R3: Adibok for Real?


May 4, 2010





With Adidas’ reporting of 1Q results this morning, there is further confirmation of a resurgence in the athletic apparel and footwear marketplace. Importantly, we still maintain that this is not a zero sum game where Adi’s success is coming at the expense of Nike or Under Armour. In fact, we expect to hear a very positive stance from Nike tomorrow at the company’s analyst day and remain confident that this pick up and athletic apparel and footwear is sustainable.


While the headlines are largely in-line with Adidas’ recent positive pre-announcement, the details are worth noting. Interestingly, though not surprising, is the company’s change in “tone” and positioning of the Reebok Brand. The company is clearly focusing on and investing in the growth of the toning platform and is seeing early success as noted by most retail partners. To support continued growth Reebok will continue to benefit from incremental marketing spend. It is clear from this morning’s release that Reebok has quickly become a key driver of Adi’s North American business and will remain a key focus along with the World Cup over the remainder of the year. Our meeting with Hibbett Sporting Goods’ management last week also confirmed that the Reebok’s toning strategy goes well beyond a single shoe launch. A women’s fitness platform built around “muscle toning and conditioning” is very much in development.


Other key highlights from Adidas:


- All regions were positive in Q1, with the exception of China and other Asian markets. North America, up 14.3%, and Latin America, up 18%, were standouts for the quarter. Western Europe was positive, but lagged with an increase of 3.7%. Retail outperformed, posting an increase of 16.2% vs. a 1% increase for Wholesale. Reebok mentioned several times as a positive and a key driver of North American strength. Overall Reebok Brand sales were slightly positive, up 1.5%.


- Golf showing some signs of life with Taylor Made increasing by 15.9% in the quarter. 


- Inventories extremely well controlled and clean. Management noted improved sales and a substantial reduction in year over year clearance activity helped to control inventories and the results are solid. Inventories declined 20% on a total topline increase of 4%. Looking at it another way, the company added about €100mm of sales while taking €400mm out of inventory. This clearly bodes well for future company gross margins as well as for the overall health of the channel.


- Reaffirmed recently raised guidance, primarily driven by a stronger topline forecast and improved gross margins. Guidance calls for EPS of €2.05 to €2.30 vs. the Street at €2.26.


R3: Adibok for Real? - ADI SIGMA





- Movie Gallery’s decision to close all its stores may present some interesting opportunities for those looking to grow in smaller box strip locations. The company expects to shutter all 2,415 doors through a liquidation process over the next couple of months. We visited Hibbett Sporting Goods last week and the company expressed interest in picking some former Movie Gallery locations given their similar footprint.


- Keep an eye out for Laurent Potdevin’s new home. The former CEO of Burton announced his resignation after 15 years with the leading snowboard maker. Founder, Jake Burton and his wife, Donna, are expected to take the helm while the company searches for a new leader. Burton remains of the largest and privately owned action sports properties. We wouldn’t be surprised if speculation begins to rise about the company’s ownership fate as a result of the recent management change.


- Add off-price to the list of retailers still making their way into Manhattan. Word has it that TJ Maxx is coming to Manhattan’s east side, with a location set in the former Conran Shop high-end rhome store. The store is primarily located below ground, under the Queensboro bridge. While this may seem to be a risky move, the Bed Bath and Beyond next door is likely to alleviate fears given its customer focus vs. the more stereotypical “upper east side” shopper.





R3: Adibok for Real? - Calendar






Cambodian Apparel Manufacturers See Stabilization - A survey of managers from 66 Cambodian apparel factories found the majority expecting to increase or maintain their current workforce, and only 10% said they anticipated additional job losses. About one-third believed business conditions would remain as dire as they were last year. The factories polled were predominantly foreign owned, mainly by Asian investors, and on average had 700 apparel workers per facility. The factories specialized in producing T-shirts, pants, jeans, sportswear, underwear and pajamas. The optimistic outlook marks a sharp turnaround from last year, when the global recession triggered a sharp decline in demand for Cambodian apparel. Exports fell by more than 20% and 70 factories were shuttered. <>


