November 19, 2009






Bottom-line: Comp and GM came in better than expected driving the beat as the company managed costs and succeeded in significantly reducing inventory (-3%). Significant conservatism embedded in Q4 guidance, but the comp guidance suggests there needs to be more than just guns&ammo rolling off in Q4 and we’re not necessarily willing to make that bet – will be a key focus of call.



Headline (and clean) EPS of $0.16 vs. $0.09E and Guidance of $0.04-$0.07


Revs (+7%) up on a 1 & 2Yr basis as well as comp and store growth in-line with plan.

(11 stores added on base of 500 – declining avg. sq. ft. trend continues).


Comps +1.9% (vs. -3%E)

                DKS: +2.2%

                GG: -1.5%

GM: -40bps (vs. expectation of -200bps as DKS clears golf inventory)

SG&A: -180bps

OM: +140bps


S: +7%

Inv: -3%




EPS $1.04-$1.09 (vs. $1.13E)

Comps -4%-3%



EPS $0.41-$0.46 (vs. $0.57E)

Comps -6%-4%

                Implying massive deceleration on a 1 & 2Yr basis – Is undoubtedly conservative but significantly divergent from the +7.5% needed to keep trends flat on a 2yr basis (there has to be more to this than just guns&ammo rolloff – will be a focus of the call)


Call at 10EST







  • Contrary to most retailers, BJ’s Wholesale management noted that private label sales have not been a key contributor to gross margin expansion this year. They also went on to note that sales of private label products haven’t really grown this year. While the comments on the topic end there, it surprising to find out that this key area of “value” for the consumer has not been outperforming at BJ’s as it has been for all other retailers ranging from department stores to dollar stores.


  • While some retailers have suggested trends have slowed since the October, due in part to warmer weather, Chico’s is not seeing any slowdown. While their overall outlook for 4Q does not call for an acceleration in same store sales trends, sales are currently increasing in the double-digit range.


  • As the Costco/Coca Cola wars perk up, we’re nostalgic for a couple of notable retailer/supplier battles from the past. While we fully expect Costco and Coca-Cola to kiss and make up in short time (after all Buffet is the largest shareholder of KO and Munger is on the board of COST), we can’t forget the Wal-Mart/Rubbermaid debacle (hurt Rubbermaid big time) or the infamous Foot Locker/Nike battle. It’s unlikely this current situation overheats to damaging proportions, but rest assure we’ll be watching for the first sign of Vitamin Water being restocked in our local Costco.





OECD Doubles 2010 Growth Forecast, Recovery to Widen - The Organization for Economic Cooperation and Development doubled its growth forecast for the leading developed economies next year and predicted a further acceleration in 2011 as China and other emerging countries power a global recovery.

The combined economy of the group’s 30 member countries will expand 1.9 percent next year and 2.5 percent in 2011, the Paris-based organization said in a report today. Output will contract 3.5 percent this year. The OECD, which advises members on economic policy, forecast 2010 growth of 0.7 percent in June. The MSCI World Index has surged 69 percent in the past eight months as the world economy emerges from its worst recession in more than half a century. While the U.S. and the euro region will return to growth next year, mounting debt burdens will keep the expansion in check, the OECD said. <>


Leading Economic Index in U.S. Probably Rose for Seventh Month - The index of U.S. leading indicators probably rose for a seventh consecutive month in October, signaling the economy will keep growing into next year, economists said before a report today. The Conference Board’s gauge of the outlook for the next three to six months rose 0.4 percent after climbing 1 percent in September, according to the median forecast of 58 economists surveyed by Bloomberg News. Another report may show manufacturing accelerated in the Philadelphia region this month. The rally in stocks, longer factory workweek and fewer jobless claims that have accompanied the recovery help mend household finances, limiting the risk the economy will again retrench. A pickup in growth is dependent on gains in hiring that have yet to develop, one reason why Federal Reserve Chairman Ben S. Bernanke this week said the U.S. still faces “headwinds.”  <>


