HBC (T) $10.08 Stock Rating: Sector Perform (Unchanged) Target: $15.00 (Unchanged) Risk Rating: Above Average (Unchanged) Est. Total Return: 50.8% Stock Data: 52-week High-Low (Canada) Bloomberg $19.69 - $8.97 HBC CN FYE: January F2015A F2016E F2017E Revenue (mln) $11,162.0 $14,447.4 $14,899.1 EBITDA (mln) $781.0 $624.5 $733.6 EBIT (mln) $316.0 $21.5 $98.8 Net Income (mln) $55.0 -$199.5 -$173.3 Diluted EPS $0.30 -$1.10 -$0.95 Dividends/Share $0.20 $0.20 $0.20 EV/EBITDA 7.4x 9.3x 7.9x Quarterly EPS: F2015A F2016E F2017E Q1 ($0.15) ($0.50) ($0.64) Q2 ($0.34) ($0.67) ($0.60) Q3 ($0.01) ($0.56) ($0.54) Q4 $0.79 $0.63 $0.83 Financial Data: Shares Outstanding (diluted, mln) 182.0 Market Capitalization (mln) $1,834.6 Dividend Yield 2.0% Net Debt (mln) $3,950.0 Net Debt/Total Capitalization 60.3% Book Value per Share $14.30 Price/Book Ratio 0.7x Industry Rating: Underweight (NBF Economics & Strategy Group) Company Profile: Hudson s Bay Company is a leading retailer offering branded merchandise in Canada, the U.S., and Europe. HBC operates under the following banners: Hudson s Bay, Home Outfitters, Saks Fifth Avenue, OFF 5TH, Lord & Taylor, Gilt, GALERIA Kaufhof, Sportarena, and Galeria INNO. The company also has material ownership interest in real estate joint ventures with RioCan Real Estate Investment Trust and Simon Property Group. Vishal Shreedhar - (416) 869-7930 vishal.shreedhar@nbc.ca Associate: Ryan Li - (416) 869-6767 ryan.li@nbc.ca March 28, 2017 Hudson s Bay Company Q4 F2016 Preview The NBF Daily Bulletin Merchandising and Consumer Products Efficiency initiatives and F2017 guidance in focus HIGHLIGHTS We project Q4/F16 adj. EBITDA of $393 mln vs. consensus at $411 mln; last year was $455 mln (1) We forecast a quarter characterized by challenged retail conditions in the U.S. and Europe. (2) We project total revenue of $4,592 mln vs. consensus at $4,552 mln; last year was $4,486 mln. Revenue growth is largely predicated on acquisition contribution (Gilt) and positive sssg at DSG and Saks Fifth Avenue; FX and negative sssg at HBC Off Price and HBC Europe are expected to serve as partial negative offsets. (3) We project EBITDAR of $579 mln vs. last year at $630 mln. Negative EBITDAR growth y/y is expected due to SG&A deleveraging (related to negative same store sales growth) and gross margin challenges (promotional activity during the holidays). (4) HBC reports Q4/F16 results on April 4, 2017 after market close. The call is scheduled for April 5, 2017 at 8:30 a.m. EST; dial-in details are (800) 535-7056 or (253) 237-1145. Quarter preview and operational review (1) In mid-february 2017, management pre-released Q4/F16 sssg (constant currency) as follows: consolidated sssg of -1.2%, DSG sssg of 0.6%, Saks Fifth Avenue sssg of 0.1%, HBC Off Price sssg of -5.9% and HBC Europe sssg of -2.0%. (2) In conjunction with issuing Q4/F16 sssg results, HBC provided an update on the previously indicated comprehensive operational review. Management expects to achieve annualized savings of $75 mln (largely in F2017) related to rationalizing corporate functions and overhead across North America. Management implemented efficiency initiatives in the past; however, benefits have not yet resulted in margin appreciation. (3) In addition, management indicates the plan to pay significantly more variable compensation to associates in F2017, with the aim to increase sales. Thoughts on acquisitions (1) In early 2017, media reports indicated that HBC may be interested in acquiring Macy s. Speculation regarding the Macy s transaction faded; however, media reports subsequently indicated that HBC may be interested in acquiring Neiman Marcus. (2) Our view is that HBC s shares are governed, in part, by success of the retail operations. As a result, while acquisitions may provide a temporary boost to the share price, we believe that improvement in the retail operations will be required to drive sustainable share price appreciation (as evidenced by prior deals). Maintain Sector Perform rating; price target is $15 We value HBC using a sum-of-the-parts methodology, separating the real estate from the Retail business. Stock Performance Price ($/share) 20 15 10 5 0 0.0 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Source: Thomson, NBF 4.0 3.0 2.0 1.0 Volume (millions)
