Retail First Look: 6/23/09


 Several key International happenings overnight in the apparel/footwear retail industry...but the most notable is added rhetoric out of India on keeping up with recent moves by China to lower VAT (taxes) and/or increase rebates for Indian textile manufacturers in an effort to stimulate both production and exports. This supports one of our key themes headed into 2010, though the interesting twist is that China is largely a footwear play (where 86% of US footwear is manufactured), but with India joining the game, this scales up the impact for apparel as well. Not all will win, as we've been highlighting - and mark my words - some will lose big time. Though this datapoint helps solidify that this is a theme that absolutely can't be ignored. I still think the impact will be far greater than what is currently being quantified (for those that are taking time to do the math).



Some Notable Call Outs

  • The streak is over! Monday marked the first day that gas prices declined, reversing a record 54 day streak of increases. 
  • European M&A following US? Mario Moretti Polegato, through his investment vehicle LIR, has entered into an agreement to acquire Diadora S.p.A. from Geox SpA. Both Polegato and Diadora are based in Italy.
  • Furniture makers in Bangladesh on Monday urged the government to withdraw the proposal for increasing VAT on furniture products in the budget for the FY 2009-10 to 15% from 4.5%. 
  • According to Reliance Retail India, Sr. Executives of Pantaloon Retail India Ltd sounded positive about the business. "Consumer demand has picked up sharply in the last two weeks, and the company has various alternate funding plans to expand its business."
  • Bata India, the subsidiary of the Switzerland based Bata Shoes Organization, has appointed Promodome Communications as its creative and media planning and buying partner. The decision follows a multi-agency pitch which saw incumbent creative agency Saatchi & Saatchi and media agency ZenithOptimedia miss the cut. [Note: any short portfolio that tracked changes in consumer products' ad agencies over the ensuing 12-months would have meaningfully outperformed over the past 10 years]. 
  • More weather woes through the weekend. There's no question that by the time June is complete, the weather will have impacted seasonal apparel sales. In particular, the northeast region is now on track to be the coldest in 27 years and one of the wettest June's on record. Couple the weather with the most difficult comparisons we have seen in a year and June is setting up to be a tough month for most retailers. There are little signs of heavy discounting to clear goods at this point, but we expect markdowns to pick up soon the keep inventories clean.



