Isolated Curiosities

“Clouds are not spheres, mountains are not cones, coastlines are not circles, and bark is not smooth, nor does lightning travel in a straight line.”

-Benoît Mandelbrot


To say Benoît Mandelbrot lived a great life would be an understatement.  The recently deceased Sterling Professor of Mathematial Sciences at Yale University had the opportunity to follow and study his passion his entire life and, as a result, his contributions to the field of mathematics were vast.


Most interesting to our Hedgeyes was Mandelbrot’s work on fractals, which underscore many of our own market models.   In fact, Mandelbrot actually coined the term fractal in his consummate work, The Fracatal Geometry of Nature.  He also did what many academics actually have a hard time doing, he extended his academic studies into the more practical areas. According to our friends at Wikipedia:


“Although Mandelbrot coined the term fractal, some of the mathematical objects he presented in The Fractal Geometry of Nature had been described by other mathematicians. Before Mandelbrot, they had been regarded as isolated curiosities with unnatural and non-intuitive properties. Mandelbrot brought these objects together for the first time and turned them into essential tools for the long-stalled effort to extend the scope of science to non-smooth objects in the real world. He highlighted their common properties, such as self-similarity (linear, non-linear, or statistical), scale invariance, and a (usually) non-integer Hausdorff dimension.”


Mandelobrot passed away at the age of 84 years after more than 60 years of pursuing his passion.  He was one of the most celebrated mathematicians of the last 50 years and won innumerable awards for his work, including:  the Wolf Prize for Physics in 1993, the Lewis Fry Richardson Prize of the European Geophysical Society in 2000, the Japan Prize in 2003, and the Einstein Lectureship of the American Mathematical Society in 2006.  Most interestingly of his awards was perhaps that fact that he has an asteroid named after him:  27,500 Mandelbrot.


As it relates to financial markets, his primary contribution was determining that price changes in “financial markets did not follow a Gaussian distribution, but rather Lévy stable distributions having theoretically infinite variance.”  In addition to his study of financial markets, he also had an idiosyncratic character that was near and dear to our hearts. So much so in fact, that he actually gave himself his own middle initial, “B”, which actually did not stand for anything.


So in memory of Professor Mandelbrot and chaos theorists everywhere (especially our Harvard friend at a well known money management firm in Canada), we are going to focus on only 3 important global macro events this morning as it relates to managing risk, which are as follows:


1.  The Election – As many of our subscribers know elections are near and dear to our hearts and the upcoming midterm election is one we’ve been very focused on. (If you would like to trial our research and to see some of proprietary election analysis, please email  In fact, we are on record saying that we are more bullish for Republican chances than our friend Karl Rove.   For us, though, it is not about politics, but is simply math.  As the math stands now, and excluding races that are “too close to call”, the Republicans will win 233 seats in the house (a majority) and will win 45 seats in the Senate.  We believe that turnout could be the wildcard and slide many of the “too close to calls” to the Republicans as many poll internals show a highly motivated Republican base.  The primary implication of this is that the Republicans will likely implement immediate budget cuts, which, according to reports this morning, could be as much as $100BN as soon as January.  While in the short term a decline in government spending may hurt GDP, in the longer term deficit reductions will put the U.S. economy on a more stable path of growth.


2.  Greek Deficits – If you don’t think that government numbers can be wrong or revised lower, well now you know.  Greek deficits this morning were revised higher to 15% of GDP as, shockingly, tax revenues were worse than expected.  As we’ve been saying for months, sovereign debt issues in Europe will rear their ugly heads again and obviously Greece is at the forefront of that again this morning.  We’ve highlighted this point of Interconnected Global Risk in the Chart of the Day below, which highlights that credit default swaps in Europe are making higher lows. As these CDS spreads increase, we are likely to see equity markets act inversely to those spreads widening.


