R3: Bill Gets It



August 06, 2010


“Expectation is the Root of All Heartache” – William Shakespeare. That’s one of the most common phrases used in our office. With 60% of retailers missing sales expectations in July vs. 52% in June and 28% in May, this is more relevant than ever.





R3: Bill Gets It - 1



- Teens: ANF outperformed as it beat estimates while ARO and AEO missed meaningfully

- Department Stores: JCP underperformed with a miss versus its peers M, SKS, and KSS

- Discounters: Disappointing with misses across the board with ROST standing out as the worst in the group



- Food: Called out as a top performing category by COST, BJ, and TGT

- Home: Performed well for TJX, ROST, COST, TGT, and SMRT; weak for DDS and BONT

- Children’s Apparel:  underperforming category in July for BONT, TGT, and ANF; positive for SSI

- Inventories: across the board inventories are still declining on a per square foot basis

- Margins: merchandise margins continue to grow, in a few cases because of fewer promotional events which hurt top-line

- Denim: mixed results with ANF citing weak denim while GPS noted strong

- Shoes: strength noted by BONT, DDS, SKS, ROST

- TV/Home Entertainment: weak trends noted by TGT, COST, BJ

- Back to School: Back to School continues the trend of getting pushed back further as consumer shop closer to the event, weakness in overall trends for July can be partly attributable to less school shopping in July



- California: remains a negative callout, notably it turned negative for ROST and called out negatively by TGT

- South: best performing region for ZUMZ, ARO, KSS


Raised Guidance/High End of Guidance

- LTD: raised to $0.34 - $0.36 vs. $0.27 - $0.32

- ZUMZ: raised to -$0.02 to -$0.03 vs. -$0.07 to -$0.10

- ROST: raised to $1.06 - $1.07 vs. $1.00 - $1.02, due to shift in distribution cost from Q2 10 to Q3 10

- TJX: guided to high end of $0.70 - $0.73 guidance


Lowered Guidance/Low End of Guidance

- HOTT: lowered to -$0.14 vs. -$0.07 to -$0.10

- ARO: guided to low end of previous guidance, $0.45 - $0.46 vs. $0.45 - $0.48

- AEO: guided to low end of previous guidance, $0.12 - $0.13 vs. $0.12 - $0.16

- WTSLA: guided to low end of previous guidance at $0.02 vs. $0.02 - $0.04

- JCP: guided to low end of the previous guidance $0.05 - $0.08

- SSI: guided to low end of the previous guidance $0.26 - $0.30





- Despite expectations of cost inflation, WRC is one of the few retailers calling for gross margin expansion in the 2H driven by growth both at retail and internationally. Retail performance in July was particularly noteworthy with domestic comps accelerating in July to up +10% from LSD in Q2 as well as in Europe up +14% from +2.7% in Q2. Contrary to recent trends, Italy (WRC’s largest market in Europe) was one of the strongest regions in July up +16% from +6% in Q2 – undoubtedly catching the ear of GES shareholders.


- Add home to the list of 30+ categories LIZ will have at JCP in the 2H beginning next month. While new to the LIZ lineup, we expect additional category extensions are likely as the company looks to leverage core strengths of its new partner.


- With a shift underway towards direct/retail, CROX is clearly focused on ramping its Asia business having accounted for nearly 50% of new stores openings in Q2 and plans to open five new websites in Asia starting this quarter. With international accounting for 60%+ of total sales and aspirations of building China into a business nearing $100mm over the next 3-years, the success of these efforts will be closely followed by many.




NPD Bullish on Back to School Outlook - According to a survey conducted by Port Washington, N.Y.-based The NPD Group Inc., fewer consumers are reporting plans to spend less this year. Only 38% of consumers polled say they will shop less for back-to-school, compared with 44% of consumers last year. While school supplies top consumers’ shopping lists, footwear is also a priority. This year, 45% of shoppers plan to buy shoes during back to school, compared with 39% last year. And though shoppers said they are feeling better about buying this year, they are in no rush to begin the back-to-school shopping season. Only 3% of those surveyed have already started making purchases, compared with 6% who had begun by this time last year. When consumers start their shopping, most will head to national chain stores, followed by mass merchants, office supply stores, department stores and footwear specialty stores. <>

Hedgeye Retail’s Take: I always take these surveys with a grain of salt. But so interesting to see apparel and footwear actually gaining share in planned purchases this fall.  Two factors, however, are that 1) people do not plan for inflation in food, or other more essential categories . 2) No one plans for a double dip – or any other pinch to their wallets that might make that ‘plan’ for a third cashmere sweater seem less appealing.


