GAP – don’t drop your pants BUY

GPS : NYSE : US$40.14

Target: US$47.00

Consumer & Retail — Specialty Retail



Investment recommendation
We are lowering our Q4 EPS estimate for GPS by $0.09 to $0.68,
below prior consensus of $0.77. There is more work to do in the
Gap brand (38% of TTM sales) than we had previously
anticipated, particularly in the women’s business. As a result, we
are lowering our consolidated SSS estimate from flat to a decline
of 2.4% on top of +1%. Our gross margin forecast moves 50bps
lower, and we now expect 59bps of expense deleverage on the
lower sales. Our BUY rating remains intact despite the near-term
headwinds. We continue to expect supply-chain initiatives will
drive gross margin expansion over the long term. This does not
appear priced in with shares trading at 13x our C2015 EPS
estimate and 7x C2015E EV/EBITDA.
Investment highlights
 Art Peck will begin his CEO stint with two new brand
presidents. Jeff Kirwan (10 years with GPS, recently as
president of Gap China) will take the reins from Stephen
Sunnucks at the Gap brand in December, and Andi Owen (19
years at GPS, recently leading the Gap outlet business) will
head up Banana Republic beginning in January, replacing
Jack Calhoun.
 Our price target moves from $51 to $47 as we incorporate
our updated estimates into our DCF model.

Rent-A-Center BUY

RCII : NASDAQ : US$26.59
Target: US$32.00

RCII is the largest RTO operator in the United States with
over 40% market share. The company operates
approximately 3,025 stores in North America. RCII also
operates nearly 1,360 AcceptanceNOW kiosks located
within retail stores, offering RTO agreements to
customers unable to garner financing to make an in-store
All amounts in US$ unless otherwise noted.

Consumer & Retail — Specialty Retail
Investment recommendation
RCII dug deeper into the initiatives aimed at improving
profitability in the core business at Canaccord Genuity’s Global
Growth Conference, and we think the decision to transition to a
more flexible labor model is a no brainer. In Q2, virtually all of
the core’s yr./yr. revenue decline fell through to the bottom line
as a result of the company’s fixed-cost labor model. We think
there is an opportunity to substantially reduce labor costs by
incorporating more part-time hours into the core RTO business.
The addition of Guy Constant as CFO should prove valuable
through this transition, as his 10-year tenure in the restaurant
industry has exposed him to a much more efficient labor model.
We believe simply replacing overtime hours in 20% of core RTO
stores with part-time labor would generate over $20MM in
annual cost savings in 2015 and lift RCII’s operating profit
margin by 110bps. We are raising our rating to BUY given the
potential EBIT margin and EPS upside we believe this transition
Investment highlights
 We are increasing our long-term EPS estimates by 28% on
average. Our 2015 estimate of $2.59 is $0.25 above
 Our price target moves to $32 based on our DCF model.

Dick’s Sporting Goods In The Rough ?

DKS : NYSE : US$44.21 HOLD 
Target: US$49.00

Consumer & Retail — Footwear and Apparel

Investment recommendation
DKS reported Q2 EPS of 67c. vs. our estimate and consensus of 65c,
driven by stronger-than-expected comp growth of 3.2%, tighter expense
controls and a lower share count, partially offset by gross margin
contraction as steep promotions in golf drove traffic at the expense of
margins. The hunting category continues to experience challenges as it
comp’d -HSD in 2Q14.
That said, growth in other outdoor categories is
offsetting the weakness in guns/ammo, which drove flat total category
comps. The company provided EPS guidance of $0.38-$0.42 for 3Q14,
including a -2c impact due to higher SG&A expense related to 32 new
store openings in the third quarter.
Investment highlights
 DKS has taken meaningful steps to mitigate the impact of the
struggling golf business, but the promotional activity is expected to
continue into 2H. Also, generally high promotional activity across
the industry will impact DKS by an estimated 4c in 2H14 as it will
need to keep the promotional pace with its competitors to drive
traffic. Lastly, hunting is expected to offsetDKS is benefitting from its move to reduce sq ft in golf and increase
the space in Women’s & Youth apparel. We would like to see an
incremental reduction in golf sq ft.; however, the company is being
methodical about the space shifts and resulting cost/benefits.
Our $49 target is a blend of 15x 2015E EPS, 8x EBITDA, and DCF the growth in other
outdoor categories in the near term.

