Double Trouble: Global Contagion, Korean Tensions Prompt Stock Market Slide

FL: Don’t Be Guided by Conservatism

In the midst of market jitters, European concerns, and a flurry of retail earnings reports, Foot Locker delivered a solid first quarter.  Results were well ahead of the Street, driven by three key factors.  First, sales came in slightly better than expected, with same store sales up 4.8%.  Domestic results came in ahead of expectations while international was at the upper end of plan.  Secondly, gross margins came in better than expected, improving by 140 bps.  Recall that the coming out of 4Q, inventories were in the best shape they’ve been in nearly a decade from both a quantity and quality (aged) standpoint.  Finally, SG&A expenses were only up slightly on a dollar basis (essentially flat) and leveraged by 100 bps due to the 5.3% increase in total sales.  All in, this represents a solid start to the company’s turnaround and it’s encouraging to see early positive results from the company’s strategic efforts. 


The biggest criticism here is likely the fact that the entire athletic footwear and apparel space appears to be producing similar, if not better, results.  While this is true and well documented, we continue to believe the COMBINATION of Foot Locker specific drivers such as improved apparel assortments, distinct banner segmentation, and inventory management will ultimately lead to a continued string of upside over the next several quarters.  Importantly, this is the first quarter to be reported since Ken Hicks unveiled the company’s strategic plan on March 9th.  As such, management remains conservative with its forecast on both the top and bottom lines, preferring to use a still “uncertain economic” backdrop as a reason for which to be reserved.  While management may be conservative, we are more aggressive both on the opportunity to see meaningful earnings upside over the next couple of years as well as the commensurate opportunity for share price appreciation.  Our estimates remain comfortably ahead of the Street for this year at $1.05 vs. $0.87.  We’d use the market weakness and any healthy skepticism surrounding management’s conservative outlook to revisit the intermediate term opportunity. 


A few highlights from the call on Friday:

  • FL remains in the very early stages of reaping the gross margin benefits from reduced promotional activity.  The result should be continued improvement in gross margin rate as well as the opportunity to strategically re-direct markdowns toward clearing slower moving SKU’s.  Importantly, 1Q was only the second quarter in almost a decade in which sales grow faster than inventory.
  • Lady Foot Locker (LFL) was called out as having the best performance domestically.  Recall that LFL has received the most attention so far as it pertains to an upgraded apparel strategy.  Yes, excitement from the toning category does help, but the opportunity to convert traffic into additional purchases by the female customer is the holy grail.  There are early signs of success here and we believe this is still early in the process of upgrading the brand’s merchandise and image.
  • With the Easter shift in the past, early May sales are trending towards a mid single digit increase through two and a half weeks.  Recall that comparisons become increasingly easier over the next two quarters, with FL posting its worst quarterly same store sales results in history in 2Q09 and 3Q09, down 12.1% and 8.1% respectively.  Putting easy compares aside, even a modest comp store increase with similar gross margin assumptions to 1Q gives us an earnings estimate $0.10 head of the Street. We shake out at $0.15 vs. the Street at $0.05.
  • Performance/technical running remains a key category, with management noting that the trend towards this higher price point footwear accelerated in the quarter.  This bodes well for future sales growth, as these products are accretive to ASP’s.  Furthermore, management confirmed that a new and innovative product pipeline across a variety of suppliers is key to the momentum exhibited in the category.
  • Management noted that the company is about 30% through the efforts to reposition the company’s apparel offerings and should be closer to 50-60% complete by the Fall season.  Domestic apparel sales, while still down low single digits, showed a huge improvement in trend from 4Q’s double digit decline.  We continue to believe the opportunity to improve apparel sales will be meaningful to both the top and bottom lines.   Lady Foot Locker is most developed here but we expect to see additional efforts in place for back to school across additional nameplates.
  • With 68% of the company’s business tied to Nike, it was encouraging to hear “the relationship [they] have right now is probably the best it’s been in some time”.  Importantly, this echoes positive commentary from Nike’s team on recent conference calls and at the company’s analyst day.  A healthy NKE/FL relationship goes a long way not just for these two companies, but for the entire competitive set.   We continue to believe exclusive content in the form of merchandise, marketing, and actual store formats (i.e. House of Hoops) will further develop in partnership between the two companies.  

