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VFC: This Makes Zero Sense

If North Face, Wrangler, Napapijri or Seven were standalone businesses, every analyst would have sells on them. Yet they look through FX, spec charges, and the mother of all back-end-loaded guidance.

I’m kind of at a loss for words on this one. The company has run out of benefit from FX and acquisitions, and the ensuing transparency shows it for what it is – a portfolio of ‘slightly above average’ brands operating near peak margins and limited aggregate organic growth opportunity.

I’m not here to beat up VFC on its quarter. After all, almost everyone posted miserable results this quarter. But I am beating up VFC over its guidance and transparency (or lack thereof). This has always been one of the few ‘stand-up’ companies in the space. But now that business is tough, the company is restructuring, taking special charges, and not giving enough information for investors to accurately nail down the real earnings power this quarter.

Also, guidance next year of a low-single-digit sales decline (flattish in constant $), but with margins up 170bp excluding the impact of higher pension expenses? This means that in 2009, VFC will need to print an adjusted margin of 14% -- its highest margin in history. On a negative comp? In a recession? With The North Face slowing on the margin? And a multi-year FX tailwind going the other way? VFC needs to cut A LOT of SG&A in order to get there. I don’t know about you, but I don’t like paying for SG&A stories in most tapes – especially this one. In fact, one of the things I liked in the past about VFC is that it would consistently invest to drive growth. I understand the want/need to push out EPS hit and save costs. But this will inherently make me question what kind of growth is coming down the pike in 2010.

My 2009 number is $5.16 – well below the $5.42 (flat) guidance for the year. That’s about 10-11x pe and 6x EBITDA with the stock at $54. Expensive? Not really. But for a levered company where earnings need to come down, short interest is still low at 4% of float, 78% of ratings are Buy, and other names that are missing earnings trade at 20% lower, I wouldn’t touch this name here with a 20 foot pole.

Who is the incremental buyer here?




SP500 Levels Into The Close...

We spoke at the Yale School of Management this afternoon and, I must say as rewardingly inspirational as that dialogue with young capitalists was, it’s such a downer to come back to my post and have to watch conflicted men compromise themselves in front of the American people. The New Reality is here, however… and unwinding the excesses associated with being compensated for being willfully blind is a process that’s finally in motion.

Bottoms are processes, not points. I maintain my view that the November low in the SP500 will ultimately hold, and that we will continue to make higher lows on selloffs. That said, Geithner and what you are seeing via the You Tubing of Wall Street on TV today have crushed confidence in both the American economic system and the leadership embedded therein.

Below I have painted a line of immediate term support for the SP500 of 807 (dotted green), and I think we are going to need to test that before this is all said and done. For now the best advice I can give you is to make sales on green.

Keith R. McCullough
CEO & Chief Investment Officer

PFCB – “Hope is not a process” – but it’s something

If PFCB did not go down today, it’s not likely to go much lower unless sales begin to look like they did in December. As we sit here today, PFCB is hopeful that same-store sales trends will be worse in 1H09 than in 2H09. When questioned about its forecast for a 2H improvement, management stated that it is based primarily on “internal optimism” (again hopeful!) that the environment will improve from a macro perspective. Although we always say at Research Edge that “hope is not a good investment process,” PFCB has taken the appropriate steps to proactively manage for this challenging environment by significantly cutting unit growth and capital spending (down nearly 43% YOY in 2008 and expected to be down over another 50% in 2009). Additionally, the company is extremely focused on managing costs more efficiently, particularly at its Pei Wei concept. That being said, I would agree with management’s comment that if and when there is some relief to the consumer, PCFB would share in the benefit.

Management also stated that should sales trends remain at such depressed levels (though sales trends to date are ahead of the company’s internal forecasts), that investors should not expect 2009 margin performance to fare as well as it did in 2008. I think this is an important point for all full-service restaurants. In 2008, companies worked to eliminate costs wherever possible in an attempt to protect margins. Most companies have already slowed unit growth significantly and have cut the fat out of their systems in order to mitigate the margin declines associated with sales deleverage in 2008. There is not much more these companies can do to benefit margins on a YOY basis outside of driving sales higher.


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MAR: TOMORROW’S CASHALYST

Mr. Marriott: BRING DOWN THAT CAPITAL SPENDING! I suppose it’s not as important as Reagan’s speech to Gorbachev but it is important to MAR shareholders.

MAR spent around $1 billion in total capex in 2008. The capex details are broken down in the table below. This is an insane amount of money for a company with a very attractive fee based business model that should not be this capital intensive. As my colleague, Anna Massion, said to me recently, “no wonder they get such a s****y multiple”. Yes, she has a potty mouth (her words), but she is also very smart. For 2009, MAR has already guided to a “cut” down to $700-800 million.