3.  U.S. Dollar – The U.S. dollar is appreciating this morning (not a sentence we have been used to typing over the last few months) on the back of Wall Street Journal reports that while Quantitative Guessing will likely be implemented on some level, it won’t be the “shock and awe” type that many proponents of Krugman Kryptonite were hoping would be implemented.  It seems Chairman Bernanke may actually be listening to some of his colleagues at the Fed like Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, who said Monday that more expansive monetary policy was a "bargain with the devil."  Indeed.  The most immediate term impact of a stronger dollar is likely a correction in those commodities that are priced in dollars.


Just like Mandelbrot, many of the fine folks at Hedgeye have left higher paying jobs to pursue their passion. This passion is the art and process of producing objective and real-time investment research, which we believe is Hedgeye’s core competency.  We aren’t always right and we aren’t always popular, but we passionately believe in what we do and we thank you for your support. 


Yours in risk management,


Daryl G. Jones

Managing Director


Isolated Curiosities - brots


Airport traffic was down 2% which should contribute to a lousy September on the Strip. Shrewd timing by MGM and its equity deal.



August was a blockbuster month on the Las Vegas Strip and MGM took advantage by pricing its equity deal the week after the numbers were released.  Nice timing.  At least they released their full quarter numbers so we could back into the September performance.  It didn’t look good then, at least in the Baccarat segment, (“STRIP BACCARAT TOOK A BIG BREATHER IN SEPTEMBER, 10/13/10) and it doesn’t look good now.  With airport traffic down 2% and facing difficult hold comparisons, the other gaming segments will likely come in disappointing as well, particularly slot win.


When MGM pre-released earnings, our conclusion then was “a 50% move in the stock for this?”  Indeed, the stock is down 19% in an up market and up sector since the day before they announced the equity deal.  In addition to the dilution, the anticipation of a September slowdown probably contributed to the stock pressure so the actual revenue release may not be a huge surprise.  However, it is clear that Las Vegas is not making the V-shaped recovery implied by the August numbers.  One month does not make a trend.


Here are our projections for September and the McCarran numbers:






The Macau Metro Monitor, October 27th 2010



The unemployment rate for July-September 2010 remained unchanged from the previous period (June-August 2010) at 2.9%.  The employed population increased by about 2,700 over the previous period to 320,200, in which employment of the Gaming Sector and Wholesale & Retail Trade both saw an increase.  Total labor force was 329,600 in July-September 2010 and the labour force participation rate stood at 71.8%, up by 0.4% point from the previous period.  Number of the unemployed held stable at 9,400, with 19.0% being fresh labour force entrants searching for their first job, up by 1.8% points over the previous period.  




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Conclusion: Results were slightly ahead of expectations but commentary indicated that current trends are sluggish.  However, on a two-year average basis the early trends in the fourth quarter continue to demonstrate acceleration on a two-year basis.


BWLD’s 3Q10 earnings came in at $0.47 per share, better than both my estimate of $0.45 per share and the street’s $0.44 per share estimate.  Company-owned same-store sales grew 2.6% in the quarter relative to the street’s 1.8% estimate, implying a 35 bp acceleration in two-year average trends.  Given the strong top-line trends and favorable food costs, which declined 185 bps YOY as a percentage of sales, restaurant-level margins improved about 110 bps YOY (putting BWLD in the Nirvana quadrant of our restaurant sigma chart).  The decline in the cost of chicken wings (down 15% YOY) drove the majority of this YOY food cost favorability.  The company’s reported tax rate of 30.4% came in lower than I was modeling and added about $0.02 per share relative to my numbers.


