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SKX: Could It Really Be This Simple?

It's extremely rare that I come across a trend that is so blatantly simple and obvious that it slaps me in the face and makes me question why I did not see it sooner. I think I just found one.

I'm obsessed these days with the follow through implications of a rebound in the athletic footwear business. I've posted on it plenty (i.e. bullish on Foot Locker). But who loses? I think it is Skechers.

This story is not without its hair - everything from the historical linkages to LA Gear, to massive quarter to quarter sales and margin volatility, and the recent spotty track record in forecasting both fixed and discretionary SG&A costs. This stock is usually a short-term proposition for most, based on some 'perceived' edge on near term info flow. That's one of the reasons I've stayed away from it in the past.

But with operating margins currently hovering at around 9%, my view is that it is time not to wonder if they're going to be plus/minus 50bps in a year - but whether they can hold the line and resist being cut in half. I'm starting to think that the latter is increasingly likely. Some additional points to consider...
  • Perhaps the biggest factor is the F word -- fashion. I've been pretty vocal about the shift away from low-profile and non-performance shoes, but when I mapped out the historical relationship this evening with SKX sales I nearly fell out of my chair. It is spot-on. (SKX is all fashion - when's the last time you saw a Skechers add of someone competing in an athletic event?) The performance/fashion footwear ratio (number of performance/fashion pairs sold) has been favoring fashion for 4 years. Not only has it flattened out, but now it's going up. Is it any wonder that the sales peak coincides with industry trends hitting a multi-year inflection point? I don't think so.
  • Keep in mind as well that almost all Skechers' shoes are made in China. I'm not going to elaborate much more on this one. Simple punchline - not good given that inflation is rising faster than wages, growth is slowing, and capacity growth has gone from +4-5% 5-years ago to flat at best today. Prices are going up and margins are coming down.
  • While I could go down the list of the things that SKX talks about as it relates to margin and growth initiatives, I wonder if it even matters given the sheer headwinds SKX is about to face from both a fashion trend AND a macro cost standpoint. Before the rise of low-profile shoes, SKX's margins were 4-5% at a time when it had the benefit of meaningful input cost deflation. Now sales should roll while margins compress. Initially I was concerned that 6 days short interest was high-ish. Now I'm starting to wonder why it's so low.

CAKE - Thoughts from the CFO

Despite the daily reminders of how tough the operating environment is for casual dining companies, whether it be company announcements or gloomy news articles about the state of the economy, tightened consumer spending or rising commodity costs, I was still shocked to hear CAKE's CFO Michael Dixon say that within our industry the Cheesecake Factory is one of the only companies that is projecting meaningful year-over-year earnings per share growth.
  • Looking more closely at a sample set of casual dining companies; I realized that CAKE's comment was sad but true. The projected year-over-year EPS declines are pretty ugly for some of the companies (CPKI and RT). However, there are a select few other than CAKE (RRGB and TXRH) that are guiding to double-digit growth (only at the top end of their ranges). That being said, it is tough out there.
  • Driving that point home was another statistic quoted by Mr. Dixon that 50% of casual dining operators are offering promotions or daily specials on their websites, which brings us back to the question around value (driving traffic) versus protecting margins. CAKE management chooses the margin side, saying We believe these types of promotions can have some short-term sale benefits, but usually at the expense of margins. More importantly, they can potentially have a long-term negative impact on a brand.
  • Although there needs to be a balance between offering value and protecting margins, getting people in the restaurant is necessary. Thus far, CAKE can afford to favor margins because relative to its competition, same-store sales growth and traffic trends have been favorable. Going forward, this focus on margins should be beneficial as the company stated today that current spot prices on many of its commodities are above existing 2008 contract prices.

CBOU - Nothing is for Free

It's amazing that today Caribou Coffee Company Inc. announced that it now offers completely free wireless fidelity (WiFi) service for consumers in 80% of its store base. It should come as no surprise that SBUX's free WiFi goes live today, too. CBOU is going after SBUX by telling customers that only a simple registration is needed for first time users with no purchase or company credit card usage needed.

The SBUX free WiFi comes with a catch. SBUX is offering two hours of free WiFi each day to holders of a Starbucks card. What's the catch? The card has to have a balance on it and you have to use or reload it every 30 days.

Chances are SBUX will be making changes to its WiFi strategy!

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MCD - The Pound Saver Menu

I have been writing constantly about the issues McDonald's is facing with slower consumer spending, rising commodity prices and the $ menu. It should come as no surprise that Europe is no different. In 2008, European commodity costs are also expected to increase significantly. For the full year, chicken is estimated to be up 6-8%, cheese up 20-25% and beef up 3-4%. With European economies slowing, the company and its franchisees are going to experience the same kind of issues with the Pound (in the UK) or Euro-saver menu as the U.S. system is currently facing with its $ menu. The margin pressure on the system will come from a negative mix shift to lower margin items, while inflation pressures come from every line on the P&L - energy, labor and food.

EYE on commodities - Milk prices

For the month of May, milk prices increased for producers. The USDA reported the base Class III price for May is $18.18, up $1.42 from April and 58 cents above a year ago. Seasonally, milk prices tend to head higher this time of year.

Nearly everybody is impacted by higher milk prices, but CAKE and SBUX stand out!

SBUX - International growth may not come easy everywhere.

SBUX - International growth may not come easy everywhere. As I said once before, SBUX is facing difficulties in France, proven by the fact that the company has appointed its third managing director for France in four years. Although SBUX opened its first store in France back in 2004, it has since opened only 41 stores relative to the company's rapid growth in the U.K. where the company has opened over 650 stores since 1998. Some attribute France's slow acceptance of the brand to the fact that the country already had an existing coffee culture, which is dominated by traditional cafes.
  • An article from Western Europe Food and Drinks Insights points out that French per capita consumption of coffee is among the highest in the world so that it would benefit SBUX greatly if it can make even the slightest inroad into the French coffee market. However, this might come with great difficulty as the article highlights that Starbuck's French operators are yet to breakeven.
  • Starbucks opened its first store in Argentina on May 30. Although the company already operates in neighboring Brazil and Chile, SBUX was slow to enter Argentina due to the country's close links to espresso-style coffee and cafe culture, which have long been part of life there. Another Western Europe Food and Drinks Insights article said that the president of Starbucks Latin America has commented that the local coffeehouse culture in Argentina is the strongest of any Latin America country and because of this the company felt it would be a difficult market to be successful in.
  • The opening in Argentina fits in with the company's renewed focus on International expansion and suggests that the company may try to push into markets that it had previously ruled out in order to offset weakness in the U.S. The company may face similar issues to that of France as it will be more difficult for SBUX to steal customers away from their independent cafes. The steady grow in Argentina coffee sales is tempting, but I hope SBUX pursues only high-return international growth and does not expand just for the sake of growth as it once did in the U.S.

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