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CRI: Opacity In, McGough Out!

I have officially been shut out of an analyst meeting for the first time in my 16-year career. Hey Carter's...there's this crazy little thing called Transparency. It matters, and I suggest you embrace it. Hedgeye is watching, and we see through the opacity of closed-door super-secret investor days.

 

"Sorry, the room is full."  Really??? Are people really beating down the doors to hike up to Shelton CT in the middle of earnings season for the meeting?  Also -- I worked in IR... No offense, but it was at a company 20x the size of Carter's. I've organized these events. There's no such thing as "no more room."

 

Can you believe that some companies still selectively pick who is invited to join the club?

 

If I were a real company with a real strategy and I firmly believed in both my strategic direction and earnings power (which is the case, by the way), I'd want to share MORE information with members of the investment community who are cautious on the story -- or flat-out short the stock. Guess what Carter's... when shorts cover it creates real demand for the stock.

 

Also, on that day when your stock crashes next year when people realize that the real underlying power is at least 25% below current expectations, or better yet -- if you proactively turn your fortunes around and prove me wrong -- don't you want one of the more influential voices on the Street to change along with the facts and get on board the stock? Do you think just MAYBE that institutions with meaningful buying power will pay particularly close attention? I suggest you ask them.

 

I'm willing to YouTube myself on all my analysis. Check it out below.

 

 

CRI: Opacity In, McGough Out! - c1

 

CRI: Opacity In, McGough Out! - v2

 

CRI: Opacity In, McGough Out! - c3

 

CRI: Opacity In, McGough Out! - c4

 

CRI: Opacity In, McGough Out! - c5


Q4 Theme Update - Consumption Cannonball

One of our key macro themes here at Hedgeye in Q4, and for the next several quarters, is the Consumption Cannonball – a period during which government supports subside while expenses ramp creating increasing pressure on the U.S. consumer. Here’s the latest update in light of today’s data from Howard Penney of our macro team:

 

 

“First, the ISM prints beats at 56.9 in October (the highest since May) from 54.4, that’s good news.  The contradicting and not all completely good news is that the upside appears to be completely driven by exports having increased 6 points in October while inventories dropped in October.  Not really a positive sign given that exports are such a small part of the economy and that the inventory builds accounted for 1.5% of the 2% GDP in 3Q10 (prior to the upcoming revisions).

 

What about the part of the economy that does matter, domestic consumption? A few bullet points:

  1. Both personal income and spending weakened in September.  Personal income fell 0.1%: the first decline since last September.
  2. The decline in income was driven by a $25.5 billion reduction in emergency unemployment insurance benefits.  Emergency benefits had boosted transfer income by $20.5 billion in August.
  3. Interest income (due to the Federal Reserve emergency interest rates fell 0.9% for the third straight month.
  4. Tax payments are up, driving disposable income down 0.2%.
  5. Real spending was up 0.1% driven by consumers diving into the savings rates which fell to 5.3% - matching its lowest level in over a year.

The Hedgeye consumer cannonball theme suggests that the next several quarters will be very taxing for the US consumer.  The thesis is based on very difficult year-over-year comparisons as Uncle Sam runs out of crutches and can no longer prop up the consumer.  A key takeaway from today’s data from the BEA is that transfer income is fading and taxes are on the rise.

 

While corporate profits are strong, the lack of confidence in the direction of the economy is holding back job growth as the unemployment rate will hit 10% before it will hit 9%.  The data continues to bolster our conviction; the private sector cannot make up the slack in income and the economy is experiencing Jobless Stagflation.”

