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The Research Edge Restaurant Process

The restaurant business is a cash business, and a large number of publicly traded companies generate a significant amount of cash each year. Therefore, any analysis of a restaurant company should revolve around the company's cash flows and how management spends it. The restaurant industry's 10 largest companies have reached such a size and maturity that their cash-generating capabilities have surpassed $13 billion. In the current restaurant environment, the redeployment of cash flows is an important factor in stock price performance and thus valuation. Properly managing cash flow will allow any restaurant stock to outperform its peer group over a sustainable period of time. A key component to sustainable, consistent growth and a premium valuation, therefore, is the proper balance between cash reinvested into the business and cash returned to shareholders.

A restaurant company with strong, sustainable trends will maintain a proper balance between debt and equity and will pursue a prudent level of unit growth (growth capital expenditures) while keeping up with maintenance capital requirements. At the same time, the company also must recognize the importance of keeping the concept relevant to the consumer. This puts a premium on initiatives within the four walls of the restaurant to drive incremental customer visits, which is critical to the overall health and perception of the concept. If the company has any cash left over, returning it to shareholders should be a top priority.

A common mistake that restaurant companies continue to make involves taking an overly optimistic view of a given concept's long-term prospects, which leads to excessive capital expenditures and ultimately erodes shareholder value. The point is, what might appear good for a company (or a stock) in the short term might not always benefit the company in the long term.

On the other hand, we have seen companies slow new unit growth in order to focus on their core business. This decision also has significant implications for shareholders, as a company will likely see a significant increase in its operating performance and its return on incremental invested capital as a result of increased sales and margins at existing restaurants combined with investing less capital in unprofitable stores in a mature business.

We have witnessed, more often than not, companies maintain an accelerated rate of new unit growth, putting significant pressure on the organization. That pressure comes in three primary forms. First, the company's real estate division might be pressured to find quality locations and invariably will compromise its standards in order to satisfy management guidance driven by a desire to meet Wall Street's performance projections. After two to three years of compromises, sales in the new units will begin to suffer and the company will miss its targeted return hurdles. Another part of the new unit underperformance can be attributed to the fact that the company cannot hire enough qualified managers and/or lacks the time to properly train them. Third, it is also possible the concept cannot survive in the highly competitive restaurant industry.

Most mature restaurant companies have enough operating cash to fund unit growth beyond their means. This fact implies that the prudent companies have cash left over to allow for incremental EPS growth from some sort of financial engineering, which leaves the board members of the leading restaurant companies with some very difficult decisions to make. These decisions range from the need to provide growth for the company's employees to maximizing value for shareholders. Unfortunately, these options do not always go hand in hand.

As I said before, over the long-term we are most focused on the rate at which companies deploy new capital in the business. We have developed a framework to help measure how senior management of any given company is deploying shareholders' capital. This approach is even more important in difficult times. In today's uncertain environment, most people do not want to touch a stock until there is better visibility on the top line. Unfortunately, easy comparisons do not necessarily mean results will improve in 12 months, as we have seen.

We acknowledge that same-store sales growth is a significant indicator of a concept's health, which affects the potential opportunity for growing total sales through new unit openings. The important components of computing same-store sales are broken down in transaction-level metrics: pricing, mix, and traffic trends.Typically, we find that the company with the highest multiple usually has the strongest same-store sales trends and nothing else seems to matter, leading us to believe that "best in class" restaurant companies do not receive premium valuations. Although same-store sales trends are important, investors must consider other factors when valuing a restaurant stock and determining whether a restaurant company is "best in class."

We have a number of measures that we consider when looking at a restaurant company, but four that are more important. Most of the criteria do not provide good or bad news in isolation. Instead, they lead us to ask questions in hopes of discovering in what direction a company is heading. Given that the restaurant business is typically a cash business, we do not focus on revenue (except for same-store sales, which are the most important indicator of a concept's health). Instead, we have centered our efforts on how management spends its cash flow. Specifically, we are focused on cash flow from operations, operating margins, and capital expenditures. Importantly, we look at these numbers not in isolation, but in how they relate to other parts of a company's financials and to other companies in the industry.

Cash flow from operations (CFFO). Is the company generating enough cash from its operating activities to continue without accessing new external sources of cash? We define CFFO as cash from operating activities less capital expenditures, less the benefits from the exercise of employee stock options and adjustment for one-time gains/losses or restructuring items. Most of the larger restaurant companies we follow generate free cash flow after significant investment in the growth of the core business. Some of the smaller companies we follow do not generate free cash flow. The lack of free cash flow is not necessarily a negative, as long as the company burns cash within the limits of its available resources.

