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The Europeans Are Now Setting Up For Their Manic Panic...

From our friends at Street Account: 1/29/2009 12:09:41 PM BOE's Blanchflower says UK may face worse recession than in 1980's; rates need to be cut further and quickly -- wires

Obamerica: The Honeymoon is Over

If we needed a reminder that partisanship still exists in Washington, we got it yesterday in the House’s vote on the stimulus bill. In the vote, 244 Democrats voted for the bill, 11 Democrats voted against the bill, and 177 Republicans voted against the bill. While the bill passed and is now on to the Senate, the vote was noteworthy in that it was solidly split across party lines.

Ironically, earlier in the week President Obama visited House Republicans in an attempt to sway some votes. Politico provided a summary of the meeting afterwards:
“He promised to make tough spending choices in his first budget blueprint — “everyone will have to take a haircut,” he said. He told them he wouldn’t increase the size of government just to increase the size of government. He even teased House Minority Leader John A. Boehner about his golf swing.”
Other media outlets provided a similar assessment, mainly that the meeting was very cordial and President Obama was earnestly attempting to reach across party lines.

In the aftermath of this meeting, expectations were raised dramatically in terms of President Obama’s ability to garner support for the bill. Some reports suggested that as many as 50 of the more moderate Republicans would vote for the bill. Obviously, these expectations were widely out of touch with reality and imply that despite his resounding electoral victory and high approval ratios, his political capital may have limitations as noted by this inability to even pick off ONE vote.

When President Obama and his advisors consider their inability to rally Republican support on this vote, they may not have to look any further than the assessment from Representative Patrick McHenry, a Republican from North Carolina, who when asked what happened to Obama’s honeymoon responded simply: “Ask Pelosi”. Clearly, President Obama is going to have to do a better job of Captaining his former Democrat colleagues in Congress, who have peeved off their Republican counterparts by failing to reach across party lines in the construction of the stimulus bill.

From an investment perspective, on the margin, this is bullish for the US dollar to the extent that the bill gets reshaped, or renegotiated, in a less Socialist fashion (via more tax cuts primarily) in the Senate where the Republicans yield more power with the ability to filibuster the bill. As you know, Keith has been saying that a stronger US Dollar is bad for stocks and commodities – you are seeing that inverse correlation play out in the market again today.

Daryl G. Jones
Managing Director


Claiming A Win For The Bears...

This week’s initial jobless claims released showed us 588,000 new applicants, 3,000 more than the revised figure for last week and 45,000 above the four week moving average. There is no need to mince words with this print – it was awfully bearish (see chart below).

Importantly, this puts the January Employment report on the table now as having to the potential to be as awful as November’s. One of the main reasons why I was bullish, for the immediate term “Trade”, in December was that weekly claims continued to decline sequentially (on a week over week basis). The end of that trend lines up almost in sync with the recent SP500 top on January 6th. The last 2 weeks of jobless data is what it is – as the math changes, I do.

In a perverse way, breaking the buck will help ease this problem. The biggest part of the country’s issue is that we have invalid corporate executives who are firing people now rather than 6-9 months ago when they proactively should have.

When you don’t have a proactive risk management process, this is what bad corporate execs do – they react to the news, buy back their stock and build capacity at economic tops, and do nothing but cut costs at bottoms. A weaker dollar will make their export business find a bid, and make these underperforming executives look as bad as they should – cutting into the bone right before demand begins to bottom is not what these guys should have their Boards sign off on paying them for.

I remain very cautious on the immediate term “Trade” in this US market – yesterday’s highs sucked a lot of people in at the high end of a straightforward trading range that we have been locking in for the last 6 weeks.

Keith R. McCullough
CEO / Chief Investment Officer

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COLM Into 4Q: It's All About Duration

Keith and I just had a healthy debate on COLM. I think it’s shaping up as a fundamentally positive risk/reward. His near-term inclination is to wait for the print. It comes down to duration.

Why I’m Liking COLM.
This is a perennially underperforming business – for good reason. It managed the transition from a small family-run specialized model into a larger mass-market portfolio of brands while tightening its wallet and starving its content of dollars needed to grow. As such, a host of brands including The North Face (VFC), Spyder, Marmot, and dozens of others have been nibbling away at its share. COLM has maintained a decent-enough top line growth rate overall, but margins came down to 10% from 20% 5 years ago as it lost relevance and ability to hold price.

But at the beginning of last year, COLM started to plow more capital into its brands – both R&D and marketing – and is finally putting capital to work in growing its footwear business. For the record, COLM has only a $200mm footwear business – which is a joke when considering that it owns brands like Columbia, Sorel, and Mountain Hardware. Just because it had 20% margins once it does not mean it is owed them again. In fact, COLM grossly over-earned then. But I think that the resources are finally being put in place that will prove this to be a margin level from which COLM can climb. All we need is flat margins and this name works. I can find a point or two of upside.

As for the business, it goes without saying that it is not good today. But with 1) the Street expecting a 50% earnings decline in the quarter, 2) a 5% earnings slip for 2009 (the first time ever that COLM went into a year w down Street expectations), 3) only 1 buy rating on the stock, 4) 35% of the float short the stock, and 5) trading at 4.5x EBITDA – I think that the results and outlook need to be really really bad for this stock to tank from here.

Fundamentally… Yes, I am concerned that the top line compares for the next 2 quarters are tough as COLM anniversaries a 4-5% FX boost, as well as the launch of Techlite and Omni-Shade – which is represented in the -11% spring backlog already reported. This should be offset in part by sales from the additional 15 outlets in COLM’s plan. Margins, however, go up against extremely easy comparisons (-4-6pts last year) in 1H at the same time it will be benefitting from the $7-$8mm from recently-announced headcount cuts. Some of this will go to additional lease expenses, but the reality is that there’s never been a better time to negotiate with landlords. I’m usually not a fan of new stores for brands like this, but the timing lowers the sales hurdle needed to leverage occupancy costs over the long-term. Finally, I loop this into what should be a decline in capex for ’09, and inventory relative to sales (see SIGMA chart below), and this all adds up to be a pretty nice story in this tape.

