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Consumer Survey - June spending intentions are not looking good

The conclusions from the June BigResearch survey are inconsistent with today's retail sales data.
Bloomberg is reporting that retail sales in the U.S. rose twice as much as forecast in May as tax-rebate checks spurred Americans to shop at electronics and department stores, helping them cope with record gasoline prices.

I don't believe it, and have some data points refute today bullish retail sales figures.

Each month, BIGresearch's Consumer Intentions & Actions Survey monitors over 7,500 consumers providing unique insights & identifying opportunities in a highly fragmented and transitory marketplace. The following are some significant data points from the June survey which is not consistent with todays retails sales numbers.
  • EconomyAlthough 45.3% of Americans report that they've received their economic stimulus checks, it appears that this boost to wallets is failing to raise morale regarding our economy...in June, fewer than one in five (18.8%) indicate that they are confident/very confident in chances for a strong economy, lowering from May's record low of 19.5% and less than half of June 2007's 43.9%: And adding to retailer woes: most consumers are making a beeline for just the necessities when shopping...in June, 53.8% indicate they are focused on needs over wants, rising three points from May (50.7%) and up almost 7 points from one year ago (47.0%). Economic stimulus checks were meant to jumpstart consumer spending, but it appears that consumers are stalling...of the almost half (45.3%) who've received their checks already, more than a quarter (26.9%) are saving them, 23.0% are paying down previous credit card debt, 16.3% are purchasing the necessities (i.e. groceries), 15.2% have put the checks toward gasoline expenditures, while 14.3% are paying down installment loans. Only about one in twenty are putting their checks toward vacation travel (5.9%), apparel (5.1%), or electronics (5.0%).
  • Personal/FinancialWith gas prices crossing into $4 territory, an increasing number of drivers are rolling back on discretionary spending...among the now 86.0% who have been impacted by rising pump prices (a new high), the majority (54.7%) indicates that they will be curbing their cars and driving less...44.8% are reducing dining out, while - with the summer vacation season upon us - 44.1% are scaling back their travel plans: Most drivers expect no relief from surging fuel costs...almost nine in ten (87.8%) expect gas prices to continue to climb through the July 4th holiday, one in ten (10.3%) feels they'll remain stable, while a minor few (1.9%) optimistically call for a price decrease. Consumers are bracing for an average expected pump price of $4.39/gal come Independence Day, which may be right on target, given their prediction for $3.97/gal on Dad's Day.
  • Future PurchasesPractical consumers, faced with rising gas and grocery prices, a crumbling housing market, increasing unemployment, forecast a continued dismal 90 day purchasing forecast, according to the BIGresearch Diffusion Index (those who say they'll spend less subtracted from those who will spend more). With most categories continuing to decline from May as well as June '07, it appears that retailers will ring up a less-than-stellar summer selling season: Six month purchase intentions for high-dollar durables aren't expected to provide retailers with revenue relief, either...compared to one year ago, fewer plan to spend on autos, computers, furniture, home appliances, housing, jewelry, major home improvements, stereo equipment, DVD/VCR, digital cameras, and vacation travel. The one anomaly continues to be TVs...9.2% intend to purchase, a slight uptick from 8.9% in June '07.

CRI: Un-Pulling The Goalie?

Excuse me for sounding self-promotional, but I called this sucker a year ago. Carter's management has been self-inflecting deep paper cuts over the past 4 years, and is officially at the point where the company needs a transfusion. Current CEO Fred Rowan is 'retiring' and the company is passing over reigning resident Joe Pacifico for the top job. CFO Mike Casey is getting the nod - which is the best decision I've seen from this Board since just about ever. Consider the following...

Pre 2003: Carters is the dominant brand in the babywear market, with about a 35% share in this space. One of the most defendable brands in apparel retail. The product is very basic, has virtually no fashion risk and is more like a consumer packaged goods model than an apparel model.
2003-'05: CRI steps up its Playwear, Company Retail and mass market (WMT, TGT) businesses. Fashion risk enters the equation. Starts to compete with the likes of Old Navy. Initially does not feel the brunt of competitive pressure as sourcing savings more than offset unit margin pressure.
2005: Buys Osh Kosh, a family-owned brand with even greater fashion risk than Carter's Playwear.

So by 2006/7, CRI's business model shifted to a mix where less than half of sales comes from that core 'packaged goods' business and the rest is fashion. Not high fashion, obviously, but one where the competitive set is far more complex than CRI had when it sold mostly onesies and baby blankets.

CRI's response? It was to cut costs, of course. I love this example... Osh Kosh had about 500 employees when CRI purchased it in 2005, and now that employee count is closer to 150. A simple fact in this business is that brands don't sell themselves. It takes talent. Designers, merchandisers, marketing, etc... CRI aggressively cut costs from its model in order to buoy earnings. CRI did not appreciate this.

