PVH: The Ultimate Consensus Long?

PVH: The Ultimate Consensus Long?


PVH is a consensus long. Period. The interesting thing is that the Tommy deal structurally makes sense, but the narrative behind how, why and when is not pretty by any means. While the world loves PVH, bears might have to wait another 3-quarters until the $300mm cookie jar is empty for some thesis validation.


This is one of those consensus longs that bugs me so many levels, but to fight the tape on a name that has a $300mm cookie jar to fuel earnings over the next year is a tough one. I love how management says that the Tommy Hilfiger deal will be $0.30-$0.35ps (10-12%) accretive, but this excludes $3.21 per share in integration costs. So let me get this straight… they’re going to INCLUDE the revenue and operating profit on the base business – but will EXCLUDE the costs to realize it. The only thing that’s worse is that the Street is taking the bait.


The irony here is that I actually think that the combination makes sense. It gives PVH significantly greater exposure to Europe – where the Tommy brand has always been exceptionally strong (despite its roller coaster ride in the US), and further diversifies PVH away from its legacy dress shirt business – which might be dominant with 46% share in department stores, but it is a price taker in a commodity category. Now the legacy biz is down to 10% of sales and 8% of EBIT vs. 23% and 22%, respectively last year (and over 75% before Calvin).


But as much as I can justify the deal, let’s not forget the fact that PVH NEEDED this. This is not Manny’s first rodeo. He saw what was coming. PVH is capping off a period where CK drove the business and then – like most other companies in retail – relied on extremely tight inventory management pushing peaky gross margins. Tack on a 4% decline in G&A due to corporate workforce cuts (400 positions at about $40mm) and write downs at Geoffrey Beane, and PVH realized 7% EBIT growth last year on a 4% sales decline.


Now, the company begins to go up against extremely tough compares on the gross margin and SG&A lines, and must rely on sales. But without the consumer showing up en masse, the company needs a PVH-specific product driver for the core business – and it would have needed to have been investing in that for the past 2-years. Either that, or it could have simply gone out and bought growth – a la Tommy.


The icing on the cake is a complete reclassification of the reporting segments. In all fairness, this is likely the proper thing to do as GAAP accounting states the company must report in a way that it runs its business – and the business structure has changed. But the reality is that the reclassification clouds the water as it relates to understanding the real trajectory of each of PVH’s units.


This note sounds like sour grapes. That’s not intended. I call the narrative for what it is, and will model it accordingly. Keith will guide with timing and sizing on either side. For now, this is a ‘Do Nothing’ stock -- though I have a fundamental bias to the downside 2-3 quarters out.



FYI: An interesting comment from management on the call about inventories. Good perspective. Sounds like the lynchpin is whether the department stores are correct in modeling 2-4% comp store sales.


I guess I'll speak on inventory levels at retail. I think the retailers -- we went through nine months starting in the third quarter of last year where retailers were chasing inventory consistently from suppliers and because of the availability of production piece goods, in that time frame you were able to react quicker. There was production availability. You were able to get it in. You were able to do what was necessary, fly goods, do whatever. There was transportation available. As demand really started to dramatically improve in the fourth quarter of last year, coming into 2010, clearly production started to fill up. You know all the stories about all the transportation issues. We were very clear with our retail partners. If you want goods, it's going to be very difficult to chase in the second half of 2010. You're going to have to get the orders. So the retailers were forced to really get ahead of the sales trend and they're buying into whatever their planned comps are. We're seeing that in our business and right now I would say to you inventories are in good position. We're in excellent shape at retail. The sales plans with our key customers seem to be running ahead. Clearly inventory's in good shape and they've bought into their 2% or 4% comp store increase depending whatever it is, the retailers have basically bought into that.



The chart was extracted from a note dubbed "HOPE FADING BUT ON ITS HOLD UNTIL DECEMBER" issued to Risk Manager Subscribers earlier today, September 8, 2010.




The chart below details where the unemployment rate would be if the labor force participation rate was at its ten-year average level of 66.1%; for the year-to-date, it has been averaging 64.8%.  This implies that many folks are losing heart and dropping out of the job hunt.



CHART: HOPE FADING... - chart1


Easy comparisons and a beneficial cost environment should translate into strong fiscal 1Q11 results.


Darden is scheduled to report its fiscal 1Q11 earnings after the market close on September 21st.  The company is lapping extremely easy blended same-store sales comparisons in the first half of the year of -5.3% and -4.7% in 1Q10 and 2Q10, respectively.  Of the three larger concepts, the comparisons are particularly easy at Red Lobster as comps declined 7.9% and 8.4% in 1Q10 and 2Q10, respectively. 


These easier comparisons should allow Darden to report positive comps during 1Q11 even if trends slow slightly on a two-year average basis.  That being said, given the current macroeconomic backdrop, I continue to think the company’s full-year same-store sales guidance of +2% to +3% could prove aggressive.  Lower food costs in 1H11, lower YOY labor costs as a percentage of sales, expected incremental cost savings initiatives of $10 to $15 million and accelerated share repurchase during fiscal 2011 leave me less concerned about the company’s ability to achieve its 14% to 17% EPS growth target.


