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BUZZKILL

Last night’s 5% pullback in the Shanghai Composite was a jolt to the system of bubble watchers like myself who have been following the trajectory of a market that appears to have come too far too fast in recent weeks -driven by a cocktail of optimistic first-time investors, easy credit and raw momentum.  5% does not a correction make however, so the price action in the next two sessions will provide us with a critical signal.

Currently, the quantitative model that Keith uses as part of our portfolio process has identified a SSEC index TRADE resistance level at 3,488 and a TRADE support level at 3,123. On a longer duration, 2776 is setting up as a TREND support line.

BUZZKILL - abchina1

In the here and now, Chinese equities are not being driven by fundamentals and only two forces are poised to force a reckoning:

  1. The IPO Calendar: In the wake  of the 12 billion share State Construction initial offering there are a slew of additional companies lined up to begin trading now that the 9 month new issue moratorium  has ended. Presumably, even with the billions of dollars that Chinese households have in savings accounts, the impact of increased supply will be felt eventually.
  2. Credit: Last night saw a 57 basis point spike in 1 month repo rates to 2.23% on speculation of tightening by the central bank. The trend in short term rates in recent weeks has been pronounced as more stock and commodity speculators enter the short term money markets (see chart below).

BUZZKILL - abchina2

On this second point, Ken Fisher was quoted today saying that Chinese regulators have “zero incentive” to curb lending since the nation’s economy is “going gangbusters compared to the rest of the world, so why would they try to kick that”. Now I know that Ken has been doing this for longer than I have, but to my mind the decision by the central bank to keep the loosening policy in play doesn’t necessarily mean that they won’t try to curb speculative excess.  Beijing doesn’t want to have volatile stock market fluctuations create discord among the new retail investors flocking to the markets so, I think that it is entirely possible that they could take steps to reign in margin lending and proprietary speculation by banks ( a growing factor in the equity markets there –see chart below) without impacting the access to credit for consumer spending on durable goods and industrial expansion.

BUZZKILL - abchina3

Andrew Barber
Director


Apparel: Small, but improving trend for the week

Despite total sports apparel sales being down again, sporting goods and family retailers had positive weeks. Total sports apparel was strong on the West Coast in all channels, but considerably weaker in the Mid-Atlantic region, especially for family retailers.  New England was soft with negative mid to high single digit declines across all channels with the exception of family retailers which increased 1.5% for the.  Columbia and The North Face were the outliers on the upside, with 43% growth in the outdoor apparel category for the week.  Hanes Brands had another slow week.  Under Armour’s decline for the week was driven primarily by weakness in compression, which recorded a  9% decline for the entire category.  Market share gainers on the week were Nike, Adidas, Columbia, and The North Face while Hanes, Russell Athletic, and Under Armour lost share.

Apparel: Small, but improving trend for the week - Sports Apparel Table

Apparel: Small, but improving trend for the week - SPorts apparel dollar chart

Apparel: Small, but improving trend for the week - Sports Apparel ASP chart

 


PNRA - Standing Apart

Going into Q2, I was having difficulty seeing how PNRA would achieve the high end of its $0.62-$0.64 EPS guidance range.  Well today, PNRA reported $0.69 per share excluding $0.04 of one-time charges.  On the high quality side, PNRA’s company same-store sales came in at -0.7%, which was better than my expectations, particularly considering the 6.5% comparison from 2Q08.  PNRA’s same-store sales improved rather significantly throughout the quarter, posting -1.9% in April, -1.6% in May and +1.6% in June.  The favorable June sales trends continued into July and even improved, running up 2.8% for the first 27 days of Q3.

On the low quality side, however, G&A expenses declined nearly 15% YOY, marking the first time this expense has decreased on a YOY basis in at least 5 years, never mind the magnitude of the decline!  This significant cut to G&A costs accounted for $0.04 per share relative to what I was modeling.  Management stated that it is not cutting G&A, but rather the quarterly decline can be attributed to the general lumpiness of projecting G&A costs as a result of timing differences for overhead expenses.   Specifically, management said that bonus accruals were lower in 2Q because relative to certain performance metrics, the company had underperformed relative to Q1.   Given that restaurant margins declined 110 bps YOY in the quarter (before the one-time charge related to the roll out of new china), the timing of such a significant reduction to G&A expense does not seem coincidental.  Instead, it seems that management needed to cut G&A to save operating margins. 

Even with PNRA maintaining such impressive top-line numbers, it is going to become increasingly more difficult for the company to maintain margins.  Unlike most restaurant companies, PNRA is still growing.  I am forecasting 4% company unit growth in 2009, which means that PNRA is still incurring growth related costs.    And, these costs are only heading higher next year because management stated today that it expects to increase its company-owned unit growth by 50% in 2010.  PNRA is only expecting modest cost inflation in 2010 as higher labor and occupancy costs are expected to be largely offset by lower food costs, but increased development costs will creep into the P&L as the company aggressively ratchets up its unit growth targets.

