EPS Revisions Challenge My Call For a Week

I’ve been noting for the past month my view that retail’s cash flow trajectory will meaningfully improve in 2H.

Last week’s earnings revisions challenged my view, as outlined in the chart below. This was largely the result of revisions at Nike, and to a lesser extent Abercrombie, and Ross Stores.

EPS Revisions Challenge My Call For a Week - 3 30 2009 6 08 41 AM

My confidence level remains high, however, as commentary from these companies are contributing to the factors that I think will cause cash flow to bounce. Again -- I am NOT making a call on the consumer, but am simply modeling that the delta in the negativity of consumer spending (less toxic is good in my model) occurs simultaneously with stabilizing gross margins, and a  cost-reduction cocktail of absolute SG&A and capex cuts. (See my March 5th note “I’m Getting Fundamentally Bullish” for more quantification).

The big question heading into 2010 will be who cut costs because they could, vs. who cut because they should. We’ll see plenty of weak companies cutting into bone this year, and they’ll be the next shoe to drop.

I’m drawn to the quality companies today who I know are investing in the right places for the right reasons, such as Ralph Lauren, Under Armour Lululemon, Hibbett, and (dare I say) Liz Claiborne. Hanesbrands also fits the bill. I don’t like those who are cutting in all the wrong places, such as Ross Stores, Iconix, Sears, Carter’s, Jones and Gildan. The challenge here is that this latter basket of companies will also show a reversal in cash flow trends, temporarily masking the damage they are doing to their base business. I’ll be working closely with Keith to game the sizing and timing on these fundamental ideas when the group looks more ‘shortable’ and/or when the near-term fundamentals for each of these names present an opportunity.

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

Early Look

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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



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