Obama Wants South Korean Trade Deal Done - President Obama said Wednesday he is committed to resolving issues with South Korea that have stalled a major free trade agreement and “get a deal done.” Obama’s comments, in an interview with Fox News during his weeklong trip to Asia, marked the most definitive support he has shown for the deal, which has created divisions between U.S. importers and domestic manufacturers. Obama arrived in South Korea on Wednesday and was to meet with President Lee Myung-bak today. Obama said the trade deal between the U.S. and South Korea, negotiated by former President George W. Bush and completed in April 2007 but stalled in Congress, will benefit U.S. exporters. Year-to-date imports of textiles and apparel from South Korea have fallen 14.2 percent to 1.1 billion square meter equivalents, according to the Commerce Department’s Office of Textiles & Apparel. In dollar value, imports of textiles and apparel have fallen 30.3 percent to $603 million year-to-date.  <>


Congress Hears Arguments on U.S. Trade Preference Programs - Executives from Levi Strauss & Co. and Mount Vernon Mills Inc. on Tuesday outlined the sharp differences between importers and manufacturers that Congress will consider in any revamp of U.S. trade preference programs that cover billions of dollars in goods. The House Ways & Means subcommittee on trade began examining whether to overhaul five U.S. trade preference programs that covered $110 billion in trade in 2008 and provide duty free benefits to hundreds of countries from South America to sub-Saharan Africa. With the global economic downturn hurting several developing countries, lawmakers are considering whether to change the programs, create new criteria and streamline and possibly expand them. Lawmakers must balance the impact of changes on U.S. manufacturers, as well as the current trade preference beneficiary countries.  <>


EU: Footwear sector under threat - The European Footwear Alliance calls on EU Member States to reject the Commission’s proposal to extend antidumping duties on footwear. The duties harm consumers, retailers and the modern footwear sector and any continuation would breach the 2006 agreement to end them after two years. “The decision tomorrow on footwear duties will have a direct and immediate effect on European consumers and businesses,” said Manfred Junkert, Director of the Federation of the German Footwear Industry. “Just as we begin to see a glimmer of economic recovery, the Commission is proposing to extend the dumping duties. It’s unthinkable,” he said. Representatives from the 27 EU Member States meet tomorrow to vote on whether or not to extend antidumping duties on leather footwear imports from China and Vietnam. <>


Exclusive: GM Must Pay Debt, Make Money Before IPO - General Motors should focus on making money and repaying U.S. Treasury loans before turning to public markets to sell the taxpayer's stake in the automaker, a senior government official said. Ron Bloom, head of the Obama administration's autos task force, nevertheless told Reuters that an initial public offering could come as soon as the fourth quarter of 2010 if the automaker meets its recovery targets and the financial markets are receptive.

Bloom said the government had previously expressed concerns about GM operations but now trusts the directors and management to do what is best for shareholders. Ensuring corporate independence at GM and Fiat-led Chrysler includes accepting decisions that may surprise the government or diverge from administration goals, such as production of electric vehicles. <>


Moody's upgrades Jones Apparel's liquidity rating - Moody's Investors Service on Wednesday upgraded Jones Apparel Group Inc. by one notch on its liquidity rating, which remained in speculative grade territory. Moody's moved Jones to "SGL-1" from "SGL-2" and affirmed all other ratings. Moody's said the rating outlook remains "Stable." The upgrade in its liquidity rating is based on the New York company's improving operating margins, more efficient use of working capital and lower planned capital expenditures. Moody's said Jones Apparel would maintain a substantial existing cash balance in fiscal 2010, meaning it will have little need to dip into existing available credit. It now has about $160 million cash on hand, Moody's said. The agency also said the company had nothing currently outstanding <>


STONY APPAREL Chooses NGC for Integrated PLM, Global Sourcing and Apparel ERP Solution - NGC(R) (New Generation Computing(R)) today announced that STONY APPAREL, a branded and private label manufacturer of girls and junior apparel for some of the nation's largest retailers, is implementing NGC's Global Enterprise System software suite, including e-PLM(R) for Product Lifecycle Management, e-SPS(R) for Global Sourcing & Visibility, and RedHorse(R) ERP for EDI, Customer Order Processing, Inventory Management, Shipping and Financial Accounting. The implementation is currently underway, and STONY APPAREL is quickly realizing benefits even in the early stages of the rollout. For example, NGC helped STONY APPAREL quickly implement the EDI module in RedHorse. As a result, STONY was able to meet a complex EDI requirement from a Tier 1 retailer and book a very large order -- something that wouldn't have been possible without the new software.  <>


