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Tales of the Global Inflation Tape: China, Brazil and India

Conclusion: Inflation continues to percolate within these economies and we expect further monetary policy tightening in each country over various durations, with China being the most imminent. Furthermore, we expect inflation to continue to remain a headwind for many countries globally and that will eventually lead to slowing economic growth (via policy tightening) which is negative for equities.

 

Position: Bearish on Indian equities.

 

Chairman Bernanke’s experiment with Quantitative Guessing continues to have unintended consequences, due to the impact of the equation highlighted below:

 

QG = inflation [globally] = monetary policy tightening [globally] = slower growth [globally]

 

A brief review of global economic data points highlights the three very key countries’ struggles with inflation (China, India and Brazil). While divergence between each country’s response reminds us that both inflation and monetary policy are local, analyzing them collectively allows us to derive the equation laid out above.

 

Let us briefly visit each country’s headlines and data points from today’s global macro run for a quick update on the global inflation front:

 

Country: China; Policy Stance: Proactive

 

On a relative basis, China has been particularly proactive in their fight with inflation of late, raising bank’s reserve requirements twice this month, hiking interest rates in October, and announcing potential price controls and supply rationing in its food market. In line with our forecast(s), recent data points support our view that additional tightening may be on the way: 

  • China’s largest banks are being rumored to have hit their government-set caps on lending this year and regulators are monitoring the banks’ loan balances daily to ensure the full-year 7.5 trillion yuan new lending quota isn’t breached. Concurrently, Industrial & Commercial Bank of China Ltd. and Agricultural Bank of China Ltd. are reported to be only extending new loans as existing loans get repaid. Overnight, People’s Bank of China Deputy Governor Hu Xiaolian said China will face challenges meeting its full-year lending target and that China will control the pace of lending for the rest of the year.
  • The premium investors demand to hold ten-year Chinese corporate bonds vs. similar maturity Chinese sovereign debt rose 16bps yesterday – the most since Lehman Bros. filed for bankruptcy – on speculation that bank lending curbs will create illiquidity in that market.
  • China’s Banking Regulatory Commission has threatened (via its website) to crack down on the use of loan funds for speculation and hoarding.
  • China’s benchmark money-market rate rose to a seven-week high of 2.22%. Yesterday’s one-year bill auction saw the lowest amount of yuan sold since July 2008 due to declining demand for the securities, which have yielded 2.3437% for the second straight week.  Translation – the Chinese bond market sees additional rate hike(s) in the near future. 

For more color on China’s inflation issues, please reference the following reports (email us if you need a copy):

 

10/19: China Raises Rates… Setting Off a Chain Reaction That’s Bad for Reflation

10/21: China Sets the World Up for a Crash

11/11: Chinese Inflation Data Confirms What We Should Already Know: QE2 Will Slow Global Growth

 

Tales of the Global Inflation Tape: China, Brazil and India - 1

 

From a quantitative perspective, China's Shanghai Composite Index is bearish TRADE and bullish TREND:

 

Tales of the Global Inflation Tape: China, Brazil and India - 2

 

Country: Brazil; Policy Stance: Reactive, Hopeful

 

The latest developments out of Brazil are supportive of our views that Brazil will be late off the snap when it comes to fighting inflation. While the latest inflation readings remain comfortably within the central bank’s target of 4.5%  (+/- 2%), the recent acceleration in price growth, appointment decisions and hopeful rhetoric from Brazilian officials have the Brazilian bond market as concerned as we have been for the past couple of months: 