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

  • Pakistan is set to give its struggling textile industry a major financial boost to aid its ailing textile industry with a policy to be introduced next month that will mirror their regional competitors.  China gives a 17% rebate to its textile exports and India gives between 8% and 9%.  Pakistan's textile industry needs the support after exports fell by 7% between now and last year.  Pakistan is the world's fourth largest producer of cotton, but is only the 12th largest exporter of cotton products. Fifty percent of the country's cotton exports are value-added products, but most are at the lower end of the price spectrum, while the rest is raw cotton, yarn or greige fabric, he noted. <>
  • China's decision to direct stimulus spending toward domestic products first, after months of complaining about a U.S. policy of the same nature, could spell further trouble for trade relations between the two nations as concerns rise about protectionism amid the global economic downturn.  China's $587 stimulus packaged has a clause directing spending on domestic goods and services and not imports.  China has ridiculed the US since February for encouraging its consumers to buy domestic with the American stimulus package. <>
  • Indian retail companies in the organized retail sector want the government to take a series of initiatives in the forthcoming budget that would boost consumption and have sought 'industry status' as well as abolition of the service tax to beat back the slowdown. Vishal Retail group president Ambeek Khemka said that besides granting industry status to the sector, the government should allow FDI into multi-brand retailing and announce some special sops for the sector.  "There should be less restrictions on the retail sector and the government should grant it industry status. It's a very big sector and a major employer," he said. Only a small portion of the retail sector is organized and falls under the purview of local laws. Khemka also said the central service tax should be abolished as it is having a negative impact on the sectors profitability. <>
  • Furniture makers Monday urged the government to withdraw the proposal for increasing VAT on furniture products and at the same time recognize furniture production as a manufacturing sector instead of service sector. Chairman of Bangladesh Furniture's Industries Owners Association (BAFIOA) KM Akhtaruzzaman said budget for the FY 2009-10 has proposed 15 per cent VAT replacing existing 4.5. <>
  • Online Brands Turn to Traditional Ads - Kayak is among a handful of online brands, including and, that are now seeking traditional agencies (and offline tactics) to create mass awareness and define more broadly what they do. Zappos and Amazon, for example, are frustrated that many consumers don't know that they sell more than shoes and media content, respectively. And while online efforts, including paid search ads, are part of the answer, they are clearly falling short in the eyes of companies with ambitious growth plans and money to spend.
  • In an RFP Zappos issued two weeks ago, the Las Vegas-based company said it was seeking "traditional mass advertising (print, TV, OOH, etc.), online advertising (brand awareness, co-op partnership development), grassroots/word-of-mouth and social media." And this month Amazon launched an online contest to solicit potential TV spots from consumers. <>
  • Saks Chief Cuts Orders to Avoid Discounts on Stiletto Heels, Men's Suits - Saks Inc., Neiman Marcus Group Inc. and other luxury retailers are reducing orders this year to limit supply and boost profitability. <>
  • The European Confederation of the Footwear Industry named Vito Artioli as president of the organization. Artioli was previously the president of the Italian Footwear Manufacturers' Association. Artioli said he would pursue compulsory labeling for products that come from outside the European Union,  investigate  into trade practices carried out by China and Vietnam, and work toward geographically expanding the European Confederation of Footwear's membership base. <>  
  • The ESCADA Group, an international fashion group for women's apparel and accessories, reported a weak first half of the year and a negative outlook ahead.  Sales for the first half of the year were down 24% (Europe -27%, North America -31%, and Asia -19%), and down 33% for the second quarter of 2009.  Gross profit declined 260 basis points from moderate price adjustments.  SG&A declined from cost cuts by 2.4% for 1H 09 and 4% for Q2 09. The company sold the entire PRIMERA segment (comprised of the apriori, BiBA, cavita, and Laurel labels) earlier this year.  ESCADA Group cited an OECD economic report that claimed the economic output of their targeted countries would decline by 4.3% this year.  ESCADA, a German based company, expects Germany to shrink by 6% in 2009 and destabilization until 2010.  ESCADA Group's largest losses come from the US and Russia where consumers are trading down from the luxury good industry.  Other events that occurred in 1H 09: appointed a Chief Restructuring Officer, improved the liquidity situation, sold their 40% stake in the fashion distributor Schustermann & Borenstein GmbH, prematurely terminated ESCADA's New York 5th Ave Flagship, and cut jobs and expenses. <>
