China is not a communist state. China is an autocracy --one with a governmental system that incorporates communist philosophical roots and social policies combined with a unique experiment in state managed capitalist economics, but an autocracy nonetheless. The entire nation is ultimately overseen by an unelected politburo selected through a process of patronage and nepotism.


Tomorrow’s celebration of the victory over the Nationalist forces and founding of the People’s Republic will provide the country’s leaders the opportunity to embrace the exploded myth of the socialist workers’ state while in the background the wheels of rapid private sector development continues at a  frantic pace. In short, tomorrow’s parades, with displays of cold war nostalgia like missiles on trailers as well as thoroughly modern features such as female soldiers decked out in chic pink uniforms with white boots and tights, will be a national exercise in delusion.


The fundamental failure of the state founded 60 years ago was brought home during the cold war as the economic might of the US and its western allies provided technological and military development that the communist nations could simply not keep pace with. Although the introduction of economic reform began in the late 1970’s when Deng Xiaoping began the painful process of recovery from the madness of the cultural revolution, it was the collapse of the Soviet Union under unrelenting pressure from the west that heralded the end of economic isolation as the Communist party leadership acknowledged the new reality of competing on the global stage.


The system that was ultimately adopted could be described as an attempt at having one’s cake and eating it as well. Beijing continues to control every aspect of life and ultimately owns all property while embracing the economic clout and prosperity brought by private enterprise. The bubbles of social discontent that have been amplified in international media coverage in recent years are a constant reminder to the party of the golden rule of benevolent despotism: the people will only be content to surrender personal freedom if the social contract (universal employment, steadily improving living conditions, social justice etc.) is fulfilled. The global economic crisis could have disrupted internal harmony, and this threat spurred Beijing into pouring massive amounts of money into the system in an attempt to buy growth. Buying growth is the most expensive thing that a government can do short of war and, to date, it appears to be working and to have been worth the cost. 




Last night the HSBC PMI Index for September was released with a level of 55.1, showing that manufacturing expanded for the 6th consecutive month and demonstrating that the stimulus policies adopted by Beijing last year to spur internal demand are continuing to reverberate through the system.


When we issued our call on Chinese equities in July, we wrote that we anticipated that the market was due a correction, and that specific sectors and industries would outperform. Of our four picks, three--Automotive, Consumer Staples/Food & Beverage  and Technology Stocks--have handily beaten the broad indices while Basic Materials have lagged under deflationary pressure. In the chart below, we have broken out these components from the CBN 600, an index comprised of the 600 largest equities by capitalization on the Shanghai and Shenzhen exchanges.




We continue to be bullish on the developing internal demand: with CAAM recording more than a million new cars monthly since March, increasing evidence of demand for nutritional diversification and the continuing transition to a society of internet surfing smart phone users, our outlook has not changed. We anticipate that the massive amount of infrastructure improvement needed in Central and Western regions will ultimately drive Basic Materials, aided by our expectations for returning global inflation in the coming quarters.



Andrew Barber




When I previewed DRI’s fiscal Q1, I said that sales would come in worse than consensus expectations.  Sales came in even lower than my expectations with blended same-store sales down 5.3%, which would explain DRI’s stock performance today.  Comparable sales slowed on a 2-year basis at each concept.  Red Lobster’s underperformance was the most surprising with same-store sales growth coming in down 7.9% in the quarter, which represents a 540 bp sequential decline on a 2-year basis.  Management attributed the softer than expected sales trends to the difficult economic environment and the company’s decision to not participate in the deep discounting tactics of its peers.  DRI’s CEO Clarence Otis even stated that DRI does not want that type of unprofitable customer in its restaurants.  Highlighting just how prevalent industry discounting has become, management commented that in fiscal Q1 the casual dining industry’s average check declined 1.5% on a sequential basis and was down 3.5% YOY.   


Despite the fact that DRI delivered worse than expected sales numbers, the company, like so many of its peers, beat the street’s EPS expectations by $0.01.  Although this was not surprising given the benefit from favorable YOY commodity costs and cost saving initiatives implemented in 2Q09, I continue to maintain that the street’s full-year EPS estimate of $2.80 is too high.  After these Q1 earnings results, this number is sure to come down.  The question now is will it come down by enough. 


