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BWLD – DID NOT FALL INTO A DEEP HOLE

After the 30 bp falloff in two-year average same-store sales trends in the first quarter and the reported -4.7% comp in April, I was not expecting too much this quarter and neither was the street.  BWLD, however, surprised to the upside with earnings coming in at $0.50 per share versus the street’s $0.42 per share estimate and company-owned same-store sales growth was down 0.1% relative to the -2.5% street estimate.  Despite the better-than-expected numbers, company-owned same-store sales slowed nearly 200 bps on a two-year average basis from the prior quarter.  Management reported that comps are running positive in July, up 2.2%.  For reference, the company is lapping a +1.2% number from the same period last year, which implies a slight uptick in two-year trends since the end of the quarter.

 

Going into the quarter, I said that BWLD could potentially move into the “deep hole” (negative same-store sales and declining restaurant level margin) quadrant of the sigma chart shown below if same-store sales trends did not materially improve throughout the remainder of the quarter.  Comps, did in fact, improve after decelerating about 420 bps on 2-year average basis in April from 1Q10.  Restaurant level margin also came in better than I expected, up 120 bps to 18.1%, with food costs as a percentage of sales declining nearly 200 bps, more than I was modeling (lower YOY chicken wing prices for the first time in six quarters).  As a result, BWLD moved from the “trouble brewing” (positive same-store sales and declining restaurant level margin) quadrant to the “life line” (negative same-store sales and growing restaurant level margin) quadrant.  And, given that same-stores sales were just barely negative, the company was operating quite close to “nirvana” (positive same-store sales and growing restaurant level margin).

 

We will see what the company has to say on its earnings call, but despite the better-than-expected quarterly results, I continue to believe the company is growing too fast and that growth related costs will become more evident as same-store sales remain under pressure.  BWLD needs to slow growth and cut costs and that does not yet appear to be in the plans. 

 

Relative to the company’s earnings guidance, BWLD’s press release stated, “We have growing confidence that our 20% annual net earnings growth goal is achievable given the recent improvement in same-store sales and the moderation of wing costs."  This compares to last quarter when the company said 20% earnings growth may be achievable but an improvement in same-store sales and moderate wing costs were key to this goal.  So, there seems to be a real shift in management’s level of confidence.

 

BWLD – DID NOT FALL INTO A DEEP HOLE - bwld

 

Howard Penney

Managing Director


NO FREE LUNCH FOR CONSUMERS

You wouldn’t know it by looking at the market recently, but consumers are not feeling very positive.

 

Once again we are seeing a major plunge in Consumer Confidence, which came in at 50.4, below expectations of 51.0, and down 7.1% from a revised (upward) prior reading of 54.3 (previously 52.9).

It has been a relatively strong earnings season for the restaurant companies to date and with the huge reported calendar 2Q10 comps by SBUX, CMG and DPZ, it is difficult to get a feel for current trends.  The management teams of these companies seem confident that current momentum is sustainable; though many restaurant companies are pointing to the current economic environment as reason to be cautious. 

 

Specifically, CMG said, “Our comps held up well throughout the quarter and into July so far; though we do remain concerned about recent reports of softening consumer confidence and the outlook for the economy. While we feel good about the strong customer loyalty our managers and crew have built over the years, we saw over the past few years, that economic concerns will affect how often our customers will visit Chipotle.”

 

To that end, today, we are seeing a major plunge in Consumer Confidence, which came in at 50.4, below expectations of 51.0, and down 7.1% from a revised (upward) prior reading of 54.3 (previously 52.9).  The Present Situation Index decreased to 26.1 from 26.8 and the Expectations Index declined to 66.6 from 72.7 last month.

 

Consumer attitudes are also being expressed in current sales trends.  According to Johnson Redbook, U.S. same store sales fell 0.7% month-to-date for the week ending July 24 (compared to the previous month); the seventh consecutive weekly decline in sales.  And, casual dining trends, as measured by Malcolm Knapp, have been slowing on a two-year average basis since April.

 

Today’s confidence reading is more indicative of where we are heading than today’s Case/Shiller home price data. 

 

As expected, home prices rose predictably in May and will rise again in June before heading lower in 2H10.  As our Financials analyst Josh Steiner noted in his Housing Black Book, May prices reflect March contract activity which was strong due to the April tax credit expiration.   

