Retail First Look: 7/7/09


View from Private Equity

We caught up with select private equity contacts recently who specialize in midsize consumer investments. The prospect of investment opportunity in retail/apparel sector remains bleak. Despite better visibility on the bottom of the cycle and on cash flows, lack of cost-effective financing for PE buyers seems to be the main reason for the minimal activity. The interesting call out there is that when fundamentals become more clear, but outside forces preclude a key buy-side constituent from hitting the bid - that creates an opportunity. There is clearly a wait and see approach whereby potential buyers have the patience to see companies fall under the court's protection before stepping in. With the cost of capital likely going higher, we're likely to see more strategic deals and less PE transactions.

New deals aside, we also addressed the environment for the companies already owned by PE firms. There's been no change to the trend whereby banks and commercial lenders that backstop loans with cash flow as collateral are doing whatever they can to avoid taking control of troubled assets - even when covenants are tripped.  

As for June trends in the mall. Father's day was promising, however traffic subsided post the event with the final week mall traffic was "brutal". Overall, the month did show a deceleration relative to the April/May trends. Interestingly, Canadian mall traffic is mimicking US trends. Despite these trends, there is a sense that the Canadian consumer remains in better shape than their American counterparts.

As for rent renegotiations, we're still not at the point where 'tenant-forced' renegotiations are a slam dunk. Landlords are not looking to bail out struggling retailers whose only hope may be rent concessions. Pier One was also mentioned as an example of a company that is seeing meaningful results from their strategic real estate repositioning.

Finally, there appears to be a growing view among the PE community that if deals are going to get done they will be more focused on medium to large size companies. The rationale here is that scale is key to generating operating leverage and garnering profitable market share gains as the economy improves. Does the prospect of a larger deal synch with the fact that cost of capital is rising? No.  In fact, the only way this makes sense to us is if the PE firms are getting 'safer' with their bets and are offsetting a higher WACC with a lower discount rate on future cash flows.  All in, that spells opportunity to us for names in small/mid-cap land.



- Domestic textile demand increases in China - China's domestic textile demand increased by 5.21% between January and May despite exports fell, according to the China Textile Industry Council. Local clothing consumption climbed from 14% in April to 22.1% in May, even faster than the 21.6% growth registered by Chinese retail. Although the export delivery value was down 8.23% over the same five-month period, the output rise was rooted in domestic consumption strengthened by governmental stimulus policies. However, faster growth for the textile industry is unlikely to kick in the near future as migrant workers and college graduates are still struggling to find work and therefore their clothing expenditure is unlikely to increase soon. <>

- Vietnamese textile and garment exports to Japan increase - Vietnam's textile and garment exports to Japan are expected to surge 20% to $900m-$1bn this year, boosted by preferential export tax rates introduced this month. Textile and garment exports to Japan using materials imported from Japan and other members of the Association of Southeast Asian Nations will enjoy a tax rate of 0%, rather than the previous 5-10% rate, under the Vietnam-Japan Economic Partnership Agreement. <>

- Indian leather exports grew in April but behind for the year - Indian exports of leather and leather products from April 2008-February this year reached $3.3bn, a growth of 2.73% year-on-year, according to the Council for Leather Exports (CLE). In rupee terms, exports grew 16.16%.Based on this trend, the exports for the financial year will be about $3.6bn, well below the $4bn target, CLE stated. Footwear holds a major share of 42% in the total export of leather products followed by leather goods (24.2%), finished leather (19.1%), leather garments (12.35%) and saddlery and harness (2.59%). Major markets for the Indian leather products are Germany with a share of 14.28% followed by Italy (13.2%), UK (11.42%), US (9.56%), Hong Kong (6.23%), France (6.23%), Spain (5.99%), Netherlands (4.22%), Denmark (1.73%), Belgium (1.53%) and Australia (1.52%). <>

- Sri Lanka bullish on future apparel exports - Sri Lanka's Joint Apparel Association Forum (JAAF) is targeting a turnover of over US$ 3.3 billion, through apparel exports this year. "We expect a turnover of US$ five billion by the end of 2011. At present, orders for summer and winter look steady this year, but the SME sectors are going through a bit of a tough time. However, the companies will be better off as soon as the global economy improves. Due to the global economic downturn most western countries will recover soon as Sri Lanka supplies apparel for them, he said. Competition among the apparel industry has grown rapidly - locally and internationally. The large-scale companies will catch up the markets while the SME sector is losing possibilities in the industry as they are unable to provide the orders for high quality products and deliver them on time.  Companies are calling upon the Government to reduce taxes in the export sectors, for exports to grow. <>

- US trade relations - Apparel executives believe regional trade deals maintain their promise as a model for international trade relations, despite some data raising questions about the benefits. Sourcing executives and trade experts said regional accords such as the Central American Free Trade Agreement and the North American Free Trade Agreement should be a key part of U.S. strategy because they deliver more benefits than bilateral pacts and are more manageable than larger multilateral agreements like the stalled Doha Round of global trade talks. The regional agreements give "large American retail and wholesale operations...the opportunity to look not just at a small-to-medium-sized country" but to a far wider area, said Jeff Streader, senior vice president of global sourcing for Guess Inc.  <>

