THIS INDUSTRY NEED A GPS, NOT A MAP

Some of my colleagues are starting to get more bulled-up in their respective spaces. I really want to be part of that club, but the facts won’t let me get there as it relates to the apparel/footwear retail supply chain. The industry needs to understand where it is in its cycle, and the winners need to step up, use their liquidity, and put the competition down for the count.

1. Softline expectations for '09 have been getting better. But down 50bps still is not enough, and such a meaningful sequential uptick is not realistic unless savings rate stays at zero and better gas prices are all spent on discretionary (AND the dollar does not appreciate, AND Obama does not take rates higher).

2. I really like the cheap 5.2x cash flow multiple. But it is simply not real.

3. The industry is coming off of 6 quarters of down margins. But we have not seen the mass capitulation into the clean-up zone in our SIGMA chart yet (see definition below). Until then, there's no reason for me to believe that this group won't trade at 5x EBITDA (or 4x, or whatever) for a while.

4. The key, and obvious, strategy is to find the names where next year's numbers are real. This is Under Armour, Lululemon, Columbia, Hibbett, Bed Bath and Beyond, and Ralph Lauren. On the flip side, beware of Gildan, Philips-Van Heusen, Skechers, and VF Corp.

SIGMA EXPLAINED
First off, SIGMA stands for Sales, Inventory, Gross Margin Analysis. As noisy as this chart might appear, it has everything you need in order to track the quarterly progression of how a company’s (or industry’s in this case) P&L synchs with its balance sheet. It’s part financial, part behavioral, in that you can see how a management team pulls one lever of the model when presented with challenges or opportunities elsewhere.

Here’s how to read…
1. The vertical axis is the spread between sales growth and inventory growth. The higher up, the better (and the cleaner the balance sheet of excess product).

2. Horizontal axis is yy chg in EBIT margin. Obviously, you want to be to the right side of the chart.

3. The yellow line synchs points 1 and 2, and shows you the path over the past 6 quarters.

4. Columns represent change in GM% and SG&A% over 6 quarters. Very important to see if a change in aggregate margin is driven by one vs another.

5. Lastly, the grey line is capex as a percent of sales. That shows where the industry is in its capex cycle.

The punchline with this industry, is that it had four quarters (all of ’07) where inventories and margins fell. In almost every instance, the next move would be to the upper left quadrant – where the balance sheet capitulates – even if at the expense of margins. We have not seen that yet. If there is any saving grace in ’09 it is that SG&A compares get easy, and capex is coming down. I think many companies need this to prevent from going away. Others with dominant brands and ample liquidity should be doing the exact opposite – accelerating investment spending to literally crush their competition. I’m not seeing enough of this yet.
TTM EV/EBITDA

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