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NKE: I’m Surprised It’s Grinding Higher

Nike is taking off today in a weak tape on heavy volume. What gives? I think the quarter next week will come in just fine. In fact, my model is nearly 10% ahead of consensus for the quarter. But I’m not so sure that will matter this time. Think of the following…
1) This is a global growth story in a slowing global and increasingly stagflationary economy.

2) With 50% of sales outside of the US, the dollar has been a meaningful driver to sales and gross profit. Nike is one of the few companies that has actually taken excess FX-related cash and reinvested back into the model instead of printing as higher EBIT margins. This allows NKE to sustain growth due to better infrastructure, and leaves it cost levers to pull in case things slow down. Good stuff. In addition, it is one of the few names anywhere near this space that has been through several FX cycles. Its hedging strategy is all about profit preservation. But what does all this mean? In ’09 the company’s P&L is going to shift from a rapid-top-line/improving gross margin story, to being a slower growth SG&A leverage story with FX offset shifted to gains in ‘other income.’ Quality of earnings probably won’t improve for FY09.

3) Costs are not getting better in Asia. 97% of the industry’s footwear is made in China (bad). Nike is less exposed at about a third, but it also is far overexposed to Vietnam (also a third of its footwear production). Two weeks ago, Hanoi announced 28% inflation – its highest rate in 16 years. In Vietnam and Thailand we’ve seen factory workers strike because mid-teens wage increases are not enough to keep pace with inflation. Ultimate, this has to impact Nike. They’re big and smart enough to pass it through to the rest of the global supply chain, but that process is lumpy.

4) Did you see Belle International? Belle is the largest shoe retailer in China. It has the exclusive distribution rights to many brands, and is also a major partner for Nike and Adidas. The stock went from 8 to 6 in a week. Margins compressed just as the Olympics peaked and all partner brands filled potential capacity as much as possible to build awareness in advance of the Olympics. Now we see China’s retail sales at a whopping 23%, but with the growth incrementally coming from Beijing, and with the Real rate ex-inflation slowing. The China growth opportunity remains HUGE. But it should take a breather for a few quarters.

5) We’re still only 3.5 months into Nike’s fiscal year – this is a time when the company is NEVER upbeat with guidance – even when not faced with these macro challenges. Guidance won’t be good. They’ll try to buy themselves breathing room.

6) ROE/ROIC has started to decouple. Cash is building faster than the company can invest it at prevailing rates of return. Not a bad problem at all in this environment. In fact, that may one of the primary reason why this name is viewed as safe by many PMs. Yes we’ll see stock repo. Yes we’ll see dividends – but both growing at a steady measured pace. Don’t expect any sudden capital returning events. Acquisitions are likely – especially with Umbro now tucked in. Timberland makes sense. I could even justify a retailer.

To those that know me, you know that I fundamentally believe in Nike’s strategy – which is why in a former life my family and I packed our bags, gave up Wall Street, and moved out to Oregon so I could work there. But based on what I see happening on the global stage, I’m surprised to see the stock continuing to grind higher.

Underneath this Financial Crisis Is An Economic Cycle

This morning's weekly US jobless claims report reminds us that the unemployment cycle in this country will continue to worsen. This week's jobless claims came in higher than expected at 455,000 vs. 445,000 last week.

The "Trend" here is up into the right. The 4 week moving average of claims bumps higher yet again to 445,000, and everyone should recall that last month's unemployment reading finally broke out through the 6% line.

While some pundits suggest this number was high last week by virtue of hurricanes Gustav and Ike, you should consider the impact of the real time structural hurricane in the US Financial industry, this week.

KM

CKR – IT’S NICE TO GET AWAY

In the past we have documented the excessive G&A spending at CKR. When questioned, management was adamant that their G&A spending was in line with other comparable companies. We can now cite a specific example where management “perks” may have led to excessive G&A spending.

As you can see from the two pictures at the right, CKE Restaurant’s corporate plane recently took a trip to Hawaii. It was there for 4 days. Nice!

I have no idea who was on the plane or what the business purpose was.

There are no Hardees’s in Hawaii and three franchised Carl’s Jr., two of which are in Honolulu. The plane spent four days in Honolulu so senior management could visit two stores?


  • On Jets.com the cost to rent a light, seven passenger plane round trip would cost $40, 000. Expedia priced out a first class ticked on United at $2,300. I would love to hear the justification for this one.

  • Even with CKR posting a good quarter, I know there is still a lot of fat to cut. I can point to other restaurant companies 2x the size of CKR that don’t have a corporate plane.



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Restaurants - Trading thoughts from the control room

GMCR interesting action today, but will be “wackamoled” tomorrow if it can’t break out through 37.92

CMG looks like it’s headed to $51

PNRA is in a dog fight here... the critical line of support/resist is 49.84

Dennis Gartman is long MCD!

CKR, bad hair day, broke down through the brave heart line which was 12.37 supports, on big volume

Fitz and Reilly

I am not going to focus on Asia or Europe this morning. We have our own mess to deal with. Why is it that the US hedge fund community loves to buy everything in life on sale, other than stocks? Why is it that the CEO of Morgan Stanley, John Mack, is pointing fingers at the US hedge fund community for the weakness in his stock price?

