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R3: BREATHING ROOM

R3: REQUIRED RETAIL READING

January 5, 2009

 

We’re on the cusp of getting the most important “rear-view” data point of the year for retailers and it’s likely to be pretty good. Positive earnings aside, now is the time to start thinking about the sustainability of both margin improvements resulting from inventory management and sales growth driven by consumer demand (or lack thereof).

 

 

TODAY’S CALL OUT

 

There’s nothing like starting the New Year with a look back.  While most of us are still figuring out our resolutions and goals for 2010, retailers are about to report their most important sales data of the year.  The month likely ended positively, with a surge in mall traffic coming in the critical final weeks of the holiday.  Calendar favorability is also expected to contribute 1-1.5% to results, which will add to both profits and positive headlines.  After a sluggish start to the holiday season (weather related), clean inventories, planned but not excessive promotional activity, and status quo demand all lined up for a solid profit picture as we wrap up 4Q and look towards Spring. As we eagerly await same-store sales results to be reported on Thursday, the bigger picture is probably the better place to focus in on. 

 

The real question coming out of the holiday season is if there were any notable signs or changes in consumer behavior.  The answer is probably not, as consumer credit, employment, housing, and even prices at the pump have remained relatively stable over the past few months.  On the margin, some of these factors are improving (albeit with the help of good ‘ol “easy compares”), but not a rate needed to support continued earnings upside at the pace we saw in 2009.   

 

The real issue here, in the wake of expense and inventory cuts is now one of demand.  As we look ahead to January, we don’t believe this month will be a good barometer as inventories are currently depleted, post-holiday clearance activity is its lowest point in years, and the cold freeze is unlikely to spark early sales of Spring apparel.  This expected lull sets up some “breathing room” to really figure out if the consumer is about to step-up and make that extra visit to the mall.  From our vantage point, we maintain that this is going to be a stock picking year.  Demand is likely to remain lackluster and cost cutting has peaked.  We may have another month to piece together a better picture of the consumer, but at the same time it’s probably best to retire the thesis of “easy compares”.

 

Eric Levine

Director

 

 

LEVINE’S LOW DOWN 

 

  • With CES taking place this week in Las Vegas, expect to hear lots of buzz surrounding the latest and greatest gadgets and technology breakthroughs. In the absence of any expected “breakthrough” technology, there is likely to be lots of chatter surrounding 3D TV (thank Avatar for the added focus here), e-readers, netbooks, mobility, and Apple’s imminent tablet launch. As always, retailers will be looking for any products that can help boost AUR’s and margins.
  • According to Forrester Research, retailers spent $4.67 billion in 2009 on interactive marketing. The figure is expected to grow to $8.6 billion by 2014, with mobile growing to almost $200 million from just $59 million this year. While the growth rates are impressive, the absolute dollars spent on interactive marketing are still small relative to traditional marketing spend. Wal-Mart and Target combined spend near $2 billion annually on marketing and advertising!
  • Over a week ago I pointed out that the UGG retail store in Soho consistently had a line out the door during the holiday season. Well, now it’s time for an update. Both the UGG store and a metro-area outlet store still have long lines of customers waiting to get in. To my knowledge, UGG is one of a very few retailers that employ a “bouncer” to control entry and exit into their stores.
  • “Green” and “sustainability” are buzzwords that are expected to continue to increase in importance to the U.S. consumer. The longevity of such trends is still questionable, but most signs suggest that retailers and brands will continue to push the environmentally friendly envelope. A 2009 survey found that 54% of consumers would purchase more sustainable, green products if pricing was at parity with non-green products. Additionally, consumers are very aware of lip-service vs. reality. Another survey suggests that 70% of consumers don’t believe companies when they tout their efforts to help the environment and sustainability. As such, 64% of consumers would like corporations to use third-party verification to ensure that intentions are honest and transparent.

