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YUM - CHINA IS NIRVANA, BUT THE US IS IN A DEEP HOLE

YUM is scheduled to report 2Q10 earnings after the close on Tuesday.  On an EPS basis, my estimate is coming in light, at $0.50 versus the street’s $0.54 estimate, but given the company’s track record of beating expectations, I would not be surprised if numbers came in above my estimate. 

 

Going into the quarter I continue to have two primary concerns, largely related to what I recognize as overly aggressive unit growth in China and profitability issues in the U.S. 

 

 

CHINA:

 

Despite the expected sequential slowdown in same-store sales growth in 2Q10 on a 2-year average basis (management’s guidance implies a 300 bp deceleration), I don’t think the issues in China will become more apparent until the second half of 2010 when restaurant profit margin should decline YOY.  Specifically, management pointed to commodity inflation and increased wage inflation in the back half of the year.  It is important to remember that restaurant margin growth in 1Q10 was driven primarily by commodity cost deflation of $15 million.

 

Although same-store sales improved significantly in 1Q10 on a 2-year average basis, I don’t think this trend is sustainable (again, management’s 2Q and FY10 guidance implies a deceleration).  Any slowdown in same-store sales growth will take a toll on margins as the company faces commodity and wage rate headwinds in 2H10.

 

As shown in the chart below, YUM China has been operating in what we call “Nirvana”, when both same-store sales and YOY restaurant profit margin growth are positive.  YUM should remain in Nirvana territory in 2Q10, but trends should get more difficult in 2H10, with the company potentially falling into “Deep Hole” territory (negative same-store sales and YOY decline in restaurant level margin) in 3Q10 and “Trouble Brewing” territory in 4Q10 (positive same-store sales and YOY decline in restaurant level margin). 

 

For reference, when we think about the four quadrants outlined below, we recognize the trends associated with operating in both the “Life-Line” and “Trouble Brewing” territories as unsustainable.  Broadly speaking, if a company is posting positive same-store sales and declining margins (Trouble brewing), the company is unable to leverage its positive top-line and is therefore spending too much (often a result of growth related costs). 

 

Within “Life-Line”, a company’s margins continue to grow despite negative same-store sales growth.  A lot of restaurant companies have operated in this quadrant in recent quarters as they have focused on cutting costs to offset the difficult sales environment.  A company cannot cut costs forever without hurting the customer experience so margins will eventually follow the direction of same-store sales growth. 

 

YUM - CHINA IS NIRVANA, BUT THE US IS IN A DEEP HOLE - yum china map

 

U.S.:

 

YUM is facing its most difficult same-store sales comparison in 2Q10 as it laps the Kentucky Grilled Chicken launch and a +3% comp at KFC (the only positive comp at KFC in 2009).  That being said, I am expecting same-store sales in the U.S. to improve slightly in 2Q10 from 1Q10 on a 2-year basis, primarily as a result of the new $2 combo meal at Taco Bell (lower drink and combo sales hurt 1Q10 trends) and the Double Down at KFC (which was reported to be on the menu indefinitely after initial plans introduced it as an LTO). 

 

During the first quarter, U.S. profitability was hurt by an increase in the number of consumers buying off the “Why Pay More” menu at Taco Bell.  Even if same-store sales get better in 2Q, this value menu will likely continue to be an important driver of traffic growth at the concept.  This combined with the fact that commodity costs should turn inflationary in the U.S. and the YOY restaurant profit margin compares get increasingly difficult for the next two quarters should continue to put pressure on U.S. profitability. 

 

The chart below highlights that U.S. same-store sales and margins have suffered for some time now, with the company operating in a “Deep Hole” for the last two reported quarters.  YUM will likely remain in a “Deep Hole” in 2Q10 but should then recover somewhat in the back half of the year as it emerges from the “Deep Hole” and potentially moves into “Nirvana” territory in 4Q10.  This expected recovery is largely a function of easy comparisons in 2H10 (as management pointed out on its 1Q10 earnings call).  YUM is lapping -6% and -8% same-store sales from 3Q09 and 4Q09, respectively. 