- Protectionist measures are significantly affected textiles and apparel - Textiles and apparel, along with motor vehicles and parts, iron and steel, and chemical products, have been the manufactured goods most affected by new protectionist measures, such as tariff hikes and antidumping investigations, during the second quarter. A report compiled by World Trade Organization director-general Pascal Lamy said the number of trade-restricting or -distorting measures announced from March 1 through June 19 "exceeds" the number of trade-opening measures "by a factor of more than two." The leading trading powers, or G20, which includes the U.S., China, India, Argentina, Brazil, Germany, the U.K. and Japan, have failed to live up to commitments not to impose restrictive measures that distort global trade. The list of measures identified in the textiles and apparel sector included the initiation of antidumping investigations by Argentina on imports of denim from China, by Brazil on imports of synthetic fibers from China, by Turkey on imports of polyester staple fiber from China and on imports of woven fabrics of synthetic yarn from Malaysia. Other measures initiated in the last few months include the increase in value-added tax rebates on exports of textiles and apparel and new export subsidies by India to cotton farmers, the report said. India has also initiated an antidumping investigation on circular weaving machines from China. The WTO said the impact of the economic crisis on world cotton-mill use is expected to cause a 27% drop in cotton trade to 6.1 million tons and production to dip 10 percent to 23.7 million tons. <>

- Obama and the apparel industry - Most trade experts expect Obama will approve some antidumping and countervailing duty cases, which could have implications for the apparel and textile industry. Some officials believe that the atmosphere in Congress is very hostile to trade. The President's overall trade policy framework remains a work in progress. U.S. Trade Representative Ron Kirk, the point man on global commerce, said last month that Obama plans to outline a new trade game plan in the "near future." The lack of specifics has been another factor in delaying measures on Capitol Hill. Obama took a tough stance on trade during the presidential campaign, singling out the unfair trade practices of China and urging the protection of U.S. workers and industries hit hard. But he has tempered his stance since taking office, balancing his emphasis on enforcement with warnings against protectionism while citing the benefits of more liberalized trade regulations. <>

- Less inventory in retail industry - With a new level of discipline tied to the times, retailers are hoping to eke out more profit with a lot less inventory. Inventory levels at many chains are down 15%  or more from a year ago, but instead of simply going on the defensive against stock gluts and consequent markdowns, stores quickly are learning to make their existing inventories more productive, bringing merchandise into stores closer to when it's needed and being more selective in what they buy and replenish based on actual sales results. <>

- American Apparel under NYSE review - American Apparel, Inc. announced that it received a letter from the NYSE that the Exchange accepted the company's previously submitted plan of compliance and, pursuant to such plan, has granted the company an extension until August 19, 2009 to regain compliance with its continued listing standards. As previously disclosed, on May 19, 2009, the company received a letter from the Exchange stating that the company failed to timely file its 10-Q. <>

- Macy's has cut the amount of newspaper ad spending in half over the past four years - While classified ad dollars have largely shifted to online sites like Craigslist, Macy's migration away from newspapers has more to do with specific business decisions that make it difficult to imagine newspapers recapturing those lost retail dollars. <>

- Reebok follows FitFlop and Others in muscle building shoe - Reebok has a sneaker out called Easytone. The sneakers actually tone key leg muscles every time you walk. Easytone uses something called balance pods, which essentially create what Reebok calls "natural instability". In layman's terms, when wearing the EasyTone sneaker, it's like walking in sand on the beach. That particular movement results in toning the gluteus maximus, hamstrings and calves due to increased use of those muscles. Now how cool is that? Miss the gym for a day or two, no problem. Just go about everyday business. Walk the dog, grocery shop, go to the mall, take the kids to the park and do whatever it is you do. As long as you are moving, EasyTone's will be working to keep you toned and fit. <>

Retail First Look: 7/7/09 - Reebok Fit Shoe 

- Consultant Toni Yacobian claims potential transactions are far too often overlooked - Yacobian that the industry's great failings is untapped consumer traffic. In their efforts to cope with the recession, she contends, retailers have applied the scalpel to personnel, prices and costs, and scrutinized all assets, except perhaps their most important one - the customers who enter their stores.  The Yacobian Group LLC, a 20-year-old Maynard, Mass.-based consulting practice with a reputation in training to motivate retail staffs and devising operating models to improve the customer experience, has begun offering retailers a new system called CIMS, or Customer Interaction Management Operating System. "It's like an X-ray into the in-store experience to see where it is not being properly delivered, and then it provides a means to set clear goals, from individual sales people right up to the chief executive, to increase productivity from existing traffic," explained Yacobian, the ceo of Yacobian Group. <>

- Christian Lacroix will undergo job cuts - Employees were informed Friday of a restructuring plan that could see the workforce cut to 12 from 124, effectively reducing the 22-year-old fashion house to a licensing operation. Workers were told layoffs could be avoided only if a buyer emerged for the troubled firm, which sought court protection from its creditors in May, caught between an expensive upscaling drive and a steep fall in orders amid the economic crisis. Nicolas Topiol, Lacroix's chief executive officer, said Monday letters of intent were expected this week and offers would be invited until the end of July. The restructuring plan, if activated by the current owner, Florida's Falic Group, would see only a handful of employees kept on board to manage Lacroix's licensing pacts, which include men's tailored clothing with Sadev, men's shirts and knitwear with Rousseau, wedding dresses with Rosa Clara and Mantero for scarves. <>