Net CFFO/Net Income. Importantly, we are looking at the proportion of earnings yielding cash. This higher ratio relative to the industry can indicate more conservative accounting, signaling a sustainable level of income. At a minimum, we believe that a mature restaurant company should have a CFFO/net income ratio of 0.6 or better. Any ratio that is nearly flat or negative raises a big red flag for future returns.

Operating margins. In the restaurant industry, operating margins measure a company's cost efficiency relative to the revenues generated within the four walls of the restaurant. Generally, margins that are declining because of slowing sales trends tend to be more important than a one-time step up in costs. High margins with stable or declining revenue growth should be examined carefully. Importantly, we are looking for margin differences relative to competitors with similar box (store size) economics. Is the trend in margins consistent with other competitors in the industry?

Capital expenditures to depreciation ratio (CE/DR). This ratio can measure whether or not management is conservative in its accounting policies relative to others in the industry. In addition, it is an indicator of the company's annual cash cost of capacity. In general, the small-cap restaurant companies' CE/DR is high because of the significant amount of new assets put into the ground each year to sustain growth.

We will follow up in the next couple of days with more company-specific comments.

 


Q. Why Is The Market Down? A. Because The US Dollar Is Up

As the U.S. market and commodities futures previewed this morning, the stock market is having a rough start to the week with the SP500 down -2.70% and the Nasdaq down -2.95%, currently.  The internals of the market are noteworthy in that there is a bifurcation of sector performance.  The XLU (utilities), XLP (consumer staples), and XLV (healthcare) are outperforming.  On the other hand, XLB (materials), XLE (energy), and XLF (financials) are vastly underperforming.  Performances for all nine sectors of the S&P is outlined in the chart below, but the average performance for the top 3 sectors currently is -0.72% versus the average performance of the bottom 3 sectors which is -4.44%, with the delta between the two groups at 372 basis points.

Many media outlets will point to the World Bank cutting global growth estimates last night and increased geo-political pressures with Iran and North Korea as the key culprit behind today's equity market declines.

In reality, the US Dollar continues to be the primary driver of asset class returns.

The U.S. Dollar Index is currently +0.58% intraday and as we've been hammering on for most this year, dollar up equals stocks and commodities down.  While declining growth estimates by the World Bank may have some sticker shock, most investors realize that those projections are more lagging than leading.  As it relates to foreign policy concerns, if they were the key driver to the market today, one would rationally expect either gold or oil to be up due to a flight to safety, but both are down -1.6% and -3.9%, respectively.

While Mr. Market seems to be acting irrationally today, one needs to look no further than the quote on the US Dollar Index to explain today's price action.  If you were locked in a dark room and could only have one quote to trade this market, it would continue to be US Dollar Index.

Daryl G. Jones

Managing Director

Q. Why Is The Market Down? A. Because The US Dollar Is Up - chart123


Approval Breaking Down For Obama

As we discussed on our morning call today, confidence in President Obama appears to be breaking to the downside.  The most recent Rasmussen Daily Presidential Tracking Poll measured -3, which is the worst reading since Obama became President.  This poll measures the differences between strongly approve and strongly disapprove, and for the first time more people strongly disapprove of the way the President is doing his job.  In the chart below, we've outlined the Rasmussen Poll since its inception for Obama, and it highlights the negative trend in Obama's approval rating.

A key shift relates to greater time away from the Bush administration.  As a point in fact, another Rasmussen poll indicates that 54% of those polled still blame President Bush and his administration for the economic woes.  While this is a large number, it is noteworthy for the fact that this number is down from 62%, from a month ago.  The implication being that, and whether he deserves it or not, this is starting to be branded as President Obama's economy as there is a direct correlation between Obama's popularity declining and people blaming Bush less for current economic woes.

The other area that seems to be hurting President Obama is foreign affairs.  As we noted in the Early Look today, President Obama is taking a very different tact than his predecessor on foreign policy and so far positive results have been limited.  As a frame of reference, the current top three headlines on the drudgereport.com are as follows:

Obviously Matt Drudge is right leaning, but the above headlines highlight the serious international issues currently facing President Obama.  Once again, while President Obama is certainly not to blame for these international threats, he is now in the driver's seat for dealing with them and as these issues manifest the news flow more extensively, they will likely continue to negatively impact the President's approval rating.