More Info on the Gordmans IPO - Gordmans Inc., the 67-unit off-price department store chain operating in 16 Midwestern states, has filed plans with the Securities and Exchange Commission for a $75 mm IPO. Gordmans is trying to ride the consumer value wave that has enjoyed strong recent performance, similar to Dollar General. Stats: Headquartered in Omaha, stores average 50,000 square feet, features merchandise at up to 60% off department and specialty store prices, strongest category is juniors and young men's. The filing said it plans to expand the store base by 10% annually over the next several years.  <>


Li & Fung Ltd. Growing from Rebounding US Consumer Spending -  L&F, the biggest supplier for retailers including Wal-Mart Stores Inc., climbed the most in more than three months in Hong Kong trading as U.S. consumer spending pointed to a sustainable economic recovery. Li & Fung surged 5.2% to HK$39.65, the biggest increase since Jan. 29. Consumer spending in the U.S. increased 0.6% in March, the most in five months and incomes climbed for the first time this year. <>


Jil Sander Extends Uniqlo Deal - German designer Jil Sander is extending her collaboration with Japanese retail brand Uniqlo’s parent company Fast Retailing after one year of partnership. The designer said she’s happy with the two collections of her new brand +J with Uniqlo, and getting the support she needed for her vision of high quality basic apparel with her minimalist signature and affordable price tags. <>


DKNY and KNL Team Up - Donna Karan International and S. Kumars Nationwide Limited have formed a joint venture and global licensing agreement for DKNY men’s wear. The deal formalizes and expands an interim agreement that replaces a similar deal DKI had with Marchpole Holdings plc. KNL will source, design, produce and distribute the full range of men’s wear apparel for DKNY Black Label, a bridge line. The agreement runs through 2015, with an option to extend the license for an additional seven years. The spring 2010 collection is the first to be offered by SKNL under this agreement. It is available in high-end department and speciality stores in addition to DKNY’s network of about 100 stores worldwide.  <>


Famous Footwear Kicks Off Mind Body Sole Tour - Famous Footwear kicked off the Mind Body Sole Tour featuring Ali Vincent, the first female winner of the NBC show, "The Biggest Loser,"* and author of "Believe It. Be It." During the tour, Ali will make special appearances at Famous Footwear stores where she will meet shoppers, sign autographs, provide fitness tips, share her personal health success story and discuss the importance of how toning and fitness footwear can help consumers take the first step to incorporating health and wellness into their lives. <>


Haiti May Enjoy Duty Free Access to US Market - Haitian apparel would enjoy duty-free access to the U.S. market until 2020 under a bipartisan bill introduced last week. The Haiti Economic Lift Program (HELP) Act greatly expands duty-free access to the U.S. market for Haitian textile and apparel exports and extends existing trade preference programs for Haiti through 2020 <>


Inflation's V-Bottom

"The prospects for significant inflation have increased, not only here, but around the world."

-Warren Buffett


One of our core Macro Themes for Q2 of 2010 is “Inflation’s V-Bottom.” Unlike most of Ben Bernanke and Timmy Geithner’s analytical liabilities, inflation in this interconnected world of prices is marked-to-marked, real-time.


Now Timmy has recently admitted that he is “not an economist” and that he really hasn’t ever had a job in the real world, so I won’t waste any time on his incompetence. He’s explained it himself. Bernanke, on the other hand, is a professor and a historian who twilights as an economist, but his forecasts since 2006 have proven to be at least as bad as some of the worst sell-side strategists on Wall Street. That’s pretty bad.


If you didn’t know, other than in your wages and the conflicted and compromises calculation of US Core CPI, inflation is everywhere. In addition to removing every day things like energy and food from its “core” calculus, the US Government has changed the calculation of inflation 9 times since 1996. That’s a lot.