  • The bond market’s expectations for annual inflation over the next two years hit a two year high of 6.68% yesterday, as measured by the breakeven rate between the government’s fixed and inflation-linked debt. The current expectation of 6.68% puts two-year inflation expectations 18bps above the upper band of the central bank’s target.
  • Yields on Brazil’s interest rate futures due in January 2012 have jumped 49bps since the start of this month to 11.83%, implying the bond market expects the central bank to raise the benchmark Selic rate to ~13% by the end of next year from the current 10.75%. This latest up-move coincides with fiscally loose rhetoric from President-elect Dilma Rousseff, who herself is a big proponent of spending on social programs.
  • It is being reported that President-elect Dilma Rousseff will not ask the hawkish Henrique Meirelles to stay on board as her central bank chairman, leading to speculation that his replacement may not be as vigilant in combating inflation. Today, it is rumored that Rousseff will appoint the 46 year-old Alexandre Tombini a the new central bank chief. This appointment is noteworthy and positive on the margin because it signals to the market some degree of continuity in monetary policy, as Tombini has served as a board member in the central bank since 2005. Further, former Brazilian president Henrique Cardoso has previously flagged Tombini as an instrumental figure in helping design the 1999 inflation targeting plan.
  • Treasury Secretary Arno Augustin said yesterday, “There is no reason to expect faster inflation and higher interest rates in Brazil.” Reminds me of another Treasury Secretary whom we’re all familiar with that simply doesn’t get it…
  • Shortly after Arno’s commentary, Brazilian inflation, as measured by the IPCA-15 Index, was reported to have accelerated to a 20-month high of +5.47% YoY in the latest reading (mid-November).
  • On top of market inflation expectations getting away from Brazilian officials, yesterday’s economic data show that Brazil’s formal employment sector added +204.8k new jobs in October. While down from September’s +246.9k rate, the January-October total of +2.4 million new jobs created is the highest rate EVER for a ten-month period. In addition to the employment tailwinds, Brazilian consumer confidence, as measured by the FGV Consumer Confidence Index, hit a record high in November. The 125.4 reading advanced +2.7% MoM. We have been in print for much of 2H10 documenting the tailwinds of the Brazilian consumer and how robust internal demand will continue to keep upward pressure on inflation readings going forward. 

For more color on Brazil’s inflation issues, please reference the following reports (email us if you need a copy):

 

10/22: Real Commotion in Brazil

11/9: Outlook for Brazilian Interest Rates: Read the Fine Print

 

Tales of the Global Inflation Tape: China, Brazil and India - 3

 

From a quantitative perspective, Brazil's Bovespa is bearish TRADE and bullish TREND - for now. Last night it tested a TREND line breakdown, closing below its TREND line of 68,826. It is trading slightly above that intraday, but we'll need to see it close above the TREND line for bullish confirmation:

 

Tales of the Global Inflation Tape: China, Brazil and India - 4

 

Country: India; Policy Stance: Inactive, Hurtful

 

It would be an understatement to suggest India is losing this three-horse monetary policy race. Having shifted from his hawkish stance (six rate hikes YTD) to a more relaxed position, Reserve Bank of India Governor Duvvuri Subarrao has recently signaled to the market that additional rate hikes are not in India’s near future. That would be fine if India had inflation under control; unfortunately, the latest WPI reading of +8.58% YoY suggests India is far from achieving its target of +4-4.5% YoY inflation.

 

Compounding this blatant lack of vigilance is the RBI’s decision to add fuel to the fire by buying back government bonds from Indian lenders with the intention of increasing liquidity in a cash-strapped banking system that has been struggling to meet demand for loans. Fueling speculation when inflation is running at twice the target rate is not our idea of risk management. We expect further tightening ahead, but only after inflation becomes the problem it was in 1H10, which suggests the RBI will be slow to react to this burgeoning issue. For now, the Indian currency market is taking the other side of the trade: 

  • The premium investors pay to exchange the rupee for dollars in 12-month forward contracts vs. the spot rate has dropped -84bps since the end of last month and is down -1.36% from its nine-year high of 6.08% on October 27th. The drop signals that investors are anticipating smaller increases in Indian interest rates over the duration of the contract.
  • The muted outlook for interest rate hikes over the near term has many investors less optimistic on the rupee, as the premium paid for options offering protection against declines in the rupee have grown +229bps to 260bps from a 16-month low of 31bps on September 20th. 

