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Major Macro Event Out of China for Retail

In another heavy earnings day in Retail, the Street, of course, looked right through what we consider to be a key overnight Macro event in China that has meaningful implications for Retail.  


China has made additional changes to its VAT (Value Added Tax) structure and has increased rebates on semi-finished leather to boost leather production and subsequent exports of handbags, leather shoes and accessories. This comes on the heels of similar actions geared towards athletic/casual footwear and apparel. What people do not realize is that these incentives are spurring the re-opening of factories every day (that closed in ‘07/’08).


With Asian capacity growth returning to the equation, do not underestimate the impact on earnings to the US retail supply chain! Key direct beneficiaries include PSS and UA. In this instance, Coach and to a lesser extent some other luxury goods brands should also benefit.


Indirect beneficiaries are those with the leverage in the supply chain to keep a disproportionate amount of the margin injection. Even though some companies have been talking about this for 3-4 weeks, it is not yet represented in estimates for some key names. People will be wishing they got these numbers right in another six months. Trust me...

US Housing: Looking For The Next Move....


We are well into 2Q09 and the news is clear: the housing market is testing a bottom.  Alongside our call on consumer confidence, the good news on housing is behind us.  The supply of new homes coming on the market and the bottleneck in lending capacity suggest we will begin to see the trends peak sequentially as we head into 3Q09. 


Today, the National Association of Realtors reported that existing home sales rose by 2.9% to a 4.68 million annual rate from 4.55 million in March.  This represents an improvement from the March figures in which sales fell by 3.0% to 4.57 million.


Increased affordability was the key driver to the better that expected performance; about 45% of the 4.68 million sales in April were foreclosures and short sales.  The pace of improvement would be even better if it were not for the tighter mortgage lending standards.


The real problem for housing now remains inventory.  Demand and underwriting constraints are keeping inventories of unsold homes at historically high levels. As reported today, inventories of previously owned homes jumped 8.8% at the end of April to 3.97 million.  Given the current pace of home sales this represents a 10.2-month supply, compared to 9.6 in March.


As we said yesterday, this thesis is also being played out in the Case-Shiller home-price index where there was a slight month-to-month acceleration in the decline of home prices. Unfortunately, that data point is somewhat stale (it's a March number).


At the beginning of this year we put in print our expectation that the rate of decline in home prices would decelerate in Q209. As we continue to search for a bottom it is important to remember that "less bad" is different from "good". The good news for the economy in this data does not represent good news for home sellers in the near future, not yet.


Howard Penney

Managing Director


US Housing: Looking For The Next Move.... - assoc

The Chart That No One In Obamerica Is Allowed To Talk About...


Or is Washington The New Reality Wall Street now? Who knows... Rhetorically, the politicization of the US Financial System is making this very hard to follow...


What is never hard to follow is the money. If you want to gain a clear understanding of where economic systems have a high probability of playing out, follow how people get paid.


In sharp contrast to the made-up rules to made-up "stress tests", the US Dollar trades on a marked-to-market basis. In global currency trading, there is no such thing as a newly implemented American Idol like "save." The chart below is the chart that matters. American Idol season is over, and the world has voted. The US currency continues to lose its credibility.


There are two TREND lines that matter in the chart below. The intermediate-term TREND line that broke in late April ($85.29) and the long-term TREND line that broke last week ($81.51). It's the latter TREND line that has the hair standing up on my back - Washington ignoring the alarm bell just makes thing worse. If Bush was willfully blind, Obama is apparently willfully deaf.


Is the brain-trust of Wall Street/Washington paid to be willfully blind and deaf? You tell me. The compensation structure of the current system will give you the bipartisan answer. Thankfully, as of yesterday's Opinion piece in the Financial Times by Stanford professor John Taylor, titled "Exploding debt threatens America", I'm not the Lone Survivor of sight and sound.


With regards to the groupthink associated with the Obama one liner of "we inherited this mess", Taylor poses an interesting question: "The debt was 41 per cent of GDP at the end of 1988, President Ronald Reagan's last year in office, the same as at the end of 2008, President George W. Bush's last year in office. If one thinks policies from Reagan to Bush were mistakes does it make any sense to double down on those mistakes, as with the 80 per cent debt-to-GDP level projected when Mr Obama leaves office?"