For reference, casual dining same-store sales trends on a two-year average basis, as measured by Malcolm Knapp, slowed about 50 bps through the first two months of Darden’s fiscal 1Q11 (June and July) from the prior quarter.  Darden’s reported results will provide the first real glimpse of casual dining trends in August and insight into whether or not the industry was able to sustain the sequentially better results from July on a two-year average basis after posting declines for the prior three months.


Increased leverage from positive same-store sales growth, combined with the expected beneficial cost environment, should lift margins during the first quarter and for the entire first half of the year.  The company guided to continued food costs favorability during fiscal 1H11 but expects costs to level out during the second half of the year.  To that end, management has good visibility on its food costs through the first half of the year as it has contracted most of its commodity needs through December.


Also helping YOY margin growth during fiscal 2011 is the fact that the company is lapping significantly higher labor expenses as a percentage of sales from fiscal 2010, largely in the first half of the year.  Management attributed these higher labor costs in fiscal 2010 to sales deleveraging, increased benefit costs, wage rate inflation and higher manager bonuses.  For fiscal 2011, the company guided to lower labor costs as a percentage of sales and I would expect the biggest YOY benefit to come during 1H11.


Darden’s cash flow story remains intact.  The company recently increased its quarterly dividend 28% to $0.32 per share and expects to repurchase about $300 to $350 million of shares during FY11, up from $85 million in FY10. 


Howard Penney

Managing Director


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With the current administration playing defense ahead of midterms in November, a positive bias to the jobs picture is all but assured as we head into the elections.  To be clear, the fudging of government data happens whatever party is in the ascendency, but politics will play a particularly significant role in government-reported statistics over the next few months.  This is the reality for GDP, inflation, and jobs.


This point has been made by various sources over the past few days but I think it speaks further to the theme of opacity, if not outright bias, in government numbers that we have been highlighting ad nauseum.  


There are two ways (maybe more) the government can manipulate the jobs data to make things look better than they appear.  The first way was highlighted in a post entitled, “FRIDAY MACRO MIXER: THE PAYROLL FUDGE FACTOR”, I discussed the implications of the Birth/Death model on the credibility (or lack thereof) of the payroll data.  As I wrote on Friday, the last benchmark revision released by the BLS indicated that the Birth/Death model numbers were grossly understating job losses and, as such, is not reliable. 


The second way the BLS distorts the numbers is through the headline unemployment rate, which is being deflated by changes in the Labor Force Participation Rate. 


Since BLS unemployment data begins, 1948, the proportion of the civilian population working or seeking work has generally been growing.  This is largely as a result of women entering the workplace and long-term growth in the U.S. economy through the 20th century.  The 1950’s saw year over year increases in the labor force participation rate of 210 bps – more than three standard deviations from the mean of all available data (January 1948 to present).  Recently, there has been a period of precipitous decline in labor force participation rate, peaking at a year-over-year decline of 120 bps – two standard deviations from the mean – which is important to note. 


The chart below details where the unemployment rate would be if the labor force participation rate was at its ten-year average level of 66.1%; for the year-to-date, it has been averaging 64.8%.  This implies that many folks are losing heart and dropping out of the job hunt.




An early indication the surprisingly positive labor market report from last week will not continue.  The ISM purchasing managers nonmanufacturing (services) survey for August showed a plunge in its employment component.  As seen in the chart below.




With the November elections right around the corner, the “spin” from both parties will reach fever pitch.  With respect to government data, we expect the numbers to remain close to consensus ahead of midterms.



Howard Penney

Managing Director

The Greek Canary in the European Coal Mine

Conclusion:  Sovereign debt issues in Europe have not gone away.  In fact, Greek CDS are approaching the highs of June, which we believe are a leading indicator for more issues to emerge on the debt front from Europe.


Just when we thought things were settling down in Europe, credit default swaps in at-default-risk nations continue to increase.  In the chart below, we’ve highlighted Greek 5-year CDS.  While we are not quite at the parabolic highs of late June, when insurance for 5-year Greek bonds reached almost 1,150 basis points, we are well off the lows of May.  In fact, CDS are up almost 50% from their lows this summer.  Interestingly, the lows were put in literally the day the EU bank test results were released. 


The Greek Canary in the European Coal Mine - 1


Back in March 2010 in our theme presentation entitled, “Where Does the Sovereign Debt Cycle End?”, we highlighted a few points related to Greece. Specifically, 

  • Greece is typically a leading indicator for defaults in Europe;
  • Debt in Europe is very interconnected, so one nation defaulting could have an impact on the balance sheet of many banks in other nations that hold that debt (we’ve posted a graphic highlighting this at the bottom of the note); and
  • The unreliability of Greek numbers as noted by the fact that in late fall of 2009 they reported their budget deficit was 3.7 percent of GDP and two weeks later that number was revised upward to 12.5 percent. 