The Gallup Daily Presidential Approval poll from yesterday mirrored the findings in the Rasmussen poll.  In the Gallup poll, President Obama's approval is at 57%, which is the lowest approval of his presidency based on this poll.  In a number of other instances, Obama has fallen to below 60% in approval for a three day period, but has always quickly recovered to above 60%.  Therefore, his approval rating over the coming days will be a real test as to whether the honeymoon approval rating is really over.

In aggregate, and not surprisingly, President Obama seems to be holding his approval with Democrats, but according to Gallup:

"The latest decline in Obama's approval score, to 58%, results from a drop in approval among political independents as well as among Republicans. Democrats remain as highly supportive of the president as ever.  Obama's approval rating was 60% from June 13-15, at which time 88% of Democrats, 60% of independents, and 25% of Republicans approved of the job he was doing. In the June 16-18 polling, Democrats' approval of him stands at 92% -- up slightly -- whereas approval is down among both independents (by seven points) and Republicans (by four points)."

Most interestingly, the independents that moved to Obama in hoards during the presidential election last fall, now seem to be seriously wavering.  While on the other hand, Obama's support among his own party is as strong as ever.  So what is happening among the independents?  The best place to find that answer may come from New Hampshire.  In the New Hampshire Union Leader this morning, which is the largest paper in New Hampshire, there was an editorial sharply critical of Obama's health care plan, and specifically the disconnect between Obama saying there will be no additional spending for his plan and the Congressional Budget Office suggesting that current proposals would dramatically increase spending.

According to the New Hampshire Union Leader:

"For health care reform to "not add to the federal deficit over the next decade," every penny of new taxpayer spending on health care reform would have to be paid for by either a tax increase or a spending cut somewhere else. We're talking about roughly $1 trillion in spending -- all paid for. But remember, we already have a $1.8 trillion deficit this year. Every penny spent on health care reform is a penny not spent to pay down the existing deficit. So in reality, health care reform will at the very least perpetuate existing deficits even if it doesn't expand them.

While having solidarity among his party is powerful, in a country where only ~ 40% of adults identify themselves as Democrats, Obama has to continue to appeal to independents and if the New Hampshire Union Leader is any proxy, he is losing them.

Daryl G. Jones
Managing Director

Approval Breaking Down For Obama - obama23


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Slouching Towards Wall Street… Notes for the Week Ending Friday, June 19, 2009

To Our Readers

With this week's offering, we announce a change of title - reflecting the challenges in the new regulatory reality.  We launched last year with a weekly oversight of anomalies from the world of regulation, taking our lead from then SEC Enforcement Chief Linda Chatman Thomsen's tip-off to Morgan Stanley, where she commented on an ongoing SEC investigation.  ("Smoke, but no fire...")

We are now staring down the barrel of the loaded gun of new global regulation.  This gun, as we have experienced repeatedly, fires exploding bullets, and the collateral damage is generally far greater than the damage caused to the target itself, even when hit square on the bull's-eye. 

For the record, these bullets are called "dum-dums".  We encourage you to bear that in mind during the coming debate over increasing government regulation...

This week starts what is likely to be a long and messy slog through an extended global process of re-regulation.  We open by asking - with apologies to William Butler Yeats -

 

                    What rough beast, its hour come 'round at last,

                    Slouches towards Wall Street to be born?

 

Tim Marches On

 Markets can remain irrational longer than you can print money.

                   - Anonymous

It is a platitude of the money management business that "the art of managing money is the art of having money to manage."  The new-century corollary might be aptly expressed as, "the art of managing an economy is the art of having an economy to manage."

President Obama is trying to rescue America's economy, and the world's.  We must surely all wish him success.  While there is much to discuss in his proposal, we are taken by the political posturing around the enhanced role of the Federal Reserve as overseer of the largest and most interconnected financial firms. 

Members of Congress claim that the Fed was at the core of the disaster and that it should not be rewarded with expanded powers.

The Fed is already one of the most influential institutions on the planet and, while it enjoys a certain continuity from Chairman to Chairman, and from Presidential Administration to Administration, it may not be accurate to portray the Fed as monolithic in the same way as, say, the great sports franchises are.  One might say it is not "the Fed" that wrecked the financial markets.  The failure at that institution can be traced to one person - to one moment.

To Alan Greenspan when, in a speech in March, 1999, he declared "By far the most significant event in finance in the past decade has been the extraordinary development and expansion of financial derivatives," and that the functioning of the OTC derivatives markets without regulation, "provides a strong argument for development of a less burdensome regime."  Shortly thereafter, Chairman Greenspan led the gang-trashing of CFTC Chair Brooklsey Born for suggesting that the dark market of OTC derivatives should be regulated.

