Please join us as we launch our Black Book:

Top 10 Retail Predictable Unpredictables in 2010


Conference call FRIDAY January 8, 2010 -- 11 AM EST 



Simply put, these are 10 ideas that we assess at better than 60% chance of happening, but today's Wizards of Wall Street either:  

A) do not acknowledge that such ideas exist, OR

B) see them as so unlikely, they do not bake them into their investment process.  

Some of our deeper conclusions will come from the following topics...


1.       M&A Targets
2.       Looming Business Failures
3.       Unionization
4.       The Retail Private Equity Pipeline
6.       Asia's Role in Sourcing
7.       Inventory Cycles and Capacity Utilization

8.       Asia Free Trade Agreement Impact

9.       Consumer Retrenchment

10.     Commercial Real Estate’s Next Leg

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FL: Close ‘Em or Suffer

FL: Close ‘Em or Suffer

Our team has roughly 30-years of cumulative experience analyzing this beast. Throughout our tenure, what we have not seen is a respectable analysis showing cannibalization factors by FL concept. Well… here you go. We still like the low-hanging fruit here.



Here’s an update on Foot Locker – one of our top bench ideas for 2010. Our team has roughly 30-years of cumulative experience analyzing the beast that has become Foot Locker. Throughout our tenure, what we have not seen is a respectable overlap analysis showing likely cannibalization factors by FL concept. Well… here you go.


The bottom line is that the overlap stats are quite sad, actually.


Here’s the analysis:


There are 111 stores or 5.4% of the domestic FL portfolio that suggest self cannibalization.  In other words, 111 units are located within a ½ mile or less of another unit with the exact same nameplate.  Think Foot Locker in a mall and another at the other end of the mall or just down the street.


FL: Close ‘Em or Suffer - 1

Source: ESRI; InfoUSA; Research Edge. Note: InfoUSA database represents 90% of the total U.S. store base.  Data not available for Champs.


The overlapping stores listed above represent the most obvious candidacy for closure.  Provided the upfront lease termination fees are justifiable, it seems reasonable to assume a productivity boost would result from closing stores that are in close proximity to other locations carrying the same brand name.  As a sidenote, FL’s implied portfolio lease duration is among the lowest in retail. It has not done a whole lot right in its history, but keeping landlords on a short leash has been an area of strength. High lease flexibility is definitely a big positive.  


After eliminating some of the more obvious locations, store closures become more strategic.  Our analysis suggests that FL’s domestic store portfolio is 81% self-cannibalizing.  In other words, 81% of all Foot Locker sub-brands have another sub-brand within a ½ mile.  However, we caution not to get overly fixated on this high number.  The majority of the concentration comes from Lady Foot Locker and Kids Foot Locker, both of which were clearly positioned with co-location in mind.  This brings us to our next step in store closures: Lady Foot Lockers.


FL: Close ‘Em or Suffer - 2

Source: ESRI; InfoUSA; Research Edge


FL: Close ‘Em or Suffer - 3

Source: ESRI; InfoUSA; Research Edge


Over time, management established Foot Locker stores as a central hub and then added additional locations in the same mall  with the opening of Lady Foot Lockers and Kids Foot Lockers.  It seemed logical to place Lady Foot Lockers next to or near Kid’s Foot Lockers because they do not compete, but instead complement each other.  That makes sense to us at some level, but with 1.7 Lady Foot Lockers for every Kids Foot Locker, the opportunity to right-size the Lady portfolio appears compelling.  In fact, we wonder why Lady and Kids need to separately exist? A one stop shop for women and children, while leveraging overhead.  After all, ‘kids’ is not a gender.  Kids also could care less where their Mom buys their kicks. Stores should cater to the person holding the cash – not the 4-year old that cannot dress himself in the morning. 


We’re still awaiting signs of management’s actual intentions, but for now we’ll continue to explore all options and ideas.  We continue to believe there is ample low hanging fruit here, and real estate may just be the easiest to pick given a 20 point+ margin delta in profitability between the best and worst performing stores.


Zachary Brown

Eric Levine


Obviously this is not a bright spot for me to start the year.  Right now $9.43 represents the 2 standard deviation oversold line…..


From a fundamental perspective, SONC is getting killed by weather, a high concentration of partner drive-in stores in Texas and intense industry discounting.  Not all of this is new, but the magnitude of the impact was far greater than expected.  Today’s shellacking is probably over done on the downside, but it will take time for the stock to regain investor confidence. 


