The Golden Arches are still infallible in the eyes of the sell-side.


Whenever you find yourself on the side of the majority, it’s time to pause and reflect.

-Mark Twain


A week ago, I held a conference call on MCD and the lofty expectations that I feel the company is unlikely to meet in 2011.  The Black Book I published that day detailing my thesis kicked off with a Mark Twain quote.   I think another of his quotes, above, would have worked equally well.  The Street adores MCD and is not keen to attach any real conditions to that affection.


In the days following my bearish conference call with clients I have heard plenty of push-back.  Having had time over the past week to think through my thesis further, my confidence in my thesis is high.  Several positive sell-side notes have helped bolster the price this week; to be clear, my call is for MCD to miss investor expectations from a sales and margins perspective for the year 2011.  I would like to take a few of the key points the bulls have made and address them.


In no particular order:


Bull case: MCD can pull the trigger on price increases in 2011, giving significant resilience to comparable restaurant sales growth.


Hedgeye Thought:  MCD has held back on price increases during 2010 and the value proposition that the chain offers is a large part of its success.  Given the outlook for the U.S. consumer in 2011, I would be less-than-confident in MCD’s ability to take pricing without significantly impacting traffic given the fragile nature of the U.S. economy’s “recovery”.   In addition, increased prices will only drive more consumers to the $1 menu, which is an unprofitable proposition.  Housing headwinds and anemic job growth, coupled with rising costs, will pressure the consumer this year.



Bull case: MCD benefits in times of rising food costs.   There is a 0.45 correlation between at-home inflation and fast food traffic. 


Hedgeye Thought:  First of all, I would be hesitant to wager too much on a correlation of 0.45.  Rising costs are a problem for the MCD system.  I am including a chart of beef, below, and one can clearly see the parabolic year-over-year move that QSR chains are enduring at the moment.  Without a doubt, the franchise model insulates shareholders somewhat from this risk but ultimately, with franchisees competing with other restaurants for value-seeking customers, the cost will have to be passed on to customers – many of whom are feeling a similar squeeze in terms of inflation (gas, education, food, clothing).  The reality is top line trends and input costs cannot be considered in isolation of the other.   I am not sure the MCD customer is ready for a price hike at this point. 


MCD: STREET IS LOVIN’ IT - beef costs


Bull case: New menu items will continue to drive sales at MCD and they will easily gain leverage and offset cost increases.


Hedgeye Thought:  In the Hedgeye MCD Black Book, published last week, I discuss the over-complication of MCD’s menu and the knock-on impact on operations.  This morning, a note published by Janney Montgomery, albeit with a “Buy” rating, detailed a survey of franchisees with some interesting commentary pertaining to the menu.  One question was “Is the menu overly complicated?”  While some of the answers cited expressed no desire to reduce or simplify the menu, the vast majority expressed an emphatic view that the menu was not only confusing customers, but also confusing employees and compounding operational difficulties.  The development that franchisees are facing increasing costs and conflict with Oak Brook is not positive for MCD.



Bull case: Inflation may be an issue, but it’s a sum zero game and competitors will likely take price before MCD, allowing them to take more price and drive same-store sales.


Hedgeye Thought:  That may be true conceptually but, absent any magic tricks; MCD cannot persuade consumers to keep paying for smoothies, frappes and lattes at higher prices.  As I illustrated in my Black Book published last week, frappes and smoothies accounted for more than 100% of same-store sales growth in 2Q and 3Q, respectively.  As prices are increased, consumers will purchase less of these discretionary items.  In 2011, this would mean pressure on margins year-over-year given that beverages are higher margin products than more staple products such as burgers.  With a complicated menu creating operational inefficiency, an increase in customer focus on low average check items will not help franchisees’ profitability.  Other “margin enhancing” initiatives being touted by many on the sell-side are also unproven at best.  24 hour restaurant openings, in particular, is not a new initiative and an idea I am less-than-convinced about.  BKC did not find this initiative accretive to their earnings.


Howard Penney

Managing Director

Company Insights from ICR Conf

As a follow-up to yesterday's industry insights from ICR, here are our company specific notes from the event. Please give us (or ) a shout if you’d like to discuss.






