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Best Buy: Cost Cutting Doesn’t Cut It

original publish date august 26, 2014

It was no secret going into Best Buy’s (BBY) earnings report that it was going to be bad.

Warnings in the rearview mirror from Wal-Mart (WMT) to hhgregg (HGG) to the Best Buy CEO himself (referred to plunging tablet sales mid-quarter) painted a pretty dismal picture for the category. But while most retailers are benefiting from the less-bad-is-the-new-good rally this quarter, Best Buy is under pressure after beating earnings expectations.

Here is the problem.

Best Buy is a cost-cutting story and all good cost-cutting stories eventually don’t cut it. As I have written before, in the end, sales rule and Best Buy is no exception.  With domestic comps down 2% this quarter and an outlook for continued negative comps in the low-single digits for the rest of the year, expect industry wide promotions to continue to drag down gross margins.

Here is the long-term story for Best Buy.

  1. Continued customer migration online, which results in fewer high-gross-margin attachments.
  2. Continued in-stores investments to keep conversion rates from declining.
  3. A category that is at the mercy of new product cycles (or lack of new cycles).
  4. One of the most promotional categories in retail due to commodity products.
  5. A cost-cutting story that will eventually be overshadowed by lack of turn in sales.
  6. Pressure from Home Depot (HD), Sears (SHLD) promotions and Lowe’s (LOW) improvements in the appliance category (one of the few that has been showing a positive comps).

Best Buy derives the majority of profits from the all-important holiday quarter. Based on the setup going in to the second half of the year, the promotional environment may just make last year look tame. That means more gross margin pain.


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Teen Retail: Old Guard May Not Cut it in New World

originally published on August 22 2014

Teen retailers have been in a death spiral for years now, yet recently the street has decided that fewer bad results are the new good.

Take American Eagle (AEO), for example. Comps declined 7% this quarter and gross margins were down ONLY 40 basis points. Most surprising, the company issued guidance that was right in the range of consensus estimates as opposed to the massive guide downs we have been trained to expect. That was enough to bring back hopium for a second-half story and catapult the stock higher. Warning ahead on this one. Take a look at the track record of guidance vs. actual results before you get excited here.

The other teen retailer on the move is Aeropostale (ARO). Finally, the company got rid of its CEO after years of execution missteps. This long overdue change at the top became less exciting to me when the company announced it would bring back its former CEO Julian Geiger. While Geiger ran ARO quite successfully years ago, I would argue the old guard may not cut it in the new world. Yesterday after the close ARO reported another painful quarter with comps -13% and guidance below the Street. That was enough to erase the euphoria from last week surrounding Geiger’s return to the company.

Bottom line on these stocks is stay away. With fast fashion changing the landscape (although retailers will deny this) the market-share losses will only accelerate. I have one recommendation for every investor who believes the teen space will make a comeback. Walk into the new Topshop flagship on Fifth Avenue when it opens this fall. When you exit the store, you will also exit these stocks.

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WMT: Break the Streak

this was originally published Aug 14 2014

Wal-Mart (WMT) must have been chanting “Break the Streak” during the second quarter, and it worked.

After five quarters of negative same-store sales, the discounter finally achieved sales guidance and put up a flat comparison. Note that this was following five quarters of missing comp estimates of flat to positive, so the bar was set pretty low. Also, it did not hurt that the former head of the U.S. division gave the nod on CNBC mid-quarter that employment gains were simply not showing up at mammoth discount stores.

Wal-Mart cutting its full-year earnings guidance to $4.90 to $5.15 per share from $5.10 to $5.45 was met with zero surprise. Consensus was already at the high end of the new range and, let’s face facts, it is about time Wal-Mart cleared the guidance decks and took a gulp of reality Kool-Aid. There was a reason I listed Wal-Mart’s 2014 guidance at the beginning of the year as “LOL guidance.” So I take a clearing of the decks as a slice of good news in this discounter’s retail funk.