 

We will have to see how same-store sales track for the rest of the year in the U.S. (QSR trends, on average, continue to be choppy), but I continue to think that YUM’s full year U.S. operating profit could fall short of the company’s guidance of 5% growth (I am currently modeling nearly 3% growth with the bulk of that growth coming in 4Q10 when the company is lapping a 23% decline from 4Q09).

 

YUM - CHINA IS NIRVANA, BUT THE US IS IN A DEEP HOLE - YUM US MAP

 

 

Howard Penney

Managing Director


UA: Leaks Lend to Bull Case

Images are leaking out on UA’s basketball shoe, supporting our view that it will be impactful to the P&L sooner than many expect (see our prior post where we YouTube UA management’s change in verbiage on the launch). One of the images from SoleCollector is interesting, as the ‘tag’ to the picture includes a big alpha-numeric name, plus some html code I don’t understand, but also the words ‘coming in November.’ (yes, Nov 2010).

 

Please don’t ask me what I think of the shoe. Judging a shoe’s fashion-worthiness is not my bag. In fact, I’m probably a contra indicator. But what I will say is that the shoe looks very un-Nike-ish. Yes, that’s a good thing. If UA tries to play Nike’s game, it will probably get whooped. It needs to be different, and that will almost certainly be the pitch to retailers.

 

To be absolutely 100% clear here...our thesis on UA is not about a single shoe, sport, or athlete. It is the sheer organic growth and earnings power that UA should realize over the next 2-years while the rest of retail struggles to stand still. Let us know if you want our more thorough analysis on UA.

 

LOOK AT IMAGE TAG

UA: Leaks Lend to Bull Case - 111

 

UA: Leaks Lend to Bull Case - 222

 

COOL-LOOKING NEXT-GEN RUNNER

UA: Leaks Lend to Bull Case - 333

 

 

Our July 2 Write Up

Finish Line’s management team slipped on Friday, giving indication that Under Armour’s basketball product is on the way sooner that many may think. So many people we talk with seem to blindly accept that UA footwear will not meaningfully push until 2H11. But c’mon… don’t you think that management would buy themselves just a little time to execute this initiative? After the first go around, where results were so-so at best, they’re not going to get this wrong. That’s not because it’s written in the cosmos, it’s because they’ve proactively invested for it, beginning last summer. I don’t believe that basketball will be UA’s saving grace, but will be one of the many categories that allows the company to take this from being a $150mm footwear brand, to being a $1bn brand.  

 

Kevin Plank Q4 08 CC (January 29, 2009)“Beyond running footwear, there are growth opportunities for us long-term in soccer boots and eventually once the product is

ready, basketball.”

 

Kevin Plank Q1 09 CC (April 28, 2009)“We have no designated date as to when we will be launching basketball, other than the fact that exactly when we are ready.” …  “But again we believe that we are going to be very important in basketball. We also believe that we have the luxury of being patient as to the point when we decide to enter that market. And we will do so, frankly, first and foremost and only when the product is 100% ready. So we're biding our time and going to make a strategic decision around that.”

 

David McCreight Q2 09 CC (July 28, 2009)“As it relates to basketball we currently are already on court. We'll continue to read the market place there and roll out when appropriate.”

 

Kevin Plank Q3 09 CC (October 27, 2009)“We've got 20 Elite high schools. We've got Brandon Jennings in the NBA, so we have presence and we more importantly have feedback from all levels of competition

and we will be evaluating and making those decisions to go at it, first and foremost when the product is ready and when we're ready to support it and tell a big story. Go heavy or go home.”