 

 

Howard Penney

Managing Director

 

 

 

 

 

 

 

 

 

 

 

 

 


Toys R Popping Up Everywhere

With the holidays on the horizon, it’s hard to ignore one of the most important gifts of all.  Toys.  Every year approximately 43% of the domestic toy industry’s $21-22 billion in sales occur in the 4th quarter.  Historically, the discounters including Wal-Mart and Target flex their square footage in the toy category to take advantage of the seasonal surge.  Toys R Us also enters the discussion as the sole category killer left in the competitive set.   At this point, TRU is estimated to be the number three player domestically, with annual market share of 16% a point or two behind TGT.  Wal-Mart dominates with a low 30% share.  Furthermore, it’s no secret that the company makes its entire yearly profit in the fourth quarter- a legacy of a fixed cost infrastructure that can only be leveraged during the highest volume quarter.   For most of us who have invested in Toys R Us in the past, we know that the company rarely exceeds expectations with so much pressure put on such a truncated but overly important selling season.  With an impending IPO on the horizon, keeping close tabs on TRU this year will be a clear indicator of what to expect in the future.

 

It’s no secret that toys are used as a traffic driver as well as a loss leader (at least for the discounters) during the holiday selling season.  With that said Holiday 2010 is shaping up to be one of the most competitive for the category in years.  Interestingly this has little to do with Wal-Mart’s obsession with price rollbacks or Target’s  “half-off” toy sale which began this past weekend.  It also has little to do with Sears’ efforts to put seasonal toy shops in its stores.  The biggest wrinkle in the no-growth toy business comes from Toys R Us and its plans to open 600 pop-up stores for the holiday season.  This represents a massive increase from the 90 temporary locations opened in holiday 2009.  As of now, the majority of the stores are open and ready to leverage TRU’s infrastructure at a very low incremental cost.  In fact, pop-up shops (a.k.a vacant stores with leases measured in months, not years) represent one of the most unique opportunities for TRU in years. 

 

TRU is looking capture the natural traffic flow that flocks to malls and outlet centers for holiday shopping by locating their pop-ups in these highly trafficked areas.  Stores will be stocked with smaller (who wants to carry a tricycle through a mall?), popular, and high margin SKU’s as the strategy aims to eliminate the need for consumers to make a trip to their local strip mall in search of this year’s Zhu Zhu pets.  The concept makes a ton of sense.  The exact  impact of such an initiative however, is unknown and remains a wildcard for the discounters.  No matter how the results ultimately shake out for TRU, it’s hard to ignore such a dramatic increase in the number of doors peddling toys this year vs. last.  In fact, TRU’s 600 pop-ups overshadow its permanent store base comprised of 483 units. 

 

Below we attempt to quantify the amount of business that TRU management expects to garner from this strategy.  While this alone is unlikely to wreak havoc on TGT or WMT, it is hard to ignore the fact that toy-driven traffic will be impacted in some way for the discounters.  We look at the impact of the incremental TRU square footage and potential sales from a few different perspectives. 

 

First we take a look at the potential amount of sales TRU could garner if 100% of the pop-ups were generating sales per foot in-line with the company’s historical 4Q average.  Management recently stated it expects productivity to be on par with that of its core business.  In reality this could be conservative given productivity in malls and outlets is generally higher than off-mall properties, but we’ll consider this a base case for illustrative purposes.

 

Toys R Popping Up Everywhere - pop up sq ft

 

Next we take a look at what these incremental sales would represent as a % of TRU, TGT, and WMT’s respective toy business over the 4Q.  In other words, if 100 % of these incremental sales had to come from somewhere (assuming the category is flat and this is a zero sum game), how would it impact each respective business?

 

Toys R Popping Up Everywhere - retail impact 100

 

Finally, we make an assumption that the impact of the pop-up shops negatively impacts each retailer’s core business at a level commensurate with the market share that each holds in the category over the holiday season.  Keep in mind that share numbers are different than the annual share numbers given that TRU experiences the largest seasonality vs. the discounters. 

