• run with the bulls

    get your first month

    of hedgeye free


The Great Balance Sheet Disconnect

What's great about lousy retail climates is that it's pretty easy to tell whether a management team is more focused on driving an income statement strategy, a balance sheet strategy, or better yet - no apparent strategy at all. When business is bad, do they let inventories climb to hold margin, or slash inventories to mitigate margin risk. With most companies in apparel/footwear retail having already reported, there's much to glean. In order to do so, I synched the trajectory of sales/inventory growth with the direction in gross margins in the Exhibit below. Here are some takeaways.

Group One: These are companies that are growing sales at a greater rate than inventories (or, sadly, are shrinking inventories at a greater rate than sales). I cut this group off at those with a positive spread of better than 10%, which in my experience is a fairly safe zone as it relates to margins in the upcoming quarter or two. What's most surprising is that most of this group is not exactly a 'who's who' in the world of quality retail. These companies include WRC, LIZ, LTD, JNY, GPS. This makes me incrementally more upbeat on LIZ (see my posting from 2 weeks ago). Also, I've got to admit that the simple fact that Warnaco remains at the top of the list perplexes me. Despite the solid 1Q, it's time to dust off the file on that one.

Group 2: These companies are neither here nor there. Most have inventories growing plus or minus 5% the rate of sales growth, and have less potential for blow out margins on the positive or negative side in the next 1-2 quarters due to balance sheet risk. It's worth pointing out Hanesbrands, that had a pretty monstrous GM boost on just a slight downtick in inventories. I still like that model into 2H.

Group 3. I've gotta admit, this is my favorite group. Inventories high across the board. It's easy to point out companies like JC Penney and Hibbett Sports that have been down and out for a year (still have inventories high AND weak margins). But the more important ones to point out here are Dick's, Columbia and VF Corp. DKS and VFC have been viewed as the quality (I agree on VFC) and immune to a bad retail climate. But now both of those are starting to roll relative to where they've been. I'd watch out being too cautious on COLM, as it 2H headcount cuts could soften the blow to more margin weakness. Dick's still has more margin pressure to come.

Exhibit Key: The columns represent the latest quarter yy change in GM and the trailing 12-month yy change in GM. The red line connects the dots for each company's sales/inventory growth spread. I realize that there's a lot going on there. Any questions or clarifications needed, just shoot me an email.

EYE on Commodities - Soybeans

Argentina is the world's third-largest soybean producer after the U.S. and Brazil. Last month, Argentine farmers went on strike to overturn a sharply higher export tax on soybeans and other products. On Friday, Argentina's government failed to resolve the farmers' dispute over export taxes, raising concerns of more protests that could slow grain shipments. As a result, Soybean futures surged 50 cents a bushel.

If rice and soybean prices stay where they are PFCB will feel the pinch in 2009.

CBRL - Guess What? - People are driving less!

According to AAA, 37.9 million people will travel at least 50 miles from home from May 23rd through May 26th - The Memorial Day holiday, unofficially is the start of the U.S. summer driving season. While the traveler total is the second-highest ever, it's 1% fewer people than last year and is the first drop since 2002. The Sept. 11 attacks caused many people to drive more and not fly, helping CBRL's same-store sales trends.

Recent data points suggest that things are not so good for CBRL. What could be a sign of things to come for CBRL, the Federal Highway Administration said yesterday that U.S. motorists cut their driving by 4.3 percent in March.

The biggest monthly drop ever....

get free cartoon of the day!

Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.

Yum Brands - China Intelligence

This is what we know so far from Research Edge postings....

Chinese market is down 43% since October...

Daily trading volumes are down 60% from the peak...

Chinese toy exports dropped like a stone....

Due to the quake, migrant workers are not showing up to work...

This is what we know from the popular press...

The confirmed death toll rose to 55,740 and an additional 24,960 remained missing 12 days after the quake, said the State Council, the government's cabinet .

12 million are homeless

Chinese banks were told Friday to forgive debts owed by survivors in an effort to revive the shattered economy, and the government warned that it was cracking down on price-gouging by merchants in the disaster area.

PENGZHOU, China: Emergency crews worked Friday to secure 15 sources of radiation buried in the rubble from the devastating earthquake that hit China this month, the government said as it evacuated thousands of survivors downstream from rivers dammed by landslides

Already, the Sichuan earthquake is being seen here in generational terms. As widely observed, it is the first time China has suffered a natural disaster on this scale since the Tangshan earthquake in July 1976, when at least 250,000 people died.

The sound of grief was heard all across China. For several minutes, at the exact time in the afternoon the quake struck in Sichuan Province one week ago, cars stopped and blared their horns. Chinese people came out on the streets and bowed their heads, in remembrance of the quake victims. One Beijing shopkeeper said he paid his respects, even though he has no relatives or friends in Sichuan, which is 1500 kilometers away.

This is what we know From YUM...

...A limited number of restaurants have been damaged, including several that remain closed or with limited service. The Company plans to reopen them as soon as it is safe to do so.

The limited information from the company is haunting. Yum's growth model depends on China. Given the recent tragic events and the other macro issues China faces, it's amazing that nothing seems to slow the YUM China story. Maybe it should be trading at 15x EV/EBITDA.

I can almost write the press release now!

Don't Mistake Footwear for Consumer

A smart guy I know (my Partner, Todd Jordan) just asked me whether he should read into the upwardly-trending comps reported by Foot Locker and Hibbett's Sporting Goods as a sign of an improving consumer.

My answer is 'No'.

I'd argue that better than 75% of any 'strength' we're seeing in yy footwear sales is due to low inventory levels, reduced clearance activity versus last year, and subsequent improvement in price points. As noted yesterday afternoon, price points are still up mid-single-digit, which is helping fuel the fire.

Don't get me wrong, I think this is a net positive for the footwear industry, as margins are looking solid for a couple of quarters (until our 'Supply Chain Vice' theme sucker-punches the industry in another 2-3 quarters).

But for those looking for any positive read-through to the consumer overall should probably keep searching.

WEN/TRY - Trying to get to $50.....

What $50 implies for WEN....

We have not had the privilege to talk to Bill Ackman about his thoughts on WEN, but here is my take on the Wendy's situation. Upon completion of the WEN deal, Pershing square will own TRY, which is trading at the low end of the valuation matrix we created. On a pro-forma basis, TRY is being valued in line with other domestic QSR companies that are experiencing declining traffic and margins. See the valuation matrix chart.

To summarize, I think the Ackman model for creating value at Wendy's requires the company to sell off assets and focus on the core business of being a franchisor. For Wendy's, this means selling the company's real estate portfolio and/or re-franchising the company store base. At this point, the market will value the company at a higher multiple due to the stability of the high margin, high return royalty stream.
  • Research Edge thoughts:In isolation, sale leaseback transactions do not create significant value. At the completion of a given transaction the company swaps valuable real estate for increased leverage. If the proceeds are used to re-purchase shares, the incremental interest expense offsets the benefits of the lower share count.
  • Both the Arby's and Wendy's chain are roughly 70% franchised. For competitive reasons, it's important for a QSR franchisor to own 10-15 of the store base. It was not long ago that Arby's was nearly 99% franchised, so we don't think management is headed down that road again. So there are not that many stores to sell to create significant value. In addition, selling company-owned stores is dilutive to EPS and reduces EBITDA.
  • In the end there is some financial engineering to do, but it's not a game changer for TRY. It all boils down to operations and can management get WEN margins back to historical levels. While operationally there may be some low hanging fruit that can improve margins, most of the margin issues rest outside of management's control.

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.37%
  • SHORT SIGNALS 78.32%