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Germany: Waiting for the Fog to Settle...

 

Position: neutral - no current position (with a positive intermediate term TREND bias)

The trifecta of negative rear-view German fundamental data points recently rolled through a dynamic landscape.

 Here's what has come out over the last two days:

 

  1. The Federal Statistics Office reported that German exports declining 28.7% from a year earlier and dropped 4.8% from March, when they rose 0.3%.

  2. Industrial output declined 1.9% in April from March, when it rose 0.3% according to the Economy Ministry.

  3. Factory orders in April held steady at the March level of +3.7%, yet are down 37.1% from a year earlier, as measured by the Economy Ministry.

 

While the data is admittedly revisionist, April's numbers could squash our incremental German bullishness. Our better-than-bad outlook was founded on a sequential improvement in unemployment (decreasing 10 bps to 8.2% in May), a stabilization and marginal improvement in German and European business and consumer confidence numbers, a reduction in PPI and CPI numbers on a monthly basis that we believed would encourage the consumer to spend, and the month-over month improvements in the three fundamentals above from the March numbers. While we stick to our forecast that Germany will experience mild economic improvement this year with positive growth starting in early Q1 of next year, today's numbers confirm that the fundamentals are still bad.

As much as we're data dependent, three substantial changes in the German economic and political landscape have happened in the last 10 days, which we believe are important call-outs:

  1. On the first of the month German Chancellor Angela Merkel decided on Magna International Inc. as the buyer for GM's Opel division in Germany. The agreement was a heavily politicized event for Merkel who is running a reelection campaign in September. With thousands of jobs at Opel and from parts suppliers hanging in the balance the decision sparked much debate, from the importance of saving one of Germany's most important industries to not playing favor to one industry. Merkel had strong opposition from her newly appointed German Economics Minister Karl Theodor zu Guttenberg who believed that her approved bridge loan of 1.5 Billion EUR to prevent Opel insolvency before a buyer resumed operations was imprudent government spending. Further the choice of Magna, a Canadian-Austrian auto-parts supplier that is backed by Russian bank OAO Sberbank and carmaker OAO GAZ, created much consternation due to the historical tensions between Germany and Russia and the sizable 35% stake a Russian enterprise would have in the company.
  2. Over the weekend Merkel's Christian Democratic Union (CDU) beat the Social Democrats (SDP) in European Parliament elections according to preliminary results. Merkel's party (along with their Bavarian Christian Social Union-CSU sister party) received 37.9% over her incumbent Frank-Walter Steinmeier of the SPD, whose party garnered 20.8%. The victory signals German support of center-right parties. Additionally Merkel's preferred coalition partner, the pro-business Free Democrats (FDP), received 11% of the vote. Should Merkel's CDU-CSU party retain this support with the FDP as coalition partners, she'd very likely be at a margin to win a solid majority for the national vote in September.

  3. Today Arcandor AG, owner of Karlstadt, one of Germany's largest department-store chains, filed for insolvency after the German government decided not to come to its aid. Bloomberg cites Merkel as saying the collapse was "unavoidable after investors and banks offered too little to save the company."  In any case the decision is reverberating hard throughout the media today, with many questioning if a merger with competitor Metro's Kaufhof might still be a possibility. Again, in the balance hang many jobs, and general confidence if household retail names like Karlstadt go away.

The recent political decisions help confirm German aversion to state aid, a conservative view prizing low government debt to prevent hikes in taxes. For Germany, a country considered by many Americans to be profoundly socialist, for the moment it sure looks as if the tables have turned.  Despite April's poor numbers our bullish bias on Germany in the intermediate term remains. Fiscal conservatism when properly balanced will help keep the country's balance sheet at a manageable level. Such leadership can only promote investor confidence.  

Matthew Hedrick
Analyst

 

 


Follow The 'E'

Now that earnings season is over, let's take a little look at earnings expectations for the remainder of the year. We've already established that the group needs positive earnings revisions to take the stocks higher - and in some cases 'run to stand still'.  Like it or not, I think we get that. Let's look at two factors...

 

1) First is the current bottom-up eps growth rate for the Apparel/Footwear Retail Supply Chain. We're looking at expectations for a 10% decline in earnings over the next 12-months. Is this reasonable? Yes, I think it is. In fact it better be given that the market is awarding a 15x pe on these earnings expectations. I like the names where I think there are meaningful company-specific earnings levers, like RL, UA and PSS. While there will unquestionably be companies at the other end, I find it more frustrating today identifying a miss than any time over the past four months.

