- PVH identified about $1.55bn in forward obligations in its 10K. But this excludes another $575mm in payments (based on my assumptions) required to be distributed to Mr. Klein under the original terms of the purchase agreement. The kicker is that this lasts until 2017, and is at a rate of 1.15% of worldwide net sales of products bearing the Calvin Klein name. When I add it all up, the CK payments are actually greater than the operating lease liabilities - which is the greatest off balance sheet liability for most other companies in this space.
- When I net it all out, PVH has forward obligations that are going up over the next 10 years, while the industry's is naturally going down. The gap is pretty startling, in fact. This is not bad by any means, but it simply means that the company's bullish CK growth strategy NEEDS to work.
- The bottom line is that I don't think that this is a short based on ugly accounting practices. That's not the case at all. PVH is a stand-up company. But if I'm going to give PVH credit for CK's growth, I've got to give credit for the liabilities as well. At 8x EBITDA, valuation is not in the ballpark of where I'm interested in owning the stock.
- CORNCorn actually moved up 5% yesterday alone, which is not surprising after seeing the USDA's weekly crop report released earlier in the week, which showed that only 74% of the corn crop had emerged relative to the 5-year average of 89%. These big moves in corn prices will impact just about all of the restaurant operators as these higher corn costs will eventually translate into higher protein prices. That being said, the biggest movers to the downside in the past week were cattle and pork (-1.5% and -5.6%, respectively). Judging from Tyson's investor presentation this week (on which I commented on June 5), I would not be surprised to see these prices move higher.
- SOYBEANSRising soybean prices will impact most companies as well as it relates to cooking oil, but P.F. Chang's stands out in my mind as the company highlights wok oil as an important component of its cost of sales.
- WHEATAlthough wheat was up for the week, year-to-date, it has actually declined 11% and is down nearly 39% from the highs seen back in March. Wheat's current price of $7.86 per bushel still represents a 23% premium over the average 2007 price and a 94% premium over 2006. The companies most impacted by these huge year-over-year increases will continue to be Panera Bread and California Pizza Kitchen. Panera is locked in for FY08 at $14 per bushel (versus an average of $5.80 per bushel in FY07). California Pizza Kitchen is only locked in for the next few months on its pizza dough needs (at a 12% YOY increase), but is contracted for the entire year for its pasta needs. Neither company has locked in FY09 prices, but Panera stated on its last conference call that it will make a decision whether or not to do so in the June/July timeframe.
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It's rare that I will give a personal opinion on a company's web site or product marketing strategy -- particularly given the lack of impactful investment significance derived from one man's opinion. But Gap's '4 for 1' strategy, whereby a consumer can shop all of its sites at once, seems ridiculous to me.
I went to the Banana site and was bowled over by the picture below. Yes, convenient that I could buy shorts from Banana and match up shoes from Piperlime, and graphic Ts from Old Navy. But management is missing the big picture.
I go directly to Banana - Gap's highest end brand - and see cross-selling with Old Navy and Gap Stores? It's bad enough that Father's Day is approaching and the only pictures on the page are women. But GPS is violating the cardinal rule of muti-brand retail. It is letting the consumer know that a corporate umbrella even exists. Does the Club Monaco customer know that it is owned by Polo Ralph Lauren? Same for Converse/Nike. Arrow shirts/Calvin Klein (PVH). The North Face and Wrangler/VF Corp. No, No, No, and No. There is ZERO benefit to a Banana customer knowing that the brand shares the same parent as Old Navy. Why? Because such affiliations do not change the allure of the lower end brand, but they (sometimes permanently) cheapen the allure of the high-end brand.
I still think that Gap's biggest problem is that it has done a tremendous job on the cost side in recent years. But that was when there was meaningful sourcing optimization opportunity in an extremely 'easy money' environment for this industry. Also, SG&A stories in this business DO NOT WORK. It takes investment in talent and best-in-class capital allocation to grow consistently. Now SG&A structure remains quite low, but GPS can't rely on industry tailwinds to soften the impact of its past missteps. Getting efficient with web-selling is not the answer. The only answer is for GPS to rely on brand strength. Guess what -- -strengthening a brand takes capital, and we're not seeing that commitment at GPS yet. The bottom line is that I think that margins need to go down before they can go up again.
PS: Thanks to my colleague Andrew Barber for his role in this post. He showed up today in jeans and Chuck Taylors. I went to Banana to find an image to forward him to gently remind him of our dress code at Research Edge. I guess I need to go to Polo.com....
- To me, the Rare Hospitality transaction was a game changer. The acquisition gave Clarence his top line growth, but at the expense of capital allocation. This is not to say the Rare deal was bad or a mistake, it just changed how the company deploys its capital, and DRI's stock price has since reflected the fact that it was an expensive acquisition and a poor short-term (1-2 years) allocation of capital. Unfortunately, for DRI, since the acquisition, the world has changed and the U.S. has entered into a consumption recession. For DRI to capture faster revenue growth, it needs to increase its spending on growth capital expenditures. Relative to other alternatives, this has the lowest potential return. So, DRI is accelerating growth at a time when the industry is slowing. On top of that, one of the new growth vehicles is seeing slippage in same store sales and increased commodity costs. That being said, overall, DRI has maintained the best same-store sales trends in casual dining.
- Needless to say, the best thing that could happen to DRI shareholders would be for the company to reallocate how it deploys its capital as a return to more rational capital allocation should again be reflected in DRI's stock price. DRI is one of the strongest companies in the casual dining space and has a rich history of making shareholders money. Clarence needs the RARE acquisition to work, and integrating the two cultures of the company is critical, especially the employees at LongHorn Steakhouse. I believe management will get there. Right now, there is a full court press on getting the integration right.
- From a cost perspective, the company is about two quarters away from lapping the big disaster that caused a significant amount of pain for shareholders. So the two key things we are keeping our EYEs on are signs of improved capital deployment and how happy the employees of LongHorn are!
First off, Mr. Cohen has no business making stock calls. He data is a very good concurrent indicator of business trends, and as such he's got some good insight into consumer spending patterns. But a trend guy making a stock call? Big no-no. (Full disclosure, Research Edge is one of NPD and Mr. Cohen's clients).
In a roundabout way, his comment about 'reckless shopcations' supports my bearish view on GES. As I noted yesterday, I think that GES underinvested at the top of its sales, growth, margin, and FX cycle, and therefore printed too much operating margin. No one knows, or cares, right now when business humming and the perceived returns are 40%+. But perception is far from reality in retail.
This actually smells a bit like the sentiment around Dick's Sporting Goods last year. The company could do no wrong, and no one cared about DKS' aggressive lease structure and deleverage risk. Two weeks ago DKS shareholders found out the hard way.
I think we'll see the same with GES.
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