Although the company reported that company-owned comparable sales declined 0.7% during the first four weeks of 4Q10, this points to a 90 bp increase in two-year average trends since the end of 3Q10 as the company was lapping a difficult +5.9% comp from the first four weeks of 4Q09.  To that end, the low end of management’s 4Q10 comp guidance of “at least flat” is somewhat disappointing as the comparisons get easier for the balance of the quarter and a flat comp in 4Q10 implies a 40 bp slowdown in two-year average trends from 3Q10.  Same-store sales growth at franchisees slowed about 40 bps during the third quarter on a two-year average basis and trends during early 4Q10 remained in line with 3Q10 results.  And, the company’s FY11 EPS guidance of over 18% growth falls short of BWLD’s more typical 20%-plus range.  On the earnings call, management explained that earnings growth will be limited somewhat by higher YOY preopening expenses and increased investment internationally.  Management said its FY11 forecasts are still preliminary, however, and for now, they are being conservative, but they will give more guidance on expected earnings growth come their 4Q10 earnings call.


Relative to expected food costs in FY11, the company has extended its contract on boneless wings (represented 19% of 3Q10 sales) through March 2012 at prices about even with 2010 levels.  Although traditional wing costs (represented 21% of 3Q10 sales) have proven extremely favorable during the last two quarters and should continue to benefit margins in 4Q10 (about $1.51 per pound versus $1.78 in 4Q09), management said prices continue to fluctuate monthly and are one of the biggest unknowns relative to the company’s current commodity outlook.  That being said, the company currently expects traditional wing costs to be beneficial to margins on a YOY basis and is planning to implement a menu price increase in January, resulting in a cumulative 2% menu price increase for 1H11.


BWLD – FIRST LOOK - bwld sigma


Howard Penney

Managing Director

PSS: Ready, Shoot, Aim

There was an odd disconnect in leaving the PSS meeting late last week. The analyst side of us was quite content. “Ok, story on track. Check the box. Now let’s move on.” But unfortunately, there’s also the part of us that has to answer those ‘freak out’ questions around “what are we missing? Why’s the stock down? What are they comping this month? What did Matt say?”. After letting the dust settle for a few days, we’re still squarely in the ‘check the box’ Camp.


We have a complete review of the event below, but there were two standouts that put the Street in ‘freakout’ mode.


Freakout #1: For the first time, PSS articulated a clear long term earnings growth model, showing how it will deliver 3-5% top line and leverage that to 12-16% EPS growth. Like any portfolio, some areas will outperform, and others will underperform. But the net should be mid-teens. But the ‘freakout factor’ was due to domestic Payless coming in at flat-lsd in the long-term model. That, of course, triggers the question as to why it is acceptable for their core business to be flat. We’d answer that 3 ways.

1)      If a flat core equals a zero-growth cash flow model, then we agree. But we’re talking about using the cash cow to fuel the PLG business (Sperry and Saucony, in particular) as well as Payless International – which have far better growth characteristics.

2)      Do you think that just MAYBE this management team is tired of having egg on its face and wants to set long term goals that are achievable, and even beatable? The answer there is yes.

3)      Lastly, as it relates to mid-teens EPS growth, though not the intent, our sense is that management would have softened up that meaningfully if current trends did not support those kind of numbers.


Freakout #2: The ‘A’ Word. [We’re going to get heavier into vetting acquisition candidates – some could be sizeable.]

Ok, now THIS is a concern I agree with. Last time around, when PSS bought Stride Rite, it inadvertently topped the credit market, housing market, and consumer spending cycle. Yes, it was totally overpriced, and the timing was aweful. The one thing that bugged me was a reminder by management that ‘we only had two weeks to vet the deal before making a decision.’ Based on our conversations with the team, they’ve got a real process this time around to vet any potential deals. If push comes to shove, they’ll bow out in a heartbeat.


But are acquisitions necessary? We’ll never justify paying for the hope of landing a good deal. But facts are facts, and Saucony and Sperry combined generate ~$450mm in revs up from ~$270mm in 2007 and now account for approximately 35% of the company’s EBIT. Also, with the percent of directly sourced product at domestic stores hovering at 73% (up from 30% 5-years ago) we think that PSS has simply become too slow. Our sense is that the company will downshift that percentage by at least 10 points over the next year. But in addition, a smaller acquisition of product exclusively sold at Payless might be a good traffic driver.