 

Pick your poison as to why you think confidence is going down, but I’m now focused on the incompetence of the people in Washington.  Washington is the epicenter of everything consumer - unemployment benefits, policies that enable job growth and a federal reserve that won’t pay the aging population an interest rate on its savings accounts.  The issues in Washington are impacting the whole country and individual states are also beginning to make significant cutbacks.

 

Nothing is getting done. 

 

The precipitous drop in confidence in Washington among the electorate has been shaped largely by the harsh economic reality facing many consumers today.  The approval rating of the president among 18-34 year olds is but one example.  Among 18-34 year olds polled by Quinnipiac University in November 2008, 73% viewed Obama favorably.   Last week, a poll conducted by Quinnipiac University revealed that only 46% of 18-34 year olds viewed Obama favorably (with 42% holding an unfavorable opinion). Additionally, 37% of the same demographic would vote for a generic Republican in a presidential election versus 34% for Obama.  No age group has a tougher time finding a job at the moment than teenagers and young adults in their twenties (a key demographic for QSR).  In turn this is putting incremental pressure on their parents…..  A vicious cycle for sure!

 

The earnings season has been strong and as expected the corporate story telling is alive and well.  We are setting up for what could be a very interesting 3Q10 preannouncement season.

 

NO FREE LUNCH FOR CONSUMERS - conf board cons conf

 

Howard Penney

Managing Director

 


Chinese Loans . . . A Crisis of Rumors

Conclusion: Reports out of China concerning the potential for a high degree of non-performing loans used to finance local government infrastructure projects appear alarmist and should not be given substantial credence at this time, which is confirmed by the CDS and equity markets.

 

In the past few days, there has been a great deal of news flow coming out of China regarding the potential for local government financing vehicles to struggle to service 23% of the 7.7 trillion yuan ($1.1 trillion) of outstanding loans which had been lent to finance local government infrastructure projects (highways, airports, etc.) – according to a person with knowledge of data collected by the nation’s regulator. With supposed at-risk debt near $261 billion (nearly five times the amount ($53.5 bil.) the nation’s five largest banks are raising to replenish capital) there is concern that the government may need to accelerate efforts to shore up its banks.

 

What cannot be overlooked here, however, is that Chinese government bailouts have helped bring the industry’s non-performing loan (NPL) ratio to 1.3% by the end of June – down 28bps since the end of 2009. Efforts to mitigate any potential buildup in NPL’s brought on by last year’s $1.4 trillion of credit expansion have been particularly successful (slowing loan growth, raising capital requirements, etc.). The Chinese government targeted a maximum of 7.5 trillion yuan ($1.1 trillion) of new loans this year – down from last year’s record 9.59 trillion yuan of credit expansion – and the central bank recently affirmed that, at the current pace of lending (which has decelerated each month since April), that goal will be met. Furthermore, last month, the China ordered its local governments to ensure repayment, concentrate on completing projects already under way, and stop spending within financing units that rely solely on the fiscal income of local governments. We expect these efforts to achieve a similar desired effect as the curbs on the Chinese banking system at large.

 

Chinese Loans . . . A Crisis of Rumors - 1

 

Still, any rapid expansion in credit always brings about a repayment risk, particularly when confounded by the complexity of China’s local government financing. Because of their inability to directly borrow money, local government set up financing vehicles to fund projects. These vehicles issue bonds in China’s exchange traded and interbank markets, which are then bought by commercial banks, asset managers, securities firms and other institutional investors – based largely on false pretenses, at least according to Dagong Global Credit Rating Co. They claim that because most companies can’t issue junk bonds, they have to be rated at least AA to apply for debt issuance, which causes local government-backed borrowers to “shop around” for the best rankings, giving business to whomever gives them the highest rating (sounds familiar? See: U.S. MBS market 2005-2008). According to China Lianhe Credit Rating Co., 43 construction companies affiliated with such financing vehicles issued 72 corporate bonds totaling 59.2 billion yuan ($8.7 billion) in 1H10. Of that total, 70 were rated AA or above.

 

Potentially faulty ratings, coupled with the repacking of such loans into investment products and shifting off-balance sheet by Chinese banks, does indeed mask the repayment risk of such ventures. Currently, China has more than 1,000 county-level governments and hundreds of city and municipal councils that get revenue from local taxes, land sales, and central-government transfers. Of those three, revenues from slumping land sales brought on by China’s efforts to cool its property market is most at risk.