For more color on India’s inflation issues, please reference the following reports (email us if you need a copy):

 

11/2: Eye On Asia: Things Are Getting Ugly

11/9: India’s Two Big Problems

 

Tales of the Global Inflation Tape: China, Brazil and India - 5

 

Indian equities got tagged again overnight (down -1.2%), which caused the SENSEX to close below its TREND line. This is new and further confirmation of this price action will lend additional support for our bearish stance on Indian equities:

 

Tales of the Global Inflation Tape: China, Brazil and India - 6

 

All told, we remain bearish on equities as an asset class globally because of the spectre of further tightening in these three economies, as well as incremental tightening in other countries. The CRB Index may have backed off its YTD highs recently, but commodity prices remain elevated enough (up +8.3% YoY) to continue to fuel inflation globally and inflation will eventually lead to slowing economic growth (via policy tightening) which is negative for equities.

 

Darius Dale

Analyst


R3: M, DSW, JCG, WMT

R3: REQUIRED RETAIL READING

November 24, 2010

 

 

 

 

RESEARCH ANECDOTES

  • Score one for Macy’s on the collaboration front.  Rumor has it the mega department store operator is close to announcing a deal with Karl Lagerfeld to produce an affordably priced ready-to-wear line.  The offering is expected to range from denim to gowns and is likely to launch in Fall 2011.  Interestingly, Lagerfeld’s namesake brand is owned by private equity firm Apax Partners, the same former owners of Tommy Hilfiger (another high profile Macy’s exclusive).
  • Celebrity sells.  Replica copies of soon to be royalty, Kate Middleton’s engagement dress sold out within 1 hour in the UK.  Even more interesting, the $26 dollar dress was sold at Tesco, a retailer more known for groceries than fashion!
  • A strong boot season last year which was driven by a perfect cold-weather set up and a growing fashion boot trend does not appear to be too big of a hurdle for footwear retailers hoping to “comp the comp”.  DSW reported yesterday that it’s boot business is up 10% on top of a 47% increase last year! And, it’s finally cold out.

OUR TAKE ON OVERNIGHT NEWS

 

More on JCG - Millard “Mickey” Drexler may have just fired the starting gun for a new and potentially transformative round of industry dealmaking. By joining with private equity firms TPG Capital and Leonard Green & Partners in a $3 billion buyout of J. Crew Group Inc., Drexler is also readying the company for expansion and giving its new concepts like Madewell and Crewcuts a chance to mature away from Wall Street scrutiny. Under terms of the deal signed Tuesday, Drexler will remain chairman and chief executive officer and keep his equity stake in the business, which is currently 5.4 percent. Stockholders will be paid $43.50 a share — a 15.5 percent premium over Monday’s closing price but still below the more than $50 the stock sold for in April. The holiday season could single out the best retail opportunities and lead to a “very active” round of mergers and acquisitions in the first quarter, Bassuk said. “You will see more retail deals in the $1 billion to $3 billion range,” said David Shiffman, investment banker and managing director at Miller Buckfire & Co. “At that size range, large-cap and midcap [private equity] firms can put significant capital to work. In addition, strategic acquirers are building large cash balances and will use M&A for growth.” <WWD>

Hedgeye Retail’s Take: Implications that Mickey is becoming a banker with this deal might be premature.  Anyone who knows Mickey is aware that he is the merchant of all merchants and not a dealmaker in the making.

 

WMT Gears up For Black Friday - Global economic crisis? Lingering recession? Apparently, retailers didn’t get the memo. They’re amping up shopping opportunities for Black Friday with aggressive incentives and promotions both online and in stores, which are opening earlier and staying open longer than ever before. Many stores didn’t save their best deals for Black Friday, offering specials typically associated with the day after Thanksgiving, some as early as Halloween. Most projections are calling for a low-single-digit increase of 2 percent to 4 percent, which would mark the best holiday results in four years. MasterCard Advisors’ SpendingPulse said sales of apparel from Oct. 31 to Nov. 13 rose 9.7 percent against the same period last year. This is on top of October’s 8.2 percent gain. Kurt Salmon Associates said that while consumer confidence “remains shaky,” retail sales are expected to show a “modest increase through the holiday season.” Wal-Mart Stores Inc. is being aggressive, starting a three-day promotion on Monday of savings typically reserved for Black Friday. It advertised 150 online specials at walmart.com, three-times as many as last year, with savings of up to 40 percent on electronics, video games and toys among other categories. Wal-Mart said it will match the price of competitors’ ads on Black Friday and is offering free shipping on electronics as well as the majority of online specials available through the Site to Store program. Most Wal-Mart units will be open 24 hours on Thanksgiving Day, with Black Friday in-store specials kicking off at midnight and 5 a.m. Starting at midnight, Wal-Mart will provide entertainment and treats for customers. <WWD>

Hedgeye Retail’s Take: WMT is the master of the deal focused press release.  At least from what we’ve seen, there is no evidence to suggest that deals will be any  better than they’ve been on past Black Fridays.  The difference is in how the message is being conveyed.