- Links of London plans US expansion - With a new president for North America, a repositioned product line and the relaunch of its Web site, Links of London is embarking on U.S. expansion. The British brand plans to open flagships in select cities, and has forged a relationship with Bloomingdale's, where in-store Links shops are being unveiled. With a deep-pocketed parent - Athens-based Folli Follie Group - and lower-priced collections with items that can be worn in multiples, the company said it believes it can succeed during the recession. Meanwhile, Links' big sister, Folli Follie, has its own growth agenda. With 250 directly owned and operated stores in Asia, Folli Follie hopes to ultimately open the same number of units in the U.S., said Ketty Koutsolioutsos, co-founder and creative director of the Folli Follie Group. <>

- Japan's Aeon Posts Fourth Loss in Five Quarters on Declining Clothes Sales - Aeon Co., Japan's second-largest retailer, reported its fourth net loss in five quarters after clothing sales continued to slump amid the country's worst postwar recession. <>

- Adidas Plans to Raise 500 Million Euros in Debut Bond Issue in Currency - Adidas AG is raising 500 million euros by selling five-year bonds, the sporting goods maker's first issue of notes in the currency. <>

- Neiman Marcus appoints new Chief Marketing Officer - The Neiman Marcus Group, Inc. announced today that Wanda Gierhart has been appointed Senior Vice President, Chief Marketing Officer. Ms. Gierhart will report to Karen Katz, President, Chief Executive Officer of Neiman Marcus Stores and Executive Vice President of The Neiman Marcus Group and will be responsible for marketing, market research, advertising, sales promotion, and customer insight activities for Neiman Marcus Stores, Neiman Marcus Direct and Bergdorf Goodman. Her appointment will be effective August 10, 2009. <>

- JNY is starting to hire again - offers a job board for people looking for positions in e-commerce. Latest postings include a director of Web production at Jones Apparel Group; a vice president of merchandising at ideeli; and an e-commerce marketing manager at Oriental Trading Co. member companies are invited to post jobs for free. <>

- Seeking Alpha calls out WEYS - Today's research recommendation is Weyco Group (WEYS) because the stock price fell within 10% of the 52 week low during intraday trading. According to Standard and Poor's, Weyco Group distributes, wholesale & retail, men's branded footwear in the U.S., Canada, Europe; offers casual footwear, dress shoes and accessories under Florsheim, other brands. WEYS has increased its dividend for 28 years in a row which gives us ample information about the quality of the company's management. Essentially, WEYS has survived 4 recessions of varying degrees since 1980 (current recession excluded.) As recently as May 28, 2009, WEYS has increased the dividend by a little over 7% from $0.14 per quarter to $0.15. This indicates that management believes that although the current recession could get worse the company will survive. <>

- Lacoste ad with losing Roddick - It has become a standard tradition that when a sponsored athlete wins a big tournament, the company runs a full page ad in a newspaper to congratulate them. It was surprising to see an Andy Roddick ad on the back page of the New York Times sports section after his loss. <>

Retail First Look: 7/7/09 - Andy Roddick Lacoste


RESEARCH EDGE PORTFOLIO: (Comments by Keith McCullough): ARO

07/06/2009 10:40 AM


Breaking $33 and the hearts of the skinny jeans fans. Covering a -3% down move today. McGough/Levine will re-short it when it's up on another fashion call. KM

07/06/2009 09:41 AM


Booking the gain here. We'll re-short strength, at a price. Barron's being short the weather is obviously company that I don't need. KM



DKS: Goldman upgrading to Buy from Neutral, price target to $20.

JNY: Goldman upgrading to Buy from Neutral, price target to $12.

KSS: Goldman upgrading to Buy from Neutral, price target to $50.

BJ: Goldman downgrading to Sell from Neutral.



LQDT: Jaime Mateus-Tique, President & COO, sold 6,400shs ($65k) as part of 10b5-1 plan, a fraction of 2.6mm shares in total common holdings.

MW: Carole Souvenir, EVP & Chief Legal Officer, ER, sold 3,825shs ($77k) nearly 50% of total common holdings.