Despite lowering the low end of its full-year same-store sales growth guidance range by 1%, DRI maintained its EPS growth range of -2% to +8% as a result of lower than expected food costs.  Going into the quarter, I did not think DRI would have to revise its EPS guidance given the wide range of DRI’s EPS forecast.  Management did say, however, that the lower end of the range is now more likely.  Based on current sales trends, achieving -2% EPS growth is no longer a given.   DRI’s new blended same-store sales guidance of flat to -3% assumes an acceleration in same-store sales trends.  Management stated that some of this improvement will result from the “arithmetic” or easy comparisons, but in this environment, I am not sure that easy comparisons matter.  Instead, I am looking at 2-year trends and a -3% number assumes an improvement in 2-year trends as well.


Management stated that blended same-store sales growth in September is running similar to August, which was down about 4% to 5% versus the reported -5.3% number in Q1.  Based on those quarter-to-date trends, Q2 is not going to fare as well on an earnings basis relative to Q1.  EBIT margins improved on a YOY basis in Q1 but even with the continued favorability in commodity costs, margins will likely decline in Q2 to the magnitude of about 100 bps.  Fiscal Q1 was also helped by the cost saving initiatives that the company implemented in 2Q09.  Management said that it is still finding increased cost saving opportunities but not of the same magnitude as last year so the YOY benefit of these initiatives will moderate in Q2 and beyond.  As DRI correctly stated on its earnings call, it is one of the few casual dining restaurants that is still growing.  This growth will make it increasingly more difficult for the company to continue to cut costs. 





Sports Apparel Numbers: Quick Take

Not a good week, as the deceleration continued. The 3-week trend – which is our focus – remains reasonably healthy in the sports retail channel. Mass channel is still a mess, and there was a disproportionate downturn in the family channel – which is a notable divergence.



Sports Apparel Numbers: Quick Take - 1


Sports Apparel Numbers: Quick Take - 2


Sports Apparel Numbers: Quick Take - 3


Sports Apparel Numbers: Quick Take - 4




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Crack In The Wall? SP500 Levels, Refreshed...

The Q2/Q3 meltup in US stocks has been one of the most expedited in US stock market history. Where does the free money momentum ride associated with an easy Fed end? Well, when the ZERO rate policy does. And we’re closer to that date today, than we were yesterday…


See my Early Look titled “3-Some” for the why on this, but the reality is that if the Buck stops Burning in October, stocks will stop REFLATING. I call this Reflation’s Rotation.


In terms of risk management levels, there is an important support line that needs to hold for the SP500’s positive price momentum to continue (1060, dotted red). That 1060 line just cracked. There is significant support at the immediate term TRADE line (1040, dotted green line), so don’t get in a heat about this, yet…


Given that today is quarter end, I think the large part of today’s move is behind us. Bullish formations need corrections in order to continue. A breakdown through 1040 combined with a breakout of the US Dollar above the $77.39 line is something that I’ll get in a heat about.


For now, this is simply a small crack in this Bullish Formation’s wall. Stay tuned.



Keith R. McCullough
Chief Executive Officer


Crack In The Wall? SP500 Levels, Refreshed...  - a1


PSS: BOGO? Yes. Less Promotional? Yes.

With 4,500 stores, it can be a daunting task to call or visit a statistically relevant sample of locations to get a pulse on Payless’ promotional activity.  However, the internet can be a powerful tool and so is our ability to look back at Payless’ promotional activity over the last 30 days.  Take a look at this snapshot that compares this year’s promotional activity with last year and precisely depicts the timing and nature of each of Payless’ campaigns over the September/October time frame.


PSS: BOGO? Yes.  Less Promotional? Yes. - 1


While the BOGO promotion remains key to the company’s strategy, look at the company’s online campaigns over the month of September.  As you’ll see, Payless DID NOT anniversary last year’s clearance events.  Everything else remains pretty much the same, barring a timing shift of a day or two here and there.  Over the next few weeks we’ll be watching closely to see how aggressive the BOGO message is delivered.  As you can see, Payless ran 28 days of BOGO throughout much of October ’08.   We think this is pretty relevant in light of the company’s change in focus starting this fall to direct-market to its core customer after 4-years of collecting data. Heading into next week’s analyst event, this is a good nugget in our book.

