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GIL: Single-Digit Purgatory

GIL has been exposed for what it is – a poorly run company that has lost its offensive weapon to maintain margin as it grows into lower margin businesses. There’s no turning back now.

I’m kicking myself over this one. GIL has long been my favorite name to short. Not only was I not there to capture today’s alpha but I fell into the trap of thinking that expectations were nearing bottom.

Lesson: When you feel so strongly that 1) management is flat-out bad, 2) they’re making the wrong strategic decisions and investing capital in higher-risk, lower return business, and 3) they're feeding a different message that the Street actually believes, then 4) stick to your guns – especially when it is at a 20% premium to the group.

A few big picture points.
1) The triangulation and rate of change between sales, inventories and gross margins was more out of whack than almost any company I have ever seen. You know that SIGMA chart we use (Sales/Inventory Gross Margin Analysis) that tracks profitability and the components thereof? We literally need to recreate it for GIL this quarter because inventories were so out of whack (+31% vs. sales-27%). See chart below.

2) Note to CEO: C’mon Glenn, you have a good base business. Why do you need to grow into all these new categories where you have minimal control and visibility over pricing and orders? In such an abysmal quarter, your market share in core T-shirts was up 4 points to 54%, and fleece share was up 3 points to 52%. And yet total sales were down 27%! Don’t you 'get it' that it’s not just the economy that’s causing your problems? All these challenges began when you ran out of sourcing savings that you used to max out share in this core, and then started to grow into a secularly-challenged business (private label for Wal*Mart) without a big cost save to pad your margins and use as an offensive pricing weapon?

3) Best quote of the conference call (per Thompson transcript) – in answer to a question to Glenn Chamandy about price discounting philosophy. “…part of pricing strategy is to try and gain as much share as possible, but the reality is that there’s a point where no return in terms of spending my good money after bad money.” I agree with the philosophical view, but I’ve never heard a CEO use the term ‘my money’ when referring to the P&L on a call with investors. Glenn, isn’t it ‘our money’ when speaking to fellow shareholders? Maybe this is McGough being petty. But the comment rubbed me the wrong way.

4) So what’s GIL worth? Every story has its price. I think it’s safe to say that the halo that has rested on the crown of this bad boy has finally been lifted, stomped on, and left for dead. So we know that the 10x-20x EBITDA multiples of yesteryear are history. Now what? I have no reason to think that GIL will earn over a buck in any of the next 3 years. In fact, this year I can model anything from $0.80 to ($0.20) – no kidding. Remember that vertically owned and operated basic apparel brands have historically traded hands for 3-5x EBITDA – and those are BRANDS (i.e. Fruit and VF Intimates, to name two). Why should GIL (i.e. no brand) trade higher? Better top line? Perhaps. But the company is proving that anything beyond the screen-printing/T shirt business is both margin and return-dilutive. I think this stock is in single-digit purgatory for a long time.

EYE ON THE CONSUMER – RETAIL SALES

In January, after six straight months of declines, the Commerce Department said total retail sales rose 1% last month versus a revised 3% drop in sales in December. December sales were originally reported to have declined 2.7%. Nearly every rational person looks at this number with a high degree of skepticism. That being said, should it be dismissed? The biggest aberration was in apparel purchases, as many specialty clothing chains reported big declines in their January same-store sales. It’s a foregone conclusion that the January number will be revised lower next month. However, even if it is revised down by 1%-2%, it still shows that the lights went out in December, but came back on in January.

The consumer is the lynchpin to stabilizing the market. Yes, the year-over-year sales statistic is horrific and will be for some time. The month-to month trend points to a bottoming process and not a continued acceleration to the downside. Yesterday, while sitting on the hot seat in Washington, all of the bankers that make consumer loans disclosed increased loan activity in the month of December and I assume will continue in January. The U.S. financial institutions that took TARP money are being forced to loan money to consumers. If the banks are lending again, was January retail sales number an aberration? The politics of the TARP and the stimulus will have a way of working themselves out to the benefit of the consumer, and ultimately, the market.

EYE ON THE CONSUMER – RETAIL SALES

Looking the Retail Sales number that was reported today, you would think we took a page from the Chinese playbook – making up the numbers!