Think about it like this - how could a company consistently miss sales targets across virtually all of its fashion-driven businesses, subsequently face a 1,500bp slowdown in sales growth, and only see EBIT margins slip from 12% to 10%? It's what I call 'pulling the goalie.' Mask underlying weakness by cutting costs for a last shot at winning the game. As far as I'm concerned, the first team lost the game. The coaching staff was turned upside down, and now some tough choices need to be made before starting the clock and facing a new opponent.

What next? I still think a 10% margin rate is too high. Mr. Casey needs to buy himself some ammo. There's nothing stopping him from clearing the deck and resetting the margin bar at 6-8%, which is a level my math suggests would give him the resources to head closer to a profitable growth trajectory. That would take EPS from $1.40 to somewhere between $0.75 and $1.00, and is when the name gets more interesting to me. I think it's more likely than not that we see it.

(The chart below shows the disconnect between such a lack of EBIT margin change in the face of such severe business pressure. This is not sustainable...)

Restaurant Industry - 2nd Round of Minimum Wage Increases Coming Soon!

2nd Round of Minimum Wage Increases Coming Soon!

The Associated Press reported that effective July 24, the federal minimum wage will increase $0.70 to $6.55 per hour. This is by no means new news, but these higher labor costs will again be top of mind for investors as this second increase will impact most restaurant companies in the upcoming quarter (3Q08), putting even more pressure on margins.

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SBUX - Better Capital Allocation Decisions

Starbucks shareholders have been penalized over the past two years for aggressive capital allocation decisions that have not generated the appropriate level of return. I believe management has seen the light and is now on the road of smarter capital allocation decisions which will reward shareholders.

A perfect example of a smarter capital allocation decision is the company's recent announcement outlining its new licensing agreement with SSP. Starbucks Coffee Company and SSP announced a significant licensing partnership to open more than 150 Starbucks stores in key European markets over the next three years.

The pan-European agreement gives SSP licensing rights to the Starbucks brand in travel channels, including airport and railway locations, throughout a number of significant markets and exclusive rights in France, Germany and the United Kingdom.

For Starbucks, this is the third announcement (following its agreement to acquire assets, including development and operating rights in Canada and its first store opening in Argentina) that signifies a change in the company's business model, particularly around its international operations. Importantly, the SSP agreement accelerates growth using a high margin, high return licensing strategy.

O'Charley's, LongHorn, SNS, RT - More Pain from Rising Gas Prices

Today's NY Times included the U.S. map pictured below, which highlights the parts of the country that are being hardest hit by rising gas prices relative to income levels. According to the map, people living in parts of Alabama, Georgia, Kentucky, Mississippi, Missouri, Montana, New Mexico, North Dakota, Oklahoma, South Dakota, West Virginia and Wyoming are spending the biggest percent of their incomes on filling up their gas tanks. This has to take a toll on discretionary spending, such as dining out!
  • Within the casual dining segment, the O'Charley's concept has about 37% of its store base exposed to these hardest hit states. Thirty percent of LongHorn Steakhouse's restaurants are located in these states while Steak n Shake and Ruby Tuesday both have about 20% exposure.

YUM - New Questions to ask Management about China!

Without the China engine the YUM story is less compelling. Whether it's a YUM analyst meeting, quarterly conference call or the CEO speaking on Jim Kramer's TV show (the stock is down 9.5% from the last appearance vs. the S&P 500 down 3.2%), all the company wants to talk about is China. The company recently hosted an analyst meeting in KY and they spent nearly 1/2 of a 1.5 day presentation talking about China. I question whether investors will be provided with this same level of disclosure now that the Chinese market is showing signs of stress? With all of the hype over China, it is easy to forget that nearly 50% of the company's operating profits come from the U.S.
  • Including yesterday's performance, the Chinese market has declined -52% from its October 2007 peak and inflation is accelerating. YUM's senior management expects that commodity inflation (including higher chicken costs) will continue into the first half of 2008 and moderate later in the year in Mainland China. It appears that the company's expectations will need to be adjusted in the coming months.
  • China is a black hole to most Americans and my guess is that most American companies don't properly risk adjust returns for the capital put into China - just ask Caterpillar Inc. (CAT). Today, CAT learned a big lesson about doing business in China! A story ran on the Dow Jones news wire that said the Xuzhou Construction Machinery Group is going to exit its JV with Caterpillar. President Wang Min is quoted as saying the company plans to sell its 15.87% stake in Caterpillar Xuzhou and set up its own excavation machinery unit. CAT is scrambling to try to figure out how to continue to cooperate with the Chinese company.
  • We bring this up because YUM's partners in China are essentially state-owned enterprises. Despite having a majority ownership position, YUM historically has not consolidated any entity in China, instead accounting for the unconsolidated affiliate using the equity method of accounting. More disclosure?

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