- Eric Levine, Director


FL: Don’t Be Guided by Conservatism - FL S 5 10



Leadership Note of The Day

We get a lot of mail. Some of it is the most thought provoking of our day.


Attached below is a note we received from a subscriber friend. He’s a veteran hedge fund manager, a thought leader, and one heck of an American.


We can change this business for the better, but we have to be the change we want to see out there every day.




Keith –


So here we are again - another "leader" (notice the small "l" and quotes) willfully blind to reality, unable to hold up a mirror to see his/her own face as responsible and to compound the first 2 errors, capable of mustering misguided audacity, as a victim, to try and call out someone else as responsible for their own mess.


This situation seems to repeat with alarming regularity these days and made me think about why.  I will continue to think it through but two thoughts that come to mind are: a) consistent under-funding of education has created an electorate (here and abroad) largely incapable of critical thinking to see the vacancy in the arguments these leaders put forth; b) the race for the victim seat in the early stage of any event is intense because the party that gets that seat gets to frame the discussion to meet their ends (which are often unclear but certainly include not being held accountable). 


So what is to be done?  Accountability has to make a comeback and more people must be spoon-fed the framework of real counter arguments in hopes that the remaining critical thinking energy left of the planet can gather enough momentum to create conditions where accountability retakes the field.


Which leads me to a better understanding of the value of your call-outs - by name and in quotes of all these dopes.  The more sunlight these guys get the better for all of us.  Keep it up as this battle is waged!


Have a good weekend. -



Leadership Note of The Day - Orb


Keith R. McCullough
Chief Executive Officer


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UA: Reasons to Revisit the Long Side

UA: Reasons to Revisit the Long Side


In my conversations over the past 2 weeks, one thing is clear about UA – sentiment stinks. Here are some reasons why I think it’s worth revisiting UA on the long side.


  1. In this climate, I like names that can drive the heck out of the top line mode. UA has been investing in the right areas to do so for the past 3 years. Footwear might not have its big breakout until 2011, but it will begin to accelerate this summer. That’s enough for me.
  2. The cycle for this space is at the start of a 2-year upswing. All boats will rise. It will be product-driven, which will be the tail wagging the dog – and is misunderstood. I’ll never bank on a cycle hoping for consumer preferences to change. But after capacity has been pulled from the market (stores), the brands have invested in the R&D, the goods on the water, and the marketing dollars ready to spend, this will all synch. Sports Authority will go public later this year. Dick’s will comp higher. And yes, doggy FL will work. That’s good for all, including UA.
  3. Funny how people beat up UA in the past when Europe was strong because UA failed to really penetrate that market (yet). Are investors going to tout that now the company lacks exposure to a market that the world is waiting to implode? Probably not. Well guess what…if we see broad-scale downward revisions due to Europe, UA won’t be included.
  4. The stronger dollar allows UA to opportunistically put capital to work in Europe today – which they are, in fact, doing.
  5. The quarter I was concerned about this year just passed. Growth should accelerate from here.
  6. I’m only a few percent above the Street for this year – but have an upside bias’ to my $1.12. Next year I am at $1.70 vs. the Street at $1.27. If I’m right, then this stock is going parabolic.
  7. Mind you, my estimate still has UA at less than a 12% EBIT margin. This name is all about sheer unmitigated top-line growth.
  8. Sell-side ratings remain net negative (only 5 out of 25 are Buy), and short interest near 15%. I like that.
  9. The biggest negative? Nike announced at its analyst meeting that it will grow its apparel R&D by a factor of 4x this year. Even though that’s coming off a 50% cut last year, this is still a force to be reckoned with. Nike is not very good at losing anything.  But I’d consider several factors…

A)     Nike has 50% of the US athletic footwear market, and about 35% of the market globally. UA has less than 1%, and there are only 2-dozen brands that make up 95% of the market. In apparel, Nike is less than 10%, UA is low single digits and there are hundreds of brands that compete. Both of these companies could grow apparel double-digit for years without even touching the other.

