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VFC: Same Guidance, Different Mix

VFC reported solid results last night, ahead of the Street by $0.10 and well-ahead of our estimate.  Admittedly, the areas of risk that we had been focused on heading into the quarter were not fully realized.  However, we’re not going to try and poke holes in earnings quality or point out the inconsistencies in the results in effort to try and justify our cautionary tone.  Instead, the reality is that VFC put up a sizeable headline beat and did not lower guidance.  Did they massage the components of guidance and adjust them accordingly to maintain the $4.70-$5.00 outlook?  Absolutely they did.  But, the reality is manufactured results are exactly what they are – a reality.  In this case, with numbers coming in close to, or perhaps even above consensus for the back half, it is unrealistic to believe VFC shares are heading meaningfully lower in the near term.  Consider the following:

Including the $0.10 beat, management reaffirmed its full year guidance of $4.70-$5.00; however, it’s important to note this guidance is now predicated on a few new factors:

1)      Foreign currency: Baked into 2H earnings is a Eurodollar exchange rate of 1.37 compared to the previous assumption of 1.30 lessening the Fx impact on revenues by ~$60mm or roughly 1%. Depending on the margin at which incremental Fx related money flows through the P&L, VF would realize a $0.07 benefit assuming corporate margins, but the reality is that it is likely to be higher so let’s call it a $0.10 benefit on a 20% incremental margin in the 2H.

2)      Tax rate: While the 25% tax rate posted in Q2 was noted as “in-line,” it was outside of the expected range between 28%-30%. As a result, the full-year rate was adjusted from 29% to 27% equating to another $0.10 tailwind in the 2H.

3)      The Q2 beat: The full-year range now includes better than expected results in Q2 that take up year-end earnings by yet another $0.10.

Despite a weakening overall top-line, dismal revenues from the company’s core cash-cow (Jeanswear), and a meaningful slowdown in the North Face, the company was able to report a substantial gross margin performance. The mix shift towards owned retail driven by robust store growth will continue to benefit gross margins (especially in international markets), but we maintain that decelerating top-line trends will have to improve to sustain operating margins. Based on 80 new stores over the last twelve months and the average store contribution, we calculate that retail contributed roughly $120mm in revenues this quarter. Taking into account management’s comment that retail accounted for a 40bps improvement in gross margin, we estimate that retail stores are operating just shy of 50% compared to a low 40% core margin. As a result, the incremental 70 stores should contribute approximately 75bps to gross margins in 2009. With management committed to a 10% inventory reduction by year-end, it will be a challenge for VF to expand margins beyond recently adjusted expectations.

Additionally, while late to the expense control party vs. other apparel manufacturers, VFC seems to have found upside from their cost cutting efforts.  After all, the company spends $400m on advertising alone, which is a huge source of funds when trying to make the numbers.  

The timing here is no longer imminent as evidenced by the 2Q results, but the reality is cutting costs and opening stores can only go so far.  With jeanswear, imagewear, and sportswear all showing meaningful declines we suspect the ability to manufacture decent results will eventually come to an end.  But for now, we’ll watch the fundamentals closely and monitor key organic growth drivers to determine when the next opportunity arises to become cautious again.

 

VFC: Same Guidance, Different Mix - VFC S 7 09


Obama’s Approval Broken

On June 22nd, 2009, we wrote a note titled, “Approval Breaking Down For Obama”, which outlined the following:

“Most interestingly, the independents that moved to Obama in hoards during the presidential election last fall, now seem to be seriously wavering.  While on the other hand, Obama's support among his own party is as strong as ever.  So what is happening among the independents?  The best place to find that answer may come from New Hampshire.  In the New Hampshire Union Leader this morning, which is the largest paper in New Hampshire, there was an editorial sharply critical of Obama's health care plan, and specifically the disconnect between Obama saying there will be no additional spending for his plan and the Congressional Budget Office suggesting that current proposals would dramatically increase spending.”

