Here's a chart from a insight created for RISK MANAGER subscribers (originally posted on August 18, 2010).
In looking over the results out of both Dick’s and Hibbett’s it would be disingenuous to say that we weren’t a bit disappointed. Both came in light on the top-line, each have their respective margin considerations, however, they both raised outlook for the full-year. Rather than looking through the quarter and chalking up favorable guidance adjustments to positive trend momentum and hopeful execution we’ve highlighted the key deltas both in the quarter and 2H as we look forward. For DKS our ‘we’re not against owning it’ positioning remains unchanged, though for HIBB, a lack of upside in margins in the quarter and marginally higher costs curb our expectation for further upside at least in the near-term. As always, our view changes as prices do, but the key is we’ll need to see an improvement in footwear trends as we enter the 2H and as the product cycle starts to pick up meaningfully before these names move up in our queue.
Thematic Call Outs:
Store Expansion: Both players remarked that 2011 will be a year of considerably more aggressive growth relative to 2010. Dick’s expects 30% store growth next year resulting in a reacceleration of square footage growth to a HSD rate up from low-to-mid single digit over the last two years. HIBB also sees opportunity primarily rooted in existing real estate opportunities at Movie Gallery and Blockbuster locations as well as adjacent states. Interestingly, while HIBB maintained its goal of closing 10-15 underperforming stores by year-end, DKS announced that it will be closing 12 Golf Galaxy locations in 3Q – an incremental and positive change that will be immediately accretive to profitability and earnings albeit small. Most importantly, while some will call for Dicks increasing focus on expanding into smaller format stores as a direct threat to the Hibbetts model, the reality is that just isn’t the case. While the new format is similar in size to new Sports Authority stores at ~35,000 sq. ft., it remains well above the average 5,000 sq. ft. Hibbett store and will still be targeted for considerably larger markets.
Category Trends: The bottom-line here is that while all three categories (footwear, apparel, and hardlines) comped positively for both companies, footwear came in softer and is clearly not materializing at the rate we have been expecting. Comps across three key retailers over the last 2-days (DKS, FL, HIBB) have all come in lighter than our expectation particularly those with greater exposure to footwear. While much of the new product that we’ve been highlighting during the year isn’t expected to start hitting floors until now, without commensurate demand sales could be softer yet again in the 2H.
Product: The outlook for basketball appears mixed with DKS far more upbeat reflecting strong momentum with Nike collaborations while HIBB was more cautious on the category citing weak launches as the cause for a challenging 2Q and modest participation in 2H launches. In addition to Nike product, the new Under Amour shoe and Reebok’s Zig remain key launches in basketball. Running continues to be the standout category with both retailers optimistic on toning, particularly in Q4 driven by accelerated marketing initiatives.
In apparel, Columbia’s OmniHeat commands all the buzz. DKS has significantly more exposure to the brand and is positioned to benefit more significantly if consumers believe the technology is as evolutionary as Columbia suggests. Importantly, Hibbetts committed to Columbia earlier this year and expects to have the brand in ~50 stores by year end as compared to some 350 stores in which North Face is carried. This is the most significant apparel launch to note for sporting goods retialers heading into the 2H hands down.
Inventories: As seen in the SIGMA chart below both company’s sales/inventory spread remains positive and little changed from last quarter suggesting that inventories remain relatively clean. While management systems are playing a key role in driving comps with considerably less inventory than in years past, HIBB is further into the process leaving DKS with an opportunity for additional and more meaningful margin gains over the next 12-months.
Company Specific Call Outs:
So where does this leave us – a bit flat-footed actually. We’re adjusting our models for the full year with DKS shaking out at $1.52 and HIBB at $1.51 down from our prior estimates of $1.58 and $1.60 respectively. While both companies raised the outlook for the full-year, confirmation of trends through August from our trend data over the next several week will be critical before these names move up in our queue.
- Casey Flavin, Director
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Foot Locker continues to deliver on its strategic turnaround initiatives as evidenced by another quarter of sequential and year over year improvement on both the top and bottom lines. For the bears out there, we are all well aware that same store sales of +2.5% fell short of the Street’s and our expectations (we were at 4.5%). We’re not shying away from the fact that the topline is and will remain a key component of this turnaround. However, the underlying message from the company’s conference call is “profitable growth”. Gone are the days of chasing sales with aggressive promotions, selling commodity apparel at a loss, and building aged inventory over multi-year periods. 2Q results confirm that progress is well on its way towards higher sales and profits, a course which has really only been set in motion for three quarters now. For the bulls, there is plenty to chew on.