 

Bulgari Signs Watch Deal for China - Raising its profile in a fast-growing market, Bulgari SpA said Tuesday it has signed a five-year agreement with Hengdeli Holdings Ltd. to distribute high-end watches through more than 50 multibrand watch stores in China. The partnership will allow Bulgari to further increase the visibility of its timepieces in China as the multibrand stores open over the next five years. Hengdeli will be the sole distributor of Bulgari watches in the country. Bulgari chief executive officer Francesco Trapani said the deal was “very important” for the Rome-based firm because it helps “to even more effectively cover the watch market, in an area with a huge potential such as mainland China,” where Bulgari already counts 20 monobrand stores. “On the other hand, this agreement, signed with one of the most important companies in the world for the distribution of international high-end watch brands, proves that our strategy for the watch business is correct and extremely competitive.” China has been particularly resilient during the global economic downturn and it ranked first among world markets with the highest potential for retail development in A.T. Kearney’s ninth annual study of areas ripe for expansion. <WWD>

Hedgeye Retail’s Take: Given the recent strength in the category, particularly from southeast Asia – there’s little risk embedded in this agreement and likely plenty of growth ahead in one of retail's hotest sub-segments.

 

Google's Local Availability Feature - Moosejaw, the muti-channel retailer of outdoor gear and apparel, will be part of the new Google Local Availability feature that recently launched. Moosejaw and Google have a long-standing relationship through Moosejaw's successful paid search programs. When Google asked Moosejaw to be one of the first participating retailers, Moosejaw jumped at the chance.  "We're really excited to be included with this new feature,s aid Kate Runyon, Moosejaw's Internet Marketing Manager. "We offer a lot of hard-to-find outdoor products, so this will really help drive people into our stores. We see Google Local converting some online shoppers back to local, as they discover specialty retailers like Moosejaw." Google Local Availability will be both available for online and mobile shoppers. The participating retailers upload inventory feeds from all their retail locations, along with their online availability and Google will offer options that are both online and in store fronts that are in close proximity to the customer. 'Google Local Availability should really drive sales, not just traffic, as this program is designed to bring in buyers that know the product that's in stock at a price they like," said Eoin Comerford, SVP of Marketing and Technology. <SportsOneSource>

Hedgeye Retail’s Take: Yet another example of new e-commerce/mobile technologies benefitting those with the exposure and systems in place to capitalize. With only seven retail locations, Moosejaw provides a limited, but important example of the evolution in the competitive landscape.

 

TRU Looking to Lure Customers - Toysrus.com will launch a weekend of Web-only deals at 12:01 a.m. on Thanksgiving Day. Free shipping will also be offered on thousands of toys with purchases of $49 or more.

Product highlights will include:

  • Up to 70 percent off on select action figures and play sets
  • Up to 60 percent off select vehicles, trains and radio controls
  • 30 percent off Crayola Pop Art
  • 20 percent off Hasbro Ultimate gifts
  • 30 percent off Club Penguin
  • 20 percent off all Tron action figures
  • 15 percent off Bratz, Liv and Taylor Swift dolls and play sets

"As gift-givers head online to begin their holiday shopping, we're planning our biggest cyber weekend ever, including our best free shipping event of the season," says Greg Ahearn, senior vice president of marketing and e-commerce at Toys"R"Us. "We know that online shoppers turn to Toysrus.com for the broadest selection of toys, and we will offer extraordinary deals on thousands of items sure to wow kids on Christmas morning." <licensemag.com>

Hedgeye Retail’s Take: While TRU’s $49 hurdle for free shipping isn’t the lowest in retail, there’s certainly no shortage of deals.