This chart isn't about being political. The American Financial system is becoming as political as politics get. The world is watching this real-time, and voting with their wallet.


Keith R. McCullough
Chief Executive Officer


The Chart That No One In Obamerica Is Allowed To Talk About...  - flames

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Germany Grinding It Out


Research Edge Position: No Active Position


A German survey points to an optimistic outlook; a number of new fundamental data points confirm that economic improvements will be mild.


GFK survey reports are signaling that the worst may be over for the German economy as its consumer climate index remains stable for May, with economic expectations improving marginally and consumer propensity to buy unchanged, but at a healthy level. Concerns over income and joblessness remain, yet in aggregate the survey is signaling the steep contraction of the German economy is bottoming out.


The survey provides an optimistic outlook, yet the fundamentals continue to yield a modest forecast for stabilization late this year and mild growth starting early next year. German GDP contracted 3.8% in Q1 on a quarterly basis according to the German Federal Statistics Office. For the export-dependent economy it comes as no surprise that the decline was mainly due to the balance between exports and imports. This will continue to be a headwind for the economy. The chart below shows this steep decline. 


Based on the previous quarter, Q1 exports declined 9.7% while imports were down 5.4% versus a quarter earlier, with the balance contributing to a 2.2 percentage points of decline to GDP.  The good news for Germany is that the country is beginning to see improvements in exports in key industries. For example, the percentage change in exports of transport equipment and machinery and equipment orders are declining sequentially over the last months, bending the curve in a positive direction. These few data points do not confirm a positive trend, yet are optimistic on the margin. Additionally Eurostat posted March industrial orders for the Eurozone today and German orders improved 3.3% M/M and declined at a lesser rate on a year-over-year basis, down 28.3%, marking another sign of marginal improvement.   


With PPI down 1.4% in April on a monthly basis and down 2.7% on a yearly basis, producers are incrementally benefitting from the reduced cost of raw materials.  The bulk of decline was attributed to fuel, down 18% Y/Y, and heating oil that declined 40% Y/Y; yet any savings that the producer can pass on to the consumer will benefit the domestic "health" of the economy.  Today the statistics office reported that CPI in May likely fell on a monthly basis in 4 of the 6 German states surveyed, with food prices falling between 0.2% and 1.0% on a monthly basis and between 0.4% and 2.1% on a year earlier.  Finally, a recent report by the office showed consumer spending rose 0.5% in the Q1 on a quarterly basis, even as households' disposable income declined 0.9%. All of this signals that consumer confidence may be rising as the cost of goods and services backs off.


A headwind for German exports continues to be the Euro. Despite substantial interest rate cuts by the ECB in the last months, leveling the rate to 1.0%, the Euro has appreciated due to the decimation of the US dollar. This morning the Euro was trading as high as $1.40. For Germany, getting past the lack of global demand will be trying.


Unemployment remains a major theme in Germany, and though a lagging indicator, may be a driving force in overall sentiment. Limiting unemployment, which stands at 8.3%, has been a central issue for Chancellor Merkel and the other parties vying for the head seat in government as elections approach in September.  Pressing for Merkel and Co. continues to be the selection of a buyer for GM's Opel unit in Germany, a decision which should come this week and includes bids from Italy's Fiat, Canadian car-parts maker Magna International, and RHJ International SA. In the balance hang thousands of jobs; her decision may very well favor an owner that can save the most jobs.


We believe Germany will have a larger upside than many of its European peers in the months ahead, especially as global economies melt up. We've been in and out of Germany on the long side via the etf EWG this year. We currently like the technical set-up and will be looking to take a position at the right entry point.  


Matthew Hedrick



Germany Grinding It Out - ger12


Yesterday, CKE rose 13% on the back of Jim Cramer recommending it as a turnaround play. His case was based on the premise that CKE is "the worst of breed" and therefore has the most upside potential. He noted that the company's operating margins of 5.7% lag behind its peers, like Burger King (BKC), with margins of 14.5% and Jack-In-The Box (JACK), with 8.5% margins.

I have some issues with his analysis. First, BKC is primarily a franchised company, while CKE is a company-owned operation; as a result comparing operating margins is a useless exercise. Although, it's relevant when looking at JACK, the analysis is still misguided.