While Wal-Mart sales did not miss this quarter, it is hardly a reason to get excited about the stock. Don’t forget traffic is still sliding at a loss of 110 basis points this quarter. And while that is a heck of a lot better than Kohl’s (KSS) 330 bps decline, I wouldn’t own that stock either.

Here is the problem: Wal-Mart is way behind in ecommerce investing, and while catch-up spending is necessary, the bottom line is going to hurt for some time. There are other cost pressures, including price investments in the face of food inflation, SNAP (food stamp) cuts that hurt to the tune of 70 bps this quarter and, oh yes, the need to invest in labor to improve customer service. Throw in some complaining about health care costs and add flat revenues for the foreseeable future and I am looking elsewhere for returns in the retail space.

Kudos to Wal-Mart for finally seeing the light and investing in smaller formats, as well as taking the hit on ecommerce spending. While those decisions may pay dividends in the long term, I see better short-term opportunities.


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Target new CEO; Clear the Decks and Target May Hit a Bullseye

Target new CEO; Clear the Decks and Target May Hit a Bullseye

Target has a new CEO and he has a lot on his plate.

Target announced the company has hired Brian Cornell, formerly CEO of America Foods at Pepsi since March 2012. Previously Cornell was President and CEO of Sam’s Club, a Walmart division as well as CEO of Michael’s Stores for two years after the chain was taken private.

While Target may now get a better deal on Doritos, Cheetos and Mountain Dew Mr. Cornell has his work cut out for him.  Probably the most pressing issue is to stop the pain related to the botched Canadian expansion, which resulted in 2.5x the original forecasted dilution.  Make no mistake this fumble was an execution issue as Target misread the all important consumables business.  So it is good news that Target has gone and hired talent with consumables expertise. The problem is as the saying goes you only make a first impression once.  Changing Targets perception in Canada may take some heavy lifting.  I would not rule out a “pull the plug” on Canada.

The second elephant in the room at Target is winning back the trust of the American consumer after the data breach that hit the company right before the 2013 holiday season.  The matter was addressed at a snails pace and left angry consumers heading into the arms of the competition.  Negative comps followed.  Investing in chip and pin technology to the tune of $100M is a move in the right direction but clearly other traffic driving steps will need to take place to get Target back on track.

Target requires a fresh look to get back in the game.  What happened to the days when the company was a fashion leader and had differentiated merchandising collections?  Simply put the company has started to blend into the discount landscape with promotions and less compelling offerings.

What does all this necessary change mean for investors? Mr Cornell may have to clear the expectation decks and prepare the street for a long term repositioning.  While a turnaround may take some time the old Target may eventually hit a Bullseye

Widlitz has no position in Target

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Beware Retail Zombie H2 Syndrome

First-quarter retail earnings have kicked off and investors seem to be willing to look way beyond the weather and Easter Bunny issues and hoping for a better second half of the year. I call this the “Retail Zombie Second-Half Syndrome.”

We have heard these stories year after year, particularly in the never-ending bloated inventory teen space. The great news for retailers this year is the weather blame game in the first quarter (which was legit in many cases) is giving investors yet another reason to believe.

Original publish date May 14, 2014

The problem is that all retailers are not created equal in the Second-Half Zombie Syndrome Game; however, there are a few retailers that are worth the second-half investment story. Look no further than the Macy’s (M) report this morning. While sales were about 3% below expectations and comps decreased 1.6%, year-over-year margins increased.

Yes, let me repeat: There is a retailer that has so much influence over vendors it has the ability to maintain/increase profit margins even when the weather and the Easter Bunny are working against us. Despite a first-quarter sales miss, Macy’s suggested that April improved and confidence that the first quarter was just a blip resulted in reaffirmed guidance of 2.5%-3% comps for the year. And then management threw in a 25% increase in the dividend and an increase in buyback plans.

Of course, Macy’s is not invincible. The retailer ended the quarter with inventories up 4.7%, year-over-year. With comp plans of 2.5%-3%, we could certainly find fault with that less-than-perfect spread. However, based on Macy’s track record of using its muscle to manage its margins, this second-half story is as good as it gets.

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