INITIAL CLAIMS FALL 34K TO NEW YTD LOWS, BUT THEY DID THIS LAST YEAR TOO

Not So Fast: Initial Claims Hit YTD Lows Falling 34k, But They Fell 39k This Week Last Year Too

The headline initial claims number fell 34k last week to 407k.  Rolling claims fell to 436k, 7.5k lower than the previous week.  For both series, today’s report is a new YTD low and the lowest level since July 2008 – certainly positive at face value. It is worth noting that during this week last year, claims had a comparable size improvement (down 39k) only to then unwind that improvement in the following weeks (see charts below for reference).  We continue to remind investors that the unemployment rate won't improve until we see claims move into the 375-400k range - this is based on our analysis of past cycles. That said, it is worth highlighting an important caveat. This recession has been different in that it has pushed the labor force participation rate down by ~200 bps, which has had a correspondingly positive improvement on the unemployment rate. In other words, the unemployment rate isn't really 9.5%, it's 11.5%. So when we say that claims of 375-400k will start to bring down the unemployment rate, we are actually referring to the 11.5% actual rate as opposed to the 9.5% reported rate. All that being said, on the margin, today's data is positive.

 

INITIAL CLAIMS FALL 34K TO NEW YTD LOWS, BUT THEY DID THIS LAST YEAR TOO - 1

 

INITIAL CLAIMS FALL 34K TO NEW YTD LOWS, BUT THEY DID THIS LAST YEAR TOO - 2

 

In the table below, we chart US equity correlations with Initial Claims, the Dollar Index, and US 10Y Treasury yields on a weekly basis going back 3 months, 1 year, and 3 years.

 

INITIAL CLAIMS FALL 34K TO NEW YTD LOWS, BUT THEY DID THIS LAST YEAR TOO - 3

 

Joshua Steiner, CFA

 

Allison Kaptur


Early Look

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INITIAL CLAIMS FALL 34K TO NEW YTD LOWS, BUT THEY DID THIS LAST YEAR TOO

Not So Fast: Initial Claims Hit YTD Lows Falling 34k, But They Fell 39k This Week Last Year Too

The headline initial claims number fell 34k last week to 407k.  Rolling claims fell to 436k, 7.5k lower than the previous week.  For both series, today’s report is a new YTD low and the lowest level since July 2008 – certainly positive at face value. It is worth noting that during this week last year, claims had a comparable size improvement (down 39k) only to then unwind that improvement in the following weeks (see charts below for reference).  We continue to remind investors that the unemployment rate won't improve until we see claims move into the 375-400k range - this is based on our analysis of past cycles. That said, it is worth highlighting an important caveat. This recession has been different in that it has pushed the labor force participation rate down by ~200 bps, which has had a correspondingly positive improvement on the unemployment rate. In other words, the unemployment rate isn't really 9.5%, it's 11.5%. So when we say that claims of 375-400k will start to bring down the unemployment rate, we are actually referring to the 11.5% actual rate as opposed to the 9.5% reported rate. All that being said, on the margin, today's data is positive.

 

 INITIAL CLAIMS FALL 34K TO NEW YTD LOWS, BUT THEY DID THIS LAST YEAR TOO - rolling

 

INITIAL CLAIMS FALL 34K TO NEW YTD LOWS, BUT THEY DID THIS LAST YEAR TOO - raw

 

Yield Curve

We look at the yield curve as a proxy for industry NIM tailwinds or headwinds. The following chart shows 2-10 spread by quarter while the chart below that shows the sequential change. After falling sharply for two quarters, the 2-10 spread has stabilized thus far in 4Q, rising 6 bps thus far (average of QTD versus average of 3Q).  Yesterday’s closing value of 231 bps is down from 238 bps last week.

 

INITIAL CLAIMS FALL 34K TO NEW YTD LOWS, BUT THEY DID THIS LAST YEAR TOO - spreads

 

INITIAL CLAIMS FALL 34K TO NEW YTD LOWS, BUT THEY DID THIS LAST YEAR TOO - spreads QoQ

 

The table below shows the stock performance of each Financial subsector over four durations. 