When looking at any restaurant company, restaurant level margins are the best barometer of how a company is performing and on this metric CKR is the "best of breed."


Looking at restaurant level margins, CKE has better margins than both JACK and BKC. In the most recent quarter FY2Q09 JACK reported restaurant level margins of 16.5% versus my estimate of 19.9% for CKE restaurants (FY1Q10.) In FY3Q09 Burger King's restaurant level margins are 11.4% - ouch! So any turnaround in CKR margins is not going to come from better sales trends and/or lower food costs, but from management getting religion cutting fat from the company's bloated cost structure. Thus the difference in operating margins cited by Cramer

Having analyzed this company for years, management is not going to give up the Cessna Citation or the other perks that keep the company cost structure bloated. As a side note JACK's senior management flies commercial and the market value of JACK is $1.8 billion and CKR's is $750 million.

Today, CKR reported that its Carl's Jr. Restaurant reported a decline of 6.2% in the period ending May 18th. Assuming 2-3% pricing, this suggests that traffic trends at Carl's Jr. are down 8-9% -- that is a problem! CKR management cites the poor economic conditions in California as the main reason for the decline in traffic trends, but the competition is significantly outperforming in that market.

Recently, JACK reported that 2Q09 same-store sales for its Jack in the Box company-owned restaurants were up 0.4%. Importantly, they said on a regional basis, same-store sales remained positive in California, Texas, and Las Vegas.

CKR takes the high road as it relates to maintaining the company's profitability and brand image, therefore significant discounting is not an option. Maintaining the company's industry leading margins is a higher priority than generating short-term positive same-store sales!

If there is a turnaround in top line sales at Carl's Jr. concept, it will come from increased discounting, which carry lower margins. This is not the type of turnaround I would be looking for!



RL: Still One To Ride in ‘09

As usual, there's a ton of noise in these RL numbers, but by my math the company came in at around $0.68 vs. my model at $0.52 and the Street at $0.42. This was a clean beat all around. Revenue, margins and capital intensity all looked better than I modeled - and I was well above consensus. Was this a 'great' quarter? No - it was not. Let's face it, these guys are perennial sandbaggers, and with sales down 1% and EBIT off by 27% there was nothing to write home about here.  But all things considered, this company continues to prove that its multi-pronged execution around an extremely focused strategy is second to none.


Ok, so back to the sandbagging comment. Management came out with guidance that genuinely represents uncertainty around the global economic environment. But as I hash through my model, I get to $4.25 for next year, and $5.50 the year after. Yes folks, that's a 15% CAGR, and is 16% and 27% above where I think the consensus will shake out in '10 (ending March) and '11, respectively.


Similarly, the first quarter guidance is a bit perplexing. Double digit decline in revs with growth in operating expenses? This comes at a time when FX hurts the top line, but helps opex. To get there, I need to assume a big sequential erosion in wholesale sales AND margins, as well as a slowdown in either .com or new store productivity (unlikely when new store growth is slowing meaningfully).  In fact, if I model the company's guidance to a 'T' I can get to a 1Q estimate as low as $0.10-$0.15 per share. Call me a perma-bull, but I'm getting to a number North of $0.50.


So what DOES concern me?  FX, for one. I could care less about the negative impact RL is feeling today from FX. But anyone who 'does macro' has got to be watching the dollar, which has been in a freefall for the past two weeks. While I highly doubt that RL as an organization is a fan of weak dollar policy, this trend may set up RL for a nice little top-line and margin pop by the September quarter. But the flips side is that this is also a time when it is investing capital in Europe and Asia to fill out the next leg of its global brand expansion. I like the fact that RL has not printed a disproportionate amount of its FX benefit in recent years (unlike WRC, GES and others), but I can't escape the fact that it is potentially investing capital at a time when a devalued currency could hit incremental ROIC.


Does threaten my EPS estimates for the next 18 months? No. But realize it or not, incremental ROIC has been THE key driver to this stock over the past two cycles, and I'll be hyper focused on how proactive the company is approaching this issue this time around. This is now one of my key issue on this name right now. Stay tuned for more analysis.


RL: Still One To Ride in ‘09 - 5 27 2009 1 14 33 PM

Brian McGough

Early Look

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