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FINL: This One’s A Keeper

This story is definitely looking good to me. Earlier this week I noted my inclination to swap out of FL and into FINL after Nike’s FY1Q09 report. I was concerned about the stocks into the numbers, which turned out to be a bad bet on my part. Good tone from Nike on a good market day sent the group up big. Keith subsequently added FINL to the Hedgeye portfolio after the Nike report. Anyone else who followed him had a good day. As much as I am in tune with (and appreciate) a day’s worth of alpha, I think hindsight 12 months out will show that a buck move here or there will prove to have been a rounding error with this story.

With the numbers I’m seeing out of FINL, my conviction continues to grow in the margin levers as the product cycle turns in favor of the athletic specialty retailers – despite stress in the global footwear supply chain. For the quarter, comps accelerated on a 1, 2 and 3-year basis (+4.7, 0.0%, -2.2%), while gross margins were up 230bps, SG&A down in absolute dollars despite a 3% sales increase, and a 12 day improvement in days inventory on hand – despite facing the toughest yy compare in inventories. Check out the quad chart below. Looks golden.

Going forward, the product cycle should start to improve more meaningfully this fall – thanks to Under Armour stimulating the competitive fires at Nike, K Swiss, New Balance, Asics, and Adidas. This industry competes on product – not price. So a product cycle inherently helps retail in its early stages (i.e. 2001/02). Nike’s US footwear futures and ASP growth support this beginning. I think that we’ll see both traffic and ticket pick up at FINL – ending a 3-year slump in comps. With Paiva gone, Man Alive being downsized, and apparel under control, FINL is focusing back on its core. Good timing. Inventories remain bloated relative to history, and SG&A still has room to come down. I think that this company has the potential to get to a 5-6% EBIT margin within 2 years. Not bad given a 2% print in FY08.

Why do I prefer this one over Foot Locker (i.e. a change of tone for me)? First is that FL’s international exposure concerns me with recent moves in the dollar. Second is that with FINL, you actually get a little square footage growth – albeit low single digits. Lastly, this is a management team that I can actually trust – unlike FL.

DRI – EYE on Hedging - an Important DRI footnote

The table at the bottom is footnote 12 – Fair Value Measurements. I’m confident that Joe Lee (DRI’s former CEO) would have never tried to hedge butter, natural gas, executive compensation or interest rates. Is it a sign of the times or a sign of management’s appetite for risk? I know the absolute dollars are small relative to the size of DRI, but the trend is important. Now that they are in the business of hedging, what’s to stop them from getting more aggressive as they try to manage EPS? A scary thought! Something to keep an EYE on!

Full disclosure: since reading the footnote, I reached out to management, but have not heard back. I will post more details as I get them.

MCD – Strengthening its Cash Flow Bull Case

MCD raised its quarterly dividend 33% to $0.50 per share. This increase follows two prior 50% dividend increases in both 2006 and 2007. Although I have communicated the issues around MCD’s U.S. margins and the company’s ability to launch its specialty coffee beverage platform by mid 2009, I can’t refute MCD’s strong cash flow story, particularly in today’s challenging environment. MCD has consistently achieved a positive net CFFO/net income ratio, which measures the proportion of earnings yielding cash. Additionally, MCD is close to achieving its target of returning $15-$17 billion of cash to shareholders through a combination of both dividends and share repurchases in 2007-2009 (returned nearly $11 billion to date).

As I said earlier this week (“MCD – The Cost of Capital Is Rising and Access to Capital is Tighter), however, I continue to be concerned about the franchise system’s cash flows as they are forced to make a fairly big investment to convert their restaurant for the specialty beverage rollout at the same time costs are rising. And the Dollar Menu can’t be helping either!

  • MCD has consistently achieved a positive net CFFO/net income ratio, which measures the proportion of earnings yielding cash.
  • And the cash keeps growing......

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Food @ Research Edge – My Perspective on Keith’s Trading Calls….

Keith: HSY; thanks for coming out Goldman; they're reiteration of their sell rating is driving this higher, $43.11 next.
My perspective: They need to do a deal to remain competitive globally

RESTAURANTS @ RESEARCH EDGE – MY PERSPECTIVE ON KEITH’S TRADING CALLS….

Keith: RUTH is plain ugly; tested and tried every line that matters; $3.96 immediate term target
My Perspective: The banker are calling the shots – see my recent post

Keith: WEN getting the lift off the lows right where it should have, but volume here isn't convincing yet on the up moves.
My perspective: it’s so bad its good! Trying to solve for duration….

Banning Gravity?

"The nine most terrifying words in the English language are: I'm the government and I'm here to help"
-Ronald Reagan

Maybe John McCain should have read the Republican history playbook before he jumped right back to where he has been for the last 30 years and removed all doubt that his strengths do not lie on the economic side of the intellectual debate.

Obama knows at least as little as McCain on the most important economic questions of our generation. This isn’t about being political. This is about being right. Who is going to get this right for this country and when? Who has a proactive risk management process, and who does America’s most relevant “Perpetually Preferred” (www.researchedgellc.com, 9/24) investor, the tax payer, trust with his/her money?

These are simple questions that do not have simple answers. Launching what Henry Paulson calls a “Bazooka” of $700B of your hard earned money at t-minus 72 hours alongside a “Fear Mongering” (www.researchedgellc.com, 9/25) threat that the “alternative” of not launching the weapon hurriedly is “financial panic” (George W. Bush, 9/24/08) is both emotionally rash and intellectually absurd.

Plenty of my critics won’t take my word for it – and I don’t expect them to this morning. Maybe they can dial up the 3 Nobel Prize winning economists and the other 166 academic economists who sent a letter to the ranking Republican yesterday, Senator Shelby, stating the same. Maybe they can dial up BB&T Bank’s CEO, John Allison, who’s stock price has not been penetrated by the “evil doer” short sellers, because he proactively managed his $136B bank like a fiduciary of this great country should.

In his memo, Allison hammered home what is such an obvious point: “Treasury is totally dominated by Wall Street investment bankers. They do not have knowledge of the commercial banking industry. Therefore, they cannot be relied on to objectively assess all of the implications of government policy on all financial intermediaries.” Objective fact finding is crucial here John; let me thank you for your better judgment on this matter. Patience pays.

In 2004, there were 5 investment banks that were freed up by the US government (Bush) to lever their brains out: Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Stearns. One, two, three – you don’t have to be a Nobel Laureate in math to count how many of the famed five flamed out. More interestingly, what have we learned lately about the remaining two? Goldman and Morgan Stanley need capital, and their alumni are steering the SEC into scaring the public into a short seller witch hunt. Last night, Paulson’s fellow Goldman alum and hedge fund PM, Ed Lampert, was able to get his stock, Sears Holdings (SHLD), on the no short sale list. Yes, they are a retailer. No that’s not a typo.

While CNBC is myopically drawn to the tree here again this morning, keep the forest in mind. Next week’s macro calendar is critical to respect. Next Tuesday, September 30th, is month and quarter end for the asset management industry. Wednesday, October 1st is day one of what could potentially be the beginning of the largest fund redemption cycle we have ever seen. October 2nd, is the last day that the short sellers are out of the game. And Friday, October 3rd (see my Beware note from 9/19/08) is what it is… it’s a Friday in October… and it’s also the day you’ll see the US unemployment report. Beware.

Self serving politicians and investment bankers cannot stop time or gravity. The Nobel laureates have my back on that too.

Enjoy your weekend – we all need it.
KM



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