Retail First Look: 7/7/09 - SV 7 7 09

The Truth

"Whoever is careless with the truth in small matters cannot be trusted with the important matters."
~ Albert Einstein
At 4:15AM this morning, I was driving down Highway 95 listening to President Obama's address to Russian students. No matter what your politics, Americans should be proud of this man's oratory skills. On that score, he is truly gifted.
In the eyes of the Russians, I am sure the content of the speech is subject to debate. When it comes to the truth - there are always two sides to a story. Recent American economic history with the Russians remains scarred. Do the Russians actually trust us? Do we have any reason to trust them? President Obama is asking the Russians for a "fresh start", and it will be interesting to see if that incorporates America changing as we are asking for as much in return.
Relationships are built on trust. Being careless with the global financial truth is what America's currency currently has issues with. Surely, when it comes to US intelligence agencies like the FBI, CIA, etc, we are at least perceived to be on the cutting research edge of information transfer. That said, when it comes to our intelligence on global finance we are in the midst of a colossal Credibility Crisis. Being careless with the truth includes not understanding it.
My contention isn't a partisan one - it's a political one. Understanding global macro is a regimented daily exercise in objectivity, not a CYA job security show. From Bush to Obama, we have empowered an economic team of group-thinkers. We have reactive and politicized points of action. We don't have a proactive risk management process.
In 1913, the US Federal Reserve was created to protect the US currency and her country from crisis', not to perpetuate them. Fixing this will take time. The truth of the matter is that we have a team of lawyers, politicians, and professors who don't have a repeatable/practical investment process that they hang the country's balance sheet on every morning. Washington doesn't do global macro. Obama's team doesn't have the tools to show him the truth.
Understanding that Obama's intention of asking for a "fresh start" was more of a point on foreign policy - understand this: the Russians, like us and the Chinese, care about money. After Obama is done shaking hands with Medvedev (who can't seem to look people in the eye), the global macro debate will move on to Italy and the G-8 Summit. The only "fresh start" you're going to see there is a renewed squeezing of America's standing as the fiduciary of the global economic system.
No, the Chinese aren't selling their largest position (US Treasuries) "suddenly", but they are selling it down gradually. Yesterday's Treasury auction bids were MIA and, as a result, the yield on 10 year Treasuries made a 2-week high at 3.54% . The recent Treasury data shows China as a net seller of Treasuries. The Russians have already told us they are selling, quietly, the Japanese continue to do the same.
The truth is that China has political issues. The truth is that America does too. The New Reality is that all of this, from Madoff/Stanford to what you are seeing on the streets in Western China (Urumqi protests), is being You Tubed, to the world, real-time...
You Tube is a 21st century metaphor for Transparency. The truth is harder and harder to hide. While plenty a short seller of everything China states that China "makes up their numbers", what would the Russians call Dick Fuld's interpretation of "level 3 assets"? We're hosting our Q3 Investment Themes call this morning for our subscribers and Andrew Barber will walk through China's latest disclosure and transparency efforts. At least they are improving.
Chinese stocks finally had a down day last night, closing -1.1% at 3089, taking the Shanghai Stock Exchange to +69.7% YTD. The truth is that relative to the SP500 and Dow Jones indices being down YTD, that's pretty impressive. So is Chinese economic growth. The head of the Chinese central banking research bureau is out with comments this morning suggesting that Q2 GDP growth in China could come in close to +7.5% year-over-year. That would be a sequential (quarterly) acceleration - those are good.
Am I suggesting that you run out and buy China right here and now? Of course not. After a decade on the buy-side, I know better than to hold a conference call suggesting people buy things at immediate term tops. We have been "long of" China since December of last year, and we are going to walk through why you should not be short it!
Despite Japan trading down modestly overnight (-0.34%), The New Reality remains that those who are shaking hands with The Client (China) in Asia are seeing their business improve alongside the stability of relationships with their neighbor. Taiwanese exports for June improved again overnight, and the stock market there traded up another +1% as a result. Indonesian stocks put in a +2.4% session, and both South Korean and Indian equity markets recovered into positive territory as well.
The truth is that the world's economies are as interconnected as they have ever been. The truth is that China has financial credibility right now. The truth is that America needs to wake up and smell the robusto beans. "Fresh starts" may begin with speeches, but need to end with actions that trade partners can trust.
I continue to see the US stock market as range bound. I have intermediate term TREND support at 873, and long term TAIL resistance up at 954. Manage your risk around that range.
Best of luck out there today,


USO - Oil Fund-We bought USO on 7/6 on a pullback in oil over the last week. With the USD breaking down, oil should get a bid.  

EWZ - iShares Brazil-President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt -leading to an investment grade credit rating. Brazil has managed its interest rate to promote stimulus. Brazil is a major producer of commodities. We believe the country's profile matches up well with our re-flation theme.

QQQQ - PowerShares NASDAQ 100 - We bought Qs on 6/10 to be long the US market. The index includes companies with better balance sheets that don't need as much financial leverage.

EWC - iShares Canada - We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's large government recent history, and believe next year's Olympics in resource rich British Columbia should provide a positive catalyst for investors to get long the country.   

XLE - SPDR Energy - We think Energy works higher if the Buck breaks down.  Energy flashed a major negative divergence last week.  TRADE and TREND are positive.

CAF - Morgan Stanley China Fund - A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth.

TIP- iShares TIPS - The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%. We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

XLV- SPDR Healthcare - We re-initiated our long position in healthcare on 6/29.  Our healthcare sector head, Tom Tobin, wants to fade the public plan, and he's been right on this one all year.

GLD - SPDR Gold - Buying back the GLD that we sold higher earlier in June on 6/30. In an equity market that is losing its bullish momentum, we expect the masses to rotate back to Gold.  We also think the glittery metal will benefit in the intermediate term as inflation concerns accelerate into Q4.


XLP - SPDR Consumer Staples - We shorted XLP on the bounce on 6/17.   Added to the position on 7/1, as our stance on the consumer is no longer bullish like it was in Q2, when gas prices and mortgage rates were dramatically lower.

SHY - iShares 1-3 Year Treasury Bonds - If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.


We first went out on the limb with the MPEL call on 6/30 with our "MPEL: NOT QUITE THE CITY OF NIGHTMARES" and the stock is only up slightly.  Granted, the XLY is down 4% since the note and LVS and WYNN are down 15% and 12%, respectively.  Thursday's release of preliminary numbers should've been more of a catalyst but for a 2.5% decline in the S&P and a CS First Boston downgrade post release.  The downgrade carried a lot of weight initially, sending the stock down 12%, but MPEL ended the day only slightly down which is more than I can say for its competitors.  Investors finally realized that calling out City of Dreams (CoD) for lagging the revenues of a property twice its size and fully ramped (Venetian) is not relevant.  Nevertheless, I don't get paid for moral victories.

