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RETAIL FIRST LOOK: HEAD SCRATCHING 101

RETAIL FIRST LOOK: HEAD SCRATCHING 101

07 AUGUST 2009

 

TODAY’S CALL OUT

 

Ok, chain store sales are out, and they showed ‘no sudden movements’ vs. the trends we’d been seeing in prior months. Now we’re in the thick of summer, earnings season is nearly over (we still have retailers – but we already know top line for many), and we’re third inning of the much anticipated ‘back half earnings growth acceleration’ period. The primary call out for me is that when stacking SSS (losing relevance due to fewer companies reporting) against Retail Sales and PCE, there’s no doubt things are getting better on a trend-line basis (see 1, 2 and 3-year trends in charts below).  Now with a solid employment report this morning, it prolongs hope that this will continue (though when an investment process includes ‘hope,’ it gets pretty thin).  

 

So add on bullet proof momentum in the group, and it all adds up to a whole lot of head scratching. My point is that it has been a long long time since I recall such a massive lack of fresh ideas in the eyes of who I consider to be the best, most successful, and process-driven investors.  If I were to boil down consensus right now, I’d say it sounds something like this… “I’m long-term negative on the Consumer – the story does not end well. But things are getting better on the margin and growth expectations are heading higher. Yeah, the whole planet knows that and the group has gone parabolic since March. But with 14% of the float in retail held short, and investors that were down big last year risking extinction if they miss out on too much of the group’s outperformance, it is very tough to make a negative bet on Consumer Discretionary now."

 

The solution? Focus on the massive earnings outliers (RL, CROX, PSS, etc…). Importantly, we’re going to see volatility return starting in 2010 as we see the bifurcation between quality (the companies that are investing today to proactively drive results next year) and the junk (those that are cutting too much today and are borrowing from next year).  There will be some big calls (both ways) emerging from the ashes over the next few months.

 

RETAIL FIRST LOOK: HEAD SCRATCHING 101 - chart1

RETAIL FIRST LOOK: HEAD SCRATCHING 101 - chart2

RETAIL FIRST LOOK: HEAD SCRATCHING 101 - chart3

  

LEVINE’S LOW DOWN

 

  • In one of the more detailed characterizations of footwear product costs out of China, the K-Swiss CEO explained that prices for both labor and raw materials have come down dramatically. Interestingly, leather prices recently hit historical lows as a result of slowing auto demand and a recent draught in Argentina. If you’re confused on the draught comment, it basically led to abnormally high levels of slaughters and ultimately a glut of cattle hides. Adding to pricing pressure is the fact that the auto industry accounts for 40% of worldwide leather demand. KSWS and PSS are two of the companies with the highest concentration of footwear manufacturing centered in China. Both will benefit greatly from this dramatic reduction in costs.

 

  • Flat panel televisions remain one of the most elastic product categories in all of retail. With prices down north of 40% year over year, unit sales at Costco were up 32% in the month. Given the success of “cash for clunkers” and the shear amount of hdtv’s being sold, some might question whether the consumer is really in a slump. On the flip side, food stamp utilization, coupon redemption, and “trading down” all remain key issues facing retailers of consumer staples.

 

  • In looking at the product categories that stand out for July, trends were essentially unchanged from the prior month. Dresses remain a key positive category across all retail channels. Additionally, casual attire continues to outperform career/dress attire. This should come as no surprise with unemployment at 9.5%. The teen retailers with exposure to earlier back-to-school markets cited strength in denim, although the majority of the selling season is just about to begin. Similar to last month, home related products were mixed, with some retailers reporting strength while others are still seeing weakness.

 

  • One of the byproducts of tight inventory control is the potential for missed sales. With increasing frequency, retailers are citing negative impact on revenues resulting from substantial declines in year over year clearance inventory. While this dynamic bodes well for margins and profits, we suspect this creates some unwanted noise for those who “play” the comps each month.