 R3: Bill Gets It - 2


India Sees Cotton Prices Stabilize With Strong Season - India, the world’s second-biggest exporter of raw cotton after China, is positioned to produce a healthy harvest this year that could help lower world prices and lift global garment manufacturers. During July, the wettest month in India’s June-to-September monsoon season, farmers planted 9.5 million hectares of cotton, up from 8 million last year. Cotton farmers have been encouraged to plant bigger crops to cash in on higher prices amid concerns over global cotton shortages. The U.S. Department of Agriculture has warned that demand this year may outstrip supply. World cotton production is forecast to increase to 113.9 million bales in 2010-11, an 11 percent increase from 102.9 million bales in 2009-10, the USDA said. However, world consumption may rise to 119.1 million bales next season from an estimated 115.9 million. India’s repeal of curbs on raw cotton exports also has given a boost to cotton farmers.While that’s good news for Indian cotton farmers and global textile manufacturers, especially in textile-dependent countries such as Pakistan and Bangladesh, Indian garment manufacturers are unhappy the ban has been lifted. As prices rise and cotton stocks fall, their margins could suffer.  <>

Hedgeye Retail’s Take: With prices up over 10% since the end of June and back at peak levels upwards of $0.85 /lb. last seen in early 2008, this crop will be one of the more highly anticipated in years as a strong yield is critical to keep prices from hitting new heights in the near-to-intermediate term.


Online Retailer Yoox Continues to Grow - International expansion and brisk orders pushed Yoox Group’s revenues up 39.2%. The 10-year old online retailer also manages e-commerce sites for designer brands such as Marni, Emporio Armani, Roberto Cavalli and Pucci. Sales in North America rocketed 85.8%, while Japan surged 51%. With a monthly average of 8.1 mm visitors, Yoox said its orders in the first half rose to 717,000 from last year’s 536,000, with an average order value of 174 euros or $231. <>

Hedgeye Retail’s Take: The initial growth of these models is obvious. The bigger question is the scalability thereafter. No one has succeeded yet, and there appears to be little about Yoox’ model that will allow it to succeed where others have failed.


Switzerland's Swatch Group Sees Strong Demand in 1H and Solid Growth in July - Strong demand for timepieces across all segments and regions helped grow sales 24.1% for 1H, sharply outperforming overall Swiss watch exports during the period. Growth has been solid in July, and they expect a strong result for the second half of 2010 in terms of both sales and profit. The major challenge will be to quickly overcome the capacity bottlenecks which already exist in some production areas. <>

Hedgeye Retail’s Take: Missing out on top line opportunity due to capacity constraints is embarrassing. That said, the demand for the product is definitely notable given that Swatch is squarely in the mid-zone of the casual timepiece pricepoint.


Asics America Corporation Saw 17% Sales Growth in 1H - For the second quarter (April-June) all categories are seeing double-digit growth, which is in line with the momentum from the first quarter of 2010. Growth was attributed to a 20% increase in apparel and accessories while retail distribution expanded product offering for volleyball, wrestling, track and field, and field hockey.  Footwear remains strong at a 15% growth rate. <>

Hedgeye Retail’s Take: Initially, the headline struck me as added fuel to the fire that Running footwear continues to outperform. But on the flip side, isn’t it interesting that a running brand like Asics mentioned 4 sports that aren’t running? Either the category is slowing, or they’re managing around increased competition from Nike, UA, and even SKX.


Columbia Sportswear to Acquire OutDry Technologies - Columbia Sportswear Company signed an agreement to acquire OutDry Technologies S.r.l., which owns the intellectual property and other assets comprising the OutDry brand and related business, via a cash purchase from Nextec S.r.l., based near Milan, Italy. The transaction is expected to close during Q3 and will not have a material effect on the company's 2010 operating results. OutDry's technology is the 'gold standard' for producing waterproof, breathable footwear and gloves that outperform products still relying on the 25-year-old method of internal booties and bladders. OutDry will be deployed across COLM's portfolio of outdoor brands, including Columbia, Mountain Hardwear, Sorel and Montrail.  <>

Hedgeye Retail’s Take: This deal will undoubtedly be overshadowed by the company’s highly anticipated Omni Heat launch, but firm’s focus on delivering innovative technologies is clear – whether it be organic or by acquisition, Columbia is taking the right steps towards rebuilding the brands authenticity.  


