Greek Goddess of Duration


Greek Goddess of Duration


You might think I am nuts, but I'd call this an in-line quarter. Puts and takes ignore the real call - but that's a full year out. If the market shoots first and thinks second, a sell-off might = opportunity.


I'm sitting here staring at my keyboard wondering what to say about Nike's quarter. The sell-side will talk about how 'management is executing in a tough retail environment' (while Analysts take down numbers and justify ratings), or that we are in a 'swoosh-shaped recovery'.  But I'm coming up dry. You're gonna think I'm nuts, but despite management's cautious tone and guidance, I really think that this Q was right in line. Yes, NKE beat by a couple pennies, and yes, the numbers Nike is printing in light of 1) its reorg and 2) the economy are commendable. But on the flip side, orders are down both sequentially and yy nearly across the board. Inventories have stopped rising, which is great, but receivables and payables went the wrong way. The balance sheet still looks stellar, but not buying any stock in the quarter is a negative.  Put, take, put, take...blah blah... I could go on, but these items add up to one big push in light of what the REAL call should be.


I'm going to tie this all back into my thesis that with Nike, we're in a period where you simply can't look at a few points either way in inventories, futures or EPS. It's pretty irrelevant in the grand scheme of this story. Nike is setting itself up today for one of those massive bursts where futures take off, inventories contract, and we're looking at 20-30% EPS growth. The bad news is we won't see this until fall 2010. Even if the market starts to discount this 2 quarters out, we've still got to wait a year.  Check out my note from 2 days ago titled 'Duration, Duration, Duration.' If you can be a year early on a stock, then knock yourself out here. But my sense is that we're looking at a range bound name for the better part of a year. I walk through why in my 'Duration' note.


What could change near-term?  The Street may or may not know. But Nike's CFO just sandbagged them big time. If we're looking at $0.20-$0.30ps reduction in consensus estimates heading into lowered 1H10 (May) guidance, then I'd be prepared to be nimble on this sucker if it sells off into the mid $40s.

CKR - Is Management Changing its Tune?


In today’s FY1Q10 press release the company made a very significant announcement about a potential value initiative.  Please see today’s post on SONC as a case study on the P&L impact when a company goes after a value initiative.

CKR’s period 5 same-store sales declined 7.1% at Carl’s Jr., accelerating the 2-year average declines at the concept to -2.3% from period 4’s -1% and fiscal 1Q10’s -0.6%.  The company blamed the weak California economy and the lapping of last year’s stimulus check spending for softness in sales.  Although these factors most definitely impacted numbers, Carl’s Jr.’s same-stores sales continued to underperform its QSR peers that are facing the same issues.  Carl’s Jr.’s underperformance stems from the company’s adherence to its premium menu strategy.  CKR’s recent press releases are loaded with comments like “not resorting to deep discounting practices designed to boost same-store sales in the short-term” and being “prepared to ‘tough-it-out’ to protect brand image.”  This premium brand focus, however, has not worked and sales have suffered as a result.  Like SONC said yesterday, value is the number one driver of traffic in this environment.

CKR announced last quarter that it would add some lower priced products to its menu but that it would not use media support for these lower priced items.  In today’s quarterly earnings release, the company said it “intend[s] to launch initiatives that increase the awareness of the value of our premium products relative to casual dining as well as our existing value items that we have previously only promoted in the restaurants.”  The key word in that sentence is "previously" as it signals that the company will begin to promote these value items outside the four walls of its restaurants.  Although I am sure the company will downplay the significance of such a change in strategy as management seems proud of its having not succumb to the deep discounting tactics of its competitors, this is a definite change in strategy, and a welcomed change as Carl’s Jr. significant same-store sales declines are evidence of recent share losses.  Too much focus on value could hurt margins, but not getting enough customers in the door will have the same impact.  The question is will management change its strategy enough to really drive traffic?

CKR - Is Management Changing its Tune? - CKR Carl s Jr Period 5 sales


BBBY: One Word...'Solid'

One word: Solid


Ok, a few more words...


BBBY reported 1Q EPS of $0.34, substantially ahead of the Street which was looking for $0.25.  Our model was looking for $0.27.  The beat came on all three key line items.  First, same store sales came in at only down 1.6%, about 80 bps ahead of the Street.  We were looking for down 2%.  Gross margins were much better than expected, down only 44bps vs. our model which had them down 80bps.  Sequentially the performance was better than 4Q. This further indicates the real opportunity in the near term from the Linen's liquidation still lies with a more benign promotional environment and fewer coupons.  SG&A was much better as well, with the expense ratio down 163 bps.  We were modeling a slight decline.  Finally, the balance sheet was solid with inventories down just over 1%, against total sales that grew by 2.8%.  Still no debt and a growing cash balance now standing at $855 million.  With almost $900 million remaining in share repurchase authorization, perhaps we'll see some activity there as the cash generation accelerates.


Bottom line here is solid outperformance with all of the key metrics coming in better than expected.  I still believe there is more upside to come as the year progresses and the couponing subsides.  To report a down 1.6% comp in what most would consider a very tough environment for home-related products is a standout on its own.  EPS growth of 14% is also a rare commodity these days.


 Our thesis here remains unchanged.