We think capex could be cut in half. Not only is such a cut possible, we think they will cut, maybe not half but certainly by $200-300 million. Timeshare looks like the most likely segment to be thrown on the chopping block. At their current sales velocity, MAR has over 4 years of timeshare inventory on hand versus a typical duration of closer to 2 years. This is money already spent. They will need to use their balance sheet to finance the sales of timeshare, since they are probably not tapping the securitization market any time soon, but our guess of what MAR needs to spend on timeshare is closer to $150MM in 2009. They don’t need to, nor should they develop anything aside from completing the projects that are already in sale.

New hotels are not being developed, financed, etc. Look for MAR’s equity and mezzanine investments to dwindle. Capex and Acquisitions of over $300 million in 2008 is puzzling to us. We will get more clarity on this item tomorrow but it surely looks like another chopping block candidate.

So the cash flow situation should, and probably will look a lot better. Where do we stand on the fundamentals? The Street is projecting 2009 adjusted EBITDA of about $1 billion. Thank God for HOT’s earnings release since it seems that sell side estimates are not that stale, for a change. We still think the EBITDA guidance should come down 5-10% but that is probably not out of line with buy side expectations. Remember, MAR doesn’t have the same susceptibility to RevPAR changes as do hotel owners. The fee based model limits the negative flow through. Additionally, MAR will not face the same FX headwinds as HOT.

We are certainly not making a top line call on business trends improving. With less than awful guidance tomorrow and the potential catalyst of a significant capex cut, however, MAR certainly looks a lot more positive than HOT did heading to its earnings release.

Here is where it all went

EYE ON AUSTRALIA: CONFIDENCE

If you read our work regularly over the past year, you know we’ve been long Australia on several occasions. Under the firm management of Glenn Stevens, the Reserve Bank of Australia managed to keep the Australian economy under control during the unprecedented run up in the cost of base metals and energy commodities in 2007/2008. As a result, the Australians have been able to enjoy a softer landing with their extra rate cushion which has left plenty of room to cut. Now that the benchmark rate has been slashed to a 45 year low of 3.25% however, the reality of Australia’s dependence on external demand for commodities has sunk in; the projections in yesterday’s National Bank report were for a contraction of 0.25% in ‘09 with growth turning positive finally in 2010. Also released yesterday was the NAB business confidence survey (charted below) which, not surprisingly, registered levels that are at an all time low.

Still there are glimmers of hope on the horizon. As the reflation theme develops in the coming months, the land down under may be among the first to reap the benefits. In fact there are signs that it may have already begun. The Baltic Dry sub Index for the crossing from Western Australia to Beilun/Baoshan, a heavy traffic area for iron ore and other basic materials, has increased by almost 70% YTD –over 65% in this month alone (compared with a 6.6% decline in the ASX all ordinaries YTD). We will be keeping our eye on Australia: when sentiment becomes so overwhelmingly negative, positive data points on the margin can sometimes have a major impact.

EYE ON CHINA: TRADE DATA PART 1, IMPORTS

The coverage of this morning’s balance of trade data has produced screaming negative headlines in the media. To be sure, the rapid decline in exports and even steeper import contraction creates a conundrum for world trade; there is real pain in the data, but there are also signs of resilience in China’s heavy industrial sector. Here is my quick read on the import portion of the equation:

IMPORTS:

With USD measured imports down 29% for the month and 43% year-over-year there is plenty of bad news to go around, as evidenced by the regional/national breakout (see table).

When considering this information as an indication of overall Chinese demand it is critical however to run the numbers.

REFLATION MATH:

Ultimately, tracking trade data in USD can partially mask the real underlying situation. As an example, considers the tonnage data for Iron ore imports in January (see table).

At 32.65 million metric tons, imports declined by only 5.4% for the month, with total tonnage remaining in excess of 30 million for every month since October 2007 (see chart below). Clearly imports of basic materials have declined, but the data for raw materials like ore suggest that purchasing agents and mill operators are still feeling demand while anticipating the impact of the stimulus programs for Q2.

There is no better illustration of Chinese appetite than yesterday’s news of a potential $20 billion investment into Rio Tinto by Chinalco, the largest Chinese aluminum producer. Yesterday we touched on some on other data points that continue to support our conviction in our Reflation/Chinese recovery themes for 2009: Coal imports, a minor but fascinating measure and the Baltic Dry sub index for Western Australia/China routes. These positives are underscored by today’s news.

We remain bullish on the waking Ox and its appetite for raw materials in the coming months. As always we will keep our eye focused on every data point as it arrives, continually testing our thesis.

Andrew Barber
Director

Early Look

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