This underscores the true nature of what we are facing: that successful regulation of the financial markets depends more than anything on the sound assessments and actions of those charged with oversight.  Had any one of the Gang of Three - Greenspan, Rubin and Summers - voiced a strong demur, it might have brought a different outcome.  Going forward, we urge the Administration to remember that all the regulation in the world is not proof against poor judgment. 

The Fed's hand is now formally on a seemingly inexhaustible spigot of Federal bailout money.  The institutions that the government financed in the past year - from General Motors to Citi - were considered all but independent empires.  Now we are in what may be a generation-long spiral of calculating how many years before we break even on the trillions we have TARP'ed and TALF'ed and PPIP'ed down the drain.

President Obama's plan, by establishing a regulatory category of "Tier I FHC's" (Financial Holding Companies), seeks to enshrine in law the accidental concept of Too Big To Fail.  Were you afraid an Obama Administration would mean rampant socialism?  This is Bushian Corporate Socialism taken to its logical endpoint.

"We should be able to do business with the Federal Reserve -" says one banker (Financial Times, 18 June, "Wall Street Says It Can Do Business With Federal Reserve") "as long as all these new powers do not go to its head."

In what other part of Secretary Geithner's anatomy might they take up residence, then?  Because it is Tim Geithner, and not some amorphous entity called "the Fed", who will call the shots.

Fed Chairman Bernanke's term expires at the end of January.  The choice of a new Chairman, or the decision to reinstate Mr. Bernanke, will doubtless be taken by President Obama in intimate consultation with Secretary Geithner.    As we move forward through the Sargasso of this debate, keep your eye on the degree of power this process will hand to Secretary Geithner.

We applaud President Obama on two counts: first, this is his proposal, meaning he stands to reap the praise for any successes, and he will be targeted for every failure or inefficiency that proceeds from this document.  Second, the President has thrown considerable support behind Secretary Geithner.  Whatever one may think of Mr. Geithner, anything less than full and public support for him at this moment would be tantamount to eviscerating him.  President Obama has voiced the courage of his conviction.  We can only hope that his confidence will turn out to have been well placed.

Speaking on Bloomberg television last week, former SEC Chairman Arthur Levitt voiced the belief that President Obama and his team had thoroughly sounded out opinion - both industry and legislative - before announcing this proposal, and that it would likely pass through the legislative process largely intact.   On the eve of Secretary Geithner's testimony, Senator Shelby piped up and said "Haste is dangerous, especially when you are dealing with comprehensive change in our financial system."  (WSJ 18 June, "Historic Overhaul of Finance Rules").  He has since expressed himself in terms that boil down to "Not so fast!"  It remains to be seen whether President Obama has truly pre-sold this critical and vast program to key players in Congress - or if, like the Bozogate surrounding his cabinet appointments, the President and his entire staff are actually clueless.  Time - and probably very little of it - will tell.

By formally establishing "2B2F" ("Tier I FHC" = "Too Big To Fail") President Obama's proposal guarantees there will be another Citibank, another Bear Stearns, another Bank of America.  But not another Lehman.  Rather, every major, poorly managed and highly interconnected financial firm now stands to be given financing.  Taxpayers, get out your wallets.  Under the proposed new structure, the emergency authority to rescue the 2B2Fs rests with the Fed, but subject to approval by Treasury.  In other words, Secretary Geithner will have legislative authority to take steps that his mentor and predecessor - Secretary Paulson - took only with gritted teeth and by sheer force of his character.

And, like the TARP money - we still don't know where it is - we do not see a black and white guarantee built into the proposed legislation to track down which drains and rabbit holes that new money will disappear.  President Obama has taken the extraordinary and emergency measures forced through by Secretary Paulson, and written them into a proposed new body of law, possibly complete with the barefaced lack of accountability.  The swilling of the next several trillion dollars of taxpayer money down the Johnny-flusher will be at the sole discretion of Timothy Geithner.

President Obama is seeking to write Moral Hazard into law.  In doing so, he has a lot riding on the skill and talents of his Treasury Secretary.  We wish we could be as sanguine.

(This might be the moment to point out that Brooksley Born received this year's John F. Kennedy Profiles In Courage Award, in recognition of her political courage in calling attention to risks in the derivatives markets.  We do not believe she received a congratulatory telegram from Mr. Greenspan.)

