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Real Commotion in Brazil

Conclusion: Recent moves in the Brazilian bond market have been attributed to the “currency war”, but analysis of the fundamentals suggest the moves are warranted. While we don’t currently have a position, we remain favorably disposed to the Brazilian real against the U.S. Dollar over the long term.

 

Yesterday, Brazilian Treasury officials walked away from a debt auction for the first time since July 22, citing bids that were deemed “unreasonable”. Why they think bids are unreasonable after effectively squeezing out half of the investor base, is beyond us. Earlier in the week, Brazilian Finance Minister Guido Mantega raised taxes on foreign inflows on fixed income investments (for the second time this month) to 6% (from prev. 4%) and to 6% on margin deposits for futures (from prev. 0.38%). A loophole that allowed Brazilian financial institutions to swap assets to foreigners was also closed.

 

The aggressive move to curb real appreciation brought on by inflows of dollars has triggered a bond market sell-off, with yields on Brazil’s longest fixed-rate securities increasing 60bps this week to 12.08%. Today’s failed auction highlights the lack of domestic demand needed to sustain Brazil’s “low” interest rates, causing Treasury Secretary Arno Augustin to suggest Brazil will have to accelerate international sales of real-linked bonds to counter waning domestic demand.

 

Brazil, like every other emerging market growth country, has been guilty of riding the yield-chasing liquidity wave brought on by expectations of QE2 in America. And while self-imposed, yesterday’s failed auction tells us exactly what direction the real is headed alongside Brazilian interest rates – up.

 

Mantega may be successful in slowing down the rate of real appreciation vs. the dollar in the intermediate term with taxes and regulation, but longer term, the fundamentals driving Brazilian interest rates higher will be tough for him to overcome:

 

Fiscal Policy: The latest polls show voter support for Lula endorsee Dilma Rousseff is growing; she currently has an 11-12% margin over rival Jose Serra and is likely to win the October 31st runoff election, barring any catastrophic campaign mistakes. This is meaningful as it relates to the direction of Brazil’s debt/deficits, as she is on record saying promoting spending cuts is a “crime”. Her fiscal policies are in stark contrast to the much more austere Serra, whose previous surge in the polls sparked a bond market rally. Currently, Brazilian government spending is growing more than twice the rate of GDP, and with Rousseff’s promise for continuity with Lula’s welfare policies, we don’t see that changing anytime soon. Further, her lax spending policies create incremental support for the next factor we outline below:

 

Inflation: September marked the first sequential uptick in Brazilian inflation in five months, coming in at +4.7% YoY vs. +4.5% in August. Prior to that, inflation was being tamed by the strengthening real, which is up around 3% YTD. We have been increasingly cognizant of the likelihood that the dollar finds an intermediate-term bottom around in the $78-$82 range. Should the dollar strengthen marginally over the next three months, as we expect it to, we will see downward pressure on the real over the near term, limiting Brazil’s ability to fight inflation with FX appreciation alone.

 

Moreover, demand from Brazilian consumers is being supported by a significant confluence of tailwinds. Brazil’s unemployment rate fell 50bps MoM to a record low in August, coming in at 6.2%. Average real incomes also increased +1.3% MoM and +6.2% YoY and the latest data (April-July) show Brazilian consumer borrowing rates are at the lowest level since 1995 (6.74% per month).

 

Real Commotion in Brazil - 1

 

All told, the direction of fiscal policy and consumer demand will continue to put upward pressure on Brazil’s inflation rate over the intermediate-to-long term, necessitating the need for future rate hikes. While we don’t currently have a position, we remain favorably disposed to the Brazilian real against the U.S. Dollar over the long term, largely based on diverging growth prospects. As mentioned, over the intermediate term, the dollar could catch a bid from 1) hawkish fiscal rhetoric from the likely-to-be Republican Congress; 2) mean reversion; and 3) widespread reflexive declines in equities and commodities globally.