Russell Agrees to Rehire 1,200 Workers in Honduras - Russell Athletic has agreed to rehire 1,200 workers in Honduras who lost their jobs when Russell closed their factory soon after the workers had unionized, according to a report in The New York Times. Russell has long contended the plant was closed due to the economic downturn and not because of unionizing efforts. Since Russell closed the factory in January 2009, United Students Against Sweatshops has initiated a nationwide campaign across college campuses against Russell. The Times report noted that the movement persuaded the administrations of Boston College, Columbia, Harvard, New York University, Stanford, Michigan, North Carolina and 89 other colleges and universities to sever or suspend their licensing agreements with Russell. <>


US: Apparel retailers see growth in October - US apparel retailers have seen positive growth in October right before the Christmas holiday, said the National Retail Federation (NRF). October retail sales, according to the US Commerce Department, including non-general merchandise categories such as autos, gasoline stations and restaurants increased 1.4% seasonally adjusted from the previous month, but decreased 1.7% unadjusted year-over-year. Clothing and clothing accessories stores saw strong gains, with sales increasing 0.4% seasonally adjusted from the previous month and 3.6% unadjusted year-on-year. <>


China: Mainland's sportswear brand goes int'l through Hong Kong - China-based Sportswear brand Xtep International has launched its first flagship store for the Disney Sport products in Hong Kong as its stepping stone into the overseas market. Established in 1999, Xtep is one of a growing number of mainland brands, with 5,800 stores across China. "Hong Kong is an irreplaceable financial center and commercial hub, which is the key reason for us to choose to list in Hong Kong," Ding Shui Po, company chairman and chief executive officer referring to the listing of the company's shares in Hong Kong last year. Ding said he planned to use Hong Kong as a platform to expand his business to emerging markets, including the Middle Eastand the southeast Asian countries. <>


Hal Extends Offer Period for Safilo - Hal Holding NV has extended through next week the provisional deadline for holders of Safilo Group SpA securities to tender their notes in the debt-ridden eyewear maker, after not enough did so by the original “early-bird” date on Wednesday. “Hal has decided to extend the offer period until November 27, 2009 5:00 p.m. CET. The new settlement date will be on December 2, 2009,” Hal stated. The extension keeps alive Safilo’s hopes of survival after Safilo chief executive officer Roberto Vedovotto warned last week that without a successful tender off, the company would likely default on its banking facilities by yearend, leaving bankruptcy its only alternative. <>


Foot Locker Elects Ken Hicks to Additional Position of Chairman - Foot Locker, Inc. announced that its board of directors has elected Ken C. Hicks, its president and chief executive officer, to the additional position of chairman of the board, effective January 31, 2010, the beginning of its next fiscal year. He succeeds Matthew D. Serra, who, as previously announced, will retire from the company and the Board of Directors on January 30, 2010. James E. Preston, Foot Locker's lead director, stated "The Board of Directors is very pleased that, as part of the planned transition in connection with Matt Serra's retirement, Ken Hicks will take on the additional role of Chairman of the Board. Ken is a seasoned retail company executive who has the background and experience to be a strong leader of Foot Locker." <>


Female "Tween" Apparel Spending Down YOY - The tween market is morphing almost as fast as its customers. First there were Mary-Kate and Ashley Olsen. Then Hilary Duff. Now, Miley Cyrus is growing her fashion empire. Who among the newest stable of starlets — including Keke Palmer and Selena Gomez — is poised to reign as the next tween queen? The opportunities are ripe, although the category hasn’t been immune to the recession. There are about 20 million girls between the ages of five and 14, according to the U.S. Census Bureau. Girls between the ages of seven and 12 accounted for $7.45 billion in clothing sales in the 12 months through August. The same age group spent $7.85 billion a year ago, according to research firm The NPD Group. <>