Secretary Paulson came to Treasury after one of the most successful careers in the history of finance.  Tough, smart - ruthless of course.  But also a prudent steward of his firm and its legacy, Hank Paulson brought a lifetime of successful deal making to the office of Chief Deal maker - and when crunch time was upon him, he forced a resolution.  To their great and lasting surprise, Congress was hopelessly outclassed.  When Paulson acted - agree with him or not - he got results.

Secretary Geithner, you are no Hank Paulson.

 

Into The Secret Garden

Whoso breaketh an hedge, a serpent shall bite him.

                   - Ecclesiastes 10:8

The United States is the only country with developed financial markets that does not require money managers to register with a national regulatory authority.  Taken on its face, President Obama's proposition to require hedge fund registration should be seen as, at worst, benign.  It will add a level of transparency designed to give future investors comfort - and transparency is really what has been lacking from the financial system.  The fact remains that, with the exception of outright criminal activity, the disasters in which hedge funds figured prominently were largely the fault of those regulated institutions, the commercial banks and brokers, who lent them money without performing their own due diligence.  In so doing, the brokers in many instances raised their own exposure to far greater levels than the hedge funds.

Hedge funds carry average leverage of under four times their assets.  This is a far cry from the brokers that had gotten up to stratospheric ratios of 30:1 leverage and beyond.  One simple reason is that hedge fund managers almost always have "skin in the game," and if they risk their investors' money, they risk their own alongside it.  Brokers, on the other hand, are tied to Wall Street's traditional compensation model, where executives justify their own paydays because of the "value" they bring to the firm.  When things work out, they take credit.  When things go wrong, they blame everyone else.  Or - this is our favorite howler - "adverse market conditions."  Is it any wonder that, from the rest of the world's perspective, corporate America looks like North Korea?  Average workers are paid small hourly wages, while senior executives make literally hundreds of times the annual compensation of workers on the shop floor.  Bankers are paid gargantuan fees by these CEOs in return for lending the corporations money at exorbitant rates, or are given cash plus stock in return for selling the company to someone else who will fire half the employees.  When firms lose money, CEO's take multi-million dollar bonuses, and hourly workers are laid off.

We are resigned to hedge fund registration.  We urge you to embrace it, too, as it is now as inevitable as tomorrow's sunrise.  The first problem - and it will be significant - is the manner in which this will be implemented.  Regardless of whether ultimate registration authority rests with the SEC, FINRA, or the individual States, the regulatory agencies do not possess the resources to handle the deluge of paperwork this requirement will unleash. 

If Chairman Schapiro reads this column, we offer the following recommendation.  The registration process should be staged, starting with the smallest firms, and leaving the largest for last.  This is because the largest firms are by and large the most transparent and the most widely watched.  In fact, some of them, such as Fortress, Blackstone and Man Group, are publicly traded.  If frauds are being perpetrated at these institutions, a new registration requirement is not likely to uncover it because guess what? - they are smarter than your people. 

Small operators may not provide increased regulatory fodder, as even truly small hedge funds - those managing $25 million or less - are generally careful about their compliance programs.  But from the perspective of gathering information, the SEC - and we believe it will be their bailiwick - should start with those firms not yet on the radar.  This will create a database that does not yet exist, and it will provide valuable training for examiners, as well as streamlining the process, as the Commission moves up to larger and more sophisticated operators.

Oh, and by the way, those really big hedge funds - the threshold is not yet clear - will be under the new Financial Services Oversight Council, to be constituted of the heads of the major financial and bank regulatory bodies.  Did you guess who is going to be chairing this council?  If you guessed Tim Geithner, you were right.

In the Odds 'N' Ends pail, we are told that government will eliminate systemic risks posed by the Tier I FHCs - firms that are now officially Too Big or too interconnected to fail - but we are not told how this is supposed to be accomplished.  The conflicts inherent in the Ratings Agencies business are left largely intact, particularly the issuer-pay model.  There is to be a new Resolution Authority to take over and wind down failed financial institutions.  But juxtaposed with the new 2B2F status - and the political pressure that is sure to be exerted as the 2B2F's start to teeter - we wonder when this resolution authority will ever actually be implemented.

At the end of the day, we generally agree with the assessment of Joe Nocera in the New York Times (17 June, "Only A Hint Of Roosevelt In Financial Overhaul") "Firms will have to put up a little more capital, and deal with a little more oversight, but once the financial crisis is over, it will, in all likelihood, be back to business as usual."