Strid Rite Rebrands Robeez - Robeez is officially moving under the Stride Rite banner. The baby shoe brand, which was acquired by Lexington, Mass.-based Stride Rite in 2007, will now be branded as Robeez by Stride Rite. According to the company, the move is designed to better streamline Stride Rite’s product offering and make the different developmental stages of the collection more understandable for consumers. Robeez by Stride Rite will continue to offer its Soft Soles and Mini Shoez collections, geared toward pre-walkers and early walkers. The Robeez Tredz line, designed for more confident walkers, will be discontinued. <>

Hedgeye Retail’s Take: The consolidation makes sense. At this point, PSS’ biggest focus will increasingly to get more content – even acquired content – into its Payless stores. Getting the house in order for its existing content first makes a lot of sense here.


ZQK Introduces New Junior Line - Quiksilver is trying to lure teen shoppers from fast fashion with a new junior line to be marketed under its namesake brand. Starting next spring with more than 100 pieces, the line is intended to complement the surf styles from the company’s existing junior label, Roxy, and serve as a bridge for customers to its two-year-old young contemporary line sold under the Quiksilver label. Roxy targets a 17-year-old customer, the junior collection aims to reach a 19-year-old, and the young contemporary line pursues women age 25 who have outgrown Roxy and other junior brands. Seeking a quick global launch of the junior line, Quiksilver hired Pencil on Paper Studio, not the first time it has used some outside resources to augment design, but this is the first time it has outsourced an entire line. Priced similarly to Roxy, ranging from $24 for T-shirts to $88 for dresses, the junior line is promoting what Florie called “modern coastal classics.”  <>

Hedgeye Retail’s Take: Natural extension in an effort to maintain customer retention – this is a solid step by ZQK to leverage one of its core brands (Roxy) to help ensure the success of its young contemporary line. The concern we’d have is that the attempt to lure a consumer away from fast fashion is probably a losing one – unless your spot-on with what the consumer wants and needs.


Victoria's Secret Launches NFL Team Branded Clothing - The National Football League and Victoria's Secret Pink have teamed up for a co-branded clothing collection to hit stores Aug. 10. The line will include tees, sweats, hoodies and tanks with the names and logos of the Chicago Bears, Dallas Cowboys, Denver Broncos, Minnesota Vikings, New England Patriots, New York Giants, New York Jets, Oakland Raiders, Philadelphia Eagles, Pittsburgh Steelers, San Diego Chargers, Washington Redskins and Carolina Panthers. <>

Hedgeye Retail’s Take: This makes more sense than one might think. Mariah Carey arguably started the trend in 2003 by wearing a Jordan #23 dress at the NBA All-Star game. Since then, wives of NBA players, and more importantly, European Footballers, have been requesting similar garbs. It makes perfect sense for the NFL and MLB to get involved.


Kmart Rolls Out Kmart Smart Campaign for BTS - Kmart Smart is Kmart's value proposition for back-to-school this year with a three-pronged strategy involving more fashion, more value, and more ways to shop. In apparel, Kmart has introduced three new brands. In addition to GLO [the Jones Apparel Group jeans and accessories line], there’s also Dream Out Loud by Selena Gomez, Bongo and Rebecca Bonbon. More value is presented in lower prices and higher quality product with a longer shelf life. More ways to shop is seen in mobile apps and  <>

Hedgeye Retail’s Take: This is counter to what we’ve seen by other retailers that have pared back the number of brands offered…we’ll see if others care to follow Kmart’s lead. Our sense is no. Is it me, or is ‘Kmart Smart’ one of the biggest Oxymoron’s in retail?



