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Here’s an update on our Three key themes, Three top longs & Three shorts.  We also include bulleted deltas that we picked up in our research over the past week that are worth noting.


1)      Consumption Cannonball: 4Q (i.e. now) will begin a period during which government subsidies subside, while expenses ramp creating increasing pressure on the U.S. consumer. Recent BEA data (11/4) shows that transfer income is fading and taxes are on the rise. Granted, this is September data, but the trend should continue. A few more bullets…

  1. Both personal income and spending weakened in September.  Personal income fell 0.1%: the first decline since last September.
  2. The decline in income was driven by a $25.5 billion reduction in emergency unemployment insurance benefits.  Emergency benefits had boosted transfer income by $20.5 billion in August.
  3. Interest income (due to the Federal Reserve emergency interest rates fell 0.9% for the third straight month.
  4. Tax payments are up, driving disposable income down 0.2%.
  5. Real spending was up 0.1% driven by consumers diving into the savings rates which fell to 5.3% - matching its lowest level in over a year.

2)      Raw Margins: The margin squeeze from raw materials is misunderstood given the lag between when product is ordered, raw materials are procured, and when factories set FOB prices. We’re seeing factories change the field goal in the middle of game play by simply not filling orders placed by certain customers due to raw materials/inventory/margin risk. Raw materials also head higher, and management teams we talk to are largely waiting to buy for Summer and Fall 2011 as they are ‘waiting for a pullback.’  If everyone is waiting for a pullback in prices, will the price relief ever come?

3)      3rd Derivative: The big margin killer in 2011 will not be the obvious hike in raw materials at the same time consumer trending trends down. That’s maybe good for 1-2 points in industry margins. But when we account for the unknown – which is ‘competitors and supply chain partners behaving badly’ in the face of obvious industry stress – we think that the total hit for the apparel industry in 2011 will be around 3-4 points at a mid-single digit top line growth rate. (i.e. the product is coming in…we know that. It WILL be sold, but at what price?).



  • Continue to believe the triangulation of a step-up in the industry R&D cycle combined with Foot Locker-specific drivers including improved apparel assortments (now over 50% changed y/y), distinct banner segmentation, and inventory management will lead to a continued string of upside over the next several quarters. 
  • Weekly industry data, a recent pick-up in basketball momentum driven by key product launches, and anecdotal confirmation that the company continues to collaborate and partner with its suppliers all support our view that strategic initiatives remain on track to support near and intermediate term upside on both the top and bottom lines.  FL reports 3Q results on Friday, November 19th.
  • Our estimates remain comfortably ahead of the Street for this year at $0.93 vs. $0.86.  Expect 3Q results to show same-store sales at 5+% along with meaningful gross margin expansion.  Looking for $0.20 vs. Street at $0.16. 


  • 5-years of torture and pain finally coming to an end. The major issues plaguing the industry – excess inventories, cotton, and supply chain uncertainty, to name a few, do not even make the list as it relates to LIZ’s key opportunities.
  • Finally transitioned away from Macy’s and other ‘better’ department stores,  marking an end to a distracting and margin-dilutive transition. Now exclusive with JC Penney and QVC, which is a steady mid-single-digit margin, and more importantly, it is very light on asset intensity due to leverage in JCP’s sourcing organization.
  • Closing LIZ outlet stores, which were some of the least productive in all of retail.
  • Mexx (1/3 of revenue but losing money) is a massive lever that is finally swinging from negative to positive.
  • More upward revisions to come. There’s better than $1.00 in EPS power. A $6 stock could care less about that.


  • It’s a tossup at current prices which name is more attractive. RL or NKE.
  • Two things they both have in common are a) sheer organic top line momentum, and b) meaningful earnings upside in both the upcoming quarter and the next two years.
  • We think that there’s less good news in and around Nike right now. If we had to pick one, that’d be it.
  • There’s going to be a meaningful product step-up in the Spring that both the company and retailers have succeeded in keeping quiet. Note: that’s good for retailers as well.
  • Also, we like the lack of exposure to cotton with Nike.
  • People STILL don’t understand the impact and duration of its category rollout.
  • How can we ignore one of the greatest structural Yuan-appreciation stories in retail.



  • Over-earning by at least 400bp. At peak margins and peak asset turns, but have not invested enough over the past 3 years of current CEO regime to sustain either metric without sacrificing top line.
  • CRI has not been focused enough on product and R&D, but rather on promotional cadence and inventory management. It is at a point in its own margin cycle where the top line MUST come through. Cotton prices 2x above last year, and recent turbulence with both KSS and WMT (the latter of which is completely re-building its apparel strategy) leave question marks in the mix.  The punch-line is that CRI is holding on too tight with its current productivity levels.
  • Our estimate stands at $1.85 next year versus the Street at $2.30. Street numbers have come down. But given the volatility in CRI’s retail sales and margins (retail is half of its overall sales, and 90% of the product is 40% off the first day it hits the floor) we think that the miss will not be a slow drip – but rather a meaningful event where investors are given ammo too challenge CRI ever earning over $2 again.


