TBL: It Doesn’t Smell That Bad

Smartwool continues to prove itself as Timberland’s diamond in the rough. While only about 6% of sales at $80-90mm, it is closer to 10% of cash flow. This is a solid brand all around, and I dare you to find a retailer that will tell you otherwise. At the time of the Smartwool deal, it seemed like a ridiculously expensive acquisition at around 13x EBITDA, but interestingly enough it has turned out to be TBL’s most accretive. Based on realized numbers, TBL is looking at a ‘hindsight valuation’ of 5-6x EBITDA.

Well…the company is extending the brand into a new category – slippers. That might not seem like a big deal, but this is a natural extension for Smartwool. Can it add $20mm in slipper sales? Yes. They will have men’s and women’s styles featuring double-merino wool uppers that are naturally antimicrobial and odor-resistant. (Author’s note: I will deny having tried this, but if you wear one pair of Smartwool socks over the course of a 5-day business trip, they still won’t smell – so I’m told). The brand’s positioning on this is “The shoes are great after skiing or snowboarding. You can slip them on and drive home.” The collection, which will retail from $70 to $125, includes three women’s and two men’s styles.

My concern with TBL near-term is still that numbers look too high for ’09. Though we can’t ignore that there’s $2.50 in cash on the balance sheet, and I can get to a value for Smartwool between $1-$1.50 per share based on range of multiple assumptions. That suggests that the base business is selling for $680mm at its current $11.75. Admittedly, this would have been a heck of a lot more attractive when the stock bottomed at $8.50. But if it trades off on a miss, or a market retracement, keep this one on your screen.
I'm not saying it's pretty...but the comfort supposedly rivals UGGs.

March Madness Branding Just Got Boring

We started off with 64 teams and some with non-traditional brand representation such as Robert Morris University (CRONS), Boston College (Reebok), Maryland (Under Armour), and Western Kentucky (Russell). Well, through process of elimination, it is now back to the Nike and Adidas show. Of the Sweet Sixteen, Nike Inc has 13 slots, with Adidas occupying the remaining 3. Nike's 82% share of the teams remaining in the tourney just about matches Nike’s share in the relevant basketball shoe market. The problem is that Nike does not score points with consumers for endorsing these teams at this point. Consumers have grown to expect it. The big deal would be if a non-Nike team won the championship. Adidas would be able to create marketing buzz if this were to happen, but the real hype would have come from some of the smaller brands. Maybe next year…


If there is a better market in the country, I’d like to know. Revenue growth has been positive for five straight months. A strong local economy and the presence of hurricane relief workers are certainly big contributors. The market standout is clearly PNK’s L’Auberge and that is where we spent our time.

The major issues facing L’Auberge are the following:

• Reliance on the local energy economy
• Can the market support Sugarcane Bay?
• Cost synergies between L’Auberge and Sugarcane Bay
• Potential for slots in Texas

Despite the sequential dip in February, market trends remain strong as the extra day and an extra Saturday in February 2008 impeded the growth a bit. March trends appear very strong. Surprisingly, the price of oil has had little impact on volumes, good or bad. Any negative economic impact has been offset by customers staying closer to home (“staycations”).

L’Auberge is also performing well in March, which should be another record month. The property continues to drive more business from Houston and even San Antonio, and is now targeting more group business which is already up double digit over the last few years. The growth has occurred without any acceleration in promotional allowances. If anything, L’Auberge has been less aggressive with the lower tier customer.

L’Auberge is currently running at 65% capacity on the slots which brings into question whether the market can support Sugarcane Bay. The answer is probably not right now but considering the growth, the market should be bigger in 2-3 years, if and when the new property opens. Construction has not begun. The good news is that there appears to be some meaningful cost synergies for PNK in opening a L’Auberge sister property. In addition to the obvious marketing synergies, the properties can share the executive management team, laundry facilities, marketing databases, etc.

Finally, on the Texas situation, we’re not sure the market participants added much value on that issue. However, we continue to believe Texas remains a long shot. Remember, 50% of the counties in Texas are still “dry”. More on the prospects for Texas slots in a later note.


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SP500 Levels, Refreshed: Trade The Range...

Provided that the SP500 cannot close above what I see as THE line that matters – the intermediate TREND line at 829 – I think we’re going to trade within a proactively predictable range. The shock and awe crashes to the upside/downside of this market’s expectations look to have subsided, for now…

Any time Timmy Geithner is You Tubed (like he was today), the sober investor who has gains to realize is going to start making sales. This is not a political comment – this is simply one of my personal judgment. However “smart” the Washington/Wall Street brain-trust claims him to be, Timmy is a squirrel hunter - and I don’t trust him.