 

MORNING NEWS 

 

-33% of Russian retailers may close up shop before 2010 - 33% of 42,000 retailers in Russia will probably be forced to close down business by year-end, according to the Chief of the European Fashion and Textile Export Council Reinhard Doepfer. It is due to continuous shrinking of consumer spending in the wake of the country's economic was hit by the global financial crisis last year, which has impacted the clothing suppliers in Europe. However, the industry said Doepfer's prediction is too severe and expected the closure figure will be only 10-15%. Germany has seen sales of clothing to Russia taking a dip by 6% in Q1 of 2009 and expects sales to drop further 30% in the forthcoming F/W collection to the country whose GDP decreased 9.8% in Q1 2009. <fashionnetasia.com>

 

-The Indian government is offering subsidies amounted to $532.5 million to the textile sector for technology upgrade - Textile minister Dayanidhi Maran said it is the first time that such a large amount of subsidies comes from the government, which is part of the Technology Upgradation Fund Scheme (TUFS), which provides preferential loans to help companies invest in new technology. Maran also mentioned a committee has been set up to devise a national fibre policy and will submit its recommendations in three months. In July, India lifted the TUFS fund from $229 million to $661 million as part of the country's budget. <fashionnetasia.com>

 

-Cambodia expects exports of garments to drop 30% - Cambodia's Ministry of Commerce has estimated that exports of garments will tumble as much as 30% in 2009 which is much higher than the 5% dip anticipated at the beginning of the year. This due to its main market the US of which the clothing market has undergone a recession. Shipments of apparels in the first five months of 2009 amounted to $909 million down by 20% from the same period of the previous year. Close to 80 apparel companies in Cambodia have shut down and another 30 leading manufacturers are also at the edge of closing down. <fashionnetasia.com>

 

-Coach Inc. has dropped a patent infringement lawsuit it brought against Brown Shoe Co. earlier this year - The suit, filed May 29 in U.S. District Court in Manhattan, accused the retailer’s Naturalizer chain of selling an “exact copy” of the Coach Ergo Pleat handbag, the design of which was patented in 2008. According to a notice filed with the court Tuesday, Coach agreed to a voluntary dismissal. A company spokeswoman confirmed Coach had entered into a settlement agreement with Brown Shoe but said the terms were confidential. <wwd.com/business-news>

 

-Stein Mart hires former CFO of Kellwood as new CFO - Gregory Kleffner, former chief financial officer of Kellwood Co., has joined Stein Mart Inc. as cfo, effective Aug. 10. He succeeds James Delfs, who is retiring. Prior to joining Kellwood in 2002, Kleffner spent 25 years with Arthur Andersen LLP, most recently as audit and advisory partner in its St. Louis office. “Greg’s strong financial and strategic experience with industry-leading manufacturers and retailers makes him a great addition to our team,” said David Stovall, president and chief executive officer of the Jacksonville, Fla.-based retailer, which operated 273 off-price department stores as of July 4. <wwd.com/business-news>

 

-France passes Sunday trading bill - More stores in France will be allowed to trade on Sunday after the country’s Constitutional Council gave the green light to a controversial bill Thursday evening. The council deemed the bill, which was ratified by a narrow majority in the Senate last month, was constitutional, but rejected the part that gave Paris’ prefect, not the mayor, the authority to designate areas that should be allowed to trade on Sundays. Instead of allowing all French stores to open on a Sunday, the law restricts the right to a limited number of commercial zones in three cities — Paris, Marseilles and Lille — and a number of tourist areas across the country. <wwd.com/business-news>

 

-Puma Reports 16% Decline in Profit on Discount Sales of Shoes and Jerseys - Puma AG, Europe’s second-largest sporting goods maker, reported a 16 percent drop in second- quarter profit because of increased discounting and said sales may start to fall in the second half. Puma AG, the world’s third-largest sporting equipment company, reported better-than-expected second-quarter earnings on Friday, but remained cautious about the second half of 2009. Puma, whose main competitors are Nike Inc. and German rival Adidas AG, earlier this year stepped up its ongoing savings program in response to the downturn. The program is targeting savings of 150 million euros, or $215.8 million, in 2010. <wwd.com/business-news>

 

-CEO Jill Granoff was bullish on the incremental relaunch of Kenneth Cole New York’s ladies’ footwear, which will roll out five styles today. -  KCP is expecting to sell through the entire initial deliveries at full price. The new shoes employ patented 9-2-5 technology borrowed from the Gentle Souls brand, which was acquired by Kenneth Cole four years ago. The first collection using the technology will be sold exclusively in the brand’s own retail stores to “build momentum and drive traffic to our stores before we expand into wholesale distribution next year,” said Granoff. “Our goal [with this line] is ‘no markdown, no promotion.’” However, the CEO said the company does plan to expand price points on the lower end of the spectrum.  <wwd.com/footwear-news>