PNRA - Standing Apart  - PNRA Restaurant level margin 2Q09

PNRA - Standing Apart  - PNRA G A 2Q09


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AS GOOD AS IT GETS

First, to state right up front, it’s been well over a year since we have shorted the financials.  Currently, the XLF is the only sector in the market not trading above the TAIL line (three years or less).    As steep as the yield curve looks right now and as good as the ted spread looks – this is, by definition as good as it gets for credit and the financials.   

On top of all this, the dollar is teetering on a major breakdown below the 78 line.  The dollar is currently down 12% since March – we call that a crash.  We view the XLF as the most politically compromised sector in the market because financials have the most political dependence, which helps to fix the earnings power of the industry.  What the government giveth, it can also take away! 

Last week, Ben Bernanke proved to the world that he is staying with his politicized strategy by keeping the low end of the curve at 0%.  As the rest of the world moves on from the financial crisis, there are many countries that may not invest in the politically compromised U.S. Financial services industry.  This fits our thesis of “buy what china needs and not what we want them to need.”  The US government wants China to buy US dollars and US treasuries, but our belief is that China’s central bankers will decide that they need to diminish their exposure, a conclusion that will be made easier by the politics of the situation. 

Provided that we keep the low end of the curve at 0% in the US, there is no incentive to save in this country, and economics 101 has taught us that savings need to equal investment over time.  Investment is perpetuated by a country that has cash and savings – think China (although it’s easy to hoard when all property and income belongs to the state).

The bulk of the XLF is made up of the Diversified Financials (55%), which include the industry heavy weights JPM, BAC, GS and MS.  Banks make up 20% of the ETF with Insurance and Real Estate companies accounting for the balance. 

The earnings trends for the Real Estate and insurance companies have been disastrous all year and did not find much support going into 2Q earnings season.  The Banks, those best levered to taking advantage of the steep yield curve, have shown the most positive earnings revisions trends of the past week and month.  Overall however, earnings revisions for the XLF continue to be negative.

AS GOOD AS IT GETS - hp12

Since the XLF bottomed on March 5th, 2009 at $6.24, we have seen a generational short squeeze that most investment managers missed.  The XLF has rallied +102% largely on the back of a massive recovery in earnings sponsored by the US taxpayer.  As you can see in the chart below, earnings for the XLF declined significantly in 2H08, have since recovered in 1Q09 and continue to improve in 2Q09.  While 2Q09 was strong for the financials, it appears that the bulk of the earnings recovery is behind us as there was a sequential deceleration in improvement.  Going forward, the pace of sequential improvement in the XLF EPS will continue to slow, declining to 9% in 4Q09.  These estimates are based on a compromised yield curve.  If our 4Q inflation call proves to be correct, interest rates are headed higher.  What will happen to Q4 numbers if the yield curve flattens? 

AS GOOD AS IT GETS - hp34

It is our conclusion that things can only go downhill from here for the majority of the financial sector for the immediate and intermediate duration. As always, we are data dependent and will be testing our thesis as new data emerges.  

Howard W. Penney

Managing Director


RCL: CONF CALL HIGHLIGHTS

We wrongly assumed that given the updated guidance on June 29th captured most of the negative news.  Commentary on 1Q 2010 was strong, but we’re not sure it matters given the credibility issues related to lowering guidance 3 times in a row.

 

RCL 2Q09 Earnings call:

Introduction of the two Solstice class ships was the most successful introductions in memory

All of the new capacity is being deployed outside North America

NA supply will be down in 2009

Think that Europe is 10-15 years behind NA in its development as a cruise market

Asia and South American virtually untapped as well

So they are very “bullish” on new capacity… we wish we could say the same

Economy in Spain:          

  • Initially hoped that Spain’s recovery would be sooner since it fell first… but not so, unemployment now at 18%

Beginning to see signs of encouragement

  • Booking levels are stable
  • Financing environment is ok
  • Situation began to stabilize 6 months ago and thought that it would lead to an upturn, but unfortunately it has not

2Q09 commentary:

Dollar weakened 15% vs sterling which produced a below the line loss

Adjusting for H1, they would have come inline

Fuel expense was 6MM better than expected, because of the IFO and MGO lag to WTI, and consumption was below guidance

Booking environment update:

  • Pricing for all three quarters remains behind last year, but magnitude is stable
  • On the volume side, they see bookings lag, up until four weeks prior to sailing… so no closing in on the short booking window
  • Yield decline of mid-single digits in 4Q09
  • 2010 commentary
    • 1Q09: Slightly more than 1/3 sold, lagging where they were y-o-y. Pricing is materially higher than where they ended 1Q09. Optimistic they will see yield improvement in 1Q2010
  • More pessimistic view on Spain, given the unemployment rates
  • 2009 full year guidance
    • H1N1 impacts 3Q yields by over 2% and 1% for the full year

Fuel hedge prices are in the equivalent to WTI in the high 60’s for 2010 and 2011, so should have another fuel benefit in 2010.

