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January 2012
Weekly Spin Cycle: January 30, 2012
Welcome to the Weekly Spin Cycle. Each week, we’ll deliver some news and commentary about the retail industry. Whether you’re an industry insider, investor, or outside observer, the articles/commentary you read here are designed to enhance your understanding of the retail sector and the issues facing it.
In addition, we’ll pay close attention to the “managerial spin” and will on occasion offer a contrarian view. You are encouraged to provide any feedback to info@RetailGeeks.com. Click to Open PDF
Irrationally Exuberant Management at JCP Better Suited for BBY
Last week, J.C. Penney (JCP – $41.42) unveiled their new strategic direction and the company’s shares skyrockedted +18.0% on the news. Clearly, new CEO Ron Johnson knows the drill. He gave the investment community an Apple-like presentation and decided to no longer provide monthly sales metrics or quarterly earnings guidance.
Here’s what we liked. Mr. Johnson made it clear that initial mark-up (IMU) does not matter. What matters is the merchandise margin as the product walks out the door (72% of JCP’s sales are at a 50% off or greater discount). How many times do investors have to listen to retail management discuss IMU as if it matters?
That said, we found it odd that new CEO Ron Johnson believes that the “#1 opportunity” in retail was the department store. Not the Internet. Nope. Yep, the department store. In addition, his longer-term idea of using 10,000 square feet to develop a “town square” is aspirational, but has ‘disaster’ written all over it.
The fact is that no matter how smart the presentation sounded, in our view, JCP has about a 5% probability of re-attaining their 13% EBIT margin goal by FY 2015. Yet, today, 95% of the investment community appears all too eager to believe that the 13% EBIT margin goal is within the realm of possibilities.
Many times investors listen to these presentations focused on longer-term strategic initiatives and forget, much like the management teams, that a retailer such as JCP does not operate in a vacuum. For argument sake, let’s say that JCP’s simplified pricing structure is a success. Don’t you think others would emulate the strategy and therefore limit JCP’s top-line benefit?
Yes, it was a smart, brilliant presentation by JCP’s Mr. Johnson. What analyst does not want to believe that Mr. Johnson can transform the industry especially given his previous successes? But, the new pricing strategy has yet to be tested.
This week, JCP management swung for the fences. The company needed to as it had performed miserably relative to its peers under the direction of ex-CEO Mike Ullman. But, don’t forget that The Gap (GPS) began to operate in a much leaner, smarter fashion a few years ago and is still under the direction of a shrewd CEO (Glenn Murphy). And you see where that got GPS. Nowhere.
At the end of the day, we doubt that Mr. Johnson will impact the department store arena as much as he thinks he will. Unfortunately, Mr. Johnson picked the wrong sector of retail. In our view, his skill set was tailor-made for Best Buy (BBY – $25.44) and the transformation that’s needed in the consumer electronics space.
Therefore, it’s a shame that Mr. Johnson’s vision could not have been better utilized in a retailing sector that is in greater need of a new strategic direction.
JCP Managerial Comments That Will Be Interesting to Review in 12-24 Months
This week, we were so fascinated by the overly-bullish proclamations made by J.C. Penney (JCP) management that we’ve decided to post the following managerial quotes from the 2-day presentation for future reference:
Ron Johnson – CEO
“The #1 opportunity in American retailing is not the Internet. It’s not discount. It is the department store.”
“Nothing was bought at full price, fewer than one out of 500 units… 72% of the revenue, three-quarters of everything sold in the stores was at 50% off or greater discount.”
“Starting August 1st of this year, we will begin an exercise to add 2-3 shops each and every month for the next 3.5 years until the entire store, every store, is merchandised in shops… in 2013, we will launch Town Square. In 2014, we’re going to launch our whole new prototype and by 2015 every one of our stores will be completely transformed.”
“This simplistic (pricing) model allows our merchants to do what they do best and that is focus on great product versus focusing on pricing cadence.”
“So, if orders are down it doesn’t mean the sales expectations are down. What it means is that we want to turn our inventory faster, right… When you make this most money is when you chase the business.”
“Shrinkage can be controlled through technology and so we’re not going to use labor to protect the merchandise… so, we are not at all concerned about that.”
“Localization will not be a primary strategy at J.C. Penney because I think that is something that is exaggerated in its importance… if we miss a local item or two, that’s okay, because the things we do well will more than offset the opportunity that you can find in localization.”
“I don’t think that there’s any need to go out and close those small stores. And that’s looked at by the economics of the stores, not the condition of them.”
