the last 3-years, acquisitions are critical to Puma’s goal of achieving of €4Bn in sales. The company can also be very liberal with its definition of “complementary” acquisitions given its brand exposure in running, football, baseball, cricket, and motorsports in addition to soccer.


Indian Garment Exports Down 2.64% in '09 to '10 - After new data showed the value of the country's garment exports fell by 2.6% in the year to March, Indian apparel exporters are calling for a tax on cotton yarn exports again.  <fashionnetasia.com>

Hedgeye Retail’s Take:   Either way you slice it this is yet another contributing factor to rising costs. 


Vietnam Leather Export Target May be Unattainable - Vietnamese leather and footwear industry is concerned that the sector might not be able to reach the 2010 export target of US$5.3 billion. <fashionnetasia.com>

Hedgeye Retail’s Take:   With more and more chatter that China costs are on the rise (driven by wage increases, labor shortages, and raw materials) is now the time for Vietnam to cut price and take back share?


Nike Introduces a Heart Rate Monitor Training Device - Nike, Inc and Polar have introduced the Polar WearLink+ that works with Nike+, enabling users to run and train with heart rate monitoring. This new product works with the Nike+ SportBand and the Nike+ iPod Sport Kit, enabling users to run and train with heart rate monitoring for the first time. It is worn comfortably around the chest and transmits the user's heart rate wirelessly to their Nike+ iPod Sport Kit or SportBand. It will improve the training experience of Nike+ users helping them to understand how hard they are working in any given run. <sportsonesource.com>

Hedgeye Retail’s Take: The latest innovation in self-monitoring workout accessories for Nike athletes serves as a reminder that many stay fit the old-fashioned way – they earn it.


BEBE and 90210 Partner for Contemporary Line - Bebe Stores Inc. and CBS Consumer Products are partnering on a Bebe for 90210 contemporary clothing collection based on CBS Television Studios’ “90210” series for The CW. It’s a collaboration between producers and wardrobe stylists from the show and Bebe’s creative design team. The line will be introduced simultaneously on-air and in stores. The label will launch in conjunction with new episodes of the series’ third season this fall and include styles worn by characters in the show along with products inspired by the series. <wwd.com/retail-news>

Hedgeye Retail’s Take: Capitalizing on its Californian heritage, you have to tip your hat to Bebe and its recent moves partnering recently with the Kardashians and now 90210 in an effort to stay relevant.


Hermès International Cautions Growth to Slow in Back Half - Sales at Hermès International rose even faster in April and May than the 18.5% increase registered in the first quarter, but these growth levels should drop off in the second half, CEO Patrick Thomas said Monday. Sales continue to progress at an extremely good rate for the time being, in fact at a rhythm superior even to the first quarter, especially in watches. The CEO added, “This very strong growth in the first half of the year must not prompt us to overestimate our forecasts for the end of the year.” <wwd.com/business-news>

Hedgeye Retail’s Take: Not exactly a surprise here as comps get increasingly less favorable and pent up demand wanes over the balance of the year.


Paris Stores Denied Bid for Sunday Trading - City Hall rejected some Paris department stores that bid to lift a ban on Sunday trading. In a joint statement Monday, the retailers said Mayor Bertrand Delanoë had turned down an application to classify the shopping district around Boulevard Haussmann as a tourist zone, which would have given them the green light to open every Sunday like stores on the Champs-Elysées. Such a move would have boosted tourism and the local economy by generating additional revenue and creating at least 600 jobs, they argued. <wwd.com/retail-news>

Hedgeye Retail’s Take:  Gotta love the archaic old-school laws.  Anyone try to shop in Bergen County, NJ on a Sunday?


Li&Fung To Produce More for TapouT - TapouT, a mixed martial arts apparel and gear brand, has extended its licensing deal with LF USA, a subsidiary of Li & Fung Limited, to include men's and juniors' sportswear. LF USA's Wear Me Apparel division will produce and distribute the sportswear under the TapouT and MPS brands. The division has produced product for TapouT since 2008. The new TapouT sportswear will hit retailers next month. <licensemag.com>

Hedgeye Retail’s Take:   Keep an eye on this growing apparel and footwear category, which appears to be gaining momentum.  While MMA has been around for a while, we’re just beginning to see sizable company’s taking advantage of the growing market.  Just last week, Payless CEO Matt Rubell highlighted a similar opportunity with its MMA brand, Strikeforce.



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