Now the topic of inflation will make the hair on the backs of US stock market bulls stand on end (for the Fed’s Janet Yellen, that can’t be a pretty sight). Make no mistake - the Fed, doves, and bulls have to be in bed together for the SP500 to breach my Q2 intermediate term target of 1214 to the upside. Being willfully blind to inflation trends is a critical aspect of their storytelling.


There are 3 arguments that have a tendency to populate my inbox on the dovish side of this inflation debate:

  1. Unemployment is high
  2. Wages are low
  3. The Fed sees no inflation

I agree with all 3 of these points. Unemployment the lagging indicator that every monkey in the Wannabe An Economist League is staring at. Wages are not inflating anywhere near the annualized pace of prices that real people have to pay for things (the spread between what you make and what you pay is widening). And Bernanke, sees only what a great historian could  – his own confirmation bias about a depression that never happened.


The only great depression I see is the output of points 1-3 on Main Street. For the last decade, the US Federal Reserve has been trained to create a boom and bust economy for Wall Street because that’s how we all get paid. The grand total of US net job adds between 2000-2009 = ZERO.


The perma-bulls cheer Bernanke on because he is daring us to speculate on inflation at the same time that he says he sees none of it. He funds inflation by marking the American citizenry’s return on fixed incomes (savings) to zero percent, and letting Piggy Bankers fly by allowing Wall Street to borrow short and lend long on a marked-to-model fed funds rate.


This thesis isn’t just a machination of my own mind. It’s actually a solution. If you want to create stable consumer spending and small business hiring patterns in this country, give upstanding and unlevered Americans an opportunity to earn fixed incomes on their hard earned cash flows (savings). Warren Buffett gets this and so does the best central banker in the world – Mr. Glenn Stevens at the Reserve Bank of Australia.


Overnight, Stevens took the short term stock market pain for the sake of his citizenry’s long term fixed income and currency gains by raising the Aussi equivalent of a Fed Funds rate by another 25 basis points. This take Australia’s base lending rate 4.5% above the compromised and conflicted fear-mongering bureaucracies of Japan and the United States. This was the 6th time Stevens has raised rates since October – as he’s raised rates, Australian unemployment has gone down!


Without cutting and pasting his entire commentary, here’s what non-group-thinking Glenn had to say about the global economy:


“In both underlying and CPI terms, inflation over the most recent 12 months was around 3 percent. Nonetheless, the extent of decline from here may not be quite as much as earlier forecast and inflation now appears likely to be in the upper half of the target zone over the coming year.


With the risk of serious economic contraction in Australia having passed some time ago, the Board has been adjusting the cash rate towards levels that would be consistent with interest rates to borrowers being close to the average experience over the past decade or more. The Board expects that, as a result of today’s decision, rates for most borrowers will be around average levels. This represents a significant adjustment from the very expansionary settings reached a year ago.


The Board will continue to assess prospects for demand and inflation, and set monetary policy as needed to achieve an average inflation rate of 2-3 percent over time."


Now call me aggressive or call me Mucker - I’m cool with both; but what Warren Buffett, Glenn Stevens, and I are saying here is that inflation doesn’t happen in the vacuum of US domestic politics. Inflation is global. Inflation is created by debtor nations. Inflation, when marked-to-market, isn’t kind.


If you are in the camp that $86/oil or your $2 million dollar 3500 square foot house in Connecticut isn’t inflationary because of where you finally noticed the deflation from the mother of all global peaks in prices in 2008, well… that’s not the real world – sorry to break it to you. For the record, I have one of those inflated houses in CT and I do consider the gas in my cars “core.”


As of last night’s close, Chinese and Indian stocks hit new YTD and 8 week lows, respectively, because governments in those countries agree with governments from Australia to Brazil – inflation continues to accelerate sequentially. It’s just math.


My immediate term support and resistance levels for the SP500 are now 1192 and 1217, respectively.


Best of luck out there today,



Inflation's V-Bottom - STEVENS


"Bearish Enough On Spain?"

“Our debt is clean, we will not have to ask for help.”

