Macau reported six newly confirmed cases of flu A/H1N1 yesterday, bringing the total to sixty-eight.  Two of the newly confirmed cases were imported while the other four were locally infected, according to the Health Bureau. 

According to the statistics from the Health Bureau, the 26 patients who tested positive for the A/H1N1 flu virus were still receiving medical treatments at local hospitals and they were all in stable health conditions.


The overriding theme for the 6% market correction is largely focused on the pace of the recovery and now more investors are focused on the ability of Q2 earnings guidance to sustain the rebound seen in Q1.  Additionally, the impact of rising unemployment on the consumers' ability to make mortgage payment and overall disposable income is creating fresh concerns for weak consumer-related trends.   

We learned this morning that mortgage applications in the U.S. rose last week while refinancing applications jumped the most since March. Additionally purchases climbed to the highest level in three months.   This week's results include an adjustment to account for the July 4th holiday.

The Market Composite Index (a measure of mortgage loan application volume) was 493.1, an increase of 10.9% week-over-week on a seasonally-adjusted basis.  While this news is good, the twelve-week moving average fell 6.4% from the previous week's reading of 752.3.

The refinance share of mortgage activity increased to 48.4% of total applications from 46.4% the previous week. Meanwhile, the adjustable-rate mortgage (ARM) share of activity increased to 4.4% from 4.3% of total applications from the previous week.  The average interest rate for 30-year fixed-rate mortgages remained unchanged at 5.34%. 

Undoubtedly the decline in home prices has brought more homes within reach of more buyers. Incrementally this creation of new demand appears positive, yet with  unemployment at a 26 year high and borrowing costs edging back up, any further improvement in housing will be further down the road. As always, we return to our mantra: "less bad" is not the same thing as "good".

Howard Penney

Managing Director


UA: The Duration Bifurcation

The BIG call is that sales/EPS will double over 3 yrs. No one owns it for blow-out EPS today, and nothing will come out of 2Q to either rattle the long-term call, or to make the 28% of float that is already short press its bet. My sense is that a beat will boost the stock more than a miss would hurt, and 2H call options are under appreciated. I remain positive.


Negative sentiment is building again on UA in advance of earnings. Duration is a major factor here - perhaps more so than with any story I can find. Why?


Core apparel sales are flattish, footwear is performing 'fine' (i.e. not stellar), management has been selling stock, key internal positions have turned over, prior guidance is vague, 2Q just closed after it rained for 80% of the most important month of the quarter, and at 26x earnings it is one of the most expensive stocks in retail.  I never ignore the facts, and they're particularly important when the stock is resting right on top of $21 TREND support in Keith's model.  I can't say that I blame the bears...


So how in the world could anyone justify being bullish? Well first off, the simple fact that this question is being asked is notable.


But there is a massively more important consideration... NO ONE who owns UA does so because they think that the company will smoke the upcoming quarter or year. It's generally accepted - and probably correct - that UA will print somewhere in the ballpark of $175mm in footwear sales this year, and that apparel revenue will be flat-to-down organically.


Is that worth 26x earnings and 11 EBITDA? Probably not -- unless you're banking on meaningful growth in the business in the next 3 years. Here's the key... The question as to whether this will happen will absolutely not be proved or disproved by 2Q results or guidance.


  • Regardless as to whether footwear sales/guidance are +/- $25mm for the year, this says little as to whether UA will succeed or fail in getting footwear market share from >1% to 5% (around $500mm in added sales) over 3 years. Bulls are unlikely to throw in the towel unless the company does. UA will definitely not back off this strategy, and in fact is likely to highlight organizational changes to take the footwear organization to the next level.


  • Similarly, for someone on the short side that is banking on a miss and/or weak 2H top line guidance, the rebuttal is likely to be that orders for fall were placed at a time retailers were choking on product due to weather-impacted comps. I rarely give that free pass, but this is one instance where it's pretty much a no-brainer.


Let's remember that only 14% of analysts have a 'Buy' rating on UA (lowest in history) and the average price target is 6% below current levels. Short interest as a percent of float has stepped up from 23% to 28% over the last three months.