UK Shop Price Inflation Unchanged, Food Inflation Increases - Overall shop price inflation remained unchanged at 1.5% in July. Food inflation increased to 2.5% in July from 1.7% in June. Non-food inflation slowed to 1.0% in July from 1.4% in June. Shop prices have remained stable largely due to aggressive discounting driving non-food inflation down to its lowest rate since November 2009. The price of furniture and flooring fell for the first time in seven months. Food inflation was higher than the previous month - driven by global factors putting pressure on the cost of fresh food, such as meat and fruit. The recent dry weather has increased the price of animal feed and poor harvests have reduced some fruit crops. Problems with production in large wheat exporting countries, such as Russia and Canada, could put pressure on overall food inflation in the coming months.  <>

Hedgeye Retail’s Take: Now that Russian Prime Minister Putin as officially banned grain exports through year-end, expect more of the same in terms of rising food inflation.




The brand management story of a few years ago hasn’t materialized.



Was anyone wondering where those supposedly lucrative resort division and the CityCenter management fees were hiding?  We were and we’ve discovered they reside in the $102.3 million revenue line item Management Operations.  Not bad until you look at the profit, or should I say loss contribution of the division.  Management Operations lost $3.7 million in the quarter.  And we thought development fees and management contracts brought fat margins.


That is why we had a chuckle when one analyst suggested that MGM should look at spinning off that part of the business to get a Four Seasons multiple.  Oh yeah?  I don’t recall Four Seasons generating negative margins on their fee business.  To be fair, no MGM branded hotels have opened yet so there is potential.  However, MGM has a long way to go before their brand moves into the same category as Four Seasons.  On second thought, MGM isn’t even known for non-gaming hotels so Sheraton would even be a stretch at this point.


We’ve gotten comfortable with the higher R&D. Here we’d like to address the incremental $40m in capital investment.



Unlike the R&D which is expensed as incurred, WMS will capitalize the $40 million in incremental Capex.  Investors are not freaking out about that as much as the $10 million R&D ramp which is strange as both expenditures are investments with real ROI.  Oh well, we thought we’d address the additional spend here:



The $40MM of incremental investment

It’s actually 3 buckets:

  • Italy (1/3)
    • Concessionaire is in the US right now as we speak finalizing the details of their contract with WMS, with initial placements expected in December
    • Since Italy will be lease market, initial December placements won’t have much impact in the quarter but will ramp through the year.
  • Leased games (1/3)
    • Operators want to lease more games from WMS rather than buy all of them 
    • As they extend their efforts in Class II, they’re willing to commit capital to that 
    • Don’t have any specific deals in mind, but there are many operators that prefer to lease right now rather than commit capital to purchases
    • For example, Harrah's preference at the moment is to lease vs. purchase.  While their budget for game purchases is almost zero, they did make a huge increase in their capital budget for leasing games this year.
    • Florida is another market where the preference is to lease vs. own, since leases are tax deductible. 
    • WMS can always recycle leased boxes for use in their participation install base should they roll off in a short period of time.
  • Growing and refreshing their participation base (1/3)
    • WMS's entire participation base is on the Bluebird 1 ("BB1") platform, which was first released in December 2003
    • As those games age and need refreshing, WMS will replace them with fresh content on the Bluebird 2 cabinet, transitioning the base to their new platform over the next few years.
    • The reason that they have continued to put out their participation content on BB1 is because BB1 has been a cheaper platform for them and customers don't care since the content was so unique. 
    • So for example, even the new Lord of the Rings, which was created to run on a BB1 or a BB2 platform, is initially being released on repurposed BB1 cabinets that are only 2-3 years old

Early Look

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Headlines on the soaring price of wheat abound this week, but prices across the board are trending higher.


Back in November 2009, I wrote a post titled “RESTAURANTS – CHART OF THE WEEK”, detailing the risk to forward earnings for the restaurant space by rising food prices.  Looking at an updated version of the same chart I posted that day, the CRB Foodstuffs Index, it is clear that the risk is still very much alive. 


The CRB Foodstuffs Index is made up of the following: butter, cocoa, corn, hogs, lard, soybean oil, steers, sugar, and wheat.  


The index reflects spot prices and not the highly volatile prices for future delivery.  As you can see below, the index is only 15% below the peak reached in July 2008.


The prospect of food inflation and how the industry/individual companies deal with it (do they raise prices or not) will separate the have and have not’s.  To be sure, inflation pressures and the potential impact on margins in 2011 will be a hot topic in the 3Q10 earnings season. 


IT’S NOT JUST WHEAT - foodstuffs


Howard Penney

Managing Director


As we look at today’s set up for the S&P 500, the range is 19 points or 1% (1,115) downside and 0.7% (1,134) upside.