NKE: Holding the Conch

NKE: Holding the Conch

SEPTEMBER 30, 2009





Gotta hand it to these guys. Nike definitely has control of its business and is proactively planning for the next burst of growth. Was this a pretty quarter? Hardly. With revenue and EBIT down 11.7% and 5%, respectively, futures down mid-single digits, and the cash cycle eroding by 10 days this is hardly a ‘victory lap’ quarter for Nike. Revenue missed my number by about 500bp, but the gross margin offset much of this (this was my biggest positive take away for NKE and the group overall). SG&A more than compensated for the rest. I can go back and forth on the puts and takes of the quarter, but the heart of the matter is that there are way too many companies out there that are printing junk numbers and sound like headless chickens on their conference calls. This is not one of them. It’s all about being in control in this business, and Nike is holding the conch.


Does this change my view on the name? No. No meaningful changes to estimates – as lower revenue and higher GM% are a wash. As noted earlier this week, I still think that we’re in a period of duration mismatch. There will be fits and starts. This quarter was a start. There will be fits – I have no doubt about that. But I also think that in fall ’10 the consensus is meaningfully underestimating the ramp in the model once the organization hits stride.  Check out my note from Monday.




Some Notable Call Outs


  • Aside from a better than expected quarter, there were a couple of noteworthy callouts from Walgreen’s 4Q conference call. First, WAG confirmed that the flu season is off to a record start. The company has already distributed more than twice as many flu shots this year so far vs. the entire flu season last year. Secondly, Walgreen showed impressive inventory management. On total sales growth of 7.6%, inventories were down 6.3% overall and 11.1% on a per store basis. These results are worthy of a double take as we normally see this type of sales/inventory spread at an apparel retailer!


  • It’s no secret, but it bears repeating. Zappos is making a big push into apparel and its Chief Merchant believes it will be the company’s largest category in 5 years. We’re assuming that does not include any existing Amazon business but if they do, it will be even larger. As more details emerge from Zappos recent advertising agency review, it is becoming clearer that the strategy to tap into apparel is slowly and steadily building.


  • If you’re already annoyed by e-mail spam or a mailbox filled with catalogs, then be on the lookout for your UPS deliveryman. UPS announced that it is joining the direct-marketing business with a test, which delivers targeted promotions, premium offers, and samples from national retailers and consumer product companies. These “packages” will be delivered by hand along with orders a customer is already expecting. As most of the world looks to go “green” it seems that “Brown” is taking the opposite approach.


  • Nike's conference call highlighted action sports, basketball, and women's training apparel as strong growth categories in North America while running, football, men's training apparel, and sportswear were weak. Charlie Denson noted that overall running was down in pretty much every geographic region. Nike’s comments on the running category come as some surprise, as most U.S footwear retailers have been highlighting running (especially performance) as the top category within athletic footwear.





-ICSC retail industry report predicts holiday sales up 1% for 2009 - A retail industry report released Monday predicts holiday sales will rise by about 1% or slightly higher, marking one of the first positive holiday forecasts this year. The International Council of Shopping Centers, a New York-based trade association for the shopping center industry, forecast sales at major chain stores, excluding Wal-Mart Stores Inc., will rise 1% for the combined months of November and December and gain 1.5% for the extended November-through-January season. Retail sales at a broad base of stores, as defined by the Commerce Department, are forecast to gain 0.9% for November-December and 1.6% for the November-through-January period, the group said. <>


-Moody's Investors Service said Tuesday it lifted its outlook for the U.S. retail industry to stable from negative - Moody's still cautioned that consumers are still facing layoffs, tighter credit and low housing prices, all of which are dampening spending. The revised outlook means that Moody's expects fundamentals in the retail sector will remain stable in the next year to 18 months. But Moody's warned that consumer demand for apparel still remains weak, and department stores are cutting back on inventory. That hurts revenue for apparel companies, which stock their merchandise in the stores. The ratings agency doesn't expect this holiday season to be as promotional as last year because inventory and demand are better aligned. Moody's believes retailers that will fare better are those with somewhat less discretionary products, such as children's clothing, and those who offer clothing at cheaper prices. <>