 

MORNING NEWS 

 

Target Launches Warehouse Club Event - One of the first discounters to advocate design for the masses, Target is now dabbling in the no-frills warehouse club concept. The Great Save, a shopping event now through Feb. 21, features low prices on bulk-packaged items and designer brands in a warehouse-club-like setting, but without club membership fees or ID cards. The event is being held in the seasonal departments of all 1,740 Target stores. The strategy could be aimed at countering the consumer perception that Target is more expensive that its rival Wal-Mart, whose parent company operates its own warehouse club division, Sam’s Club. Wal-Mart Stores Inc. has consistently outperformed Target Corp. over the last year in comparable-store sales gains. A Target spokesman declined to speculate as to whether The Great Save is a harbinger of the retailer rolling out its own warehouse club format. <wwd.com>

 

Tesco Clubcard company Dunnhumby buys KSS Retail - Dunnhumby, the market research company that is majority-owned by Tesco, the UK supermarket, has bought KSS Retail, a US price-modelling company, for an undisclosed sum. KSS Retail analyses and predicts shoppers' behaviour by tracking the effects of price changes on shop shelves and on online stores. It then generates pricing "models" for the retailers to implement based on consumer demand. Its technology and services are used by retailers such as Kroger, Portugal's Sonae, and Associated Food Stores.  Dunnhumby, which runs Tesco's hugely successful Clubcard loyalty scheme and analyses shopper activity in over 200m households worldwide, said that the acquisition will enable it to combine its know-how and expertise with that of KSS Retail. <telegraph.co.uk>

 

Asda steps up UK grocery battle with price cuts - Asda, Britain's No. 2 grocer, is cutting prices on 3,600 products by an average of 13 percent, intensifying the battle between the big supermarket groups at a time when lower food price inflation is hitting sales growth. Asda, owned by the world's biggest retailer, U.S. group Wal-Mart Stores Inc (WMT.N), said on Tuesday the cuts covered one in five products in its stores, including potatoes, carrots, bananas, milk, nappies, rice, bread and cheese, and represented its biggest and broadest reductions in over a decade. The cuts would more than offset an increase in VAT sales tax applicable to some non-food products on Jan. 1 and the vast majority would last for a minimum of six to 12 weeks, it said. The move appears to ratchet up a price war between supermarket groups, although it is reminiscent of similar campaigns in previous years which have been funded mainly by cost cutting and have not undermined industry profit margins. <reuters.com>

 

PacSun Names Cameron New Marketing Chief - In a move designed to help the company recapture its roots, Pacific Sunwear of California Inc. will today name former Levi Strauss & Co. executive Robert Cameron senior vice president of marketing. At PacSun, Cameron, formerly vice president of Levi’s Brand Marketing, will be responsible for creating a differentiated experience at the company’s 897 stores around the U.S. as well as on its Web site. He will also work with the company’s major brands to re-create the California lifestyle at its stores. This is a new position. “Robert has a tremendous track record of building brands and creating world-class customer experiences, particularly in the youth segment,” said PacSun president and chief executive officer Gary Schoenfeld. “We’ll leverage his background to reclaim our position as the favorite place for 15- to 24-year-olds to shop.”  <wwd.com>

 

Military Retail Giant Seeks Growth - A $10 billion retail giant that operates in 49 states and more than 30 countries is on the prowl for market share. The Army and Air Force Exchange Service, which sells 877,000 items from socks to electronics to 11.6 million active and retired military personnel, plus their spouses and dependents, is stepping up fashion, modernizing systems and investing to improve service. It’s also building malls and lifestyle centers at major bases in the U.S. and abroad. The exchange service sees the potential to grow despite the impact of the recession. “It’s the largest $10 billion business that nobody knows about,” said Maj. Gen. Keith Thurgood, commanding general and chief executive officer. “I was asked how gloomy 2009 would be, and I said one word — ‘opportunity.’ This is the time for us to invest in technology, spend money and focus on the customer in terms of pricing and promotion. If we get our strategy right, we can put ourselves on a glide path to grow in ’10, ’12 and the future.”  <wwd.com>

 

Next Sees Momentum Slowing After Holiday Sales Gain - Next Plc, the U.K.’s second-largest clothing retailer, said a recovery in consumer spending may not be sustainable after a rebound in holiday sales caused the company to raise its annual profit target. Chief Executive Officer Simon Wolfson expects a “similar” level of profit in the coming year as shoppers feel the effects of tax increases or job cuts, the company said today. Next is buying inventory at the “lower end” of its sales budget. Next fell as much as 3.5 percent in London trading as the company’s comments on the outlook offset the increased earnings forecast and higher holiday sales. The retailer today raised its pretax profit goal for fiscal 2010 for a fifth time to as much as 500 million pounds ($807 million) after Britons bought more of its women’s fashion ranges in the build-up to Christmas.  <bloomberg.com>