 

When it’s all said and done, servicing loans has always been about the generation of aggregate cash flow – which is precisely why we like the health of China’s banking industry a great deal more than the its U.S. and European counterparts. In China, you have a consumer whose purchasing power is growing (wage inflation, currency strengthening) and has a history of thrift brought on by decades of minimal social services; that same thrift allows China’s banks to keep mortgage down payments north of 40-50%. Contrast that with the Western consumer, whose purchasing power is eroding due to austerity measures and currency debasement, is mired in stagnating-to-worsening high unemployment, and is in the early stages of a secular deleveraging.  Moreover, China, on an aggregate level, has the ability to grow into its ability to service loans.

 

All told, let’s just say that if China’s banking system is in a precarious scenario based on these recent reports of potential non-performing loans, domestically speaking, we better start heading for the hills.

 

Darius Dale

Analyst

 

Chinese Loans . . . A Crisis of Rumors - China


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DPZ – SOUNDING CONFIDENT

Domino’s U.S. comp sales growth came in slightly below the street’s expectations with company-owned same-store sales growth up 8.3% but management’s tone continues to be extremely positive.  Management did not provide any color on quarter-to-date trends, but repeatedly commented that it thinks the current momentum behind its new and inspired pizza product is sustainable.  Specifically, management said, “We really like where we are….We are performing better than most or all within the pizza category.”

 

Even with same-store sales growth up over 8%, both one-year and 2-year average trends slowed rather significantly from the first quarter when the comp was up 14.7%.  This sequential slowdown spurred a lot of questions and concern on the earnings call about the sustainability of top-line trends.  Management defended its recent performance by pointing out that the new pizza is not a promotion and is driving significant repeat visits with the majority of the sales growth in 2Q10 driven by repeat customers and increased frequency relative to the heavy trial period during the first quarter. 

 

Relative to guidance, management stated that its full-year 2010 results should come in better than its stated long-term outlook on a lot of fronts, driven by a higher than typical range of comp growth in the U.S.

 

Pressure in 2H10:

 

Management reiterated its outlook for cheese prices to be in the $1.50 to $1.70/lb range in the back half of the year.  Although cheese prices remained below this level in the first half of the year, cheese is currently at $1.60/lb.  Management also stated on the call that for every $0.40 move in the price of a block of cheese, there is a 100 bp impact on food costs at the store level.  Relative to the recent move in wheat prices, DPZ locked in on all of its wheat needs through the first quarter of 2011. 

 

Foreign currency benefited earnings by about $0.02 per share in 1Q10 and a penny in 2Q10 but management expects this trend to reverse in 2H10 with currency hurting by a penny or two during the fourth quarter.

 

DPZ – SOUNDING CONFIDENT - DPZ 2Q10 SSS

 

Howard Penney

Managing Director

 


CONSUMERS ARE NOT SEEING GREEN LIKE THE S&P 500

Once again we are seeing a major plunge in Consumer Confidence, which came at 50.4, below expectations of 51.0, and down 7.1% from a revised (upward) prior reading of 54.3 (previously 52.9).  The Present Situation Index decreased to 26.1 from 26.8 and the Expectations Index declined to 66.6 from 72.7 last month.

 

Consumer attitudes are also being expressed in current sales trends.  According to Johnson Redbook, U.S. same store sales fell 0.7% month-to-date for the week ending July 24 (compared to the previous month); the seventh consecutive weekly decline in sales.

 

Today’s confidence reading is more indicative of where we are heading than today’s Case/Shiller data. 

 

As expected, home prices rose predictably in May and will rise again in June before heading lower in 2H10.  As our Financials analyst Josh Steiner noted in his Housing Black Book, May prices reflect March contract activity which was strong due to the April tax credit expiration.   

 

Pick your poison as to why you think confidence is going down, but I’m now focused on the incompetence of the people in Washington.  Washington is the epicenter of everything consumer - unemployment benefits, policies that enable job growth and a federal reserve that won’t pay the aging population an interest rate on its savings accounts.  The issues in Washington are impacting the whole country and individual states are also beginning to make significant cutbacks.

 

Nothing is getting done. 

