Apparel Industry Needs More Babies!

Demographic waves tend to be just about the most predictable facet of consumption. That is, until there is a massive shock to the economic system that makes people call into question their ability to care for a new child. The birth rate has been running between +1% to +3% over the last nine years. That's big... If history is any gage, we'll be seeing the US birth rate decline starting next year. This will have close to zero impact on current results, and I fully acknowledge that the average hedgie PM would take this nugget and laugh at it given how far out it is. But if we take a company like Carter's, for example, where babywear is between 25-30% of sales, it's certainly something we can't ignore. Same holds true for Gymboree, Children's Place, and Gap (both baby Gap and Old Navy).

Apparel Industry Needs More Babies! - Birth Rate and GDP

The First Skate Retailer to Topple

Last week the Active Wallace Group became the latest retailer to file for Ch. 11. What is interesting to note is that it’s the first specifically in the skate category this year. As an online skate retailer with 21 retail locations in CA, this reflects slowing sales in what has been one of the hottest categories over the last 5 years (as well as the sad state of the California economy).

The list of unsecured creditors includes several notables in the top 20; however, the impact on a per share basis is minimal.

Nike at #1 with $1.5mm at risk, less than $0.01 per share.

Quicksilver at #6 with $515 at risk, less than $0.01 per share.

Vans at #11 with $348k at risk, less than $0.01 per share.

In 2007, skate approached 5% share of the broader footwear market outperforming other categories, but sales growth has slowed dramatically and now accounts for less than 3% thus far in 2009 (see chart). While Heelys admittedly drove part of the 2007 results, the decline we’re seeing today more than offsets that. Nike is now one of the top brands in this space (Nike 6.0 and Hurley) and the company recently noted on its call that it is a standout in its US business. Not good news for Vans (VF Corp) which is disproportionately exposed to the coast. Another nugget to lead to our bearishness on VFC.

The First Skate Retailer to Topple - FootwrMSChg Cat 3 09

US Market Performance: Week Ended 3/27/09...

Index Performance:


Week Ended 3/27/09: DJ +6.8%, SP500 +6.2%, Nasdaq +6.0%, Russell2000 +7.2%


March To-Date: DJ +10.1%, SP500 +11.0%, Nasdaq +12.2%, Russell2000 +10.3%.


2009 Year-To-Date: DJ (11.4%), SP500 (9.7%), Nasdaq (2.0%), Russell2000 (14.1%)


Keith R. McCullough

CEO / Chief Investment Officer

US Market Performance: Week Ended 3/27/09...  - USA


Talking Valuation – a welcomed blast from the past

It was not that long ago that I was maintaining a bankruptcy watch list because sales trends for the casual dining industry were declining sequentially every month at the end of 2008. It got to a point where some companies were seeing 10-20% declines in same-store sales. The last data point for the industry was a 5% decline in traffic for February 2009.

The average Casual Dining stock is up 152% from the 52-week lows just three months ago. Brinker International (EAT) is up the most from the lows rising 295%; with Ruby Tuesday’s (RT) a close second, up 287%. The QSR group is only up 94% from the 52-week lows!

Currently, as a group, consensus estimates have average FSR revenue, EBITDA and EPS declining -0.5%, -3.2% and -19.7%, respectively. The same consensus estimates for the QSR group are 8%, 8% and 12%, respectively. Yes, the fundamentals are better at QSR, but as I said yesterday, the big market share shift from FSR to QSR is over. So for the domestic based QSR companies, fundamentals are not accelerating, but could decelerate. The global QSR companies face slowing demand overseas and currency related issues. Just this week, we got two negative data points regarding MCD’s international business. First, we learned that German business confidence fell to the lowest level in more than 26 years in March, and this follows on MCD having previously reported that Europe’s February sales were hurt by weakness in Germany, a trend that continued from the fourth quarter. Second, it was reported that MCD’s sales growth in Latin America will slow this year as a result of the recession. Woods Staton, the CEO of Arcos Dorados SA, which is the owner and operator of all of MCD’s restaurants in Latin America stated regarding sales, “If we grow by 5 percent, that will be good. It’s a recessive year.” This expected 5% sales growth compares to 26% growth in 2008. Given the fact that QSR companies could face slowing sales trends, there is not much upside to the group’s current average 8x NTM EV/EBITDA multiple. Although the group should trade at a premium to the FSR names, primarily as a result of the group’s more franchised business model, the names are not cheap.