 

Darius Dale

Analyst

 

Real Commotion in Brazil - 2



FL Takes the Prize on Launch Day

In case you missed the 15 second teaser spots on Monday Night Football this week, we remind you that Under Armour’s basketball launch hits the marketplace tomorrow.  Interestingly, Foot Locker appears to have locked up THE key player in the whole marketing effort, Brandon Jennings.  He’ll be appearing at a Milwaukee mall for the launch.  No, not the UA flagship store in Maryland.  The Foot Locker in Milwaukee.  Who cares?  Footlocker and UA do.  This is a subtle but relevant start to a partnership that historically got off on the wrong foot (pun actually intended).  Look for FL to be a key component of the basketball strategy as it moves beyond its four shoe debut.

 

FL Takes the Prize on Launch Day - brandon jennings

 

Beyond UA, we’re also including a banner ad from today’s ESPN homepage.  Yes, the NBA starts up again this weekend so it makes sense to see an increasing marketing push behind the category.  However, we point out another subtlety which supports our ongoing thesis that the retailers win when R&D, marketing, and competition heat up in the space.  Take a look at the co-op branding below.  Can you guess who paid for this one?

 

FL Takes the Prize on Launch Day - espn

 

Eric Levine

Director


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Bear/Bull Battle: SP500 Levels, Refreshed...

We are about 25% of our way through earnings season with 132 companies in the S&P 500 having reported earnings to date.  The non-financial sectors appear to be holding up well this season, supporting the +10.9% move in the S&P last quarter. 

  1. 113 or 85% (80.9% for all of 2Q10) have posted positive surprises on EPS - the Industrials are the only sector with a perfect batting average  - 23 of 23 companies have beaten on EPS
  2. 87 or 66% (57.8% for all of 2Q10) have posted positive surprises on Revenues.  

Not surprisingly, we are seeing the cream of the crop get the good news out first and would expect the tone of earnings season to deteriorate from here.  This is an important factor to keep an eye on; as positive as earnings have been, a reversal in tone could have strong implications given how high this market has run.

 

In addition there are two important MACRO data points out next week:

  1. The BEA is expected to release the advance estimate of 3Q GDP on Friday, October 29th.  There is a significant chance that this GDP report is close to consensus expectations as it is the last major piece of economic data before the midterm elections.  The economic data reported of late suggests that.  However, reporting risk remains for a downside surprise to those expectations and here is why: 
  2. We expect the Case/Shiller print on Tuesday next week to decline sequentially and to show acceleration in the downward trend.   That said, the “bomb” print won’t be for another month when the April data, and with it the last impact of the home buyer tax credit, finally comes out of the calculation. 

We’re short the SP500 (SPY) and our refreshed immediate term TRADE line of resistance is now 1187 and there’s plenty of resistance all the way up to the YTD highs established in April during the frenzy of the 1Q10 earnings season.   

 

Enjoy the weekend,

 

Howard Penney

Managing Director

 

Bear/Bull Battle: SP500 Levels, Refreshed...  - 1


R3: COLM, GGP, VRA, JCP & KCP

R3: REQUIRED RETAIL READING

October 22, 2010

 

Following a successful IPO of Vera Bradley (as measured by day one), continue to expect high premiums on growth given its scarcity.  We challenge anyone to name 5 retail concepts with square footage growth over 10%.

 

RESEARCH ANECDOTES

 

- According to a Gallup poll tracking average daily spending for low and in middle income consumers, new YTD lows were reached in September.  The self-reported survey for September reported average daily spend of $48, down sequentially from $54 in August and $64 in July.  On a year over year basis, spending also declined significantly from last year’s average spend of $60.

 

- While traffic has doubled on COLM’s e-com site a year after shifting from simply a marketing to a commerce site, management noted that conversion rates are in-line with the rest of the industry – nearly 90% of consumers that visit research the product then buy it elsewhere.

 

- After winning numerous awards with the Kinvara, Saucony’s first lightweight running shoe, expect the brand to be a primary player in this emerging category in 2011. A discussion with the head of the brand suggests that initial plans are to offer at least four more lightweight models next year. Following the mantra of ‘less is more,’ the weight of next year’s line is going to make the Kinvara heavy by comparison.

