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R3: Lew vs. Ralph

R3: REQUIRED RETAIL READING

August 02, 2010

 

I think that the ‘RL vs. COH’ argument is more interesting now than ever. With both companies reporting earnings this week, there are some important financial and sentiment considerations.

 

 

TODAY’S CALL OUT

 

Lew vs. Ralph

My inbox has had more inquiries than usual lately about the merit of owning RL vs. COH, with more people leaning towards COH. I don’t get it. There are a few considerations…

 

1)      To start, an important note from a sentiment perspective. General interest in RL has cooled off dramatically over 6-months. One of the reasons, I think, is that with the consolidation of licenses (China, etc…) and the shift in mix towards Int’l shop-in-shop, retail, and dot.com, the model has become so dang complex. Seriously…people are losing interest.

2)      Second, the reality on RL is that as it takes control of its distribution globally, and shifts from a wholesale/licensed model to a global direct-to-consumer model over multiple categories and price points, gross margin has a natural tailwind. Take dot.com for example. It is only $200mm in revenue today, but with a 75% gross margin. RL has not yet even turned on its dot.com platform in Europe or Asia, which could add another $200-$300mm in revenue and $150mm-$225mm in EBIT over 3 years. Yes, that’s $1.00-$1.50 per share alone.

3)      As it relates to Coach, I won’t debate that it’s a good brand. We all know that it is, and that the company executed flawlessly over the 10-years subsequent to its spin out of Sara Lee.  But keep in mind that this was, in large part, driven by increased unit purchases by the core consumer while Coach consistently traded her up in price point. People look at recent Gross Margin performance and think that GM% is bottoming out. But the reality is that before the ‘trade up effect’ took place, Coach’s Gross Margin rate was in the mid-50s. Now it is 72% and continues to roll-over.  Moreover, Coach is trading down in key areas to fuel its top line, and although they appear to be doing so in a way that is not hurting the brand, the reality is that when price point goes down, unit sale requirements go up to keep the top line even. In this global economy, that’s a challenge.

4)      Are margins going back to the mid-50s for COH? No. I don’t think so. But are they headed to the mid-60s? My sense is Yes.   Regardless, as long as the chart below exists, the ‘Coach is cheap’ argument doesn’t hold much water.

5)      With RL, will it’s margins ever converge with those of COH? No. The reality is that even with its geographic, channel, and product expansion, it still is primarily an apparel company, which cannot sustain 60%+ margins. But what I can say is that a) margins are headed higher over the near term, b) revenue should reaccelerate in 2011 (Mar), and ultimately, consensus estimates for RL are way too low for the quarter and the year. (I’m at $1.12 for the quarter and $5.70 for the year vs. the consensus at $0.89 and $4.68, respectively). Is it possible that RL hides some EPS this quarter in its model as a buffer for its Asia business as the year progresses? Yes. But even if it does that, we’re looking at a 1Q11 EPS number above a buck (12% above consensus).

 

R3: Lew vs. Ralph - RL image

 

 

 

MORNING NEWS 

 

The New Norm of Consumer Behavior? - Several recent research reports on consumer sentiment and shopping behavior show that Americans are not ready to open their wallets any wider this year than last. Nearly half of the people polled by BIGresearch disagreed or strongly disagreed that a financial recovery is under way. Two-thirds of the 6,648 consumer polled said they had cut back on their credit card usage and 72.9% said they didn’t plan to return to how they used credit cards before the recession. AlixPartners found even gloomier sentiments: 70% of Americans said their economic situations were the same or worse than a year ago, and 83% expect to spend the same or less on non-essential purchases in the next 12 months. Almost two-thirds (63%) do not expect an economic recovery until 2012—or later. That percentage is strikingly higher than the firm’s previous surveys. To cope, consumers are resetting their spending behaviors and focusing on value. For example, they shop at more stores but realize they can leave without buying something. They have also widened their brand considerations.  <emarketer.com>

 

R3: Lew vs. Ralph - 2 

 

China Manufacturing Faces Slowdown, Not Meltdown - China’s July manufacturing data were the weakest in more than a year as the government clamped down on property speculation and investment in polluting and energy- intensive factories. A purchasing managers’ index released today by HSBC Holdings Plc and Markit Economics slid to 49.4 from 50.4 in June. A separate, government-backed PMI fell to 51.2 from 52.1, the Federation of Logistics and Purchasing reported yesterday. Fifty is the dividing line between expansion and contraction. Officials may delay raising interest rates from crisis levels as austerity measures and unemployment in advanced economies dim the outlook for exports.  <bloomberg.com>

Hedgeye Retail’s Take: From a retail perspective, we’re looking at the relative spread between import costs from China and other Non-Japan Asia countries. These other countries know where their bread is buttered. They can’t set the tone in Asia. But those who arb the spread in costs vis/vis China will gain the most share. Translation = if you hear about China slowing (which our Macro team called 9 months ago) don’t discount other nations that will pick up the slack and pump product into our stores. 

