China bounced overnight: Golf Clap...

Chinese stocks avoided their 11th consecutive day of losses overnight, closing +5.2% on the day.

Like a nice putt, we'll give this aberration in the data a golf clap. The "Trend" in the data is a crashing one. Inclusive of today's bounce, China is down -52% from the "its global this time" October 2007 highs.

My next support for the Shanghai Stock Exchange is 2696. Today the Index closed at 3085.


(chart courtesy of

Volatility: Beware...

The VIX is looking to breakout big time here. While it is +6% on the day, if it can close above my 22.23 line, i think this is going at least +45% higher over the course of the summer.

No charts. No other points to be made here.

It is time to manage risk, not take it.

PNRA - Eating Wheaties!

Panera Bread raised its 2Q EPS guidance by $0.06-$0.08 to $0.48-$0.50 due primarily to better than expected company-owned same-store sales growth of 6.1%-6.4% (versus its initial guidance of +5%-6%). This good news release was partially offset by the fact that the company also stated that its 2H EPS results will be more negatively impacted than originally planned by rising gas prices (an incremental $0.02 to $0.03 negative hit). The 6%-plus same-store sales number, however, signals a huge uptick in top-line results from 1Q08 and FY07, up 3.3% and 1.8%, respectively. Our grass roots survey (posted on June 10) indicated that PNRA's new breakfast sandwiches were performing well, which could account for some of the same-store sales and margin upside (the new sandwich generates a higher penny profit than all of its other breakfast offerings).

Additionally, a big part of the bearish story about Panera has centered on the company's declining operating margins, which have been down every year since 2004, and yesterday's press release mentioned that management's renewed focus on driving higher gross profit per transaction started to yield better margins in the current quarter.

PNRA's stock price has recently reflected the change in wheat prices and yesterday's company announcement also removed some of the uncertainties around the company's exposure to this volatile commodity (up 20% from May). Management stated that it is has now locked in about 95% of its wheat requirements for 1H09 at $10/bushel (down more than 30% from the average $15 paid in 1H08). With wheat moving up so much in the last 3 weeks, this will be welcomed news to investors. Interestingly enough, the company wanted to lock in its 2H09 requirements as well, but suppliers are not offering commitments on basis for that time period.

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From Iowa to China

The flooding in our nation's heartland is bad enough. But in taking a global view it is clear that we are not alone. The worst floods in 50 years in Guangdong, China are starting to take a toll on factories and finished goods inventory across all industries - including apparel and footwear. Not to diminish the pain being felt by US farmers, the floods in China have affected 5.8mm people (equal to twice the size of the entire state of Iowa). It's vital to step back and look at the progression of Mother Nature's wrath in China - debilitating snowstorms in February, Sichuan earthquake last month, and now the flooding. Three's a charm.

Capacity growth (measured by number of factories) was already slowing headed into the year. But now we're seeing an increasing number of factories close their doors. As I've been commenting on, migrant workers are not showing up to work at the seasonal peak when they are needed most. Add on the fact that we're seeing minimum wage increases better than 15% in certain provinces (18% in Shenzhen on July 1) as well as raw materials head higher, and the outcome is not good. Also keep in mind that in advance of the Olympics, the Chinese government instituted mandatory back pay for vacation days at bottom-tier factories producing lower-end product with questionable labor standards. Clearly, this serves as a financial 'incentive' for the factory to take up its mix and work standards (making China look better while in the Olympics fishbowl), or pay the penalty. Yes, another example of the sheer power of the Chinese government to push its own agenda at the expense of anything remotely resembling capitalism.

Bottom line, costs will continue to rise. Yes, they have already gone up, but they will accelerate in 2H and make their way into the US supply chain by 1H09. Short weak content and distribution (SKX, ADS, DKS). If you need exposure here, long brand strength (NKE and even UA), as well as turnarounds who can sidestep this impact (FL).

Adidas: Time To Dust Off The Short File

I'm getting more cautious on Adidas. Yes, it is a great global brand, and overall a reasonably well-run company. CEO Hainer reaffirmed guidance again today, the same guidance he said in the past that he would hit 'come hell or high water.' To his credit, it appears that he's hitting it. But I think they're pulling out all the stops this year, and with margins at peak, I wonder how much gas is left in the tank in '09. Here's what concerns me...

1) The German consumer confidence number came out today. Not good. -53% vs. expectations of -42%. While Germany is not its biggest European market despite its domicile, Europe overall accounts for 45% of sales and 75% of operating assets. Weaker German confidence, higher UK inflation (+3.3%) and a downturn in UK retail sales will not help this story - especially if the dollar strengthens.

2) The Euro Champs (going on right now) are boosting the athletic space. Then we deal with the hangover.

3) Same goes for the Olympics - for which Adidas is the sole apparel sponsor. 2Q and 3Q09 will be tough to anniversary.

4) US will not get any easier. The Reebok brand is seemingly going away. Retailers don't want it, consumers could care less, and market share for both Adidas and Reebok combined in the US is about in line with New Balance. That's sad. With Under Armour aggressively pushing into the footwear space, this should put pressure on the incumbents (especially Reebok). Let me know if you want any specific market share numbers.