Oh, and by the way – inventory of cold weather gear is not exactly fat out there. After a string of mild winters, it’s been very cold in key regions of the US relative to past years. I hate bringing up the weather card, but it has always been a factor here, and that fact remains.

This company has a lot of wood to chop, but for every negative fundamental factor, I can come up with two positives. It is not a 'big idea' for me here, but the risk/reward can't be ignored.

HOT: EXPENSE NOW, SAVE LATER

HOT’s fundamentals are worse than we thought yet guidance was better. While 2009 EBITDA guidance was worse than the Street it was much better than our estimate by about $100MM. This happens to be the amount of cost savings indicated by the company.

While we are impressed by the cost cutting progress HOT management has made, our enthusiasm is tempered by the timing and categorization of expenses. In Q4 HOT recorded “non-recurring” charges and expenses of $350-400MM offset by a gain on asset sale of around $175 million. Some of these expenses will clearly benefit 2009, making the margin gains somewhat suspect. The initial reaction of investors may be to push the stock higher due to less than toxic guidance but the stock is not cheap, the underlying fundamentals are much worse than the guidance indicates, and estimates are likely to continue you to come down.

The following are some of our observations:

• The fundamentals are awful in lodging and timeshare
• HOT continues to beat and lower guidance, a trend we expect to continue
• Timeshare write downs totaled $101MM – Q4 timeshare margin was 45%, around 20% higher than normal. The write down will likely continue to benefit margins and the margin gain is reflected in guidance. However, this does not change the economics at all.
• Q1 guidance is much worse than full year – It looks like HOT is banking on a 2nd half recovery which won’t happen.
• A deferred gain on sale of assets of $27MM is likely included in 2009 guidance as fee income, which already includes $83MM of amortizations of deferred gains from 2008
• The stock looks like it is trading over 9x EBITDA which is not cheap, particularly since some of the margin improvement (especially timeshare) is not sustainable.

SBUX – WHEN IS ENOUGH ENOUGH?

It was a little over a year ago that SBUX first announced Howard Schultz’s return to the CEO position and the company’s new transformation agenda, including slowing the pace of U.S. growth and closing underperforming store units, to renew its focus on store-level unit economics. There was much anticipation for the 1Q08 earnings call that followed shortly after that initial announcement to learn the magnitude of the changes. On that 1Q08 call, SBUX reduced its 2008 U.S. new unit opening targets and announced the closure of 100 underperforming stores. Additionally, the company said that it would open less than 1000 stores in the U.S. in 2009.

Here we are one year later and SBUX has since increased those 100 expected closures to 961 with 800 in the U.S. (384 of which are already closed) and 161 internationally (including the 61 stores that have already closed in Australia). Regarding new unit growth, SBUX now expects a decline in net new stores in the U.S. in 2009 following all of the expected closures. Unfortunately, these significant downward revisions to store growth and store closures did not come at once. Instead, we have had to agonize through these additional cuts each quarter since the transformation agenda was announced. I thought SBUX’s initial announcement last January was reactionary as comparable sales trends had already started to decelerate and yesterday’s revisions are once again reactionary. That being said, no one expected this quarter to be good. We did not need CEO Howard Schultz to remind us that unemployment, jobless claims and the number of housing foreclosures have increased while consumer confidence has fallen to an all-time low to know that.

Even if the announced changes continue to be reactionary, they are the right moves for the company going forward, and they prove that CEO Howard Schultz is willing to make the difficult and necessary decisions to improve SBUX’s profitability. The fact that Mr. Schultz said he has a “Plan to Win” (MCD called its 2003 turnaround plan the “Plan to Win”) and that SBUX is going to begin offering some type of value breakfast combo meals at a national price point in March show that he no longer thinks SBUX is immune to the issues facing his competitors.

And, these store closures, slowed unit growth, headcount reductions and increased focus on managing costs are already yielding results. Although same-store sales declined 9% on a consolidated basis (-10% in the U.S. and -3% internationally), the company’s EBIT margins improved on a sequential basis to 8.3% in 1Q09 (excluding restructuring and impairment charges) from 4.5% in 4Q08. Although margins declined nearly 380 bps YOY, an 8.3% margin is not a bad number for a restaurant company in today’s environment. Yesterday’s, we also learned that the company is expecting to yield an additional $100 million in fiscal 2009 cost savings, primarily from additional reductions in non-store positions and store closures, bringing the total expected savings in fiscal 2009 to $500 million. Margins should improve throughout the year as the company’s savings are expected to ramp up in each subsequent quarter from $75 million in 1Q, to $100 million in 2Q, to $150 million in 3Q and $175 million in 4Q. The comparisons get significantly easier as we trend through the year as well.

Predicting when SBUX’s top-line results will improve is much more difficult. These comparisons also get easier but easy comparisons no longer seem to matter when it comes to same-store sales growth in this environment. In the short-term, investor sentiment will be influenced by SBUX’s top-line results, but the company is now well-positioned for the long-term and is managing the aspects of its business it can control. We have already seen an improvement in margins and the company’s current cost initiatives are expected to lead to increased savings in 2010 and beyond. It should also not go unnoticed that even with comparable sales down 9%, SBUX generated over $100 million in free cash flow in the quarter, which on an annualized basis is a 6% cash flow yield, also not a bad number in today’s environment.

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