Cost Inflation:

  • Still too early to tell if they will be able to completely offet
  • See HSD increases as the peak
  • Key offset to cost inflation is markdown management - faster reaction increases turns = max gross profit $$
  • Keds most exposed brand (canvas) with 7-8mm  of ~195mm pair in total annually


  • Expressive consumer still larger portion of business than more cost conscience customer
  • Focused on hitting trends for expressive customer and driving price to offset lower end
  • At this point, a return of the lower end consumer would be gravy


  • ROST and TJX have offered lower price offering at times but not consistently
  • Have stopped trying to compete at the very low end - hurt them in early 2010

Gross Margins:

  • Engineer down to the material level to manage cost
  • Size Assortment Matrix (SAM) - key process used to decide whether to include tail sizes (beyond core sizing) for new styles + colorways to increase turns
    • At most Payless locations now shifting to implement at Stride Rite retail

Capital Spending:

  • Expect 2011 capital allocation to reduce debt to be ~1/3 of EBITDA consistent with recent years


  • Sperry - women's segment now as big as men's
  • Have reduced door count by 1000 doors while growing retail driving gross margin expansion
  • Likely to add another 10 stores this year
  • Not sure where ceiling is for stores beyond 50


Cost Inflation:

  • HSD, LDD price increases in 2011
  • Will continue to operate under the same margin requirements
  • Labor accounts for 25-30% of cost of shoe
  • Don't expect cost inflation to impact GMs in 2011 due to ability to pass through

Gross Margins:

  • Could see margins dip below 40% depending on how fast they can sell through overhang - but only for short periods of time


  • Still source 90%+ in China and expect to maintain that level near-term rather than shift like rest of industry


  • All core backlogs are positive, with mens and kids showing the most strength.
  • Women's SRR selling better than men's
  • Kids "on fire"
    • ~$300mm worldwide
    • Priced at the higher end
    • Accounts for ~20-25% of sales
    • Doing more business with FINL than in years past


  • Toning sales 50-75% the size of U.S. at peak

Marketing Spend:

  • Q2 & Q3 largest qtrs in terms of spend


  • <10% of sales
  • Did very well in Q3 & Q4

European Weather Impact:

  • Didn’t see material slowdown others have highlighted (boot sales offset declines in other categories)

Technical Athletic Launch in 2011:

  • July/Aug launch - first at SKX retail then at wholesale 4-6 weeks later
  • Lightweight running first test of $100+ product post toning – will also offer $70 entry point
    • Believes toning success gave brand confirmation/right to sell through premium priced product

DC Update:

  • Transition expected to take place in Q4 2011 - will store product in new facility starting in April/May
  • Expect to be shipping out of by the '11 holiday


  • Seeing new store opportunities for LIDS up to 1100-1200 locations domestically – not anchored to malls (i.e. ski slopes)
  • LIDS Locker Room concept born from Sports Fanatics acquisition/added capability adds opportunity for ~500 locations
  • Has been comping nicely
    • In-store embroidering capability a key sales driver
    • Adds ~8% to sales
    • Roughly 50% of stores have capability
  • Building Lids Team Sports concepts closely with NKE
  • NKE is well penetrated with top 100, but very little exposure to smaller teams both College and HS at the local level - GCO offers that oppy.
    • Most players in this space private players, Nike ramping efforts aggressively will have product/blanks that can be customized
  • Also issued 5-year financial targets


  • For the last several weeks men's footwear has outperformed women's
  • SKX did their homework in evolving the toning brand – like the evolution of product will continue to support
  • the Big Deal promotion has regularly been 12% of total sales for at least the past year.
  • Will have a mobile transaction system implemented by end of Q1
  • Capacity is freeing up as demand for toning shoes rolls over.


  • Int'l a key growth opportunity - only 5% of total sales
    • Currently $31mm in sales via distribution agreements - goal to get to $100mm+ by 2012
    • 7 new brands added since 2009 should grow to ~$150mm over next 3-years from $50mm currently
    • Fixing direct retail a key initiative with goal to get to 10% EBIT margins by 2012
    • e-commerce only accounted for $22mm in sales LTM (<4% of sales)


  • Goal to reach $2Bn in sales by 2015
    • Int’l be 40% of rev. by 2015
    • Marketing currently only 2% of sales, will be increasing UGG marketing spend by 1.5% of sales in 2011
    • Men's business a key initiative: Pilot program in U.S. for 2011 launching in Q4 (Tom Brady endorsement)
    • Stores expansion - 260 by end of 2011 - vs. ~180 at end of 2010Business very strong
    • 5-10% growth in raw materials
    • Shift to men’s on the margin
    • Tom Brady….ugg! Now’s he’s wearing UA AND Ugg. That’s a first…
    • SIGMA not looking good. Actually, it looks bad.