  • Over the next 12-24 months BBBY is a "mean revision" story, driven by an improving economic backdrop, the elimination of the company's most direct competitor, and the bottoming of the worst period in modern history for home furnishings consumption.
  • Gross margin recovery is the most overlooked item by the Street and the source of upside over the near and intermediate term. A more rational promotional environment driven by Linen's absence is key to the story.
  • Modest square footage growth of 5% coupled with operating margin recovery should drive FCF growth in excess of 15% over the next 2 years. Cash flow yield remains attractive at 6.1% ('09) and 9.0% ('10) respectively.
  • Multiples are full, so this needs to be an earnings-driven story. The good news is that the Street's numbers are 1-year behind. $0.25-$0.30 beat per Yr1 and Yr2  x current multiple = $5-$6 in share price/yr.


Eric Levine


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Export data released by the Japanese customs office today showed a decline of 40.9% year-over-year, lower than consensus estimates and a sequential decline from last month's figures.


Critically, May exports bound for China registered under 5% of Total exports -the lowest percentage in over 20 years. Although the Japanese auto manufacturers and other durable goods producers are participating in "the client's" recovery financially through joint ventures, the reliance on higher margin North American and European markets continues to keep domestic assembly lines stalled.

With job security still weighing heavily on domestic consumers and nowhere for rates to go but up, we continue to see Yen weakness as the sole near term positive catalyst for Japanese manufacturers as they grapple with stagnant customer markets.

Andrew Barber


Liquidity Abounds!

Today the ECB announced it will offer 442 Billion Euros of 12-month loans to banks at the current Euribor rate of 1.57%.

This is a massive issuance with a minimal rate of interest! In context it's equivalent to one third of all sovereign issuance in the Eurozone this year, and should go a long way to unlock European credit markets. Since October 2008 the ECB has lent to banks for terms of 6 months against eligible collateral; yet this new issuance is a sizable boost. 

Today was the first of three auctions scheduled for this year, with the others set for September and December. The increase in lending is bullish for European recovery, which the Central Bank has forecast to decline 4.6% this year before returning to mild growth next year. We'll be monitoring the extent to which these monies reach Main Street. Should mortgage rates compress it could significantly improve the consumer's health.  Despite increased business and consumer sentiment readings from Europe's largest economies (German, France, and Italy) retail sales and exports -as well as home prices and sales, are at depressed levels with little signs of sequential improvement across most of Europe. 

We've had a bearish bias on Europe generally but have strategically traded European countries from a fundamental and quantitative set-up this year as we anticipate greater divergence between the major EU economies as the global recovery process continues to drag on. We're currently short Italy via the etf iShares EWI and have recently traded the Swedish and German markets on the long side, and the Swiss market on the short side.

Matthew Hedrick


While Jack-in-the-Box is outperforming some of its competition (Carl's Jr.) on a same-store sales basis, it's underperforming the industry-behemoth McDonald's.

Generally, I like the direction management is headed by concentrating on the core business by selling underperforming, low return assets. While it's not new news that JACK has agreed to sell 55 of its 61 Quick Stuff convenience stores and gas stations, it is a statement as to where management is taking the company. The re-franchising strategy is also a long-term net positive, but the dilutive nature of each transaction is less of a positive.

The biggest negative for JACK has been the rapid growth in capital spending over the past two years, which has contributed to the decline in JACK's return on incremental invesed capital (ROIIC). Over the past two years capital spending has grown 10% and 16% faster than revenues, respectively.


Management doubled its new Qdoba company-operated openings in 2008 just as same-store sales started to slow. The company plans to increase Qdoba company openings to 30-40 per year from its prior 10-15 run rate (21 in FY08 and 25 planned for FY09). In this environment, it's unlikely that the company will get paid for an accelerating rate of growth. With Chipotle growing at 125+ stores a year, the heat in on Qdoba not to fall too far behind, a situation that is not necessarily good for shareholders.

The company is increasing its Jack in the Box company openings in FY09 at the same time it is accelerating the refranchising program. Increasing company new unit development is clearly inconsistent with the company's refranchising goal of operating less company restaurants.
The company has attributed part of the increase in capital spending each year since at least FY06 to its ongoing reimage program at Jack in the Box so it is spending incrementally more on these reimages each year. In FY08, the capital spending increase was also attributed to a kitchen enhancement program at Jack in the Box (a program to increase restaurant capacity for new product introductions while reducing utility expense using energy-efficient equipment) and the purchase of smoothie equipment.

While these non customer-facing initiatives, such as the kitchen enhancement program and the purchase of smoothie equipment, are important, they do not typically generate incremental returns. Based on my estimates, with the number of new company units coming down in FY08, these non customer-facing initiatives grew as percent of overall capital spending at the same time capital spending grew 17% YOY, thereby explaining the decline in returns. The company plans to maintain the same level of capital spending over the balance of FY09 but with new company unit growth accelerating in FY09 relative to the prior year and the kitchen enhancement spending wrapped up in FY08, a greater level of the spending should be allocated to more customer-facing and typically higher return initiatives.

The real turnaround in returns could come in 2010. The company's exterior reimage program is expected to be complete by the end of fiscal 2009 and the interior reimage program finished by 2011 so the level of capital spending associated with these reimages should be less going forward. If the company keeps its new unit growth in check and more prudently manages its capital spending, cash flows can be redeployed to shareholders, thereby providing a positive catalyst for the stock.


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