 

Herrera Greets 2010 With New Game Plan - While many companies are hunkering down given the sputtering global economy, Carolina Herrera is forging ahead with new stores, sharper pricing and an aggressive rollout of CH Carolina Herrera. “Fashion is about movement. It is a dream you can make a reality when people wear your clothes,” the designer said during a Monday morning interview with Marc Puig, chairman and chief executive officer of the Puig Beauty & Fashion Group, which owns the Herrera fashion house. While some might argue last year was one bad dream given the recession, the duo is determined not to get mired down by the malaise that seems to have engulfed many shoppers around the globe. <wwd.com>

 

END Footwear Co-Founder Launches LUME - Andrew Estey, former END Footwear co-founder and award-winning footwear designer, announced the launch of LUME, a premier active-lifestyle brand focused in the fusion of health and wellness. Influenced by the active baby boomer and grounded in a design philosophy of “inside out,” LUME’s main focus is to drive innovation through fit with a focus on how the foot connects to its environment. As footwear will be the catalyst, LUME’s plan is to move quickly over the next few seasons to complete a unique wellness system comprised of Footwear, Inserts and Socks, all designed to benefit and enhance the foot's comfort. With its core group in place, the brand is moving full steam ahead with a planned launch into footwear as their first introduction in FA’10.  <sportsonesource.com>

 

Lanvin Investor Revealed -  Lanvin’s parent Arpège SAS, which last November sold a 12.5 percent stake, realized a capital increase totaling 27.5 million euros, or about $39.3 million at current exchange rates. The amount is disclosed in documents filed with the commercial court here and obtained by WWD. They describe a two-prong capital increase, with 10 million euros, or about $14.3 million, representing a debt-to-equity conversion, and 17.5 million euros, or $25 million, deposited at the private bank Neuflize OBC. It is understood the minority investment was made through a family trust associated with the Bartel family. The documents name Ralph Bartel, born in Germany and resident of Switzerland, as a new director of Jeanne Lanvin SA.  <wwd.com>

 

Congress Inaction Puts Tariffs on Textile Imports - U.S. apparel, textiles and footwear manufacturers could be hit with tens of millions of dollars in duties on imported components after Congress failed to pass legislation extending hundreds of expiring duty breaks before adjourning for the year. The so-called temporary duty suspensions, which must be renewed periodically by Congress, are intended to help domestic manufacturers compete by giving them tariff breaks on components such as certain yarns, fibers and footwear parts that are no longer made in the U.S. and must be imported. Lawmakers granted three-year duty suspensions on an estimated 500 imported categories in 2006, but those breaks expired on Dec. 31, leaving U.S. companies to pay for the duties on the imports that enter the country, beginning Jan. 1. The tariff suspensions are contained in legislation dubbed the “Miscellaneous Tariff Bill” that has a strict set of criteria, including stipulations that each import category receiving the breaks is “noncontroversial,” which means the items are no longer made in the U.S., and cannot cost more than $500,000 in lost revenue per category annually to the U.S. Treasury. <wwd.com>

 

E-commerce stocks roar into 2010 up 91% from January 2009 - Despite an off week as the year came to a close, 2009 represented a big rebound for e-commerce stocks. The Internet Retailer Online Retail Index of 25 e-commerce stocks advanced 91.44% over the course of 2009, easily exceeding the gains in the broader stock market. By comparison, the Dow Jones Industrial Average gained 18.82% and the Standard & Poor’s 500 Index was up 23.45% for 2009. The e-commerce index’s gains were more in line with that of the NASDAQ exchange, which includes many high-tech companies, and which advanced 43.89% in the past 12 months. E-commerce and other tech companies were bouncing back from a miserable 2008. While Internet Retailer only began tracking its Online Retail Index in February 2009, those 25 stocks collectively were down 39% in 2008. The NASDAQ fared even worse in 2008, sinking 41%, while the Dow was off 34% and the S&P 500 37%.  <internetretailer.com>

