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Levi's Tells It Like It Is

Levi’s is one of the largest (privately held) apparel companies that at the same time evades many radar screens of those who solely trade equities.  Nevertheless, the company often provides interesting  and honest insights into its business trends. Last night was no exception, with Levi’s reporting it’s 4Q results.  We believe the company’s candid commentary on the cost environment provides valuable insight into the challenges facing an iconic, cotton-dependent brand such as Levi’s.

  • Despite possessing one of the world’s most recognizable trademarks, the company has launched a new global brand called dENIZEN to address emerging middle market consumers in growing markets.  The brand launched in China in 4Q with 50 doors. India and Singapore also have transitioned doors to the new
  • The company continues to view the economic environment as difficult, especially in Europe.  Southern Europe remains particularly challenged.
  • The market for cotton was described as “unpredictable”.  Increased cotton prices will work their way in the company’s COGS and as a result they’ve taken selective price increases to protect margin and mitigate inflation’s impact.  It was noted that a further increase in cotton prices could negatively impact margins and working capital in the latter part of 2011. 
  • Cotton prices in the back half will have more impact on 2012 than 2011. 
  • Management explained its relationship between Levi's, third-party manufacturers, and denim/textile manufacturers:

"We actually don’t hedge cotton where we buy finished product from our third-party manufacturers. Those manufacturers are buying denim from denim manufacturers, who are essentially buying raw cotton. So, we’re three steps or two steps removed from the actual purchasing cotton or the ability to hedge that. And so our real controls are essentially through pricing, as well as cost controls that run through our supply chain that we manage, which is primarily the third-party manufacturers."

  • When asked about the demand elasticity of their customer base, management noted that it’s too early to judge.  In three months there should be more data for which conclusions can be drawn.
  • The company has not seen customers attempt to increase purchases near-term ahead of further potential price increases. 
  • Spring deliveries which are just now arriving on retail floor are the first products carrying increased costs.
  • Japan continues to be a struggle.   Over the past three years the denim market in Japan has decreased by 40%!

Eric Levine

Director


WYNN YOUTUBE

In preparation for WYNN’s Q4 earnings release tomorrow, we’ve put together the pertinent forward looking commentary from WYNN’s Q3 earnings release/call.

 

 

YOUTUBE

  • “We’ve seen the bottom in Las Vegas, and I don’t know how fast it’s going to get better, but I don’t think it’s going to get any worse. And we had a really nice October, too. And we had a record-breaking October in China.”
  • [Cotai budget] “It’s a little early for me to say it, but I could say it’s between 2 and $3 billion, probably closer to 2.5, but I’m not sure. I’d like to finish doing the whole takeoff.”
  • “The one segment where I think we’re starting to see more stability that was hardest hit coming into the recession, was the convention and group business. And so we’ve seen that improve. I feel pretty good about moving into next year as to the amount of business that we currently have on the books committed. I mean to give you a comparison last year coming into this year, we had about 35% of our convention room nights on the books, and going into next year we’ve committed about 65% of our convention room nights on the books. So we’re happy to see that that segment’s going to return to somewhere between 18, 19% of our overall occupancy. And also we’re seeing some rate improvement.”
  • [Table game play in Vegas] “Length of play is what’s happening. It’s improved over the last year.”
  • “We’re looking to add two or three more junkets within the next year. We have one actually coming up before the end of the year.”
  • “So what I think a lot of operators do, whether it’s with credit or incentive, which is commission, is they use it for short-term purpose to increase revenue, to increase market share. So, obviously they go hand-in-hand. One is giving more incentive, which is commission back to the customer to bring the business. The second is you need credit, you need to give them facility to get the business. So they use both of them hand-in-hand to gain short-term market share, whether it’s for IPO or they’re trying to do different purpose to gain that short-term market share. However, the danger with that is first, we’re believing stability. Obviously if you give something more away on the commission then you have to cut something back, whether it’s salary or renovation dollars.”
  • [Mass/VIP mix in Macau] “So in the future years to come, we hope that both markets maintain about the same percentage.”

Emerging Markets Are Tightening Monetary Policy, How Are You Positioned?

Conclusion: Seven of ten of the largest emerging market economies are tightening monetary policy.

 

In the table below, we’ve outlined the largest ten emerging market economies, their 2009 GDP, their most recent CPI reading, and the current monetary stance of their federal banks.  To say that emerging markets are leaning towards tightening their monetary policy, which will lead to slower growth, is an understatement.  Some key takeaways: 

  • In aggregate, the ten largest emerging market economies represent ~$12.7TN in GDP, which is ~21% of global GDP and the fastest growing portion of global GDP;
  • The current average CPI reading for this collection of economies is 6.3%, and only Poland has a reading below 4%; and
  • Of the 10 economies, 7 are currently tightening, 2 are neutral and likely to tighten, and 1 is loosening (albeit in the face of 5%+ inflation). 