 

Kevin Plank Q4 09 CC (January 28, 2010)“Being a great footwear company is not just about making a big splash with launched products, and we have no major footwear launches planned for 2010. However, we are developing our basketball footwear and positioning for a future launch. While you won't be able to find Under Armour basketball footwear for sale at retail, you will find it being tested and authenticated throughout 2010 on the feet of ten Division I basketball programs, more than 20 top high school programs, as well as on the feet of NBA Rookie of the Year contender, Brandon Jennings. We can be patient because of the multiple growth levers that

allow us the patience to prioritize.”

 

Kevin Plank Q1 10 CC (April 27, 2010)“As it relates to basketball, number one, we are very committed to getting into this category. And for us it's not a question of if as much as it's a question of when.” … “I think we are very, very pleased, I think, with the progress we've made to date. And I think we're frankly sitting in the catbird as to the timing and when we choose to enter this category. And I think we'll be opportunistic with that approach, but it doesn't have to be something we can force. And, frankly, as you can see, with the strong Apparel business we can use timing to our advantage and are not forced from a revenue standpoint. So the answer to that is we're not making any declarations as to when we're going to enter the market. But when we do we'll walk in with a point of view and we'll enter with strength.”

 

Sam Sato FINL Q4 09 CC (June 25, 2010)"As we move into Q3 and beyond, Reebok under the Zig Tech is introducing a basketball shoe as is Under Armor and we've seen both of those and put orders against that and think there's a tremendous opportunity for us to capture some business in that category as well."

 


Bernanke: "Get It Off Zero!"

Conclusion: Washington’s Economic Officialdom doesn’t understand that a ZERO percent “risk free” rate of return not only scares capital out of this country, but that it is also a tax on the fixed incomes of baby boomers with hard earned savings accounts. 


It’s no secret that we are not fans of Ben Bernanke and his Princeton crony Paul Krugman. We don’t believe in disrespecting the cost of (or access to) capital. When you socialize an economic system, you encourage bad behavior by undisciplined allocators of capital. Bad players then perpetuate existing problems.

 

Thankfully, there seems to be a reasonable voice at the US Federal Reserve who doesn’t wake up looking to pander to a Nobel Prize winner that has seen nothing but his 2008 theories fail. When you watch Krugman speak, you tell me if the man looks right stressed. If I were him, I would be too.

 

Kansas City Fed head, Thomas Hoenig, speaking with Kathleen Hays on Bloomberg Radio's "The Hays Advantage," yesterday at 11:30AM EST said he didn't think a one percent interest rate would be harmful to the economy. "I am not saying raise rates to very high levels. I am saying get it off zero," Hoenig said. (Source: Bloomberg) 

 

Below, Darius Dale did a solid job paraphrasing the highlights from an outstanding Hays interview:

  • You have to be careful with resisting the inertia of “extended and exceptional”.  Just because the EU sovereign debt crisis scared investors and inflation fears subsided doesn’t mean that we should hold rates low indefinitely.
  • How do you incentive savings and subsequently loans when you’re giving people zero % returns on saving?
  • You can’t solve every problem with monetary policy. It is an allocative instrument and we need to use it carefully.
  • I’m not saying take rates up substantially. I’m advocating a policy towards a slow normalization of rates (i.e. what we’re seeing in Australia, etc.)
  • There is a time factor; the more we delay, the more difficult it will be to make a move, as uncertainties and issues build up. Slowing growth, housing, and the Bush tax cuts expiration will all be factored into the debate as we progress through the year.
  • There will always be risks and the more you delay in acting, the more the risks begin to pile up.
  • To have lived through three bubbles (housing, tech, 1970’s), not calling out the negative implications of negative real interest rates would be a derelict to my responsibility as a official of the FOMC.
  • It’s expensive to hire people in the U.S. That and uncertainty about the future – including burgeoning fiscal deficits – means we are going to have to wait until the confidence comes back for job creation to accelerate.
  • When I was elected Federal Reserve president of K.C., I was given a single reichsmark by my elderly German neighbor. He said to me, “When I was a boy, this could buy a small house. By the time I got older, it couldn’t even buy a loaf of bread. Don’t let that happen here.”
  • The German hyper-inflation was caused by trying to fix every single economic and political problem with monetary policy.