5) Did I mention that cost pressures in the industry are exploding? Check out my early posts outlining the emerging secular margin challenges. Bottom line is that capacity growth in Asia is slowing, pricing is headed higher, and the supply chain is being stress-tested to a greater degree than we've seen in 10 years.

There's got to be some really powerful bull case out there to justify 9x EBITDA. I'm having a tough time finding it. This is officially a name where I need to dust off the short file.

CKR - Circling the Clouds in a Cessna Citation X

Back on May 3, I posted my concerns about the level of G&A spending at CKR, highlighting the fact that although the company's system-wide store count had declined by 8% since 2002, G&A per store had grown nearly 40%. On May 15, I pointed out that CKR's aggressive capital spending over the past 2 years has not led to incremental returns for shareholders and said that management needed to change its long-term unit growth strategy in order to reverse declining returns. It turns out I am not the only one with these concerns as Ramius LLC (owns 3.6% of CKR's shares) sent a letter today to Andrew Puzder, CEO of CKR, in which it calls for the company to:

1. Significantly Reduce Operating Costs
2. Shrink the Capital Spending Plan to Improve Free Cash Flow

My letter to management, however, would not have been as nice. First, I would have spent more time pointing out that senior management is significantly overpaid. Please refer to my posting from May 12 for more details about my frustration with management's recent bonuses relative to company performance, but I can't help but reiterate the point that in FY08 despite a nearly $600 million decline in the company's market value, the CEO still made $6.2 million (down only slightly from the $6.8 million he made the prior year). The Board pretty much made excuses (they called them material events ) about why CKR did not hit the targeted income for management to receive a bonus so in the end, they received their money while shareholders did not.

More importantly, it would have been easy to show that the company's senior executives fly around the country in a Cessna Citation X. They justify the expense of the plane due to the vast number of restaurants around the country. Not! I can name several restaurant companies that are significantly bigger than CKR and the senior executives fly commercial. As the Ramius letter suggests the company should consolidate its headquarter operations in California. If management did this, I would guess that most of the flights on the Cessna Citation X would stop! The hourly cost of flying a private jet has increased 100% over the past two years and management continues to abuse shareholders money.

Although I agree with all of the initiatives outlined in the letter and think that reducing both operating costs and capital expenditures are necessary to improve operating margins (which fell 170 bps in FY08) and to increase returns on incremental invested capital, I do not think this one letter will spur any immediate changes or even cause management to miss a step as it my understanding that CKR management does not listen to its shareholders. Ramius LLC points to this very point in its letter, saying we have repeatedly stated in conversations with you and with the senior management team, we believe there is currently a substantial opportunity to improve shareholder value at CKE. If management were to get its heads out of the sands, well, then, maybe things would be different...

Significantly Reduce Operating Costs
There is substantial opportunity to drastically reduce overhead costs at CKE. The Company currently operates three headquarter facilities, one of which occupies some of the most valuable real estate in the U.S., west of the Pacific Coast Highway in Carpinteria, California. Two of the three facilities are located less than 100 miles apart. Given the close proximity of the Company's two offices in California, one in Carpinteria and one in Anaheim, it is prudent for CKE to consolidate both offices into a lower cost facility as well as to simultaneously explore the feasibility of combining all locations into one facility. In addition to consolidating offices, there is an opportunity to meaningfully reduce general and administrative expenses ( G&A ) per store. As you can see in the table below, since 2001 the absolute level of G&A has remained almost unchanged yet the store count has been reduced by almost 20%. This has created a substantial increase in G&A per store from $38,400 in 2001 to $46,700 in 2008, an increase of 22%.

The Company was able to maintain a positive trend in lowering G&A in proportion to store count from FY2000 to FY2004 with G&A being reduced by $39.8 million and store count decreasing by 16%. However, since FY2004, while store count dropped by an additional 5%, G&A actually rose by $36.6 million.

From FY2000 to FY2004, the Company on average reduced G&A by $2.5 million for every 1% reduction in store count. The average G&A per store achieved by FY2004 was $33,100. By applying the FY2004 average G&A cost per store to the current store count, excluding any additional necessary public costs such as FAS123, the Company would operate at a G&A of $102.0 million, or $42.1 million lower than the current amount.

Our analysis indicates that CKE's G&A costs as a percentage of total revenues, company owned revenues, and on a per employee basis are out of line with competitors in the QSR industry and clearly demonstrate an opportunity for improvement.

Shrink the Capital Spending Plan to Improve Free Cash Flow
In light of the current economic outlook, the Company's $145 million capital spending plan for FY2009 is too aggressive and unwarranted. The Company is expected to generate $155 million of EBITDA based on analysts' 2009 consensus estimates and has roughly $50 million in annual interest expense and cash taxes, thereby producing $105 million in cash flow from operations excluding working capital adjustments. A capital plan of $145 million would yield a $40 million free cash flow deficit which we believe is unacceptable given the current environment and balance sheet leverage. Furthermore, we fail to see the rationale for such a large capital spending plan since the Company has failed to achieve a measurable increase in returns on investment from past spending.

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