The trading range that I’d like to start covering/buying stocks again continues to shift to higher lows (753-780 in the chart below). As the market’s trading range narrows and volatility continues to rally to lower highs, the market’s March 9th bottom looks more convincing as an established intermediate term low.

Buy low, sell high.

Keith R. McCullough
CEO & Chief Investment Officer

Taiwan: Economic Bottoms Are Processes, Not Points

Export orders are significantly better than they were last month. No matter how bad on an absolute basis, better than toxic matters.

Taiwan has felt the pressure of contracting global demand for consumer technology products acutely, with declining orders driving unemployment levels to 5.75% (an all time high for the island republic), and February export orders data was released today by the Ministry for Economic Affairs, showing the 5th consecutive year-over-year decline.

At -22.7% Y/Y, Export orders came in over 5% better than the median market forecast and showed a 13.81% improvement over January’s numbers. Meanwhile, Industrial Output also showed signs of relative improvement, arriving at -27.14% Y/Y, up 8.32% from January on a monthly basis. Significantly, the impact of Lunar New year, which fell in January this year, accounts for a large portion – though not all, of the relative improvement.

Although a bottoming in the Taiwanese economy will be a process, the evidence that Panda Diplomacy is starting to thaw trade relations with the mainland continues to be a secular positive. Meanwhile, signs that the bullish TREND in semiconductor demand (that our Tech group identified six weeks ago) is helping to slow the rate of export contraction in that critical Tech sector. These are steps in the right direction. Don’t forget, everything that matters in our macro models happens on the margin.

Central Bank Governor Perng Fai-nan will lead a board meeting on Thursday to discuss cutting rates below the present 1.25%, but it’s doubtful that any resulting uptick in domestic consumption arising from lower interest rates could move the needle significantly. We will remain focused on Taiwan and its etf, the EWT, looking for any signs that external demand may be starting to find its feet.

Andrew Barber


It was only 9 months ago when SONC reported its 3Q08 results that management was blaming overly aggressive pricing for the underperformance at its partner drive-ins…now, the company’s declining average check is the main concern.

SONC implemented its Everyday Value Menu on December 29th and has since experienced sequentially better traffic trends across multiple day parts. On a system-wide basis, traffic improved to only down 0.2% in 2Q09 (actually increased slightly excluding the extra day in February 2008 due to the Leap Year) from -1.7% in 1Q09. Despite this sequential pick up in traffic, system same-store sales declined 3.6%, even with the prior quarter. Again, last year’s Leap Year negatively impacted comparable sales growth by about 1% in 2Q09, but regardless, the new value menu put increased pressure on average check. On a reported basis, average check declined 3.4% relative to -1.9% and -0.6% in 1Q09 and 4Q08, respectively. So the company is giving away food to get people in the door…not a new concept within QSR.

Surprisingly, despite the damage the value menu has done to SONC’s average check, the company’s food costs as a percent of sales were flat with 1Q09. The value menu already accounts for about 10% of SONC’s sales so management has done a good job managing its costs to prevent margin erosion. Going forward, management expects the value menu to contribute 12%-15% of sales, a level that is comparable to that of its competitors. As the value menu becomes a bigger part of the company’s mix, I would not expect margins to remain immune from the pressure that is already hurting SONC’s average check. Management stated that the value menu is attracting incremental customers and has not yet materially cannibalized sales of other menu items. This translates to the company has been successful in attracting the bottom feeder customers, which if it continues, will eventually impact margins. MCD’s dollar menu has helped the company to post consistently strong comparable sales number, but its U.S. restaurant margins have declined for the last eight quarters. Increasing value menu contribution and growing margins just do not go hand in hand.

In an attempt to boost average check, management said it will split its advertising dollars between promoting both the Everyday Value Menu (almost all of the company’s ad spending has been allocated to the value menu since its introduction) and its more premium menu offerings. From both an average check and margin perspective, this is the right strategy for the long-term. In the near-term, however, I would suspect that any pullback on advertising of the new value menu could result in a slowdown in the traffic growth that we saw in the second quarter.

We have always been impressed with the SONC business model and management team. I suspect that we have 3-6 months before the concept can adjust and work through the new operating business model. As we begin to see some stabilization in the trends, the stock will work higher. I’m just not ready yet to pull the trigger.

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