 

37% of smartphone owners purchased merchandise via their phones in 2009 - Mobile commerce is poised to explode this year, says online marketing and research firm Compete, which has found in new research that 37% of smartphone owners purchased merchandise via their phones in 2009. However, smartphone owners are not all alike, the firm says. “We’re seeing notable behavior differences across devices. So, for example, users of the Android operating system share different characteristics than Blackberry and iPhone enthusiasts,” says Danielle Nohe, director of consumer technologies at Compete. “As marketers better understand how each group actually uses their devices, there’s a huge potential in 2010 for mobile commerce to explode.”  <internetretailer.com>

 

Supreme Court to Consider NFL's Exclusive Licensing Deal Case - The National Football League next week will ask the U.S. Supreme Court for a broader shield from antitrust lawsuits, one that would let teams act as a group in marketing their logos and trademarks. The court will hear arguments over the league’s exclusive agreement with Adidas’s Reebok subsidiary to sell hats, jerseys and all clothing with team logos. The Supreme Court will decide whether the National Football League should be considered as a single entity or as separate businesses when defending against antitrust claims, according to the Los Angeles Times. Lawyers for pro football owners will ask the justices to rule that the NFL should be shielded from antitrust laws because its teams, while competitive on the field, function in business as one entity. If exempted from the antitrust laws, sports leagues could be insulated from antitrust claims over video-game licenses, television rights, franchise relocation and even player salaries, Bloomberg News reported. Only Major League Baseball is exempt from antitrust laws now. <sportsonesource.com>

 

Vietnamese Footwear exports fall sharply - Vietnam’s earnings from footwear export in 2009 dropped by 15.8 percent to US$4 billion despite the sector’s efforts to weather the global economic crisis. According to the General Statistics Office, the country’s footwear exports to all its main markets fell sharply. This was attributed to Vietnam’s shrinking export markets. Following the EU’s decision to continue imposing anti-dumping taxes on Vietnamese leather-capped shoes, many footwear companies, including foreign-invested companies in the country had to cut down production levels by between 10-30 percent in comparison with 2008.  <vovnews.vn>


Going After Gold

“You wanna settle old scores, you're on the wrong team. We move forward starting right now.”
-Herb Brooks (Miracle)
 
Tonight, in Saskatoon, Saskatchewan, Canada will face-off against a young American team in the gold medal game of the World Junior Hockey Championship. The Canadians will have the edge with the home crowd behind them, but we men and women of the ice never, ever, underestimate the US National Team’s potential for a Miracle On Ice.
 
For Americans and Canadians investors alike, going for gold in 2010 is as consensus as consensus gets. Thankfully, I have been a gold bull since 2003. That score means nothing to me this morning. It’s a new season, with a new score. On this research bench, if “you want to settle old scores, you are on the wrong team.”
 
Today, we move forward. We have moved to a zero percent position in our Asset Allocation Model in Gold. Are we early? Maybe. I have immediate term TRADE resistance for the price of gold at $1137 – but I sold into the biggest up day gold has had since November 3rd (+2.3%), and I like being early.
 
I wrote an intraday note to our Macro Subscribers on December 2nd titled “Bubbly Gold: Selling Some, Again!” – that wasn’t early. That was, as they say on the ponds of Thunder Bay, “ticklin’ the twine”…
 
The top right corner of the twine, net, or chart, is the same thing. For the foreseeable future, you cannot get the puck, or the gold price, stuffed any higher than that. A decade high for the price of gold was established on December 2nd of 2009. Mark that date down. You might not see a higher-high for gold until the Fed stops raising interest rates.
 
Raising rates? Huh? Knuckle head hockey boy – Goldman says the Fed is on hold until their 2012 banker bonus season. We’re long of gold and levering up returns for some free moneys, eh.
 
That, hockey fans, would be the consensus view for 2010. Actually, throw “Long China” onto that bucket of consensus ice too (after an +80% run in 2009, Goldman is also saying buy China right here this morning as well). Sorry to keep score guys – but there’s a new chirper in this league. Game on.
 