Keith McCullough

Chief Executive Officer

 

Darius Dale

Analyst


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Thanks Bron Bron

So will LeBron go to Miami, New York, Chicago???  From an investment vantage point, I could care less. The simple fact that I am addressing this point is a big positive for the athletic brands and retailers.

 

Can anyone remember a time when there was this much hype around an athlete’s decision to play in a given city – or to play at all? I can… It was summer of 2001 when Jordan returned (which arguably should never have happened). Heck, I even recall sitting in the hot seat in the morning meeting room of my then-buldge-bracket employer and a seasoned salesperson literally asked me in front of thousands of ears whether Jordan was returning.

 

I thought that was both sad and ridiculous at the time.  The reality, though, is that it mattered. It mattered because it was an incremental boost to the product cycle. Nike amped up its product line around MJ with the Wizards, and kicked its marketing machine into high gear. Any retailer worth its salt could not afford to miss out on that, so orders followed. Jersey sales also picked up, and Reebok had the exclusive license for ‘official’ league jerseys. Adidas has since restructured the deal such that it sells them under the Adidas logo.

 

So what are we looking at here?  With the exception of LeBron ending up in the media-market-equivalent of Outer Moongolia like Portland (Trailblazers) or in Kobe’s shadow like w the LA Clippers (it'll never happen), this event will be incremental across the board.

1)      For Adidas, they’ve been relying on World Cup and Shape Ups. WC is almost over, and Germany was sent packing by a ‘lesser’ Adidas team. Not sure when the bubble will end on shape ups, but a pick-up in Jersey sales from the most exciting free agent switcheroo will help keep adi’s momentum going for another quarter.

 

2)      For Nike, they have LeBron, Wade, Carmello, and Bosh. From an asset standpoint, they can’t lose. Now they need to execute on product and marketing. That’s where my confidence level is highest. If these three guys (LeBron, Bosh and Wade) all end up in Miami, then Nike will be giddy with how they can build up this franchise into the next season. Given Nike’s legacy in Chicago with in the 1980s and 1990s with the Jordan/Rodman/Pippen trifecta.

 

3)      Arguably, the biggest winners across the board are the retailers.  We’re only talking about a half a point to a point in comp for a company like DKS, HIBB or FL. But given that this is a business that has faced headwinds for the better part of four years, we’ll take what we can get.

 

Thanks Bron Bron - 7 7 2010 9 22 14 AM


R3: Football & Fung

R3: REQUIRED RETAIL READING

July 8, 2010

 

We’re going with two call outs today…and they have nothing to do with Same Store Sales. The first is a glimpse into recent activity at Li&Fung, which is one of the best global long-term investment stories I have seen in years. The other is Italy, which has resorted to blaming €140mm on its Football team.

 

 

TODAY’S CALL OUT

 

Li & Fung Hot With Activity - Hong Kong-based sourcing giant Li & Fung said Thursday it has made three acquisitions over the past two months and struck a series of licensing deals in an effort to boost its market share and profitability. The company said it has bought the following companies for an initial cash consideration of $140 million: The Hong Kong-based Jackel Group, a player in the beauty and packaging industries; HTP Group, a Hong Kong-based denim specialist; and nearly all of the assets of Cipriani Accessories Inc. and its affiliate The Max Leather Group. Li & Fung said it has signed four additional licensing deals: a pact with celebrity stylist Rachel Zoe to launch a new contemporary collection, an expansion of its existing licensing deal with martial arts apparel maker Tapout to include men’s and junior’s sportswear, the formation of a new company with Star Branding to create new lifestyle concepts, and a new licensing deal with Sean Combs’ Sean John label for sportswear and active wear.  <wwd.com/business-news>

Hedgeye Retail’s Take: In the world of global retail, I can not find a better structural story than Li&Fung. As a 20-year trend of outsourcing and offshoring to China by US companies leveraging the US$ as the world’s reserve currency comes to an end – and reverses – LF is the only company that will win consistently. Small acquisitions into ancillary areas on which to leverage sourcing infrastructure makes a ton of sense to me. And that’s coming from someone that rips apart 9 out 10 acquisitions that comes across the retail tape.

