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Rally to Zero

Today's late-day rally did wonders for apparel/footwear retail. The sell-off in the CRB and supportive comments from the Fed came at a good time for the group - which is trying to figure out how to be positioned in advance of same store sales this Thursday. I'm not one for predicting the primal reaction of this heavily-shorted group when numbers come out, but I can analyze the facts. The facts are not encouraging.

One of the most notable is in looking at the RTH versus the S&P in the periods leading up to sales day over the past 12 months. There are three key takeaways.

1) The stability of the RTH this month has been surprising. There has not been a month in over a year where we have not seen anything less than a 2% relative performance gap from one sales day to the next. This time, we are sitting at zero.

2) With everyone freaking out about the consumer, I'd have thought the market would be discounting more bad news. Maybe the market is looking at the earnings revision chart I posted earlier today and is assuming that most revisions have already passed. They probably did not read the second part of my posting that talked about earnings expectations still being 1,000bp+ too high.

3) The May comp reported 5 weeks ago came in at 3.1% based on my math. While little changed sequentially, this represented a 220bp improvement in the 2-year run rate. It just so happens that to maintain this 2-year rate, we need to see a 3% comp out of the industry this Thursday. Let's hope that the consumer is spending more than recent newsflow suggests.

The Exhibit shows the RTH relative to the S&P 500. Recent stability is very surprising.

Performance Outperforming

Data points continue to come in to support my 'shift back to athletic' theme.
  • The chart to the right shows the year/year change in market share for the running category (the best proxy for Performance), and 'Low Profile' (i.e. fashion) through the end of June. The trend is unmistakable.
  • I continue to think that on the margin this helps Foot Locker, and hurts Low Profile beneficiaries such as Skechers, DSW and Brown Shoe.

TXRH - A Nonsensical Press Release

DJ - Texas Roadhouse Inc. (TXRH) said Tuesday in a regulatory filing that its board approved a $50 million increase in the company's stock-repurchase program to a total of $75 million.

Call me old fashioned but I just don't get this move by the Board of TXRH. What exactly is this supposed to mean? Here are some possibilities...

(1) Buy the stock now because we are going to make the quarter.
(2) We are confident in the long-term prospects for our business.
(3) We have so much cash lying around we have nothing better to do with it.
(4) The BOD has a crystal ball that says commodity prices are going down and the consumption recession is over.
(5) Management got the board to prop up the stock because some the large shareholders want out
(6) The stock is undervalued!

The reality is they have no intention of buying this much stock; TXRH does not have the money to do it. Sure they can go to a bank and borrow the money to do it. But why? At this point in the cycle why would you want to add leverage to the balance sheet?

I can understand a share repurchase program when a company has excess capital to put to work. This is not the case for TXRH. Since 2005 the company has not generated free cash flow and its debt/equity ratio has gone from 3.2% to 20.1%. In other words the company has needed to fund it growth with incremental leverage. Over the same time period the company's return on capital has gone from 14% to 10%.

The economics of the casual dining business have changed dramatically over the past twelve months and nobody is immune. I don't care how under penetrated the concept is. What the Board of Directors should have done was announce that they were cutting square footage growth by 50% to improve its ROIIC and using the excess cash flow to buy back stock. Then I would argue that there is more than just a trade into a nonsensical press release. The long term trends for TXRH look suspect to me.

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Wheat Harvest Update

CBOT Wheat contracts rebounded slightly into positive territory today after yesterday's decline as the market weighed-in more heavily on a strike at Canada's largest grain elevator operator than it did on positive supply data points from the Midwest and reported price declines in Russia.

Kansas: 79% of the winter wheat crop has been harvested vs. 36% last week. 98% of state crop now ripe for harvest. Normally 89% is in the bin by this time but a cool spring slowed maturity. Kansas Agricultural Statistics Service 7/7.

Texas: 93% of the crop is in the bin. National Agricultural Statistics Service (NGSS) 7/7

Oklahoma: 98% in the bin. NGSS 7/7

Nebraska: harvest has started with 6% cut so far. Statewide yield is expected to come in above average with Western counties seeing 70 bushels per acre and an estimated state average of 50 (almost 2MM acres were planted this spring). Nebraska Wheat Board 7/7

Russia: The average price of wheat was 8,200 rubles per ton at the July trading session with a range of 8,090 to 8,300 on the Moscow Stock Exchange, a decrease of 7.7% from the June trading session. The Russian Agriculture Ministry forecasts that this year's grain harvest will amount to 85 million tons, which is not enough to guarantee the country's absolute food security TASS 7/8

Canada: In Regina, 200 workers went on strike at the head office of Viterra, Canada's largest grain handler. More than 600 employees at grain elevators and other facilities across Saskatchewan took limited job action by refusing to work overtime or train replacement workers. Calgary Herald 7/8

Andrew Barber
Director

ASIAN SLOTS: SELLING HAGGIS TO VEGANS?

The anemic growth of domestic slot sales and the lengthening of the replacement cycle are well known dynamics of the current slot environment. As they should, Bulls are shrugging off near term trough sales and looking long term. However, I am beginning to question one of the pillars of the long term thesis on this space: international (Asian) growth. A closer look at the Macau gaming picture reveals some cautioning trends for investors expecting big slot unit growth in Asia.
  • The first chart shows the YoY change in revenue (win) per slot per day and revenue per table per day. Revenue per slot has not had a positive quarter since Q1 2005. One could reasonably attribute the cause of the consistent decline to the large increase in the number of slots. In my opinion, that is certainly the explanation for the YoY decline in revenue per table as the number of tables has exploded too.
  • However, the volume increase is only part of the answer in the slot trends. Look at the next chart that compares Macau slot metrics with Las Vegas. Despite a slot to table ratio of 30, almost 10x higher than Macau at 3, Las Vegas casinos generate revenue per slot per day at a level almost equivalent to that in Macau. As you may know, casinos in Las Vegas generate the lowest revenue per slot of any major market in the US. Slot supply there is not capped and Las Vegas is the most mature market. Compare the slot performance with the next chart. Clearly, this chart depicts a much different situation for table games. Despite the tremendous growth in number of Macau tables, revenue per table remains well above the Las Vegas level, indicating significant growth potential.
  • What does this tell us about the Macau slot market? It may already have matured at only 14,000 slots, offering little growth to suppliers. Culturally, Asians may not adapt well to the slot product. A broader question is what does this mean for the rest of Asia? Singapore, Japan, Thailand, Taiwan, Malaysia, South Korea, Philippines, etc. are all potential growth markets for gaming. Culturally will gamers there align closer to China or the West? It might be time to redefine the international growth thesis for slot machine companies.

Icahn: Too Bad We Can't Buy Puts...

There is an article in the Boston Globe today titled,"Carl Icahn has hit the roughest patch of his hedge fund career."

Icahn's long term track record speaks for itself. It's a great one. That said, I have not been bearish on him until recent months where I have taken the appropriate amount of heat for calling it like it is. Timing in this business is everything.

The bottom line remains. "Concentrated Activist" investing really only outperforms in bull markets where access to capital is readily available.

KM

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