Net, net this was an essentially inline quarter driven by an impressive gross margin performance offset by a slightly weaker than expected topline. There is nothing that we see in the 2Q results that change our view on the opportunity for the company’s turnaround or our above-expectation earnings over the next 12-18 months. We’re tweaking our model a bit to reflect the lower earnings in 2Q relative our expectations, but still stand above the Street at $0.92 for the year. We continue to believe that the opportunities to improve assortment, right size inventory levels, and profitably maximize FL’s market share dominance will unfold over the next 4-6 quarters.
Conclusion: Don’t mistake yesterday and today’s weakness in the Bovespa for anything more than a global selloff due to weak U.S. economic data. At a point, U.S.-centric investors will be forced to look to places other than U.S. Treasuries and equities for a rate of return. We feel the emerging market consumer in places like China, SE Asia and Brazil will see the bulk of that investment.
Position: Long Brazilian equities (EWZ).
Today we sold our exposure to Indonesian equities for a modest 2.7% gain because we didn’t want to overstay our welcome, particularly as it relates to trade exposure to an increasingly weak U.S. consumer (10.5% of all Indonesian exports in 2009). Furthermore, we’d be remiss to suggest that exporting nations like those of SE Asia, China and Brazil will flourish if our estimate that U.S. GDP growth in 2H10 and 2011 comes in at about half of current consensus estimates. With that said, however, everything that matters in Macro happens on the margin. And in an environment where growth and trade are slowing globally, the marginal direction of domestic consumption will be paramount as it relates to where capital will likely flow.
We know what direction U.S. consumption growth is headed – down. Contrast that with the direction Brazilian consumption looks to be headed – up. As a result of favorable employment, inflation, and credit conditions, the Brazilian consumer is strengthening. Unemployment is 20bps off all-time lows, inflation has improved on the margin for the past three months (down to 4.6% in July vs. 4.84% in June), and, as a result of benign inflation, interest rate hikes have come to a halt (recent reports suggest the central bank expects 3Q inflation to come in below forecast, further reducing the risk of a Selic Rate hike).
The confluence of these three factors creates a bullish setup for the Brazilian consumer, which has been supported by recent data:
Globally, P.E.M.A.C. (private equity, M&A and capital markets) has been investing in this trend, and with the economic situation slowing in the U.S., we should see even more of this activity. According to KPMG Brazil, the number of Brazilian companies acquired by foreigners has more than doubled Q/Q in the second quarter. The 56 acquisitions (vs. 21 in 1Q10) was the highest second quarter number since the data started being tracked in 1994. Of the 77 total acquisitions in 1H10, more than one third were by American firms. It seems all that cash on U.S. corporate balance sheets that many bulls are hoping to fuel a cycle of investment domestically is leaving the country in search of higher growth and higher rates of return. Capital Chases Yield… globally. To affirm, international investors bought a net $1.35 billion of Brazilian domestic bonds in June, boosting their holdings to $13.5 billion in 1H10 – the most in three years.
As always, our style of investing requires a prudent risk management approach that is duration agnostic. Given, we will continue to analyze and interpret the near-term risks to our long position in Brazilian equities. We don’t have to be bullish on the Brazilian consumer in perpetuity or at every price, so we’ll manage risk around market reaction to the Petrobras saga and the upcoming Presidential election.
Regarding Petrobras, recent reports suggest the company and the government remain split over the price of the oil reserves which will determine the size of the company’s upcoming share offering. As a refresher, the higher the price the government slaps on the oil, the more equity Petrobras will have to issue, creating further dilution of the share base. Market sources believe the government’s consultant priced the barrels at $10-12 per barrel vs. Petrobras’ consultant’s estimate of $5-6 per barrel. ANP, Brazil’s oil regulator sees a “reasonable” price for the oil somewhere in between, around $8 per barrel. The pricing disconnect has some investors worried that the share sale, which has a Sept. 30 target (three days before the election), could be delayed as far as 2011 on speculation that the elections and earnings season will force the issuing to take a back seat. Further uncertainty and speculation from here will continue to weigh on Petrobras’ stock price and, as a result, the Bovespa (Petrobras is Brazil’s second largest company by market cap).
With regard to the elections, it appears Lula endorsee Dilma Rousseff has taken a commanding lead. The latest IG poll shows Rousseff doubling her lead to 16 percentage points over opposition candidate Jose Serra. Support for Rousseff rose to 45% from 41% in the previous poll taken during July 17-20. Serra’s support fell to 29% from 33%, while Green Party candidate Marina Silva’s support was unchanged at 8%. A candidate needs more than 50% of the vote, excluding blank or invalid ballots, to win in the first round and the trajectory of Rousseff’s support suggest a victory for her in early October. The key takeaway here as it relates to the Brazilian economy is that former cabinet chief Rousseff is widely believed to be in support of big government spending, particularly when compared to the more austere Serra. Critics agree that her support is likely a function of her affiliation with current President Lula, whose social welfare programs and increased spending earlier in the year made him a very popular man amongst Brazilian voters. Investors fear that a Rousseff-led administration would bring about inflationary government spending and central government balance sheet deterioration, as her vow to cut taxes will likely force the government to fund any increases in spending via more debt issuance. This is all negative for the Brazilian private sector (and equities), as the need for higher interest rates to fight inflation and attract capital to public debt will keep a lid on private investment and credit expansion. Time will tell whether these fears are warranted.
