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Chinese Stocks: What Are They Telling Us about the Olympics?

Chinese stocks continue to be under heavy selling pressure, closing down another -2.8% overnight, taking the Shanghai Index down to 2931, which is -54% from the October 07' highs. When we read the South China Morning Post in the mornings, we continue to observe local Chinese sentiment as nothing short of alarming.

I do not see any support for this Index until the 2759 line, but that's really focusing on the tree. The forest remains what big news is this stock market discounting? Since the Chinese clearly have inside information that most US centric investors do not, we need to be focused on this question, particularly ahead of the Olympics in August.

In my investment models, managing risk is about managing tail risk. We are not in the heart of the bell curve of normal distributions here anymore. China's stock market crash is signaling a major problem, and we have our Eyes on it.

(chart courtesy of stockcharts.com)

STAGflation facts continue to emerge, but remain misunderstood...

While the Street is rightly focused on the Producer Price Index this morning, I think that the US Industrial Production report needs to be considered as well. The two reports combined, provided a direct path to the same fundamental conclusion we were beating on in our morning call note - Stagflation.

The PPI report came in well ahead of already elevated consensus expectations at +7.2% year over year headline inflation. Meanwhile, the May Industrial Production report missed expectations, coming in light at -0.2% for the month versus the Street expecting another positive #.

While US growth has not slowed (on a reported basis) yet in Q2, that has not been my call. My call is for stagflation to emerge as we exit Q2 and enter Q3.

Many Wall Street economists are calling for a Q3 "recovery". That's a hope, not a process oriented conclusion.

(picture courtesy of: http://www.thevicenarian.com/wp-content/uploads/20070413_money_grip_2.jpg)

Goodbye Goody's

It's funny to me that for so long, so many of us would walk the retail landscape and occasionally ask why does XYZ brand/retailer need to exist? Despite those questions, so many marginal brands and retailers managed to hang in there with enough operating cash to service their lease obligations and sustain a fairly miserable existence. Many investors came to (falsely) believe that these entities were like cockroaches - they simply could not be killed.

Well, that was in an easy margin environment for this industry, and an easy credit environment for both strategic and financial buyers. Guess what guys...now we're in something called a bankruptcy cycle. These marginal players can, and will go bankrupt. Goody's is one of the first to file (after Linen's n Things and Sharper Image) but certainly won't be the last.

There are some interesting trends in going through the list of creditors - which Goody's filed as between 25k-50k. The biggest is Levi Strauss at $9mm. Lee is rather meaningful at $4.7mm - though this is only $0.025 (half a percent) per share for parent VF Corp. Skechers' exposure is surprisingly high at $1.9mm ($0.027 ps, or 1.5%), and Jones Apparel Group is about $2.5mm ($0.02 ps or 1.5%).

One of the more notable points is that out of the 30 companies listed as creditors, I've only heard of 8, and my extremely hip interns have only heard of 5. Goody's is not exactly a fashion mecca, but clearly the major vendors saw this coming. It's a shame Wall Street did not see the same.

PS: Note the snapshot from the Goody's website below. The promotional code for the extra 50% discount is TNT (i.e. Boom). Seriously, I'm not making this up.

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MCD - The Stress is Emerging

In February, McDonald's gave away its McSkillet Burrito with the purchase of any medium or large drink for two days. In April, an internal memo urged franchisees to cut the price on its 32-ounce soft drinks to $1 in some markets, and on May 15, its newly launched Southern Style Chicken Sandwich/Biscuits were free with the purchase of any medium or large drink. And everyday, there is the Dollar Menu.

Today, Crain's reported that a panel of MCD's owners that sets national advertising for all 14,000 U.S. restaurants is resisting the company's plan to give away more chicken sandwiches in August as a result of rising food costs. The article highlights the issues that can emerge within the typical franchise business model when the franchisor (McDonald's) puts driving sales, on which it collects a royalty, ahead of franchisee (85% of MCD's U.S. system) profitability.

I have written extensively about the issues surrounding the Dollar Menu and how it is impacting franchisee's bottom lines and now these same problems are surfacing around the company's recent promotions. Ed Bailey, who owns 60 restaurants in Texas, said, There is no question the tension is greater now than it has been in some time. He estimates that the May 15 Southern Style Chicken giveaway cost franchisees about $600 per restaurant and that despite a 7% increase in sales last year, his profits were relatively flat due to higher costs.

