Retail Hardlines: Purchases: Don t leave home without it

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1 Aram Rubinson, CFA Retail Hardlines: Purchases: Don t leave home without it Chris Bottiglieri, CFA, CPA CBottiglieri@wolferesearch.com Carol Krakowski CKrakowski@wolferesearch.com Priced after the close of markets on 3/12/14, except where noted This report is limited solely for the use of clients of Wolfe Research. Please refer to the DISCLOSURE SECTION located at the end of this report for Analyst Certifications and Other Disclosures. For Important Disclosures, please go to or write to us at Wolfe Research LLC, 420 Lexington Avenue, Suite 648, New York, NY

2 Rating Market value Wolfe estimates Wolfe implied multiples Yield metrics Company Ticker Rating Target Px / Fair value % Up / Downside Price Market cap EV EBITDA EPS vs. Street* EV/EBITDA PE Dividend FCF 3/12/14 ($MM) ($MM) Current 2013 Ulta Beauty ULTA OP $135 47% $91.39 $5,870.2 $5,657.2 $539.9 $661.5 $3.12 $3.83 $ % 5.2% 10.5x 8.6x 23.8x 19.0x N/A 1.3% Lowe's LOW OP $58 17% $49.38 $50,861.4 $62,337.2 $6,455.7 $7,188.2 $2.17 $2.72 $ % 7.4% 9.7x 8.7x 18.2x 14.6x 1.5% 6.2% Lumber Liquidators LL OP $115 12% $ $2,833.2 $2,797.6 $175.4 $218.7 $2.77 $3.50 $ % (0.7%) 16.0x 12.8x 29.4x 23.7x N/A 0.9% Williams Sonoma WSM OP $70 18% $58.97 $5,560.7 $5,483.5 $659.5 $710.4 $2.84 $3.26 $ % 3.2% 8.3x 7.7x 18.1x 15.7x 2.2% 4.7% Amazon.com AMZN OP $430 16% $ $170,222.0 $166,817.6 $6,547.2 $9,195.1 $0.59 $1.68 $3.59 (0.9%) 6.2% 25.5x 18.1x 220.5x 103.3x N/A 1.2% Sherwin Williams SHW OP $205 0% $ $20,447.5 $22,023.7 $1,557.7 $1,845.7 $7.45 $8.75 $ % 6.4% 14.1x 11.9x 23.3x 18.6x 1.1% 4.6% Restoration Hardware RH UP $55 (17%) $66.37 $2,582.2 $2,851.0 $208.0 $257.5 $1.73 $2.18 $ % (8.9%) 13.7x 11.1x 30.4x 27.1x N/A -2.2% PetSmart PETM UP $60 (13%) $69.33 $7,191.6 $7,393.9 $936.6 $944.3 $4.03 $4.30 $4.61 (3.8%) (8.9%) 7.9x 7.8x 16.1x 15.0x 1.1% 5.5% CarMax KMX PP NA NA $47.64 $10,634.4 $10,502.1 $1,027.3 $1,090.1 $2.25 $2.35 $2.50 (4.6%) (8.3%) 10.2x 9.6x 20.2x 19.1x N/A 5.2% Home Depot HD PP NA NA $80.56 $113,446.8 $128,318.0 $11,989.9 $13,090.7 $3.77 $4.46 $ % 3.4% 10.7x 9.8x 18.1x 15.2x 2.3% 3.5% AutoZone AZO PP NA NA $ $18,042.1 $22,714.0 $2,111.6 $2,267.1 $27.79 $32.00 $ % 2.7% 10.8x 10.0x 16.9x 14.7x N/A 5.5% Bed Bath & Beyond BBBY PP NA NA $69.18 $14,856.1 $13,993.8 $1,856.8 $1,871.4 $4.79 $5.00 $5.28 (5.4%) (9.8%) 7.5x 7.5x 13.8x 13.1x N/A 5.3% Tractor Supply TSCO PP NA NA $72.09 $10,060.8 $10,075.3 $694.0 $802.9 $2.31 $2.60 $3.04 (0.8%) (0.1%) 14.5x 12.5x 27.7x 23.7x 0.7% 1.1% Genuine Parts Co. GPC PP NA NA $86.78 $13,340.4 $14,118.1 $1,300.7 $1,368.0 $4.19 $4.62 $ % (0.3%) 10.9x 10.3x 18.8x 17.7x 2.7% 7.0% O'Reilly Automotive ORLY PP NA NA $ $15,869.7 $17,741.2 $1,436.0 $1,501.6 $6.03 $7.00 $7.63 (0.3%) (4.7%) 12.4x 11.8x 21.3x 19.6x N/A 3.2% Advance Auto Parts AAP PP NA NA $ $9,224.5 $9,261.9 $1,216.4 $1,306.3 $5.69 $7.33 $8.20 (1.1%) (1.1%) 7.6x 7.1x 17.2x 15.4x 0.2% 3.8% Best Buy BBY PP NA NA $25.74 $8,906.2 $7,703.2 $1,813.7 $1,727.6 $2.08 $2.11 $2.14 (5.5%) (16.1%) 4.2x 4.5x 12.2x 12.0x 2.6% 6.1% Staples SPLS PP NA NA $11.50 $7,483.3 $8,192.3 $1,451.5 $1,305.2 $1.16 $1.09 $ % (9.6%) 5.6x 6.3x 10.5x 12.0x 4.2% 9.8% Wolfe Coverage Median 10.7x 9.9x 19.5x 18.1x 1.3% 4.2% * Shows EPS vs. the Street for all names except AMZN, which shows EBITDA vs. the Street. Note: Wolfe Research does not asssign Target Prices to Peer Perform rated stocks. We use an estimate of Fair Value. AAP estimates exclude GPI. Source: Wolfe Research, Company data & reports Priced as of 3/12/14 1

