The Line On Hardlines With Brian Sozzi (TBL)

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I'm your host, Chris Ciaccia, and today our guest is Brian Sozzi, a research analyst from Wall Street Strategies who specializes in apparel/hardline goods in retail.

How ya doin' today Brian?

Brian Sozzi: I'm doing quite well, thank you.

Lately you've been positive on Columbia Sportswear Company COLM and Timberland Company TBL. Can you tell us why?

Brian Sozzi: Well, the investment thesis [is] driven by the weather. It's not just the weather here in the U.S. Sure, earlier in the quarter we had suspect weather on the west coast. It kind of went south in December in the northeast and the Midwest, and also weather internationally.

Regarding these picks, Timberland (which I'm a little more positive on than Columbia) has really strong exposure to the areas that were impacted by inclement weather in Europe. Now, Columbia does have exposure – 16% of annual sales come from Europe. But Timberland, about 45% of their sales are devoted to Europe. So I think in terms of a short-term trade, which is what these calls predominately are, and what I actually call them is a snow trade, is on Timberland.

I know Columbia should benefit. I think the upside potential is going to be greater with Timberland because I think the stock is valued at a more discounted level.

Do you recommend buying the common stock?

Brian Sozzi: I follow equities, so I'm recommending the stock of either company. You don't have to own both. They both are in the same space. They both were able to capture demand. I just think at this point, given the valuation, and their stores, and their wholesale accounts toward the holiday season, I think they were better able to capture demand.

But again, Columbia had probably one of the most exciting product lines to launch in company history. This company threw a significant amount of dollars at the Omni-Heat, which is a pretty radical shift from the usual, I would say boring, Columbia brand. The technology is there throughout 2010. Things that seemed interesting certainly caught the consumer's attention. Consumers were out there buying interesting products, and Columbia was out there as well.

Do you think someone like Nike NKE or Adidas would take over one of these companies?

Brian Sozzi: Each one has their own story. Timberland has been in the rumor mill almost as long as I've been covering the company. My sense is that Timberland would go before Columbia. But there's a common thread here; the families that created each brand is still in the mix.

You have the Swartz family that's heavily involved with Timberland, and you have the Boyle family heavily involved at Columbia, so they own a significant number of shares. Now, speaking of Timberland, they have a specific brand heritage. They're very environmentally friendly.

In many respects I would kind of compare them to Haagen-Dazs, and I believe Unilever UN bought them out a couple years ago. They have a special culture. I think that any company that wants to take them over not only has to pony up a significant amount of money but they also need to meet some of the concerns of the Swartz family that they will preserve this environmentally friendly message.

Columbia, on the other hand, I don't see a clear succession plan there to current President and CEO, Tim Boyle. Gertrude Boyle, who married the founder of Columbia, she's still the chairman. They're both getting up there in age. My sense in covering Columbia for close to six years is that they've never quite lived up to the earnings potential of the business.

What are your top retail picks for 2011?

Brian Sozzi: Recently, our top pick was New York & Company NWY. The thinking behind that is the turnaround play. Normally I wouldn't recommend a turnaround play in the type of topsy-turvy market that we continue to see in the retail sector. But New York & Company really struck me.

Number-one, they brought in a whole new management team. I like what they're doing with New York & Company, trying to bring more fashion to a brand that I think has been dead 10 years. Within three years, they will have cut out 200 million operating expenses. [That] could be quite powerful.

Ironically, when same store sales for December were reported last week, New York & Company was positive in earnings for the quarter. [That] countered most of what we saw throughout the retail sector, which was sales misses and earnings warnings. So I think the earning story is finally starting to play out at New York & Company.

Another company [to watch] is Big Lots BIG. My thinking of Big Lots, here, was in the spirit of what we saw with Jo-Ann Stores JAS; a company that's not too sexy, selling boring-type products, but at a depressed valuation at this point. Jo-Ann was brought private a couple months ago for a significant premium.

Big Lots is trading pretty comparable on a valuation basis and maybe a little less [prior] to the Jo-Ann Stores deal. I just finished my due diligence on that. I reached out to the management team. We've been holding calls with them. All in all, I think there's an interesting story brewing here for the next year or two years.

One of the problem areas in their business, which was consumables, which was important for a big-box retailer because it helps drive greater traffic to the stores, and hopefully sell the higher-margin stuff. They brought in several new merchants. They also plan to ramp up store growth acceleration.

I also like how they're managing their portfolio; they're very willing to close underperforming stores, and quite aggressively. By the end of 2010 [I believe] they closed or relocated 40 stores. That's really important to be constantly pruning your store base and pull out stores on a cash-flow negative.

Again, at about 2.5 times earnings, and those earnings would be on my estimate for this year, [and] about 5 times enterprise value to EBITA, I think it's a compelling opportunity in retail, especially with all the buyout transaction we're starting to see.

Do you have any short ideas?

Brian Sozzi: I have a couple: One would be Wal-Mart WMT. I've caught a lot of flack on this, but it's one that I've been recommending as a short for at least a month and a half on CNBC. Ironically, it [recently] caught a downgrade by Goldman Sachs.