 

-Perry Ellis International has signed a licensing agreement with SG Footwea - Perry Ellis International has signed a licensing agreement with SG Footwear for the design, manufacture and distribution of men’s slippers under the Perry Ellis and Perry Ellis Portfolio names. The debut fall ’09 line will be available in the U.S. and Canada and will be sold through department stores that include Macy’s, Dillard’s and Belk.  In a company release, Bernard Leifer, president and CEO of Hackensack, N.J.-based SG Footwear, said, “We are very excited about partnering with a great brand such as Perry Ellis, one of the most iconic brands in menswear.” He added that the deal offers the company a chance to grow its portfolio of licensed brands in the department store channel. <wwd.com/footwear-news>

 

-New Balance is targeting tweens with its new NB Fierce Trax collection, built around its new kids’ 900 running shoe model - Inspired by the cheetah, the 900 features the Boston-based brand’s kids-only N-Grip outsole technology, an aggressive, paw-inspired turf outsole that supplies slip-resistant footing and enhanced traction. In addition, New Balance’s patented N-ergy responsive cushioning technology in the heel provides for a smooth transition and delivers impact force distribution, reducing the number of hot spots in the shoe. The offering is composed of four styles, two boys’ colorways and two girls’ colorways. The girls’ models are detailed with a cheetah print on the upper. Slated to hit stores in January, the NB Fierce Trax shoes, to be packaged in custom shoe boxes, will retail for $55. Going forward, additional shoe models will be added to the collection. <wwd.com/footwear-news>

 

-Steven Madden Ltd. has dropped a trademark lawsuit it filed against eBay Inc. two weeks ago - According to court records, the footwear and accessories firm agreed to a voluntary dismissal of the suit Wednesday. Steven Madden had brought the complaint against the online auction house in U.S. District Court in Manhattan on July 21. It accused the e-commerce giant of trademark infringement because unauthorized watches made by former licensee Vestal were allegedly for sale on the site. Steven Madden did not return calls inquiring about the nature of the dismissal. <wwd.com/footwear-news>

 

-Sales drop for Blue Nile in the second quarter, but not as fast - Compared to previous quarters, sales didn’t fall as far for online jeweler Blue Nile Inc. in the second quarter. Sales dropped 5.2% in Q2 as net income fell by 12.5%. <internetretailer.com>

 

-Burberry scouts for new partner for fresh Indian partner - Burberry Group, the iconic UK-based luxury retailer, is on the verge of ending its tie-up with the UAE-based Jashanmal Group in India and is instead looking to rope in Indian retailers for a possible tie up, a person close to the development said. Burberry has three stores in the country at Delhi and Bangalore. It had set up its first store in September 2008. Burberry is looking for a new partner for faster roll-outs in the country and, with a new arrangement, Burberry plans to open 20-30 stores across the country in the next couple of years, sources said. The increased focus of the Burberry group on emerging markets like India stems from the fact that, in 2008-09, Burberry achieved 50 per cent of its growth from emerging markets such as the West Asia, China and India. Emerging markets contribute 9 per cent of its sales, up from 6 per cent in 2007-08, the company said in its annual report. Burberry has shown interest in Genesis Colors, the parent of designer labels such as Satya Paul, Deepika Gehani and Samsaara, as the latter moved swiftly in luxury space at a time when others like Murjanis exited the luxury business. Genesis Colors had bought the rights of Bottega Veneta & Jimmy Choo from Murjani group and now have 15 luxury stores in the country. <indiaretailing.com>

 

-Jewelry retailer Zale Corp. said Thursday that it closed 118 retail locations in the fiscal fourth quarter due to underperformance - The company has closed 191 locations in the calendar year, including 160 retail stores and 31 kiosks. Zale will also settle some rent obligations for 34 Bailey, Banks & Biddle locations. It is still trying to negotiate agreements for the 11 remaining locations. The closings and Bailey, Banks & Biddle liabilities will result in a fourth-quarter charge of $50 million. Zale has 1,931 retail locations excluding the announced closures. <www.google.com/hostednews>

 