Since I have partnered with some of Morgan Stanley’s top horses, I know a thing or two about their business. One of those things is that Prime Brokerage is one of the most important drivers of their profit growth. For those of you who are unfamiliar with what holding a prime brokerage account means to a hedge fund, quite simply, it’s where you keep your money, short balances, etc.

When my Partner and I started our own hedge fund in 2005, I used Morgan Stanley as my Prime Broker. Why? Well, I felt (and still feel) that they are the best on the Street in this business. There are two fine gentlemen who currently work for John Mack who I will refer to as Fitzpatrick and Reilly (their last names) who are two of the most intelligent and upstanding men I have ever had the pleasure of working with in this business. They understand that this is a client business. They understand the meaning of a handshake. They, unlike Dick Fuld, who calls it a “franchise business”, are the guys rolling their sleeves up every day, who understand that this is a people business.

John Mack has done the best job out of the bulge bracket investment bankers in keeping his antiquated ship from sinking, but yesterday he threw his clients and credibility into the water. He sent a letter to his employees that I have sitting here on my desk (no, neither Fitz or Reilly sent it to me). He wrote “there is no rational basis for the movement in our stock… we’re in the midst of a market controlled by fear and rumors, and short sellers are driving our stock down…”. C’mon John – now I am confusing you with the politician, Johnny Mack. I didn’t get the memo in October of 2007 that the market was being driven by “rumors and greed.” That was 26% higher in the S&P 500, but hey, the leadership on Wall Street hasn’t paid much of a premium for economic historians as of late, so I digress…

Mack proceeded to call up his boys at Goldman’s, Lloyd Blankfein and Hank Paulson, to go after their now evil prime brokerage clients. All he needed was George Bush on the call saying “we’re gonna smokem out of their holes”! Oh, my bad, Paulson is the head of the US Treasury now… and right, right… those “holes” are client accounts held at Morgan Stanley and Goldman Sachs!

Somehow I had another up day in the Portfolio yesterday – I was being an “evil doer” being short Goldman Sachs, I guess. If I haven’t made my point yet on why I’ve been short GS, I’ll say it again – the current structure of a fully integrated global “investment bank” is being revealed as conflicted, compromised, and constrained. You cannot run these businesses together anymore. It’s impossible to always be putting the client first, across the “franchise” platform. This forces executives to take on monstrous leverage and risk.

Fitzpatrick runs a heck of a prime brokerage business. Reilly is as good as they get on the institutional brokerage side of the house. These guys put the client first, not the “franchise”. The franchise issues you more disclosures and disclaimers than they do actionable real time advice. The franchise is willing to let their employees’ life savings go to zero or sell it to the lowest bidder. Why? Because their principal, prop trading, and banking businesses have conflicting agendas with your account. C’mon John, this is why your stock is going down. This is why you’re announcing that you need to talk to Wachovia about a merger.

Others will say that your firm is levered 28x to your shareholder’s equity, and that you need Wachovia’s backstop of cash deposits (liquidity). If that isn’t partly true John, why are you talking to them? If none of it is true, why didn’t you tell your employees that you, as in you yourself, bought stock in Morgan Stanley yesterday? You’re an upstanding man of the highest reputation. The Street loves you. Fitzpatrick and Reilly have families and commitments. Stand up and tell it like it is. Pointing fingers at your clients is going to be very difficult for these two fine gentlemen to explain on the phones this morning.

On massive volume and volatility yesterday, I moved from 84% to 76% cash. It’s time to take some ownership out there in the USA. US market game time is in t-minus 2 hours. Let’s get ready to win out there. Buy low, sell high. Let everyone else worry about why they bought high and why they are now selling you their stock and excuses, low.

Best of luck today,
KM



BYD: ADD ANOTHER GAMER TO WINNING SIDE OF LIQUIDITY

I think management finally has their heads screwed on tight. Free Cash Flow, Return on Investment, and Internal Rate of Return have all reentered their vocabulary. My call is that we don’t see Echelon construction ramped up until 2010. The upshot? The dam has sprung a leak. Free cash flow is going to start pouring in. I’m talking real cash, not free cash flow before I spend billions with little associated ROI.


  • BYD should be able to generate $2.50 in net free cash flow next year. That is a 25% FCF yield. As I discussed in my 6/25/08 post, 15% is the magic number for the regional stocks where outsized returns have followed. By no means is BYD sitting on its cash flow. The dividend yield is 6% which is as high as I’ve seen for a gaming company. We’re big on dividend stocks right now at Research Edge.
  • How safe is that dividend? With Echelon on hold, BYD has tremendous liquidity. Unlike the rest of the industry, borrowing costs will not explode higher in 1 to 2 years. BYD maintains $2.4bn availability in its credit facility that doesn’t mature until 2013. The interest rate on that facility ranges from 0.625-1.625% above LIBOR. PENN is the only other liquid gaming company.
  • I’m not predicting blow out quarters but management has set the bar pretty low. Near term comps get a lot easier in the LV locals market and at Blue Chip in Indiana. They have been getting killed in both those markets. Of all the gaming markets, I think the Strip has the furthest to fall. BYD now has no exposure there. With gas prices declining, the regional markets could show some stability. With a 25% free cash flow yield, stability is all we need.
With Echelon on the back burner, cash flow pours in and BYD delevers
Comps begin to ease in Q3/Q4 2008

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