 

The precipitous drop in confidence in Washington among the electorate has been shaped largely by the harsh economic reality facing many consumers today.  The approval rating of the president among 18-34 year olds is but one example.  Among 18-34 year olds polled by Quinnipiac University in November 2008, 73% viewed Obama favorably.   Last week, a poll conducted by Quinnipiac University revealed that only 46% of 18-34 year olds viewed Obama favorably (with 42% holding an unfavorable opinion).   Additionally, 37% of the same demographic would vote for a generic Republican in a presidential election versus 34% for Obama.  No age group has a tougher time finding a job at the moment than teenagers and young adults in their twenties.  In turn this is putting incremental pressure on their parents…..  A vicious cycle for sure!

 

The earnings season is been strong and as expected the corporate story telling is alive and well.  We are setting up for what could be a very interesting 3Q10 preannouncement season…

 

Howard Penney

Managing Director

 

CONSUMERS ARE NOT SEEING GREEN LIKE THE S&P 500 - conf board cons conf


R3: UA: Bullet Proof?

R3: REQUIRED RETAIL READING

July 27, 2010

 

UA had a critical setup into this quarter. It delivered. But the market was ready for it.

 

 

TODAY’S CALL OUT

 

The setup heading into this eps release was questionable at best. On one hand, apparel trends clearly looked good at retail, inventories were in check across the board, channel partners consistently leaked out indications that a bigger footwear push was happening sooner than later (in line with our view), and the consensus estimates were just flat-out low across the board. In fact, our estimate for next year still stands head and tails above the Street at $1.75 vs. the Consensus at $1.30.

 

But then Kevin Plank threw a changeup and booted his President of just 2-years just 2 weeks ahead of the quarter – and the seasonally weakest quarter at that. This thing was primed for fireworks. But every analyst came out and defended the stock in the face of the event. Even I thought the management change was perfectly rational – though would never have thought the stock would tread water (nevermind go up!).

 

In the end, this quarter was another outstanding one for UA. 24% top line growth with 1% inventory decline? Sweet…  Also, I love the fact that the company delivered its SG&A in spite of such big top line numbers. The punchline there is that it is spending when it should in order to sustain its growth trajectory – instead of printing unsustainably high margins in a period of questionable growth (i.e. Skechers).

 

The question here is whether the recent run has this stock priced for perfection. If so, then UA delivered. But if the company says anything remotely cautious on its call, I can’t imagine that the stock cannot be bought lower. Will be back after the conference call as warranted.

 

 

LEVINE’S LOW DOWN 

 

- Luxury retailer, Saks Fifth Avenue, is about to launch designer plus size apparel with partners including Chanel and Dolce & Gabbana.  However, the store’s merchandising approach will be slightly different than a traditional retailer which would normally have a “department” devoted to the larger sizes.  Saks will mix these items in with existing stock, extending the traditional size runs.

 

- According to the 2010 American Pantry Study, 93% of consumers expect to remain cautious with spending even when the economy improves.  Interestingly, 55% of those cutting back suffered no decline in income, but felt they “should be” cutting back.  When it comes to using loyalty cards and coupons, 81% of respondents indicated the process is “fun”.

 

- Sales of significant retail properties (over $5 million) slipped again in the second quarter, declining 9% sequentially from 1Q to $2.9 billion.  This marks the seventh time in eight quarters that investment spend in retail real estate has remained below $5 billion.  From 2001-2008, total investment in retail properties topped $5 billion consistently, quarter after quarter.

 

 

MORNING NEWS 

 

China Labor Shortages May Impact Fall Sporting Goods Deliveries - Of all the challenges facing the U.S. sporting goods industry in 2010, one would hardly think labor shortages in China would top the list but whether it comes to making golf clubs, toning shoes or hiking boots, the topic is dominating earnings calls and boardroom discussions across America. The deep recession and a steep rebound in orders this spring have made it difficult for Chinese factory owners to fill jobs. <sportsonesource.com>

Hedgeye Retail’s Take:  It’s been a long, long time since we’ve talked about out of stocks and product shortages.  Good for margins, not so good for the topline.   

 

Bangladesh Garment Factories Unwilling to Meet Minimum Wage Demands - As garment factory owners in Bangladesh are unwilling to offer workers as per their minimum wage demands, the government is indirectly intervening into the matter. The country’s Prime Minister, Sheikh Hasina, stressed that apparel factories paying their workers are insufficient as well as inhuman. The government will reveal the minimum wage structure for garment workers by July 28th. The Labor Ministry has been in talks with the garment factory owners to fix an apposite wage structure for their workers although the government cannot directly intervene into the privately-run industry.  <fashionnetasia.com>

Hedgeye Retail’s Take:  More inflation.