In sum, the emerging markets see inflation, are tightening policy, and this doesn’t bode well for the slope of global growth.

 

Emerging Markets Are Tightening Monetary Policy, How Are You Positioned? - 1

 

Daryl G. Jones
Managing Director


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DSW: Strength Notable on M&A Day

While the focus on DSW is inevitably the company’s merger with holding company RVI, the 4Q same store sales increase of 14.9% should not be ignored.  The overall strength was broad based, but below the surface there are some interesting trends to note:

  • Strength was pretty consistent across the board.  Every single category had comp increases reflecting a continuation of the momentum seen in 3Q.
  • No major fluctuations month to month, with consistency throughout the quarter.
  • Cost increases remain consistent with prior views coming out of the NY Shoe Show.  Expect impact at end of 3Q, early 4Q.  7-12% increase in general with fluctuations between categories.  Getting “nice” results from early spring.
  • Boots were very strong once again, up 16% in 4Q and 57% on a two year basis.  Positive comp increases in December and January for cold-weather product but fashion boots drove the strength.  Strength continues into 1Q.  Expect that 2011 could actually be another strong boot year based on what was shown at Shoe Show. 
  • Not expecting much of an uptick in in-season opportunistic closeouts.  Company did do some pre-buying of inventory to hold for next year.  Management expects this strategy to enable a greater value proposition next year in the rising cost environment.
  • Flat clearance levels year over year in 4Q.
  • Men’s business up 14% in 4Q.
  • DSW will look to hold price on more commodity-like items responsible for bigger volumes overall.  Fashion items will see increases where the value is warranted.

Eric Levine

Director


BWLD - BUFFALO SOLDIER

BWLD reported strong 4Q10 EPS results after the close yesterday, reporting $0.55 per share relative to the street’s $0.52 per share estimate.  Top-line trends fell short of street expectations, however, with company same-store sales growth coming in -0.3% relative to the +0.4% consensus estimate and management’s guidance for at least a flat YOY result. 

 

Going into the quarter, I thought management’s comp guidance could prove conservative as it implied a 40 bp deceleration in two-year average trends after beginning the quarter strong with two-year trends up 90 bps in October from the end of 3Q10.  Industry trends, as measured by Malcolm Knapp, also slowed during the quarter, down nearly 90 bps on a two-year average.  BWLD underperformed Knapp trends on a one year basis for the first time since 4Q05.  The company still outperformed on a two-year average basis but the gap to Knapp has narrowed considerably (to 3.3% in 4Q10 from 8.9% in 4Q09).

 

Despite this comp slowdown during the quarter, BWLD is trading significantly higher today (currently +12%), which I would attribute largely to the strong reported same-store sales trends in early 1Q11.  During the first six weeks of the first quarter, company comp growth was +3.8%, implying a 100 bp improvement in two-year average trends since the end of the year.  Management would not comment on whether this comp acceleration is reflective of a sustainable trend for the remainder of the quarter and year, but they did say the comp growth did not include any one-time benefits outside of the company’s being extremely focused and ready for Super Bowl this year. 

 

BWLD’s 1Q11 comp trends will benefit from both an 80 bp increase in average price during 1Q11 relative to 4Q10 and from the expansion of its Happy Hour initiative from only three markets in 4Q10 to about 65% of its company markets by the end of the first quarter.  That being said, I don’t think the company will be able to sustain the same level of momentum from early in the quarter for the balance of the quarter; though trends should accelerate from 4Q10 levels with increased pricing helping to offset my expectation for a continued slowdown in overall casual dining trends.  I am currently estimating +3.5% company-owned comp growth during the first quarter, which assumes a 60 bp increase in two-year average trends.  I think two-year average trends will be flat-to-slightly down for the remainder of the year, implying about +2.5% growth for the full year.

 

Restaurant-level margins improved an impressive 140 bps YOY during the fourth quarter as the company continued to benefit from favorable traditional chicken wing prices (traditional wings accounted for 20% of 4Q10 sales).  Cost of sales as a percentage of sales was down nearly 150 bps YOY.  Given that chicken wing prices were down 16% YOY, I was actually expecting this expense line to come in even more favorably, but management stated that the lower wing prices were partially offset by a slightly lower traditional wing sales mix (-1% YOY) and higher beer costs during the quarter. 

 

The company took a price increase in early January to slightly offset these higher beer costs, but they will continue to put pressure on margins going forward as could a continued decline in wing sales.  It is important to note that overall alcohol sales mix fell to 23% during the fourth quarter from 25% in the year ago quarter, which is not good for margins.  The company is hoping that the expansion of its Happy Hour program will work to once again boost its alcohol sales mix. 