-Small apparel maker files lawsuit against CIT - A small clothing maker called Scherr Inc filed a lawsuit last week against CIT Group, saying that the lender's financial problems and possible bankruptcy are threatening its business. Scherr, based in Livingston, N.J., said in court documents that CIT has not been able to give it the assurances it needs that it will hold up its end of the "factoring agreement" it signed earlier this year. Scherr asked the court to terminate that agreement. In a factoring agreement, the lender buys a client's accounts receivables at a discount, with the discounted amount of each account receivable payable to the client when the full amount is paid by the client's customer. In some cases, if the customer does not pay by a certain date, the lender is committed to paying the client.  <reuters.com>

 

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

 

08/06/2009 03:06 PM

COVERING XLY $25.68

I'll take my medicine and cover this position for a loss on a down day. I'm too early shorting these consumer stocks. Inflation won't be here until Q4. KM

 

INSIDER TRADING ACTIVITY:

 

WWW: James Zwiers, Sr VP & President, Outdoor Group, sold 7,000shs ($172k) roughly 12% of total common holdings.

SHOO: John Madden, Director, sold 10,000shs ($332k) after exercising the right to convert options representing a token share of a 2mm share (11%) ownership stake.

 

MACRO SECTOR VIEW AND TRADING CALL OUTS

RETAIL FIRST LOOK: HEAD SCRATCHING 101 - chart4

 

 


Restaurants - What Happened to Business in June?

For QSR operators, we are hitting the peak season for average unit volumes, making it a very difficult time to see sales trends slow.  The nimble operators need to be quick to react to weakening sales trends by cutting labor costs or margins will suffer.  When sales drop off suddenly, it gives operators less time to adjust their business models, thereby putting margins at risk.

 

We have seen an unprecedented decline in June same-store sales for nearly every restaurant operator.  This can best be seen in the steep decline in McDonald’s sales trends.  In May, MCD reported a 2.8% same-store sales number and it quickly fell off to 1.8% in June, and the company is likely to report 2% in July.

 

CKR also saw a slowdown in sales in June.  The company reported same-store sales growth of -7.1% and -6.1% at Carl’s Jr. for the four week periods ending June 15 and July 13, respectively.

 

JACK is another concept that is seeing weakness.  As of May 14, when the company reported fiscal 2Q09, management was pretty bullish about sales trends.  Yesterday, we learned that the company experienced a significant deterioration in sales beginning in mid June, with June coming in down about 4.4%.  Sales have recovered slightly in July to down around 3%.

 

JACK’s CEO Linda Lang offered the following explanation of why sales slowed so dramatically:

 

“We saw positive mix on our product promotions, so we really contribute the sales weakness to -- we initially thought it was potentially all of the discounting that was done at the causal dining and bar and grill concepts. However, as we now hear from those concepts that they experienced weakness as well, my theory is that -- and this is just theory, because I am not an economist -- is that we typically see a nice lift in the summer as kids are off of school, as college kids come home and get part-time sales jobs. And we just did not see that typical seasonal lift and I don’t think most of the competitors saw the lift that we would see in June.

 

If you look at unemployment rates among teenagers, very high at about 24% so they are just not getting those summer jobs and don’t have the discretionary income or spending that they would typically have.”

 

Restaurants - What Happened to Business in June? - Teen Unemployment

 


Mr. Macro Market

“Everything comes to him who hustles while he waits.”
-Thomas Edison
 
While it makes perfect sense for market operators to take some time off in the summer, Mr. Macro Market waits for no one. Yesterday, I wrote that I was going to wait and watch for the US Dollar’s reaction to this US unemployment report – that doesn’t mean I stop hustling.
 
For me at least, this is not unlike preparing for a hockey game. The discipline and repeatability of my preparation process is critical. If I sleep in or let someone in my inbox distract me, I will undoubtedly miss something. You have to eliminate all the noise – stay focused.
 
What’s most interesting to me this morning is the Russian stock market getting hammered (down over -3%) after their central bank CUT interest rates. Not only is it interesting from a causal perspective, but it correlates with the reaction we saw in Indonesia on Wednesday (they cut rates to 6.25%, and stocks on the Jakarta Composite Index suffered a -1.8% down day). This is new.
 
What’s new? The marked-to-market reaction to central bankers pandering to the political pressures to cut interest rates is much different than what we saw 9 months ago. At that time, I called it “going Greenspan” – which simply meant that Asian and European central bankers simply followed the strategy that the US Financial System’s “maestro” taught them. Everyone cut rates.
 