-U.K. Consumer Confidence Jumps the Most in 14 Years - U.K. consumer confidence jumped in September by the most since 1995 as optimism about the economy’s prospects rebounded, GfK NOP said. An index of sentiment rose to minus 16, the highest since January 2008, from minus 25 the previous month, the market researcher said in an e-mailed statement today in London. A gauge of confidence in the economy for the next year increased 13 points to 4, the highest in more than a decade. <>


-Global: Steady growth in global apparel manufacturing despite downturn - Revenues in the global apparel manufacturing industry are forecast to grow at an average annual rate of 3.5%, to $476.8bn from 2008 to 2013, according to forecasts from market research firm IBIS World. Despite the world growth will still be low due to the current financial crisis, demand for basic clothing is likely to remain fairly constant. <>


-India: Clothing exports slid 6% in July - India's garment exports fell by more than 6% in July due to the slowdown of its major markets of Europe and the US, according to the latest figures from the country's official body of apparel exporters APEPC. During April to July, garment exports decreased by an even higher 9.3% to $3.31bn, from $3.65bn in the same period last year. <>


-Big 5 Sees Q3 EPS at Top of Range, Comps Ahead 1.6% - Big 5 Sporting Goods Corp. said comparable store sales for the third quarter increased 1.6%. The company now expects earnings per diluted share for the third quarter to be at or near the upper end of its previously issued guidance range of 27 cents to 34 cents. For comparative purposes, the company's EPS share for the third quarter of fiscal 2008 was 21 cents.

The sporting goods chain updated its guidance in anticipation of the company's upcoming presentation at the Thomas Weisel Consumer Conference on October 1, 2009 in New York. <>


-It’s a pivotal season for the 120-year-old Modell’s sporting goods, apparel and footwear chain - The $600 million, 144-unit regional retailer hopes to score big with a prototype opening Thursday in the Post Road Plaza in Pelham Manor, N.Y., representing the first dramatic updating in 15 years for the family-owned business. Compared with other Modell’s locations, the prototype is streamlined with delineated “category shops” devoid of clutter, has more seating, wider aisles and a virtually unobstructed vista across the selling floor. “Consumers want a convenient and compelling shopping experience. Those are our two catchwords,” said Seth Horowitz, president of Modell’s Sporting Goods, during a preview of the 18,000-square-foot, one-level Pelham unit. “Although much of what we’ve done here seems simple, it’s game-changing,” Horowitz said. The project reflects extensive consumer research over the past year, including 24 focus groups, 12,000 consumer surveys by e-mail, and accompanying 200 shoppers through the stores to gauge reactions. It also reflects the Modell family’s desire to shed the chain’s outdated image and invest in brick and mortar despite the tough economy. Since the mid-Nineties, growth has stemmed from store openings. Modell’s stores typically range from 13,000 to 20,000 square feet and are located in power strip centers, regional malls and high-traffic urban locations in the Northeast. <>


-M&S Says Sales Are Stabilizing, Predicts Rising Costs - Marks & Spencer Group Plc, the U.K.’s largest clothing retailer, said sales are stabilizing after two years of declines and forecast an increase in costs as it takes on more temporary workers at Christmas. Sales at U.K. stores open at least a year fell 0.5 percent in the 13 weeks ended Sept. 26, the London-based company said today. That beat the average estimate of nine analysts surveyed by Bloomberg News for a 1.6 percent drop, and represented an improvement on the previous quarter’s 1.4 percent decline. <>


-American Apparel has fired about 1,500 immigrant production workers in the last month - The firings occurred because the immigrant workers were unable to prove to federal authorities they had the legal right to work in the U.S.  American Apparel’s made-in-the-U.S.A. and pro-immigrant stance have become integral parts of its brand image. The 1,500 employees who have departed represent 27% of the 5,600 factory workers employed at American Apparel before the federal investigation. In a filing with the Securities and Exchange Commission, American Apparel has said the firings would not have a material impact on the company because of its healthy inventory levels and continuing manufacturing capacity. American Apparel also has hired a “substantial” number of new employees over the past year, and may seek to hire “a few hundred” replacement workers in the near future for the 1,500 who have left, Schey said. <>