-          Elena Salgado, Spanish Finance Minister, April 30th, 2010


We often say at our firm that as investors we can be bullish, bearish, or not enough of either.   As it relates to sovereign debt risk, the question remains, which are you? 


Currently, there is no shortage of bearish sentiment around global sovereign debt issues.  In recent weeks, Greece, Portugal, and Spain have all had their credit ratings downgraded, with Greece being downgraded to junk status.  Despite this flurry of negative news, I would submit that investors are still not bearish enough, particularly on Spain.


Historically, Greece is consistently an early and serial sovereign debt defaulter.  As a result, it is difficult to consider Greece anything but a leading indicator for sovereign debt issues.  While Iceland, Ireland, and Portugal all matter to a degree and will likely have accelerating debt issues, we view Spain as the key mispriced and misunderstood sovereign debt risk globally.


Spain has economy of size that matters.  According to the most recent estimates from the World Bank, Spain was the 9th largest economy in the world in 2009 with a GDP of $1.4 trillion. From a pure geography perspective, it is the second largest country by land size, after France, in the European Union.   It also has a government budget that is more than 4x that of Greece, and a commensurate debt balance.


We look at two primary facts to analyze sovereign debt default risk: the ratio of budget deficit-to-GDP and debt-to-GDP.


On the first point, the budget deficit-to-GDP, Spain is clearly in the danger zone.  As of the end of 2009, Spain’s ratio was 11.2% of GDP, and set to accelerate in 2010. Historically, anything beyond 10% is in the danger zone of potential for sovereign debt downgrades, and will lead to an acceleration of borrowing costs.  Based on that metric, Spain will need roughly 150 billion Euros in debt to fund its budget this fiscal year.


On the second metric, debt-to-GDP, Spain is more favorably positioned, with a ratio lower than the EU average of 54%.  While favorable at first glance, the reality is that this ratio has doubled in the last year. This ratio will continue to as the Spain’s budget is increasingly funded by debt. 


More importantly as it relates to outstanding debt, Spaniards have a substantial amount of debt that has to be rolled over this year.  Estimates suggest that figure could be as high as 225 billion Euros, of which almost 45% is held by foreigners.  Considering that the totality of the proposed Greek bailout is 146 billion Euros over three years, any potential bailout (and we are not there yet) would be of an exponentially larger scale than Greece.


Ironically, as recently as a few years ago, Spain’s leadership in growth and stability were a beacon with the European Union. The reality was, though, that Spain’s economic growth was predicated on the construction industry.  In essence, Spain was the poster child for the global housing and real estate boom, bubble, and subsequent bust.  In fact, home building and construction spending represented 20% of GDP and 12% of employment at the industry’s peak in Spain.  Due to an economy has limited exports to drive GDP, the evaporation of the construction sector as a major engine of growth and employment suggests the Spanish government’s estimates of 3% GDP growth in 2011 and beyond are likely optimistic.


Not surprisingly, as went the global construction market, so accelerated Spain’s unemployment.  Currently Spain’s unemployment is sitting at just north of 20%.  Just for the sake of anecdote, both the Sudan and West Bank are currently more employed than Spain.  There is good news, though, according to Spanish Finance Minister Elena Salgado only 290,000 jobs were destroyed in the first quarter of 2010. Good news is relative, it seems.


Another debt issue as it relates to Spain’s fiscal health is private indebtedness, currently at 178% of GDP, according to a recent S&P report that downgraded Spain’s long-term sovereign debt.   A substantial portion of this debt relates to mortgages and home financing.  While defaults have been increasing, doubling for the last three years in fact, we believe they are set to accelerate one again due to unemployment and the timing of benefits.


Spain has a very generous unemployment system that pays the unemployed 65% of the average national earnings for up to two years for those who have worked for the prior six years.  The risk, of course, is that as these benefits begin to run out, the ability of the unemployed to pay their mortgages diminishes substantially, which could lead to broad issues for the Spanish banking system.


