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GIL: Stock Popped, but Model Has Not

GIL's stock has had a nice bounce since hitting its $23.75 low on the 5/2 preannouncement. Tough to explain away every tick, but one of the factors is likely the 6% drop in cotton prices and breaking through basic technical readings. Perhaps it gets a boost today with the positive mention in Barron's over the weekend. That's good, no doubt. But this story goes way beyond cotton folks. I'm extremely cautious on the fundamental model here. Here's why.

GIL Then . Gildan is coming off of a 7-year run where it radically altered its cost structure as it shifted production from North America to the Caribbean basin. Over that time period, GIL used its improved cost structure to double its share in the 'blanks' t-shirt business to 60%, grow share in fleece to 50%, and still have enough cost cuts left in the tank to improve reported Gross Margin rate from 25% to 33%. As always, I've gotta give credit where it is due. GIL has succeeded in offshoring where others have failed. But the rate of improvement is in its 9th inning. GIL has benefitted from 20%+ top line growth, 1 point/yr+ annual GM rate improvement, extraordinarily low levels of SG&A spend, and a tax rate close to zero. That equaled net income growing by 3x over 4 years. Not a bad story at all, and no surprise that GIL's cash flow multiple went from 10x to a peak of 26x (now down to a still lofty 16x).

GIL NOW : One of the nice things about GIL is that we have visibility on its new capacity, and can make assumptions about productivity and pricing to forecast revenue. Based on my math, I think that revenue growth in '09 and '10 will slow dramatically from the 30% rates we've seen recently. At the same time, I think that Gross Margins (which had been heading straight up) will reverse course due to cotton costs and a shift in mix to mass retailers. As a frame of reference, GIL needs to take up price by 1% to offset every $0.04/lb in cotton prices. At current prices, we're already looking at a 2% price increase needed in FY09. That's tough to bank on. Lastly, I think it is important to note that GIL has an SG&A ratio of only 12%, which is lower than just about any consumer goods company out there. Given that the retail-growth strategy requires SG&A spending to build the brands, I don't think that GIL can continue to spend at a rate less than half its competitors. The bottom line is that revenue is slowing, gross margins are peaking, and SG&A needs to head higher. This should take a 40%+ EPS growth rate towards something well below 20% (and perhaps even 10%) for '09 and '10.

In the Barron's article, Royce Associates notes that Gildan could be double its current size in five years. That's entirely possible. But I'd argue that it would be at a margin structure about 1/3 below where it is today, and not worthy of its current mid-teens p/e and EBITDA multiple.

Chart below shows sales slowing, GM eroding, and SG&A heading higher based on my model.

Warnaco's Time Has Come

One company that has been on my short watch list for the better part of a year is Warnaco. I'm not the only one with that idea, as it has been a somewhat crowded sandbox. Much to short-sellers' dismay (and mine) this stock has done nothing but go up. But insiders are selling, inventory/sales spread is peaking, margin compares are getting tough, cotton costs are rising, and a cleaner P&L is making it tougher for WRC to sandbag. Not good.
  • Yes, the company has made some very good decisions over the past few years. No argument there. WRC cleaned its books after accounting irregularities (which were set in place in part by the ops folks under the former regime), as well as sold and closed down unprofitable divisions. There's no denying that this is a better company today than 2 years ago.
  • Now we're looking at a streamlined WRC, whose main profit engine is Calvin Klein Underwear. A great global business - and probably the best undergarment brand aside from Victoria's Secret. But with margins topping 20%, cotton costs up 30% vs. last year, and what I would argue is too much FX benefit flowing through to the EBIT margin line instead of being reinvested in the business (CKU as well as CK Jeans), this thing just smells off to me.
  • In addition, a key factor I like to track is the ratio of sales growth vs. inventory growth, and WRC's ratio has been defying gravity - leading the industry for 3 quarters. In fact, WRC's inventories have trended from 130 days to 110, partially due to divestitures. Though now inventories have ticked up, suggesting that perhaps they've found a near term bottom. When I layer that on top of WRC hitting very tough margin compares 2 quarters out, and a much cleaner P&L (making it difficult to sandbag with guidance) then I truly wonder how this multiple stays at a 20% premium to higher quality companies.