 

INITIAL CLAIMS FALL 34K TO NEW YTD LOWS, BUT THEY DID THIS LAST YEAR TOO - subsector perf

 

 

 

Joshua Steiner, CFA

 

Allison Kaptur


Cost Pressure Perspectives From the Horses Mouth(s)

Over the past couple of weeks we’ve listened to numerous retailers and manufacturers of all types address the issue of inflation and cost pressures.  While it’s 100% clear that cotton has risen to new heights, wages are on the rise, and inflation across a wide range of product categories is clearly in sight, how companies are proactively planning their 2011 production and pricing plans remains up in the air. 

 

The following are excerpts from a myriad of conference calls all centered on the topic of product cost inflation.  Interestingly, there is a wide range of strategies being employed to deal with cost pressures.  These range from “wait and see” to “we’re planning to increase prices to mitigate costs”.  The consensus is that prices are on the rise.  The reality is, every company is taking a slightly different and not always obvious approach to the first major influx of inflation to hit the sector in decades.  Read on to see which companies are letting the market dictate their next moves and which are using the dislocation to their advantage.

 

FROM THE HORSE"S MOUTH

 

URBN on pricing cost increases:

 

We always develop our pricing structure based on supply and demand. We never base it on the cost of product. That's a dangerous thing. So, if we have something that we have alone in the market and there's a high demand, then we can charge a lot for it. If we have something that's kind of towards the middle or the end of the product lifecycle and it's ubiquitous in the market, then we have to be more competitively priced. So, it's really a function of economics and not product cost.

 

DLTR on cost pressures:

 

The margin really is in our power. We are still finding success in planning our assortments.  We have not seen overall inflationary pressures. Cotton is at record highs I think. It is extremely expensive. But we are not in the apparel business. We saw a few kitchen domestics and that type of thing, so it's not a big issue for us. But we do see some of the commodity prices like cotton going up. But our experience has been that our margins have actually been increasing in our sourcing out of China.

 

PETM on inflation:

 

Right now we are not experiencing any inflation. We haven't this quarter. And from a go forward perspective just looking for the next three to six months and speaking with our vendors, even though you are hearing a lot of things about commodity price increases, we are not seeing it in the prices coming from the vendors. We are not expecting it for the next six months. A couple of reasons for that. One, we think the vendors have been able to manage it, and are a little bit anxious to pass that on if they are seeing those price increases, passing it on to both the retail and the consumer -- some of what they learned in 2008. So they are reluctant to do that for now.

 

ROST on uncertainty in the marketplace:

 

The recent buying environment has been slightly more favorable as a result of Asian supply chain disruptions and erratic sales patterns at retail.  This favorable buying has resulted in a year over year increase of 500bps in the company’s pack-away levels. 

 

It is kind of hard to predict. I mean what is going on in the apparel manufacturing cycle is in the early stage so we don't exactly know how this is going to land. But periods of disruption in pricing create uncertainty in the whole supply line, creates some uncertainty in mainstream retailing and historically has been good for us in access of product.

 

AEO on product costs:

 

There are clearly pressures in the marketplace with sharp increases, primarily in cotton and, to a lesser degree, labor. For the second half of 2010 and spring 2011, costs were held flat, however, we expect modest pressure for summer product. Beyond June, it is still too early to forecast. Importantly, we are doing everything possible to minimize the impact. For example, we are consolidating vendors and fabric purchases and leveraging our volume to negotiate better costs.  Additionally, we continue to move production to the Western Hemisphere, which has been advantageous to cost, transportation,  and increased efficiencies. What we absolutely will not do is lower the quality or fashion content.

 

LTD on cotton:

 

Also importantly cotton for us, as you know, is a lot less significant than it is for a straight up apparel company. With that said, it does have an impact, particularly in the Victoria's Secret business. We don't expect a big impact this fall. You might

see some beginning in the spring. But again, for the overall Company, not a big impact as compared to some others.