 

Toys R Popping Up Everywhere - retailer share impact

 

While there is no sure way to know what the impact of the pop-ups will be on the discount channel, it’s pretty hard to ignore the fact that traffic may in some way be negatively impacted.  This comes at an especially important time for Wal-Mart given management’s renewed confidence in generating a positive same-store sales result for 4Q.  Is the impact of Toys R Us alone going to cause WMT to miss?  Probably not.  However the fact that TRU has the potential to generate an incremental $100-$400 million in revenue from its pop-up strategy is definitely worth watching. Something has to give and in a category with so much share centered on three retailers it may not be easy for any one of them to escape without impact (including TRU cannibalization). If anything, we’ll now be better prepared for the roadshow which is likely to follow the outsized growth TRU expects generate from the pop-up strategy.  

 

Eric Levine

Director


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WYNN Q3 CONF CALL: A DELICIOUS MEAL

In between bites, Steve Wynn held an upbeat call except when talking about the US government.  Here is the transcript – minus the munching sounds.

 

 

HIGHLIGHTS FROM THE RELEASE

  • "Wynn Resorts also announced today that its Board of Directors has approved a cash dividend of $8 per share on its outstanding common stock...payable on December 7, 2010, to stockholders of record on November 23, 2010. The stock will begin to trade ex-dividend on November 19, 2010."
  • "On November 2 , the Wynn Macau, Limited Board of Directors approved a HK$0.76 per share dividend...payable on December 3, 2010, to stockholders of record on November 22, 2010. In addition, the Board of Wynn Macau, Limited determined the Company will consider paying recurring dividends, with a target yield of 1-3% annually, after a review of the then current financial results during each year and having regard to the terms of the financing documents that Wynn Macau, Limited is party to. The Board of Directors has determined that a target yield of 1-3% annually, will allow Wynn Macau, Limited to maintain ample liquidity to achieve its Cotai growth strategy."
  • Wynn Macau reported net revenues of $671.4MM and EBITDA of $198MM (below whisper expectations that we believe were a little north of $205-215MM range)
    • Hold was normal at 2.88%
  • Wynn Las Vegas reported net revenue of $344.5MM and EBITDA of $76.5MM
  • Cash: $1.9BN; Debt: $3.2BN with $2.6MM at Wynn Las Vegas and $552MM at Wynn Macau.  Post dividend cash will be $1BN and total debt will equal $3.4BN.
  • Capex was $40MM, almost entirely related to Wynn Las Vegas' room remodel

 

CONF CALL NOTES

  • "I believe that we've seen the bottom in Las Vegas" and had a nice October as well
  • EBITDA shouldn't be the most important metric - rather cash flow since interest and maintenance expenditures are real expenses
  • $150-160MM in LV at the nightclubs with 40% margins
  • Remodeled Wynn LV rooms are getting ADR premiums
  • They have been the victims of 8% annual increases in healthcare costs. As a result of the HC bill, it will now increase to 11-12%/ year.
  • Cotai - finally have a plan and a building drawn.  They have begun soil testing and will start site clearing soon.  Will show pictures and models in a few weeks.

Q&A

  • Some of the other fellows are desperate to increase their business in preparation for their IPO.  They made over $90MM in Oct in Macau. Would prefer that their competition adhere to the rules but they will leave that to the government.
  • Won't publish the building cost until their next conference cost - but it will be around $2.5BN. Will be open for business by 2015.
  • Japan strategy and update?
    • A cross party committee has been formed to study the matter and report back to the Diet
    • Exploratory committees are visiting Las Vegas and Macau
    • What happens is murky at best. They need to accept a budget which in itself can cause a crisis and a new election which can change the government.  Over the past 6 years, the average life span of a prime minister in Japan is 1 year.
  • Cotai land concession?
    • You lease the land from the government for a ground rent based on the property description.  The government commits in advance of the land grant.  The final land grant and lease payment is determined by what is being built and the license gets published in the gazette.
    • Final lease execution will occur in a few weeks
    • Will probably do an add-on to their credit facility and use the FCF to fund the majority of it
  • Additional commentary on Vegas bottom?
    • Convention and group is starting to improve and sees more stability
    • Have 65% of their convention room nights on the books for next year. Should return to 18-19% of their room nights and there is some rate improvement there.
  • They like it when their earnings are 50% of their debt
  • They would look at other markets in the interim of Cotai opening but don't want to talk about it now.
  • Trends in Macau - seeing more customers and longer stays
  • Hold percentage in Las Vegas has started to come back - as they get the better customers and better players back in 
  • Will they be adding more junket partners and thoughts on extending credit
    • They do have plans to add more junkets - 2-3 more junkets over the next year and one of which will be added before year end
    • Will not use credit to buy business
  • I don't know why they are so defensive about losing some market share... I mean their numbers are still good but clearly they did lose business
  • Do they think that Cotai will cannibalize Wynn Macau? 
    • No