UA: The Duration Bifurcation - 7 8 2009 7 19 14 AM


So it sounds to me like this is going to hinge upon a meaningful negative earnings revision to beat it down. In going through our model, I've got revenue growing about 5% better than consensus for the remainder of the year. Margins are more of a question mark. But keep in mind that we are anniversarying the launch of cross training - which had a negative impact on mix and margins.


Also, starting in 2H there will be a notable favorable change in capacity for footwear production (and prices) in China, which should ease margin compares. Let's also not forget the Foot Locker factor. Brand new CEO coming from JC Penney where he was President and head of merchandising. Every vendor was at his mercy. Now he comes in to a smaller box where one vendor accounts for over 50% of sales. Not a good setup... His first move will be to sit down with every vendor and find ways to optimize his shoe wall. That means more Under Armour as FL will want to be in the pole position for driving starting a partnership not unlike what DKS and UA had in apparel off-mall. I can't imagine that these are consensus ideas.


The bottom line is that we get to UA beating the quarter by a couple pennies, and earning $0.88 for this year in both EPS and FCF/share, and then $1.10 and $1.35 in 2010 and 2011, respectively. A mid-teens grower this year and 20-25% the two years thereafter? Yeah, I'll stomach a multiple starting with a 2-handle for that. Mind you, this is $1.2bn in revs which only represents 3% share of the relevant footwear market (Adi is 6%, Reebok = 4%, Puma = 3%, Asics and New Balance range between 6-8%).  It also assumes very little success driving a women's business and International presence.


As for the quarter, when I add up all the puts and takes on sentiment, my sense is that a beat (or any bit of positive news) will disproportionately boost the stock as opposed to how much a miss would hurt.

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Sequential Improvement for Europe’s Workhorse

German Factory Orders and Industrial Output Improve

If you've been following our work you'll know we have a bullish bias on countries with economic leverage and a bearish stance on countries with financial leverage. As it relates to Europe we've seen a number of countries that have underperformed due to the latter, including (but not limited to) Switzerland, the UK, Spain, and Italy in 2009; and we expect this trend to continue well into next year-with budget deficit rising, access to credit should tighten, which will be prohibitive to growth.

Conversely, Germany occupies a spot on a small list of European countries we're incrementally bullish on. The DAX has yet to show signs of real positive returns this year, currently hovering at -3% YTD, yet German Chancellor Angela Merkel and her economic team have shown strong leadership in adequately stimulating the economy while not overextending debt levels. This should be a huge benefit on the TAIL to growth. Approval of her management is confirmed by the most recent Forsa poll that places support for her party, the CDU, at 37%, up one point from the previous week's reading and increasing her party's spread over its rival, the Social Democrats, to 16 percentage points. 

Fundamentally we're starting to see signs that economy is bottoming out. As a leading economic indicator German factory orders increased 4.4% in May on a monthly basis, as reported yesterday by the Economy Ministry in Berlin. The reading was the biggest gain since June 2007 and nine times the 0.5% increase forecasted by surveyed economists. Today the Ministry reported that industrial production rose 3.7% from April; you'll notice from the chart below that industrial production on a year-over-year comparison is bottoming out and showing signs of positive momentum.

The improvement can be attributed in part to the stimulus from the eco premium for scrapped cars, which has been so popular it's oversubscribed, and the income-enhancing measures of the stimulus package, including:  cuts in income tax and increases in child benefits. As these benefits work through the system we expect consumer spending to improve. Already we've seen sequential improvement in forward-looking consumer, business, and investor confidence.

Exports still look battered on a year-over-year comparison (May data is out tomorrow), yet the increase in factory orders is decidedly bullish if the trend can continue. The report showed that demand from outside the Eurozone gained 8.2% and domestic demand improved 3.9%. With the Ministry revising April's reading to an increase of 0.1% from unchanged, factory orders have increased over the last three months.

Exports, which make up nearly half of total German GDP, could remain a stumbling block in the near term as global demand is still depressed, yet we believe that Germany's significant industrial capacity gives it a structural advantage over its European peers moving into 2010.

Matthew Hedrick


Sequential Improvement for Europe’s Workhorse - GermanyIndust

RT - Who Knew What When?