According to the New Hampshire Union Leader:

"For health care reform to "not add to the federal deficit over the next decade," every penny of new taxpayer spending on health care reform would have to be paid for by either a tax increase or a spending cut somewhere else. We're talking about roughly $1 trillion in spending -- all paid for. But remember, we already have a $1.8 trillion deficit this year. Every penny spent on health care reform is a penny not spent to pay down the existing deficit. So in reality, health care reform will at the very least perpetuate existing deficits even if it doesn't expand them.

While having solidarity among his party is powerful, in a country where only ~ 40% of adults identify themselves as Democrats, Obama has to continue to appeal to independents and if the New Hampshire Union Leader is any proxy, he is losing them.”

It is fair to say that Obama’s approval rating is now broken, and the independents are slipping away. Since June 30th, the Rasmussen daily tracking poll has measured a negative rating for Obama and since July 9th has registered a rating of between – 5 and – 8.  This is a major divergence from the first couple months of his Presidency in which he was rated in the +15 to +20 range.  This poll measures the delta between strongly approve and strongly disapprove. 

Not surprisingly, the underlying data shows the tale of the tape.  According to Rasmussen, almost 83% of Democrats approve of President Obama, while 81% of Republicans disapprove, and approval among those voters without party affiliation is basically split.  This leads to broad approval rating for Obama, according to the Rasmussen polls, which is still positive with 51% of voters approving.  Despite the still positive approval rating, as we’ve noted before, the Rasmussen Daily Tracking poll is often a leading indicator for broader approval as it measures what is happening on the extremes.  Shifts in strongly approve and strongly disapprove reflect these extremes and sustainable changes on the extremes will lead to a sustainable change in overall approval ratings.

Obviously highlighting President Obama’s approval rating is not a political comment by us, but an observation of fact.  The reality is, President Obama has been spending substantial political capital in the first few months of his Presidency.  Unlike his predecessor who asserted that he had earned political capital going into his second term and was going to spend it, President Obama did have real political capital to spend.  That said, President Obama’s political bank account now has substantially less capital in it as he has spent it on healthcare, foreign policy, and the stimulus package.  As of yet, he has seen only a negative return on this capital, and if he cares at all about his approval rating he will be much more prudent in spending political capital on a go forward basis.

Daryl G. Jones

Managing Director

Obama’s Approval Broken - rasmussen

 


CKR - Still in Trouble

CEO Andrew F. Puzder, says this morning “the decline in our same-store sales remains our management team’s primary focus” – it better be!

CKR reported that blended same-store sales declined by 5.0% during period six; an improvement from period five when comparable sales declined 5.2%!  There are not many QSR concepts with same-store sales trends as bad as these. 

For period six, Hardee’s same-store sales declined 3.6%, compared to an increase of 5.7% last year; on a two-year basis, Hardee’s same-store sales increased 2.1%.  Same-store sales for Carl’s Jr. declined 6.1% for period six as compared to an increase of 4.9% last year; on a two-year basis, same-store sales decreased 1.2% for period six.

It appears that a little bit of discounting is creeping into the game plan, but it is not moving the needle on traffic counts.  In period six, Carl’s Jr. began running a limited time 2 for $4 Western Bacon Cheeseburger promotion supported with TV advertising.  If I’m not mistaken, this is using TV to discount one of the concept’s core products – something management said it would never do.  Management is clearly passing some of the benefit of lower commodity costs to the consumer.  Without incremental traffic coming into the door, this is a net negative to margins. 

Industry leading margins and a mid-single decline in traffic are not a sustainable combination.  The only way to get traffic back is to give up some margin in order to improve the company’s affordable perception.  Relative to what we are seeing from other restaurant companies over the past two days, there is little upside to EPS for CKE but rather the downside risk is looking better.  

CKR - Still in Trouble - Hardee s Period 6

CKR - Still in Trouble - Carl s Jr. Period 6


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Misguided

"Perceived perception, misguided conception."
-Anonymous

I can't, for the life of me, understand how the manic media still clings to Ben Bernanke and Wall Street strategists for guidance as to what is in store for the US Financial system's future. The #1 risk that remains in this market is the pervasiveness of groupthink.
 