 

China Shuts Down Five Tanners in Fuzhou City - Five tanneries in Fuzhou city, China are closing down their operation by October this year as part of a plan to eliminate outdated production capacity and clean up the environment. All 5 of the Tanneries have annual production below 20,000 pieces of standard cattle equivalent. The announcement has shown China’s plan to eliminate outdated production capacity. Production and effluent treatment systems that fall below environmental standards and those tanneries that have a low production volume under 30,000 pieces per year will be the target of elimination. <fashionnetasia.com>

Hedgeye Retail’s Take:  Keep an eye on leather pricing as China continues to crack down on a substantial number of tanneries that are harming the environment.  China has said it expects to close 1,000 small and medium tanneries in its effort to eliminate harmful pollution created from such facilities.  Approximately 700 large and more environmentally friendly factories will remain.

 

Brazilian Footwear Brand Corso Como Growth Spurt - Since its 2006 launch, the Campo Bom, Brazil-based brand has been steadily adding new categories, expanding its retail and online presence and bolstering its name in the U.S. and abroad. Sold in 870 doors in the U.S., including Nordstrom, Bloomingdale’s and Anthropologie, and in another 250 shops internationally, Corso Como in May made its first move into branded retail with a website and e-commerce platform. The company also is eyeing expansion across Europe, particularly in England, France, Italy and Spain, and plans to up its trade show presence in the region. Corso Como has made its mark in the women’s market with its collection of low-key, sophisticated and comfort-driven designs at accessible price points, and is growing the category mix. <wwd.com/footwear-news>

Hedgeye Retail’s Take:  While most brands see Brazil as a substantial end-user market, it appears competition is brewing on domestic soil.  Brazil has been a large player in the footwear market for years, but branded exports to the US have not been a huge part of the equation, until now.

 

Warnaco Names Jim Gerson President, Swimwear - The Warnaco Group, Inc. appointed James B. Gerson as president of its Swimwear division. Jim joins Warnaco from V.F. Corp, where he most recently served as president of Reef.  <sportsonesource.com>

Hedgeye Retail’s Take:  Another high profile defection from VF Corp.  Recall that VFC has been trying to build Reef into another of the company’s large lifestyle brands, like Vans and TNF.

 

Nike Saves Face on Honduran Labor Issue - Although this has virtually no financial impact, Nike saved face by pledging to pay $1.54 mm for a worker relief fund to Honduran workers after University of Wisconsin at Madison terminated its agreement and Cornell warned it would follow. Nike’s action is a reversal of its stance in April, when the company said the contract factories bore sole responsibility for paying the workers’ severance. <wwd.com/business-news>

Hedgeye Retail’s Take:  For a company of its size, Nike is keenly aware of how important image and social responsibility is to today’s consumer. Score one for the college students.

 

Eastern European Malls Use Dinosaurs, Spas to Lure Shoppers - If Christian Dior’s brand name can’t attract customers, maybe dinosaurs will. That’s the plan behind Galerie Harfa, a half-built shopping mall perched above Prague’s Vysocany suburb that will have a dinosaur-themed amusement park, fitness center and rooftop swimming pool. As the economic slowdown squeezes retail sales in the Czech Republic and Hungary, companies such as Hochtief AG, Strabag SE and Skanska AB help construct venues with spas and electric-car tracks to lure shoppers. Mall space has more than quadrupled since the former Communist nations joined the European Union in 2004, exacerbating the need to offer more than just shopping. “It’s not enough to line up the usual suspects like Zara, Esprit and H&M,” said Lenka Hartmanova, a Prague-based analyst at real estate company DTZ Holdings Plc. <bloomberg.com/news>

Hedgeye Retail’s Take:  If only they could take apart and move the failed Meadowlands, NJ mall, Xanadu, to eastern Europe.

 

 Drugstore.com Branches Out - The e-retailer today unveiled VitaminEmporium.com, which sells vitamins and supplements as well as such items as shampoo, toothpaste and pet products. The site went live quietly a few weeks ago, but drugstore.com only announced it today. <internetretailer.com>

Hedgeye Retail’s Take:  Competition is heating up in the vitamin and wellness category, this time drugstore.com is taking a stab at the market.  Haven’t we seen this before?  Remember St. John’s Wort?

 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.28%
  • SHORT SIGNALS 78.51%
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