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Bottom Fishing in a Sinkhole

I'm getting conflicting factors on whether to own this group. Near-term, the market is discounting that more downward revisions will come on either sales day or EPS season. Add that to trough valuation/ growth expectations and easy 2H margin compares, and this group might look like a nice trade. I remain concerned, however, that the consensus is not bearish enough for 2009, as the Street's 'trough' NTM earnings growth still appears over 1,000bp too high. Be selective.
In analyzing where the US apparel industry is in its earnings cycle, I come up with the view that NTM earnings growth will go negative. While there are trade-offs between sales and margins, the end result is the same. Down earnings. Consider the following...
  • 1. Revenue still has a long way to go to secure the inevitable 'downtrend' a. As I've been posting, I believe we are on a multi-year consumption downtrend. With that, could the public companies print average revenue growth rates in the mid-single-digit range for the foreseeable future instead of the 10-12% 10-year average? ABSOLUTELY! b. Importantly, one of the drivers to above average top-line growth in this space has been $30+bn in sourcing savings injected into the supply chain over 8 years to stimulate per capita consumption. As that factor unwinds, growth goes into hiding. c. Consider that from a top-line perspective, the industry is still a good 3 quarters away from reaching the new trendline growth, and 1-2 years away from setting a new baseline.
  • 2. Margins: I am absolutely convinced that margins will continue to trend down 100-200bp on both a 2 and 3 year basis for at least the next 1-2 years. Check out my posts on the supply chain squeeze for full color. Bulls will respond that even though the industry is likely never to post a positive margin comp again for another 3-5 years, the 1-year erosion should get 'less bad' in 2H.
  • 3. In the context of troughy valuations and weak earnings expectations, a 'less bad' margin trend piques my interest. That is, until it is squashed by the simple math that even a 'less bad' margin trend coupled with slower consumption nets out to around a -10% EBIT growth rate for the space. That puts the earnings revision and industry valuation analysis into a new perspective.

SBUX - A long hot summer!

It almost does not matter what you like today as everything is going down in my world. Recently, SBUX has been getting hammered; despite the company making the right moves to clean up the excesses of the past. I have said many times that SBUX shareholders are paying the price today for the excessive capital spending over the past three years. Now management is taking the right steps to fix those issues and shareholders will be rewarded in the coming quarters.
  • The issues that are within the company's control are the same issues that MCD faced in 2003 (a need to slow unit growth and refocus on the customer and in-store execution) with some slight differences. Unfortunately for SBUX, MCD's fix came at a time when we were in a much stronger consumer environment. Working in SBUX's favor, however, is the fact that the SBUX brand is not tarnished with the bad product image like MCD was. SBUX is just relatively expensive and frequency is declining.
  • As it turned out, MCD's plan to win strategy had a silver bullet to bring customers back - salads. SBUX is losing frequency due to economic issues and not due to issues with the brand. The new coffee SBUX recently introduced helped to broaden the appeal of the concept, but it was not a silver bullet. Right now the SBUX silver bullet is on the drawing board in Seattle.
  • MCD announced its plan to win in April of 2003 and saw immediate results in that quarter. Like SBUX, MCD had been experiencing declining same-store sales trends and operating margins. From a timing standpoint, MCD's plan translated into to an immediate uptick in trends because it coincided with the introduction of salads and the company was able to cut is capital spending right away. MCD's capital spending was down 22% in the same quarter the plan was announced and down 35% within the year the plan was implemented.

WRC: Wedgie?

Levi Strauss is launching Levi's Underwear for men in JC Penney and Urban Outfitters in October - which I think is a material move with negative implications for Warnaco, and to a lesser extent Gildan and Hanesbrands. Here's why...
  • 1) This is not a typical tighty-whity knock off product. It appears to target an 18-35-year old male willing to drop $12 on a pair of skivvies. This is right in line with CK Underwear's sweet spot.
  • 2) Let's not underestimate the sheer size and marketing power of Levi's. This company is private, so naturally no one knows (or seems to care) how big it is. But at $4.4bn in revenue and a 15% operating margin, it is roughly the same size as Warnaco, Gildan and Hanesbrands combined. My point here is that its marketing budget is 1.5x Warnaco's total EBIT. If Levi's wants to take share - it will take share.
  • 3) There's not that much share to go around. The chart to the right shows that 50% of the market is locked down by four brands. But when we take out lower priced basics, that concentration goes closer to 80%. That's where Levi's is headed.

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Back To The Well: Bought My Gold Back...

As I alluded to in this morning's note, I have gold support at $911. Now that I bought it back, I'll tell you my short term upside target is $964.

Selling my gold in June was an unacceptable mistake. I am not in the business of making the same one twice. I am thankful to have been able to buy it back on a down move today.

*Full Disclosure: I own gold again (via GLD) in my personal fund.
KM

(chart courtesy of stockcharts.com)

Lehman (LEH): Down -9% Today... Did I Buy Some?

Thankfully, No. Keeping a "Trade" a trade works, and so does doing nothing. The way the math works is that for a stock to hit lower lows, you need a few up days in the time series.

Next stop on the elevator down for Dick Fuld's stock looks like $19.46 to me.
KM

(chart courtesy of stockcharts.com)

Blue Horseshoe didn't buck up for the Weather Channel...

The announcement of a $3.5 Billion NBC Universal/Bain/Blackstone purchase of the Weather Channel today represents several elements of the monumental shift that has occurred in the capital markets this year.

First -Pricing: In January when Landmark Communications initially began shopping the deal, the asking price was $5B, by accepting 30% less than their original number, Landmark has made the same hard acknowledgement that hundreds of Manhattan apartment owners have had to in recent weeks - that no rich US market centric Wall Street buyers are likely to chase bids, anytime soon.

Second -Financing: Three of the four primary financing sources are related companies to the Buyers - Blackstone's GSO, Bain's Sankaty, and GE commercial finance, with deal advisor Deutsche Bank as the fourth. In this market the only people doing deals are those that can finance them themselves. They also set the price.

Third -Attrition: This acquisition is an acknowledgement that NBC Weather Plus has been a bust and that the network has failed in its attempt to organically grow a viable competitor to the Weather Channel. This is the start of an important cycle where large companies that tried to grow for growth's sake (at the top of an economic cycle) are being sent packing. Misallocating capital gets people fired.

If you subscribe to the thesis that the current market shares many similarities with the early 1970's then it might be interesting to recall that the only guys that were able to get deals done in the mid and late 70's were junk bond traders - not bankers or entrepreneurial visionaries. The next couple years may prove to be a less friendly environment than many younger Wall Street professionals fully anticipate.

Andrew Barber
Director

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