  • Core product now accounts for only 10% of revs
  • Excited about new technology in ’11, with emphasis on lightweight product.  5 crocs chuck taylor-like shoes equal weight of one original converse version.
    • Dual injection with both softer and harder material for increased durability
    • Expect the company to continue to operate under one brand.  Believes DECK is a great company to emulate.
    • Likely to see rollout of Jibbitz by Crocs at TGT.  $14.99 price point using molds from the Mamba line, originally slated for JCP 3 years ago.
  • Just launched "duet" product this week
  • Marketing Spend of $15-$18mm in 2010 towards integrated efforts nonrecurring 2011 efforts will shift toward direct to consumer


  • Footwear wholesale - goal to grow 2x industry
  • Believe Merrill will be company's first $1Bn brand
  • Sold more than 400k pair of new Merrill barefoot shoes for Spring 2011 season - launched mid Feb
  • Has been very well received at specialty running shops to get M into those doors
  • Consumer Direct only ~7% of sales expect to take to 15% of sales over time
  • Cost inflation MSD in 1H, MSD to HSD in 2H


  • One of the most bullish at the conference – on both square footage and comp
  • 12-15 new stores in 2010 were Movie Gallery locations
  • Opportunity for 30-35 net store additions in 2011
    • 40-50% from Movie Gallery or Blockbuster locations
    • Plan to expand an additional ~20 stores in 2011 up to 7-8k sq. ft. formats
    • Only 20-25% of store base competes with a FL
    • Nike supporting marketing both in-store and external - HIBB's full-service positioning a competitive advantage
    • NKE accounts for ~50% of sales overall; 60-65% of footwear
    • Interestingly, they specifically called out KSWS from a product standpoint
    • That matters when a company’s (KSWS) sales is cut in half over 3 years.
    • KSWS Tubes for Spring '11 one of CMO's highlights
    • E3 replenishment system hasn't resulted in material bump in inventory as expected - even more efficient
    • “A NFL lockout would have a small impact on comps.  However, we’re more excited about the prospects for the NFL/Nike relationship and what it will mean for new products.  Did you see the Oregon Ducks uniforms?  Very exciting.”
    • Landlords still not giving in on rents, even though these stores have sat vacant.  Expect capitulation and the sites are pretty good.
    • Being in-stock, aided by replenishment systems, is still key to driving comps.


  • Weather is simply impossible to read
  • Toning is a Fad
  • In 2H11 there WILL be a product margin squeeze.
  •  ‘We’ll all work together in ironing out the costs.’
  •  ‘But it won’t be an even distribution, and uncertainty is significant on timing and magnitude.


  • Paul Marciano, 1st presentation in 14 years.  Brand name inspired by billboard from McDonalds.  Wanted one syllable brand name.
  • 40% of rev’s licensing, 50% in Europe
  • 15% NA wholesale, 85% NA retail….global: 36% eur, 44% NA retail, 8% asia, 8% NA wholesale, lisc 4%
  • Opportunity in north Europe, currently in south.  Germany being evaluated
  • Italy is half of Europe


  • Pricing at wholesale Ts going up
  • Blank Ts demand is stronger
    • No unit degradation in last 6mo
    • 6mo lag between cotton costs and sale is puts significant strain on industry requiring much higher working capital
  • Spent another $15mm on inventory YY due to cost increases