We note that the banks which, this week, paid back the TARP money to great fanfare were institutions Secretary Paulson had forced to take the funding, so that they might be brought under the accompanying restrictions with respect to executive pay and government meddling in general.  It is thus no big news that Goldman and J.P. Morgan, for example, have repaid the money. They never needed it in the first place.  Is this regulatory smoke and mirrors?  You decide.

Our investment thesis for the New Regulatory Reality: go long lobbyists.

As Yoda might say - Good on paper it looks.

 

 

ETFs: We Don't Want To Say We Told You So...

Well, actually we do.

The Wall Street Journal (16 June, "A Volatile Mix: Natural Gas, ETF") reports "assets in U.S. Natural Gas Fund recently swelled to almost $3.7 billion from about $670 million in February, even sparking fears it could be disrupting the futures market."

For the first time, price movements in ETF shares appear to be affected by trading in the instruments themselves, and not in the underlying index or futures contracts. 

This calls into question the key underlying concept of the ETF model - that the ETF tracks the underlying instruments and is not affected by other ETF traders.  The other piece of news is not new - that the ETF causes disruptions in the underlying markets.  Indeed, this effect has been observed in the past, but generally pooh-poohed by market participants.  Unless, of course, those participants were senior executives of the stocks underlying the indexes on which the ETFs traded.

The ETF has submitted a request to the SEC for substantial new flexibility, asking for a tenfold increase in shares available for issuance.  In the current regulatory climate, we do not look for quick relief from the Commission.

 

Chinese Double-Down

Pretend inferiority and encourage the arrogance of your enemy.

                   - Sun Tzu, "The Art of War"

The China Investment Corp - China's sovereign wealth fund - is publicly talking about making significant investments in Western hedge funds, starting with $500 million in a hedge fund unit of Blackstone.  The Wall Street Journal (19 June, "China Ready To Place Bets On hedge Funds") reports "CIC is considering opening its checkbook to a handful of hedge funds, a move that comes as CIC Chairman Lou Jiwei is concerned his fund may miss opportunities near the bottom of the market, according to people who work closely with the Chinese fund."

Miss opportunities?  Is this the same kind of opportunity that, as the popular saying would have it, is written with the same Chinese character as their word for "Crisis"?  The WSJ article goes on to point out that Chairman Lou has refrained from investing in Western financial institutions because "we don't know what trouble they are in."

Why, then, would they be making these investments now?  To us, the answer is obvious: China has too much of our money. 

In the global environment that spawned the Yekaterinburg summit, it should be clear that China has few trade partners with whom it can swap its vast supply of dollars.  Far from a vote of confidence in the American financial system, this looks like a desperate play by those responsible for China's global investment portfolio.  One can almost hear them, as they turn the billions over to us... "you got us into this mess.  Now get us out!"

 

Worth A Thousand Pictures

From the Wall Street Journal (19 June, "Prison Term for Murder Of Financier").

"A Swiss court sentenced the former lover of French financier Edouard Stern to 8 ½ years in prison for murder after she confessed to shooting him during an argument while the two were having sex and he was tied to a chair in a flesh-colored latex bodysuit."

Almost makes you forget about Iran for a moment...


FINL: Man Alive Deal = No Brainer

It's about time. FINL is finally jettisoning its perennially money-losing 'Man Alive' business for $7mm. I could care less about price at this point. All I care about is that the distraction is gone. This concept worked for only a fleeting moment - unfortunately that was around the time FINL bought and build it. It lost $13mm last year, which nets out to 1 point in operating margin. Does not sound like much until you take into account that the company only had 3.2% operating margins last year. Man Alive hurt EPS by 32% last year. What's funny is that the Street has FINL EPS growing by only a dime over 12 months. But add back the Man Alive loss or $0.15, lower interest expense, and more efficient working capital, and I get to something closer to $0.20. So using the Street's $0.58 next next year as a baseline, this math nudges that closer to $0.78. In that regard, we're still looking at less than 10x EPS for a more focused business with higher incremental ROIC. This name had not been at the top of my list despite my positive stance on the footwear space due to a tougher 2H setup relative to its peers. But even after today's 6% move it's not looking too shabby...

 

FINL: Man Alive Deal = No Brainer - 6 22 2009 10 33 35 AM


Retail First Look: 6/22/09

LOCKED AND LOADED

Am I the only one who feels like the chamber is locked and loaded, and the Retail gun is waiting to shoot - but it simply does not know in which direction?  The group was down less than 1% last week, tightly tracking the broader market after a blistering 40% (2.5x to 1) run vs. the S&P. Yes, the stocks have finally stopped going up on good news, but even with all the incremental data points about how weak sales have been over the past 3 weeks, the group is largely looking through it. At 15.5x forward earnings? That does not leave me in my comfort zone.