As noted in the introductory quote, the Spanish leadership does not believe they have to ask for help.  In the short term that may be true.  In the longer term, they will have to show that they can help themselves.  Spain is not Greece, we agree with that. But if the Spaniards do not change their trajectory, they have the potential to be much more than Greece.  And that is not priced into the markets.



Daryl G. Jones
Managing Director


"Bearish Enough On Spain?" - Spain EU Unemployment

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Reports spectacular EPS and margin improvement, but this too shall pass.


TXRH confirms that April was soft from a SSS stand point.  The company was quick to point out that the second half of April was better than the first.


At 8.8x EV/EBITDA, TXRH is one of the most expensive Full Service restaurants with a mediocre story.  SSS are punk with no real plan to drive traffic and the cost of construction does not justify new unit growth.


The company is also looking a developing another concept (Aspen Creek) to help drive incremental growth.  Why would TXRH need to develop a second concept?  The new concept and its ROI would need to be spectacular for this to overcome the obvious issues that can be inferred from this move - the original concept does not have the growth opportunity that was initially planned.



Notes from the call:


Food, labor, and utility costs were all favorable

  • Comparable restaurant sales growth of 0.4%
  • Margin expansion of 218 bps paved the way for better-than-expected earnings
  • Improved cash position and paid down debt
  • Being conservative until returns justify increased investment
  • Positioned well to take advantage of future opportunities



  • Revenues increased 6%
    • 5.4% increase in restaurant sales
    • 5% store week increase
    • 0.2% increase in AUVs
    • Opened 2 restaurants in 1Q
    • Comp store sales positive for first time in over two years
    • Guest traffic down 0.1% for quarter
    • Comps in January were down 1.6%, down slightly in February, and up 2.6% in March
    • 231 SSS restaurants averaged $75,100 in sales per week
    • 24 restaurants open 6-18 months that were in the AUV comp averaged  and averaged $73,100/wk
    • Others averaged $93,400/wk



  • Restaurant margin up 218 bps YoY
    • COS line down 185 bps
    • Food cost deflation
    • Labor down 18 bps
    • Low hourly turnover – below 80%
    • Preopening costs were down thanks to reduced openings
    • More assets becoming fully depreciated than they are adding



  • Paid down 12m in debt
  • Net debt of $35m



  • Tax rate for 10 will be ~33%
  • Continuing to generate excess cash flow and paying down debt
  • EPS now estimated up 14% to 18% (from $0.67) growth for 2010 (upward revision from previous 5%-10% growth estimate)
    • Flat to up 1% SSS growth
    • 14-15 openings
    • Food cost deflation of 2.5% to 3%
    • Capex of $50m
  • Food cost deflation will be less for the remainder of the year because of contracts
  • Spending on their conference will be $1-$1.2m more than last year
  • 2010 development is backend loaded
  • Confident necessary returns will be generated


Working on ways to enhance the guest experience

  • Refining processes
  • New menu rolling out
  • April gave back some sales momentum during the holiday season
  • 2H April was better
    • Sales environment will gradually improve
  • New kitchen design is decreasing development costs
    • Also looking at smaller units
    • Lower investment cost
  • 2010 investment cost could come down 200-400k from the 4m last year
    • If sales hold steady TXRH should hit the 1.1x sale : investment ratio
  • Looking at international markets carefully
  • Will be looking at two more aspen creek restaurants this year







Q: Can you quantify the “improvement” in the second half of April? Menu impact on average check? More or less items?


A: Second half of April is consistent with what competitors have said.  There is no price increase in the menu.  Adding fried pickles, taking off one other item. Check neutral.



Q: Were you positive in the second half of April? Commodity deflation in 2Q?


A: Yes we were.


Commodity deflation in 2Q will be less.  Contracted for proteins through 2010.



Q: Any thought about extending contract on beef?


A: It’s early to talk about beef prices.  Will keep all doors open.



Q: 1Q comps, any negative impact from weather?


A: No, we don’t keep up with that. We don’t calculate bounce back from pent up demand either.



Q: Increase seating capacity initiative, how may units have been completed? Outlook for ’10?