Since then (in a testimony to Congress in October 2008), Greenspan himself has gone on the record saying that there “was a flaw in the model that I perceived as the critical functioning structure that defines how the world works.” Doh! Now what?
 
Now what we have are a lot of politically compromised (and very inexperienced) international equity market policy makers being directed by a failed strategy of perceived wisdom. That’s not good – and Mr. Macro Market is going to fix it.
 
As opposed to some of those Blackstone “marks” on their private equity book that Steve Schwarzman marked-to-model (UP!) in his Q2 earnings report, Mr. Macro Market operates on a real-time, marked-to-market, basis. No, this isn’t new. This has been happening for hundreds of years. The only thing that is new is that the American Financial system has allowed the “how much money do you make” mantra to eclipse the laws of bid-asked gravity.
 
Gravity is what you are seeing Mr. Macro Market show you in these countries that continue to cut interest rates ahead of a significant acceleration in reported inflation here in the USA in Q4. This is one of our three core investment Macro Themes for Q3 – we have labeled it “Reflation’s Rotation.”
 
Cramer is too busy getting bulled up on Citigroup to poach that one liner from me this morning, so let me explain what it means before his hounds make a US currency style debauchery out of it. Reflation Rotation means that instead of reflating prices (Q2-Q3 of 2009) from year-over-year DEFLATION price levels, REFLATION will morph into reported INFLATION in Q4. That’s it. It’s that simple.
 
Does Mr. Macro Market see this coming? You tell me – here are his marked-to-market signals this morning:
 
1.      Chinese demand is running in the high single digits now year-over-year now to the point where their government admits the need to tighten “appropriately”

2.      Inclusive of the corrections they’ve seen in the last 3-days, stocks on the Shanghai and Hang Seng are still up a by a moon-shot in 2009

3.      The US Dollar continues to make a series of lower-highs and lower-lows (imports inflation to America by Q4)

4.      The CRB Commodities Index continues to make a series of higher-lows and higher-highs (that’s why the American commoner is bitter)

5.      Dr. Copper, one of inflation’s best prognosticators, is trading at $2.71/lb this morning – that’s will be +94% over Q4 of 2008 prices (no more deflation in Q4)

6.      Oil prices continues to test YTD highs, and will be trading 2x where they were in Q4 of 2008 (no more deflation in Q4)

7.      The US Treasury yield curve is trading within 15 basis points of its all-time steepest this morning at +255bps wide (10’s to 2’s)

8.      3-month LIBOR (as in the rate that $375 Trillion of the world’s debt is based off of) is hitting new YTD lows this morning at 0.46%

9.      The US Financials sector ETF (XLF) is up over +125% since March 5th of this year (classic reflation rotating into inflation)

 
The Bank of England opted for the political compromise yesterday, keeping Quantitative Easing in place. The pound immediately got pounded on that news, and this morning you are seeing the FTSE in London trade down a full -1%. If there is one country that has been willing to sacrifice her currency’s credibility for political job security other than the USA, it’s the UK. The Dow and the FTSE are two of the worst performing markets in global equities YTD for good reason.
 
The New Reality is this: if you maintain an un-objective monetary policy into Q4, Mr. Macro Market is going to sniff you and your lack of domestic rates of return right out of your hole.  As for the right here and now, well… I’ll deal with how the US unemployment report affects the US Dollar in 2 hours. In the meantime, I’ll hustle while I wait.
 
My immediate term upside TRADE target for the SP500 is now 1,012, and I have downside support at 991. A breakdown through 991 puts 969 in play.
 
Have a great weekend with your families,
KM
 


LONG ETFS
 

EWG – iShares Germany Chancellor Merkel has shown leadership in the economic downturn, from a measured stimulus package and budget balance to timely incentives such as the auto rebate program. We believe that Germany’s powerful manufacturing capacity remains a primary structural advantage; factory orders and production as well as business and consumer confidence have seen a steady rise over the last months, while internal demand appears to be improving with the low CPI/interest rate environment bolstering consumer spending. We expect slow but steady economic improvement for Europe’s largest economy.

XLV– SPDR Healthcare Healthcare has lagged the market as investors chase beta.  With consumer confidence down and the reform dialogue turning negative we like the re-entry point here. Buying red.

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.

QQQQ – PowerShares NASDAQ 100 With a pullback in the best looking US stock market index (Nasdaq) on 7/24, we bought Qs. The index includes companies with better balance sheets that don’t need as much financial leverage.