Q4 F2016 Preview: Efficiency initiatives and F2017 guidance in focus Quarter Preview HBC reports Q4/F16 results on April 4, 2017 after market close. The conference call is scheduled for April 5, 2017 at 8:30 a.m. EST; dial-in details are (800) 535-7056 or (253) 237-1145. We caution that y/y EPS comparisons are difficult given normalizing adjustments necessary to account for significant acquisitions and real estate joint ventures. We view adjusted EBITDA and EBITDAR to be more appropriate measures of performance at HBC. We project Q4/F16 EBITDA of $393 million versus consensus at $411 million; last year was $455 million (adjusted). We project EBITDAR of $579 million versus last year at $630 million. We note that Q4/F16 is a seasonally significant quarter representing ~63% of yearly EBITDA (based on our F2016 estimates). On Feb. 23, 2017, HBC issued a press release disclosing Q4/F16 same store sales growth (sssg) performance. Q4/F16 consolidated sssg was -1.2% versus 1.8% last year on a constant-currency basis. Also on a constant-currency basis, DSG sssg was 0.6% versus 4.0% last year, Saks Fifth Avenue sssg was 0.1% versus -1.2% last year, HBC Off Price sssg was -5.9% versus 2.0% last year and HBC Europe sssg was -2.0% versus 0.4% last year. Further details on our quarterly forecasts are available in Figure 5. Thoughts and comments F2017 guidance in focus: We expect management to provide F2017 guidance along with issuing Q4/F16 results. We believe that investors will be more focused on F2017 guidance given that management already provided Q4/F16 sssg performance and its updated F2016 guidance. o We currently project F2017 revenue of $14.9 billion versus consensus at $15.2 billion, F2017 EBITDA of $734 million versus consensus at $778 million, and F2017 EBITDAR of $1,494 million versus consensus at $1,513 million. DETAILS: On Jan. 9, 2017, HBC provided an update on its partially completed Q4/F16 and also lowered sales, EBITDAR and EBITDA guidance for F2016; capex indications were also reduced. Sales guidance is now $14.4-$14.6 billion, EBITDAR guidance is now $1,340-$1,390 million, and EBITDA guidance is now $615-$665 million. An update on the comprehensive operational review: In conjunction with issuing Q4/F16 sssg results, management also provided an update on its previously announced comprehensive review of its operations to identify efficiencies, streamline processes and improve back-of-store productivity. Management indicated annualized savings to be ~$75 million; most of this will be achieved in F2017, though one-time severance charges will approximate $30 million. Identifying additional opportunities to address efficiency improvement is ongoing. o Our forecasts reflect gradual margin improvement given numerous ongoing efficiency initiatives (leverage from investments in digital supply chain, reduction in expenses). We acknowledge uncertainty regarding our forecasts as management s previous efficiency initiatives did not support margin expansion. We note that HBC will also increase variable compensation paid to its associates in F2017 we believe to motivate its salesforce and align expenses with sales growth. New York City retail cap rates increased in Q4: Given that our valuation of HBC s shares assigns significant value to the real estate and a large portion of this real estate is located in the United States, we monitor capitalization rates for select U.S. regions/property types. As can be seen in Figure 3, U.S. retail cap rates (adjusted based