A: Done 47.  Did 4 in 1Q.  Will do another 6 or 7 in the balance of the year.



Q: Comment on deflation?


A: In January beef costs were higher. Last year there were higher food costs in January but much lower in February and March.  This year then, there were substantial deflation in January but less so in February and March. That will continue into 2Q.



Q: When will you be considering expansion pace increasing?


A: Having those conversations now, have to be having them now.  We’re happy with the costs coming down and the performance of the recently opened stores.



Q: Does the 14 to 15 openings include the Aspen Creek locations?


A: Yes.  Store 15 may open after December 31st, they have to be built.



Q: Development – should we think about 2Q openings being similar to 1Q?


A: Fewer in 2Q. Late third quarter and beginning 4Q will have 75% of the remainder.



Q: No menu pricing going forward?


A: Lapped price at the beginning of April?



Q: Rate of deflation? Could 2Q food costs touch 33%?


A: Would expect them to be a little higher in 2Q as % of sales.



Q: In the long term is it a 35% concept?


A: Can’t predict what commodity markets are going to do or what pricing strategy is going to be.



Q: Clarify pricing versus ticket and traffic…was most improvement in the traffic line or did check pick up also?


A: Traffic was down .1% and check was up 0.4%.  Traffic was constant through the quarter, check improvement drove the quarter. No regional disparity – broad based.



Q: Marketing is getting more competitive, when you think about fighting for traffic since you’re not taking price and how are you managing the price versus marketing for that traffic?


A: If you compare historical performance through difficult times, TXRH does well through local store initiatives.  Looking at

how commodities behave will dictate future pricing.



Q: What are you doing to prepare for future price increases?


A: Not testing anything and have not made that decision yet.  I would guess that we will test it but have not made a decision yet.



Q: Development outlook.  Give some thoughts on why it makes sense to look at a second concept.


A: Texas Roadhouse will continue to be the focus but need to look at what will propel the brand  in 5 years.  Looking internationally.  The second concept is driven by the chairman and, starting from scratch, it could have future growth potential if the new concept works.



Q: International agreements…what is the number of near term units? What are the costs of development and negotiating/sourcing…negative G&A impact this quarter?


A: Franchise deal for 35 restaurants in 10 years.  Not a negative to G&A…no incremental G&A piece going forward. We’ve dedicated some resources to the international effort . 



Q: Capex outlook?


A: Lighter than last quarter…15m maintenance and remodel and the majority will be cost of new development.



Q: Other regions besides Middle East?


A: We are taking a targeted approach in Asia and Mexico also.



Q: Labor per operating week has fallen for 4 quarters in a row. Continuing?


A: Turnover is less – below 80%. Not sure it will continue to decrease.



Q: 2011 development, if ramped up, will it be spread across geographies?


A: Would like to spread it out as much as we can, similar to how it has been in the past.



Q: Competitive pressure in late night…alcohol is only 10% of your sales but have you seen pressure in late night?


A: We’re not a late night concept. Mix has continued to go down as a percentage of sales.  Not seeing anything different trend-wise. No impact from that…



Howard Penney

Managing Director

Even the bears aren't bearish enough on Spain's coming sovereign debt problem


While deferred capex must certainly be accounted for when accounting for NAV’s, the math shows it’s not that material for the public hotel owners.



By the end of 2010, hotel owners in aggregate will have under spent for two consecutive years in terms of maintenance capital expenditures.  The following chart shows the trend as a percentage of revenues for the public hotel owners:




The following chart shows maintenance CapEx per hotel room.  Under spending is clearly evident in this chart as well.  However, even if you assume that 2008 peak spending is the right number, the maximum amount of under spending would total only $9,500 ($4,750 multiplied by 2 years of under spending).  At best, deferred CapEx looks to be only $4,500 ($2,250 multiplied by two years) if we assume reversion to the trend line.




While the public companies have certainly cut back spending, they have not fallen that far behind.  The situation for the private owners is quite different.  Most of the major transactions we've seen involve significant amounts of deferred CapEx.

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