“Our online percent of sales is still about 9% where Macy’s with all their growth I believe is at about 6%.”
“We do think there’s an opportunity over time to slightly reduce the private brand to replace that with more global brands.”
“I really believe in credibility and there is absolutely no way that guidance for 2012 that we didn’t have extraordinary confidence we could meet or exceed.”
Michael Kramer – COO
“We’re confident that we can reduce our SG&A as a percent of sales to a sub-30% rate by 2013… we are strongly committed to the fact that we can reduce our SG&A structure to 27% by 2015.”
“There’s roughly $400M of expenses in the stores that we can cut over the next year, advertising $300M and home office $200M. So, that $900M run rate will not be effective till 2013, but we’ll get a portion of that in 2012.”
“Here’s what we know. Ron said yesterday he’s confident that we can get to 40-plus margins. I said today that we’re confident that we can get to 27% SG&A structure by 2015. Clearly, doing the math represents a 13% contribution. That’s in stark comparison to the 6% contribution that JCP provided in 2010.”
“Sephora as an example, as we’re rolling out Sephora we’re seeing a 2% lift in the rest of the store. So, if you take that and exponentially calculate what that can do, as we’re bringing in great brands in terms of shops over the course of those 4 years, you can imagine what that can do.”
“J.C. Penney has roughly 400 stores in those same markets that Kohl’s has 722… That represents just a comparison of roughly 300 more stores that we can do. And I think that’s really important to understand as we roll-out this transformation and when you take a look at the upside potential.”
Weekly Top 5 – Five Articles Worth Reading
Each week, we provide a PDF of 5 articles of interest to investors focus on the retail/consumer space. Enjoy.
How the U.S. Lost Out on iPhone Work Click to Open PDF
The conventional wisdom is that the only reason products are sourced from overseas is cost. This article suggests that it’s much more than cost alone. It’s the flexibility and access to mid-level labor that manufacturers overseas enjoy that we are unable at present to replicate here.
Posted: Saturday, January 21, 2012
Source: New York Times
Talbots Shares Soar as Buyers Circle Firm Click to Open PDF
Yes, the clowns that pretended to be a capable management team have left the building (or, at least are in the process of departing). But, Sycamore clearly has a greater motivation for making this deal happen… they own 51% of Mast Global Fashions.
Posted: Monday, January 23, 2012
Source: WWD
The Year in E-Tail: Lessons Learned and Looking Ahead Click to Open PDF
Nice overview of e-commerce and the dramatic rise of late of m-commerce.
Posted: Wednesday, January 25, 2012
Source: WWD
J.C. Penney Chief Thinks Different Click to Open PDF
Historically, 72% of JCP’s product has been sold at 50% off or more. Yikes! Also, it’ll be interesting to see if Mr. Johnson’s idea of a “Town Square” works. Our guess is that it will not. Others that have tried to get folks to “hang out” in a mid-level retail environment (think Paul Pressler and The Gap in mid-2000’s) have failed.
Posted: Thursday, January 26, 2012
Source: WSJ
Penney CEO Says Profit Won’t Suffer Click to Open PDF
Historically, JCP management had a dismal track record when guiding go-forward EPS. Today, with the many strategic undertakings that will transform the store over the next few years, incoming CEO Ron Johnson professes that FY 2012 EPS will be much greater than today’s consensus expectations. Good luck with that.
Posted: Friday, January 27, 2012
Source: WSJ
GPM% Upside vs. Expectations Continues at AAPL Driven by Favorable Sales Mix
While we don’t cover AAPL as closely as many of the retailers that we follow, we have put together a robust set of earnings analytics based upon company disclosures in SEC filings and quarterly conference calls. See our updated company Data Packet following the research note. Click to Open PDF
AAPL should again easily exceed the consensus sell-side EPS expectation in Q1 2011 (December 2011). In our view, GPM% upside versus consensus expectations appears to be the largest driver of material EPS outperformance versus today’s consensus sell-side estimates.
Why? GPM% pressures began to ease in Q3 2010 (June 2011) as the company fully lapped its iPad launch (i.e. today, iPad sales mix has become much less of an issue).
Also, keep an eye on Product Warranty Accruals. Per SEC filings, AAPL’s Product Warranty Accruals (see table below) have greatly out-stripped the actual Product Warranty Costs for the past 5 fiscal quarters. AAPL may receive a GPM% boost if Product Warranty accruals are scaled-back versus the prior year (relative to sales growth).