Never mind Bernanke's batting average on inflation forecasting for the last 3 years. YouTubing that would be too embarrassing. Now we are supposed to believe in the perceived wisdom of a man who allegedly knows more about the Great Depression's history than God himself. I have a fond appreciation for history professors - I just don't want them anywhere near managing the risk associated with my family's hard earned capital.
 
Bernanke's perceived perceptions never cease to amaze me. Yesterday, in addressing the potential for reflation to morph into inflation, he talked down Mr. Market's prowess as a leading indicator. He said that as he looks at long term US Treasury rates, "I don't think the financial markets are indicating a great deal of concern about inflation." Yes, fellow commoners - the willfully blind now refers to us non- rear view mirror prognosticators as "misguided."
 
Let's get back to reality here and get 3 things straight when it comes to the market's interpretation of interest rates:
 
1.      Bernanke has the political power of the Almighty to set rates on the short end himself - that's not a market rate
2.      The long end of the curve is marked-to-market
3.      The spread between the short end and the long end = the yield curve; it's also marked-to-market, not Madoff
 
Mr. Bernanke, Given that you and Greenspan have completely politicized the short end of this financial market curve, the only way to monitor the market's concern for reflation/inflation is to look at the spread. The spread between 10-year and 2-year US Treasuries is as wide as it has EVER been. You know this. C'mon man.
 
I will be dedicating the rest of my professional career to You Tubing the perceived wisdom of Wall Street and all those who are hostage to its conflicts and compromises. This is getting so bad, that I have to say it that way. If I were on the ice with Bernanke yesterday, he'd have his jersey pulled over his head.
 
The real people who are "misguided" are those who missed both the -57% peak-to-trough crash in the US stock market from Q407' to Q408', then called for a Depression (at the bottom), and now missed the +41% Q109' to Q309' generational short squeeze. I refuse to put in the reps to play this globally interconnected game and not use that genius technology that every other profession other than Wall Street seems to use called the replay button. I have said my piece.
 
Our Range Rover call was for the SP500 to trade in a range for Q3 of 871 to 954. We are 22 days, or 25% of the way, into Q3. The closing low for the SP500 for Q3 to-date was 879 (July 10th) and the closing high came yesterday at 954.
 
If the SP500 closes above 954, I will guide you to 955... then 956... and yes Mr. Bernanke, you can do this too - then you should stand up at the Senate today and call for 957! Waive your arms and stuff - get a little nuts like a hockey player for the camera maybe. Your seriously misguided conceptions of reality are wearing on me.
 
Many people write off Ron Paul for being a little nutso - and maybe they should. He's a pistol and he definitely doesn't fall in line with Groupthink Inc. While he may be too alarmist at times, he often makes one very simple point - what is it that gives you confidence in your economic predictions and why should we trust you? Fair question Mr. Paul - as a fiduciary of financial recommendation, I think there is responsibility in explaining one's analytical process. History will judge my accuracy.
 
History, of course, is not written by CNBC. The long term tail of this country's economic history is looked back upon long after the fact. In the moment, its our human nature to dismiss evolution. In the moment, the best job security is issued to those who fall in line. In the moment, we allow some of the most reckless abuses of political power that we can never imagine. The long term's unintended consequences of our perceived financial wisdom are what are most often "misguided."
 
Morgan Stanley is out with a call telling you to sell everything today. Then again, that's what their management team has been saying for the last +41% up...
 
Best of luck out there today,
KM


LONG ETFS

CYB - WisdomTree Dreyfus Chinese Yuan-
The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

COW - iPath Livestock - This ETN tracks an index comprised of two thirds Live Cattle futures, one third Lean Hogs futures. We initially began looking at these commodities because of recession inspired capacity reductions combined with seasonal inflections. A series of macro factors including the swine flu scare, a major dairy cattle cull in response to collapsing milk prices and the collapse of the Argentine agricultural complex due to misguided policy provided us with additional supporting fundamental data points for the quantitative set up in price action.  

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.


SHORT ETFS

 
LQD - iShares Corporate Bonds - Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back.

XLI - SPDR Industrials - We don't want to be long financial leverage, which is baked into Industrials.