The point is, Greek could be worse than we know and there will be a domino effect if Greece unravels.


To the lack of understanding the numbers point, the Wall Street Journal wrote an article yesterday criticizing the efficacy of the recent stress tests. The key point from the article was that the stress tests potentially understated the debt levels of many banks.  To highlight this point, we’ve posted a chart from this article directly below. If the analysis is in the ball park of reality, the stress tests missed the mark by a staggering margin. 


The Greek Canary in the European Coal Mine - 2 


Not surprisingly, the Council for European Banking Supervisors released a statement attempting to rebuke this criticism. The key points from the statement, which defended the tests, are highlighted below: 

  • The “gross exposures” disclosed were on-balance sheet exposures net of impairments but gross of collateral and hedging. 
  • CEBS notes that comparison with other sources should be treated with caution as a result of different reporting dates and reporting methodologies. For instance, data provided by the Bank for International Settlements (BIS), is aggregated in a way which makes comparison with the data disclosed by banks during the CEBS exercise impossible. 

Maybe it’s just me, but with a defense as non-transparent as that, it is really no surprise that the market is once again losing confidence in the at-risk European sovereigns.


Chirp, chirp says the Greek Canary.


Daryl G. Jones

Managing Director


The Web of European Debt


The Greek Canary in the European Coal Mine - 3

EARLY LOOK: Someone Gets to be Canadian

This note was originally published at 8am this morning, September 8, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.




“Somebody gets to be smart and somebody gets to be dumb. If we win, it'll be because of the President. And if we lose, it'll be because of me.”
-Karl Rove



Yesterday afternoon at our offices in New Haven, CT, Daryl Jones and I hosted former White House Deputy Chief of Staff and Senior Advisor to President George W. Bush, Karl Rove, for a political strategy conference call.
For the record, before you call me a raging Republican, remember that I am neither a Democrat nor a Republican. I am Canadian (with a green card and an American son who has much better chances of wearing his country’s Olympic hockey jersey on this side of the border!).
I, like most immigrant small business owners in this country, fundamentally believe in doing the best I can to provide for both my American family and American employees. This includes analyzing and understanding US political policy as it is going to affect markets and my firm’s future.
If I couldn’t stand Karl Rove’s politics, I’d still have invited him to our offices to meet with us. How else would a Risk Manager of both global market strategy and local payroll-punching get to the right answers?
It turns out that Rove was perfectly analytical and proactively prepared with plenty of math. The data, after all, doesn’t lie as much as some of America’s current politicians do. That said, the data can still change before the mid-term elections in November.
Daryl Jones will publish a more in depth research note later on today that covers some very interesting intermediate to long term US political strategy topics that we dug into with Mr. Rove in our Q&A session (the changing US electorate, small business healthcare spending, taxes, etc.).
For now, I’ll spare you having to watch the DVR version of this weekend’s Meet The Press where CNBC’s money-honey-mini, Erin Burnett, espoused her unqualified US political strategy thoughts about how the economy has seen the “stimulus really work” and give you some proactive political predictions that you can hold Karl Rove to:
1.      The Republicans will win the House by a wider than expected margin.

2.      The Democrats will cede at least 8 seats to the Republicans in the Senate.

3.      The anti-incumbent vote in America will be pervasive theme.

“Anti-incumbent” means anti any professional politician in Washington who sold you a bill of dry heaves in the most recent election, or as Mr. Rove called them, incumbent politicians with a “D” after their name who are perceived to be easiest to blame. Shock-and-awe, eh? A Republican strategist concluding that the Democrats are going to get rolled over in the mid-terms!
Well, take it from one Canadian with an American family looking to be on the right side of this immediate term TRADE rather than get stuck in the partisanship of being wrong and blaming someone else’s politics for it – I think Rove’s got this one right.
If you’d like the slide deck that backs Rove’s analysis and the replay of the conference call, please email <> . I’ll be happy to print the most analytical rebuttal to Mr. Rove’s conclusions, provided that you let me print your name on the analysis like he did with his. This is the only way I know to strap on the accountability pants folks. I’d much rather be proven wrong here than remain wrong…
Whether we like politics or not, we all have to play the risk management game that’s in front of us. To spend or not to spend more taxpayer moneys on “stimulating” the economy, remains the question.
The SP500 was down -1.2% yesterday to 1091, taking its cumulative decline since its YTD high on April 23rd to -10.4%, and its YTD loss for 2010 to -2.2%. Was yesterday’s weakness related to an expectation mismatch associated with an alleged “better than expected” employment report on Friday? Or was it based on another partisan “spending plan” of $50 BILLION that Americans don’t buy into?
Plenty more questions remain for the Fiat Spending Bulls this morning than there are answers. I don’t need Karl Rove to remind me of that. My immediate term support and resistance levels for the SP500 are now 1086 and 1107, respectively.
Best of luck out there today,

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