April 3, 2017 Consensus

The Weekly Consensus – April 3, 2017 (Volume 9, Number 14)

The Big Story
J.Crew: A Harbinger and Lesson?
Paul Alexander, CFA

While preppy retailer J.Crew has long been known for its colorful and playful catalogs, the most recent pages of the company’s history have unfolded not on an inviting, sandy beach, but in court. Last week, the company’s debtholders moved to block J.Crew’s recent efforts to transfer a large portion of its intellectual property into a subsidiary beyond the reach of lenders. Wilmington Savings Fund Society argued that J.Crew’s plan to move 72 percent of its trademarks, worth $250 million, should be stopped because the IP belongs to the company’s lenders as per a 2011 loan agreement. Wilmington further referred to the retailer as “insolvent,” and said J.Crew’s owners are trying to “improperly advance [their] self-interest over the interest of J.Crew and its creditors.” In its own defense, a J.Crew spokesperson argued that its proposed IP transaction “fully complied with governing loan agreements,” reiterating a stance the company took in an early February court filing, where it contended, according to the Wall Street Journal, that J.Crew continues to work “on strategic opportunities that will benefit all of its stakeholders, including lenders.”

The struggle between J.Crew and its lenders raises three key points. First, we may see more legal battles in the coming weeks and months as a wave of bankruptcies sweeps through retail. Numerous news outlets reported last week that Payless Inc. was preparing to file bankruptcy imminently, and could close as many 400 to 500 of its over 4,000 stores. Payless would be the latest in spate of recent retail bankruptcies, including RadioShack, BCBG, The Limited Stores, HHGregg, and Gander Mountain Sports, and more appear to be on the way. For instance, Sears Holdings Inc. warned two weeks ago in its annual report that “substantial doubt exists related to the company’s ability to continue as a going concern.”

Second, the resolution of this battle could embolden either retailers or lenders to make various copycat moves or preemptive strikes to advance their interests. Claire’s made a similar move to J.Crew’s last year, and other struggling, indebted retailers may also be eyeing the strategy, according to Pacer Monitor.

Lastly, the J.Crew example stands as a cautionary tale: be prepared for counterparties to employ all measures at their disposal to their benefit. The more sophisticated the capital structure, the more one can and should expect financial and strategic maneuvering. In this case, an argument can be made that J.Crew acted within its legal rights in its recent transfer of IP, regardless of the lenders’ objections.

While observers should take note of this developing story, none of this answers the bigger question of how retailers should adapt to today’s more challenging retail landscape – the problem that has largely precipitated J.Crew’s underlying struggle. If only J.Crew (or any of us) had an easy answer to that question, the company and its lenders could go back to enjoying their partnership with as much frivolity as there is on the pages of the J.Crew catalog.

(About the author: Mr. Alexander worked as a merchant at J.Crew from 2005 to 2007, and then covered the company’s stock (JCG) as an equity research analyst at Bank of America Merrill Lynch until the company was taken private in 2010.)

 Apparel & Footwear

VF Corp. in Reshaping Mode; Focus on Consumer and Retail

VF Corp. is reshaping itself again — this time to be more consumer- and retail-focused to drive total shareholder return. That was the key point at the company’s investor day presentation from chief executive officer Steve Rendle. According to Rendle, retail will be a key strategy of the company going forward and is expected over the next five years to comprise 35 percent of the company’s total sales, up from the current 28 percent. Prior to the presentation, VF outlined some initiatives for its 2021 strategic growth plan, the first one under new ceo Rendle. The plan projects revenue growth from 2017 to 2021 at a five-year compounded annual rate of between 4 and 6 percent. That growth will be fueled by VF’s key brands — VansThe North Face and Timberland — as well as its growing international business and direct-to-consumer platform. Over the next five years, the company expects to generate more than $9 billion of cash from operations and return $8 billion to shareholders through dividends and share repurchases.