  • Hong Kong-based global consumer goods exporter Li & Fung Limited is enhancing its supply chain management capabilities with a revolutionary portal to support its extensive supplier network. Provided by ecVision, Li & Fung has deployed a supplier portal that will be used by vendors and internal sourcing teams as they collaborate on global supply chain management and shipment tasks. The web-based, role-based application serves as a common platform to standardize trade and customs documents, consolidate shipment data, and provide a means of collaboration between the vendors and the agents. With its extensive global presence, Li & Fung operates a sourcing network of over 80 offices covering over 40 economies across North America, Europe and Asia. <>
  • Isaac Mizrahi, known for his products lines ranging from Target to Liz Claiborne, is turning a renovated brownstone in New York into a showcase for his own Isaac Mizrahi New York collection. The 1500-square-foot store, on East 67th Street between Madison and Fifth Avenues, is the designer's first freestanding store and will showcase his accessories, shoes and sportswear.
  • German shopping center developer Management für Immobilien AG (Mfi-Group) has emerged as a second potential candidate to take over some of the 90 insolvent Karstadt department store doors. But the Essen-based group denied reports it is actively pursuing plans to bid for any of the Karstadt properties. <>
  • Marks & Spencer will start the search for a new chief executive in September, making it likely that executive chairman Sir Stuart Rose will leave the company early next year, according to The Sunday Times. The newspaper reported that M&S had been inundated with calls from headhunters looking to win the search contract to find Rose's replacement. It added that M&S planned to start the search after the summer which was likely to mean Rose was almost certain to leave a year earlier than the previously agreed to 2011. <>
  • A survey of 1,067 consumers ages 18 to 65 by Chicago-based market research firm Information Resources Inc. found: Seventy percent reduced clothing purchases, with 56 % saying that they will do so in the future, 60% wear clothing multiple times before washings to save on cleaning costs and 30% said they will continue to do so, 82% wash laundry only when they have full loads and 60% plan to keep doing that, and 51% repair clothes by sewing and patching them. <>
  • Kitson is ratcheting up its global footprint with store plans for new units in Tokyo, with the first opening Sept. 6 in the Harajuku area and the second in March 2010 in the high-end Omotesando district. Under a licensing agreement, all of Kitson's stores in Japan are owned and operated by Itochu Corp. Kitson founder Fraser Ross said he is in talks to open boutiques in China, South Korea and Singapore, possibly in the next year. <>
  • Following up on its successful collaboration with "Sesame Street," Boston-based New Balance has partnered with licensing and syndication firm United Media to create a line of co-branded children's sneakers based on the popular comic strip "Peanuts," penned by the late Charles M. Schulz. The launch will hit stores in October and initially feature three versions of New Balance's heritage running shoe, the 574, that bring to life three of "Peanuts'" most popular stories: "It's the Great Pumpkin, Charlie Brown;" "A Charlie Brown Thanksgiving;" and "A Charlie Brown Christmas." All three sneaker styles will be available in infant, preschool and grade-school sizes. Retail prices will range from $38 to $60. <>
  • W.L. Gore & Associates, which works with apparel, outerwear and even architectural fabrics announced that footwear will be its focus, aggressively expanding from rugged outdoor footwear into new categories. To do it, the company has partnered not only with the brands it supplies (including The North Face, Nike, New Balance, Ecco, Merrell and Salomon) but with the entire manufacturing chain - and it is seeking to bring its partnership model to more retailers, factories and brands. <>
  • German Consumer Confidence Rises for Second Month on Outlook, Price Drop - German consumer confidence rose for a second month as the economic outlook brightened and retreating prices boosted household purchasing power. <>
  • French consumer spending fell by more than expected in May, underlining worries about fragile domestic demand but business morale ticked up in June
  • Carrefour Gains Most Since April on Report Costs to Be Cut by $2.8 Billion - Carrefour SA, Europe's largest retailer, rose the most in more than two months in Paris trading after Le Figaro reported that the company is planning annual cost savings of 2 billion euros ($2.8 billion) by 2012. <>