  • “We want to own your closet, the whole closet. And, maybe some drawers and shelves as well” 
  • More than double north face to $3 bil. -5 yrs
  • Mid march investor day will layout 5 year plans
  • International EBIT 200 bps higher than total corp op margin.  Lower tax rate abroad helps EPS.  Will be 40% of total in 5 years.
  • China $1 bln opportunity
  • No single brand fully developed on retail. Vans largest.  67 TNF, grows to 190 globally 5 years
  • GM’s will continue to expand in same manner as prior 5 years.
  • Spent incremental $100 mm on sg&A in 2010 centered on marketinf.  Half on tnf and vans.
  • 5.6% of total (mktg) was, 5% historically.  Will be lower in 2011, to offset margin pressure
  • Cash flow: exceed $900 mm, was $850. Acquisitions top priority.
  • Focus on outdoor, action sports
  • 5mm repurchase in 2010, vs. historical rate of 1-2mm shares per year.
  • May see north of 80 new stores in 2011, incremental comes from international
  • Will cut incremental marketing spend from ’10 to offset cost pressures
  • Not yet locked in on denim for Fall.  Many denim mills still not accepting orders and holding out for more clairty.
  • Bought some denim textiles in late ’10, will show up in YE inventories.  Small but will help to offset costs.
  • Rock and Republic (if successfully closed with courts) will be positioned away from competing with Seven.  Likely goes downstream from super premium.
  • All brands taking price, but not all due to cotton.
  • Feb 1st will see price increases in denim at retail, at WMT
  • Low-end denim price increase will not fully offset costs
  • Expect 10-15% more cotton to be planted, which may result in substantial price relief by year end.


Gordman’s CEO:  “Pricing is not the issue to understand the Gordman’s model”.



  • Is it me, or did this story actually sound decent???
  • The growth profile seems to be improving.




Today COSI reported 4Q10 company-operated same-store sales of +6.1% as compared to -6.6% in 4Q09.  The franchise comps were +1.8%, bringing system wide same-store sales of 4.5%.  The increase for the 4Q10 was comprised of a +3.8% increase in traffic and a +2.3% increase in average check.


On a two-year basis same-store sales improved by 240pbs to -0.3%!


The COSI turnaround continues and we will learn about profitability for 4Q when the company reports earnings after the market close on March 28, 2011.




Howard Penney

Managing Director

Daily Trading Ranges

20 Proprietary Risk Ranges

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R3: TGT, Zappos, OSTK, TBL


January 21, 2010




  • With the annual Sundance Film Festival kicking off yesterday, several brands are viewing the event as a prime marketing opportunity given the high-profile attendance. Timberland will be outfitting filmmakers and staff with over 300 new Earthkeeper boots, while COLM’s Sorel is sponsoring a ‘scavenger hunt’ to win access to after hour parties and gear. A less conventional fit is K-Swiss, which will be hosting its second annual ping pong classic featuring directors, producers and actors - suggesting the first was a success.
  • According to, US consumers saved $32 million over the November/December time frame by using digital coupons.  The coupon aggregator site also notes that digital coupon traffic rose by 25% for the holiday period, with discounts averaging 27%.  Amazon, Victorias Secret, and Kohl’s were top ranked as the most searched retailers for online coupons.
  • According to Outdoor USA Magazine’s 2010 Social Media Award results, there were only four brands that ranked in the Top 10 across each of the popular social networks (Facebook, Twitter, and YouTube) – K-Swiss, Crocs, Columbia/Mountain Hardware, and Vibram Fivefingers. Surprisingly, Patagonia ranked #1 on YouTube with nearly twice as many viewings (3million+) ahead of #2 K-Swiss and its viral Kenny Powers parity.



H&M Partners with Hasbeens - H&M looked to its homeland for its latest collaboration. The Stockholm-based retailer has partnered with footwear brand Swedish Hasbeens, to produce three exclusive styles of wooden-soled clogs. They will be available on April 20.“I love the genuine feeling you get from Hasbeens, from the wood and the leather, and also how they take something traditional and Swedish and make it contemporary and modern,” said Ann-Sofie Johansson, H&M’s head of design, in a statement. “These Hasbeens for H&M fit perfectly with the ’70s bohemian look that’s so important this coming season.”<WWD>

Hedgeye Retail’s Take: Another endorsement for the 70’s which appears to be making its way to the mall in a fairly big way. Recall that Gap is betting on high waisted, flared denim as well. The question remains however if the wooden clogs success can even come close to the last collab with Lanvin. 