-ANN TAYLOR’S NEW SPOKESWOMAN - Catherine Fisher, former senior vice president of corporate communications at Tommy Hilfiger, has joined AnnTaylor Stores Corp. in the new post of vice president of corporate communications, reporting to Kay Krill, president and chief executive officer. The company said Fisher will be responsible for corporate media relations, internal corporate communications and philanthropic initiatives. Prior to her time with Tommy Hilfiger, she held marketing and public relations positions with Joseph Abboud Co. GFT (USA) Corp. and Calvin Klein Menswear. <>


-Sears Holdings Corp. on Tuesday agreed to pay $6.2 million to settle a class-action lawsuit filed by the U.S. Equal Employment Opportunity Commission for alleged disability bias. The EEOC filed the case against Sears, claiming it failed to provide the required accommodations for employees returning from workers’ compensation leave who remained disabled, as mandated by the Americans with Disabilities Act. <>


-Wellco Enterprises will open a new manufacturing and distribution center next month - The maker of Wellco Footwear and Smith & Wesson shoes will open a new manufacturing facility and distribution center in Morristown, Tenn., next month. The 110,000-sq.-ft. facility will be used to manufacture military shoes, work boots, outdoor sporting footwear, as well as law enforcement shoes. The opening is expected to add more than 100 jobs in the area and concludes a multistage reorganization that included shifting production elements and closing a smaller facility in North Carolina. <>


-Giorgio Armani SpA announced three senior management changes, which signaled an easing of the 75-year-old founding designer’s workload - Effective Jan. 1, Gianni Gerbotto will leave his post as general manager of the Italian fashion group and take board responsibility for financial management and investments. Livio Proli, currently general manager of subsidiary Simint SpA, will replace Gerbotto as general manager of Giorgio Armani. John Hooks, who is currently deputy general manager, will become group deputy chairman and will join the board of directors with responsibility for global strategy and markets and brand development. Hooks will maintain all his current responsibilities for the group’s foreign subsidiaries, Armani said. <>


-Women’s footwear brands are taking cues from the sailing sector for resort ’09 and spring ’10 - Nautical-inspired flats and heels embellished with anchor hardware and rope and cork details make a statement in standout reds, whites and blues. <>


-Alabama Retail Association honored Hibbett Sports - Statewide retailers gathered Tuesday at The Club to honor their own and hear from one of Alabama’s most experienced retailers. The Alabama Retail Association and University of Alabama at Birmingham School of Business hosted the 2009 Retail Day, where Hibbett Sports CEO Mickey Newsome shared strategy on his sporting goods company. Strong information systems and low operating costs have been key to Hibbett’s success throughout its history, as cardboard boxes are continuously reused – for a savings of about $100,000 a year – and pennies are scraped starting at the top, he said. “Water runs downhill and it has to start at corporate,” he said.  <>


-Kohl's to Launch 35 New Stores, Lauren Conrad Line - Mid-priced department store chain Kohl's will open 35 new stores at former Mervyns locations this week, as well as launch an exclusive clothing line from MTV reality star Lauren Conrad. Thirty of the new store openings are located in California. <>


-Nautilus to Divest its Commercial Business - Nautilus, Inc. said it is actively seeking buyers for substantially all of the assets, liabilities and ongoing operations of its commercial business. The fitness company said the move will enable it to focus its resources solely on its branded consumer businesses.

Nautilus said this is a further step in the company’s restructuring plan of improving its cost structure and focusing on the consumer market through the direct and retail businesses. <>


-Kmart Rolls Out First "Fab 15" Holiday Toy List - More than a dozen Santas were on hand to help unveil Kmart's first-ever "Fab 15" holiday toy list. A number of licensed items based on popular kids' properties made the lineup, which was revealed yesterday morning in New York City. <>




RESEARCH EDGE PORTFOLIO: (Comments by Keith McCullough): AZO, WRC, DKS


09/29/2009 10:45 AM


See Levine's note "The Repurchase Zone" from 9/23, and you'll get the point. Stock is up today, so we're re-shorting it on green. KM


09/29/2009 10:35 AM


Looking for names in Discretionary that have seen massive short covering. McGough made cautious comments on BofA's bullish WRC initiation this morning. Shorting high. KM


09/29/2009 10:07 AM


Keeping a trade a trade. Booking a small gain in DKS after a weak consumer confidence read-through and a solid 2-day move. KM

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