A Look at Consumer Confidence and Spending into 2011 1
Minneapolis London San Francisco New York Chicago Hong Kong Specialty Retail, Apparel & Footwear Brands, & Mass Merchants Sean Naughton, CFA Vice President Senior Research Analyst 612.303.6326 sean.p.naughton@pjc.com October 7 th 2010
DISCLOSURES Disclosures for universe of Jeff Klinefelter & Sean Naughton 1. I or a household member have a financial interest in the securities of the following companies: none 2. I or a household member is an officer, director, or advisory board member of the following companies: none 3. I have received compensation within the past 12 months from the following companies: none 4. Piper Jaffray or its affiliates beneficially own 1% or more of any class of common equities of the following companies: none 5. The following companies have been investment banking clients of Piper Jaffray during the past 12 months: GIII, GMAN, RUE 6. Piper Jaffray expects to have the following companies as investment banking clients within the next three months: none 7. Other material conflicts of interest for Jeff Klinefelter and Sean Naughton or Piper Jaffray regarding companies in my universe for which I am aware include: GIII, GMAN, RUE: underwriting 8. Piper Jaffray received non-investment banking securities-related compensation from the following companies during the past 12 months: none 9. Piper Jaffray makes a market in the securities of the following companies, and will buy and sell the securities of these companies on a principal basis: CROX, CTRN, DECK, GIII, HOTT, PSUN, ROST, VLCM, WTSLA, ZUMZ 10. Piper Jaffray usually provides bids and offers for the securities of the following companies and will, from time to time, buy and sell the securities of these companies on a principal basis: ANF, ARO, AEO, GCO, GES, GPS, JCG, JCP, KSS, PVH, RL, RUE, TGT, UA, VFC, WRC, ZQK 3
CONSUMER SECTOR INVESTMENT RISKS Risks include, but are not limited to: Reliance on key top management Changing consumer preferences; brand relevance Cycle transitions & seasonality Changes in input costs & raw materials; manufacturing risk Markdown risk Product flow; inventory disruptions; product recalls; health & safety concerns Competition; lack of pricing power Deleveraging of fixed expenses, R&D, and design costs Foreign exchange rate risk Government regulation Weather General macroeconomic uncertainty 4
EXECUTIVE SUMMARY Thesis Declining asset values, combined with high unemployment rates and decreased access to capital, will continue to influence consumption of discretionary categories in 2011 as well as 2010. While difficult to predict, we think it s important to consider current trends in consumer spending, management outlook, and consumer psychology/demographics. We favor companies targeting high-income households and companies that offer value to middle-income consumers. Macroeconomic Trends Employment Situation Income Statement of the Consumer Balance Sheet of the Consumer Confidence of the Consumer Outdoor Industry Economic Sentiment Expectations Back-To To-School Implications for Holiday Opportunities: The Next Generation Consumer & International 5
EMPLOYMENT INITIAL UNEMPLOYMENT CLAIMS Initial unemployment claims down 15% year-over-year; Rolling 4 week numbers at 465k, have been rising since late-march 6
EMPLOYMENT TEMPORARY VS. NON-FARM PAYROLLS Temporary employment remains solid, up +22.1% Y/Y and up +0.8% in August; Y/Y growth in Non-Farm payrolls up +0.2% in August, second consecutive positive month 7