 I think the crux of it all is that 'the E matters.' I know I said this last week, so I hate to be repetitive. But after being on the road for a few days one of the dominant themes that came out was that people are - without a doubt - looking into 2010. But don't seem to delineate between companies that are proactively making decisions right now to drive 2010 growth and earnings (UA, RL, PSS, WSM), versus others that are cutting SG&A and Capex for the wrong reasons and will be left with little to stand on in 2010 when they need it most. Those will set up to be the best shorts. I've got my eye on easily half a dozen (WRC, JNY, GIL, Adidas - to name a few) - but it is early. Anyone can print good numbers if they so choose, but at what cost?

 

TODAY'S HAPPENINGS

Key calendar events to look out for.

  • Deutsche Bank - German Austrian Conference, Frankfurt June 23, 2009 - Adidas participating

 

LEVINE'S LOW DOWN

Some Notable Call Outs

  • Embedded in Carmax's first quarter results were some interesting trends.  SUV sales were up 7% year-over-year, rebounding off of weakness last year when gas prices were still very high.  Compacts, mid-size cars, and trucks decreased by 5% for the quarter.  Interestingly, following the Chrysler bankruptcy, residual values and sales volumes on used vehicles remain unchanged.
  • According to the NRF, Americnas spend an average of $130 on Mother's Day gifts compared to $90 for Dad.
  • While Yue Yuen posted solid interim 2009 results owing to stable demand from brand name customers, further consolidation in the footwear manufacturing industry, and strong domestic sales, the company highlighted a 1.6% decline in sales in the first two months of the 3Q. Should top-line results end up down in Q3, it will be the first time in over 5 years, since March '04. 
  • Smith & Wesson management remarked in its updated Q4 results that demand for handguns and rifles remain strong as evidenced in their growing backlog; however, Barron's suggests the FBI's National Instant Criminal Background Check System reveals slowing trends for background checks suggesting fewer gun sales. While there is no doubt that post-election gun demand has fueled earnings growth, the acquisition of Universal Safety Response is critical to diversifying the company's earning streams and should therefore be less effected than it's close competitor Ruger (NYSE: RGR) when demand wanes.  (call at 5pm today)

 

MORNING NEWS 

ZachHammer's overview of items you're unlikely to find in the general press.