With two sell-side downgrades this morning on top of the already 5 sell recommendations (a lot relative to most other QSR names), I don’t think now is the right time to get incrementally more bearish on the name.  Add to that the fact that short interest on the name is high at 7.6% relative to the QSR group’s average of 6.5%.  I was obviously early on this name, but EBIT margin comparisons remain easy for the next two quarters.  This may not matter much to investors if we don’t see any abatement in same-store sales declines.  We know that fiscal 2Q10 is going to be another tough quarter from a top-line perspective, but management made that very clear yesterday on the company earnings call so that should be baked into expectations as of today. 

Bernanke's Letter V

He Who Sees No Data (Bernanke) can look at the following chart, and pretend no one else is looking.  He claims to be “data dependent”, but that must be a joke.


This morning’s ISM Non-Manufacturing reading for the month of December came in above the all so important 50 line (economic expansion line), at 50.1. This was another sequential improvement versus the November reading of 48.7.


Now, both the ISM Manufacturing (released earlier this week) and Non-Manufacturing surveys are holding at/or above the levels we saw in early 2008. These, to the plain eye, look a lot like the Letter ‘V’. Unfortunately, the willfully blind of Washington groupthink aren’t allowed to see these charts, and the rate of return we are issued by the US Government on our savings accounts remains ZERO as a result.


I am by no means suggesting that this V-bottom is sustainable. But I am definitely not refuting that a V-bottom has occurred. It’s now a fact. To have witnessed the incompetence of the US Federal Reserve’s forecasting ability in missing this chart on the way down in late 2008 was one thing. Now we are seeing them miss the entire bounce on the way up, and it is both professionally embarrassing and sad altogether.


I remain bullish on US Treasury Yields (short SHY) and bullish on the US Dollar (long UUP) for the intermediate term (3 months or more). Either the Fed’s mea culpa is coming, or something far darker than I can imagine for America’s place of leadership in setting global monetary policy.


America’s Creditors are watching.



Keith R. McCullough
Chief Executive Officer


Bernanke's Letter V - ISM6


Bingo!: U.S. Debt Watch

“If you establish a democracy, you must in due time reap the fruits of a democracy. You will in due season have great impatience of the public burdens, combined in due season with great increase of the public expenditure. You will in due season have wars entered into from passion and not from reason; and you will in due season submit to peace ignominiously sought and ignominiously obtained, which will diminish your authority and perhaps endanger your independence. You will in due season find your property is less valuable, and your freedom less complete.” –Benjamin Disraeli


As we roll our broader coverage and expand our focus on the macro research side of our business in 2010, one area of focus will be sovereign indebtedness, which changes daily.  Internally, we have ceded the critical role of following the national debt of the United States to Darius Dale, and you will likely be seeing some notes from him on this topic in the near future.  As a precursor to what will become an ongoing discussion for us, I wanted to outline some key facts relating to the burgeoning U.S. national debt:

  • Total current U.S. National Debt - ~$12.17 trillion;
  • Total current U.S. National Debt per taxpayer - ~$111,622; and
  • Debt to GDP ratio – 83.5%.

These numbers are subject to some debate and we have sourced them from  Setting aside specific debate on the precise number, the point remains the U.S. National Debt is large and expanding.  The key components of this debt are as follows:

  • Medicare and Medicaid 21.9%;
  • Social Security 19.2%; and
  • Defense and Wars 19.1%.

U.S. National debt as a percentage of GDP has been climbing steadily since 2000, and has seen exponential growth in the last two years.  At the current ratio of ~83.5% debt to GDP, we are at level not seen since the 1950s. We have outlined this metric in the chart below going back 90 years. By the end of 2010, this number is projected to be near 100% of GDP absent a dramatic shift in domestic budgetary policy.  As with any borrowing, the more a person or entity borrows, even the United States of America, the cost of borrowing will go up, all else being equal.  This will have an increasing impact on the pricing of U.S. government securities in time.


Interestingly, the national debt of ~$12.17 trillion, actually excludes Fannie Mae and Freddie Mac debt.  The U.S. government became the effective conservator of both of these entities with the Housing and Economic Recovery Act of 2008.  The estimated combined on and off balance sheet debt of Fannie and Freddie is purported to be just over ~$5 trillion. Including this additional $5 trillion in debt, U.S. Government debt as a percentage of GDP is actually more than ~120%.  On that basis, U.S. government debt as a percentage of GDP is the highest ratio it has ever been, or at least since the numbers have been recorded, which is since 1792.  Needless to say, both ever, and since 1792, are a long time.