The major concern is whether GPM% will materially decline from the impact of recently reduced price points on iPhones and iPods and the stronger U.S. Dollar. Therefore, our GPM% expectations beyond Q2 are for AAPL’s reported GPM% to decline versus the prior year.
In Q1 2011 (Dec 2011), we’re forecasting EPS of $10.83 versus the current consensus sell-side estimate of $10.05. Our estimate implies revenue growth of +49.1%, a +350 Bps GPM% versus LY, and a +421 Bps EBIT margin improvement versus LY.
Weekly Spin Cycle: January 23, 2012
Welcome to the Weekly Spin Cycle. Each week, we’ll deliver some news and commentary about the retail industry. Whether you’re an industry insider, investor, or outside observer, the articles/commentary you read here are designed to enhance your understanding of the retail sector and the issues facing it.
In addition, we’ll pay close attention to the “managerial spin” and will on occasion offer a contrarian view. You are encouraged to provide any feedback to info@RetailGeeks.com. Click to Open PDF
Pricing Changes at JCP/TGT = Recipe for Disaster
This week, we noticed that J.C. Penney (JCP – $35.09) stores began to implement the new EDLP pricing strategy that many have been expecting. Interestingly, Target (TGT – $50.17) is rumored to be thinking about a new pricing strategy as well (see Associated Press article on Friday January 20th).
Have you seen the changes that are taking place in JCP stores today? Many store associates believe that the “elimination of promotional signage” may be a recipe for disaster. Not a good sign for the beginning of Mr. Johnson’s tenure.
If anyone needed further evidence that TGT’s RedCard and PFresh remodels were an abysmal failure versus the company’s original expectations… the company’s move towards a new “pricing strategy” may put a nail in that coffin and has an air of desperation about it.
Big picture, JCP and TGT have “disaster” written all over them.
Mickey Drexler Criticizes Mall Owners and Says Holiday 2011 “Most Discounted Ever”
Check out this week’s article in WWD where Mickey Drexler criticized mall owners/operators.
In that article, Mr. Drexler suggests that the holiday 2011 season was “one of the most discounted ever” and that last season was marked by “enormous apparel deflation.” In addition, he wondered “what the optimism is about” after sitting through a Financo-organized panel that gave no hint of the travails of retailers.
Mall owners that were criticized by Mr. Drexler for “lacking innovation” suggested that the spread between high-performance malls and low-performance malls is widening.
It’s a very interesting article. Click to Open PDF
Weekly Top 5 – Five Articles Worth Reading
Mickey Drexler Blasts Malls Click to Open PDF
Mr. Drexler suggests that the holiday 2011 season was “one of the most discounted ever” and that last season was marked by “enormous apparel deflation.” In addition, he wondered “what the optimism is about” after sitting through a Financo-organized panel that gave no hint of the travails of retailers.
Mall owners, that were criticized by Mr. Drexler for lacking innovation, suggested that the spread between high-performance malls and low-performance malls is widening.
Posted: Tuesday, January 17, 2012
Source: WWD
Sears Shares Spike 9.5% on Talk of Going Private Click to Open PDF
While SHLD management has a transparency issue, the recent factoring concerns were largely blown out of proportion. Why? Factoring is a much bigger issue with apparel vendors and SHLD is primarily a hardlines retailer
Posted: Wednesday, January 18, 2012
Source: WWD
Old Navy President Resigns Click to Open PDF
3.5 years of leading Old Navy while sales materially underperformed its peer group. The press release talks about his involvement in the “creation of the successful Supermodelquins marketing campaign.” That campaign was reasonably successful and may have been Mr. Wyatt’s only success story during his tenure. We’re still scratching our head as to why the company ended that campaign in the first place.
Posted: Thursday, January 19, 2012
Source: WSJ
Target Said to be Looking at New Pricing Strategy Click to Open PDF
If anyone needed further evidence that TGT’s RedCard and PFresh remodels were an abysmal failure versus the company’s original expectations… read this article. This new “pricing strategy” has an air of desperation about it.
On a related note, have you seen the changes that are taking place in JCP stores today? Many store associates believe that the “elimination of promotional signage” may be a recipe for disaster. Not a good sign for the beginning of Mr. Johnson’s tenure.
Posted: Friday, January 20, 2012
Source: AP
Ikea Profit Rises on Continued Growth Click to Open PDF
Sales growth at home furnishings retailer Ikea came at a cost. The chain cut its prices by -2.6% despite higher raw material costs and GPM% fell -190 Bps versus the prior year.
Posted: Friday, January 20, 2012
Source: WSJ