 

Sports Participation Rankings of 2009

  • 1 Basketball, '09 PARTICIPATION 24 million, CHANGE FROM ’08: -8.6%
  • 2 Baseball, '09 PARTICIPATION 13.8 million, % CHANGE FROM ’08: -7.9%
  • 3 Outdoor Soccer, '09 PARTICIPATION 13.7 million, % CHANGE FROM ’08: -3.7%
  • 4 Touch Football, '09 PARTICIPATION 9 million, % CHANGE FROM ’08: -14.6%
  • 5 Slow-Pitch Softball, '09 PARTICIPATION 8.5 million, % CHANGE FROM ’08: -13.3%
  • 6 Court Volleyball, '09 PARTICIPATION 7.3 million, % CHANGE FROM ’08: -11.1%
  • 7 Tackle Football, '09 PARTICIPATION 6.8 million, % CHANGE FROM ’08: -11.7%
  • 8 Flag Football, '09 PARTICIPATION 6.6 million, % CHANGE FROM ’08: -10.4%
  • 9 Indoor Soccer, '09 PARTICIPATION 4.9 million, % CHANGE FROM ’08: 3.7%
  • 10 Grass Volleyball, '09 PARTICIPATION 4.9 million, % CHANGE FROM ’08: -4.6%
     <wwd.com/footwear-news>
  • Hedgeye Retail’s Take: These numbers are a year-old, but quite sad in that 9 of the top 10 sports in the US showed a meaningful decline in participation rates last year. I guess these statistics don’t count time played on a Wii.

Visa Steps Up Online Shopping Service With Rightcliq - Starting today, Visa Inc. gets serious in its battle with online giants like Google and PayPal for the loyalty of web shoppers. The world’s leading credit and debit card brand is launching a major marketing push for Rightcliq, the online shopping service it announced in March and has been testing ever since. Rightcliq provides an electronic wallet where consumers can store their payment card numbers—including those from Visa competitors like MasterCard and American Express. Visa is adding several other components as it tries to distinguish itself from competing online payment systems. They include:

  • Discount offers from participating merchants, some of them retailers that already work with the Visa Incentive Network, a targeted marketing system Visa introduced in 2005. About a third of the top 100 Internet retailers will be making offers at the outset, Visa says.
  • The ability to track in one place the delivery status of pending purchases, initially with the U.S. Postal Service, as well as to store online purchase history.
  • A browser plug in that will fill in personal and payment information on checkout pages.
  • A social component that allows consumers to drag images of products they’re considering from retailers’ web sites into a section of their Rightcliq accounts Visa calls My Wishspace and then to seek advice from their friends on those products via Facebook or e-mail.  <internetretailer.com>
  • Hedgeye Retail’s Take: Makes perfect sense.

Sears To Begin Home Delivery Services - Sears Holdings Corp., which earlier this month began offering to parts of the Chicago area home delivery of groceries, prescriptions and other items from its mygofer.com e-commerce site, plans to announce Tuesday that it will expand that home delivery option to merchandise sold in its marketplace. The option will initially be available to consumers in the Chicago, Boston, Washington, D.C. and New York City areas. The service will also allow consumers to buy online at Sears.com but pick up the order directly from either the marketplace merchant's Store or Sears stores.  <internetretailer.com>

Hedgeye Retail’s Take:  Great… the retailer that is more levered to the Housing Cycle than any other (yes, including Home Depot) is strengthening this bond further.

 

Hanes Can’t Get Enough of Michael Jordan - The basketball pro is yet again the star of new ads in an ongoing campaign for men's underwear, dubbed "Hanes Flight 23." The TV spots, breaking this week, mark phase two of a Hanes campaign—via The Martin Agency—that kicked off in May. The ads highlight new underwear with Comfort Flex waistbands, which are more stretchable waistbands now included in all Hanes men's briefs, boxers and boxer briefs. <brandweek.com>

Hedgeye Retail’s Take: MJ’s relevance to the urban consumer with Nike’s Jordan brand is unquestionable. But I gotta wonder how long MJ’s pitchman status is a positive ROI for underwear.

