The near-term cotton trade is done like dinner. But CRI is putting up –HSD EPS on +HSD sales with raw materials set before a quarter of CRI’s customers were even born. How can they do +7% sales and +6% EPS next year??? No Way.
Keith added Carter’s to the short side of Hedgeye’s virtual portfolio yesterday; revisiting a high-conviction call that we have that margins will unravel by 400bps in 2011. See our 9/16 post ‘CRI: One of the Worst Stories in Retail.’ Also as noted in that report, the next 1-2 quarters have numerous events to be cognizant of as it relates to timing and sizing a position.
In his words (plucked from our email exchange) “Pretty bullish volume/price move there today – either someone knows something we don’t or someone thinks they do. I’d be digging for what you don’t want to find if I were you. TAIL/TREND lines of resistance converging in the $27.06-$27.76 range = bearish. TRADE support = $25.01, bullish.”
So let’s think about this for a minute… What can go wrong for a short here? The catalyst calendar is a pretty good place to start.
1) Same store sales next week. Will likely confirm upside to anyone who owns/operates boxes that sell apparel.
2) CRI reports 3Q on Oct 19. 12 weeks ago they lowered comp expectations from 4% to 2%. It’s no secret to anyone that business in September across all of retail was strong. Carter’s won’t be left out of that dynamic. The company stated outright on its last call that a better comp could mean upside from its $0.76 implied guidance (Street at $0.74). Sensitivity is high on such a low (and insufficient) cost structure.
3) Then 2-weeks later, CRI is hosting an analyst meeting to show the fruits of the new design team at Osh Kosh (15% of sales and EBITDA). It’s unlikely that the company is inviting analysts in to show them ‘how horrible the product is.’
Here are some offsets to keep on your risk-management plate.
A) Message to the Street: Cotton COGS is not Real Time: The Street has come down a couple pennies in 3Q to $0.74, which I’m willing to bet is due to cotton shooting from $0.75/lb to $1.01 today. But here’s what gets me… The company is selling product today based on cotton bought six months ago. It is competing with others at retail who have a cost of materials set when a quarter of CRI’s customers weren’t even born yet. Think about that for a minute.
B) Timing Mismatch:In a ‘rebound’ quarter like 3Q could be, the company is looking at mid-high single digit sales growth and a double digit decline in EPS?!? On top of that, the Street is modeling 7% sales growth in 2011 along with 6% EPS growth!?! Can someone – I mean anyone – please explain to me how this is mathematically possible given the confluence of Macro factors?
C) ‘We get it’ that everyone understands the near term cotton risk.What we don’t think people have really thought through are the implications for the margin climate as the companies start to absorb the real cost, and get pushed by partners in the supply chain. This supply chain is extremely complex, and is the key factor in sparking irrational pricing behavior (which, to a company like CRI that has a 40% discount on its product the day it hits the floor, is untenable).
D) If Everyone Waits For Prices To Decline, Will It Happen? Consider this…We met with HBI and VFC last week, and have since had conversations with 2-other major apparel companies. While hardly a representative sample, one factor all had in common is the view that 1) cotton prices will stay at elevated levels, and 2) they’re not locking in anything at a buck per pound. So if they all agree that there is a supply problem, but will wait until prices come down before locking in, then it begs the question as to whether price will really come down after all?
E) Why did so many companies blow off the cotton issue at the GS conference – and others since?Aside from not wanting to beat up their partner’s CEO at the very start of back-to-school season, the reality is that they were having a good revenue month. Good revenue on product procured before input costs went parabolic is hardly a reason for any CEOs to sweat during their few dozen double-secret one-on-ones.
We outline the full CRI thesis in out 9/16 report, and if anything feel stronger today than we did then about the idea. But if there’s any one clarifying factor today vs. then it is duration. For those who are shorting names like CRI today based solely on the ‘cotton trade,’ then congratulations, you’re late. Those fans who are chirping that strength in cotton provide an opportunity to get involved with a ‘high-quality’ growth idea like CRI. Then I wish them the best of luck. They’re gonna need it.
We’re going to stick with our research, good 'ol fashioned math, and our process. There might be near-term ‘Oohs and Ahhs’ around leverage to a good September and the cute little denim for Jr. out of Osh Kosh. But it can’t sidestep what is a very big problem lurking below the surface. Our team will continue to dig deeper into the story, and unless the facts change meaningfully, we’ll get louder with our call on any strength. As always, Keith will manage around the timing/sizing.