  • In all the wrong spots as it relates to where you want to be at this point in the cycle – overexposed to a) middle America, b) apparel, c) private label, and d) weak management.
  • Remain unconvinced that company’s stated goal to drive $5 billion in incremental revenues over the next five years is achievable via a combination of new stores, new concepts, a same store sales CAGR of 4%, and accelerating e-commerce growth. 
  • Near-term profits being driven by expense cuts at the risk of further damage to the company’s customer experience and competitive positioning.  Gross margins likely to erode due to: peak gross margin compares, rising input costs with 50% of product exclusive or private label, and unfavorable sales/inventory spread which remains elevated entering the holiday selling season.  JCP remains one of a handful of retailers citing a highly promotional environment.
  • Distractions from both activist investor attention and formation of a “growth brands initiative” takes focus away from fundamentally improving existing store productivity and profitability.  Risk to short is that this process becomes self-fulfilling with weak management leading credence to Ackman’s pursuit.


  • Not and LBO candidate!
  • Free-shipping initiative yet another example of how focused WMT remains on competitive pricing.  Continue to believe inflation in both consumables and discretionary items will not be entirely passed on as WMT’s remains focused on reinvesting in price.  Self-imposed deflation will remain the key factor limiting comp acceleration.
  • Still not convinced a true strategy is in place to improve high margin apparel opportunity in the near to intermediate term.  Management is focused on basics but that puts the category in the sweet spot for competition.  Without a pick-up in non-food areas, comps and profitability is destined to move sideways for yet another year.


Here is an overview of some of the more relevant research anecdotes for the industry over the past week.

  • The issue of rising cotton and sourcing costs is nothing new but JCP management noted that they are now encountering some factories which are not accepting orders due to input cost uncertainty.  While these orders primarily center around goods to be manufactured for Fall ’11 delivery, the data point is noteworthy. If this becomes a more widespread stalemate between manufacturers and suppliers, there will likely be capacity constraints come next year.
  • A quick check of Footlocker.com and UnderArmour.com reveals that UA’s flagship basketball shoe (Micro G Black Ice) is sold out in black and almost sold out in white.  While the launch was done on a small scale, the sell through is noteworthy. 
  • Wal-Mart’s  free shipping announcement essentially forces all other major retailers to match the offer.   While free-shipping has always been part of the holiday promotional calendar for most e-commerce players, the PR alone on this might leave free shipping offers in place longer than retailers would have liked.
  • Holiday marketing campaigns are creeping up earlier than ever, with most retailers launching their efforts a full two months in advance.  This year Best Buy launched its official holiday campaign on November 1st, a full 10 days earlier than last year.  By this weekend, almost all retailers will be in full on holiday marketing mode.
  • KSS and JCP both highlighted warm weather as a reason for slightly higher inventories at quarter end.  Outwear sales were substantially below last year in early October, but have since recovered.  JCP noted that category has gone from down 30-40% for a couple of weeks to up 20% as soon as cooler weather moved in.
  • While it’s clear these trends suggest the trajectory of positive footwear sales since August may now be in question in the face of more challenging comparisons looking forward – the opportunity for retailers to outperform based on portfolio mix is now greater than it has ever been over the past 2-years. The bifurcation between performance and non-performance footwear has widened since late summer with the current 40-point spread at its widest margin in 2-years. The bottom-line here is that with a favorable comp outlook for athletic footwear through November getting progressively more challenging through year-end – portfolio mix between performance and non-performance footwear will be critically important in driving near-term sales performance at retailers.
  • U.S. apparel and textile imports increased +16.7% in September. Keep in mind this is a substantial deceleration from the August rate of +29% reflecting retailers push to restock earlier than usual driven by fears over transportation cost inflation. We expect continued sequential deceleration with inventories now at higher year-over-year levels coupled with retailer interest in avoiding excess buildup.
  • We’re seeing the 13D/F filings pick up meaningfully in Retail. Since we’re at the point where average/poor CEOs are facing the music as it relates to negative organic growth due to poor planning and investment in growth during the recent downturn – why not? They’re either blowing up, buying growth, or both. With the cost of borrowing just about as close to Japan as it can get, and the M&A cycle at the lowest level in almost 2 decades, M&A activity seemingly has only one way to go. That’s higher. On a recent Cramer segment, Wes Card (JNY CEO) was asked why he’s not buying back stock? Wes answered by saying that he’d rather buy other businesses than his own. Additionally, at JCP, CRI, and SKX, we saw several examples of investors stepping in ahead of the game.
  • Steven Madden confirmed that while boots started selling earlier this year than last, the category continues to be robust again in 2010. In addition, the company is also seeing a shift into booties as well with a lace-up style one of the brands hottest selling SKUs currently.