So why am I still positive on MPEL but not Macau, LVS, and WYNN?  We are very concerned about supply growth, particularly when Beijing is restricting demand.  Specifically, the supply growth is concentrated in the Mass Market and Beijing effectively controls Mass visitation.  Our belief that Beijing is targeting mid-to-high single digit MARKET growth means that same store revenue growth will be decidedly negative.  We want to own the provider of new supply (MPEL, SJM) and sell those properties most susceptible to Mass market share loss (Wynn Macau, Venetian, and Sands).

City of Dreams June numbers were better than the whisper number and our expectations.  Here are our takeaways from last week's release:

  • CoD Mass Market drop was spot in line with our $100MM estimate
  • CoD Rolling Chip volume of $1.94BN was much better than our $1.5BN estimate. It looks like some of this strength came at the expense of Altira's RC which came in at $2.76
  • RC at Altira was down 55% y-o-y in June vs. down 44% in the 2 prior months. However, June was also the toughest comp of the year
  • Slot volume of $81MM came in above our $51MM estimate

The incremental news on CoD is likely to be positive since expectations have been set so low.  Both segments are ramping.  Mass advertising in mainland China only began two weeks ago and the VIP business was effectively launched a few days later.  With CoD's ramp and Beijing controlling the visitation spigot, Mass numbers for the existing Mass properties will be under pressure.  Wynn Macau is at risk due to the Cotai undertow pulling visitors away from the Peninsula while Sands may get drowned by the coming tidal wave of Oceanus (See "OCEANUS TO SINK SANDS").  We don't want to fight those tides.

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PNRA - Checking in on the Model

PNRA was one of the few restaurant stocks that saw its price increase in 2008 and it increased significantly, up 45% relative to the restaurant group's average 40% decline. And, the company's stock performance was warranted. Year-to-date, however, PNRA's stock performance has lagged the group, down 7% versus up 50%. Using our "Research Edge Restaurant Process" metrics (please refer to the post dated June 22, 2009), which look at how a company manages its cash and deploys new capital in the business, PNRA management made a lot of the right decisions and improved the company's sustainability trends in 2008. The company reduced its 2008 new unit development by 60% and cut its capital expenditures in half. As is typically the case when a restaurant company decides to slow new unit growth and focus on its core business, PNRA was able to grow operating margins in 2008 after four years of declines and reverse two years of declining returns on incremental investment.

Relative to PNRA's recent stock performance, these sustainable trends should continue throughout the balance of 2009 as the company has maintained its more prudent level of new unit growth and capital spending. We should see another year of margin improvement, but I would not be surprised to see somewhat of shortfall relative to management guidance and consensus in the second quarter as the benefits that stemmed from slowing growth really started to impact the P&L in 2Q08. In 2Q09, PNRA is facing its toughest same-store sales comparison of the year and a difficult operating margin comparison as 2Q08 marked the first time PNRA grew its operating margins on a YOY basis in over 10 quarters.

Management guided to a -1% to flat same-store sales number for the second quarter and said that it expects FY09 operating margins to come in at the high end of its targeted 75 to 125 bps of improvement. Given the tough 6.5% same-store sales comparison from 2Q08 and the fact that most restaurant commentary regarding May and June trends has been less than favorable, I think it could prove difficult for PNRA to post only a 1% comparable sales decline. For reference, even a 1.5% decline would still mark a sequential improvement in 2-year trends from Q1. This weaker than expected top-line number will put real pressure on margins despite the expected food cost favorability in the quarter (lower wheat costs are expected to benefit food costs by $5 million in the second quarter alone).

To help build top line momentum, PNRA has been testing media (radio/billboards) in roughly 50% of its markets for the better part of two years. In 2009, the plan is to increase the media impressions up to 70% of the store base beginning in 3Q09. In 2010, marketing will become a larger part of driving traffic growth; it will not be until the company executes a TV strategy (currently in test) that we will see incrementally better sales trends. In the short run, the results appear to be lumpy.

Even with same-store sales down in the quarter, I am still modeling margin expansion in the quarter, which points to the increased operating leverage in the business model post 2007, but I think earnings numbers could fall short of the street's EPS estimate of $0.64. Instead, the low end of management's guidance of $0.62 to $0.66 per share seems to make more sense.

PNRA - Checking in on the Model - PNRA 1Q09 SSS

PNRA - Checking in on the Model - PNRA 1Q09 EBIT


Slouching Towards Wall Street… Notes for the Week Ending Friday, July 3, 2009


Bye-Bye, Bernie

It is the end that crown us, not the fight.

- Robert Herrick

Bernie Madoff must be upset.  Here he went to the trouble to make sure everyone knows he perpetrated the greatest financial fraud in history, and he doesn't even come close to the all-time record sentence.

As reported in the Wall Street Journal (29 June, "Madoff's 150-Year Sentence: Long, But Not Longest") "Sholam Weiss received an 845 year sentence for a fraud scheme that took $450 million from an insurance company... In 2008, Norman Schmidt was sentenced to serve 330 years in federal prison for his role in a fraudulent 'high yield investment scheme.'"

