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Saturday, August 21, 2010

Double Dip? Check "Selfish" Discretionary Spending versus "Gifting" Discretionary Activity; Tough for FLWS, Others Prevailing

For the most part, the American consumer remains weak. We knew this in building our 1-800-Flowers.com (FLWS) position during the first half of 2010. However, we found comfort in a margin of safety relative to our estimate of fair value underpinned by several durable competitive advantages: (1) strong brand equity, (2) economies of scale across segments, and (3) capital light business model. Further, more recently, we also pointed to the bright side of retail sales data showing healthy Y/Y increases (on easy Y/Y comparisons) versus mixed M/M performance in recent months.

Here's the latest month over month retail data from Briefing.com:

AND, part of the "Big Picture" conclusion (emphasis added) and two caveats, also from Briefing.com:
  • Retail sales are likely to remain weak for quite a while given the current trends in employment, and the negative wealth impact for depressed prices for homes and stocks.
  • The retail sales report is a measure of the total receipts of retail stores. The changes in retail sales are widely followed as the most timely indicator of broad consumer spending patterns. Retail sales are often viewed ex-autos, as auto sales can move sharply from month-to-month. It is also important to keep an eye on the gas and food components, where changes in sales are often a result of price changes rather than shifting consumer demand.
  • Retail sales can be quite volatile and the advance reports are subject to rather large revisions. Retail sales do not include spending on services, which makes up over half of total consumption. Total personal consumption is not available until the personal income and consumption reports are released, typically two weeks after retail sales.
YET, performance by retailers has been a mixed bag, with some reporting surprisingly strong results and others beset by weak consumer.

We previously mentioned the favorable performance of Pier One Imports (PIR) and Select Comfort (SCSS), which sell "imported decorative home furnishings and gifts" and "adjustable-firmness beds and other sleep-related accessory products," respectively. Here are two companies one might expect to be in a world of hurt given the ailing consumer, right?

Let's briefly look at a broad sampling of retail results/news, including recent results from Select Comfort:

  • Select Comfort Corporation (NASDAQ: SCSS) reported second quarter results for the period ended July 3, 2010. Net sales for the quarter totaled $139 million, an increase of 15 percent on same-store growth of 28 percent, compared to $121 million in the second quarter of 2009. The company reported net income of $6.2 million, or $0.11 per diluted share in the second quarter of 2010, compared to a net loss of $4 million, or $0.09 per diluted share, in the second quarter of 2009.
  • "During the second quarter, our focus on key priorities delivered double-digit growth in same-store and total sales as well as improved profitability," said Bill McLaughlin, president and CEO, Select Comfort Corporation. "The progress we made during the past 18 months in our cost structure and operational execution is generating sustained profitability. In addition, these enhancements are proving particularly valuable as we lap stronger comparisons to a year ago and the macro-economic environment remains uncertain."
  • McLaughlin added, "In the second half of 2010, we will continue to execute against priorities designed to drive sales and profitability. We also will selectively invest in and test programs to advance longer-term growth including evolving our media messages, our digital and web presence, and store locations, as well as further enhancing our customer experience."
Landscaping gear:
  • The Toro Company (TTC) reported net earnings of $33.4 million, or $1.01 per share, on net sales of $458.9 million for its fiscal third quarter ended July 30, 2010. In the comparable fiscal 2009 period, the company reported net earnings of $19.8 million, or $0.54 per share, on net sales of $394.9 million.
  • For the fiscal year to date, Toro reported net earnings of $90 million, or $2.66 per share, on net sales of $1,353.1 million. In the comparable fiscal 2009 period, the company reported net earnings of $63.4 million, or $1.73 per share, on net sales $1,234.9 million.
  • "Even with concerns expressed by many economists of a slower recovery, we experienced strong end-user demand during our summer selling season," said Michael J. Hoffman, Toro's chairman and chief executive officer. "Positive momentum for our innovative new products, particularly within our Professional markets, enabled us to deliver better-than-expected revenue and profit growth. Additionally, our ongoing focus on asset management resulted in a further reduction of average net working capital which, along with improved earnings, contributed to record operating cash flow for the nine month period."
Assorted items (QVC) -- well-known household name in retailing:
  • QVC, part of Liberty Media Corporation and attributed to Liberty Interactive Group (LINTA), observed its largest CHRISTMAS IN JULY® event in the company’s 24-year history, with more than $46.5 million in orders – representing a 14 percent increase over prior year CHRISTMAS IN JULY results.
  • QVC’s holiday weekend event kicked off early, Friday evening, with special CHRISTMAS IN JULY offers both on-air and online and continued all day Monday on QVC.com. The largest CHRISTMAS IN JULY event in the company’s history gave viewers a head start on holiday shopping, offering everything needed for holiday gift-giving and decorating, including a sneak peek at some of the hottest items for the season.
  • “We’re thrilled with the overwhelming response we received from our customers especially during these challenging economic times,” said Mike George, QVC’s president and CEO. “The entire QVC team worked incredibly hard to provide viewers with a fun and entertaining event that offered unique and exclusive gift-giving items as well as holiday d├ęcor ideas at great values. All these elements combined represented the fuel that powered the successful event.”
  • [Beyond an artificial Christmas tree and toys] Additional top selling brands included specialty gift bags, boxes and wrap from Isaac Mizrahi; home fragrance from Slatkin & Co; great gifts for the gourmet from Kansas City Steak Co., Mrs. Prindable’s Apples, Harry London Gourmet Chocolate, Harry & David and Godiva.
Weight loss services, insight from our WTW:
  • Weight Watchers International, Inc. (WTW) announced its results for the second quarter of fiscal 2010, which ended July 3, 2010, and narrowed its fiscal 2010 earnings guidance.
  • Revenue of $376.7 million, up 1.1%, and EPS of $0.73 versus $0.76 in the prior year period
  • Newly launched North American marketing campaigns exceeded expectations
  • Success of new program innovation -- ProPoints(R) -- in Continental Europe continued; CE paid weeks up 11.2%
  • Internet revenues grew 20.6%; Weight Watchers Online active subscriber base passed the 1 million milestone
  • "The second quarter 2010 results of the Weight Watchers business improved significantly after a disappointing first quarter," commented David Kirchhoff, President and Chief Executive Officer of the Company. "In the second quarter, we saw acceleration of revenue growth in our WeightWatchers.com business and substantial stabilization of our North American meeting business as a result of strong spring marketing campaigns. This is all particularly gratifying as most of our planned growth initiatives will not provide their positive contribution until we move into fiscal 2011."
Fragrances - for some European perspective, acknowledging that strength is partially a benefit of new product launches:
  • Inter Parfums, Inc. (IPAR) reported record results for the second quarter and six months ended June 30, 2010. Second Quarter 2010 Compared to Second Quarter 2009:
  • Net sales rose 22% to $107.8 million from $88.6 million; at comparable foreign currency exchange rates, net sales increased 28%;
  • European-based operations achieved sales of $91.9 million, a 16% increase from $79.4 million;
  • Sales by U.S.-based operations rose 71% to $15.9 million from $9.2 million;
  • Gross margin was 60% compared to 57%;
  • Operating income rose 68% to $11.5 million from $6.8 million;
  • Operating margins were 10.7% of sales compared to 7.7%;
  • Net income attributable to Inter Parfums, Inc. rose 27% to $5.4 million from $4.2 million;
  • Russell Greenberg, Executive Vice President & CFO commented, “The continuation of comparable quarter top and bottom line growth is indicative of the strength of our existing brand portfolio, the expansion of the portfolio with new high value brands, our skill in developing and rolling out new brand-appropriate products as well as the onset of a recovery in many of our global markets. Details of the current period sales increases have already been reported.”
  • Raises 2010 Guidance - Mr. Greenberg then stated, “Based upon our year-to-date results and expectations for the second half of 2010, we have raised our full year guidance. We expect 2010 net sales to come in at approximately $445 million and net income attributable to Inter Parfums, Inc. to reach $24.8 million or $0.82 per diluted share. As always, our 2010 guidance assumes the dollar remains at current levels.”
AND, finally, "private sale" fashion E-commerce:
  • RueLaLa.com, a subsidiary of GSI Commerce (GSIC), which we mentioned in our Bidz.com (BIDZ) post the other week, "nearly doubled sales" versus last year during the June quarter: "Rue La La site sales nearly doubled from last year, increased sequentially versus the first quarter and also increased against the seasonally important fourth quarter."