EMPLOYMENT REAL PCE VS. REAL HOURLY WAGE GROWTH Real hourly earnings up 0.7% y/y, down sequentially in July at -0.2%; Real PCE continues to move higher as July up 1.9% y/y. 8
DEBT SERVICE AND FINANCIAL OBLIGATION RATIOS Debt service at lowest levels since 2000; consumer has capacity to borrow 9
CONSUMER CAPACITY TO SPEND Income Statement for the consumer is improving, confidence will be next step 10
CONSUMER CONFIDENCE EXPECTATIONS Confidence Expectations Index has a.68 correlation with retail sales ex-autos w/ 6mo lead 11
PERSONAL SAVINGS RATE Personal Savings Rate continues to move higher after years of declines 12
HOME PRICES Home prices have declined y/y in 33 of the last 34 months 13
HOUSEHOLD NET WORTH Household net worth increased in Q409 to Q210 y/y after 7 quarters of y/y declines 14
SPENDING PATTERNS Spending on health care is displacing spending on discretionary categories such as clothing/footwear and furniture/equipment 15
DISPARITY IN INCOME GROWTH BY QUARTILE Wage Growth By Income Quintile 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% May-10 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 Source: IRS, Piper Jaffray & Co. Highest Quintile Fourth Quintile Middle Quintile 16
HIGH-INCOME CONSUMER WAGE GROWTH OFFSETS TAXES THE 800-POUND DONKEY IN THE ROOM INCREMENTAL TAX BURDEN IN A POST-BUSH-TAX-CUT ERA Adjusted Gross Income Taxable Income Marginal Marginal Taxes Incremental AGI/Hhld Incr. Tax By Household Bracket Up To $250K* Tax Base (+460bps) Taxes/Hhld By Bracket % AGI $200,000 under $500,000 $693,238,200 $96,779,951 $4,451,878 $1,284 $227,921 0.6% $500,000 under $1,000,000 143,669,250 188,907,915 8,689,764 15,121 578,720 2.6% $1,000,000 under $1,500,000 34,915,000 111,770,193 5,141,429 36,814 1,050,302 3.5% $1,500,000 under $2,000,000 14,769,500 74,224,112 3,414,309 57,793 1,506,375 3.8% $2,000,000 under $5,000,000 21,422,250 203,966,926 9,382,479 109,495 2,630,316 4.2% $5,000,000 under $10,000,000 5,309,500 123,756,355 5,692,792 268,047 6,077,119 4.4% $10,000,000 or more 3,350,750 344,888,323 15,864,863 1,183,680 25,982,174 4.6% Total ($200K +) 916,674,450 $1,144,293,775 $52,637,514 $12,073 $472,706 2.6% *Except the $200K under $500K bracket, in which we assumed $200K. All dollars in thousands, except household data; based on 2008 tax year. Source: IRS, Piper Jaffray & Co. research 17
RETAIL SALES TRENDS RETAIL SALES EX. AUTO (SA) VS. PRIOR YEARS 2009 vs. Prior Years 2010 vs. Prior Years ($ BILLIONS) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2005 2006 2007 2008 2005 2006 2007 2008 2009 January 176 187 189 198 210 225 247 252 265 245 257 8.7% -0.7% -2.9% -7.6% 14.0% 4.1% 1.8% -3.1% 4.9% February 179 187 190 197 210 227 247 253 263 246 259 8.4% -0.2% -2.6% -6.3% 14.2% 5.1% 2.5% -1.4% 5.3% March 182 185 191 200 215 228 247 256 265 243 263 6.7% -1.7% -5.1% -8.3% 15.4% 6.3% 2.5% -0.9% 8.1% April 180 188 193 198 214 231 249 255 268 244 264 5.5% -2.2% -4.3% -9.1% 14.2% 5.9% 3.6% -1.6% 8.3% May 181 189 193 198 216 230 249 259 270 245 260 6.8% -1.5% -5.2% -9.3% 13.3% 4.6% 0.6% -3.7% 6.1% June 182 188 193 200 216 232 248 257 273 248 260 6.8% -0.2% -3.4% -9.2% 12.0% 4.7% 1.3% -4.7% 4.9% July 182 187 193 203 217 233 249 258 274 247 260 6.4% -0.8% -4.3% -9.8% 12.0% 4.5% 0.8% -5.0% 5.3% August 183 189 193 205 217 236 251 257 270 250 262 5.7% -0.4% -2.9% -7.5% 11.1% 4.6% 2.0% -2.9% 5.0% September 185 186 193 205 219 240 248 259 267 251 4.7% 1.1% -3.0% -6.0% October 185 188 195 205 221 243 248 260 259 251 3.3% 1.3% -3.4% -3.2% November 186 188 196 207 223 241 248 266 250 