Weiss' 845 years, amortized over $450 million, works out to over half a million dollars per year - more than $530,000.  At that rate, Madoff's declared $65 billion fraud should have brought him over 130,000 years in the slammer.  Now that's what we call something To Write Home About!

Compared to Schmidt and Weiss, Madoff hardly even qualifies for the Hall of Fame.  Why did he do it?

What really sparks our interest is: why, when he saw it all crashing around his ears, did Madoff not throw a few hundred million dollars into a duffel bag and travel to some part of the world where they would neither find, nor extradite him?

He is not protecting his family - at least not from legal action.  His guilty plea means he will not have to testify, but there will be intense scrutiny on every aspect of his business - and every person involved - as the civil suits start to unfold over what promise to be a chock-full several years.

So we repeat: why did Bernie cop a plea?

One tale making the rounds is that Bernie lost a few hundred million dollars belonging to some high-profile Russian mobsters.  We find this believable for several reasons.  One is that we have worked on Wall Street long enough to know that there is no type of nasty person who does not have a finger or two in a pie.  Typically, the nastier the pie, the nastier the fingers.  It is crystal clear that everyone who understands the markets even a little recognized that Bernie was violating the rules - if not breaking the law.  There was no other way he could have delivered steady returns year in, year out.  And bad guys like dealing with bad guys - their secrets are safer with someone who has significant secrets of his own to protect.

Another reason - circumstantial, to be sure - is Harry Markopolous' statement, buried in his now-famous correspondence with the SEC, that he feared for his safety and the safety of his family if his work on Madoff's dealings became widely known.  Another is that we have heard this story from people who invested with Madoff.  And don't forget, the unspoken reason the judge permitted Madoff to show up in court in a suit, instead of his prison jumpsuit, is he was wearing a bulletproof vest and could keepit out of sight under his coat.

Judge Chin's sentence of 150 years guarantees that Bernie Madoff will die in prison.  Now it looks to us like the only question is: how soon?



Fighting the Good Fight

Will no one rid me of this meddlesome priest?

Pity poor Sheila Bair.  She is getting kudos from the public - including a smart piece praising her in the current New Yorker magazine (28 June, "The Contrarian: Sheila Bair and the White House Financial Debate").  Bair was just honored with the Profile in Courage Award from Boston's Kennedy Library Foundation - awarded annually to public officials that the Foundation deems to have "exhibited political bravery."  Bair, the article reports, "was recognized for her early, though ultimately futile, attempt to get the Bush Administration to address the subprime-mortgage crisis before it became a threat to the entire economy." 

Bair is on the move.  She has started laying down the law to newcomers, letting them know in no uncertain terms whose territory they are now on (WSJ, 3-5 July, "FDIC Proposes New Bank Rules").  Bair is proposing new standards for firms that want to buy into the banking business, including greatly increased capital reserve requirements, and what many are calling an unreasonable proposal that buyers from outside the banking industry not be given a green light to buy banks merely to flip them.

Bair is struggling to maintain her balance atop a stack of shifting tectonic plates.  As private equity discovers banking, Chairman Bair is trying to create rules that will protect the remnants of the banking system from the worst of the private equity abuses.  Who would have thought that a US regulator would attempt to inject a note of caution into the business of banking?

As the New Yorker article points out, Bair is hardly your typical Washington Insider, and is that much more of an outsider in the current administration.  The political process that continues to unfold is highlighted by recent stories about the promotion of William Dudley to the position of president of the New York Fed, the post vacated by Timothy Geithner when he became Secretary of the Treasury.

As reported in the Wall Street Journal (2 July, "Fissures Appear At The New York Fed"), a number of New York Fed directors were not pleased with Geithner's obvious efforts to push Mr. Dudley into the role.  Dudley, it should be noted, is a former Goldman Sachs economist.  He stepped into his new role shortly before the eruption of publicity surrounding New York Fed board chairman Stephen Friedman, who had not disclosed his trading in the stock of his former employer - Goldman Sachs - despite requirements that he do so.  "Some are calling for more oversight of both the reserve banks and the central bank," reports the WSJ article.  We wonder who shall do this overseeing.

It is clear that Tim Geithner has been given the go-ahead to create a new financial system.  Nor do we perceive the influence of Goldman on the wane in the Business As Usual initiatives of the current administration.  (Business As "Use You All"?).

In short, FDIC Chairman Bair is facing extremely long odds.  She is being set up by the Old Boys' Network.  The Journal article quotes billionaire investor Wilbur Ross as saying Bair's proposed new requirements are "harsh and discretionary."  Ross, part of the consortium that acquired Florida's failed BankUnited, now says "I think it could guarantee that there will be no more private equity coming into banks."

First, given the current model and primary players in the private equity business, we fail to see that as an unmitigated disaster.  Add to that the reality that the government is handing out incentives to buyers who neither come from, nor care to understand the banking business, merely to get someone to take the liability off their hands.  Finally, the incentives come with a powerful precedent and an implicit guarantee that, if the bank fails again, there will be a bailout.

Which lands these future disasters right in the lap of the FDIC.  We note that the Journal article is flanked by a column headed "Tally Hits 52 As Regulators Close 7 Banks."