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.

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.

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

DIA  – Diamonds Trust- We shorted the financial geared Dow on 7/10 and 8/3, which is finally overbought.

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.

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.


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KSWS: Warming to a Dog

Core biz hit bottom, new biz ramping while R&D rolling and product costs out of Asia are down. New CEO at FL is big call option. Until then, $11 stock with $5 is cash. Not bad when I’m modeling a 40% 2-yr growth acceleration and 25 point boost in mgns.

 

It’s pretty darn rare for me to warm up to a story when sales are down 35% and inventories are flat. That kind of trajectory and its implication for margins is just outright scary. But K Swiss is proving to be the exception. I think we’re at an inflection point here. It will initially be a ‘results are trending less bad’ story, but I have many reasons to believe that fundamentals will turn positive within 12 months.

Here’s the ‘Then vs. Now.’

Then… (2007-Today)

1)      K Swiss has had a fashion trend going against it for the past 2-3 years (weakness in ‘classics’), which hit revenue by 50%.  Some companies would retrench and pull back in every spending area imaginable when under such top line pressure. But KSWS invested in two new technologies – Tubes and miSoul in order to grow around the core fashion category.

 

2)      At the same time, we were looking at the tightest capacity strain out of Asia that we’ve seen in over 10 years. Not a pleasant margin event for anyone in this industry – especially a small player like KSWS.

 

3)      Foot Locker was a massive drain on KSWS’ top line. I’d characterize FL as one of the worst managed companies in retail over the past ten years – up there with Sears. As FL struggled with its US business, it cut KSWS orders meaningfully. FL went from a peak of 29% to less than 10% today. Being held hostage to a bad retailer is, well…bad.

 

4)      At the same time, the company was also dealing with its failed Royal Elastics division, which was losing money and distracting management.

 

 

Going Forward

1)      The new running line is ramping up at the same time the R&D related to the technology is rolling over. In addition, a new line is always lowest margin when it starts – i.e. now. Each incremental pair that sells gets more profitable due to amortization of tooling and molds.

 

2)      I feel pretty comfortable in banking on KSWS’ ‘classics’ business being close to the bottom. It’s now sub-$200mm globally. The math there on both door penetration and pair per door is pathetic.

 

3)      We don’t need to assume any growth in the core, and with the addition of running, Palladium (its new boot business) and skate, we’re looking at over 40% growth in revenue over 2-years.

 

4)      With costs out of China coming down near double digits for footwear as capacity reopens from 6,000 factories up to a number closer to 10,000 in the Pearl River Delta, there is a meaningful COGS tailwind.

 

5)      Let’s not forget the Foot Locker factor. Next week, the new CEO starts his job – Ken Hicks, formerly President and head merchant at JC Penney. Think about it…If you come from a company where you flat-out own every vendor that tries to sell to you, and you end up at a retailer where one brand is half of your sales (Nike), what will your first move be? Probably to sit down with smaller, but profitable, brands that can be better partners to Foot Locker under its new leadership. Keep in mind that a K Swiss classic shoe is one of the most profitable sales for FL. I don’t have anything in my model for a major change in this relationship.

 

6)      Did I mention that KSWS has over $5 in cash on its balance sheet? With the stock at $11, and near a buck in EPS power, this is tough to ignore.

 

What concerns me…

1)      Time… You could have made the ‘great balance sheet’ call in each of the past 3 years. You’d have gotten smoked. There’s nice support here, but it might take time to get paid.

 

2)      I can’t shake the possibility that this management team goes out and does a stupid deal to ‘get more connected with the youth consumer.’  C’mon guys… Fix your current business, pull the levers you can, and get on with it. You’ve proven that your deal prowess isn’t anything to write home about. In fact, you have yet to make one work.

 

3)      I want to make sure that these guys are allocating enough capital to growing these new businesses. If it turns out that I need to take up SG&A in my model north of 10% to get the product to resonate w consumers, then it’s tough to find any earnings.

 

KSWS: Warming to a Dog - KSWS miSOUL

 

KSWS: Warming to a Dog - KSWS Palladium 2

 

KSWS: Warming to a Dog - KSWS Tubes


Shanghai's SHIBOR Experiment...

Over 700,000 new trading accounts were opened by Chinese brokerage firms last week as more first time investors flock to the Shanghai market. Even after last night’s downturn as the market digested a slew of newly announced IPOs the Shanghai composite is still up 84% YTD.  