After 36 Years, J.C. Penney Ends 'Big Book' Catalogue - J.C. Penney is bidding farewell to its biannual “big book” catalogue. Instead, the retailer said it will throw greater weight behind “customized, more timely” specialty catalogues for targeted audiences, and online and social media opportunities. The 36-year-old big book had the heft of a telephone book and ranged from 900 to 1,500 pages. It surpassed $1 billion in sales in 1979. The big book became a victim of rising costs and a shift by customers to shopping online. Penney’s direct business, catalogue and online, exceeds $4 billion. Sears had the longest-running big book, but it folded in 1993 after 106 years. Penney’s final big book is the current fall-winter edition.  <>


Nike Tops Annual Climate Action Scores - Nike has topped Climate Counts' third annual corporate climate performance scorecard with 83 points (out of a possible 100) for the second year in a row. Stoneyfield Farm followed closely with 81 points. Unilever received 80 points. The climate performance scorecard ranks 90 American companies in 12 sectors. Compiled by the nonprofit group Climate Counts, the survey found that most of the 90 companies were addressing environmental responsibility, either by cutting their energy use, measuring their output of greenhouse gases, adopting policies to reduce emissions or pushing for federal legislation to do the same. Among Apparel/Accessories companies that were tracked, Nike was followed by Levi Strauss, with a rank of 58; Gap Inc., 52; Limited Brands, 35; Jones Apparel Group, 20; Liz Claiborne, 7; and VF Corp., 6. <>


Adidas to Make €1 Sneakers - Adidas has reached an agreement to make €1 sneakers for millions of people around the world who cannot afford to buy shoes, with pilot production to begin next year in Bangladesh. The move, according to the Daily Telegraphy, was inspired by Bangladesh's Nobel prize winner, Muhammad Yunus. Yunos is the pioneer of micro-loans which help the poor start their own businesses. Adidas has agreed it will produce shoes in Bangladesh on a non-profit basis, although a spokesman stressed the final price may be higher than the €1 target. <>


Walmart Offers Black Friday Sales One Week Early - Beginning Saturday, Walmart will serve up discounts similar to day-after-Thanksgiving sales on various toys and entertainment. Licensed products in the one-week-early campaign include discounts on toys and video games for as much as 60 percent off. Offerings include Barbie Generation of Dreams collectors' doll for $25, Disney Princess scooter for $99, Nerf Capture the Flag for $19 and others. Video games such as Band Hero (with drum and guitar controllers, microphone and game), DJ Hero and Guitar Hero 5 are also part of the promotion. <>


The North Face Launches PlanetExplore in Denver - The North Face announced the Denver, Colorado, launch of PlanetExplore, a new online community that connects people to the outdoors in meaningful ways by serving as a hub for local outdoor activities and events. “Denver is very special to The North Face,” says Steve Rendle, president of The North Face. “In many ways, Colorado leads the nation and sets an example of what embracing the outdoors is about—this is why we decided to make Denver a pilot city for PlanetExplore, to build on this excellent foundation.” <>





VLCM: Richard Woolcott, Chariman & CEO, sold 20,000 shares for a gain of $334k.


FOSL: Tom Kartsotis, Chairman, sold 100,000 shares for a gain of $3.2mm.


GPS: John Fisher, 10% Owner, sold 26,000 shares for a gain of $562k.


KSS: John Worthington Sr. EVP, sold 20,600 shares after exercising options to buy 20,600 shares for a net gain of $247k.


COH: Lew Frankfurt, Chairman & CEO, sold 2.2mm shares after exercising options to buy 2.2mm shares for a net gain of $48mm.



  • Allen Lenzmeier, Vice Chairman, sold 150,000 shares after exercising options to buy 150,000 shares for a net gain of $90k.
  • John Pershing, EVP-Human Capital, sold 5,000 shares after exercising options to buy 5,000 shares for a net gain of $77k.



  • Andrew Jassy, SVP, sold 15,000 shares after exercising options to buy 13,000 shares for a net gain of $1.95mm.
  • Jeffrey Wilke, SVP, sold  17,000 shares after exercising options to buy 17,000 shares for a net gain of $2.2mm.
  • Steven Kessel, SVP, sold 13,000 shares after exercising options to buy 13,000 shares for a net gain of $1.7mm.
  • Michelle Wilson, SVP, sold 13,000 shares after exercising options to buy 13,000 shares for a net gain of $1.7mm.
  • Diego Piacentini, SVP, sold 10,000 shares after exercising options to buy 17,000 shares for a net gain of $1.33mm.
  • Jeffrey Blackburn, SVP, sold 6,000 shares after exercising options to buy 15,000 shares for a net gain of $786k.