In the world of things that ain't over till they're over, this ain't anywhere near over.  Chairman Bair is collecting bids to acquire failed banks, and she has already seen a few that didn't pass the smell test.  We are rooting for her to stick to her guns - we just wish the President would give her a much bigger arsenal.  We fear Chairman Bair will be beaten from all sides by the fairy tale that she is single-handedly impeding the recovery.  That, if not for This Meddlesome Regulator, the billions sitting idle in private equity coffers would come charging in off the sidelines and win the day.

The fact is that private equity is not the gem of the investment world it once was.  There is idle cash lying around because deals are going too cheaply, or because investors are clamoring for the managers to stop screwing up with their money - all while demanding greatly reduced fees.  Is it any wonder the private equity guys are looking for new fields to furrow?

The final paragraph of the Journal story tells us "Ms. Bair said she remained open to make changes on most parts of the proposal."  We would hate to think that, now that the crush is coming, Sheila Bair is preparing to bend in the political wind.



The Long And The Short Of It

The New York Times (3 July, "SEC May Reinstate Rules For Short-Selling Stocks") reports that the Commission looks set to bring back the Uptick Rule, abolished by the Commission under Chairman Cox in 2007. 

The Rule, voted out based on studies that seemed to show it had no effect on market stability, is on the political agenda.  According to the Times, House Financial Services Committee Chair Barney Frank is pushing SEC Chair Schapiro on the issue, as is Delaware Senator Edward Kaufman, who has introduced a bill to reinstate the Rule.

It appears that reinstating the Uptick Rule will end, at least temporarily, the long-winded discussion over short selling circuit breakers.  This is presumably good news on many fronts - not least for the politicians themselves.  It will enable Frank, Kaufman and others to show instant action on a subject that they have made sure is uppermost in the minds of their constituents - even those who do not know what short selling is. 

Underlying the battle over short selling is the fairy tale about unfettered growth.  "Think and grow rich," wrote Napoleon Hill.  The mantra of both Wall Street and Washington is, "Let us do the thinking - and you'll grow rich."

Under the mysterious machinations of the Maestro - Alan Greenspan - the nation was lulled into a sense of entitlement.  All we had to do was buy stuff, then sit back and wait for it to go up in price.  Then we bought more stuff.  Then we used that as collateral and leveraged it to buy still more.  Irrational exuberance - shamelessly promoted by the most irrational of them all - led us to where we are today.

Short sellers have long been seen as un-American.  As a balance, we offer a piece from this weekend's Wall Street Journal (3-5 July, "New Evidence On The Foreclosure Crisis"), in which Stan Liebowitz, of the University of Texas, Dallas, argues that the greatest single contributing factor to the foreclosure crisis was not subprime loans, but zero money-down mortgages.  The incidence of defaults among zero money-down mortgages far outweighs those among subprime, NINJA ("No Income, No Job or Assets"), or "liar" loans.  The Mortgage Bankers Association's own statistics show "that 51% of all foreclosed homes had prime loans. Not subprime, and that the foreclosure rate for prime loans grew by 488%, compared to a growth rate of 200% for subprime foreclosures."  What, then, is determinative?  In the figures quoted by Professor Liebowitz, the twelve percent of homes having negative equity accounted for 47% of all foreclosures. No skin in the game.

This is the new American Dream: working for what you want, and keeping what you build, has been replaced by Something for Nothing.

Something for Nothing became the driving force behind Wall Street.  In the 1980's and 90's, tens of thousands of young men flocked to Wall Street where the business was fueled by OPM - Other People's Money.  No one has had skin in the game for a generation.  No one except the customer.  And now - as a result - the taxpayer. 

Regulators and brokerage managements insisted that financial salespeople not invest in the same instruments they pitched to their customers.  Under the guise of Conflicts of Interest, the purveyors of investments were insulated from the negative effects of owning them.  Investment banks, meanwhile, created product - in the form of deals and public offerings - promoted them through their own in-house advertising agencies - research departments - and pumped them through their own distribution pipeline - the brokers.

Ultimately, that model caused a global crash - because not everyone can get out the exit at the same time.  Short sellers, dubbed unpatriotic because they take up permanent residence outside the exit, are our society's Mark of Cain.  In a culture that has confused Owning with Creating, it is virtuous to possess.  It hardly matters what - just go out and obtain something.  If you can not afford it, we will arrange for you to borrow the money.  Or you can buy it with OPM.  Or, as Professor Liebowitz' research indicates, if you can not afford it, we will give it to you anyway.

In a seemingly unrelated story, the Wall Street Journal had a front-page item (1 July, "Finance Lobby Cut Spending As Feds Targeted Wall Street") saying political contributions from Wall Street to Washington are down a whopping 65% in 2009, as compared to 2007.  Also, there has been an upward trend in giving to Democrats over Republicans - which only makes sense when you consider a random list of Dems in a position to exert influence on Wall Street: Barney Frank, Chuck Schumer, Chris Dodd, Henry Waxman and Barak Obama come to mind, just to name a few.  By making the fuss about short selling go away, Frank and his cronies hope to emerge as the good guys in this debate.

Clearly, the outcome most devoutly wished by all is a return to Business As Usual - investment bankers will return to doing deals, private equity will gobble up banks, brokers will go back to cramming deals in their customers' accounts, and the money will flow back from Wall Street to Washington. 

Folks, short sellers are not the heart of the problems facing the world's economies today.  The real question is, who will rein in the Long Buyers?



Coded Messages

Just walk 'round like you own the place.  Always works for me.