H&M Falters as Zara Owner Inditex Speeds Ahead

The two-horse race in Europe’s fast-fashion sector is widening. Sweden’s Hennes & Mauritz on Thursday reported a 3% fall in first-quarter net profit from a year earlier on lower-than-expected sales growth and increased markdowns, sending its share price more than 5% lower. H&M’s results come as a blow amid strong momentum at its main rival, Zara owner Inditex. Earlier this month, the Spanish company reported a 14% rise in net profit for the fourth quarter of last year, as well as record annual sales. The Swedish company’s earnings underscore the two rivals’ diverging fortunes. Inditex, which also owns retail chains including Pull&Bear and Bershka, has long benefited from a rapid-fire production system that lets it replenish its stores more quickly than its rivals. But last year it started to ease the pace of its rapid global expansion, closing small stores and sharpening its focus on bigger outlets. Meanwhile, H&M kept up the pace of store openings around the world, before changing course earlier this year, with a new emphasis on online sales, after it reported a fall in profit for 2016.

Your chances of scoring a deal on shoes at a Gordmans fire sale may be slim: DSW wants its merchandise back

Anyone counting on picking up some bargain-priced designer shoes at Gordmans’ going-out-of-business sale might be out of luck. The shoe departments in the bankrupt Omaha-based retailer’s 100 or so stores are operated by an outside company — DSW, the Ohio firm that also has about 500 stores of its own. But that all might be over. DSW said in court filings last week in the Gordmans bankruptcy that it should be allowed to go in and recover its merchandise — with a retail value of about $24 million — along with shelving and fixtures it says it owns. “Quite simply, the DSW merchandise and fixtures are not property of the bankruptcy estate,” the company wrote in court documents filed with U.S. Bankruptcy Court in Omaha late last week, citing about $800,000 owed to it by Gordmans for unpaid shoe-sale remittances. “They are the property of DSW.” The DSW spat is just one of the moving parts: As is typical in such consignment arrangements, Gordmans collects a fee from the net revenue of the shoe sales in its stores. But depending on what happens next, there might not be any more Gordmans stores in which to operate shoe departments.

Athletic & Sporting Goods

Eastern Outfitters Skipping Auction For Private Sale

Eastern Outfitters, the parent of Eastern Mountain Sports and Bob’s Stores, plans to hold a private sale to Sports Direct rather than hold a bankruptcy auction as part of a deal reached with unsecured creditors.  At the same time that Eastern Outfitters filed for bankruptcy on February 6, Sports Direct, the U.K.-based sporting goods chain, committed to serve as the stalking horse bidder for its assets. Sports Direct also agreed to purchase its outstanding second lien debt from Versa, which had acquired the company out of bankruptcy proceedings last year, as well as to serve as the DIP (debtor-in-possession) lender in the chapter 11 case.  As reported, the Official Committee Of Unsecured Creditors had said in court papers that it “does not object to the sale to Sports Direct in principle: the transaction, if consummated, would preserve jobs and allow at least some of the debtors’ stores to continue operating post-sale.”  But it called the stalking horse bid “an inherently unfair sale process,” with a “highly conditional stalking horse agreement that exposes the estates to significant risk.”

Amer Sports acquires Armada, a US ski brand

Amer Sports Corporation acquired Armada, the iconic US ski brand, with annual net sales of approximately USD 10 million. The acquisition includes the Armada brand, Armada-branded products, as well as intellectual property and distribution rights. The transaction value is approximately USD 4.1 million, of which USD 2.5 million will be settled with cash. Armada will be integrated into Amer Sports’s Winter Sports Equipment business unit.  Amer Sports is a sporting goods company with internationally recognized brands including Salomon, Wilson, Atomic, Arc’teryx, Mavic, Suunto and Precor.

Cosmetics & Pharmacy

Amazon Is Shutting Down Diapers.com — Amazon’s Fourth-largest Acquisition

Amazon is shutting down Quidsi, one of its largest-ever acquisitions, which runs six shopping sites, including Diapers.com, Soap.com and Wag.com. In a statement, an Amazon spokesperson blamed the shutdown on profitability issues. “We have worked extremely hard for the past seven years to get Quidsi to be profitable, and unfortunately we have not been able to do so,” the statement said. “Quidsi has great brand expertise and they will continue to offer selection on Amazon.com; the software development team will focus on building technology for AmazonFresh.” Amazon bought Quidsi almost six years ago to the day (not seven, like the statement says) in a deal valued at around $545 million — the company’s fourth-largest purchase as of now.