RT's stock price moved up 12.5% yesterday prior to the company reporting 4Q09 earnings after the close. And judging by RT's significantly better 4Q performance, someone knew something! Earnings came in at $0.28 per share relative to the street's $0.20 per share estimate. Company same-store sales declined 3.2% in the quarter. This was a surprisingly strong number on many counts. RT easily beat the street's expectation of -5.3%. It showed significant improvement from RT's recent performance (-6.8% in 3Q and -10.8% in 1H). And RT outperformed its casual dining competitors by 2.4% in the quarter as measured by Malcolm Knapp. This last point was the most surprising as RT has underperformed its casual dining peers by 5%-10% for the better part of the last two years.

RT - Who Knew What When? - RT FY09 Gap To Knapp

RT management attributed its relatively strong top-line results to its marketing initiatives that have focused on communicating the concept's compelling value proposition. The increase in same-store sales does not come without cost, however, as RT is driving increased traffic with its value message at the expense of average check and restaurant margins. For reference, RT's 2.4% same-store sales outperformance relative to its casual dining peers stemmed from its 8%-9% traffic outperformance, which points to the company's underperformance on an average check basis. RT's CEO Sandy Beall stated that the company's first priority is to "get bodies in seats." Along those lines, the company has not increased its average check in 2-3 years and is not focused on driving check higher in FY10. Instead, Mr. Beall said RT "will keep pushing value for some time to come until the consumer changes."

This increased focus on value will continue to put pressure on restaurant margins, primarily from the negative impact discounting has on food costs as a percent of sales. Despite declining restaurant margins, another bright spot in the quarter was RT's nearly 250 bp YOY increase in operating margins, which was a continuation of the improvement we saw in 3Q. RT has been able to offset its lower restaurant margins in the back half of FY09 by cutting costs in other parts of the P&L. Specifically, the company reduced its annualized costs by $45-$50 million, with the bulk of these cost savings implemented during 3Q. A big portion of the cost savings stem from reduced labor costs as a result of a more efficient labor-scheduling process and lower supervisory costs as RT expanded control for both regional and area supervisors. The company will continue to see the benefit of these cost reductions, particularly in the first half of fiscal 2010, but taking more costs out of the business going forward will be difficult without impacting the guest experience. I have always said that cutting costs that the guest cannot see, taste or experience makes sense, but reducing area supervision can be risky as it can often impact the overall guest experience. This just means it will become increasingly more difficult for RT to protect its operating margins in this challenging sales environment from increased discounting and lower restaurant margins as a lot of the fat has already been cut from the P&L. The company currently has no plans for company-owned unit development, however, which will provide some operating flexibility going forward.

All of that being said, RT has come a long way. It has gone from being a concept that seemed close to becoming a thing of the past to outperforming its peers from a sales and guest count perspective. It has gone from being a company that was at risk to breaking its debt covenants to one that paid down $112 million of debt in one year, in excess of its initial $80M-90M and revised $90M-$100M targets. And in FY09, RT reversed 4 years of operating margin declines.

RT - Who Knew What When? - RT 4Q09 EBIT



Japanese Industrials continue to bleed out

May machinery order data released overnight by the Japanese Cabinet office registered at a third consecutive month-over-month decline with a year-over-year shortfall of 39%. In fact,  at 668 billion Yen (SA), orders are now at their lowest absolute level since the summer of 1987. As a leading indicator for production, declining orders for industrial machinery continue to suggest that factory managers are restricting investment in the face of still declining demand for exports. 

Industrials are further hampered by a still dead credit market, with expectations that BOJ will be forced to extend its emergency credit program since liquidity has still failed to materialize in the commercial paper market. These still lower expectations for near term production also bodes ill for the employment picture, placing further strain on the Aso administration's programs to stimulate domestic demand.

Trapped in a vicious cycle, Japanese industrials are already finding that decreased global demand has been matched by increasingly competitive pricing from Korean and ASEAN based rivals and failure to invest at this stage in the cycle could signal a slower recovery process if and when demand rebounds.

Calling a bottom in Japan has thus far been as difficult as catching a falling knife. With no signs of strengthening demand from their major exports markets in the near term, "less bad" is not good enough. As Japanese equities continue to trade as a proxy for Yen relative strength, we are maintaining our negative bias. For now no long term positive catalysts appear on the horizon.

Andrew Barber



Early Look

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