on HBC s real estate holdings) have been on a rising trend over the last three quarters largely due to increasing cap rates in New York City. We estimate that New York City would represent over 60% of HBC s annual rent expense/operating leases (if we include the Saks Fifth Avenue and Lord & Taylor flagships). If we exclude New York City from our calculations, cap rates demonstrated a generally flattish trend over the last several quarters. We continue to monitor. An update on expansion: Media reports indicate that HBC finalized leases for 17 locations (15 Hudson s Bay stores and 2 Saks OFF 5TH stores in total) in the Netherlands. Recall that HBC plans to enter the Netherlands with up to 20 new stores over the next two years. Thoughts on acquisitions: In early 2017 media reports indicated that HBC may be interested in acquiring Macy s. Speculation regarding the Macy s acquisition faded; however, media reports subsequently indicated that HBC may be interested in acquiring Neiman Marcus. o Our view is that HBC s shares are governed, in part, by success of the retail operations. As a result, while acquisitions may provide a temporary boost to the share price, we believe that improvement in the retail operations will be required to drive sustainable improvement. We note that HBC closed on substantial acquisitions in the past, including Saks and GALERIA; however, the share price has weakened given tepid retail performance. Rating and Recommendation We maintain our Sector Perform rating and our price target is $15. We value HBC using a sum of the parts methodology, separately valuing the real estate and the Retail business. We value the real estate portion of the company at approximately $14.50 per share and the retail component at approximately $0.50 per share (DCF). Our valuation implies a 5.62% capitalization rate (weighted average) for the real estate joint ventures. We believe that HBC possesses solid real estate, an international platform, good store brands, innovative management and strong market presence in select markets. However, these favourable investment attributes are offset in part by high financial leverage, low ROIC/profitability, a challenging industry backdrop, an economically sensitive merchandising mix with high seasonality and low real estate lease coverage. Looking forward, if management were to considerably improve profitability in the retail business while reducing financial leverage, we see the market ascribing greater value to the company. Charts and Tables Figure 1: Estimate Revisions We made revisions to our estimates, largely to reflect incremental sales growth pressure in the U.S. department store channel. F2016 F2017 Before After Before After Revenue 14,535 14,447 15,150 14,899 EBITDAR 1,376 1,368 1,509 1,494 EBITDA 632 625 748 734 EPS -$1.06 -$1.10 -$0.92 -$0.95 Q1 -$0.50 -$0.50 -$0.65 -$0.64 Q2 -$0.67 -$0.67 -$0.61 -$0.60 Q3 -$0.56 -$0.56 -$0.54 -$0.54 Q4 $0.67 $0.63 $0.87 $0.83 Note: In $ millions, except per share data. Source: Company Reports, NBF
Figure 2: Credit Metrics Q4/F2015 Q1/F2016 Q2/F2016 Q3/F2016 F2016 F2017 Net Debt/EBITDA 4.3x 4.4x 5.0x 6.4x 5.9x 5.0x Adj. Net Debt/EBITDAR 6.2x 6.4x 6.6x 7.3x 7.2x 6.7x Net Debt/Capital 46.3% 53.1% 56.4% 60.3% 53.8% 55.5% Note: Operating leases have been capitalized at 8.0x. Adj. net debt / EBITDAR reflects the real estate joint ventures and recent acquisitions. Source: Company Reports, NBF Figure 3: U.S. Retail Capitalization Rates Retail capitalization rates (excluding New York City) have been on a generally flattish trend since Q4/13, though volatility remains on a quarter/quarter basis. We note that New York City capitalization rates increased over recent quarters. U.S. - Weighted Average Retail Cap Rates (incl. New York City) 