  

Italian Retail Troubled by Economy, World Cup Woes - Local retailers in Italy are claiming to have a hard time meeting sales targets as consumer is failing to buy in the summer months due to weather, lack of confidence, and World Cup woes. The summer sales season, one of two times each year when retailers like Benetton and Prada mark down prices, normally accounts for about 12% of annual Italian revenue for the clothing and shoe industries. This year’s sales period coincides with unemployment at an 8-year high, consumer confidence slipping to a 16-month low in June and hotter-than- average temperatures in city centers from Milan to Rome. <bloomberg.com/news>

Hedgeye Retail’s Take: Italy takes the cake – twice. First by flopping out of the World Cup. Then by actually quantifying the impact on its economy of the failure of its football team to perform – 140mm Euro.  Let me get this straight…that’s 8.5% of GDP. For losing to Slovakia and drawing vs. New Zealand??? I know Americans don’t ‘get’ football. But c’mon. They can hardly quantify their unemployment rate nevermind the consumption impact of World Cup. Let’s get real.   

 

 

MORNING NEWS 

 

JJB Sports Experienced Nice Lift from World Cup - British sportswear retailer JJB Sports, which avoided administration last year, said sales have continued in line with expectations even after England's premature exit from the soccer World Cup. The company, a seller of England soccer kits as part of its World Cup range, said comps in the six weeks to July 4 jumped 22.3%, while gross margins surged. Cumulative like-for-like sales from Feb. 1, the start of the financial year, to July 4 rose 12.1%.  <reuters.com>

Hedgeye Retail’s Take: Spain/Netherlands is a dream matchup for Europe. But what’s next?

 

Uniqlo's Parent Fast Retailing Company Cuts Full Year Forecasts - Fast Retailing Co. Ltd. saw double-digit growth in the first nine months of the year but uneven sales of its spring items forced the company to cut its full-year forecasts, just months after raising estimates in April. The Japanese company’s monthly sales performance so far this year has been mixed, an outcome the company has blamed on unseasonably cool spring months and problems keeping some popular spring styles in stock. <wwd.com/business-news>

Hedgeye Retail’s Take: You know what this means? Yes, they’ll pick up the deal cadence.

  

Twitter Enters E-Commerce - Twitter is launching @earlybird, its own take on popular daily deal sites such as Rue La La or Gilt Groupe that offer limited-time sales at deep discounts. Twitter has not elaborated on the types of deals it might promote, but it did say that initially the offers will be from large, international brands or focused on the U.S. market. Participating retailers will set the terms of the offers, including the availability, amount offered and price. <internetretailer.com>

Hedgeye Retail’s Take: T’was a matter of time.

 

DKNY Opening in Singapore - DKNY Jeans International will unveil a new retail concept with today’s opening of a Singapore boutique. Located in the city’s Paragon Shopping Center, the new store will be a prototype for other DKNY Jeans freestanding units and concept shops. The company plans to unveil boutiques in Jakarta, Indonesia; Hong Kong; Beijing, and Sydney, as well as concept shops in China, Taiwan and Thailand. The company operates and distributes to 160 DKNY Jeans freestanding, shop-in-shop and multibrand stores. At this point, 11 new concept stores are expected to open by next year. <wwd.com/retail-news>

Hedgeye Retail’s Take: This makes sense. DKNY has been around for about 20 years now, which is like forever in the fashion world. All along it has maintained relevance as a global brand.