 

PLCE on cost pressure:

 

There has been a lot in the news lately about the significant cost increases in Asia, which are expected to impact apparel retailers in 2011. We were able to significantly mitigate the cost increases for the first half of the year, through product cost engineering, significant mix changes, and selective price increases. However, costs have continued to escalate, particularly cotton prices, and we now expect more pressure in the back half of 2011.  We have a diversified sourcing base, which gives us some flexibility in shifting fabric orders, as well as production, to countries that have less inflationary pressure. We're working diligently to mitigate the impact for our customers, but if cotton prices remain where they are, which appears likely in the short term, there will be an impact on the product pricing throughout the industry in the back half of the year. We'll know much more after we complete our 2011 back-to-school buy over the next months, and we'll provide further updates in March, when we announce our fourth quarter earnings.

 

BONT on sourcing:

 

We've had no increases this fall of 2010, and spring has gone up on about 10% of our merchandise that we buy, and private brand has gone up about 5% to 8% depending on the item. And it's mostly cotton-related that gave us about a 2% impact in total of our private brand for spring.

 

For fall, we are hearing about price increases. There's lots of drama that changes on a weekly basis. We have big swings in costing, mostly cotton. And again, apparel prices appear to be going up, as well as textiles. We've had a lot of our overseas vendors here in the first week of October to partner with us, specifically to attack this issue about how we take costs out, and help mitigate the cost increases.

 

We then had our agent, Connor, here actually the second week of November, to follow up specifically to address this issue. Part of the thing that we do is about 40% of our private brand is produced in China, 12% in Vietnam, 17% in Jordan, and 12% in India. So we have been moving away from China, where most of the issue is. And we actually have 25% of our merchandise is produced in duty-free countries of Jordan, Africa and Nicaragua. Now that's the private brand piece. From the domestic market, we haven't really seen the big increases for spring, and we really won't be placing the fall businesses until the first quarter. So the only thing I can really comment about is our own private brand. But from the market, we are hearing the same drama of prices going up.

 

WSM on cost pressure:

 

We have seen increasing pressure on cost, particularly this last month, both raw materials as you all know, and I'm sure aware of the cotton prices, and then also labor rates in Asia. The good news is we've been very proactive in cost containment efforts, and are still in the early implementation stages of some of these efforts, and I mentioned them earlier, but I'll just bring them back up again. So, both from a network design perspective, also containerization and packaging reengineering. So yes, we see the  pressure, obviously, and we are building strategies to combat it, and to continue to improve our profitability.

 

PVH on rising costs:

 

Sure. It's an issue that the entire industry is dealing with. We talked about that our spring costs were going up in the 5% to 6% range. Clearly, that dramatically accelerated for fall. We haven't priced for. We haven't [costed] it yet. It's not just the course of the economy, it's really much more of a supply and demand issue as these developing countries, which were producers are now also becoming consumers. And there is more demand for product and there's not new places to go. There's not another China.

 

There's not -- duties have come down. The apparel industry has gone through 15 years of product cost deflation. The Calvin Klein Jean today going out the door at $49.99 to $59.99 in the United States was going at a similar price in 2000. So, there just hasn't been any inflation in the category. That's going to change. Our strategy is to raise retail prices.

 

The way the business model works we are raising MSRPs. We're re-sourcing product. We're managing the content of product. We're managing how we produce product, (inaudible). So we are doing everything possible to manage the cost side of it and on the retail side for a brand like Calvin and Tommy, I think there is significant price elasticity and it won't be much of a significant issue for us to raise prices $3 on average, it gets more of a challenge with our more moderate brands like Van Heusen and IZOD and ARROW, when you are hitting key opening price point -- hitting key opening price points. The issue there will be, it's clear to us, we've talked to every retailer, our (inaudible) everyone will be raising MSRPs and prices and then the question will be is, how the consumer reacts to that. So we are being prudent by how we plan that on a business-for-business basis, where we will probably plan margins down but overall we have seen margins based on our mix of business going forward continuing to grow much faster internationally that has higher margins are Calvin and Tommy businesses that have higher margins that should continue as we go forward. Yes.