 

Callaway Restructures Manufacturing/Distribution Processes - Callaway Golf Company announced a restructuring of its global operations to occur over the next 18 months. The initiative encompasses the reorganization of manufacturing and distribution centers located in Carlsbad, CA and Toronto, Canada; the creation of third-party logistics sites in Dallas, Texas, and Toronto; and the establishment of a new production facility in Monterrey, Mexico. <sportsonesource.com>

Hedgeye Retail’s Take: ELY is taking down cost of manufacturing, as well as asset intensity of warehousing and delivery. If the quality of the clubs holds up throughout this, then this could be a massive event for ELY.

 

Footwear Firm Aetrex Worldwide Making Serious Waves - For Aetrex Worldwide, the next year will be one of many firsts. With sales already on the upswing, the roughly 60-year-old family business is planning a string of new initiatives, including its first concept store, a TV campaign and a line of toning shoes. CEO Larry Schwartz said 2010 has been encouraging. The Teaneck, N.J.-based company, known for its comfort footwear and accessories, experienced only single-digit growth in 2009 over 2008, but in June, business was up 20% from last year. And Schwartz said he expects similar growth through the year’s end. The company, whose warehouse can stock up to 300,000 pairs of shoes during peak periods, routinely fills orders for one or two pairs of shoes, as well as orthotics.  <wwd.com/footwear-news>

Hedgeye Retail’s Take: Great example of how toning is helping little brands redirect newfound capital into R&D.

  


WYNN: LOWER MARKET SHARE MAY LEAD TO STORY TELLING

July Macau market share was subpar which could give legs to the bear call that Encore hasn’t been additive enough.

 

 

Encore had a high ROI out of the box in Q2 but that won’t change the bear view that Encore isn’t incremental.  We think this negative thesis will actually gain momentum as the July market share numbers are digested.  As we reported today, we think Wynn’s July Table GGR Macau market share fell to 14.6%, down from May and June (both post Encore opening) of 15.6% and 17.2%, respectively.  Obviously, hold percentage is volatile – May and especially June were high – and July was probably low at the Wynn Macau properties.

 

At least for the short term – a lifetime for Macau stocks – this negative Encore narrative may dominate the discussion.  After a nice recovery, the stock could be under pressure.  We reserve the right to get positive again down the road at lower levels.


WMS: PLAYING THE EXPECTATIONS GAME

WMS reports tomorrow night and while FY2011 revenue guidance could fall below the Street, the contrarian in me thinks that may be ok.

 

 

Given the poor investor sentiment surrounding the gaming equipment suppliers – thanks in part to IGT – we think expectations are already pricing in lower FY2011 revenue guidance.  FQ4 should be fine and in-line with our $0.57 estimate although investors may be expecting a miss.  The long-term story is very powerful both from an industry and company specific perspective and the now low valuation provides a unique entry point.  We believe there are a significant number of interested investors on the sidelines because they fear the lower guidance. 

 

WMS may indeed provide revenue guidance modestly below the Street’s $852MM – we’re at $834MM – but expectations are low and the stock has underperformed.  WMS could see a relief rally due to short covering and the sidelined investors jumping in with the theory that projections will be once again beatable and the long term story remains intact.

 

If we were WMS, we would certainly capitalize on the opportunity to provide very conservative FY2011 guidance.  Investors seem to be expecting it and IGT has laid the groundwork.  Guidance will be back end loaded given the uncertainty surrounding the timing and type (for sale vs lease) of the Illinois business and well as timing issues surrounding Italy. 

 

Investor expectations may be even lower following IGT’s weak FQ3 performance and guidance.  However, we would caution investors that IGT’s slot ship share was dreadful in FQ3 and actually in the March quarter as well, so the industry overall is probably performing better.  As we’ve written about, IGT had a big one-time shipment into Canada in its FQ2 which inflated market share.  IGT is now tracking in the mid 20s% of total ship share.  In fact, WMS may surpass IGT’s ship share in the quarter for the first time in history.

 

So we’re does that leave WMS? 

  • Highest quality player in an industry at the trough of a 5 year bull slot market
  • Well positioned to steal participation revenue share from an unsustainably high level at IGT
  • Built-in growth from entering Mexico and Australia
  • Near term new markets of Italy, Illinois, and Ohio
  • The sky’s the limit on additional new state and international markets given the thirst for additional tax dollars
  • A now low valuation

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THE DAILY OUTLOOK - JUST CHARTS

As we look at today’s set up for the S&P 500, the range is 42 points or 2.3% (1,076) downside and 1.5% (1,118) upside. 

