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MCD - Losing Momentum

MCD is scheduled to report its May same-store sales results next week on Monday, June 9th, and based on the current environment combined with more difficult comparisons in the offing, I would not be surprised to see same-store sales results soften.
  • U.S. - Continues to struggleI have been saying for some time now that U.S. sales results could lose some momentum in 2008 due to the absence of any real incremental sales layers being introduced into the system. The specialty coffee launch, which although it is receiving much media attention now, is more of a late 2009 event and, I think, may even be pushed out further. Looking at the chart, it is clear that 2-year trends are coming down (outside of February which included a 4% benefit from an extra day due to leap year). MCD's U.S. segment is facing its most difficult comparison year-to-date in May (up 7.4% last year). In March, when the company was lapping its second toughest comparison year-to-date of up 6.2%, it posted a negative same-store sales number (down 0.8%).
  • Europe - Starting to follow U.S.'s lead Although MCD's same-store results in Europe have been consistently strong (primarily up in the 5%-plus range), 2-year trends have come down rather significantly in the last couple of months. Based on the Eurozone Retail Sales report released last night that showed European retail sales declined 2.9% in April, more than three times as much as economists forecast, as soaring fuel and food prices undermined consumer spending (and other signs of slowing consumer spending in Europe - refer to my News from Europe post from 5/30), MCD's 2-year European same-store sales trends could get worse before they get better. Although MCD typically outperforms other restaurant companies in a tough consumer environment as people trade down , no company is completely immune (as we have seen even with MCD in the U.S.). Making matters worse, the company is facing more difficult comparisons in May and June (up 8.9% and 11.1% last year, respectively). It is important to note that Europe represented 38% of MCD's consolidated 2007 operating income
  • APMEA - How far behind is Asia?Although APMEA's same-store sales trends look great with comparable sales consistently up 8%-plus, the year-over-year comparisons only get more difficult going forward in 2008. Add to that our view that growth is slowing in Asia (please refer to Keith McCullough's portal for his views on that), and MCD could face declining trends in each of its three major geographic segments.

Quick Read on FW Sales Data is Positive

NPD just released last week's sales data. I can't stand being a news reporter. But in this instance, let's get used to it. Our systems here at Research Edge allow me to get a quick post pretty darn fast -- so I'll take advantage.

Sales trends are still looking healthy, and I saw nothing in the data to challenge any themes I've been working. A few nuggets...

1) Dollar sales were only up about 1%, but average selling price is up closer to 2%. No one's knocking the cover off the ball with dollars, because there's not enough inventory to do so. I'll take that.

2) Low Performance sales were down 12%. The recent shift I've been discussing continues. Good for FL, bad for SKX.

3) Nike share accelerated for the week by another 50bps, while unit share stayed flat vs last week (+3pts yy). Price points are up 5% -- an uptick from last week.

4) Under Armour business remains healthy. Share in cross training decelerated by a full 10 points to 25%. But price points remain constant. Either inventory is building (which I do not believe to be the case) or UA is simply selling through.

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.

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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!

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.

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