Eye On Asia: Things Are Getting Ugly

Conclusion: With the U.S. facing the Consumption Cannonball and Jobless Stagflation, China, India, and Australia tightening monetary policy, and Western Europe fully implementing austerity measures, we think many Asian equity markets are due for a meaningful correction over the intermediate-term TREND. Supporting this outlook are increased signs of slowing growth and accelerating inflation throughout the region.

 

Positions: Long Chinese Yuan (CYB); Short Japanese yen (FXY); Short Emerging Market Equities (FFD); Bearish on Japanese Equities; Bearish on Indian Equities

 

There has been a slew of economic data coming out of Asia over the last few days – some good, some bad, and some ugly. Rather than belabor the point(s) with excessive prose, we’ll just highlight the meaningful deltas and inflection points in the call-outs and charts below.

 

The Good 

  • China’s PMI accelerated in October to 54.7 from 52.9 in September.
  • China granted the Hong Kong Monetary Authority a Qualified Foreign Institutional Investor license, which gives the city-state the right to invest Chinese stocks and bonds in an effort to diversify its $266 billion in reserves. This is yet another step in the yuan’s march up the global currency totem pole. Furthermore, today’s announcement gives rise to speculation that the HKMA will shift the Hong Kong dollar’s exchange rate peg to the yuan from the U.S. dollar in the coming years.
  • Japan’s Unemployment Rate ticked down in September to 5% from 5.1% in August.
  • Singapore’s Industrial Production growth accelerated substantially in September to +26.2% YoY from +8.1% YoY in August. We continue to be bullish on Singapore’s equity market and currency from a long-term  TAIL perspective due to reasons outlined in a July 14th report titled: The Singapore Sling – Why We Are Long of Singapore (email us if you need a copy). We, however, don’t have be bullish at every price as there is a fundamental difference between liking an investment and actually being invested in it.
  • Singapore’s PMI accelerated in October to 50.7 from 49.5 in September.
  • Singapore’s Unemployment Rate ticked down in 3Q10 to 2.1% from 2.2% in 2Q10.
  • Korea’s Export growth accelerated in October to +29.9% YoY from +16.5% YoY in September.
  • India’s Export growth accelerated in September to +23.2% YoY from +22.5% YoY in August.
  • Thailand’s CPI slowed in October to +2.8% YoY from +3% YoY in September. 

Eye On Asia: Things Are Getting Ugly - 1

 