WMT: Lee Scott Jr., Chairman of the Executive Committee, sold 244,000 shares for a gain of $13mm.


DECK: Constance Rishwain, President of Simple & UGG, sold 3,000 shares for a gain of $300k.

The Game Of Risk

A perfection of means, and confusion of aims, seems to be our main problem.”
-Albert Einstein
If that Einstein quote doesn’t summarize the failure of Obama and China to communicate this past week, I don’t know what does…
In my recent years of international travel, it has been fascinating to observe the diametrical shift in how the wizardry of American finance is perceived. Long gone are the days of giving America the benefit of the doubt. Foreign investors are rightly challenging the perceived wisdoms embedded in the US Financial System.
I am in Vancouver, British Columbia this morning. It’s early, but the coffee is good. The news hour at 3AM local time kicks off with Canadian hockey wonder, Sydney Crosby, carrying the Olympic torch in a pre-Olympic games event. For a small town hockey boy like me, these moments in Canadian hockey history are magical. The 2010 Winter Olympics will be too.
Then the news shifts to the not-so-magical. The New Reality bites – if you are American that is. President Obama ends his trip to Asia with a trip to South Korea and, by and large, his trip is being rightly depicted as a loss by the international media.
A loss of what? One more loss in The Game of Risk. This is a game of balance of global power shifting – shifting away from America, towards China in global finance.  We can wakeup pretending that this isn’t a New Reality, or we can look at this like foreign investors do, and understand that it is.
What is The Game of Risk? Well, it’s a very popular board game produced by Parker Brothers. However, the game was not an American invention. It was a French one. It was originally released in another time when Macro really mattered to global investors – 1957.
Per our friends at Wikipedia, The Game of Risk is “a turn-based game for two to six players. The standard version is played on a board depicting a stylized Napoleonic-era political map of the Earth, divided into forty-two territories, which are grouped into six continents. Players control armies with which they attempt to capture territories from other players. The primary object of the game is "world domination," or "to occupy every territory on the board and in so doing, eliminate all other players”…
This is either a really good or bad metaphor for China vs. USA, depending on where you live and/or how you get paid. As I said while in a meeting in Calgary, Alberta a few days ago, I’m definitely not Jerry McGuire, but if all you do in global macro is follow the money – you are probably going to end up finding the right answers. America is a “show me the money” economy, and the rest of the world likes playing that way too.
China is acquiring everything from African gold mining assets to Australian copper mines. They are doing deals all over the game-board of The Game of Risk. From Russia to Canada, they don’t really seem to care so much for anything other than moving toward their end game. All the while, America doesn’t seem to get where China is going with this.
China is doing less and less with Japan. These countries really don’t like each other, fyi. And now America’s myopic financial leadership is giving China every reason to be doing less and less with us. I am now “us.” My young family is American. For any American team in this game, this is plain embarrassing and sad all at once.
Consider the most recent marked-to-market price momentum of China versus Japan. For the month of November:
1.      Japan -4.8%

2.      China +10.9%

Last night the Nikkei in Japan dropped another -1.3% (we are short Japan via the EWJ), meanwhile China chugged forward by another +0.53%. The Shanghai Composite Index is +82.4% for 2009 to-date. At +6.8% for the YTD, Japan is the worst performing major equity market in the world.
Why does this matter? Because, for whatever reason, America’s financial thought leaders don’t know what they don’t know. They are so focused on the narrative fallacy of the Great Depressionistas that they can’t understand that every day we maintain a policy of ZERO rate of return for both our Creditor and Citizenry alike, we become more and more Japanese. Economically speaking, that’s not good.
At 0.74%, this morning you are seeing the lowest rate of return on 2-year US Treasury yields that we have seen since the US stock market crash of 2008. When we called that crash, we were very much focused on the US Government crushing the value of US currency. From a Burning Buck perspective, the only difference between this morning’s obvious correlation of US Dollar weakness to the short end of the US yield curve is this – Obama doesn’t know what he doesn’t know.
There has never been a winner in the global macro Game of Risk that sustained her economic power via a crashing currency. From Germany in the 1920’s to Japan in the 1990’s, this hasn’t been for a lack of effort! Top country players have definitely tried it. Newsflash for all you board game fans: it hasn’t worked.
As I wind up my morning missive (patiently awaiting the Canadian hotel staff to fire up some room service!), I will leave you with a thought about all of this from Tversky:
“It’s frightening to think that you might know something… but more frightening to think that, by and large, the world is run by people who have faith that they know exactly what’s going on.”
If you don’t travel internationally, get a satellite dish. Turn on the world.
My immediate term upside/downside levels for the SP500 are 1096 and 1020.
Best of luck out there today,