 

 

OUR TAKE ON OVERNIGHT NEWS 

 

General Growth Property's Reorganization Plan Confirmed - A Manhattan bankruptcy court judge has confirmed General Growth Property’s plan of reorganization, paving the way for GGP to exit bankruptcy court proceedings on Nov. 8. As part of the restructuring, GGP will split into two publicly traded companies. The new GGP will continue to be the second-largest shopping mall operator, with more than 185 regional malls in 43 states. The spin-off, called The Howard Hughes Corp., will own the master-planned communities and work on development opportunities. GGP filed for Chapter 11 bankruptcy court protection in April 2009. It has since restructured $15 billion in mortgage debt. The reorganization plan provides a full recovery to creditors and shareholders. William Ackman’s Pershing Square Capital Management is among the firms supplying $6.8 million in equity commitments to GGP, and Ackman will serve as chairman of the spin-off. <wwd.com/business-news>

Hedgeye Retail’s Take:  With a very efficient bankruptcy process, it appears that retailers will be heading towards more visibility with the second largest mall landlord in the near future.  In reality, the bankruptcy process was nothing more than a headline distraction for the tenants.  Over the past year, there were no reports of service level disruptions or operational issues as a result of the company’s financial collapse.

 

Vera Bradley IPO Has Successful First Day - After pricing at the high end of its expected range, Vera Bradley Inc. ended its first day of he-counter trading by spiking up 55.3% in its initial public offering debut. The 28-year-old handbag and accessories firm priced its IPO of 11 mm shares of common stock at $16 a share, raising $176 million. The shares, which trade under the symbol “VRA,” opened at $23 and closed at $24.85. Based in Fort Wayne, Ind., the company sells through a network of 3,300 independent specialty retailers, company-owned stores and on its Web site. The firm operates 31 full-price stores and two outlet locations. According to the prospectus, it plans to open nine full-price stores and three outlets in 2011, with at least another 14 stores each year thereafter for the next five years. The company-owned stores average 1,800 square feet. The company is focused on expanding distribution in underpenetrated markets in the U.S. <wwd.com/business-news>

Hedgeye Retail’s Take:  With growth a premium in retail, it will be interesting to see how more mature retail companies fare in the IPO market (TOY, TSA).  Clearly a brand with just 31 stores has room to expand, hence the excitement.  We challenge anyone to come up with 5 retail brands growing at over 10%.

 

JCP Ends Big Book Catalogues - J.C. Penney Co. Inc.’s transition from “Big Book” catalogues to “look book” mailers is now complete. J.C. Penney will still be in the print media business, but the new books will become “specialty in-store” mailers showcasing select fashion looks or must-haves to encourage consumers to shop in-store or online. The traditional catalogue format featured everything in a particular category. Penney’s catalogue dates back to 1963 and grew to $1 bn in 1979. Shoppers who relied on the catalogues for their purchases can either go to jcp.com or contact a Penney customer care center, which will input the order through the Web site. <wwd.com/business-news>

Hedgeye Retail’s Take: The end of an era and the end of having to talk about “Big Book” compares.  Time to focus solely on e-commerce.

 

KCP and Macy's Work Together - Kenneth Cole Reaction launched at Macy's stores Wednesday, solidifying an exclusive collaboration built on a new partnership model that will in turn drive sales higher. This has proved to be the case with partners as diverse as Tommy Hilfiger and Rachel Roy, and Macy's expects similar results from Reaction. Since Macy’s started working with the Kenneth Cole team on the sportswear, the product has already evolved. The sportswear is intended to appeal to the young, contemporary guy. The retailer initially carried Reaction outerwear, footwear, tailored clothing, dress shirts and ties, pants and accessories, and the brand had had a track record of success. Since hitting the floor last week, bestsellers have included dress pants, sport coats, slim suits and patterned suit separates. Long-sleeve wovens, novelty knits, cardigan sweaters and graphic T-shirts have also been strong, said a Kenneth Cole spokeswoman. Beginning in February and continuing through the year, the retailer will work with designers to create capsule collections of women’s apparel that will rotate on the floor every two months. <wwd.com/retail-news>

Hedgeye Retail’s Take:  While exclusivity has worked in the past with M, we’re still not convinced that KCP has turned the corner on its apparel efforts.  There is still much work to do here, although the M collaboration and the acquisition of its sportswear license from Chaus are a start.