The Bad 

  • Australia’s CPI quickened in 3Q10 to +0.7% QoQ from +0.6% in 2Q10.
  • Japan’s Personal Income growth slowed in September to +1.5% YoY from +1.8% YoY in August. Concurrently, overtime hours at manufacturers, a leading indicator for earnings, fell (-2.9%) MoM in September.
  • Japan’s Core CPI slowed in September to (-1.1%) YoY from (-1%) YoY in August. Deflation continues…
  • Thailand’s Export growth slowed in September to +21.8% YoY from +23.6% YoY in August.
  • Thailand’s Industrial Production growth slowed in September to +8.1% YoY from +8.4% YoY in August.
  • China’s Ministry of Foreign Affairs rebuffed U.S. Secretary of State Hillary Clinton’s offer to mediate a territorial dispute between China and Japan over the Diaoyu Islands, saying “[the islands] are Chinese territory, and the dispute over the islands with Japan is a matter between China and Japan… Clinton’s position is extremely wrong and the U.S. should correct its wrongful stance immediately.” This aggressive commentary out of China is the latest in a series of growing bravado towards the U.S. and Japan out of the Asian power.
  • Japan recalled its ambassador to Russia in response to a renewed territorial dispute with Russia over inhabited islands between the nations’ boarders. The islands, known as the Southern Kurils to Russia and the Northern Territories to Japan, are now in question following Dmitry Medvedev’s visit to the territory yesterday (he is the first Russian president to do so). Japan can now add another check mark next to “geopolitics” in its growing list of economic headwinds. 

Eye On Asia: Things Are Getting Ugly - 2

 

The Ugly 

  • China’s Input Price PMI accelerated meaningfully in October to 69.9 from 65.3 in September. As we have been calling out for months, QE2 = global inflation.
  • Japan’s Retail Sales growth slowed in September to +1.2% YoY from +4.3% YoY in August. Further along the consumer front, Japan’s Registered Auto Sales tanked in October, in line with our call, due to the unwinding of stimulus tailwinds: down (-26.7%) YoY from (-4.1%) in September. As we have learned for the greater part of the last two decades, this is not an economy that is able to support itself, relying exclusively on government intervention and global consumer demand to drive the paltry 80bps of average YoY GDP growth over the last 17 years.
  • Japan’s Industrial Production growth slowed in September to (-1.9%) MoM from (-0.5%) MoM in August.
  • Japan’s PMI slowed in October to 47.2 from 49.5 in September.
  • Japan’s PCE growth slowed in September to flat YoY from +1.7% YoY in August. One of the core tenants to our Japan’s Jugular thesis is that a slowdown in manufacturing and exports will resonate throughout Japan’s economy and exert downward pressure on GDP growth.
  • Japan’s Construction Orders growth slowed in September to (-15%) YoY from flat YoY in August.
  • Japan’s Prime Minister Naoto Kan’s approval rating dropped in October to 36.4% from 48.5% in September. This latest survey is a public vote of no-confidence in the face of the recently announced ¥6.6 TRILLION worth of stimulus. The Keynesian end-game seemingly draws closer with every passing day in Japan.
  • Indian companies are paying the highest short-term borrowing costs in 19 months, due to a series of rate hikes by the central bank to combat inflation, which is running at double the target rate (per the Indian Finance Ministry). Three-month funds have nearly doubled this year to 8.25%, putting pressure on corporate profitability within India. Anyone who says Indian equities are “cheap” on a NTM P/E basis relative to their 2007 peaks is likely using the wrong earnings forecast.
  • Korea’s GDP growth slowed significantly in 3Q10 to +4.5% YoY from +7.2% YoY in 2Q10. The slowdown in growth here is representative of a broader slowdown in growth we’ve seen across Asia over the last couple of months. More specifically for Korea, the 3Q10 print lapped the last of the easy YoY comps. In 4Q10 and 1Q11, Korean GDP has to comp against +6% and +8.1%, respectively.
  • Korea’s CPI quickened in October to a 20-month high of +4.1% YoY. Korea’s central bank has been reluctant to follow its Asian neighbors in aggressively combating inflation, opting for lip service regarding capital controls instead. The lip service has been unsuccessful to date, as the Korean economy is experiencing Marginal Stagflation (slowing growth; accelerating inflation). 

Eye On Asia: Things Are Getting Ugly - 3

 

Eye On Asia: Things Are Getting Ugly - 4

 

The Murky 

  • Both Australia and India raised their benchmark interest rates 25bps today in an effort to combat rising inflation brought on by global speculation that is being driven by dollar-debasement ahead of QE2 in the U.S. Furthermore, Australia’s largest home lender will raise its standard mortgage rate 45bps on Nov. 5th and India’s central bank proposed capping home loan-to-value ratios at 80% in an effort to cool domestic real estate speculation that has spread throughout the region (China, Australia, Singapore, Hong Kong, etc.). 