FXE – CurrencyShares Euro Trust
We bought the Euro on 11/12 on a down move against our short position in the British Pound. A bullish formation in the Euro remains and we think the ECB could hike before the Fed does.

XLU – SPDR Utilities We bought low beta Utilities on discount on 10/20. TRADE and TREND bullish.

GLD – SPDR Gold We bought back our long standing bullish position on gold on a down day on 9/14 with the threat of US centric stagflation heightening.   

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. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.


EWJ – iShares Japan While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. 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.

EWY – iShares South Korea South Korea has joined Japan in the ominous position of broken TREND and TRADE. This is not China or Taiwan. This is an early cycle economy that we want to be short against China/Taiwan.

XLI – SPDR Industrials We shorted Industrials again on 11/9 on the up move as the US market made a lower-high.  This is the best way for us to be short the hope of a V-shaped recovery.   

EWU – iShares UK Despite areas of improvement, broader fundamentals remain shaky in the UK: government debt continues to expand, leadership in critical positions lacks, and the country’s leverage to the banking sector remains glaringly negative.  Q3 saw its GDP contract by -0.4%. Further bank stimulus and the BOE’s increase in its bond purchasing program suggest that this will not end well.

XLY – SPDR Consumer Discretionary We shorted Howard Penney’s view on Consumer Discretionary stocks on 10/30. TRADE and TREND bullish.  

FXB – CurrencyShares British Pound Sterling The Pound is the only major currency that looks remotely as precarious as the US Dollar. We shorted the Pound into strength on 10/16 and 11/16.

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.


The Macau Metro Monitor.  November 19th 2009.




The Chief Executive of Macau, Edmund Ho Hau Wah, said on Wednesday that accumulated budget surpluses and the Reserve Fund of the Special Administrative Region of Macau are expected to be over MOP 100 billion (US$12.5 billion) at the end of the year.  He stated the government’s intention to “continue to implement measures for exemption and reduction of taxes adopted over the last few years, with the aim of helping companies and citizens to face up to the pressures and difficulties resulting from the international financial crisis”.





Galaxy Entertainment Group is attempting to raise more than US$1 billion to complete the construction of its Cotai mega resort, according to sources cited by the South China Morning Post.  While details have yet to emerge, “people with direct knowledge of the plans” said that the financing package may include high-yield or convertible bonds, syndicated bank loans or a combination of bonds and bank debt. 


Galaxy is attempting to tap local markets to fund construction at the same time as Las Vegas Sands Corp who, in the past week, announced that it had secured commitments from banks for US$1.45 billion of a total US$1.75 billion in new loans it was seeking to restart works on Lots 5&6.

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We recently learned more about Starbuck’s plans for VIA with CEO Howard Schultz calling it more than just a product introduction or promotion.  Instead, he said, “It is a significant new global growth platform within our core business with strong margins consistent with our other whole bean and ground coffees.”  According to Mr. Schultz, VIA performance had already exceeded test markets and was doing well in the initially introduced CPG channels, such as Costco and Target. 


Relative to future growth opportunities, SBUX announced the launch of VIA Decaf, which was to be debuted on November 17, plans to expand VIA internationally beyond Canada in 2010, including in the U.K. (where 80% of the coffee market is instant), and a domestic launch of the brand in the CPG channel in the middle of fiscal 2010 through a recently signed broker agreement. 