 Retail First Look: 6/23/09 - 1 


Retail First Look: 6/23/09 - Calendar

Broke Down Engine?

"Feel like a broke down engine, aint got no driving wheel"
 -Blind Willie McTell
The World Bank's annual Global Development Finance report issued yesterday provided a grim assessment of the near term situation including estimates of a 2.9% decline in global output, a 10% contraction in world trade and a projected decline in private capital flows from $707 billion last year to $363 billion for 2009.  It wasn't the bad news in the report for this year that really spooked investors however, but rather the diminished expectations for recovery in 2010 -with a new global GDP growth forecast of just 2% and a predicted contraction for the developing world, excluding China and India. In short, the World Bank's annual report failed to identify any catalyst that could drive growth rates to pre-crisis levels over the next 24 months. Not a "V" recovery on the horizon, not even a "W" recovery, just a great big capital L for the next several years.
For our portfolio, yesterday was an unwelcome stress test as our commodity, energy and international long positions were pummeled by waves of selling. Yesterday's broad market action felt like an inflection point when short term consensus shifted focus from inflationary to deflationary concerns and the safety trade returned in a concentrated form: with treasuries and the Dollar as the only safe haven left for the timid.
While the market reaction to the World Bank's conclusions caught us off guard, we expected their argument. With conservative estimates drawn from rear view mirror observations, the data they released was hard to challenge but their conclusions were not. We are not joining this dash for the exits trying to stay ahead of a cyclical asset class shift, but rather are remaining firm in our convictions that the fundamental facts have not changed, and are as comfortable with our strategic convictions now as we were in January -before the 60% and 30% rise in the Shanghai Composite and the Bovespa respectively made our Q1 call consensus.  
Chinese data continues to support our thesis. With Q1 GDP still registering above 6% growth, Industrial production levels rising back towards double digits, imports of base metals and coal showing resilience,  new ground breaking daily on infrastructure projects and domestic consumption for durable goods from cars to laptops -Chinese internal demand measures continue to expand across the board. This weekend Premier Jiabao pledged to continue to pump more liquidity into the system, showing that Beijing continues to be willing to put their money where their mouth is and take risks to drive internal demand expansion.  
A fresh report released by the National Bureau of Statistics, written by Guo Tongxin, even tackles the omnipresent concerns over Chinese data quality, presenting greater transparency of the inner workings of Beijing's accounting process -not a fix by a long shot, but a promising start.  And, by the way, while the Chinese may make up their numbers, so do we!
Make no mistake: Chinese demand can't save the whole world on its own, but like the proverbial butterfly wings that drive hurricanes a thousand miles away, demand from "The Client" continues to be felt throughout the global supply chain.
Not that we dismissed all of the World Bank's conclusions entirely. The argument for a longer recovery period for weaker emerging economies seemed spot on to us -as long time readers know we have never bought into the emerging markets craze and have remained skeptical of the prophets of profit who espouse "frontier economies" from Ghana to Kazakhstan.
We diverge from their thesis on demand from the "developed portion of the developing world" if you will. As such, we continue to see growth prospects that can jump start global demand in the major Asian economies ex-Japan, combined with the smaller markets that stretch along the supply chain connecting them all the way back to commodity producers like Australia -which has thus far managed to avoid recession, and Brazil -which although challenged by commodity dependence continues to navigate the choppy waters with pragmatic leaders and significant room for policy loosening.  Furthermore, since all of this will occur inside a central bank sponsored free money vacuum, we expect this resurgent demand will drive inflationary pockets inside the global commodity matrix and drive rates higher ahead of policy shifts during the fourth quarter of this year.
As such, we won't be anchoring on one report from the World Bank. While our longs hurt us yesterday, our shorts made us money and we have better things to do than sit and sing the blues.
Andrew Barber

MCD - Nearly Free Food

The level of discounting is truly amazing and it's everywhere!


(1) The McDonald's Family Restaurants of Greater Baltimore are proud to offer customers a FREE McMuffin or Biscuit breakfast sandwich with the purchase of any McCafé Coffee from June 22 - 28, 2009.


(2) McDonald's restaurants are giving their Southwest Florida customers some financial relief Thursday as they can purchase a second Big Mac sandwich for 25 cents after buying the first one at regular price. The offer is valid from lunch to midnight.


How are BKC and WEN going to get same-store sales in this environment?

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Historically, gas prices have been a highly significant driver of same store regional gaming revenues.  We have expounded upon this relationship in our 06/29/08 note, "GAS PRICES AND THE ECONOMY DO MATTER", and several other posts since then, including "REGIONALS: DISCERNING A TREND" (06/18/2009).  For regional gamers, every 1% y-o-y change in gas prices results in an inverse 0.15% change in same store gaming revenues, holding all other factors constant.  In thinking about organic growth in regional revenues, it is necessary to focus on the trend in gas prices.

Despite the estimated benefit from the significant y-o-y drop in gas prices in 2009, same store revenues for the regional gamers have been negative in every month since January.  The 40% decline in gas prices through May 2009 may be masking worse fundamentals than the numbers are suggesting.  So the question is to what degree were the less bad numbers we saw come out of regional gaming a result of the nose dive in gas prices?

According to our calculations, the 40% y-o-y decrease in gas prices through May 2009 has had a 6% positive impact on same store gaming revenues.  YTD same store gaming revenues through May 2009 declined by 3%, implying that if not for the gas tailwind, gaming revenues could have been down 9%.  Note the chart below.


Looking at spot prices today at $2.72 implies a 30% y-o-y decline in gas prices in 3Q09, resulting in an estimated 4% positive impact on same store gaming revenues.  However, the tailwind turns into a potential headwind in the fourth quarter of this year, as the y-o-y comparison for gas prices turns negative, leaving the regional numbers to reflect a more true demand level without the mask of the fuel benefit.

As can be seen in the chart below, gas prices have spiked dramatically in the last two months.  It remains to be seen what the "sticker shock" impact will have resulting from the sequential change in gas.


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

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%