 

Target Prepares for Shaun White Shoe Line - The premiere collection of Shaun White shoes is set to hit Target stores nationwide and online at Target.com the week of July 11th. Shaun White shoes, an expansion to his line of clothing with Target, features a variety of skate and lifestyle shoes for boys and young men.  <sportsonesource.com>

Hedgeye Retail’s Take: You gotta love this kid… What’s interesting is that White’s apparel line did not sport a logo. He purposely minimized any glaring logo to maintain some form of anti-establishment status. Not quite sure if that will work with footwear. In fact, his Red Bull commercials have a very ‘big business’ slant that augers to him going more mainstream. But mark my words, this is as important a launch to watch (for Vans, Converse, Nike 6.0) as some of the Asian brands coming into the US.

 

Cornell University Drops Nike Contract Due to Honduras Labor Dispute - Without "significant progress" toward the resolution of an ongoing labor dispute in Honduras, Cornell University said last week it will follow the University of Wisconsin at Madison's lead and end its licensing agreement with Nike by the close of the year. In April, UW became the first university to cancel its contract with Nike over a contractor's treatment of workers in Honduras. <sportsonesource.com>

Hedgeye Retail’s Take: After all the progress Nike has made, this is yet another sign showing how hard these reputations are to shape. Let’s hope that these Universities don’t do any business with Gildan – who is massively overweight Honduras.

 

Who Spends Most Time on Facebook? - Age, income and ethnicity all play a role in how much internet time users spend on the social giant. And marketers may find the heaviest users the most valuable to target. <emarketer.com>

Hedgeye Retail’s Take: I have no clue what the investment significance is of this chart. But thought it was interesting from a social networking standpoint.

 

R3: Football & Fung - R3 7 8 10


TO BE OR NOT TO BE TAX FREE

As fiscal losses mount at the local level and the back to school season begins,  the discussion surrounding tax free holidays is building.   Some states view these holidays a stimulus to help local businesses and consumers while others are clearly seeing incremental sales tax as a source of revenue.  As we head into the critical back-to-school selling season, it’s important to understand what’s different this year vs. last from both a timing and magnitude perspective.   And, with June sales reported tomorrow,  we expect to hear the first indications of how tax free holidays may be expected to impact July and August results. In an effort to capture the various shifts in timing and program parameters versus last year, we present the following graphics below. Here are a few noteworthy observations:

  • There are typically 3 different types of sales tax holidays: hurricane preparedness, clothing and school supplies, and energy efficient appliances.  For the purposes of this post we are focused on the clothing and school supplies.
  • The top 5 states most exposed to teens in the 15-19 year-old demographic are CA, TX, NY, FL, IL, representing 37% of the entire domestic teen market.  However, only three offer a tax free holiday (TX, NY, & FL).
  • The two biggest teen states (CA & IL) that don’t offer the tax free holiday have some of the highest state sales taxes in the country.  CA and IL are also #1 and #4 respectively on a list for highest projected budget gaps as a percent of the state’s general fund budget.
  • So far, FL and MD are the only two states adding events vs. this time last year.  They are adding 3 and 7 day tax-free events respectively.
  • GA, Washington DC, and South Carolina have either repealed or suspended their respective tax free holidays.
  • NY just repealed it’s tax-free status on shoes and apparel under $110, however this will not take effect until October 1st.  The suspension will last until April 1st, 2011, at which point a $55 tax-free threshold will be established for a year.  Then, in 2012, the original exemption will be reinstated.

With municipalities struggling to meet budgets, we should expect continued contraction in this list of tax free events as well as growth in efforts to add or boost sales tax overall.  

 

TO BE OR NOT TO BE TAX FREE - TeenStateExp 7 10

 

TO BE OR NOT TO BE TAX FREE - TaxHoliday Sched 7 10

TO BE OR NOT TO BE TAX FREE - TaxHoliday 2 Sched 7 10

TO BE OR NOT TO BE TAX FREE - TaxHoliday 3 Sched 7 10

 

Eric Levine

Director


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