 

THE DAILY OUTLOOK - JUST CHARTS - S P

 

THE DAILY OUTLOOK - JUST CHARTS - DOLLAR

 

THE DAILY OUTLOOK - JUST CHARTS - VIX

 

THE DAILY OUTLOOK - JUST CHARTS - OIL

 

THE DAILY OUTLOOK - JUST CHARTS - GOLD

 

THE DAILY OUTLOOK - JUST CHARTS - COPPER


END OF JULY SLOWDOWN IN MACAU

July table revenues rose to HK$14.8 billion. Adding in slots should yield full month revenues of around HK$15.5 billion, up 67% YoY, but down from the 75% pace we had expected just last week.

 

 

The last week of the month slowed markedly since through the first 25 days. July’s revenues were tracking up 76% as we noted in our 7/26 post but will end up "only" 67%.  Whether the slowdown was volume or hold related, we won’t know until we get the full details.

 

The only meaningful changes in market share from our 7/26 post is that Wynn lost another 100bps and MGM dropped below 7% again.  MPEL actually increased share 20bps from an already strong 14.4% through the 25th. 

 

Here are the table revenues for the full month of July in Macau in HK$.

 

END OF JULY SLOWDOWN IN MACAU - chart1


WEEKLY RISK MONITOR FOR FINANCIALS - VERY POSITIVE

All Indicators Improved Last Week

In spite of a modest 1% rise in the XLF last week, all 8 of the 8 risk measures we track registered positive readings on a week-over-week basis.  

 

Our risk monitor looks at the following metrics weekly:

1. CDS for all available US Financials (29 companies)

2. CDS for large European Financials (39 companies)

3. High Yield

4. Leveraged Loans

5. TED Spread

6. Journal of Commerce Commodity Price Index

7. Greek Bond Spreads

8. Markit MCDX

 

1. Financials CDS Monitor – Swaps were mostly positive last week.  Swaps for 17 of the 29 CDS reference entities tightened, while 12 widened, with an average change of -1.7%.  Conclusion: Positive.

 

Tightened the most vs last week: MBI, AXP, XL

Widened the most vs last week: PGR, AON, MTG

Tightened the most vs last month: MBI, MS, AXP

Widened the most vs last month: ALL, TRV, AON

 

WEEKLY RISK MONITOR FOR FINANCIALS - VERY POSITIVE - us cds

 

2. European CDS Monitor – We include a look at European swaps to gauge risk perception across the Atlantic. Swaps for 37 of the 39 reference entities tightened, while only 2 widened, with an average tightening of almost 10%.   Conclusion: Positive.

 

Tightened the most vs last week: Aviva PLC, Assicurazioni Generali, Banco Espirito Santo S/A

Widened the most/tightened the least vs last week: Sberbank, Caja de Ahorros del Mediterraneo, Investor AB

Tightened the most vs last month: Assicurazioni Generali, Credit Suisse, Aviva

Widened the most vs last month: Banco Pastor, Investor AB, IKB Deutsche Industriebank AG

 

WEEKLY RISK MONITOR FOR FINANCIALS - VERY POSITIVE - euro cds

 

3. High Yield (YTM) Monitor –High Yield rates fell 16 bps last week. Rates closed the week at 8.44% down from 8.60% the week prior. Conclusion: Positive.

 

WEEKLY RISK MONITOR FOR FINANCIALS - VERY POSITIVE - high yield

 

4. Leveraged Loan Index Monitor - Leveraged loans rose steadily last week, closing at 1489 versus 1475 the week prior. Conclusion: Positive.

 

WEEKLY RISK MONITOR FOR FINANCIALS - VERY POSITIVE - leveraged loan

 

5. TED Spread Monitor – Last week the TED spread fell 4 bps, closing at 31 bps versus 35 bps last week. Conclusion: Positive.

 

WEEKLY RISK MONITOR FOR FINANCIALS - VERY POSITIVE - ted spread

 

6. Journal of Commerce Commodity Price Index – Last week, the JOC index rose slightly, closing at 12.6, up just over 3 points versus last week’s close at 9.5.  Conclusion: Positive.

 

WEEKLY RISK MONITOR FOR FINANCIALS - VERY POSITIVE - joc cpi

 

7. Greek Bond Yields Monitor – Greek bonds yields and CDS continued to plateau at a high level.  Last week yields fell 8 bps, ending the week at 1030 bps versus 1038 bps the prior week. Conclusion: Positive.

 

WEEKLY RISK MONITOR FOR FINANCIALS - VERY POSITIVE - greek bonds

 

8. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps.  We believe this index is a useful indicator of pressure in state and local governments.  Markit publishes index values daily on four 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. Our index is the average of their four indices.  Spreads continued to fall last week, closing at 204 versus 214 the prior week.  Conclusion: Positive.

 

WEEKLY RISK MONITOR FOR FINANCIALS - VERY POSITIVE - markit

 

Joshua Steiner, CFA

 

Allison Kaptur


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