With the U.S. facing the Consumption Cannonball and Jobless Stagflation, China, India, and Australia tightening monetary policy, and Western Europe fully implementing austerity measures, where will global demand growth for Asia’s exports come from over the next 3-6 months? To whom will Asia ship its products? Keep in mind the following stats as you ponder the next moves in GDP growth and equity markets throughout Asia: 

  • Exports account for roughly 40-45% of Asia’s GDP;
  • The U.S. and E.U. combine for roughly a third of Asia’s export destinations; and
  • 40-50% of intra-regional trade within Asia is basic and intermediate goods meant for re-export outside of the region. 

Today we covered our short position in the U.S. Dollar (UUP) for a 14% gain, after having top-ticked it on June 7th. In that same time period, many Asian equity markets are up multiples of that, driven higher by reflationary inflows of yield-chasing capital. As evidenced by our most recent move in this globally interconnected chess match, we think the music stops here (much to Barton Bigg’s displeasure – see his bullish commentary on emerging markets from this morning).

 

Eye On Asia: Things Are Getting Ugly - 5

 

Should the dollar break out for a sustained period of time, we think the deteriorating fundamentals in Asia will be exposed, as growth in the region set to slow meaningfully over the next 3-6 months.

 

For reference, we outline below three factors we think could cause the dollar to break out: 

  • Hawkish fiscal rhetoric from the likely-to-be Republican Congress (we forecast a +65 seat gain by Republicans in the House and a potential tie in the Senate after today’s elections);
  • Mean reversion; and
  • A QE2 announcement shy of consensus expectations could trigger widespread reflexive declines in equities and commodities globally, which should support the need for increased liquidity as investors shift to cash on the margin. 

Buckle up; it’s likely to be a bumpy ride.

 

Darius Dale

Analyst


Election Day . . . Some Early Looks From The Ground

We’ve sourced some of our political contacts around the country and want to offer some early views of what we are hearing from the ground: 

  • Fond Du Lac, Wisconsin – “City of Fond du Lac Clerk Sue Strands said there’s been a steady stream of voters at the polls since they opened at 7 a.m. Strands had predicted a 63 percent turnout.” 
  • Cincinnati, Ohio – “An Enquirer analysis of early returns in Southwest Ohio shows that 43 percent of ballots mailed in were requested by Republicans, and 30 percent by Democrats. The rest were from independents or third party voters.” 
  • Portland and Bangor, Maine – “City officials in Portland and Bangor said the turnout as of midmorning was light. In Lewiston, an election official described the early turnout as steady.” 
  • St. Louis, Missouri – “It's a very heavy turnout," said Rich Chrismer, director of elections in St. Charles County, who predicted 65 to 70 percent of registered voters in the county will vote.” 
  • North Carolina – “State Board of Elections director Gary Bartlett says the two words he's been hearing from county officials so far are "steady" and "moderate." 

While it is difficult to read too much into these comments, it does appear broadly speaking that turnout will be more than the typical midterm election.  Interestingly, we have been watching the Intrade electoral markets this afternoon as well and would highlight a number of points there: 

  • The contract for the Democrats to control  the Senate has rallied well off its lows and is now registering 47.0, while the contract for the Republicans to hold 50 seats in the Senate is also rallying and is now at 38.0. 
  • The contract for Patty Murray (D) retaining her seat in Washington state is now at its highs of 69.2, which is likely leading to the increase in the Democrats chances of holding the Senate. 
  • The contract for the Republicans to gain a net 60 seats in the House is now 59.9, which is slightly off its highs of ~63, but still largely in positive territory for the Republicans.

More importantly: whatever your affiliation . . . get out there and vote! 

 

Daryl G. Jones
Managing Director


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