255 5.9% 2.7% -4.1% 1.9% December 187 189 196 208 224 240 252 264 241 255 6.3% 1.3% -3.3% 5.8% Total 2,188 2,250 2,315 2,424 2,602 2,806 2,983 3,096 3,167 2,981 6.2% -0.1% -3.7% -5.9% % Change 2.8% 2.9% 4.7% 7.3% 7.8% 6.3% 3.8% 2.3% -5.9% DPI* 7,327 7,649 8,010 8,378 8,889 9,277 9,916 10,403 10,806 10,924 % Change 4.4% 4.7% 4.6% 6.1% 4.4% 6.9% 4.9% 3.9% 1.1% % of DPI 30% 29% 29% 29% 29% 30% 30% 30% 29% 27% *Disposable Personal Income Source: Census Bureau and Bureau of Economic Analysis Retail sales have increased +6.1% YTD after steep decline in 2009; still below 2008 levels 18
RETAIL APPAREL SALES TRENDS TOTAL RETAIL CLOTHING STORE SALES (SA) VS. PRIOR YEARS 2009 vs. Prior Years 2010 vs. Prior Years ($ BILLIONS) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2005 2006 2007 2008 2005 2006 2007 2008 2009 January 13.3 14.1 14.2 14.6 15.5 16.2 17.4 18.5 18.7 17.3 17.6 6.8% -0.6% -6.8% -7.3% 8.9% 1.3% -5.0% -5.5% 1.9% February 13.6 14.2 14.4 14.2 15.7 16.7 17.4 18.3 18.3 17.8 18.0 6.8% 2.5% -2.4% -2.8% 7.7% 3.4% -1.6% -2.0% 0.8% March 13.9 13.9 14.5 14.5 16.0 16.3 17.4 18.8 18.7 17.4 18.5 6.4% -0.4% -7.5% -7.0% 13.2% 6.0% -1.5% -1.0% 6.4% April 13.8 14.2 14.4 14.4 15.6 16.8 17.6 18.2 18.6 17.2 18.4 2.8% -2.2% -5.4% -7.5% 9.5% 4.1% 0.7% -1.5% 6.5% May 14.1 14.0 14.2 14.7 15.7 16.5 17.5 18.6 18.6 17.3 18.1 4.5% -1.1% -6.8% -7.1% 9.6% 3.7% -2.3% -2.5% 4.9% June 13.9 13.9 14.4 14.9 15.5 16.8 17.6 18.3 18.6 17.1 18.1 1.4% -3.1% -6.7% -8.2% 7.7% 2.9% -1.0% -2.5% 6.2% July 13.8 14.0 14.2 15.1 15.6 16.5 17.7 18.4 18.5 17.2 18.1 4.4% -2.7% -6.7% -7.2% 9.6% 2.2% -2.0% -2.5% 5.0% August 14.1 14.2 14.4 15.1 15.6 16.8 17.6 18.3 18.4 17.5 18.3 4.2% -0.8% -4.7% -5.3% 9.1% 3.8% -0.3% -0.9% 4.7% September 14.4 13.3 14.0 15.2 15.8 16.5 18.3 18.5 17.6 17.6 7.1% -3.8% -4.8% -0.1% October 14.2 14.0 14.6 15.1 16.1 17.2 18.2 18.5 17.3 17.5 1.9% -3.7% -5.4% 1.4% November 14.3 14.0 14.5 15.3 16.0 17.1 17.9 18.7 17.3 17.5 2.0% -2.2% -6.7% 1.0% December 14.1 14.2 14.8 15.5 16.2 17.2 18.4 18.4 16.8 17.3 0.5% -6.0% -6.1% 3.1% Total 167.4 167.8 172.6 178.5 189.2 200.6 213.1 221.7 217.5 208.7 4.0% -2.0% -5.8% -4.0% % Change 0.2% 2.8% 3.4% 6.0% 6.0% 6.2% 4.0% -1.9% -4.0% DPI* 7,327 7,649 8,010 8,378 8,889 9,277 9,916 10,403 10,806 10,924 11,229 % Change 4.4% 4.7% 4.6% 6.1% 4.4% 6.9% 4.9% 3.9% 1.1% 2.8% % Apparel 2.3% 2.2% 2.2% 2.1% 2.1% 2.2% 2.1% 2.1% 2.0% 1.9% 1.9% *Disposable Personal Income Represents declining investment in apparel Source: Census Bureau and Bureau of Economic Analysis Est. apparel $s '10: 214.5 % change from '09 2.8% 19
MACROECONOMIC REVIEW Thesis Declining asset values, combined with high unemployment rates and decreased access to capital, continue to influence consumption of discretionary categories in 2010 as we believe it is impacting the consumer psychology and confidence. Macroeconomic Trends Employment situation is improving, but not as quickly as was initially hoped Consumer has the capacity to spend, but will they? Home prices and net worth improving, but partially driven by stimulus Confidence will be key driver of consumer spending Non-Discretionary spending increasing as a portion of total Retail Sales excluding autos remains below 2008 levels 20
ECONOMIC CONCERN FROM OIA COMMUNITY Respondents Very Concerned About the Economy 60% 50% 47% 57% 55% 40% 37% 37% 30% 20% 23% 10% 0% Fall '08 Spring '09 Summer '09 Fall '09 Winter '09 Spring '10 Source: Piper Jaffray & Co. 21
