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WRC/DKS: Sales Nugget From DKS 2Q Call

Interesting comment just made by DKS CEO about no pick up in business from the Olympics, and no change in sales rate for Speedo.
Q: "A strange question, but with the Olympics going on, are you selling, first of all, more Speedo swimsuits, but are you in general seeing an impact, or do you normally see an impact from the Olympics?"

A: ED STACK (CEO): First of all, we have seen no significant change in the sale of our Speedo's. [Second] I think there may be some indirect component on a go forward basis and I think these games have done really exciting for people to watch and has gotten people maybe more interested in sports at least for this period of time, but we don't think that it has had an impact on our business.

YUM – KFC’s Rising Prices In China Anger Consumers

The China Daily reported today that KFC raised its prices in China for the second time this year due to increasing commodity costs. The first price increase was implemented in March and menu prices increased between 0.5 yuan and 1.5 yuan. The magnitude of this second price increase is even greater, ranging from 0.5 yuan to 2.5 yuan. For reference, the price of a medium coke is now 6.5 yuan, up from 6 yuan (an 8% increase).

One KFC customer responded to these recent price increases, saying “Its products are quite small in size, and not worth the money if prices continue to go up.” On its 2Q earnings call, YUM management stated in reference to China, “In 2008, as an example, we will meet or exceed our profit targets despite unusually high commodity inflation. We have been able to pass on strategically targeted price increases while maintaining transaction growth.” YUM raised its prices in China by 6% in July 2007 prior to the 2% price increase in March 2008. Before this most recent price increase, prices in China were running up a little over 2%. This price vs. traffic relationship is one that I have talked a lot about and if customers begin to think the price increases are too great, YUM’s traffic growth in China will begin to suffer. These issues could be further magnified by the fact that YUM’s China division is facing more difficult comparisons in the back half of the year with management commenting on its last call, “Also, while we expect China to meet or exceed our full-year profit growth targets, we cannot expect mid-teens same-store sales growth and 30% to 40% profit growth to continue.”

Charting India: Going Back To The July Lows?

India's Sensex Index got pounded in Asian trading overnight, closing down another -3%. After making a valiant effort to breakout through my model's resistance line at 15,211, the Indian market closed at 14,239 and now looks very ominous as a result.

Asian economic growth is slowing, big time.
  • The BSE Sensex Index looks ripe to test its July lows near 12,500.
    KM
chart courtesy of stockcharts.com

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

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LDG, Part V: Numbers Don't Lie, People Do

I don’t need to sit across the table from a CFO in a conference 1-on-1 to get the inside scoop on how it is managing its growth trajectory. I have a much better source – it’s called a balance sheet. Better yet, it is in the notes accompanying the balance sheet, where we find some very large obligatory payments that are treated by most on Wall Street as if they don’t exist.

Well, that’s something we just can’t let fly here at Research Edge.

I’m referring to the minimum rent obligations on a go-forward basis, which gives us some pretty solid insight into CVS leading up to its decision to buy Longs Drug. Why does this matter? Because aside from discretionary SG&A spending, these minimums represent the single most meaningful place a retailer could go to manipulate reported margins. Every CFO will argue with me on this, and give you fluffy reasons as to why they don’t do that. But the option is there.

How? There are 2 main ways this can manifest itself. 1) A retailer could guarantee a landlord a steep escalating rent structure in order to outbid a more profitable competitor with deeper pockets, 2) The retailer could sign rental agreements with much longer property lead times, taking on the risk from the landlord that the quality of the location does not pan out as planned.

Why? This usually happens when one of two factors exists – and both are bad. The first is when a management team is super bulled-up on its growth trajectory and thinks that it can fund a high hurdle rate for growth in rent payments regardless of the macro environment. These companies don’t ‘do macro.’ This includes Whole Foods and Dick’s (check out those charts). The second is when a retailer sees a growth or margin trajectory eroding, and management starts pulling levers to keep its margins high, instead of investing in better and more profitable growth platforms. This is Circuit City, DSW, and you guessed it, CVS.

Yes, lease escalators are in place for everyone. Including the likes of Wal*Mart – and especially CVS and LDG. But all leases that come due each year are backed out of this minimum. Hence, when it all nets out, no retailer should have minimum lease obligations 3-years out that are higher than they are today.

That’s where CVS looks so fascinating. The chart below shows the ratio of year 0 to year3 payments for CVS vs. LDG. As reference, $100 in rent today and $50 minimum in 3 years would equal a 200% ratio. That’s good. Unfortunately, both of these are sitting at about 100%. There are other small format retailers that operate near 100%, so I won’t dwell on absolute levels. But what concerns me more is the trajectory of CVS’ numbers.

Check out my Partner Tom Tobin’s 8/19 post on the secular slowdown in pharmacy revenue. We saw growth in Rx spend per capita peak in 2006, and then trend downward. Tom’s analysis builds a pretty strong case that it will continue eroding from here. Ironic that this is the precise time we began to see CVS’ longer-term rent minimums head higher relative to current payments (i.e. CVS either getting overly bullish or overly scared). Then by the time ’07 rolled around, the ratio continued to drop dramatically to what I’d call an unsustainable level, and CVS went ahead and bought Caremark in a transformational acquisition. Now it is sitting there almost 2 years since the announcement, and it needs yet another margin kicker. L-D-G.

Brian McGough
President
Director Of Research

Get Ready For A 6-7% Unemployment Rate

Some of the bulls are running around suggesting that this morning’s jobless claims number was "better than expected", c'mon. This week's jobless number of 432,000 ensures that the upward sloping "Trend" in the 4 week moving average continue to move higher.

The 4 week moving average takes out the noise, and this morning's report lifts that average by another 7,000 jobs to 446,000.

We won't see a 6% unemployment report when the August monthly report comes out in 2 weeks, but we will see that print in the fall, then the 7% unemployment rate line comes into play.

The US economy is experiencing stagflation. There are very few winners in this economic scenario. Be careful out there.
KM

PVH: Pulling The Goalie? Initial Take on 2Q

PVH 2H guidance still does not look like a slam dunk to me. The company is in a precarious position right now. I’ll refer, as usual, to my little inventory/margin Quad chart below. This quarter PVH slipped into the zone where gross margins are 184bps higher than last year, but where inventories are outclipping sales growth by 4%. If you check out PVH’s chart over the past few years, you’ll see that when inventories are growing faster than sales, this stock does not go up.

Moreover, the company’s guidance suggests that we need to see a 200-300bp revenue acceleration on a normalized run rate. Yes, we’ll see a ramp in PVH’s new Timberland business, and growth in Izod, but at a combined size of sub-5% of total, they’re still not particularly meaningful. Calvin Klein’s licensing business continues to crank – and I don’t have many concerns there aside from the negative impact of FX that is passed through indirectly to PVH. But let’s remember that ½ of the company’s cash flow is still men’s dress furnishings, which is in the bulls eye of both the negative secular inflection point for margins due to changes in sourcing patterns and global trade, as well as a cyclical hurdle in the form of white collar layoffs (see my prior posts on this relationship ).

With the company beating 2Q by a penney, and deleveraging SG&A by 233bps (more than I suspected) it smells to me like this company could have beat the quarter by much more than it did. That’s a positive in some respects, unless PVH only printed what it had to in order to keep its powder dry to fund an otherwise daunting (or simply unknown) 2H.

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