 

Espirit Targets Growth Through Outlet Expansion - Targeting cost-conscious shoppers, Esprit Holdings Ltd. is accelerating its U.S. retail growth with outlet stores, initially focusing on the West Coast and Southwest. The U.S. expansion strategy will be dominated by 3,500- to 5,000-square-foot outlets. Esprit plans to add 15 to 20 outlet stores over the next year — five this month in the California cities of Los Angeles, Gilroy, Vacaville, Desert Hills and Milpitas — and no full-price stores. Esprit manufactures merchandise specifically for its outlets and that constitutes 95% of what is on the floor. The average price is 30% less than Esprit’s full retail prices. <wwd.com/retail-news>

Hedgeye Retail’s Take:  Late to the outlet party but probably not a bad time to pick up some quality locations as even outlet malls have recently suffered a bit on both productivity and traffic levels.

 

Hilfiger Launches Younger Targeted Retail Store - On Thursday, Tommy Hilfiger unveiled the first Tommy boutique in the U.S., a 1,000-square-foot store at 375 Bleecker Street in Manhattan, in a former Hilfiger collection location. Two other U.S. Hilfiger stores will be converted to Tommy boutiques and two more Tommy stores were recently opened in Toronto. Tommy differs from the Tommy Hilfiger flagship sportswear stores, which are more uptown prep, more refined and more grown up. This is focused on the younger customer. The line will also be available at tommy.com beginning in the spring. Aimed at 20- to 30-year-old customers, the Tommy merchandise is accessibly priced. For example, Tommy knits will retail from $24 to $59, denim will run from $69 to $129, and outerwear will start at $129 for men and $139 for women. The collection is sourced through Li & Fung Ltd. and manufactured in the U.S., Asia, India and Mexico. <wwd.com/retail-news>

Hedgeye Retail’s Take:  While probably not a huge growth vehicle given the high cost real estate strategy (at least to start), this sounds very similar to Rugby.  Something to keep an eye on over the intermediate term.

 

Supply Constraints Dent Lacrosse Footwear - Supply constraints in China continued to impact LaCrosse Footwear Inc.’s business in Q3. The Portland, Ore.-based company saw stronger demand in the quarter for both its core work and outdoor products but revenue for both categories suffered from the capacity limitations of the firm’s third-party manufacturing partners in China.As a result, LaCrosse had a significant volume of work and outdoor boot orders that it was unable to fulfill, but it expects to ship them early in the fourth quarter. <wwd.com/footwear-news>

Hedgeye Retail’s Take:  Add Lacrosse to the list of companies including COLM and FINL expressing challenges in the supply chain over the past 3-4 months.

 

Sport Chalet Secures Credit Agreement - Sport Chalet, Inc. has secured a four-year, $65 million credit agreement with Bank of America, capping what it said was the first phase of a strategic plan to align its business with post-Recession reality.  Sport Chalet has embarked on a multi-pronged strategy to better align its business with the challenging economic environment. Initially, these directives included renegotiating rent on existing stores, deferring store openings, improving inventory management and reducing selling, general, and administrative expenses. To achieve sales growth, the company enhanced its online presence, aggressively growing its vendor brand shops, along with product and service offerings, while further expanding its Team Sales division. Additionally, the company continues to source the best technical performance and lifestyle merchandise in order to further differentiate the Sport Chalet shopping experience. Sport Chalet has implemented new micro-merchandising strategies to more accurately reflect each store's customer demographics, including specialty concepts such as new running and triathlon shops.  <sportsonesource.com>

Hedgeye Retail’s Take: The company’s updated strategic plans may buy SPCHA time, but with competition heating up for west coast locations from the east, it may only be prolonging the inevitable.

 

Russell Athletic Partners with the Harlem Globetrotters - Russell Athletic has signed a three-year deal to become the official uniform, practice gear and travel gear provider for the Harlem Globetrotters. Under the agreement, sister companies Brooks will be the Globetrotters' official supplier of casual footwear, and Bike is the team's official provider of athletic training supplies.  <sportsonesource.com>

Hedgeye Retail’s Take: Assuming the deal came at minimal cost relative to other opportunities, the ‘Trotters will give the brand a great opportunity for some highly recognizable marketing & advertising.