Calypso St. Barth Expands at Target - With Calypso St. Barth for Target bowing May 1, the mass retailer is hoping to reprise the success of its Liberty of London for Target launch last spring. The multicategory Calypso collection will feature apparel, accessories and lingerie for women, clothing for girls and babies, and home items such as candles, decorative pillows, dinnerware, glassware and serving pieces. The collection will be available in about 1,200 Target stores and through June 11. <WWD>

Hedgeye Retail’s Take: With some fashionistas wondering if TGT had lost its way with its designer collaborations, we suspect this effort will resonate well with its multi-category approach.  After all who doesn’t aspire to live the French Carribean lifestyle?


Zappos Named No. 6 on ‘Fortune’ List - is making some big moves.  This year, the e-tailer ranked No. 6 on Fortune’s annual “100 Best Companies to Work For” List, released last week.  The company made its debut on the list at No. 23 in 2009, moved up to No. 15 in 2010 and rose nine spots again this year. Zappos also registered the biggest percentage year-over-year job growth on the list, at 37 percent. “While the external recognition of making the list for the third year in a row is great for recruiting purposes, internally the most important thing is for us to take our culture to the next level as we continue to grow,” said Zappos CEO Tony Hsieh in an email sent to employees last Thursday.<WWD>

Hedgeye Retail’s Take: It should come as no surprise that the retailers on the list not only treat their employees well, but commensurately treat their customers well.  High correlation between happy employees and exceptional customer experience.  Other retailers in the top 20: Wegman’s, REI, Nugget Market, and Stew Leonards. Brands Itself around the Letter O - today began using the domain, directing consumers who type in to the web-only retailer’s e-commerce site, The company says the new name represents a step in Overstock’s effort to brand itself around the letter O. Overstock, No. 28 in Internet Retailer’s Top 500 Guide, paid $350,000 for the domain name in July on the first day that .co domain names became available from the .CO Internet S.A.S. registry operator.  Organizations and individuals have bought about 600,000 .co domain names. Social network site Twitter, for instance, has bought, while GoDaddy, a web hosting domain registry, now owns According to the client list on .CO Internet’s web site, appears to be the only e-commerce company using a one-letter .co domain. <InternetRetailer>

Hedgeye Retail’s Take: Long ago the single letter ticker on the NYSE was a true status symbol.  Looks like the times have surely changed.  We now wonder which other brands/business will pay up for the chance to rebrand with a four keystroke URL.


Orchard Brands Files Chapter 11 - Orchard Brands on Wednesday said it reached an agreement with the majority of its lenders to restructure the firm in a move that also includes a voluntary Chapter 11 filing in Delaware.  The bankruptcy filing was under the name Appleseed’s Intermediate Holdings. The catalogue operator, which targets men and women in the 55-plus age demographic, is owned by private equity firm Golden Gate Capital.  Golden Gate in October hired Moelis & Co. to find a buyer for the business, which does an estimated annual volume of nearly $1 billion, according to financial sources. Market and financial sources in November said there were few takers, and by December there was speculation that a bankruptcy filing was on the horizon. <WWD>

Hedgeye Retail’s Take: With most missy apparel retailers working on taking their brands to a younger demographic, we wonder if the combination of catalog plus aging demographic finally became too hard to overcome. Of all the catalogers trying to convert to internet, this one is likely one of the more challenging transformations.


Store Expansion High on Agenda for 2011 - Retailers in 2011 will be intent on actively growing their businesses and improving customer insight capabilities, in addition to continuing efforts begun during the economic downturn to stabilize operating costs and focus on financial discipline, according to a report from the National Retail Federation’s research and education arm, the NRF Foundation, and KPMG LLP, the U.S. audit, tax and advisory firm. In surveying 318 retail executives for the ninth annual Retail Horizons: Benchmarks for 2010, Forecasts for 2011 report, 41 percent said that their companies intend to increase domestic store expansions in 2011, up from 25 percent in 2010. Additionally, 25 percent will expand overseas, up from 21 percent a year ago. Signaling an overall consensus that the worst is behind them, 58 percent of retailers surveyed report that cost reduction/cost containment will remain a companywide strategic initiative, down from 81 percent in 2010.


Hedgeye Retail’s Take: The key callout here is the change in outlook regarding cost containment year-over-year – the more telling indicator of management sentiment. The change on the margin is also consistent with accelerated M&A efforts of late as well.