 

The “it’s a bubble” crowd are pointing out, correctly, that short term rates have been spiking as more hot money flows into the equity and futures markets (see the 7 day and 14 day SHIBOR chart below). Despite an 18 basis point pullback last night the one week swap rate is still up 32% from this time last month. Clearly the bearish thesis is based on a common sense perspective that often: unbridled optimism + easy credit + inexperienced investors = an overextended rally.

 

Shanghai's SHIBOR Experiment...  - barber123

 

The “it’s not a bubble (just yet)” crowd – which includes the strategists at most big banks,  are arguing that multiples, while expensive, are justified by ramping internal demand dynamics that presents the best long term growth prospects on earth. In other words, on a longer duration the exuberance is justified. Where these cats were 9 months ago on China (100% lower) is beyond us…

 

The PBOC quarterly monetary report released yesterday stated with usual opaqueness that policy tools would be used to achieve “appropriate” liquidity levels. Although I am not privy to any inside track at the PBOC, if I was going to speculate about exactly what “appropriate” means in this instance –I’d guess that it means that the desire to continue bring new issues to market will be offset by an equally stronger desire to avoid any market volatility that could cause consternation among the masses in advance of the celebration of the anniversary of the People’s Republic on October 1st. As such any tightening of credit will likely be executed in stages designed to provide a soft landing. 

 

China is a managed economy, not a free market, and order is prized above all else in Chinese society. Therefore it is only natural that the powers that be in Beijing will attempt to manage the equity market towards an orderly outcome in advance of the biggest public event since the Olympics.

 

How appropriate.

 

Andrew Barber
Director 


Director


EAT – WHAT IS MANAGEMENT GOING TO DO?

I could spend the next 500 words expanding on all of the details of the past quarter and rehashing the guidance, which was obviously a big disappointment, but I don’t see the point.  Right now, the only thing that matters is what senior management is going to do to stem the decline in same-store sales and take the Chili’s brand to a level that will put it significantly above the competition.

While the current promotion “3 courses, 2 people for $20” may have helped have helped stem the decline in same-store sales in July, it’s not a game changer for Chili’s.  The current Chili’s promotion is only slightly different from the current Applebee’s promotion of “2 entrée’s for $20.”  Management acknowledged that this current promotion is only a short-term fix to drive traffic in this extremely competitive environment.  To that end, management said it will be implementing a new initiative in late fiscal 1Q2010 that it said will drive long-term menu innovation.  The company did not provide any further details about this initiative.

So what is management thinking?  The Brinker management team needs to be thinking that it must elevate the Chili’s brand, so that the food it serves is substantially better than the competition.  In the Bar & Grill “sea of sameness,” it’s imperative that it makes substantial changes and does not just launch some run of the mill value promotion.  Chili’s needs to start taking significant market share from its competition while its competitors are on the ropes.  Many of Chili’s competitors in the Bar & Ggrill segment are either marginally profitable or are so significantly leveraged, they have limited ability to navigate the challenging environment. 

Chili’s needs to go for the jugular while it can! 

Earlier this year, I had the opportunity to work in a Chili’s, put on a Chef’s coat and “fire up” a Fajita.  Without going into details, what struck me was how complicated it was to execute the current menu.  If my memory serves me correctly, there are three different sizes of chicken breasts with six different marinades.  It is very easy to put the wrong size breast with a meal at the wrong price point, costing the store incremental profitability.      

So why do I bring this up?  The menu has begun to complicate Chili’s ability to execute effectively.  Chili’s needs to simplify its back of the house operations by reducing the menu to include only the core items that represent the bulk of the chain’s sales.  At the same time, it can increase the quality of the items left on the menu.  A menu that is simpler to execute will translate into better food delivered to the guest with fewer complaints, thereby allowing the concept to build increased customer loyalty.  Importantly, it will provide a better work environment for restaurant employees.

A strategy like this is not without risks, but it’s also not unprecedented in the restaurant industry and for consumer companies.  In the restaurant industry, McDonald’s did it a few years back and the old “Philip Morris” did it in 1994 when it was under attack from “discount” brands.  Also, if I’m not mistaken, Grand Metropolitan (the UK based beverage company) reduced its SKUs in the mid 1990’s before it was taken over.


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