The thing [about] Wal-Mart is in a retail market where there are clear winner and clear losers, Wal-Mart falls in the category of clear loser. When I see reasonable same-store sales results from Macy's M, Target TGT, Costco COST, BJ's BJ, someone has to be losing in this environment. And I think Wal-Mart is losing.

I think this is a value-trap at this point. I think the traffic isn't there. I think dollar stores are taking traffic from Wal-Mart, or continuing to take traffic. Family Dollar Stores, Inc. FDO, for example, had a 7% traffic increase for the quarter they just reported.

Now, when I see Macy's, Target, BJ's, dollar stores are gaining traffic… Wal-Mart is losing traffic. I don't think their merchandise selection is there. I think they remain focused on too many areas, too many things going on with the business. International expansion, trying to expand to inner-city dwellings. And I think they've lost sight of what Wal-Mart stands for: great customer service and low prices. We've done pricing studies and they've [been raising] prices.

You put out a report that focused on Lululemon Athletica LULU versus Gap's GPS Athleta.

Brian Sozzi: Obviously I don't wear the stuff, and if I did I think it'd be kind of weird. But yoga market is over $30 billion annually – it's a big market, and there's room for everyone to play. There's really Lululemon mania right now. It started last year. It's really picking up analyst rating after analyst rating – it's Buy, Buy, Buy. Price targets – I think one analyst hit the $100 price target. And I've seen this before in retail where people go gaga over certain retail names and they see endless growth. For me as a contrarian, and a value investor, that's when I start to worry.

Now, speaking specifically to Lululemon, they've been on a run. The numbers support that their model is not a fad. They have a good model where they partner with local gyms to promote the product, basically free. They give their clothes out for free to what they call some of these yoga ambassadors, which basically go out and promote the brand.

I like that they test their stores very significantly before they roll them out. They're not just going out there like [many retailers did in] 2007 and pumping stores out in markets it doesn't make any sense to be in, and then having to close them a couple years later. Eight percent of their business is online and growing. The margins of the business are quite strong. I mean, if you can sell a bottom that is primarily made of synthetic material for $110, and you see a lot of volume in that, you can really drive significant earnings growth, and that's what they're doing.

Now, Athleta, I think is a different… Gap bought Athleta in 2008 for $148 million. It was the first big buy by CEO Glenn Murphy, so in many respects he owns Athleta. This was his deal, his baby.

So what's coming to market? Athleta is bringing a complete lifestyle brand to market. They [recently] announced their first store opening; 5,000-foot square store. The average Lululemon store usually averages about 2,900 square feet.

[Gap] knows what product is selling. They've been at this brand for two years online. They already have a strong relationship; Athleta offers New Balance shoes, Oakley sunglasses, Merrell sneakers. Lululemon still doesn't offer this stuff yet. They're still growing. They're still trying to forge their relationships. They remain in growth mode where they're opening stores.

Let's not forget about the buying leverage of Gap and the hungriness of Gap. On the buying leverage standpoint, they have more buying leverage than Lululemon at this point, and they can drive better prices, and that's particularly important when you see all this talk of rising inflation in the retail sector. I think it's already starting to show up. You go to the website, and when compared to Lululemon, [Gap's] prices are a little cheaper. I think the quality might be a little worse than LULU, but the price is more attainable, and I think that speaks to the buying leverage.

Two, the hungriness of Gap. The Gap team has been sitting on established brands: Old Navy, Banana Republic, pretty much modeling along same-store sales, eh, so-so. Earnings growth, so-so. Most of their earnings growth has been driven by share repurchases. So I think with Athleta they see an opportunity for a growth-driver, maybe the first growth-driver for them since Old Navy was launched.

Will the price of cotton affect Lululemon's margins?

Brian Sozzi: I don't know how much LULU can push their price point. I think they're very expensive. What they're selling is premium-type products, and I think they don't have the supplier base that the Gap does. So while their products are not necessarily all cotton, common sense tells me that they're going to have an impact gross margin.

(1) Because inflation is starting to increase. (2) You're having greater competition in this space. (3) The comparisons in their business are going to be quite tough over the next couple of years because they've pretty much been dealing with deflation and driving pure profit within their model. So I think it's a concern for investors, especially at the valuation level.

What's your outlook for the consumer this year? Will consumer spending rebound?

Brian Sozzi: My general theme this year is mini booms and mini busts. And that's not so much different from what we saw in 2010. In 2010 we saw buying around specific periods: back to school, holidays, maybe a little in the spring. This year I think you will see stronger buying during those key periods.

But not during those key periods, I think you'll be getting lulls within these retail sales. I think the first part of 2011 is going to bring that to surface. For example, January. We have storm activity. I think the numbers right now are tracking not so well. Same-store sales have weakened since December, so that's quite indicative. It's not just the storm activity – I think there's also some holiday hangover.

We also have a late arrival of Easter. I believe it arrives on April 24. So theoretically you're looking at a void in the retail sales data maybe until April. But even outside of April, and I still see it when I go out and look at consumer spending, I think they're not buying every piece of item in the store. I still think a promotion is needed. And I still think the market doesn't appreciate that a promotion is needed.

Pre-planned promotions or not, it's still a promotion. If you're a retailer offering 30% off and in addition you're having to contend with inflation, and a consumer that's up and down, I think that these retail stocks are going to have another year like last year – a bold and maybe misguided call.