Deckers Outdoor Corporation

DECK : NASDAQ : US$85.90
Target: US$111.00

Deckers Outdoor Corp. engages in the design, manufacture, and marketing of footwear and accessories for outdoor activities and casual lifestyle use. DECK distributes their goods through specialty retailers, department stores, outdoor retailers, sporting goods retailers and online retailers. DECK also sells directly to consumer through its websites and retail concept stores. The company was founded in 1973 and headquartered in California

Consumer & Retail — Footwear and Apparel
Investment recommendation
In this report, we discuss our view on how 2014 will unfold for DECK and the roadmap to 30% EPS growth. The crux of our increase in sales/EPS estimates is our improved outlook for 2014 wholesale orders. After discussions with our industry contacts, we believe a positive 2013 holiday season has given retailers renewed confidence in the winter boot category which should manifest in strong 2014 orders. In addition, DECK is making solid progress on its structural gross margin expansion plan that we believe is still in the early stages as both retail and UGG Pure penetration should increase through 2015. With both sales and gross margin accelerating coupled with our expectations for a much improved inventory position, we reiterate our BUY rating and are raising our 12-month price target to $111.
Investment highlights
 We now anticipate wholesale growth in 2014 to be +6% vs. our prior estimate for -1%; an estimate that could prove conservative given a turn in Europe and an improving assortment in Asia.
 While we expect Q4 results to produce a solid beat, we are not anticipating a pre-announcement at ICR since it is not customary practice (the last preannouncement was in 2008). That said, we expect positive commentary by management to be well received.
Our $111 target is a blend of 19x our 2015E EPS /12x EBITDA/ DCF

Bed Bath & Beyond – Watch and Wait

BBBY : NASDAQ : US$79.68
Target: US$73.00

Bed Bath & Beyond sells a wide assortment of merchandise including home furnishings, domestics, giftware, health and beauty care items, and infant and toddler merchandise. BBBY operates around 1,010 Bed Bath & Beyond stores, 270 Cost Plus World Markets, 75 Christmas Tree Shops, 85 buybuy BABY locations, and 50 Harmon stores.
All amounts in US$ unless otherwise noted.

Consumer & Retail — Specialty Retail
Investment recommendation
BBBY’s Q3 EPS of $1.12 was $0.03 below our estimate and consensus. Q3 SSS increased 1.3% on top of +1.7% versus our +3% forecast. Higher couponing and mix shift led to a 60bps gross margin decline, worse than our -13bps forecast. Items below the EBIT line added $0.02 compared to our forecast. We downgraded shares to a Hold rating on 10/30/13, and we remain concerned about retail traffic trends and heavy couponing. BBBY reduced Q4 EPS guidance by $0.10 to $1.60-$1.67 after December transactions fell short of expectations. We remain on the sidelines with shares trading at 14x our FY14 EPS estimate and 8x FY14E EV/EBITDA based on the after-hours quote of $73.
Investment highlights
 We believe BBBY suffered its first market-share loss since the World Market acquisition in Q2/12. Based on home furnishings sales as reported by the U.S. Census Bureau, we calculate BBBY’s share slid 19bps to 22.3%.
 Weaker sales and greater margin pressure push our Q4 EPS estimate $0.16 lower to $1.64, versus prior consensus of $1.78. We lowered our Q4 SSS forecast 150bps to +2% on top of +2.5%. We reduced our gross margin outlook by 30bps and raised our SG&A expense rate forecast by 50bps.
 Our price target moves from $84 to $73 based on our updated DCF model.