Starbucks had said it intended to spend significantly higher marketing dollars than any typical quarter to support the North America VIA launch in Q1.  Based on an article published today by MarketWatch, Starbucks is not the only company increasing its advertising spending behind the instant coffee category.  According to the article, “Nestlé marketers were recently spotted for the first time roaming the streets of downtown San Francisco, handing out samples to caffeine-savvy citizens. This month, Nestlé tweets have been urging people to find seek out their street marketers at specific corners or landmarks in Los Angeles, Philadelphia, and Washington, D.C…. In a Web commercial, Nestlé touts the fact that one cup of its Taster's Choice costs 17 cents, while Via costs four times that. It shows a Starbucks cup at the end.”



Cuckoo For CoCos?

Below you’ll find an excerpt from our Chief Compliance Officer Moshe Silver’s weekly screed, “Slouching Towards Wall Street”. In it, he discusses CoCos, or contingent convertible bonds:


Cuckoo For CoCos?


The latest regulatory trial balloon being floated in the financial press is the CoCo – the contingent convertible bond.  This new-fangled instrument appeared at its coming-out party on the arms of no less a beau than Lloyds Bank.  The debutante was wearing a tattered dress, but smiling nonetheless.


Lloyds Banking Group has offered to exchange some $11 billion of debt into CoCos, a form of subordinated debt that morphs into common equity – generally at the worst possible time, and without the bondholder’s consent. 


What is this odd beast, and how does it work?  As described in the Financial Times (13 November, “A Staple Diet Of CoCos Is Not A Panacea To Bank Failures”) “What differentiates them from a normal convertible bond is that the trigger is a regulatory flashpoint, not an asset price swing.”  This allows banks to “strengthen their capital base in a crisis, without tapping taxpayer funds, or going to the markets.”


Simple English:  when a bank’s capital ratio goes down to the point that it can no longer sustain the total debt it has issued, your chunk of that debt automatically converts to equity.  Voila!  No more nasty debt clogging up the bank’s balance sheet, no fresh injection of capital needed, and no risk of default.


Pardon us, but this looks like a total win for the banks and the leading edge of significant regulatory caving-in.  The CoCo is essentially a bond which, instead of a covenant, is issued together with a put to the bondholders.  In the Lloyds case, the exchange is being offered at a discount of more than 50% of face value to holders of subordinated debt.  One might argue that, in the current climate, subordinated debt holders are lucky to be offered anything at all – the bonds in question are no longer paying.  Still, in the good old days bondholders were protected by covenants, and banks had to maintain capital, or go to court to prove why they should not pay out on their obligations.  The risk of bond defaults, with reputational damage and the looming threat of bankruptcy, were all seen as protections for those pieces of paper whose very name means “obligation”.


Enter the CoCo, which permits the bank to automatically convert its “obligation” into “equity”.  “Equity,” we should point out, means “what is fair,” which can be very good.  It can also be very, very bad.  If there is an obligation of the bank that it pay its bondholders, the shareholders will get what’s left over.  That is fair.  And if there’s nothing left over, well, that’s fair too.


The Basel-centered regulatory regime is considering promoting CoCos across Europe and the US.  New York Fed president William Dudley recently said (Financial Times, 12 November, “Wall Street And Fed In Discussions Over CoCos”) that “the worst aspects of the banking crisis might have been averted” through the use of “contingent capital buffers.” 


This looks to us like a stupendously dreadful idea and all sorts of words come to mind.  Slippery Slope – the looming regulatory change permitting banks to all but dispense with capital requirements.  Moral Hazard – the notion that an obligation will no longer be “really” an obligation, but only an obligation as long as the bank feels like it.


This further feeds the bifurcation of the marketplace, as strong participants, major financial institutions, will insist on, and receive, guaranteed obligations with actual capital reserves underpinning them.  Meanwhile weaker investors will increasingly be cashed out with the corporate equivalent of a Pay In Kind transaction.


All of this means that legislation to promote the use of CoCos will probably be implemented soon, as the world’s regulators are desperate to be seen as doing something.  And it looks set to create a splendid new government loophole that will allow banks to issue bonds without additional capital requirements.