Bad To Worse

“I toil beneath the curse,

But, not knowing the universe,

I fear to slide from bad to worse.”

-Alfred, Lord Tennyson


Keith was off managing domestic risk last night taking his wife out for their anniversary dinner, so I’ve been handed the pen for the Early Look this morning.  Later today our firm will be having our annual picnic at our colleague Todd Jordan’s lake house in rural Connecticut.  It has just been over two years ago since we welcomed our first client, and the growth trajectory since has been meteoric.   On behalf of all of my teammates I’d like to thank all of our clients that have helped make this possible.  It has been a pleasure working with every one of you.


We now have close to forty employees.  We have three offices around the globe, with plans to open our fourth this fall.  And with the pending launch of Energy Sector Head Lou Gagliardi in September, we will have seven senior sector heads who cover close to 50% of the SP500.  Following our firm meeting yesterday, I can tell you this, we are just getting started.


So, as I was contemplating our firm’s growth yesterday at the Hedgeye Happy Hour following the firm meeting, I was also mulling over the future economic growth of the United States.  While I’m not in the double dip camp, I do “fear to slide from bad to worse”.  As Lord Tennyson would say.  (Incidentally, Tennyson is the second most quoted person in the English language after Shakespeare.)


Earlier this week, Keith and I presented to our clients on the topic of U.S. Sovereign Debt.  Debt and deficit issues in the United States are not exactly non-consensus as they are widely discussed and contemplated.  In fact, in the spirit of “watch what they do and not what they say”, we had the second Obama administration economic official resign today in Christina Romer, the chair of the Council of Economic Advisors.  This of course comes on the back of the July departure of Peter “The Paparazzi” Orzag, who ran the Office of Management and Budget.  Watch what they do and not what they say . . .


Undoubtedly, both Orzag and Romer have come to the same realization as us, which is that U.S. economic growth is poised to slow in coming years.  In our presentation on Tuesday, we narrowed this projection down to one key variable in our multi factor, chaos theory based model.  This factor is sovereign debt.  So if you are staffed with managing the budget or the economy in a slow growth environment, you better either wave the white flag and go back to teaching at Berkeley (Romer), or prepare your stomach for the new reality of Bad To Worse.


While many of you have read Reinhart and Rogoff’s book, “This Time is Different”, which studies the long term implications of large sovereign debt balances,  the professors also wrote a fascinating paper earlier this year, “Growth in a Time of Debt.”  This paper looks at over 210 years of data relating to sovereign debt balances and future economic growth.  The key conclusion is that as debt-as-percentage-of-GDP crosses the Rubicon of 90%, future growth slows.  And in dramatic fashion.


According to their paper, from 1790 to 2009, for 20 of the most modern economies, as debt exceeded 90% of GDP, average annual economic growth was 1.7%.  This was compared to economic growth of 3.7% at less than 30% of debt to GDP, economic growth of 3.0% with debt to GDP from 30% to 60%, and economic growth of 3.4% with debt to GDP of 60% to 90%.  In effect, as debt as a percentage of GDP passes the Rubicon of 90%, growth falls below the average by more than three standard deviations.  As the quants will tell you, that is statistically significant!


Being the industrious young analysts that we are, we actually applied this thesis to Japan.  In the attached chart of the day, we outline this point graphically. In the last three decades in Japan as we see a step up in debt, we see a corresponding step down of economic growth with the inflection point being . . . you guessed, it 90% debt-to-GDP.  Specifically,

  • 1981 – 1989 – Japan has average economic growth of just 4.6% and an average debt to GDP balance of 64%;
  • 1990 – 1999 – Japan had an average economic growth of 1.5% and an average debt to GDP balance of 92%; and
  • 2000 – 2009  - Japan had an average economic growth of 0.8% and an average debt to GDP balance of 179%.

As they say, facts don’t lie, politicians do.  And the facts as it relates to debt and growth are quite clear, as debt climbs and exceeds the Rubicon of 90%, economic growth will slow.  If you don’t believe me, believe the 200+ years of data.


It is clear to me that, “The old order changeth, yielding place to new.”  With the new order being a meaningfully different growth trajectory for the United States than the prior thirty years.  


But as always, “Tis better to have loved and lost, than never loved at all.”


The Poet Laureate of Hedgeye,


Daryl G. Jones

Managing Director


Bad To Worse - DJEL

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%