L Catterton Invests in Skincare Brand TULA

TULA, a leading innovative skincare brand, announced that it has received a significant growth capital investment from L Catterton, the largest consumer-focused private equity firm in the world. The investment will be used to drive TULA’s rapid growth by funding marketing, working capital and product development. Terms of the transaction were not disclosed. Founded in 2014, TULA’s groundbreaking approach to skincare leverages probiotics to improve the overall health and appearance of the skin. Since its founding, TULA has experienced enormous growth by building off of a unique and successful launch strategy. TULA launched first exclusively with QVC, where it received rave reviews from women across the country, leading to the brand being named the winner of QVC’s “Rising Star Award.” From there, the Company has built a strong online presence through partnerships with digital influencers and selectively launched in brick and mortar stores across the U.S. with SpaceNK.

CVS Pharmacy to Introduce K-Beauty HQ

CVS Pharmacy, looking to meet growing shopper demand for Korean beauty products, is launching its K-Beauty HQ at 2,100 stores nationwide starting in April. K-Beauty HQ will include more than 100 new products from South Korean beauty brands, several of which are exclusive to CVS. To curate the collection of skin care and makeup products, CVS Pharmacy said it worked with Korean beauty expert Alicia Yoon, who founded online beauty store Peach & Lily. “We are very excited to bring the latest global beauty phenomenon to CVS Pharmacy with our own exclusive K-Beauty offering, developed uniquely with our customers in mind. Increasingly, we’ve seen our customers turning to CVS Pharmacy for healthy beauty — from advanced skincare to naturals — and for products that are inspiring, fun and new,” CVS Pharmacy VP merchandising for beauty and personal care Alex Perez-Tenessa said. “With the launch of the new K-Beauty HQ, we’re able to deliver an extensive collection of new, on-trend products across healthy skincare and playful beauty, further establishing CVS Pharmacy as the leading health and beauty destination.”

Discounters & Department Stores

Sam’s Club overhauls pick-up service with eye on Costco

Sam’s Club, the warehouse club operated by Walmart Stores, has overhauled its in-store pick-up service for online orders as it looks to gain an edge in e-commerce over archival Costco Wholesale. The company, the eight largest U.S. retailer, with sales of $58 billion last year, already gives customers the option to order products online and pick them up in stores. But Sam’s Club said Thursday that it has improved the service, renamed “Club Pickup” from “Click ‘n Pull,” to let customers build and save shopping lists online so they can reorder the same items later or do so automatically. They can also get suggestions for substitutions if an item is out of stock. The service, which has an expanded assortment of items available, will be open for business seven days a week rather than just five.

Sears CEO Lampert takes bigger stake in ailing chain, shares jump

Shares of Sears Holdings jumped more than 9 percent after Chairman and CEO Edward Lampert bought more of the department store’s shares. Lampert, already Sears’ largest shareholder, recently bought nearly 526,000 shares, according to a regulatory filing. Fairholme Capital Management has also recently bought up nearly 614,000 shares. Fairholme Chief Investment Officer Bruce Berkowitz is a member of Sears’ board of directors.  Lampert’s purchases came shortly after Sears acknowledged in a regulatory filing there was “substantial doubt” it will be able to stay in business, sending the company’s shares tumbling by about 12 percent.

Why has it taken mass retailers like Target so long to diversify their product?

Target is finally following in the footsteps of smaller brands like Nubian Skin and Naja by diversifying its fashion product offerings. It has started with lingerie and hosiery under its in-house Merona line, both of which come in a wide range of skin-colored tones, including cocoa, caramel, honey beige and mochaccino. Target intends to do the same with its intimates and shoe lines this coming fall. “At Target, we know that women come in all shapes, sizes and ethnicities, and our assortment needs to reflect their outfitting needs,” Target’s senior vice president of apparel and accessories, Michelle Wlazlo, said in a statement, citing a push to be more inclusive. Presumably, the fact that the world is diverse isn’t news to Target, so it’s curious why it has taken the mass retailer so long to adapt its product accordingly.

Grocery & Restaurants

Darden to buy Cheddar’s for $780M

Darden Restaurants Inc. it has agreed to buy Cheddar’s Scratch Kitchen from the private-equity groups L Catterton and Oak Investment Partners for $780 million in an all-cash deal. The acquisition, coming three years after Darden sold Red Lobster, gives the Orlando-based casual-dining operator its eighth concept — along with Olive Garden, LongHorn Steakhouse, Yard House, The Capital Grille, Seasons 52, Bahama Breeze and Eddie V’s.