In the case of the Lloyds bonds, they are already in trouble.  Swapping subordinated debt which will not be paid off anyway, with a junior-junior obligation on its way to converting to equity looks like prolonging the agony.  But investors and issuers alike are notoriously reluctant to switch off life support, especially if it means a capital impairment for the bank.  In the world of financial services, where everything comes down to convincing someone else to buy something, it is easier to sell a loser a new piece of paper that, one day, will convert to yet another piece of paper than to say “Ooops.  Guess that didn’t work out.”


Forgive our ignorance, but to us the CoCo looks like a pre-guaranteed default.  It gets the government off the hook for at least that piece of the bank’s capital, and it puts the bondholder well on notice.  “Don’t say we didn’t warn you.”  This looks like a regulatory cop-out of staggering proportion, which guarantees it will be implemented.  If the whole world agrees to undermine bank capital requirements, does that make it OK?


If a bond covenant is like a prenuptial agreement, the CoCo is like asking the bride to waive alimony and child support before ever she walks down the aisle.


Would you buy a used bank balance sheet from this regulator?



JACK is scheduled to report fiscal 4Q09 earnings after the close today.  Similar to its competitors, I am expecting margins to improve YOY despite the continued deceleration in same-store sales trends on both a 1-year and 2-year basis.  When JACK reported 3Q09 sales trends below its targeted range at Jack in the Box, management attributed the weakness to unemployment and significant industry discounting.  Those comments set the stage for Q4 results as those pressures remained throughout the quarter. 


We know that July comparable sales at Jack in the Box were running down about 3.5% and the street’s full quarter estimate of -4.2% implies further sequential declines from that level.  Management highlighted on its 3Q earnings call that it would be lapping the successful Smoothie rollout in August, but we also lapped the Hurricane Ike impact in September, which negatively impacted 4Q08’s same-store sales growth by 1%, so I am expecting same-store sales growth to hold steady with the July level and come in slightly better than the street’s expectations.  We will learn today whether the company’s newly offered bundled meal called the Big Deal, which was launched in mid-July continued to drive traffic throughout the quarter as it did help to improve same-store sales trends in July from -4.4% in June. 


Margins should be up fairly significantly on a YOY basis as the company is lapping its lowest reported restaurant level margin in over 5 years; though management did say that margins would come down on a sequential basis from Q3 as a result of normal seasonal trends.  In 4Q08, JACK faced significant food cost inflation of +7% with beef costs up 18% YOY, and the hurricane hurt restaurant margins by about 50 bps as well.  To that end, commodity costs should prove favorable in 4Q09 with food costs expected to be down about 2%-3% (based on management’s full-year +2% guidance) after being down only 0.8% in Q3.  


From an earnings standpoint, my EPS estimate of $0.54 falls one penny short of the street’s estimate but based on recent restaurant earnings reports, over delivering on earnings despite continued sales misses would not be a surprise.


Even more important than reported Q4 sales and earnings results will be what management says about early fiscal 1Q10 sales trends and FY10 sales guidance.  Based on the comments and results we have gotten about October trends from SONC (“seen more challenging weather”), MCD (-0.1% or -1.1%, excluding the estimated benefit from the calendar shift), WEN (-4%), CKR (-7% at Carl’s Jr. and -3.4% at Hardee’s), JACK’s October trends will most likely not be good.  Management will provide full-year sales and earnings guidance based on recent trends so if October was not a good month, the guidance will most likely be extremely conservative.  For reference, a -3.5% to -4.0% Q4 comp at Jack in the Box implies that 2-year average growth declined -2.2% to -2.4%.  Assuming that level of 2-year average growth for all of 2010 yields a 3% to 3.5% decline on a 1-year basis, which I think is a reasonable range to expect.  


Going forward, I continue to think JACK is well positioned to outperform over the long term.  And, as I have said in the past, following what JACK does with its cash will generate the most incremental return for shareholders over the next 12 months.  I know that JACK is a California-centric concept with more premium offerings, but it has significantly underperformed its peers, down nearly 19% in the last 6 months relative to the QSR average performance of up 15.5%.  In that same timeframe, even CKR, which has seen its trends fall off more significantly than JACK, is up 4.4%.  It is only in the last 3 months that JACK has outperformed CKR, up 1.2% vs. -7.5%; though its peers on average still significantly outperformed, up 8.2%.

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