EXPECTATIONS FROM OIA COMMUNITY 65 60 55 50 45 40 35 Expectations Index 58.9 52.4 48.9 48.5 63.1 Spring '09 Summer '09 Fall '09 Winter '09 Spring '10 14% 12% 10% 8% 6% 4% 2% 0% -2% Source: Piper Jaffray & Co. Expectations Index 22 Q/Q Change
RETAIL SALES TRENDS Source: Census Bureau, Piper Jaffray & Co. Strong August retail sales suggests holiday sales growth ~ +5% Y/Y 23
IDENTIFYING POTENTIAL OPPORTUNITIES Piper Jaffray Taking Stock with Teens Survey Spending by category (apparel, food, entertainment, etc.) Total spending per teen Market size for apparel and footwear products Brand preferences Environmental awareness Higher Profitability in International Markets Favorable operating margin differential Higher price points 24
TEEN SPENDING BY CATEGORY 25
TEEN MARKET SIZE X = $71 billion 28.2 million $2,500/person Apparel Shoes Accessories = 39% $71 billion X = 39% 39% $28 billion Source: Census Bureau and Piper Jaffray & Co. 26
TEEN SPENDING ON FASHION PER TEEN 27
BRANDS TEENS PREFER IN ATHLETIC/PERFORMANCE APPAREL PREFERRED ATHLETIC CLOTHING BRAND - UPPER INCOME STUDENT SURVEY Fall 2010 Spring 2010 Fall 2009 Spring 2009 Fall 2008 Rank Sport % Total Rank Sport % Total Rank Sport % Total Rank Sport % Total Rank Sport % Total 1 Nike 51% 1 Nike 47% 1 Nike 48% 1 Nike 43% 1 Nike 38% 2 Under Armour 18% 2 Under Armour 25% 2 Under Armour 25% 2 Under Armour 26% 2 Under Armour 23% 3 adidas 6% 3 adidas 7% 3 adidas 6% 3 adidas 6% 3 adidas 8% 4 The North Face 2% 4 The North Face 3% 4 Soffe 2% 4 The North Face 4% 4 Puma 3% 5 Mizuno 1% 5 Soffe 2% 5 Jordan 2% 5 Champion 2% 5 Jordan 1% Puma 2% PREFERRED ATHLETIC CLOTHING BRAND (F) - UPPER INCOME STUDENT SURVEY Fall 2010 Spring 2010 Fall 2009 Spring 2009 Fall 2008 Rank Sport % Total Rank Sport % Total Rank Sport % Total Rank Sport % Total Rank Sport % Total 1 Nike 49% 1 Nike 48% 1 Nike 46% 1 Nike 41% 1 Nike 39% 2 Under Armour 16% 2 Under Armour 19% 2 Under Armour 23% 2 Under Armour 26% 2 Under Armour 18% 3 Adidas 7% 3 adidas 8% 3 adidas 7% 3 adidas 6% 3 adidas 10% 4 The North Face 2% 4 The North Face 4% 4 Soffe 3% 4 The North Face 5% 4 Soffe 4% 5 Mizuno 2% 5 Soffe 3% 5 The North Face 2% 5 Champion 2% 5 Puma 4% PREFERRED ATHLETIC CLOTHING BRAND (M) - UPPER INCOME STUDENT SURVEY Fall 2010 Spring 2010 Fall 2009 Spring 2009 Fall 2008 Rank Sport % Total Rank Sport % Total Rank Sport % Total Rank Sport % Total Rank Sport % Total 1 Nike 52% 1 Nike 46% 1 Nike 49% 1 Nike 46% 1 Nike 38% 2 Under Armour 19% 2 Under Armour 30% 2 Under Armour 27% 2 Under Armour 26% 2 Under Armour 29% 3 Adidas 6% 3 adidas 5% 3 adidas 5% 3 adidas 6% 3 adidas 7% 4 The North Face 2% 4 Jordan 2% 4 Jordan 2% 4 The North Face 3% 4 Jordan 2% 5 Jordan 2% 5 Puma 1% 5 Reebok 1% 5 Puma 2% 5 Reebok 1% Puma 1% Source: Piper Jaffray & Co. 28
TEENS CONCERNED ABOUT GLOBAL WARMING 29
TEENS WHO RECYCLE AT HOME 30
TEENS WHO HAVE PURCHASED ORGANIC PRODUCTS 31
TEENS WILLING TO PAY MORE FOR ORGANIC 32
YOUNG ADULT POPULATION CONTINUES TO GROW 21.0 20.0 19.0 18.4 18.5 18.6 Population Trend 21-25 year old age group Millions of persons 18.9 19.3 19.7 20.1 20.3 20.4 20.4 18.0 1.1% CAGR 17.0 16.0 15.0 U.S. Census Bureau & NCHS Compared to 0.85% estimated growth rate for total U.S. population from 2010-2015 33
INT L REVENUE VS. INT L OPERATING INCOME 34
REVIEW OF OPPORTUNITIES SUMMARY 1) Teen and youth markets - Teens spend about $28B annually on discretionary categories - Demographics favor young adult, growth exceeds rest of population - Teens care about the environment 2) Higher profitability in international markets - Higher margins and price points 35
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