 

Follow The 'E' - NTM June 5

 

2) So what's so unique about the group right now? Not to sound like a broken record, but the as outlined in our 3/5 group call (I'm Getting Fundamentally Positive on Retail) we're entering a period where sales trends are stabilizing, inventories are in check, capex is coming down by over 10% (25% if we exclude Wal*Mart), and we start to go up against very easy compares on gross margins and SG&A. Tack on conservative guidance by companies who are tired of missing, and we get to a few quarters where it's tough to be bearish in aggregate.  This is best illustrated by our SIGMA chart below, here the latest quarter showed a move towards the upper right - meaning that capital efficiency is improving alongside a better delta on margins. As we've been trumpeting, this will continue into holiday, at which time key companies (especially footwear) will start to really benefit from lower sourcing costs.

 

Follow The 'E' - Industry SIGMA Q1 09


MW: A Buyer not a Seller

Men's Wearhouse reported 1Q EPS of $0.10 vs. 1Q08 EPS of $0.20 and far better than the Street which was looking for a breakeven quarter.  Results were better across the board with same store sales coming in above expectations, gross margins less bad, and SG&A expenses well controlled.   Perhaps the most surprising factor in the upside was the gross margin line, which was under considerable pressure in 4Q08 due to the company's decision to BOGO suits.  Offsetting this margin pressure was a solid performance from the company's tuxedo business, which grew by 1.7% in the quarter and helped to offset merchandise margin declines in the core retail business.  Overall, a solid performance and yet another example of "stabilization" in the marketplace.

 

More interesting than the 1Q results is the company's bid of $67 million for Filene's Basement (out of bankruptcy).  The company actually delayed its quarterly conference call as it awaits final court approval on the offer.  Remember, that only a few weeks ago (see our note: Activism Brewing?) we pointed to a new change in control clause in the proxy which essentially gave executives added compensation if the company were to be acquired - the same type of clause used to scare away activists.  Now it goes ahead and bids for Filene's. Interesting narrative.  The purchase price includes 17 of 20 leases, inventory from a total of 25 locations, leases on the headquarters and distribution facility, as well as the Filene's Basement trade name. 

 

MW's strategy is historically rooted in EDLP.  If you think about it, an off-price chain presents unique opportunities for the company as it diversifies the customer base with a heavier focus on women, offers a channel to clear goods from the namesake chain, and potentially gives the company a growth vehicle for the future.  Additionally, with the success of off-pricers lately (take a look at a ROST or TJX chart), the severe mismanagement of Filene's Basement over the past few years, and the fact that there is still a deep heritage associated with the brand, this might end up being the type of ownership structure that can give Filene's Basement another chance. 

 

If there is one thing to hope for (admitting that 'hope' is not an investment process), it's that MW brings back the automatic markdown system that actually made Filene's Basement an icon in the industry for so many years.  Yes, it actually was 'iconic' in the retail landscape of yesteryear. This is the type of differentiator that can make this small, regional off-price retailer stand out from the rest of the pack.  For those of you unfamiliar with the automatic markdown system, give us a call and we'll walk you through a quick recap in retail history.  In the meantime, it's probably worth switching gears to focus on MW's plans for growth rather than who might be buying them.

 

Eric Levine

Director


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Need A Job?

 

We had a number of inquiries about our unemployment post yesterday. A lot of readers asked us why we seemed to be suggesting that US Job losses were decelerating while at the same time the unemployment rate was accelerating , and how the math behind that observation worked. 

 

The math is actually very straightforward: This divergence between measures of employment stems from differences in the methodology used by the government to calculate different figures, combined with cultural and psychological inflections.

 

The Current Population Survey (the monthly survey of 60,000 US households used to calculate the unemployment rate) classifies people in one of three ways: "Employed", "Unemployed" or "Not in the Labor Force". Unemployed people are defined as: jobless, looking for jobs, and available for work. This means that those not looking for work and not available for work are counted as "Not in the Labor Force" even if they have no current source of income. Meanwhile, payroll data is collected through a business survey of wages paid and Initial Claims are calculated through a count of new state benefits applications.

 

During periods of increasing layoffs, a phenomenon sometimes occurs in which the first wave of individuals who lose their jobs do not feel compelled to begin looking for new employment until after successive waves of additional individuals entering the market has created greater competition for available positions.  I'll use myself as an example: In early  2001 when I was laid off by an investment bank I decided to kick back with my (by the standards of 29 year old) considerable savings and take the summer off while I recharged the batteries and considered my next move.

 

As such, an initial wave of unemployed workers like my 29 year old self are sometimes less likely to identify themselves as actively seeking employment immediately than people who lose their jobs at a later time will, and those initial individuals respond to increasing competition later by re-entering the market and identifying themselves as seeking a job. I'll use myself as an example again, as the NYC finance job situation deteriorated post 9/11; I was suddenly energized in my job search and began looking aggressively.

 

In the charts below you can see how payroll data began to show improvement while the unemployment rate was still climbing during periods of increased job loss during 1990-92 and 2001-03 and how the current cycle seems to be indicating a similar pattern (at an accelerated rate and trajectory).