My research team remains outside of consensus on all 3 of our core Macro Themes for Q1 of 2010. As a refresher, here they are:
 
1.      Buck Breakout

2.      Rate Run-up

3.      Chinese Ox In A Box

 
We authored the “Breaking” and “Burning” The Buck thesis early last year, so we think we have some credibility in calling the turn on our own bearish US Dollar thesis. We aren’t making this call for the sake of being contrarian. We are making it because we think we have an increasing probability of being right.
 
We put our bucks where our mouths were yesterday and bought the UUP (Dollar ETF) in our Virtual Portfolio. We also sold our position in Gold (GLD). Both of these moves are born out of the same investment thesis. He Who Sees No Bubbles (Bernanke) is way behind the yield curve. Consensus that he will remain asleep at the switch for another full year of Obama getting blamed for funding banker bonuses is politically reckless, at best.
 
Politically reckless? Pardon? What do intermediate term breakouts in both US Dollars and Treasury yields have to do with politics? Answer: Everything.
 
As Herb Brooks would say, “Again!” … “Again!”. Forget the new normal folks, we came up with The New Reality before that low growth, low rates, thesis started getting parroted by the CNBC plebes. “Again!”, The New Reality is that US monetary policy is as politicized as it has ever been. Ever, by our math, is a very long time.
 
Last week, saw the Piggy Banker Spread (yield spread between 10 and 2-year interest rates) hit its widest margin EVER. At the same time, you saw the US stock market hitting its highest of highs for the year. And, at the same time, you saw President Obama’s approval ratings hit some of the lowest levels ever in an environment of expeditiously rising stock prices.
 
You don’t need a puck to the melon to wake-up to the political conclusion that the President of the United States needs a big political win here in 2010. It’s not coming from Healthcare or Afghanistan either. Ask Hillary and Bill about that. The turn-coats are moving in on the Obama Hammer. This top political draft pick of 2009 needs to put one in the back of the net, and soon.
 
We think that political win comes against the bankers. We think the best way to ensure that populist win is to raise the rates of return on American savings accounts.
 
Forget “extended and exceptional.” ZERO rate of return being issued to the US citizenry is unreasonable and unsustainable. As soon as Ben Bernanke gets re-confirmed as Fed Head by the Senate, look for Obama to be having a little fire-side chat with He Who Has Great Depression about the same.
 
Our job is to wake-up every morning and manage risk, not to make friends. Sell your gold. Buy some dollars. “We move forward starting right now.”
 
My immediate term support and resistance levels for the SP500 are now 1123 and 1135, respectively.
 
Best of luck out there today,
KM

 

LONG ETFS
 
UUP – PowerShares US Dollar Index Fund
We bought the USD Fund on 1/4/10 as an explicit way to represent our Q1 2010 Macro Theme that we have labeled Buck Breakout (we were bearish on the USD in ’09).

XLV – SPDR HealthcareBuying back the bullish position Tom Tobin and his team maintain on the intermediate TREND term for the Healthcare sector.

VXX - iPath S&P500 VolatilityFor a TRADE we bought some protection at the market's YTD highs by buying volatility on 12/14/09.

EWG - iShares GermanyBuying back the bullish intermediate term TREND thesis Matt Hedrick maintains on Germany. We are short Russia and, from a European exposure perspective, like being long the lower beta DAX against the higher beta RTSI as well.

EWZ - iShares Brazil As Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero.  On 12/8/09 we started buying back exposure via our favorite country, Brazil, with the etf trading down on the day. We remain bullish on Brazil's commodity complex and believe the country's management of its interest rate policy has promoted stimulus.

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.

 
SHORT ETFS

RSX – Market Vectors Russia
We shorted Russia on 12/18/09 after a terrible unemployment report and an intermediate term TREND view of oil’s price that’s bearish.

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.

XLY - SPDR Consumer Discretionary We shorted Howard Penney's view on Consumer Discretionary stocks on 10/30/09 and 12/2/09.

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.


BRAZIL FOLLOW UP

A vote on gaming legislation in Brazil probably won't occur until the spring, at the earliest.