- Dr. Who, "The Shakespeare Code"

First, do no harm.  Then, when they're not looking - f*** 'em where they breathe!

This was the text first considered for the new Code of Ethics for new MBA graduates.  After due consideration, it was shelved in favor of a somewhat more flowery text that includes such notions as protecting the interests of shareholders, managing one's enterprise in good faith, and taking responsibility for one's own actions.  We especially like the undertaking to "understand and uphold, both in letter an in spirit, the laws and contracts governing my own conduct and that of my enterprise."  Considering how many folks get to squirm out of a tight spot by pointing to inconsistencies in the black letters of law or contract, it would be a welcome breath of fresh air to have managers one could actually rely on to interpret such documents for the benefit of the enterprise.

Now (WSJ, 2 July, "Adviser Adopts Cuomo's 'Code Of Conduct'") Pacific Corporate Group Holdings LLC has voluntarily signed on to NY Attorney General Cuomo's new document, the Code of Conduct.  In so doing, PCG "also will return $2 million in fees it received from the New York State Common Retirement Fund."  As has been earlier reported, both the Carlyle Group and Riverstone Holdings have signed this documents and made payments to the State of New York.

The Code of Ethics is now a requirement for investment advisory firms, and brokers and hedge funds have long wrestled with the compliance manual, endlessly supplemented by memoranda and addenda.  This cumbersome document is almost never read by any person to whom it pertains, but read in meticulous detail by examiners who pick apart every sentence and now actually quiz employees on its content, and on how the prescribed procedures are implemented.

The Code of Ethics is a sort of pre-consent decree.  Regulators often have a hard time proving a case, but at a certain point it becomes compelling for both sides to seek a settlement. So the firm, or individual, pays a fine and enters into an agreement "without confirming or denying" the charges.  They then promise that, even though they do not admit that they violated a rule or broke a law, they will not violate that rule or break that law in the future.

This has now led to the Code of Ethics, where firms and employees sign a document in advance of engaging in any business, affirming that they will not break the law.

This process of regulatory creep goes on constantly.  In an ideal world, it would be a positive.  Regulators who were well versed in the industry would fine tune their approach as the industry evolved.  Over time, regulators in the field would report a consensus that the industry had changed, and the commissioners and senior staff would review rules and procedures accordingly.  From this process would evolve Best Practices.  New rules would be drafted, and old ones scrapped or modified to keep pace with reality.  This would keep the rule books lean, and the rules and practices current.  It would achieve buy-in and self policing from the industry and would benefit all.

Until the SEC and FINRA drop the pretense of knowing what they are doing and actually hire large numbers of people with real industry experience, regulatory creep will ensure that old rules stay in place - and stay old - while new rules will continue to display a tin ear with respect to the marketplace.  In the current political environment, the regulators are too busy appeasing special interests. Ditto the White House and Capital Hill. 

Check out this howler from the Wall Street Journal (2 July, "SEC Plan Aims To Better Foretell Risks") in a description of new rules proposed to regulate executive pay.  "The proposed compensation rules would require public companies to disclose information about how compensation policies can lead to increased risk-taking and explain how those risks are managed.  Companies would only need to provide this information, however, if the risks could have a material effect on the business."

When is disclosure not disclosure?  When it's not material.  Who gets to decide when an item is material?  Well, since the company itself will not have to make a disclosure unless it is material, logic dictates that the company itself makes the determination as to materiality.  After all, no one but the company itself will ever have access to this information.  Why did we just bother using taxpayer resources to discuss and propose a rule designed to enshrine in statute a company's prerogative to scam its shareholders?

MBA students are lining up to swear an oath of morality, integrity, and good business practices.  Why aren't their professors telling them that it puts them at an immediate disadvantage in the careers they are preparing for?


Moshe Silver

Chief Compliance Officer


Charts Of The Week: Unemployment's Double Top

When we called this out as a major go forward positive in March (post the February employment report), not many people agreed... and after the stock market's response to the better than expected unemployment rate on Friday, I have no reason to believe that consensus will agree with me right here and now.

The crowd likes holding hands. In the moment of redness, post a +40% trough-to-peak rip from the March 9th low, I understand how it may be hard to see that the US stock market may have already discounted some of this better than expected economic news. This is what it is. Markets look forward.

The June unemployment rate came in at 9.5%. That was both better than expectations of 9.6% and only a 10 basis point sequential increase versus that last nosebleed charge (+50bps sequentially) that we saw in May versus April. This, on the margin, is bullish for the US Dollar and bullish for long term interest rates. We aren't going to have the next Great Depression. Sorry storytellers.

Plenty of people still mistake  good news for the US currency as good news for stocks. After markets recover from their freak-out lows, that doesn't make sense in the early part of a recessionary recovery. What's good for the economy, is bullish for interest rates and the Dollar. What's bullish for those two factors is nasty for what's been working for the last 3 months - the REFLATION trade. 

In the charts below, Andrew Barber provides important historical context. My view is that in the next 6-9 months, you're going to see this chart of US unemployment rollover. No, I'm not saying it's a new bull market in employment. I am simply saying that the rate of change will rollover to down sequential monthly reports.

Keith R. McCullough
Chief Executive Officer

Charts Of The Week: Unemployment's Double Top - ab34

Charts Of The Week: Unemployment's Double Top - ab45

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