H1N1 impact 5 cents worse, fuel is 8 cents per share higher, interest expense is 7 cents (upsize of debt deal), balance of weakness is Pullmantur

Don’t see the need to access capital markets for 2010 & 2011 even in their pessimistic scenarios

Remain reserved in their expectations for economic rebound

Shipboard revenues have declined meaningfully, with gaming most negatively affected

Europe & Alaska price declines are putting the most pressure on yield declines, but are pleased with the increased local sourcing in European markets. 

  • Alaska, no new supply, but massive price declines.  Change in the profitability of this market has been dramatic
  • Selling fall cruises to Mexico remains a challenge for the 3Q and 4Q

Taking possession of Oasis in a few weeks, continue to be very pleased with the bookings for this ship

Cost control initiatives continue throughout the organization

Solstice class ships

  • Pricing ahead of 4Q08 & 1Q09 but behind last year’s levels
  • Will account for 40% of Celebrity’s capacity

Q&A

In general 2/3 of passengers in Europe will be non-US

How is the carve out of Azamara going to change the reporting/ cost structure?

  • Won’t … just trying to achieve better brand recognition

Why did constant dollar yields decline by 2% … we know 1% was due to H1N1

  • Took down Spain – 25-30bps on yields (7 cents on earnings)
  • Balance is a rounding error??? Ok – looks like expectations are simply lower across many markets

Fuel hedge strategy – probably won’t see large increases in hedge positions for 2010

What have booking volumes done over the last few weeks?

  • See “remarkable” consistency
  • Dip was bc they ran out of inventory
  • 4Q09 guidance assumes a  lot of cost savings-so EPS growth is driven by cost savings

Greatest upside from Q1 2010 really due to easier comps and new ships

Swine Flu issue – what are they doing to mitigate the impact… you can’t… but they spoke about containment and gradual fade of panic

Net Cruise Costs – G&A continues to run very efficiently but remain very committed to marketing and sales efforts as those are strategically important

Yield management systems- what are they doing?  Seems like they have no visibility since they keep lowering their guidance.  Shorter booking windows really hamper forecasting- I don’t think that’s any surprise

  • Think that their yield systems are the best in the industry, especially when you take into consideration H1N1 and FX movement
  • Their leverage is also huge so small changes in yields have huge impacts on bottom line

Yields in 2010 – will they still be negative

  • Sticking with the expectation of yield improvement in the 1Q 2010 (FX helps them too) plus better product mix… YES POSITIVE YIELDS NOT LESS NEGATIVE
  • Higher occupancy on newer vessels, benefitting from newer vessels

Sounds like CCL is going to start building more ships beyond 2012… does that mean that they will as well?

  • Clear that this isn’t a market share game… claims there is brand loyalty… etc… we’re skeptical about the whole brand loyalty thing
  • Will look a the decision of building purely based on getting best ROI – and that comes from margin expansion not supply growth – Hallelujah

Decline on the short Caribbean- what happened?

  • Those have the least visibility and the shortest booking cycle? Close in bookings were weaker than expected and hence pricing was disappointing

New ship financing on Allure – still 15 months away, will start looking at that.  Have had some preliminary conversations, but feel very good. Don’t expect to have an update until year end

Fuel technology – too early

IFO/MGO gaps to WTI - we don’t get this question because you can simply track IFO and MGO directly so why even rely on WTI

If the flu season is much worse this year, that is going to negatively impact guidance


TBL Angry, UA Happy

Here's the quote of the day -- live from the TBL conf call. Jeff Shwartz at TBL is just flat-out angry. He just lost his rock star teamate (Gene McCarthy) who is one of the best brand-builders in the business right now. When I hear this I get even more pumped about Gene being at UA today.

 

"It's 10 minutes to 9 on the 29th and I'm finished with the arrogant conversation from Timberland about we are restricting the allocation. It sounds terrific, but the bottom line is we have a clean distribution network and we are out in the world fighting for every pair of orders we can get with consumers. The speechifying about -- we will make it harder for you to get. That crap is done. My view is we have a clean, balanced distribution network of retail partners we want to do business with and we are interested in serving consumers. We are not going to stuff the channel and we are not going to starve the channel. We're going to serve the consumer."


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