 

 

As we wrote about in our 12/18/09 post, "SIZING UP THE BRAZIL OPPORTUNITY", the Brazilian federal government is considering gaming legislation.  The proposed legislation, Bill No. 270/03, would legalize licensed bingo and electronic gaming machines and allow for gaming parlors with 20-40 devices in some of Brazil's larger cities and a maximum number of 75 devices per location in Sao Paulo.  We believe the market could be at least 40,000 machines

 

In mid-September 2009, a draft version of Bill 270/03 passed in the Chamber of Deputies by a 40-to-7 vote.  The Bill is now awaiting debate and vote in the lower house of the Brazilian Congress.  While the Bill was given the green light to go to floor a few weeks ago, it appears that the debate has been delayed because of a provision dealing with the retirement age of public servants that was tacked onto Bill 270/03.  There may be other issues since we are now hearing no vote until the spring, at the earliest.

 

The October presidential election is the key time frame.  Our sources indicate the likelihood of a successful vote diminishes post election.


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US STRATEGY – PERFECT IS AS PERFECT DOES

The S&P 500 started out the new decade on a strong note on Monday, with the index up 1.6%.  The rally was broad based as all the major indices finished at least 1.5% higher on the day.  The Research Edge quant models now have all nine sectors positive on TRADE and TREND. It should be noted that the move came on very light volume.

 

On the MACRO front there were a number of positive dynamics at work yesterday, including a batch of largely upbeat global PMI readings, particularly out of China and the US.  The improved PMI readings led to a big move in the high beta RECOVERY trade.  The official December Chinese PMI rose to 56.6 from 55.2 in November, expanding for the tenth straight and marking the highest level since April of 2008. In the US, ISM manufacturing rose to 55.9 in December from 53.6 in November, the highest level since April of 2006. December marked the fifth consecutive month of manufacturing expansion. Importantly, the forward-looking new orders component rose to 65.5 from 60.3. 

 

The two best performing sectors were Energy (XLE) and Materials (XLB).  Both sectors have the most leverage to the RECOVERY theme and a weaker dollar.  The Dollar index declined to 77.52, down 0.43%. 

 

Rounding out the top three best performing sectors was the Financials (XLF).  The XLF posted its best one-day gain since November 30, 2009.  Within the XLF, the banks snapped a four-day losing streak.

 

Next to the Utilities, the two notable underperformers were the Consumer Staples (XLP) and Consumer Discretionary (XLY).  The retail group was a notable standout with the S&P Retail Index finishing unchanged on the day. 

 

The range for the S&P 500 is 12 points or 0.5% upside and 1.0% downside.  At the time of writing the major market futures are trading flat on the day.    

 

Copper is trading lower ending a sixth day winning streak.  The Research Edge Quant models have the following levels for COPPER – buy Trade (3.25) and Sell Trade (3.42).

 

GOLD continues to trade in a very narrow range around $1,127/OZ.  The Research Edge Quant models have the following levels for GOLD – buy Trade (1,083) and Sell Trade (1,137).

 

Crude oil traded near a 14-month high as cold weather in the U.S. and signs of economic recovery are helping demand.  The Research Edge Quant models have the following levels for OIL – buy Trade (77.85) and Sell Trade (82.59).

 

Howard Penney

Managing Director

 

US STRATEGY – PERFECT IS AS PERFECT DOES - sp1

 

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US STRATEGY – PERFECT IS AS PERFECT DOES - copper6

 


THE M3: MACAU GROSS GAMING RECEIPTS

The Macau Metro Monitor.  January 5th, 2009



2009 CASINO REVENUES HIT RECORD US$ 14.875 BILLION

Macau’s gaming industry logged gross gaming receipts of US$ 14.875 billion (MOP 119 billion) in 2009, according to an article in the Macau Post Daily.  The revenues represent an increase of 9.4% on the previous year’s total of US$ 13.6 billion (MOP 108.8 billion), which was 31% higher than the 2007 total.  Last month’s casino receipts amounted to US$ 1.4 billion (MOP 11.3 billion), an increase of 47.6% compared to December of 2008.  Month-over-month, revenues were up 50% in December.