Market Share Blowout

I commented last week about my 'Athletic Footwear Rebound' theme, and FL being the best and most levered value-play on this trend. It probably makes sense to look at market share trends with the different brands as well. The trends are very telling.

Nike and Brand Jordan. What's there to say here? Business is solid. The brands have collectively gained 5 points of share thus far year-to-date (and not slowing). They won't give it up anytime soon. I wish I could say this about Nike's apparel business, which still can't find its groove. But with 46% share of a $9bn wholesale footwear market, Nike needs about 1.5 points of share gain to maintain the 3-4% top line growth rate necessary to fuel its broader financial model. 5 points gets Nike's USA team a strong finish to a solid year.

AdiBok: Adidas and Reebok can't get out of their own way. Brand adidas is not doing badly - market share consistently down by half a point (but getting less bad on the margin), and order levels are healthy. Adi might fare well in an athletic rebound as the brand never lost relevance (especially in apparel). But Reebok's chart almost suggests that share is going to zero. Almost every retail contact I have in my arsenal agrees that there is absolutely no reason to buy Reebok. The consumer simply does not want it. Reebok's share is down to 3-4%, but keep in mind that its share in lower-end department stores is closer to 8%. Yes, this is very very bad. With cost pressures heating up, and Under Armour coming in (Reebok owns the NFL license, and UA is all over football) my bet is that RBK loses another point at a minimum over a year. That might not sound like much, but it cuts the size of the US business by another 25%, or $90mm wholesale. While not a death sentence for AdiBok, UA has got to have its eye on this one.

One statistic I've got to throw out there is that New Balance - which has 9% of the US market - is larger than both Reebok and adidas combined. It now stands as the number 2 brand in the US measures in sales. Though with 80% of its sales in running and cross training (the two categories UA is targeting) I suspect that things will get ugly for NB.


Chart below shows year/year point change in market share by brand. Courtesy of NPD Fashionworld.

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GMCR - Barron's and GMCR

Barron's pointed out that GMCR is slightly over priced! The clever writer at Barron's asked the question is coffee the new black gold? At 44x NTM EPS people are buying into the single serve coffee brewing revolution. As I pointed out a few weeks ago, the GMCR business model has a few small holes in it, because a licensed roaster can't make any money. Importantly, GMCR is a regional company and does not have national manufacturing capabilities. As a result, it will be very expensive for the single serve revolution to spread past the North East.

...the Donger need food.

Yes, this title partially refers to the character Long Duk Dong in the 1984 hit '16 Candles.' But more importantly, it refers to the crisis with the Vietnamese Dong. The currency is coming off its greatest 2 month slide since the Asian currency crisis 10 years ago. Why does this matter to me as an apparel/footwear analyst?
  • Vietnam is the #2 producer of footwear outside of China. While its share is only 5% vs. China's 84% (it is also 5% of apparel vs. China at 40%), it serves as a low cost buffer for production when China takes up prices and/or cannot meet production needs.
  • With inflation running at 22% and workers are striking because wage hikes as high as 14% are not enough, and the currency doing nothing but go down, I can't possibly see how this is a good thing. This is not good for anybody in any industry.
  • While I think that numbers look very good at Nike, I'd be remiss to not point out that 31% of its sourcing is in Vietnam. Adidas is 28%

MCD - News from Europe

Over the past three years, McDonald's same-store sales in Europe increased 2.6%, 5.8% and 7.6%, respectively. The primary countries contributing to the strong trends performance included France, Germany, Russia and the U.K. In total, Europe represents 38% of McDonald's 2007 operating income. Here is what we learned today about two important European economies:

According to Experian Group Ltd., the number of Britons visiting malls and town-center stores dropped in May as higher food costs, fuel prices and mortgage rates cut into disposable incomes. The shopping statistics in May dropped 1.5% from last year and 3.4% from April.

Retail sales in Germany, Europe's largest economy and McDonald's largest European market, unexpectedly dropped for a second consecutive month in April as faster inflation left consumers with less money to spend.

The three year stack in same-store sales is as difficult as it's ever been for McDonald's and European consumer spending is slowing.

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