Tuesday, March 23, 2010

Saks (NYSE:SKS): Gator Boots & Gucci Suits, Upgrade to Overweight - J.P. Morgan

J.P. Morgan is upgrading Saks (NYSE:SKS) to Overweight from Neutral boosting their 2010 price target to $11 from $7, implying ~26% upside from current levels.

Firm notes that following a recent meeting with CEO Steve Sadove, they’d be comfortable owning the stock today from both a sentiment and fundamental perspective. From a sentiment standpoint, SKS stands out as the least loved name in our coverage group with the highest short interest ratio (37.4% of the float) and percentage of sell-side Underweight ratings (33.3%). On fundamentals, the combination of 1) sales momentum (3 consecutive months of positive SSS), 2) the easiest top-line compares in JPM universe (-20.4% SSS average over next 6 months), 3) opportunities to reach a new peak GPM, 4) expense/ inventory/capital discipline, and 5) a solid FCF profile are all attractive attributes.

Turning to their model, JPM is significantly raising their FY10 EPS and FY11 EPS estimates – to ($0.06) and $0.20, respectively, from ($0.19) and ($0.09) previously. Importantly, their FY11 EPS forecast is 2x current Bloomberg consensus and would represent the company’s first fiscal year of profitability in four years. JPM's increased confidence reflects management’s re-focus on improving store productivity vs. peers and a return to its previous MSD operating margin level. In the near term, recent channel checks suggest luxury retailers continue to see augmented basket sizes and sharp improvements in traffic trends, and they are increasing their March SSS estimate 200 bps to 8.0% (ahead of consensus of 5.7%) accordingly. Last, on valuation JPM's $11 price target reflects a 9.5x EV/EBITDA multiple, an appropriate discount to its historical multiple of 17.3x, in firm's view.

Least loved stock in the group. Saks stands out as the least loved name within JPM coverage group, which they love to fade, particularly when a company’s topline is reaching a positive inflection point. Three supporting facts worth noting: 1) SKS has the highest percent of sell ratings within their entire Broadline & Food coverage group at 33.0% (vs. the 7.5% coverage group average); 2) SKS is the least recommended stock within the department store space at only 33.3% buy ratings (52.7% average); and 3) SKS also has the highest short interest ratio in JPM coverage group at 28.6% of total shares outstanding at the middle of February, which compares to a 7.5% average across their universe. As a percent of the float, short interest is even higher, standing at approximately 37.4%.

Near-term outlook remains bright... but longer term opportunities are most intriguing. While the company’s stock run to date has reflected its ability to weather the recession and avoid bankruptcy, they believe further appreciation is likely as investors gain further understanding that Saks has emerged as a stronger company, in firm's view, with i) a lowered cost structure, ii) stabilized balance sheet, and iii) significant long-term opportunities ahead.

To this end, JPM notes they walked away from their recent meeting with SKS management most impressed about the company's focus on returning to its previous (2007) mid-single-digit operating margin levels.

JPM believes the company has 5 specific catalysts ahead:

LT Catalyst #1: At the beginning of the runway toward sales per sq. ft. goals.

LT Catalyst #2: Internet and Off 5th are growth channels.

LT Catalyst #3: New peak in GPM by 2012.

LT Catalyst #4: $100 million of fixed cost taken out of structure is permanent.

LT Catalyst #5: FCF flexibility as capital spending will stay at moderated.

Notablecalls: Retail is red-hot and Saks is going to be its poster boy today. You can almost hear the shorts screaming every time the Retail Holdrs (RTH) moves up another 1/4 pt. The move doesn't seem to make any sense but yet it's there, it's happening.

Is it the inflation trade? If so, why isn't the commodity space making new highs right here, right now?

I can't understand it either.

And here you have SKS breaking to new 52 week highs.

SKS is going to trade up today to the tune of 6-8% (or even more) as shorts scramble to cover.

It kind of makes me wonder though if we are getting closer to a blow-off top in the market...

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