ALL OF THE ABOVE RETAIL NEWS should help allay fears that the world is ending and a double dip is most certainly on the horizon and/or that the U.S. is doomed. Somehow, the consumer lives.

YET, of course, we know: ongoing real estate and government debt/deficit challenges are real and anticipated higher taxes will be a drag on both spending and new capital/entrepreneurial investment. Consumers are clearly picking their spots. Surprisingly, even consumer staples companies such as Walmart (WMT) and consumer packaged goods companies such as Kellogg Company (K) are posting disappointing results amidst a competitive retailing environment.

NOW, putting this all together alongside lackluster results from 1-800-Flowers.com -- we reach the following conclusion: what we'll call "selfish" discretionary retail segments are clearly outperforming "gifting" discretionary segments. Put simply, people are more willing to spend on themselves than on others: buy a new mattress, or a new mower, or new Christmas decorations (in July?), or lose weight for a better self image, or new perfume to smell nice, or discounted fashion merchandise. Maybe this should not be a surprise, especially in the current environment?... Further, note that many of these items have a natural replacement cycle that automatically generates demand over time.

This current trend is negative for our 1-800-Flowers.com and makes life more difficult for a company with low historic margins and seasonality (reasons why some investors steer entirely clear of FLWS or other discretionary retailers). Still, the company is prudently managing costs and focused on driving repeat business across the company's diverse portfolio of products. Plus, the balance sheet continues to improve on the back of steady cash generation. Importantly, we think our analysis of competitive advantages still stands. Meanwhile, the stock is again near an all-time low - from Google Finance:

Like other investors long the stock, we were hoping to see a turn in fundamentals this quarter (or at least stabilization), yet -- per the above summary -- "selfish" purchases are currently higher priorities than gifting. Fortunately, 1-800-Flowers.com can somewhat play in the selfish arena by motivating more customers to indulge in chocolates, cookies, popcorn, and other items for self-consumption. Recall that QVC cited Harry London chocolates as a popular seller. Also, 1-800-Flowers.com's plan to further expand the company's Fannie May chocolate presence is sensible. We think these product lines represent higher margin, hidden gems in the company's basket of properties. For now, we will remain patient. We might even order some Dark Pixies chocolates from Fannie May.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long FLWS, WTW, BIDZ.
© 2010 Jeffrey Walkenhorst
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