3 Why Purchases should be in every retail model What is Purchases? Purchases = Δ Inventory + COGS Why does Purchases matter? It tells us how steady a company s merchants are It tells us how confident a company is about future sales It helps predict a retailer s Gross Margin How can Purchases predict Gross Margin? Purchases serves to leverage the fixed components of COGS Purchases is a mathematical determinant of Gross Margin since COGS = Purchases - Δ Inventory What companies are best (and worst) under a Purchases lens? Merchants have a steady and confident hand at HD, WSM and increasingly LOW Merchants are erratic at ULTA and AAP Merchants are losing confidence at SPLS, PETM, BBBY 2

4 Purchases = Δ Inventory + COGS A B C Beginning inventory $100 $100 $100 Ending inventory Change in inventory 0 20 (10) COGS Purchases YoY % Growth 20% 47% 7% Store growth 5% 5% 5% Comp Purchases 15% 42% 2% Comp Purchases = YoY% Δ Change Purchases Store Growth 3

5 Purchases = A tale of two cities HD historically buys consistently LOW historically buys erratically HD buys to a forward sales plan LOW has often chased its tail HD over-bought in H2 13 LOW over-bought in H2 13 HD has remained steady LOW has BECOME steady HD bought for 3-4% growth in Q1 LOW bought for 3% growth in Q1 Home Depot: Steady and Confident Lowe s: Getting religion Note: HD and LOW Q4 13 forward revenue are Wolfe estimates. Source: Wolfe Research estimates, Company filings. 4

6 Petsmart: reining in its horns A harbinger of things to come? Bed Bath & Beyond: reining in its horns Getting cautious Note: PETM and BBBY Q4 13 forward revenue are Wolfe estimates. Source: Wolfe Research estimates, Company filings. 5

7 Staples: Can t cut fast enough Williams-Sonoma: Can t buy fast enough Note: SPLS Q4 13 and WSM Q3 13 forward revenue are Wolfe estimates. Source: Wolfe Research estimates, Company filings. 6

8 AutoZone: Steady Eddie Advance Auto: Self-Fulfilling? Note: AZO Q1 14 forward revenue is a Wolfe estimate. Source: Wolfe Research estimates, Company filings. 7

9 Using Purchases to predict GM If Purchases = Δ Inventory + COGS Then COGS = Purchase - Δ Inventory 8

10 Inventory growth Predicting GMs using LL as a theoretical example Company ticker LL Desired yoy Δ in inventory 5.0% Purchases yoy 10.0% Q1A Q2A Q3A Q4A 2013 A Beginning inventory Ending inventory $ Δ inventory COGS Purchases Q1E Q2E Q3E Q4E 2014 E Beginning inventory Ending inventory yoy % chg 5.0% 5.0% 5.0% 5.0% 5.0% $ Δ inventory (31.8) COGS Purchases Sales ,205.5 GM 43.1% Sensitivity Analysis Every 5% change in Purchases growth triggers as much as a 260bps change in GM Higher Purchases pressures COGS to reach desired inventory level Every 5% change in Inventory growth triggers as much as a 100bps change in GM Higher inventory eases pressure on COGS by keeping it on the balance sheet Purchases growth 43.1% 5.0% 10.0% 15.0% 20.0% 25.0% 0.0% 44.7% 42.1% 39.4% 36.8% 34.2% 5.0% 45.7% 43.1% 40.5% 37.8% 35.2% 10.0% 46.8% 44.2% 41.5% 38.9% 36.3% 15.0% 47.8% 45.2% 42.6% 39.9% 37.3% 20.0% 48.9% 46.2% 43.6% 41.0% 38.3% Source: Wolfe Research estimates, Company filings 9

11 Purchases: Try it for yourself with our interactive Doh! model Click here to try it for yourself! Step 1: Step 2: Step 3: Step 4: Step 5: Step 6 Choose a desired grow th rate in inventory Choose an appropriate grow th rate in Purchases Input historical ending inventory and COGS in highlighted cells Input forw ard sales forecast in highlighted cells See w hat GM spits out See how sensitive your company's GMs are to input changes in the grid below Company ticker Desired yoy Δ in inventory Purchases yoy Q1A Q2A Q3A Q4A 2013 A Beginning inventory Ending inventory 0.0 $ Δ inventory COGS 0.0 Purchases Q1E Q2E Q3E Q4E 2014 E Beginning inventory Ending inventory yoy % chg #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! $ Δ inventory COGS Purchases Sales 0.0 GM #DIV/0! Source: Wolfe Research 10

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