For FSR, the business is getting less bad as most companies are trying to narrow the price gap at lunch with the QSR names. Given the rally we have seen in the FSR names, however, we don’t have the valuation support for some of the key names. The large cap casual dining names are now trading at 7.0x times NTM EV/EBITDA, with the overall FSR group trading at 6.0x. In the heyday of the buyout craze, 9x NTM EV/EBITDA was the peak multiple. For the FSR group, sales trends are less bad, but it’s hard to make the case that NTM EV/EBITDA estimates are low, providing limited upside from the current levels. That being said, it is important to note that the FSR group continues to have higher average short interest at 14% relative to the QSR group at 10%, which provides some support to the FSR names.

We are still buyers of large cap, early cycle casual dining names (EAT, DRI, CAKE and PFCB) on down days. Right now I’m working on some of the names that have lagged so far this year like MSSR, MRT and LNY. Another thought would be to look at the QSR names that have underperformed so far this year like SONC, PEET, JACK, WEN and CMG. I continue to favor SBUX.

I’m still not buying MCD, despite it being down 11% this year.



U.S. consumer confidence rose slightly in March, but sentiment remained near an all-time low according to the Reuters/University of Michigan Surveys of Consumer Confidence. The final index of confidence rose to 57.3 in March from 56.3 in February. This was a touch above consensus expectation of a 56.6 reading.

Since Obama’s State of the Union Address late last month and with his daily addresses to the media, consumers now have a better picture of how he is handling the crisis. To a certain extent, this means that consumers can now weigh in on the state of the future economy with more knowledge and our belief is that most like what they hear. Despite the employment outlook continuing to look dim, consumers are not hiding in a hole. As evidenced by the Commerce Department report, consumer spending edged up 0.2% in February, consumers are finding more reasons to get out (and spend) and feel better about themselves—be it with a trip to a casual dining restaurant or a trip to the mall with the kids. All of this adds up to stability in the confidence indicators.

What is not included in this number is the fact that stocks are seeing their biggest monthly rally since 1974; the S&P is now up 23% from the March low. Taken together, the improved sentiment about the government's ability to fix the financial system, better-than-expected economic news, and surprise EPS announcements from early cycle companies are driving the market higher.

The implication is that the next move in confidence in April is higher not lower.

Bond Market Hangover

The Queen Mary is starting to turn as Governments around the world try to spend their way out of the hole…

Treasuries advanced yesterday for the first time in six days as the Federal Reserve conducted open-market purchases as part of "quantitative easing" campaign and demand for the 7-year note auction was strong enough to keep yields in line with expectations. This rally comes after the sale of 5-year Treasury notes on Wednesday was met with apathetic demand, with the ratio of bids to securities offered at the low end of the range, and a higher yield of 1.85% vs. 1.80%.

This rebound in demand came as a welcome relief for the treasury with total new debt issuance for the week totaling $98 billion, but the concerns linger as even larger auctions loom. To be clear, we will be able to sell the securities to finance huge budget deficits, but at what cost? The implications of yesterday’s auction are that fixed-income investors do not have an unlimited appetite for government debt earning virtually nothing.

The US is not alone in facing a push back from bond buyers. European governments are selling record amounts of debt to finance their stimulus programs. On Wednesday German officials expressed confidence that they will be able to sell 346 Billion EUR ($470 Billion) of paper this year. Germany plans to sell 45 Billion EUR of bonds and 51 Billion EUR of securities with maturities no longer than one year in Q2. The spread between 10-year and 2-year Bunds has increased by almost 60 basis points YTD and we can expect rates to continue to rise on the longer end of the curve as investor demand a higher risk premium.

Clearly, no nation is experiencing creditor exhaustion more acutely than the United Kingdom. On Wednesday, the UK’s 1.75 Billion Pounds ($2.55 Billion) 40-year bond auction failed. The failure, the first of its kind in almost seven years, is relatively easy to explain: 4.42% is simply not enough to entice investors to lock up capital for four full decades. For PM Gordon Brown, the auction failure underscores a collapse in confidence in his leadership. On Tuesday Bank of England Governor Mervyn King warned that the cupboard is now nearly bare and that there is simply no more money to spend, calling into question the hope that quantitative easing will be the elixir to the financial crisis.

In Japan, the central bank increased its purchase program targeting longer maturity bonds as Tokyo tries to combat upward creeping yields in advance of the third stimulus plan, which may entail 20 Trillion Yen in new debt issuance. With the national debt now hovering well above 170% of GDP the BOJ buyback program has the appearance of a man treading water with a bowling ball in his hands.

Given the massive supply of securities that governments globally need to sell the prospects for programs designed to artificially stimulate demand seem very unlikely to succeed for long. Right now, other markets are providing superior risk adjusted returns, driving investors to look elsewhere until yields rise.
One of our Global MACRO themes is the Queen Mary (Bond Yields) turning. She is indeed!

Howard Penney
Managing Director

Andrew Barber

Matthew Hedrick

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