I hate to give a statement that is so cliché, but one thing that is clear is the depth of the bench at this company. Find me another company – in any space – that literally has its 20-top managers available in one room at the same time to a group of 20 sell side analysts and 40 investors. One smart young lad and I were talked after the meeting and he said something like “when I listen to these guys present, it makes me think I’m listening to a management team of a $5bn Enterprise Value company. Not one that is struggling to keep its head above a billion.”


So let’s take this full circle. We walked away thinking that the story is on track.


PSS: Ready, Shoot, Aim - PSS SOP 10 10



Despite consolidated growth expectations of 3%-5%, we believe some investors were expecting more robust growth from the domestic business, or even a major “we have it all figured out” announcement. But put into context, even if we assume flat domestic sales over the next 3-years, the PLG segment has substantial upside from low-to-mid teens growth in our view. With Sperry and Saucony combined accounting for just over 50% of PLG sales (~$450mm), Saucony has been a consistent 20%+ grower with sales recently trending north of 30% (see chart below). Moreover, in addition to the build out of retail stores, Sperry is continuing to aggressively ramp its women’s business. With roughly 7 stores by year end and approximately 15/yr going forward, we estimate retail growth alone will account for ~5% annual growth in PLG. Women’s represents an even greater opportunity. According to NPD data, women currently represent ~20%-25% of Sperry sales, which may be slightly understated but is 4x-5x year ago levels on an apples to apples basis. Based on discussions with management, expectations are to have womens at 50% of sales by year end implying over $50mm in incremental sales over the next year – another 6%-8% growth in PLG. While calling fashion is certainly not our specialty, what we saw in KC in initial product from Sperry’s new head designer was a drastic improvement from what customers have been accustomed to from the brand. Lastly, the brand is also benefiting now from a materially improved tiering strategy that was simply not in place 6-months ago with more product being flowed through the higher priced department store channel.


One additional comment on the flat domestic outlook – the company’s expectation for accessories (including apparel) to grow from 10% in 2010E to 12% by 2012 implies a ~$330-$340mm business growing 10%-15%/yr to $420-$440mm in 2012 adding another 1%-2% growth to consolidated top-line.


Sperry Top-Sider Store Walk: 

  • Opened first store opened in Feb 2010 (at 5 in total) with another 2 before year end (Burlington, MA & Westchester Mall, NY in mid Nov.) 
  • Size: Kansas City store ~2,000 sq. ft. – company has determined ~1,500 sq. ft. is optimal size
    • Have a few stores as small as 1,000 sq. ft. - too small
    • Customers doesn't use the ‘boathouse' (the help yourself layout more typical of a Payless store in the rear) in smaller footprint stores 
  • Growth: looking at 10 in-line + 3 outlet locations annually depending on opportunity (analyst day suggested closer to 10-20 stores/yr
  • Distribution: The first initiative of Bill Bettencourt, SVP of Sales, Marketing, and Business Development,  after joining the firm in May 2010 was to properly tier the product by channel
    • Sperry developed the Compass line (more value) for the mass channel
    • Tiered product more by design differentiation than price
    • Select product is now released downstream on a lag (e.g. a style launched at Nordstrom hits shelves at Dillard's 3-months later) 
  • Apparel & Accessories: Company findings from focus groups suggest that consumers are challenged with how to match product with apparel
    • Starting next month, PSS will be working with a partner showcase apparel along with the footwear in an effort to help educate the customer – the byproduct is acquiring an acute sense of what resonates with the Sperry consumer as PSS looks to pursue its own branded opportunity in the channel 
  • AUR has been above plan all year as well as less promotional
  • Head designer Bradley started roughly 12-months ago – product just starting to flow through now (Fall 2010) and has been very well received so far