6.00% 5.75% 5.50% 5.25% 5.00% 4.75% 4.50% U.S. - Weighted Average Retail Cap Rates (excl. New York City) 8.00% 7.75% 7.50% 7.25% 7.00% 6.75% 6.50% Q4/13 Q1/14 Q2/14 Q3/14 Q4/14 Q1/15 Q2/15 Q3/15 Q4/15 Q1/16 Q2/16 Q3/16 Q4/16 Q4/13 Q1/14 Q2/14 Q3/14 Q4/14 Q1/15 Q2/15 Q3/15 Q4/15 Q1/16 Q2/16 Q3/16 Q4/16 Note 1: Cap rates are weighted geographically utilizing estimated rent and assigned regions for each of HBC s properties. Note 2: Cap rates are based on transactional data. Source: Company Reports, Bloomberg, Reis, RCA, NBF Figure 4: North American Department Stores SSSG Trends We present recent same store sales growth (sssg) trends for North American department stores. In the last quarter (in general), sssg trends were mixed across department stores. 10.0% 5.0% 0.0% -5.0% -10.0% -12Q -11Q -10Q -9Q -8Q -7Q -6Q -5Q -4Q -3Q -2Q -1Q Macy's J.C. Penney Kohl's Nordstrom Neiman Marcus HBC (Total) Note: HBC (Total) sssg represents consolidated same stores sales growth on a constant currency basis. Source: Thomson, NBF
Figure 5: Q4 F2016 Financial Summary Q4 Q4 F2016E F2015A Cons. Act. Comments DSG 4.0% 0.6% Management indicated DSG sssg of 0.6% on a constant currency basis; we believe that sssg was positive at Hudson's Bay and flattish at Lord & Taylor. Saks Fifth Avenue -1.2% 0.1% HBC Off Price 2.0% -5.9% Management indicated sssg of -5.9% at HBC Off Price (Saks OFF 5TH and Gilt). We estimate double digit negative sales growth at Gilt. HBC Europe 0.4% -2.0% Total Same Store Sales Growth 1.8% -1.2% Canada 1,011.0 1,046.3 We project Canada revenue to be slightly higher y/y, largely reflecting the expectation of positive sssg at Hudson's Bay and the introduction of Saks Fifth Avenue and OFF 5TH in Canada. U.S. 1,993.0 1,965.6 We project U.S. revenue to be lower by 1.4% y/y. We reflect positive sssg at Saks Fifth Avenue and new OFF 5TH stores; F/X and negative sssg at OFF 5TH (not disclosed, but the most likely scenario) are expected to serve as partial negative offsets. Europe (includes Gilt) 1,482.0 1,580.5 We project International Revenue to be higher by 6.7% y/y largely due to inclusion of the recent Gilt acquisition (Gilt sales are included in HBC's Irish subsidiary/international). Management's pre-released sssg data points indicate that Gilt sssg was negative; we anticipate a continuation of depressed sales at Gilt due to more liberalized return policies designed to forge longer/stronger relationships with customers over the long term. Revenue 4,486.0 4,552.0 4,592.4 We reflect 2.4% y/y revenue growth, largely due to contribution from the GALERIA and Gilt acquisitions. Cost of Sales 2,635.0 2,715.7 Gross Margin 1,851.0 1,876.7 We project gross margin dollars to increase by 1.4% y/y largely due to acquisitions. The gross margin rate is projected to be lower by 40 bps y/y, reflecting higher promotional activity during the holiday season. SG&A 1,372.0 1,465.2 We project SG&A to be higher by 6.8% y/y, reflecting acquisitions. The SG&A rate is expected to be higher by 132 bps y/y, reflecting challenging industry conditions which we expect will cause SG&A deleveraging. EBITDAR 630.0 579.0 EBITDA 455.0 411.1 392.5 Depreciation & Amortization 149.0 164.0 We project D&A to be higher by 10.1% y/y, largely reflecting acquisitions. Pension Expense/Other 7.0 9.0 EBIT 323.0 238.5 Interest Expense 52.1 44.3 Share of net loss (gain) in JV 50.2 36.0 Dilution loss (gain) from JV -6.4 0.0 Other 0.0 0.0 EBT 227.1 158.2 Tax 82.1 42.7 Net Income 145.0 115.5 EPS $0.79 $0.67 $0.63 Note 1: Income statement data (except per share data) is denoted in Cdn$ millions. Note 2: Same store sales growth data is indicated in constant currency terms. Current quarter data for sssg is disclosed by HBC through a press release prior to reporting results. Source: Company Reports, Thomson, NBF
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