If Your CEO Ever Says This, Find a New Boss

I’m sitting here having my morning coffee going through last week’s bankruptcy filings. This quote from the CEO of Active Wallace almost made me choke on my bagel.

“The swift and dramatic downturn in the local economy had a major impact on our business in the 3rd and 4th quarters of 2008. The preemptive cost cutting initiatives that we took throughout 2008 were not enough to protect our investments...”

Ok…I’m not a retail CEO, so I don’t purport to be able to do this guy’s job better than him. But the statement referring to “cutting costs to protect investments” is flat-out ridiculous. Maybe if you cut costs and reinvest in your brand then this works. But when you cannot cut a leg off a bar stool and expect it to stand on its own.

Bankruptcy Exposure Monitor

Yes, I know, another post about bankruptcies, but to say that Q1 2009 has been notable would understate the obvious. As it relates to bankruptcies there are two points of interest that we take note of in each filing, the companies that file and the often overlooked creditors who have capital at risk. Given the flurry of activity over the last three months, we thought it would be helpful to review the quarter in aggregate.

YTD there have been 8 retailers file for bankruptcy. As a point of reference, over the last ten years there have been up to 22 retail bankruptcies in a single year only twice, in 2001 and 2008 and so far we are on pace to top that by nearly 50%. With the number of filings mounting, it’s important to keep track as small increments can add up quickly for creditors who find themselves at risk in multiple bankruptcies. Some notables from the list creditors:

Bankruptcy Exposure Monitor - Bankruptcies09EPSImpact

Columbia and Quicksilver have the unfortunate distinction of being the only companies with capital at risk in three separate bankruptcy filings. Given that consensus estimates are $0.07 and $0.05 respectively, a couple pennies are worth noting even though we have COLM earning in the range of $0.20 in Q1.

Other creditors exposed by multiple filings include Warnaco and Hanesbrands albeit with no more than a $0.01 at risk.

Are these totals enough to sound the alarm on any of our creditors that they too may soon fall victim to the same fate, not just yet. But we’ll be keeping track and let you know if that changes.

Casey Flavin

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

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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.

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