Commercial Complex for Chinese Goods to be Built in Thailand - After China gained a free trade pact with Southeast Asian countries last year, the country now plans to construct a vast commercial building named China City Complex in Bangkok, Thailand to house over 70,000 Chinese traders, with an investment of $1.5 billion. Construction of this complex is planned to start in March 2011 and is scheduled for completion in 18 months. Various China-made items such as ornaments, household products, garments and leather goods will be sold at the complex. Once the complex starts running, the Chinese traders can sell their goods to people from different parts of the world through Thailand, which would help them save the heavy duties imposed on their exports to many western countries.<FashionNetAsia>

Hedgeye Retail’s Take: The combined benefit of lower wage costs and side-stepping export duties could help Chinese manufacturers slow the rate of sourcing shift we’re seeing to some extent to other countries like Vietnam, Indonesia, and Bangladesh – that is until countries revise export duties to include Thailand to counter what is a completely transparent move.




Notable news items and price action over the past 24 hours:

  • WEN shares surged on emerging news of Wendy’s/Arby’s planning to sell Arby’s.  I have been in favor of this divestiture for some time and wrote about this yesterday.  I think the stock is worth close to $7.
  • MCD was the subject of yet another positive report, this time from Janney.  There were some interesting points in the report, including; “For this go-round of the survey, we asked our participants the following two questions: ‘The Wall Street Journal recently reported that, at present, McDonald’s offers over 100 menu items. Do you feel menu complexity is a problem in your operations?’ and ‘What items (if any) would you remove from the McDonald's menu, and why?’  The majority of responses indicated that in fact franchisees believe that the menu is getting to be too complex.  Some respondents to the survey stated that the menu contained “too many slow moving products such as salads, McCafe” and that “Even our customers know it and complain they can’t read the menu boards.”  Thank you to Janney for confirming what we already knew.  Franchisees want McCafe to go because it is not working.  As I said last week on an conference call with clients, Starbucks can’t sell food and McDonald’s can’t sell espresso because these products are not part of their core business.
  • MCD - In maple country of Vermont, consumers know the real thing. So starting Feb. 1, customers at Vermont McDonald's stores can request 100 percent maple syrup or sugar to be added to the restaurant chain's new Fruit and Maple Oatmeal to settle complaints that the company improperly labeled the product as maple flavored in the state.
  • YUM  - down on accelerating volume.  The company has the street focused on Emerging markets as the next avenue of growth for the company.  The current problem with that  is slowing growth in the Emerging markets in 2011.  As Keith McCullough noted today Asia was a mess again overnight; China bounces to another lower-high (to down -3.3% YTD), but Indonesia, which has been getting powdered YTD lost another -2.2%, Korea had its worst day in 3 months -1.7% and Japan wasn’t much better at -1.6%. Thailand, which internally cut their GDP growth forecast this week almost in half vs. LY +8% GDP down another -1.5%.  Global Inflation matters when it ramps sequentially like this. It always has – and a 42% owner’s equivalent rent weighting on US CPI will not change that.  MCD will be impacted too.
  • EAT, PFCB, CAKE, and  CBRL gained on accelerating volume.  Brinker continues to perform well and, the intra-quarter slowdown in Knapp Track trends notwithstanding, I maintain a positive view on this stock for 2011. 
  • The Orlando Sentinel published a story titled, “Rising food prices hit Central Florida shoppers” which details the impact of rising prices on food consumption patterns, particularly those of older generations living on fixed incomes.



Howard Penney

Managing Director


The Macau Metro Monitor, January 21, 2011

WYNN LEADS FROM THE TOP Intelligence Macau,

Steve Wynn announced a 6% salary increase yesterday for all the company’s non-management employees, effective February 1, 2011.  He said, “This is our grateful response to the leadership provided by Chief Executive Fernando Chui Sai On and Secretary Francis Tam concerning the rise in the cost-of-living for Macau residents.” 


IM praised Wynn's decision, citing its leadership in dealing with the inflation issue and a reminder on why Wynn Macau deserves a valuation premium.  Also,  IM says the timing of the announcement is interesting given that there have been rumors of poor credit decision-making by inexperienced staff at some of the other casinos.




Dec CPI rose 0.59% MoM and 3.92% YoY.  Inflation rate for 2010 stood at 2.81%.

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