Tiffany & Co. SELL

TIF : NYSE : US$78.24
Target: US$65.00

Tiffany & Co. is the parent corporation of jeweler and specialty retailer Tiffany and Company. Through its principal subsidiary Tiffany offers an extensive assortment of jewelry, as well as timepieces, crystal, sterling silverware, and accessories.

Consumer & Retail — Specialty Retail
Investment recommendation
We expect TIF will report a 65bps yr./yr. improvement in gross margin when it releases Q3 results on November 26, the second straight quarter of expansion following seven consecutive periods of declines. The company should be seeing some benefit from price increases introduced in Q1, and metal and diamond cost deflation is starting to flow through the P&L statement.

We analyzed the potential upside from sustained commodity cost deflation. Based on a composite we compiled, we believe that as this lower-cost product flows through inventories, it would add about 60bps incremental gross margin in FY14, and we are raising our EPS estimate by $0.12 to $4.01. We do not think this is sufficient for a rating change. Our FY14 EPS estimate remains $0.09 below consensus, and the $65 price target generated by our DCF model, up from $57, still indicates notable downside.
Investment highlights
 We expect weaker sales of silver product will remain a gross margin headwind. We think this higher-margin product has been a victim of stale fashion in recent quarters.
 TIF trades in line with the luxury group despite slower projected growth. We expect sales and EPS will grow at compounded annual rates of 5% and 12%, respectively over the next three years versus the group averages of 10% and 13%.

Canadian Tire Corporation Ltd.

No Longer ” Crappy Tire” )

CTC.A : TSX : C$96.97
Target: C$109.00 
Canadian Tire is Canada’s most shopped general merchandise retailer, operating stores under the Canadian Tire, Mark’s, and PartSource banners. Through Canadian Tire Financial Services the company also manages a portfolio of credit card receivables.
All amounts in C$ unless otherwise noted.

Consumer & Retail — Merchandising
Investment recommendation
We are reiterating our BUY rating and C$109.00 target price following Canadian Tire’s Q3/13 earnings results.
Investment highlights
 Canadian Tire reported Q3/13 earnings results on Thursday morning, before the market open. Revenue increased 4.5% YoY to $2,956 million. EPS of $1.79 was in-line with our estimate, and above consensus of $1.76 and last year at $1.61. The company also announced a 25% increase to its quarterly dividend to $1.75 per share.
 Retail appeared to be firing on all cylinders during the quarter, with healthy same-store sales growth at all banners. CTR, Forzani, and Mark’s delivered 2.0%, 6.3% and 4.3% increases in same-store sales, respectively. At CTFS, a 118 bps YoY decline in write-off rates to 5.74% allowed the company’s return on receivables to increase to 7.21% from 6.68% last year. EBT at CTFS increased to $80 million, up 8.5% YoY.
 Looking forward, we expect continued strength at the company’s Retail division as we head into the holiday season, with management noting that inventories remain in a healthy position in advance of Q4/13. Furthermore, we believe investors will focus on the potential announcement of a credit card partnership over the next 12 months which we believe should unlock meaningful cash for Canadian Tire.
Our 12-month C$109.00 target price reflects our sum-of-the-parts valuation, whereby we value the company’s real estate, Retail division, and Financial Service division separately.

Under Armour Update

UA : NYSE : US$82.12
Target: US$92.00

Under Armour is a leading manufacturer of athletic apparel, footwear, and accessories. The company sells through wholesale channels of distribution, factory outlet stores, and through its e-commerce platform. Geographically, North America represents 94% of UA’s sales with the remaining 6% from international countries.