  • Changes in the bankruptcy code have complicated the quest for retail reincarnation - and the evaporation of financing in the past nine months has made it even harder. Since the rewriting of the bankruptcy law in 2005, debtors are in a race against time with a 120-day period to file a plan of reorganization (and the possibility of a 180-day extension) where debtors have an initial 120-day period to assume or reject leases. Previously, there were unlimited extensions to both time periods, as well as more lenders ready to work with the debtors. So now retailers have to make business decisions as soon as they file, and often don't get the chance to operate through the crucial Christmas selling period to determine if they've made the right decisions. If one isn't likely, they've usually pushed for a liquidation, Gottlieb said. Just ask Steve & Barry's, Mervyns and Gottschalks. <http://www.wwd.com/business-news/>
  • The German state of Bavaria has agreed to grant financial aid to the struggling Quelle catalogue business, a subsidiary of the insolvent Arcandor Group. Bavaria agreed to contribute 21 million euros to a planned government guarantee of 50 million euros, or $69.5 million. Quelle currently lacks the funds to print its fall-winter catalogue and to secure orders; Bavaria's 21 million euros would cover the catalogue costs. <http://www.wwd.com/business-news/>
  • Carrefour to Sell or Close 20 Express Stores in Poland, Parkiet Reports - Carrefour SA, Europe's biggest retailer, plans to sell or shut more than 20 Carrefour Express stores in Poland, Parkiet reported, citing Maria Cieslikowska, spokeswoman at Carrefour's Polish unit.  <http://www.bloomberg.com/news/industries/consumer.html>
  • Footwear News, total 2008 pay packages for the highest-paid footwear executives rose 13 percent in 2008, though at a slower pace than the prior year's 14 percent growth. On average, management at the 26 publicly held retailers and vendors tracked earned total pay packages of $3 million last year versus $2.6 million in 2007. The increase was attributable to employment contracts put in place years ago, when business was brighter, guaranteeing their 2008 salary. <http://www.wwd.com/footwear-news/ceo-compensation-what-they-made-2181827?navSection=footwear-news>
  • Sperry Top-Sider's famous boat shoe is celebrating its 75th anniversary in 2010, but executives at the brand are hoping a strategic growth plan will drive sales far beyond next year. Sperry has spent the last 18 months expanding into new markets, introducing new performance technology and growing the women's mix. More specifically, the brand has solidified product and marketing in three areas: American Original, Authentic Performance and Enduring Style. <http://www.wwd.com/footwear-news/ceo-compensation-what-they-made-2181827?navSection=footwear-news>
  • A growing number of footwear brands are committed to "greening" their products, but with an increasingly fractured supply chain, guaranteeing the sustainability of every component, process, and source is no easy feat. Earlier this month, environmental watchdog group Greenpeace released a report (covering 2005 to date) saying that illegal hides were making their way into the footwear supply chain - and mentioning Adidas, Gucci, Nike, Timberland and Clarks as potential, possibly unwitting end users. The report, "Slaughtering the Amazon," alleged that some leather sourced from Brazil originated on illegal cattle ranches in the Amazon rainforest that contribute to deforestation.  <http://www.wwd.com/footwear-news/ceo-compensation-what-they-made-2181827?navSection=footwear-news>
  • Erke, the Chinese tennis apparel company, has reached an agreement to become the designated apparel supplier for Shanghai ATP 1000 matches during 2009-2013. The Shanghai ATP Masters 1000 tournament, which will occur around October each year, is second only to the world's four Grand Slam tennis tournament and regarded as the top tennis tournament in Asian region. <http://www.sportsonesource.com/>
  • Spending, Home Sales in U.S. Probably Rose as Consumers Gained Confidence - Consumer spending in the U.S. probably rose in May for the first time in three months and home sales increased as Americans became more confident the recession will end this year, economists said before reports this week. <http://www.bloomberg.com/news/industries/consumer.html>
  • Kurt Geiger has inked a licensing and distribution deal with US footwear firm Nine West just one month after the US firm severed ties with its former UK partner Shoe Studio Group. <http://www.drapersonline.com/>
  • Skechers recently ran a variety of display advertisement campaigns. It opts to use the services of ad networks to place ads on thousands of sites aggregated by the ad networks across the Internet. For this select group of campaigns, Skechers achieved a 283% return on ad spend, $2.67 million in revenue and 172 million ad impressions. <http://www.internetretailer.com/dailyNews.asp?id=30868>
  • Traffic falls or is flat at top three home and garden retail sites in May -It seems fewer consumers spent time and money cultivating their lawns and gardens in May. As a result, the top three home and garden e-retailers cultivated poor traffic numbers last month. <http://www.internetretailer.com/>
  • Product sales of the 2009 NBA Champion Los Angeles Lakers have surpassed previous championship merchandise sales at New York City's The NBA Store and NBAStore.com. Lakers' product sales more than doubled last year's sales within the first two days after the team won its 15th title, reported the retailer. Meanwhile, adidas and Wheaties have introduced a special-edition Lakers champions T-shirt, featuring a picture of the commemorative box with the entire Lakers' team. <http://www.licensemag.com/licensemag/Sports/Lakers-Merchandise-Sales-Break-Record-Wheaties-Tee/ArticleStandard/Article/detail/604760?contextCategoryId=9996>
  • Ahmedabad, India (popularly known as the city of textile industries) has become a robust retail destination quite recently with the launch of five malls in quick succession. The city has also been witnessing a series of infrastructural development and has already emerged as one of the most promising cities in the country in terms of economic prosperity. The city formally witnessed organised retail boom with the launch of 3.24 lakh square feet Gallops Mall, followed by Himalaya Mall and the trend is enhanced when 4.5 lakh square feet Iscon Mega Mall on SG Highway opened its door for brands including Tommy Hilfiger, Giordano, Esprit, Westside, Benetton, Wills Lifestyle, ColorPlus and Reliance with Mega Mart as one of its anchor tenants, the shopping behaviour of the local residents are getting transformed.  <http://www.indiaretailing.com/news.aspx?Id=3895&Topic=2>

 

RESEARCH EDGE PORTFOLIO: (Comments by Keith McCullough):

XLY

06/19/2009 10:33 AM

SHORTING XLY $23.21

My team has done plenty to signal our turning negative on consumer in the last week. Being patient on price was my responsibility. Selling high today. KM

 

THIS WEEK'S COMPANY CALENDAR:

Retail First Look: 6/22/09 - Calendar


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