  • Saucony:
  • Selling into FL well, great representation at new Run concept
  • Less enthusiastic re FINL - appears to be diluting their offering on the margin
  • 1 lightweight shoe currently (Kunvara), will have 5 by next year
  • Sporting Goods channel one of most significant growth opportunities going forward


  • Sperry:
  • JWN, M, DDS, & Belk (4 of top 5 customers)
  • Have closed 2,000+ doors over the last 18-months at past customers KSS, JCP, & FINL (400 doors)
  • Have entertained/discussed partnering with JCG to curate apparel in-store for the intermediate-term, another smaller brand near-term that they will use
  • Expect women to represent ~50% of sales by year end
  • Sperry retail stores carry ~300+ SKUs per store; Department store customers more like 30-40 SKUs per store

Highlights from Presentations:



  • Contrary to the company's historical view on guidance, it provided an initial 3-year outlook with annuals goals of Sales +3%-5%;  Operating profit growth of +9%-12%; and EPS growth of +12%-16%.
    • Payless > flat-to-+LSD (domestic +/- flat/ Int'l +MSD); CLI > +mid teen; PLG > +low-to-mid teen

1)       Appears conservative though little upside in setting the bar high when sentiment is already low

While some expected more robust growth from the domestic business, smaller segments CLI and PLG appear to have upside


PSS: Ready, Shoot, Aim - PSS AD 3 10 21 10


PSS: Ready, Shoot, Aim - PSS AD 2 10 21 10


PSS: Ready, Shoot, Aim - PSS AD 1 10 21 10



  • Rubel first mentioned acquisitions as in the bolt-on kind, then suggested the possibility of a larger deal later in the presentation - this is after being more focused on share repurchase and debt reduction following Q2 results
  • Company hasn't made a transformative deal since Stride Rite in 2007 - this likely raised concern among investors given the length of integration

Store Growth:

  • Int'l accounts for ~$445mm and nearly 700 stores
  • Int'l far more productive with EBIT margins of 10.5% vs. 4.2% at domestic Payless stores
    • Payless stores have ~$575k store productivity; Canada/Puerto Rico ~$625k; and Latin America ~$750
  • Latin America key growth region (Canada and Puerto Rico mature)
    • Current store base of ~300 with opportunity for additional 100
  • Jamaica to add 10 in 2011
  • Mexico to enter Mexico via franchise model then invest as JV - expect 5-15 stores by 2012 with opportunity for 300+
  • Newly announced franchise agreements for Middle East, Russia, Turkey, Israel, Singapore, Malaysia, Philippines, and Indonesia give Collective Brands access to 800mm people
  • Plans for 80+ stores under franchise agreements to open in 2011 with an opportunity for 700+ stores within 5-years


  • Plans to aggressively shift out of China to other countries (primarily Vietnam and Indonesia)
    • % of footwear production from China from 96% in 2008, to ~85% in 2010E then down to mid-to-low 70s in 2011 and 2012
  • Migrating stitching and operations to west and north China
  • Continue to consolidate # of factories to increase synergistic value and quality control from ~125 in 2010E to <100 by 2012
  • Distribution infrastructure in Colon, Panama adjusted for growth through 2012, then flexible to grow or potentially move depending on growth prospects in Central/South American growth

Apparel & Accessories:

  • Category has grown to 10% in 2010E from 8% last year with the expectation of reaching 12% by 2012
    • Implies a ~$330-$340mm business in 2010 growing 10%-15%/yr to $420-$440mm in 2012 and adding 1%-2% growth to top-line alone


  • Expect inventories up in Q3 when Oprah left levels very low and again in Q4 with new product in (e.g. boots & toning) versus lower than average levels at the end of last year

Improvement in Store Metrics:

  • Typically fluff, but measureable improvement out of the company's 'New Customer Engagement Model' including 90bps improvement YTD in customer conversion and 350bps improvement in units per transaction

PSS: Ready, Shoot, Aim - PSS S S SalesTrends 10 23 10


PSS: Ready, Shoot, Aim - PSS S S Units ASPs 10 23 10


PSS: Ready, Shoot, Aim - PSS Sperry SalesbyGender 10 23 10


PSS: Ready, Shoot, Aim - PSS Sperry ChanDist 10 23 10



Lecturing Myself On Shorting, Part II

This note was originally published at 8am this morning, October 26, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Learn to fail with pride and do so fast and cleanly. Maximize trial and error, by mastering the error part.”