Ruby Tuesday gets interesting new investor

Leon Capital Group announced through federal securities filings that it had made a 9.5-percent investment in Ruby Tuesday Inc. The filing was activist in nature, meaning that Leon Capital plans to hold talks with the company’s management. Here’s the kicker: Leon Capital is not an activist investor. It is an investment fund that focuses on — wait for it — real estate. Earlier this month, Ruby Tuesday said it was exploring strategic alternatives, including a potential sale. The company’s primary asset isn’t its restaurant chain. It’s the 300 or so restaurant locations the company owns, rather than leases — an asset that itself is valued at far more than the company’s market capitalization of nearly $160 million.

Cava Group receives $30M in new funding

Cava Group Inc. has received a new $30 million investment from existing equity holders to expand its Mediterranean-focused Cava Grill chain, the company said. Washington, D.C.-based Cava Group said the Series C funding came from existing private-equity group Invus, along with venture capital firm Revolution Growth and Swan & Legend. The three investors were in a $45 million Series B investment in Cava in September 2015.

Home & Road

Restoration Hardware Pops after Sales Forecast Beats Expectations

Restoration Hardware announced a forecast for first-quarter sales that beat analysts’ expectations, sending its shares higher in extended trading.  The high-end furniture retailer said it saw first-quarter net revenues in a range of $530 million to $545 million, beating the forecast for $485.1 million. For the fourth quarter, Restoration Hardware reported adjusted earnings per share of $0.68 and net revenues of $586.7 million, both in line with its earlier guidance. “We made several strategic investments and changes to our business last year, which temporarily depressed financial results in the short term, that we believe will strengthen our brand and position the business for accelerated growth in fiscal 2017 and beyond,” said Gary Friedman, the company’s CEO, in the earnings statement.

Bassett Furniture Industries Inc Profit Retreats 11% In Q1

Bassett Furniture Industries Inc announced earnings for first quarter that decreased compared to the same period last year.  The company said its profit came in at $2.86 million, or $0.27 per share. This was lower than $3.23 million, or $0.30 per share, in last year’s first quarter. Analysts had expected the company to earn $0.29 per share, according figures compiled by Thomson Reuters. The company said revenue for the quarter fell 0.9% to $105.89 million. This was down from $106.87 million last year.

Jewelry & Luxury

2016 Diamond Pipeline – Survival In The Absence Of Growth

For five years in a row, the industry’s global polished diamond sales, measured in Polished Wholesale Prices (PWP), have followed a downward trend. Commencing in 2011, when sales peaked at $22.6 billion, this figure gradually declined to $18.7 billion in 2016 – registering a 17% accumulative decline. Last year, the decline was merely 3% over the $19.2 billion of 2015. Economic models predict that in 2017, global polished sales will remain steady, while the industry’s rough replenishment will continue, comfortably absorbing the higher rough supplies already announced by the main producers.

Jeweler Speaks Out on “Rocks” Billboard

When Spicer Greene Jewelers erected a billboard that read, “Sometimes, it’s ok to throw rocks at girls,” it didn’t expect that online commentators would soon be throwing (metaphorical) rocks at it. But the message struck a chord—a negative one. Many found the ad tone-deaf and believed the tag line was making light of, or, worse, condoning violence against women, in particular, little girls. The Asheville, N.C.–based store’s co-owner Eva-Michelle Spicer says the gripes began in a local Facebook group. They soon spread to local media. Then the issue hit national news. After Chelsea Clinton tweeted about it—“Talking about hitting girls is never funny. Ever,” wrote the former first daughter—international newspapers joined in. The store even attracted a mini protest, with 10 to 15 people picketing it over the weekend.

New Signet Shareholder Suit Targets Sexual Harassment Response

Signet Jewelers has been targeted by a new shareholder class action—this one targeting the company’s reaction to allegations of sexual harassment at its Sterling division.

The complaint, which seeks securities fraud class-action status, was filed March 28 in Northern Texas federal court on behalf of the Irving Firemen’s Relief and Retirement System. It claims that Signet and certain of its officers “made materially false or misleading statements…in press releases and filings with the [Securities and Exchange Commission.]” It notes that, after The Washington Post printed damaging excerpts of 249 previously sealed declarations filed in Signet’s ongoing gender-discrimination arbitration, the company’s stock dropped 13 percent, its largest one-day drop in eight years.