The relatively low annual increase has been attributed to the impact of the global economic downturn as well as visa restrictions enforced on mainlanders by the central government.  According to the unnamed source in the Macau Post Daily’s report, SJM has remained the top market share holder with 30% of revenues.  LVS came in second at 23% with WYNN at 15%, MPEL at 12%, and Galaxy and MGM at approximately 11% and 9%, respectively.

 

 

CASINO STOCK SOAR ON STRONG MACAU GAMBLING REVENUES Reuters

Shares of Macau casino operators rose on Tuesday on reports that gambling revenues in the enclave in December rose 48 percent from a year earlier, signalling sustained growth in the world's largest gambling market.

 

 

NO MORE H1N1 PATIENTS IN HOSPITAL macau daily Times

There are no influenza A (H1N1) patients in Macau hospitals, the Health Bureau reported yesterday. While the Government is urging residents to receive the flu vaccination, up to 65,000 citizens already have had the jab.  The warning of pandemic influenza provided by the World Health Organization (WHO) remains at level 6 – moderate. Currently, the alert level issued in Macau is also 6 (blue), and the risk of transmission is moderate.  As of yesterday afternoon, no new confirmed cases of people suffering H1N1 and needing hospitalization were reported. The last confirmed patients hospitalized reported by the Government have been discharged, and no new patients have been hospitalized.


SONC – EARNINGS PREVIEW

SONC is scheduled to report fiscal first quarter 2010 results after the close today.  I think earnings could come in slightly better than the street’s $0.14 earnings per share estimate.  I don’t think investors will care too much about that number, however.  What will matter is what management has to say about top-line trends in the quarter and going forward.  Management told us during its fiscal 4Q09 earnings call that the first quarter did not start out strong as a result of “challenging weather” and that statement was made more than six weeks into the quarter. 

 

To that end, my partner drive-in same-store sales growth estimate of -5% comes in below the street’s -4.6% estimate and assumes no acceleration in 2-year average trends from the fourth quarter.  As in the most recent quarters, I am expecting most of this decline in same-store sales to be driven by continued weakening of average check.  This will be the case until the company laps the launch of its Everyday Value Menu in 2Q10. 

 

My more bullish stance on SONC is based largely on the fact that the company’s margins are moving higher in fiscal 2010.  Based on what we have been hearing from SONC’s peers, QSR trends are under increased pressure and SONC’s full-year same-store sales guidance for flat growth currently seems like a bit of a stretch.  For reference, management admitted that it might need to revisit this guidance, which was given in September, after 1Q10. 

 

Even if top-line numbers come in light (I am modeling -2% for the full year), EBIT margins should improve more than 250 bps during the year to a level more consistent with what the company achieved prior to fiscal 2008, with the biggest improvement coming in the first half of the year.  SONC is lapping extremely easy margin comparisons in the first half of the year as a result of the 6%-plus declines in partner drive-in comparable sales in 1H08, but the company’s refranchising initiative (refranchised 205 restaurants in FY09) will help a lot in this regard as well. 

 

Management is expecting food costs to be relatively flat as a percentage of revenues for the full year.  Although this guidance could be at risk as food costs have moved higher since this guidance was given and the company was still in the process of negotiating contract renewals, SONC was largely locked in on its food and packaging costs through the first quarter.  The company’s refranchising efforts should benefit both the labor and other operating expense line, particularly in the first half of the year; though this will be somewhat offset by continued sales deleveraging.

 

My full-year same-store sales estimate of -2% does assume some improvement in 2-year trends for the balance of the year so there is some risk to my numbers, but margins are moving higher even if it is not to the magnitude I have laid out.  Offsetting some of the top-line risk to earnings is the fact that SONC started the year with $125 million in excess cash investments over and above what the company calls its normal operating needs.  Management said it will use this money along with its free cash flow (I am modeling more than $120 million) to continue to pay down debt and increase shareholder value, which it said could include share buybacks.  My earnings estimates do not currently reflect the benefit of share repurchase.  I continue to believe that the company’s return on incremental invested capital bottomed in fiscal 2009, which should help SONC to outperform its peers going forward after consistently underperforming its peers in calendar 2009 (down 21% in the last year relative to its QSR peers’ average nearly 70% move higher).

 

SONC – EARNINGS PREVIEW - bhs


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