 

Vancl.com Says 2010 Sales May Triple on China Growth, Plans Nasdaq Listing - Vancl.com, China’s biggest online clothing retailer, expects sales to triple this year as more people in the world’s largest Internet market use the Web to buy apparel, the company’s chief executive officer said. <bloomberg.com>

Hedgeye Retail’s Take: The shift towards increased domestic demand has been underway for much of the year, but 3x is material step function up in anyone’s book. With e-commerce a robust growth channel, there is sure to be interest in the ADR should it get listed on the NASDAQ.

 

Ikea Plans Growth in China - Ikea, whose biggest Asian store is in China, plans to more than double its outlets in the country by 2015 as rising incomes turn more dozing visitors and diners at in-store restaurants into furniture buyers. The home-furnishings market is projected by Euromonitor International to surge 17% this year in China, the world’s fastest-growing major economy. Ikea said this month it will add $300 mm to the $1.2 bn being spent by a mall developer part-owned by the furnishings company, as the chain increases its stores in China to 18 from 8. The retailer also has three outlets in Hong Kong among more than 300 worldwide. China’s economic transformation lifted 300 mm citizens out of poverty during the past three decades, according to the United Nations. The growing prosperity will help the nation’s home-furnishings market expand to 186.9 bn yuan ($28 bn) this year. <bloomberg.com>

Hedgeye Retail’s Take: As the country’s economy grows – so does the nations wealth. Natural focus for the affordable home furnisher.

 

 


CAKE: GOOD BUT NOT GREAT

Conclusion:  While this was a solid quarter for CAKE, the company keeping quiet on the impact of the small plate menu on the average check is telling; traffic and price alone will not keep this company on the right trajectory.

 

CAKE comparable store sales at both concepts, Cheesecake Factory and Grand Lux, came in ahead of the street’s expectations.  EPS of $0.37 was comfortably ahead of the consensus of $0.34 (although helped by a lower tax rate).  Looking at CAKE’s position on our SIGMA chart, which measures comparable sales growth against restaurant operating margin growth, the company remains in the optimal “Nirvana” quadrant with both metric showing year-over-year improvements.

 

CAKE: GOOD BUT NOT GREAT - cake sigma 1022

 

Looking at the top line, blended same-store sales growth of 2.8% handily beat the consensus estimate 1.6%.  Imbedded in the comp was 2.8% traffic and 1.3% of price.  This implies that the company experienced mix of -1.3%.  While management was averse to discussing the impact of small plates and snacks on average check during the earnings call, there is clearly an issue there.  The only instance where management touched on “check management” was in reference to a “sequential stabilization” in non-alcoholic beverage incidence rates.   Should this trend continue, as management rightly pointed out, it would enable the company to capture more of its menu price increases.  I will watch this space – one quarter does not a trend make.   The main takeaway is that – over several quarters now – CAKE has had an average check problem and it is not going away.

 

Unit growth guidance was certainly positive.  Management guided to six-to-nine new units for 2011, a sharp increase from three new units in 2010 (the last opening for 2010 was completed in 3Q). 

 

Turning to the bottom line, there were several factors that contributed to the impressive earnings growth in the third quarter.  As was the case in 2Q10, the company gained leverage on the following expense lines in the P&L: 10 bps of leverage on labor costs, 60 bps of leverage on other and operating costs, 40 bps on D&A, and 30 bps on G&A.  COGS were up as a percentage of sales by 50 bps. 

 

In terms of commodity cost guidance for 2010, the company adjusted its prior guidance of flat-to-1% to a new outlook of 1%-to-1.5%.  CAKE is vulnerable to price fluctuations (or moves straight up) in several commodities where the company is not locked in on a price but dairy was singled out as one example by management. 

 

All in all, a strong quarter from Cheesecake Factory and the concept has strong consumer position.  The decline in average check is definitely a red flag. 

 

Howard Penney

Managing Director


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