The winners and losers in a Coach-Kate Spade acquisition

With reports swirling that Coach’s acquisition of Kate Spade is imminent, what would a merger of two of the leading American handbag brands look like? “Coach has viability again,” said Jessica Ramirez, retail analyst at boutique firm Jane Halli & Associates. “Now, they’re targeting millennials and looking to further elevate the brand. For Kate Spade, Coach could do for it what they did for Stuart Weitzman.” Coach, which acquired footwear brand Stuart Weitzman for $574 million in 2015, has been undergoing a restructuring since annual sales dipped as low as $4.1 billion in 2015, down from $5.1 billion in 2013. Now that sales have started to turn around, up 7 percent over last year, the company is exploring the Kate Spade acquisition as an avenue for accelerating growth.

Office & Leisure

For nearly every bookstore Barnes & Noble loses this year, Amazon will open a new one

Americans are swapping bookstores. Bookselling chain Barnes & Noble will lose a total of eight stores across the United States by the end of this fiscal year, but digital behemoth Amazon will fill the gap by December. Last week, Amazon opened a store in Chicago, Illinois, its first physical bookstore not in a coastal city, and the second of the seven it plans to open this calendar year. Meanwhile, Barnes & Noble plans to open four new stores and close 12 by April 30, according to David Deason, vice president of development. Last fiscal year the company closed eight locations. Eight was good news for the bookstore chain: It was the fewest closings Barnes & Noble had seen since 2000, says Deason, and five fewer than originally planned. Barnes & Noble also opened three “concept” stores last fiscal year, which included attached restaurants with $11 hummus. But as Barnes & Noble goes through an identity crisis, Amazon is extending its reach. The e-commerce giant opened its first store in November 2015 in a Seattle, Washington mall—where a Barnes & Noble sold books until 2011—and has since has picked up the pace of brick-and-mortar openings.

Staples Tries to Become a Hip Co-Working Hangout

Staples has revamped the space inside its very first store in America, in Boston’s Brighton neighborhood. Inside the “co-working” space, millennials on laptops set up their instant offices, and sip gourmet coffee in comfy booths as a chill soundtrack plays. There’s funky art, as well as skylights, and an artificial putting green. The move shows how Staples Inc. is digging up its roots as one of the first, and most successful, big-box retailers. Under Shira Goodman, the company’s new chief executive officer, Staples hopes it can reverse its years of declining sales, unlike so many other retailers left for dead in the internet age. Staples is targeting small businesses, from independent contractors who patronize co-working offices to entrepreneurs on Main Street and in Silicon Valley. Goodman sees a revamped Staples as a small-business consultant of sorts — “indispensable partners” to companies.

Technology & Internet

Amazon reveals details of Pickup stores

Amazon on Tuesday revealed details of its grocery click-and-collect sites in Seattle, saying the offering, to be branded AmazonFresh Pickup, would provide a full array of grocery and household items available for online ordering and pickup, free to its Prime members.

Retailers could use ISP data for dynamic pricing or marketing

Retailers might soon have access to lot more consumer information that will enable them to dynamically price items and market to consumers based on the websites and apps consumers visit and where they connect online. That’s because President Donald Trump is expected to sign a bill that passed in Congress that lets internet service providers (ISPs) sell consumers’ internet history and other sensitive information, such as their location, financial information, health information and the content of their online communications.

Finance & Economy

Consumer confidence soars in March to highest level since December 2000

Consumers’ attitudes to current conditions in the U.S. jumped in March, according to a monthly survey. The Consumer Confidence Index hit 125.6 in March according to data from The Conference Board, its highest level since December 2000.  Economists expected the Conference Board’s consumer confidence index to hit 114 in March, according to a consensus estimate from Reuters.  The survey, a closely followed barometer of consumer attitudes, measures confidence toward business conditions, short-term outlook, personal finances and jobs.

US home prices rise 5.9 percent to 31-month high in January

US home price gains reached a 31-month high in January, according to the S&P/Case-Shiller U.S. National Home Price Index.  The index, which measures all nine U.S. census divisions, found that home prices rose 5.9 percent year-over-year in the month, up from December’s 5.7 percent annual gain.  Of the nation’s 20 largest cities, three reached their all-time highs in January: Seattle, Portland, and Denver. And 12 cities reported greater price increases in the year ending January 2017 versus the year ending December 2016, the report said.