 

DBRN on price increases:

 

We continue to work to address areas of concern, such as price increases for material, labor and piece goods. This created challenges for all retailers. We are taking a thoughtful approach at our three divisions and looking at brand appropriate ways to address these increases. Justice has already implemented a mid single-digit price increase on the average for the fall, which we intend to maintain for the spring. Dress Barn and Maurice's have held prices flat for the fall and anticipate being able to do so for the spring without impacting margin. Instead of price increases, in some cases we are sharing these increases with suppliers while in other cases we are utilizing other cost savings techniques, such as changing the fabric content and the detailing of our merchandise. Unfortunately, it appears to us these price increases are here to stay and we will continue to address them for next year's fall season.

 

ANN on three areas of opportunity to mitigate cost pressure:

 

First, as it relates to advanced commitments, consistent with the first half activity, we are making meaningful commitments on a significant portion of our key core fabrics. Second thing is we are aggressively looking at opportunities to procure off peak production. That's a strategy that we have historically utilized within the factory outlet channel and we are rapidly expanding that across the full price channels. Third, strong vendor partnerships. I cannot emphasize that enough. It's a tremendous benefit to us as we manage through these challenges. And then also just value engineering the product where it makes sense. We have our designers and our merchants on the ground in Asia working directly with our vendors and our factories, and we continue to strengthen our raw materials trim staff in Asia to ensure that we have flawless execution in this area. From a costing perspective, while we know the situation is clearly more challenging than we've seen, we believe we are approaching this in the right way

and that we are doing everything in our power to mitigate the costing pressures for the back half of 2011.

 

HIBB on minimal impact of price increases:

 

Are you seeing any -- are you worried at all about the increase in cotton prices? We've seen a little bit of that. We don't really sell a ton of cotton, so we really don't think overall it will have a major impact to

us, but we have seen some things for spring on cotton prices.  And you think you'll be able to pass those price increases on through?  Yes, it's such a minimal part of our business.

 

PSUN on passing cost increases on to consumers:

 

Like any apparel manufacturer or retailer, there are going to be some very real challenges in sourcing and product costs that we are going to have to deal with, that will have an adverse impact on our merchandise margins, and in today's environment, we are not expecting that these cost increases can simply be passed along to consumers, across the board. We're going to have to be creative and diligent throughout the supply chain, from factories to brands, to achieve reasonable solutions that can mitigate these pressures. It is still too early to know the full effect of these changes, but we are committed to working aggressively to try to maintain our gross margins next year.

 

GCO on lack of clarity on price pressures:

 

We see cost pressures arising out of the labor and capacity issues in China that may possibly impact next year. Although it is not all that clear how it will play out, we believe our vertical and wholesale businesses, Johnston & Murphy and

license brands, are most exposed. They naturally are pushing to get corresponding price increases to anticipated cost increases which will be challenging in this economic environment.

 

Of course we compete on the other side as well and our branded retail businesses will look to their vendors and suppliers to absorb much of the increases.

 

DSW on following the marketplace’s lead:

 

Costs are going up. There is no question, and we're going to have to look at specific places where retails may elevate but our retails will elevate in the same way that you're going to see retails elevate across the entire industry. So we're not going to look out of proportion or out of synch with what's happening across the entire retail sector. What we're going to do is we're going to work closely with our manufactures. We are looking to mitigate those costs as best we can with cost increases but the one thing I don't want to do is I do not want to compromise quality in our product and just lower cost prices and put a less than stellar quality product on our selling floor. The first person that will vote on that will be the customer and you'll get hit pretty bad if you do that.

 

Eric Levine

Director


TALES OF THE TAPE

Some interesting divergences in yesterday’s price action.

 

In quick service stocks yesterday:

  • Extremely light volume throughout the category with the exception of JACK
  • CMG and PNRA both up on low volume
  • JACK down 10% on high volume following a poor quarter with little in the way of a solution from management

In casual dining stocks yesterday:

  • More volume in this category yesterday with PFCB, TXRH, CHUX, and  MSSR all posting gains on strong volume
  • EAT also gained on the day, albeit on volume that fell below the thirty-day moving average, and has almost pared back the losses it suffered in stock price since its disappointing earnings release in late October. 
  • CBRL underperformed on the day following disappointing sales numbers in earnings along with conservative 2011 guidance released yesterday

 

TALES OF THE TAPE - qsr price

TALES OF THE TAPE - casual dining price

 

Howard Penney

Managing Director


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