In January, after six straight months of declines, the Commerce Department said total retail sales rose 1% last month versus a revised 3% drop in sales in December. December sales were originally reported to have declined 2.7%. Nearly every rational person looks at this number with a high degree of skepticism. That being said, should it be dismissed?

The biggest aberration was in apparel purchases, as many specialty clothing chains reported big declines in their January same-store sales. It’s a foregone conclusion that the January number will be revised lower next month. However, even if it is revised down by 1%-2%, it still shows that the lights went out in December, but came back on in January.

The consumer is the lynchpin to stabilizing the market. Yes, the year-over-year sales statistic is horrific and will be for some time. The month-to month trend points to a bottoming process and not a continued acceleration to the downside. Yesterday, while sitting on the hot seat in Washington, all of the bankers that make consumer loans disclosed increased loan activity in the month of December and I assume will continue in January. The U.S. financial institutions that took TARP money are being forced to loan money to consumers. If the banks are lending again, was January retail sales number an aberration? The politics of the TARP and the stimulus will have a way of working themselves out to the benefit of the consumer, and ultimately, the market.

Howard W. Penney
Managing Director

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Covering/Buying: SP500 Levels Into The Close...

Realizing that 2009 YTD performance anxieties are heightening on the way down here, my best advice is to take a deep breath and patiently start to cover/buy all the way down to the 803 line in the SP500.

The VIX is only up +4% here at 46.34, which is far away from the aneurisms associated with Q4 of 2008, when volatility was 40-45% higher. Provided that the VIX stays in check under the 53.96 line, I think this is a very trade-able SP500 range that we can nestle into. See chart below for the Trade(dotted red) and Trend (thick red) lines that we could easily bounce to.
KM

Keith R. McCullough
CEO / Chief Investment Officer

India's Economic Disaster Continues Brew...

“The most barbaric and basic truth about the Indian state. That it has failed the country's poor” -Sanjeev Srivastava

BBC News Editor Sanjeev Srivastava wrote the quote above in January 2007 in an article about a series of grisly murders committed in the Noida suburb of Delhi by two men who are members of a privileged class and ignored by local law enforcement officials because the victims, all children, were from poor families who lived in a neighboring slum.

The two men were convicted of those killings this week and are due to be sentenced tomorrow in the final chapter of a case that has been a source of newspaper headlines in India for months and is seen by many as a symbol of the class divide within the nation.

The other dominant headline story today was a 152 point decline in the SENSEX in the wake of Industrial Output and Inflation data that point to likely rates cuts by the RBI as the government struggles to meet growth targets for 2009 that seem increasingly implausible. For Prime Minister Singh, still recovering from open heart surgery, this is a battle of political life or death … and India’s elections are looming.
Industrial output registered -1.97% for December, only the second negative year-over-year number since 1993. This suggests that the suspicion we discussed in our post on the 16th of last month that the declining WPI data issued then was being driven by sluggish industrial demand on the subcontinent rather than declining global commodity prices was correct.

We have had a consistently negative bias on Indian equities since we launched the firm early last year, and our thesis rests, in part, on the class divide underscored by the Noida murders. Simply put, We believe that the Indian population, grappling with rampant poverty and poor health and education services, will not be able to sustain internal consumption levels sufficient to sustain the growth levels targeted by the Singh administration.

Andrew Barber
Director

US Jobs: Not Horrendous Enough...

At 623,000 this week’s initial jobless claims came in 8,000 less than the last week (last week was revised up by 5,000 to 631,000) and 15,500 above the 4 week moving average.

While this nudges up the moving average, I don’t think it provided the kind of shock that the US Financial system really needs. A horrendous number relative to the already sufficiently bearish expectations out there is what we need to break the US Dollar. Until we get that, the US Dollar is going to continue on the path of least resistance – higher.

Today the US$ Index us up another 50 basis points to $86.24, hammering home the same inverse correlation that has held steady for the better part of 2009 – US$ up = stocks down. This equity market continues to be worried about her government’s credibility. A Crisis in Credibility leads people to hoard cash and gold – that’s what people do when they don’t trust the system.

Keith R. McCullough
CEO / Chief Investment Officer

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