The article also states that food and paper costs are expected to increase $32K-$35K per restaurant this year and the franchisees (again 85% of the system) are absorbing the brunt of these rising expenses. Another MCD owner with five locations in Oklahoma said that in voting against a second chicken promotion in August that franchisees aren't pushing back but rather making an intelligent business decision.

At the same time franchisees are facing pressure on the bottom line, they are being told to invest their own capital in the infrastructure necessary for the company's extended beverage platform...so as I have said once before regarding MCD's U.S. system, where there is smoke, there is fire!

MCD- Grass Roots Southern Style Chicken Biscuit Survey

We have done another proprietary grass roots survey on the state of breakfast product launches. This latest survey focuses on customer reactions to MCD's new Southern Style Chicken Biscuit breakfast sandwich, which was launched in May. We surveyed over 89 MCD locations across the U.S. The following conclusions can be made from the survey data:

(1) The stores generally indicate the new breakfast sandwiches are well received.
(2) Adoption of the Chicken Biscuit in the Northeast appears to be behind other regions.
(3) A few locations indicated confidently that some customers had tried the sandwich because of the promotion offering a free Chicken Biscuit with purchase of a regular drink, but had continued to purchase it after the promotion ended.
(4) The results were mixed as to whether the Chicken Biscuit is bringing in new customers versus cannibalizing other sandwiches.

  • If you would like to learn more about the comments by region, please call for details.
  • COMMENTS THAT STAND OUT:ME: People still like the sausage biscuit, but the chicken is popular also. NH: It is the same people coming in to buy the chicken; they buy other things with it. NH: The chicken has replaced the sausage biscuit on the menu as number 5, they still sell the sausage but it's not promoted now so people are buying the chicken. MA: After they had a promotion where they gave it away with a free drink, people came back to buy it. MA: It is more popular than the sausage right now because they are advertising the chicken so much. MA: Some people find it bland. CT: The chicken started taking off after the promo. CT: They get some people switching over and some new customers coming in for it. NC: Compared to a similar priced item, like maybe the bacon, egg and cheese, the chicken sells pretty well. I think a lot of people prefer the chicken over pork because it is healthier. NC: New people are coming in for the chicken. NC: The sausage is still more popular, it is only $1 whereas the chicken is a little bit more. SC: They sell more sausage than chicken because it is a price point issue. NM: They have run a promotion, so they're pretty popular right now. NM: They sold 75 chicken yesterday...35 cash, 40 with the coupon. They sold 150 sausage biscuits yesterday. TX: They are selling real well. LA: Relative to new people coming in, no, it's just the regulars. UT: They are good. They are popular. The people that are buying the chicken are a mix of new and regulars. UT: She was pretty sure they sell more sausage than chicken. CO: The sausage, egg and cheese is the most popular, but she sees people switching over to the chicken who would have gotten the sausage before. CO: They are running a coupon on the chicken and they are seeing new faces coming in for the chicken. CO: The sausage, Egg Mcmuffin is the most popular. It is $1, which is a price that everyone can afford.

NKE: Loss to the Little Guy

Nike caved-in, allowing 7 of its athletes to wear the controversial Speedo LZR swimsuit if they choose to at the US Olympic trials (Speedo is about 8% of WRC cash flow). This is very un-Nike-like. Those following Nike for a while and can think back to the 1992 Olympics in Barcelona when Jordan draped an American Flag over the Reebok Logo on his uniform as a sign of brand loyalty. Nike is a fierce competitor. It does not like to lose, and it likes its competition even less.

Is Nike getting soft by allowing another brand onto its turf? Not quite. Think about the PR decision tree. Nike got beat on this one. There's no way around that. Now Nike says that it is allowing its athletes to wear competing product without any 11th hr corporate pushback so that its athletes can compete without distractions. If Nike instead were to hold its ground and the athletes lose, then Nike looks bad. If Nike flexes and the athletes win, Nike is the good guy by supporting its athletes. If the athlete loses in a non-Nike product, then that fuels Nike's fire.

Is this the optimal strategy? No. It is Nike playing defense. Nike's never been too good at defense. In fact, when Nike is on defense it just makes them plain 'ol angry. Yes, this could give Speedo a bump in sales over the next quarter (likely not enough to be a financial boost to WRC). But I would not want to be in their suit 12 months out...

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