Globally, this data hasn’t been updated since 2008, but based on 2008 data, the U.S. has the fifth highest indebtedness as a percentage of GDP, just barely above Singapore and just below Jamaica, man.  The only other countries more indebted than the U.S., on this basis, are the economic stalwarts of Zimbabwe, Japan, and Lebanon. 


Keep your eyes  on U.S. government debt . . . this Queen Mary is not turning any time soon and will hold investment implications related to many asset classes for years to come.  Not to mention, as former British Prime Minister Benjamin Disraeli states above, implications for our very freedom and prosperity.


Daryl G. Jones
Managing Director


Bingo!: U.S. Debt Watch                - feddebt



Divergence of trends between QSR and Casual Dining and comments on sales trends in Texas!


Yesterday, SONC reported horrific fiscal first quarter 2010 same-store sales trends, with partner drive-in comparable sales coming in down 9.1% relative to the street’s -4.6% estimate and my -5.% estimate.  This 9.1% decline implies a 200 bp deceleration in 2-year average trends from the fourth quarter.  And, based on management’s comments on the earnings call, the freefall in top-line trends continued into 2Q10.  Specifically, management stated, “The environment continues to be a challenging one from the standpoint of the industry, so heavily focused on price and moving into the winter months that's traditionally when there is so much more sensitivity to cost anyway post holiday season, and you add to that the unpredictable weather mix that we've had December moving into January. And our perspective is that the same-store sales will continue to be a challenge moving into our second fiscal quarter, our fiscal quarter ending February.”


SONC is not the only company citing challenging weather in December.  This morning CKR reported period 12 comparable sales trends for the period ended December 28 and attributed the 6.5% decline in blended same-store sales to “ongoing weakness in the overall economy coupled with poor weather conditions negatively impacted both brands' sales results during period 12.” Same-store sales at Carl’s Jr. declined -8.9%, pointing to a nearly 130 bp decline in 2-year average trends from the prior period and marks the fifth consecutive month of sequentially worse trends.  Hardee’s -3.2% comparable sales decline came in sequentially worse on a 1-year basis but the concept’s 2-year average trends have remained relatively flat for the past 6 months.


So we have gotten two worse than expected data points on QSR trends in December while the only glimpse of December out of the casual dining operators (that I can recall) was the more favorable comment made by Darden.  On its last earnings call, the company said, “The sequential improvement in same-restaurant sales has continued so far in fiscal December for both the industry and for our brands after adjusting for the estimated impact of the Thanksgiving shift. However, we're still early in the month and weather can always be a factor in December.”  The casual dining operators are facing easier comparisons than the QSR industry, but both SONC’s and CKR’s recently reported numbers point to increasingly worse results on a 2-year average basis.


To that end, Darden did not clarify whether December trends were looking better on a 2-year average basis or whether the improvement is the result of the industry’s (as measured by Malcolm Knapp) easiest comparison from calendar 2008 when comparable sales declined 9.5%.  It is important to remember that casual dining trends in November improved on a 2-year basis.  We have yet to learn how December played out for the casual dining operators, but like Darden said, weather can always be a factor in December and if SONC and CKR are any indication, weather was a factor.


SONC also pointed to recent weakness in Texas to explain the company’s worse than expected trends.  Management stated that the “higher unemployment that we've been experiencing for a while in the more recent past more negatively impacting our brand because of the late impact of the recession on some of our core markets such as Texas and Oklahoma, and so with a more pronounced impact on those markets in the more recent past, their shift having a more pronounced effect on our brand and on our system than some of our competitors.”  In an attempt to provide some proof of the slowdown in Texas, management cited the fact that the sales tax collection statewide was -12% in October and -14% in November.  And, with SONC having about 45% of its partner drive-ins located in Texas this recent YOY slowdown disproportionately impacts its numbers.


If SONC management is correct in its assessment of the current situation and the macro environment in Texas is largely to blame for its fall off in trends, then that will have an obvious impact on players with high geographic exposure to Texas.  EAT, PFCB, TXRH, BJRI and JACK all come to mind.  Looking back at the regional trends provided by Malcolm Knapp, Texas was the best performing region of the country in late 2008/early 2009 so on a YOY basis, Texas is currently lapping more difficult comparisons than much of the country. 


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