Consumer & Retail — Footwear and Apparel

Investment recommendation

We are expecting solid Q3 results from UA when it reports on 10/24 BMO. Despite generally inconsistent traffic at retail, athletic has been the outperformer with UA a key beneficiary of this trend, we believe. We estimate of 25% sales growth could prove conservative given new product intros at higher ASPs, accelerated shop-in-shop openings at DKS, and DTC growth. In addition, we believe modest gross margin upside stemming from the yet-unresolved Canadian duties issue could materialize. Separately, while UA has been vociferous about its intent to accelerate investments in international, resulting in less EPS flow-through, we believe this is more a Q4 event. As such, we are comfortable with our 69c EPS estimate (3c above the Street). With improving consistency in execution and sales momentum, we feel it appropriate to roll forward our valuation to 2015, resulting in our new price target of $92 from $76. We reiterate our BUY rating.
Investment highlights
 ColdGear Infrared (~$100M launch at 10%-15% higher prices), Alter Ego (first wholesale sell-in quarter), expanded Storm Fleece program, and a re-launch of bags should combine to propel sold sales growth in Q3. Also we expect ~60 new shop-in-shops at DKS to drive a significant sales lift that could contribute ~3c to Q3 EPS.
 While input cost comparisons are more difficult in Q3, we believe there could be modest upside to our -35bp gross margin estimate stemming from (1) better quality/margin excess product in outlets

Francesca’s Holdings Corporation Target Price $35

FRAN : NASDAQ : US$18.08
Target: US$35.00

Francesca’s Holdings Corporation is the holding company for specialty retailer Francesca’s Collections. Through a national chain of around 440 retail boutiques and an e-commerce web site, Francesca’s sells apparel, jewelry, accessories, and gift items with an assortment tailored to its core 18-35 year-old, fashion-conscious female customer.
All amounts in US$


Investment recommendation
On September 4, FRAN reported Q2 results that fell below expectations as traffic weakened and greater promotional levels persisted. Since that time, the stock has declined 25%, compared with the S&P 500 index +2%, the RLX index +4%, and the specialty apparel peer group +2%. We consider this an overreaction for a company we forecast will grow sales and EPS at compounded annual rates of 15% and 17%, respectively, over the next five years. Traffic has remained soft, which does cloud the H2 picture, but we think this is priced in following the stock’s recent move. Over the long haul, we believe FRAN will continue to generate one of the highest EBIT margins (in the mid-20% range) and returns (TTM ROIC of 29%) in the specialty retail group. We do not think this is fully reflected with shares trading at 12x our C2014 EPS estimate and 7x C2014E EV/EBITDA.
Investment highlights
 We expect square footage to increase at a five-year CAGR of 18%. This is the highest rate of growth among all the retailers we cover and is three times the group’s average.
 Shares trade at a discount to specialty apparel peers despite top growth prospects. FRAN trades at a sizable discount to the group’s average C2014E P/E of 17x and C2014E EV/EBITDA of 8x, while our sales and EPS growth projections are more than double the mean.


GPS : NYSE : US$42.01
Target: US$44.00

Gap is a global specialty retailer of clothing and accessories for women, men, and children. GPS brands consist of Gap, Old Navy,
Banana Republic, Athleta, and Piperlime. The company operates around 3,100 stores worldwide, and GPS products are sold
through 300 franchise locations.


Investment recommendation

GPS’s Q2 EPS of $0.64 met our expectation and consensus. The company generated 99bps of operating expense leverage, versus our estimate of a 52bps improvement. This was offset by a lower gross margin increase than our forecast and a higher tax rate.
The gross margin expanded 60bps, driven by buying & occupancy leverage, less than the +83bps we had expected.
Merchandise margins declined 30bps in the quarter, while we had modeled for an 80bps expansion. We believe the stock’s
current valuation of 15x our FY14 EPS estimate and 7x FY14E EV/EBITDA is appropriate for a mature retailer that we project
will grow square footage at a five-year CAGR of 2%.
Investment highlights
 We expect a flat gross margin in H2. We were previously forecasting a 30bps margin expansion in the back half of FY13. Our Q3 EPS estimate moves $0.01 lower to $0.67, $0.03 below prior consensus. We continue to view GPS’s FY13 EPS guidance of $2.57-2.65 as conservative.

For FY13,  we are reducing our EPS estimate by $0.02, but we remain $0.04 above the high end of management’s outlook. Prior consensus was already $0.13 above the high end.
 Our price target moves from $45 to $44 based on our discounted NOPAT model. We have adjusted on long-term EBIT projections about 1% lower.


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