EWI - iShares Italy - Italian Prime Minister Silvio Berlusconi has made headlines for his private escapades, and not for his leadership in turning around the struggling economy. Like its European peers, Italian unemployment is on the rise and despite improved confidence indices, industrial production is depressed and there are faint signs, at best, that the consumer is spending. From a quantitative set-up, the Italian ETF holds a substantial amount of Financials (43.10%), leverage we don't want to be long of.

DIA  - Diamonds Trust- We shorted the financial geared Dow on 7/10, which is breaking down across durations.

EWJ - iShares Japan -We're short the Japanese equity market via EWJ on 5/20. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

XLY - SPDR Consumer Discretionary - We shorted XLY on 7/9 on a rip as our team has turned negative on consumer.  

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.


THE MACAU METRO MONITOR

WYNN RESORTS FILES FOR HK IPO OF MACAU UNIT scmp.com

Wynn Resorts has submitted an application to list its Macau unit on the Hong Kong exchange, hoping to raise between US$500 million and US$1 billion.  Wynn’s plans come as LVS prepares an IPO of its own Macau division.  No decisions have been made regarding the timing or terms of any offering or whether the subsidiary will proceed with the transaction.

 

MACAU AIRPORTS PASSENGERS DOWN 22% IN 1ST HALF YEAR macaunews.com.mo

Macau International Airport’s passenger traffic was down 22% for 1H09, compared with the same period last year.  A statement from the Macau International Airport Company said that “there is the need to prepare for the after-crisis, and CAM has been proactively promoting the airport to airlines in target markets and developing strategic alliances with other airports”.  There is also a planned new service between Macau and South Korea due to start “after the summer”.

 

MACAU’S INFLATION IN JUNE THE LOWEST IN 5 YEARS macaunews.com.mo

Macau’s composite consumer price index rose just 1.1% in June. It was the lowest year-over-year growth rate in five years, according to the Statistics and Census Service (DSEC).  The average consumer price index for the first half of this year grew 2.54% on the same period of last year.  The composite CPI is intended to reflect the impact of price changes on the general population. 

 

MACAU’S GAMING TAX PAYMENTS DROP 10% IN FIRST HALF YEAR macaunews.com.mo

The government income from taxes decreased 10.3% y-o-y to MOP18.51 billion in the first six months of the year. Direct gaming taxes accounted 72.5% of the government’s total revenue in 1H09.  The Gaming Inspection and Coordination Bureau announced a 12.4% decrease y-o-y to MOP51.42 billion in 1H09.  The number of casino licenses – not necessarily all operational – held by Macau’s six gaming operators stood at a record 32 at the end of June.


IGT: CITYCENTER MAY NOT BE THE POSITIVE CATALYST

The SBG system seems to be having some technological difficulties at CityCenter. We’re also not sure IGT will get its typical new casino market sure.

 

The casino at CityCenter is expected to open in December of this year.  Our sources indicate there are numerous technological difficulties associated with the Server Based Gaming (SBG) system.  Apparently, the system’s compatibility with non-IGT games has been inoperable.  We’ve also heard from other sources that SBG trials at tribal casinos have lacked functionality.  If so, what exactly would casinos be paying for?

CityCenter would be the most important test yet of SBG.  SBG has long been promised as the future of the slot machine business.  Serious operational issues could further delay widespread SBG implementation by years.  IGT needs to get the house in order quickly by fixing the problems and offerering some meaningful applications.

The second potential issue with CityCenter, as it relates to IGT, is slot market share.  Even as its overall market share has declined, IGT has maintained a 50-60% or so ship share into new casinos and expansions.  Unfortunately, IGT may struggle to obtain a 45% share at CityCenter.

We’ve been on the right side of IGT the last few months and still believe that we are about to embark on an extended slot bull market.  However, the near term looks to be pretty rocky.  IGT will report its fiscal Q3 on Thursday and we, like a lot of investors, think they could miss the Street consensus of $0.18.  Other than potential for new markets (Ohio, video poker in IL and PA, and more casinos in IA), there probably won’t be a lot of positive data points discussed on the conference call.  Given the lack of near-term visibility, we don’t expect strong earnings guidance from the company, either.

As we said in our 7/20 post, the right strategy might be to fade the optimism ahead of earnings. 

 


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