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Australia vs. Japan: Sobriety vs. Socialism

I am short Japan for a variety of reasons that I've discussed in prior portal postings. These two charts that we put together this weekend depict the Reserve Bank of Australia’s inflation fighting vigilance versus the Bank of Japan's easy money political pandering.

*Full Disclosure: I remain short Japan via the EWJ etf.
KM
Australian Sobriety
Japanese Socialism

Apple (AAPL): Macro Short?

Precisely 2 years ago, AAPL was trading at $50/share and plenty of doubt surrounded the company’s ability to continue to deliver product momentum. On Friday, the stock closed at $162/share (19x trailing cash flow!), and we’re looking at a company that is rightly the apple of every investors qualitative eye – pardon the pun.

I am very weary of letting our analysts hang their hats on qualitative thesis’. Research Edge was built on quantifying everything we can. From a quantitative factor perspective, AAPL is finally breaking down. We saw $189/share tested and tried on 3 separate occasions since mid May (May 13th, May 15th, and June 5th). Today, the stock is -14% lower, and it’s in a very precarious position, both fundamentally and technically.

From a fundamental modeling perspective, six months from now the Street will be forced to look a what was the best revenue quarter that a high growth consumer product company can deliver. Year over year growth will slow materially, and the momentum community will be out of this stock faster than they got in. Apple’s management gets this, and as our friend, Michelle Leder, at ‘Footnoted.Org’ called out this week, they are already preemptively calling out “macro” as the reason.

We’ll let you pull up the 10Q and read it, but Michelle’s posting on this does it for you just the same: “While some people continue to debate whether or not we’re actually in a recession, Apple went a step further in the 10Q it filed… using stark new language to describe the state of the economy in its risk factors section.”

This isn’t Apple’s fault. This is called macro – and it matters. Apple’s shareholder’s list is decorated with all of the top mutual funds in the world, and short interest is remarkably low at 2.2% of the float. Shorting Apple is far from consensus, and if it breaks down closing below $160.34, the institutional selling will look far from over.
KM
(Chart courtesy of stockcharts.com)

Rose Colored Kool-Aid

Brian McGough has been clear about our negative multi-year apparel thesis, where the industry will lose 3 points of margin over 2-3 years. As noted in his post yesterday ‘The Song Remains the Same’ it’s clearly playing out this quarter -- organic sales are under pressure, order cancellations ticking up, FX benefits are easing, cost inputs are rising, pricing power is nil/negative, GM% eroding, and SG&A is heading higher. This has been extremely consistent with most companies thus far.

While it might be tempting to think that our view is now consensus – guess again. These headwinds are going to strengthen before they subside. This is not a fast moving storm front, and the Street still does not get it.

Current estimates across every publicly-traded apparel retailer and brand suggest that the worst is already over. Consensus is looking for a 31bp decline in margins this year, and for nearly all of that to be recaptured in FY09. It looks like most analysts are keeping on the rose-colored glasses and drinking managements’ Kool-Aid.

Stay tuned for further developments on the earnings front, but expect downward revisions as analysts ditch the glasses, dump the Kool-Aid and start to see the light. Until then, be very cautious about which EPS estimates you believe.


Casey Flavin
Director
Global Softlines Team
RESEARCH EDGE, LLC
Gross Margin expectations are looking past the fact that a massive sourcing tailwind reverses.
Same holds true for Operating Margins.

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Deflating Inflation: Nat Gas Loses 1/3 of its Value, In 3 Weeks!

Nat Gas got hammered this week, closing Friday at $9.08, down from the early July highs of $13.50. When a commodity loses 1/3 of its value in 3 weeks, it gets the market’s attention. Within the deflating inflation narrative we’re were beating on all week, the attached chart of the September contracts over volume traded is the one we’d like to highlight.

On the supply/demand front, the weekly storage report from the EIA came in at an increase of 84 billion cubic feet. This was higher than anticipated supply increase provided sellers with all the excuse they needed to keep the pressure on the September prices.

Within the construct of the longer term view, one interesting data point did cross the tape this week that was actually bullish for Nat Gas prices. On Tuesday, congressman Dan Boren and Democratic Caucus chairman Rahm Emanuel introduced legislation which includes incentives designed to get the number of NG fueled vehicles on the road to 10% by 2018.

KM
Chart by Andrew Barber, Director (Research Edge)

The Bankruptcy Cycle Continues: Two More Banks Go Under This Weekend

The bankruptcy cycle continues to pick up momentum. This morning the Wall Street Journal reported that “Federal regulators shut down two national banks, First National Bank of Nevada, based in Reno, Nev., and First Heritage Bank of Newport Beach, California.”

These banks fall under FDIC protection, but don’t forget that insurance is generally only up to the first $100,000. The FDIC is basically a mutual insurance company. The FDIC has to fund any deficits by laying higher premiums on the banks that they continue to insure (i.e. premiums are going up).

This is what we have been pounding into the summer sand as of utmost importance to the US economic systems. Access to Capital is tightening as Cost of Capital is going to continue to rise.

I’ve attached the “Bankruptcy Cycle” chart that we used for our conference call on July 16th. We’ll re-run the data driving the chart on Monday, but the math is straightforward – 7 banks have now gone belly up in 2008 and 3 of the 7 had assets exceeding $1 Billion.

This is not good.
KM

Big Chain Players Should Win at the Expense of the Little Guys

According to the NPD Group, the restaurant segments which are experiencing the most severe traffic declines in the March-May 2008 timeframe are the full-service restaurant categories and those dominated by independents. The pizza category is one such category that is dominated by independent players. Domino’s highlighted in a recent presentation that small chains and independents accounted for 54% of pizza delivery dollar share in 2007, and in line with NPD’s comment, the QSR pizza category has faced significant traffic declines with negative YOY traffic trends in the last 5 quarters and down again through May in 2Q08.
  • On DPZ’s 2Q08 conference call earlier this week, when asked about independent closures, the company’s CEO David Brandon said:
    “Our belief, and it’s more anecdotal than it is statistical, is that the pressure that’s happening out there is clearly creating closures. I mean we’re seeing a few of them and we’re stronger and we can buy cheaper and we’ve got a better brand, and a 47-year track record. We are in a position where we feel the pressure with our weaker operators. We can only conclude and we’re witnessing that same pressure translating in an even bigger way to a number of the smaller operators out there. But it will take a couple of quarters for that to show up in some of the data that we can share with you and certainly when it’s available we will be talking about it.”
  • DPZ management has stated in the past that overly aggressive pricing actions across the industry are to blame for the fall off in traffic. Although more disciplined pricing should help traffic trends (but not necessarily margins), a reduction in supply could only help as well. I don’t want to root against the small players, but if more independents are forced to close their doors as a result of their not having the scale necessary to deal with both lower consumer spending and higher commodity costs, the bigger chains should emerge as winners.

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