-Nassim Taleb


Before I shorted the SP500 on October 13th, I wrote an Early Look note that was titled “Lecturing Myself On Shorting.” I shorted the SP500 again yesterday, so I figured I’d call this morning’s note Part Deux. Immediate term tops are processes, not points.


Chapter 1 of Pablo Triana’s “Lecturing Birds On Flying” provided some food for thought in my initial note and this morning I’ll review Chapter 2, “The Financial Economics Fiefdom” where Triana takes the ball right up the middle on the academic dogma that permeates the US economic system.

  1. On Milton Friedman – Triana argues that the heart of Friedman’s economic theory is that “theories should not be judged based on the realism of their assumptions.”
  2. On Business School – Triana writes on page 37 that, “In sum, B-schools discarded tangibly accurate knowledge and information while embracing what may be deemed as analytical make-believe.”
  3. On Herbert Simon – Triana reminds us that it was Simon who “held behavioral parapet, embracing observation-based empiricism and avoiding dogma-based economic theory.”

Most financial types know who Milton Friedman was but couldn’t tell you much about Herbert Simon. As I read Triana amplifying his point by calling out Simon’s name, I couldn’t help but smile.


Herbert Simon wrote one of my favorite multi-factor modeling books, “Models of My Life.” Charlie Munger recommended it at one of Berkshire’s annual meetings. As Triana points out, Simon was a Hedgeye kind of guy - he “ruthlessly ridiculed the financial economists’ assumptions about human action.”


My analytical team doesn’t wake-up every morning looking for someone to chirp. Keynesians are easy targets right now. They missed Jobless Stagflation in the 1970s too. Fed Chief Arthur Burns opted to monetize US Treasury debt and a Debauched Dollar was the result. Back then, the Nobel Prize in Economics was a new award. Today, some of the biggest risks in life are associated with investing alongside the academic premise of a Nobel winner.


This is where the likes of Simon, Soros, and real-time market practitioners of daily risk management take over the game. Anytime we see someone talking up an economic theory (QE2) that we’d have reserved seating for in the cheap seats, we’d just as soon call these wannabe market players out for who they really are. They travel in packs and are rarely accountable to their theories where it matters – on the tape.


On page 41, Triana offers a solution to this mess. He writes that “once you have mastered the analytical toolbox through your PhD training, churning out research output that may be simply the result of repeatedly applying well-worn techniques… the amount of true innovativeness may be limited. Much more creativity is required from those who can come up with applicable actionable breakthroughs and hard industry knowledge.”


Then on page 43, Triana supports his solution by quoting the former dean of MIT Sloan School of Business, Richard Schmalensee: “The academic system’s current methods for hiring and rewarding professors don’t necessarily attract or encourage the kind of practitioner-oriented faculty we need to make business-school research and MBA education much more attuned to meeting today’s and tomorrow’s management challenges.”


Point made, Mr. Triana. Point made.


Anytime you take a position in this game, measuring time and space is critical. When it comes to timing a short position, I don’t think I ever really had anyone teach me in real-life never mind at school. Maybe that’s what makes me better than bad at shorting stocks. I teach myself by doing. I learn to fail with pride. And, in most cases, I try to do so “fast and cleanly.”


My immediate term support and resistance lines for the SP500 are now 1178 and 1189, respectively. For now, by all of +0.10% my current short position in the SP500 (SPY) is in the black. I raised the Cash position in the Hedgeye Asset Allocation Model to 64% yesterday.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Lecturing Myself On Shorting, Part II - lecture

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