 

BWLD will see the biggest benefit to its restaurant-level margin in Q1 from an estimated 30% decline in chicken wing prices (prices averaging $1.29/lb during the first two months of the quarter).  Chicken wing prices peaked in 1Q10 at $1.91/lb.  Depending on where prices come in for the remainder of the year, BWLD will likely continue to benefit from favorable prices; though the YOY favorability will lessen as the year progresses.  Increased labor costs will likely continue to pressure margins in early 2011 as the company rolls out its Happy Hour program and invests to improve service during the lunch daypart.   

 

BWLD maintained its FY11 guidance for 13% unit growth, but is now expecting to open 50-55 new company-owned restaurants relative to its target of at least 40 units outlined on its 3Q10 earnings call.  This new development target assumes a 40-60% increase in new company-owned unit growth from 2010 (total company-owned unit growth +16-18%).  Although the company’s AWS have outpaced same-store sales growth for the last three quarters, highlighting the strength of new unit openings, I am not convinced this aggressive acceleration in unit growth is good for returns.  Management stated that cannibalization negatively impacted quarterly comps during 2010 by about 25-50 bps and would expect that trend to continue in 2011. 

 

The company justified the acceleration in unit growth by saying, “But we've been gearing up for increased company store growth over the last couple of years. And again once you have that first one or two in a market it's certainly easier to add that third, fourth and fifth because you've got teams in place, you have an ability to hire and train.” Management went on to partially blame its lagging franchisee comp growth on cannibalization in markets such as Texas where franchisees have opened second and third stores in markets that only had one for a while. 

 

I don’t think it is ever a good sign for returns when management is explaining away sales cannibalization.  In some markets, there just may not be a need for a third, fourth and fifth store.  Based on my assumptions, ROIIC (return on incremental invested capital) should continue to be strong in 2011, but I would expect it to decline from the nearly 30% level in 2010.  The direction of returns is worth keeping an eye on.

 

Same-store sales growth should come in strong during the first half of 2011 on a one-year basis as YOY comparisons get much easier.  Higher menu pricing, combined with extremely favorable wing prices, will continue to push margins higher during the first quarter, but I would then expect margin trends to decelerate for the balance of the year.

 

All in, I think BWLD’s earnings results will be in line with the street’s expectations during the first half of the year but could fall short in the back half of the year.  I am currently modeling FY11 EPS of $2.45 (+16.5% YOY) relative to the street’s $2.50 estimate and management’s FY11 guidance of at least 18% growth.  Going into the quarter, I thought management’s FY11 +18% EPS guidance was conservative, but same-store sales trends fell short of my expectations during 4Q10, COGS as a percentage of sales were not as favorable as I was modeling, management guided to some G&A pressure in 2011, primarily as a result of incremental investment internationally and the company will face sharply higher preopening expenses YOY. 

 

Sell-side sentiment has improved over the last four months as reflected by the 67% of analysts recommending BWLD as a buy relative to only 44% in November 2010.  Although the next two quarters should be fine relative to current expectations, I would expect trends to decelerate in the back half of the year.

 

BWLD - BUFFALO SOLDIER - BWLD sales vs. margin

 

Howard Penney

Managing Director


The UK Sees Inflation

Position: Long Sweden (EWD); Short Italy (EWI), and Euro (FXE)

 

As was the case in Ben Bernanke’s testimony before the House Budget Committee today, it continues to amaze our team that The Ber-nank says he sees no threat of inflation domestically and has no concern that US monetary policy is contributing to massive inflation in global commodities. In contrast to Bernanke, both ECB President Trichet and BoE Governor King have expressed in recent weeks that 1.) they see inflationary pressures mounting, and 2.) they’ll appropriately address inflation through monetary policy. 

 

While we don’t purport to have a crystal ball to predict when central banks will raise main interest rates, the rhetoric from the ECB and BoE would suggest a much higher probability that they’ll raise rates sooner than the FED. In fact, we think the BoE will be the first to raise given the higher rates of inflation that the economy is being hit with.

 

In the UK, CPI has ticked higher over recent months –currently at 3.7% year-over-year—and data out today from the British Retail Consortium on the UK Shop Price Index showed further confirmation of this inflationary trend with price inflation for the overall index, and food inflation accelerating at the fastest pace in 19 months (see table insert in chart).

 

The UK Sees Inflation - pen1

 

We think in the near-term, and as soon as this quarter, it would be prudent for the BoE to hike to combat inflation. However, pinning the tail on the timing of a hike is exceedingly difficult, especially given that there’s significant concern that a hike would stymie the already weak GDP outlook for the country this year and next. No doubt the UK economy is in a tough policy spot. The chart of 2 year UK government bond yields below continues to warn of pressing inflationary risks.

 

The UK Sees Inflation - pen2

 

With the minutes of the last BoE meeting on January 13th showing a shift by most members to the upward medium-term inflation risks, we’ll take our cues from the action and any incremental statements from King and Co. tomorrow.

 

Matthew Hedrick

Analyst


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