For now, we are comfortable with our long position in Brazilian equities.
This note was originally published at 8am this morning. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK in real-time, published by 8am every trading day.
“Each moment of a happy lover’s hour is worth an age of dull and common life.”
I love my family, my firm, and my macro model. There is no hiding love – especially after the lover’s hours we’ve had on the short side of the US stock market for the past few days and weeks. Winners love to win.
No, dear Bullish Sirs – this isn’t about slapping you in the face this morning. This is all about a man named Mucker showing you the love. The love of something that brutish men of markets could never understand – the love of a woman.
If Aphra Behn were to join the ranks of we who are wedded to our writings, I think she’d have sufficiently stirred the pot of conventional market wisdoms too. In the 17th century she became one of the first professional female writers in England. Per Wikipedia, “She has since become a favorite among sexually liberated women.”
Having been ball-and-chained to plenty a Wall Street trading desk in my day, the liberation associated by this great country’s freedom of speech has made me a very happy man. The love I have of seeing the conflicted and compromised walls of the Fiat Republic fall has no end.
Being Nemo in the fishbowl has its perks. I get fed a lot of emails. Most of the notes that people take the time to send me are very thoughtful and additive to my risk management process. Once in a while, I get sent something very special.
While the bullish brutes were running up the buy-and-hope score in July, an interesting player in this game made my day. He sent me a note that accused me of being married. He wrote, and I quote, that “you sound like a wife defending her husband."
Now, both on and off the ice, I have been called a lot of things in my day, but never a wife. If I could be someone’s wife, I would definitely be Laura’s.
Altogether, being wed to a view in this business can be as dangerous as being single minded. Being wed to a flexible, multi-factor, and multi-duration investment process is something I may forever wear as a badge of honor that some men in this business will love to hate. I’m cool with that though – I don’t foresee seeking the love of another man.
Let’s end this diatribe with what players in this game really feel. They hate being wrong. They love being right. For me, I have been happily wed to the bearish view since I put it on the tape on April 16th. Let’s get back to the positive messaging I am working hard on this week – winning and the love:
1. Unemployment – yesterday’s jobless claims number was an absolute bomb. As my teammate Allison Kaptur summarized yesterday, initial jobless claims rose 12k last week to 500k, the highest level since November 2009. Consensus had called for a small decline. Rolling claims rose 8k to 482.5k, also the highest level since last November. We have been looking for the range of 375-400k as the maximum level for unemployment to fall meaningfully, but with claims moving the wrong direction, the spectre of rising unemployment looms.
2. US Economic Growth – JP Morgan joined Goldman Sachs yesterday as the latest sell-side firm to cut their GDP estimates for the back half of 2011 closer to ours. As a reminder to all of those who are wedded to the bullish case that “earnings are good and US growth is good”, there is a very high likelihood that US GDP growth comes in at or below the Hedgeye estimate (established via my love letter dated July 1, 2010) of +1.7% for Q3.
3. US Housing Double Dip – we fully realize that our current 2011 US GDP estimate of +1.7% doesn’t equate to what newsy pundits call a “double dip.” To be clear, we are calling for a significant sequential slowdown in US GDP growth over the course of the next 3-6 months and an acturial “double dip” in US Housing prices over the course of the next 6-12 months (our Q3 Macro Theme call for Housing Headwinds lays out the case for US Home Prices in the Case-Shiller series to drop -15-20% from the cycle-highs that are being established here in Q3).
Now what would my lover’s hour of watching the US futures trade lower again this morning be without giving my bullish friends both a line and a catalyst?
1. The Line – the next line of immediate term TRADE support for the SP500 is 1058. Below that, the gravitational forces of chaos theory don’t signal any significant support for the SP500 until 1041. That line would register as a 3 standard-deviation move in our immediate term model and a very good spot to be covering shorts, buying some longs, and loving happy hour thereafter.
2. The Catalyst – the next catalyst is starring us right in the eye on August 24th when the next bomb is dropped on the bulls barns via Twitter, Facebook, and email in the form of the US Existing Home Sales report.
As Oscar Wilde said, “the world has grown suspicious of anything that looks like a happily married life.” But the investment world as the Fiat Republic knows it is ending.
‘Tis Lover’s Hour in New Haven, CT. Stay transparent, my friends.
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