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.

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.

When Biz Stinks, Stick With The Winners

Sports apparel sales trends are starting to bug me. Retailers are being very careful about which brands they reorder. They’ll stick with the winners, and so should you.

Sports apparel sales trends are starting to bug me. There’s noise around this week’s SportscanINFO numbers due to the timing of Thanksgiving, but looking at the 3-week trend (what we do anyway) suggests flattish industry wide sales. Not a disaster by any means relative to other parts of retail. But the fact that the trajectory in average price point is dropping like a stone is not comforting. Promotions are happening early, though the silver lining is that they’re working – and that unit sales are climbing at about the rate of price point declines.

Bottom line. Stick with the market share winners, and companies that are growing outside of this core sports apparel category. Under Armour’s trends remain fine in apparel. Still gaining share in its core training business (48% of total), and recent Compression category share trend has rebounded (and remains at 70% of the category). Also, expect to see running and basketball apparel step up in ’09 in conjunction with UA’s ‘year of footwear’ (when it gets into running and basketball footwear). These are two categories where I think that UA can realistically add $500mm in revenue on top of its $750mm base over 3 years while maintaining a 10-11% EBIT margin. Tough to find a 20%+ grower in any industry these days.

Eye On Obamerica : Sentiment Shifting

Keith and I have had many political debates over the last 12 months. He tends to be more flexible when it comes to politics and I tend to be more partisan.

In fact, I’m about as Republican as they come. In 2004, I actually worked on Get Out the Vote efforts for Bush-Cheney in Ohio. Obviously, it is difficult for me to not to admit that the team I campaigned for has executed terribly over the last four years. Nonetheless, my biases remain and I do have questions about Obama.

My biases aside, I have to fully acknowledge Keith’s point from the Early Look today, Obama is not only popular, but he makes people feel good. Not that there is any way to value “feeling good” from a stock market perspective, but it is potentially an important indicator of broader popular sentiment.

In a recent poll from the LA Times, “nearly three-quarters of those surveyed feel positive about Obama's election as president, a figure that includes not just an overwhelming majority of his fellow Democrats but a substantial majority of independents and nearly a third of Republicans.” In addition, nearly 8 out of 10 approve of the way he has handled the transition and nearly 3/4s approve of his cabinet picks.

While we can debate the semantics of this poll, and maybe even the methodology, it is, as always, hard to ignore the facts. President-Elect Obama has roughly 75% of the population that feel positive about him and the job he has done in the transition. On the other hand, President Bush currently has 26% approval rating.

The fact is, President-Elect Obama becoming President Obama is and will be a positive catalyst for the sentiment, and likely the stock market – at least in the short term.
Daryl Jones
Managing Director

Early Look

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Table Of The Day: University/College Endowment Allocation

Suffice to say, there was an allocation problem this year… but this has been a decade in the making. Note the % growth in Hedge Funds and Private Equity. We all of a sudden “have a call” on Asset Allocation because we took our Cash position to 96% in September. I am thinking the Cash allocation percent change increases in 2009!

Eye on Activists: Memo to Ivory Asset Management

Memo to Ivory Asset Management
Subject: Long only levered activism is dead

While we don’t know anyone at Ivory Asset Management, and we are sure they are great people, we do have some advice for them, activism is dead. If the only way you can get the stocks up that you own is to throw out hail Mary activism proposals, the market is more likely to look at that for what it is, a last ditch attempt to save a bad investment.

Back in the market mania highs of 2005/2006, these strategies worked. Unfortunately, the cheap money, private equity bubble has popped, like all bubbles inevitably do, and with it so has the long only levered activist model.

Microsoft CEO Steve Ballmer has said the idea of acquiring Yahoo is dead and while the idea of doing a search deal is still alive, the likelihood of anything getting done at Ivory’s proposed $24 - $29 is preposterous at best. Ballmer understands that he will get a real shot at Yahoo if he wants it, but it will likely be at a much lower price.

The days of long only activists actually mattering are long gone. We would use Ivory’s press release investment strategy, and any short term increase the stock price that come with it, as catalysts to sell positions.

Daryl G. Jones
Managing Director


Yesterday Wyndham had a call to discuss its announcement that it was going to self fund its timeshare development business given that the asset backed securitization market is essentially closed and showing no signs of improvement for 2009. Basically, WYN is reducing its sales velocity by approximately 40% from 2008 levels to get the business to a level where it can drive positive FCF and become self-funding.

Like other development businesses, timeshare is capital intensive and typically cash flow negative when the business is growing rapidly. There is no revenue recognized until the building is complete and over 10% of the purchase price has been collected. However, when the business is being wound down, it throws off a material amount of cash. The average duration of a timeshare loan is about 7 years currently.

Since 2000, the timeshare industry has grown at a 14.5% CAGR, driven by demand, abundant and cheap financing, exchange programs (RCI & Interval International) and introduction of new products (fractionals, condo hotels). Marriott, Starwood, and Wyndham have been beneficiaries of this trend, experiencing an average CAGR of 19% from 2003-2007 in their timeshare business.

According to our calculation the industry will need to contract by about 45% from peak levels in order to become “self funding.” Currently most sell-side analysts model some contraction for 2009, with a large rebound thereafter. If the industry needs to become self-funding, it will take many years to return to 2007 sales velocity.

We’re pretty sure we’re not going to see the same hockey stick growth in timeshare experienced earlier this decade. Timeshare growth will likely be constrained to funding availability and free cash flow generation. Investors looking for growth may want to look elsewhere.

For those focused on cash flow like us, the winding down of timeshare development is a positive event. The Street is likely to understate the potential cash flow generation of this business in the coming years. We’ll have much more to say on this soon. Also, the evaporation of the credit market might be a blessing in disguise by forcing companies to trim development activity proactively before demand falls apart as it has for most large discretionary leisure purchases. This cutting back should minimize the inevitable future write-downs and growing delinquencies as the value of inventory gets written down and the rate of defaults on loans accelerates.

We are not yet ready to pound the table on the lodging sector. However, despite the near term earnings drag from turning timeshare into a self-funding vehicle, the FCF picture for MAR, HOT, and WYN should improve dramatically.

Anna Massion

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