 

Andrew Barber

Director

 

Need A Job? - employment1

 

Need A Job? - employment2


Burning The Buck

  

From the authors of Breaking The Buck, we now have the sequel - Burning It!

 

In the short run, this is going to stoke REFLATION. In the long run, the US Dollar's stature as the world's reserve currency will be dead. In the chart below, we have broadened the duration associated with this debate. Andrew Barber has illustrated our new long dated duration - we're calling this the "TAIL" line of resistance ($81.62).

 

You learn a lot about markets and their pressure points by watching what they do intraday. Yesterday was a critical day on this score for the US Dollar. In the face of heightened (realistic) concerns about an eventual rate hike, the Dollar rallied +3.5% from its recent lows (see chart). As the Dollar rallied, the REFLATION trade (globally) fizzled. We saw petrodollar markets like Russia and Saudi Arabia correct between 5-11% from their respective peaks in very short order.

 

Importantly however, the Buck backed off at the immediate term TRADE line of resistance ($81.36) and has subsequently started to break down again. If yesterday's intraday reversal of the buck's bid was important, today's follow through selling is critical.

 

As of 11AM EST, the US Dollar Index is down another -0.85% at $80.13. This is good for the anyone levered to the REFLATION trade. What has come down in the last few trading sessions, globally, is preparing to launch higher again.

 

Are there fundamental data points supporting this renewed crisis in the credibility of America's currency? Consider the following points of rhetoric that we're amplified in my notebook in the last 48 hours:

 

  • 1. The IMF's Lipsky said a "new reserve currency is possible"
  • 2. The World Bank's President, Zoellick, said "China may diversify"
  • 3. Timmy Geithner is back on American soil, being YouTubed

 

The Buck Is Burning. Trade the implications surgically.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Burning The Buck - burning


PFCB – THE R.T. VIVIAN SQUEEZE

I have been chiding Burt Vivian about his sourpuss attitude when speaking to the street. Right now, few restaurant companies are "kicking ass" so there is part of Burt's commentary that is born out of the reality of today's economic climate. But anyone who has heard him recently knows that he takes cautious commentary to a whole different level than other restaurant industry executives.


Is his overly cautious tone having an impact on the stock? It sure looks like it!


I have been cautious on the casual dining names for the better part of a month as we head into 2Q09, with many companies facing stimulus headwinds. While the group has been churning in a tight range, I'm less convinced there is any real reason for them to go down.

 

PFCB – THE R.T. VIVIAN SQUEEZE - bistrosss

 

I'm now becoming a bigger believer that for most restaurant companies, the top line is not that relevant - to a point. In 2Q09, if a company misses top line expectations, but can beat earnings by a significant margin, the stock is not going down. Even on a lower sales base operating margins are rising, which implies that cash is growing. The mature casual dining companies that have whittled growth capital to a minimum are gushing cash! On this basis the stocks are cheap!


The mature casual dining names always seem to move in a pack and there rarely is there a "best in class" company. For years, it seemed like PF Chang's (PFCB) and The Cheesecake Factory (CAKE) have been on the same trajectory. Both companies have been living the same life cycle and benefiting from the same industry trends. Still today the companies seem to parallel each other, yet a significant discrepancy exists that is not easy to reconcile and definitely worth a closer look.


I'm not sure a pair trading these two will work on the margin; they're either both going to keep working higher or they both won't. The Research Edge Quant model's set up is bullish for both companies, not including the short interest factor. The short interest factor is off the charts for PFCB!


The set ups look like PFCB is trading at 6.1x EV/EBITDA versus CAKE at 7.9x. The short interest for PFCB is an astounding 40.1% and only 14% for CAKE. The consensus has voted and PFCB is going down hard! I'm not convinced that there is a smoking gun at PFCB. For every improvement in PFCB's cash flow multiple is $5.66 of upside.


While still relatively small in size, PFCB is a mature restaurant company throwing off lots of cash. Like many restaurant companies, the slower, more controlled growth is having a significant impact on the company's financials. I have always used a company's return on incremental capital as an initial screen to understand where the company is going with its cash. Is a company reinvesting its cash to generate the best return for shareholders? On this metric PFCB is killing the competition.

 

PFCB – THE R.T. VIVIAN SQUEEZE - pfcbroiic

 

Both concepts experienced a nice improvement in 2-year same-store sales trends in 1Q09 with PFCB having seen slightly better earnings revisions over the past three months at 35% (25% for CAKE). Both companies run the risk of a sequential deceleration in same store sales trends, but I don't think that really matters for either company. Margins are improving on the back of cost cuts, pricing and lower inflation. My model is coming up with estimates for 2Q09 and for FY2009 that are significantly better that consensus estimates.


Where is the negative catalyst? Or is Burt to blame for the discount valuation?


What do you think the shorts are going to do when Burt Vivian gets up in front of the investment community and his sourpuss face is gone?

 


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