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MCD - Trading Down

McDonald's senior management is on record saying that they are seeing more activity on the Dollar Menu, but it still remains consistent at 13-14% of sales. However, average unit volumes have improved significantly over the past four years so senior management's comments imply that there are significantly more customers using the Dollar menu.

It would also appear that management is very comfortable in the current environment growing traffic in its restaurants by using a value strategy. Management thinking here is that it's much harder to get customers to come back (from the likes of Wendy's, Jack in the Box, etc) than it is to keep them in the restaurant.

The question becomes at what cost?

This is where the friction between the franchisees and franchisor arise. Incremental Dollar menu transactions help revenues and transaction counts, but depress margins. Under this scenario the franchisors win at the expense of franchisees.

Since December 2007, McDonald's U.S. has seen a significant slowdown in reported same-store sales. Given the slowing sales trends and the increase in Dollar menu transactions, it's important to understand the components driving same-store sales. Until recently, menu prices were increasing faster than transactions. It's not inconsistent to think that the current economic environment coupled with the emphasis on value is causing transactions to grow faster than the average check.



German press printed an interview this morning of Nike Brand President Charlie Denson, who commented that a Nike 'takeover' in China could indeed happen.

While not a sensationalistic quote by any means, it was taken out of context. First off, the word 'takeover' has a different connotation in the US as opposed to Europe (also note that Germany is Adidas and Puma home turf). Nike does not do 'takeovers' as defined by a US audience. It might go hostile on offense from a brand and marketing perspective, but not from a strategic and fiscal perspective.

Also, Nike's strategy is to buy brands that get them to consumers that it can not touch (or does not want to touch) with its own Brands. I can't imagine that with the Nike Brand, Converse, Umbro, and Cole Haan, that Nike can't tap into its share of the 2.8 billion feet in China without having to add to its arsenal.

Could lower-end Li-Ning make sense strategically? Yes, perhaps given the delta in price points as Li-Ning price points are about half those of Nike. But the only reason Nike would do this now would be a defensive move to the extent that Adidas/Reebok attempted to scoop it up first. And even then I'm not convinced they'd go for it.

The punchline here is that the probability of Nike buying anything in China right now is very low in my humble opinion.

Clip below courtesy of StreetAccount.

LIZ: A positive inflection within reach for Liz?

Liz Claiborne's business is so bad in more ways than we can count. The portfolio is flux, customer traction is weak, and the Direct vs Partner brands strategy has yet to yield any positive benefits. The kicker is that LIZ is in the bulls eye of an industry-wide margin squeeze that could last for another five years. At face value, it's tough to make a long-term bull case on this one. But a deeper look reveals a different story emerging.

Consider the following near-term factors...
1) Say what you want about McComb (CEO) and his ill-timed decision to take the helm of one of the faster sinking ships this industry has seen in years. But one area Wall Street has consistently overlooked is the fact that the guy 'gets it' as it relates to building brands. With sales down by 2% over 3 years, SG&A is actually UP by over 10%. This cost LIZ about 8 points of EBIT margin. By no means was this a pure offensive move, and it was certainly not all well spent (the return on retail stores continues to be nearly nonexistent). But we'd rather see a margin hit come from SG&A up than GM down.

2) Now LIZ is sitting there with an SG&A ratio of better than 40%. That's nearly unheard of in this industry. Even Nike, Under Armour, and Ralph Lauren (perennial high-spenders) are in the high 30s. Either we're going to see some sales associated with the spend of the past two years, or a good CEO will pull the plug on the SG&A. We think McComb will do just that.

3) That brings me to the next point. The structure of McComb's incentive compensation should not be ignored. He has 341,370 options struck at $36.65, 63,150 at $50.13, 63,150 at $41.78 and has 138,855 restricted shares that are worth about $2.5m -- about 60% less than when they were granted. The options vest by the end of 2009 based on an even split of EPS and ROIC hurdles. To the extent that the business simply fails to grow and gross margins are unable to recover, then there's a whole lotta margin that can be found to improve profitability for all shareholders (both external and internal).

4) It's probably worth mentioning that in the latest proxy, LIZ adopted a cliff-vest for 2008 performance after 1-year. Yes, this pegs 2009 as the breakout year for margins.

5) A glimpse of it beginning? I don't think there's a single fundamental analysis better for understanding the margin trajectory for a company in this space than measuring the sales/inventory spread versus margins. The quadrant analysis in our chart shows that LIZ has just entered the 'sweet spot' where sales outpace inventory growth, and gross margins turn positive. The market shrugged it off. In fairness, the top line numbers are still extremely weak. But inventories are looking solid. This is setting the company up for a potential SG&A pull-back and margin pop. $3 in EPS power might not be a pipe dream after all...

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China Quake Impact on Footwear

We've had a lot of queries about the extent to which the earthquake in China has impacted product flow in the footwear space (i.e. 85% of our footwear consumption comes from China).
The bottom line is that the answer is 'No' as it relates to finished goods, but we're less certain about the availability of raw materials for future product.

With the epicenter in the Si Chuan province, the area around Chengdu is the focus as it relates to the footwear industry. There are not many athletic factories in the area, as it is rural and in most cases cost ineffective from an infrastructure standpoint. But there are several factories in the women's dress shoe segment that have been mildly impacted. These represents moderate price points that would sell into retailers like Target, Wall Mart, and Payless.

What might be of greater consequence is that there is a greater number of materials suppliers in the area, including leather and cotton, which is used by factories outside of the immediate region. While finished product appears to be moving, we'll keep an eye on the draw down of raw materials and subsequent product flows in the future.

CMG - Signs of Slowing....

I love going to Chipotle! Every time I go, the stores are clean, the food is tasty and there is usually a line of people waiting. But is that enough?
  • Valuation - CMG is the most expensive restaurant stock on the planet.
  • Peak Margins Right now CMG is the only restaurant company with double digit EBIT margins. In the world before rampant food inflation, labor inflation and consumer distress the best run restaurant companies barely achieved double-digit EBIT margins. To be clear, we are not talking about those companies that generate most of their revenues from a royalty stream. In the heyday when P.F. Chang's and The Cheesecake Factory were trading at 40x EPS, they generated EBIT margins around 10%.
  • Same-Store SalesGiven the current economic environment, CMG's same-store sales are in a class of their own. Over the past two quarters the company has posted same-store sales of 10.6% and 10.2%, respectively. Looking out over the balance of 2008, CMG's same-store sales are likely to slow to mid-single digit growth. In 1Q08, CMG did benefit from an easy 8.3% comparison due to a tough winter last year. For the next two quarters comparisons get more difficult at 11.6% and 12.4%, respectively.
  • Current TrendsCurrent Trends

Rebate Check Spending Survey

The following press release is from BIGresearch. Over the past four year we have found the BIGresearch surveys to very good insight in consumer spending trends.

NRF Survey Confirms Consumers Plan to Spend Much of Rebate Checks on Necessities

--Spending on Gas and Groceries Top Consumers' Lists--

Washington, May 13, 2008

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