B)      More R&D at one company helps the space. As noted, all boats rise. Why has the athletic space been in a funk for 3 years? Innovation has been nada. Why? The demise of Adidas/Reebok after the merger in 2005 took away all incentive for Nike to plow capital back into the market. That was also when Nike management was transitioning (remember Bill Perez?!?). It was simply a different time. R&D and product capital reaccelerated about 9 months ago, which means that product comes to market starting this spring.

C)      In this space, the brands compete on product, not price. Athletic shoes and shirts are not like lightbulbs at Home Depot or data storage devices at Best Buy. The vendors drive the ship. The tail wags the dog.




I remain skeptical on the housing market and the recovery portrayed in the current numbers.


The National Association of Realtors reported today that purchases of previously owned homes in April rose to the highest level in five months.  Purchases increased 7.6% month-over-month to a 5.77 million annual rate (the median price climbed 4% from April 2009). The housing industry is still being supported by the Government and the positive trends are expected to hold up through next month as buyers who close by June 30th are still eligible for the $8,000 Federal Housing Tax Credit.


Part of our negative thesis on Housing was based on rising mortgage rates, triggered by the end of the Federal Reserve's $1.25 trillion mortgage-securities purchase program.   While we understand the issues surrounding the “Sovereign Debt Dichotomy” in Europe, we did not see mortgage rates going lower.  Sovereign debt issues are forcing money to seek a safe haven in the U.S., pushing domestic mortgage rates to the lowest levels of the year and back to near 50-year lows.


I remain skeptical on the housing market and the recovery portrayed in the current numbers.  Today’s housing data, once again, showed the volatility associated with the government stimulus program and the unsustainable nature of the improvement in the housing market.


It is questionable that the recent drop in borrowing costs, prompted by concern over the European debt crisis, will help underpin sales after the loss of government support.  A more important issue will be employment trends and how fast the Obama administration can get the job growth engine started again.  Based on last week’s jobless claims numbers, a leading indicator, it is likely that the next move in the unemployment rate will be up, not down.


The Consumer Discretionary sector (XLY) and stocks leveraged to the housing sector have been among the best performers today with the XLY up 0.4% and the S&P Home Builders index up XHB +1.2%.   The XHB fell 6.9% last week, underperforming the broader market.  As our Financials analyst, Josh Steiner, pointed out, the news was not particularly good on the inventory front, as the number of existing homes on the market jumped 12% to 4.04M, the highest level since July. This pushed the months' supply to 8.4 from 8.1 in March.  Interestingly, the NAR noted that the jump in inventory was larger-than-normal for this time of the year and is not a "healthy" development, adding that there will be no "meaningful" increase in home prices in 2010 and possibly in 2011.



Howard Penney

Managing Director


HOUSING: A 50-YEAR LOW - existing home sales


HOUSING: A 50-YEAR LOW - mortgage rates

Squeezy Has Eaten: SP500 Levels, Refreshed...

Our macro risk management models refresh every 90 minutes of marked-to-market trading. Our models are multi-factor and this construction is primarily born out of my career’s mistakes of using price momentum (and the simple moving averages of price) one dimensionally. On balance, multi-factor modeling adheres to the principles of chaos theory much more appropriately than basic algebra.


What’s most interesting about the second meaningful short squeeze (100bps or more) since the closing low of 1071 last Thursday is that volume and volatility studies are flashing bearish on the second squeeze. Not only is the rally from the morning lows 1/3 less in terms of trough-to-peak price percentage, but volume continues to slide and the VIX is running ½ the percentage drop it saw at this stage of Friday’s rally. The VIX continues to hold its most immediate term line of support of $33.09.


For the first time in the last 3 days of trading, I am also registering a lower-low of immediate term TRADE support at 1055. This is important 1. because its new and 2. because a breakdown through the long term TAIL line of 1070 has its implied risks if it were to occur.


Squeezy has eaten the shorts twice now in 2 trading days. I think he’s full, for now, and I am much more comfortable having no position in the SP500. It’s time to wait and watch as Squeezy swims below 1070.



Keith R. McCullough
Chief Executive Officer


Squeezy Has Eaten: SP500 Levels, Refreshed... - S P

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