We Think Ackman Is Wrong on Housing

While we weren’t at the most recent Value Investors Congress, we have heard about a number of the ideas that were presented.  As usual, it sounds as if most of the ideas were thoughtful and well researched.  The one idea that we would take the other side of, though, was Bill Ackman from Pershing Square’s idea to be long, literally, U.S. housing, which was unveiled in a presentation titled, “How To Make a Fortune”.  To state it bluntly, we think Ackman is wrong on housing.


We understand his thesis on U.S. housing focuses on a few key points.  First, affordability is at its highest (so most affordable) in decades due to low low mortgage rates.   Second, household formation will rebound and go back to long term trends, which suggest growth in demand.   Third, supply of housing, which he admits is high, will start to decline as builder production rates are as low as they have ever been.  Finally, he believes the downside in housing is limited because at a price institutions could step in and soak up the excess inventory.  To be fair to Ackman this is a secondhand summary of his thesis, but we wanted to address some of these key points and highlight where this thesis falls short.




The oft used point to support a bottom in U.S. home prices is affordability, which is underscored by the fact that mortgage rates are at all time lows and make the financing costs as low as they have ever been.  While we can’t disagree that mortgage rates are at all time lows (that is just a fact), we do disagree on affordability.  First, credit standards have increased and lenders typically require larger down payments and more upfront points, which increase the “all-in cost” of a house. (If the consumer can get a loan at all.)  Second, we believe, based on our supply and demand models, that home prices have anywhere between 15 – 30% more downside, which implies that the U.S. housing stock is actually overpriced.  Finally, and most importantly, our analysis actually shows as houses get “cheaper”, or more affordable, demand goes down.


Household formation


As we’ve highlighted in the chart below, based on our proprietary census work, household formation has turned negative for literally the first time ever.  This is attributed to the fact that individuals are getting married at later and later ages.  In fact, we have seen a 1000 basis points growth in unmarried people in the aged of 25 – 34 over the last decade.  As these people get married less and later, it has a commensurate impact on household formation.  In the shorter term, unemployment is also a key negative catalyst for household formation.   If the long term trend in the chart below tells us anything, we shouldn’t look at history as a guide for future household formation.


We Think Ackman Is Wrong on Housing - 1


Housing supply


Despite new homebuilding rates being at all time lows, we have seen no meaningful improvement in the national housing inventory overhang.  In the chart directly below, we highlight months of supply of homes on the market.  Currently, there are almost 11 months of supply on the market, which is near the highs of 2008.  Specifically, there are now 4.04 million housing units on the market, a number which has accelerating throughout the year.  So, while it would be nice if low new homebuilding rates had an impact on this massive inventory overhang, they do not.  The primary reason for this is, of course, that new home sales are a small percentage of the overall housing market. (As an aside, there are also an estimated 6 million houses that are not on the market, but are considered “shadow” inventory.)


We Think Ackman Is Wrong on Housing - 2


We Think Ackman Is Wrong on Housing - 3


Institutional buying of houses


While on a limited basis, small funds have been created to buy housing stock, we have not seen institutions stepping up on a larger scale to buy houses.  The primary reason for this is that individual homes don’t lend themselves to purchases of scale due to their localized nature.  Each and every neighborhood is unique and has its own attributes from which value must be determined and researched.  As well, the management of single family housing as an asset is labor intensive as it relates to managing the rentals of these properties.  Further, a wide-scale institutional buyout of housing stock would require banks to suffer massive losses on their loan books – a scenario that they have been avoiding the entire time, as evidenced by the growth in average number of days homeowners spend in foreclosure (which is also impacted by other factors such as moratoriums and litigation).


Our Financials Sector Head Josh Steiner and his associate Allison Kaptur have done the bulk of our work on housing, include a 101 page presentation, and as noted above, one of the primary reasons that we remain bearish on housing is that we expect future prices to decline anywhere between 15 – 30%.  Specifically, supply of housing is in the top two deciles of inventory levels, and historically prices have typically fallen more than 15% over the following 15 months when at these levels.  The correlation on an r-squared basis of supply and future pricing is 0.83.


As our CEO Keith McCullough likes to say, facts don’t lie, people do.  As the housing river cards continue to show their data, it is becoming increasingly that U.S. housing in no bargain.


Daryl G. Jones

Manging Director



November 19, 2010






  • Foot Locker management confirmed our view that acceleration in the basketball category remains in the early stages.  This is consistent with our weekly trend data that showed a 50+% increase in the category for October.  Management also highlighted that demand is across the board, with key products from UA, NKE, Adi, and Reebok selling well.
  • GPS noted that it will pull back on holiday marketing spending this year.  Recall that last year the company returned to TV for the first time in three years, only to find that it did little to move the needle on sales.  Capital preservation remains the key here.  Consistent sales growth in core Gap remains elusive.
  • In a positive sign of improving traffic, SCVL highlighted trends were up +2.5% in Q3 against the first tough comp (i.e. +5.7%) in over 2-years. Moreover, while posting a +7.2% comp for the quarter, the company reaffirmed comps would still have been up mid-single digit excluding the positive contribution from toning reflecting the underlying strength in core sales.



APP and Groupon Hookup - American Apparel Inc. today launched a nationwide Groupon offer in which consumers pay $25 for $50 of merchandise. However, unlike Gap Inc. , which offered its Groupon deal in August only for in-store purchase, American Apparel is allowing consumers in markets that do not have an American Apparel store to use the voucher online. For consumers in markets that do have a bricks-and-mortar store, the Groupon offer is in-store only. The offer also excludes shoes, sale items and various other categories. “We wanted this to be a truly national deal and it didn’t feel right to exclude people just because we haven’t opened a store in their city yet,” says a spokesman for American Apparel, No. 269 in the Internet Retailer Top 500 Guide. “This hybrid model should allow us to reach new customers we otherwise wouldn’t have met and drive traffic to our retail stores and web site.” American Apparel says that its goal is to give consumers an opportunity to try the retailer’s new knitwear products, its nail polish line and other products that are new to the company in the past year. “There is simply no other opportunity around to do something like that on a such a large scale,” he says. While Groupon typically takes a 50% share of the revenue generated from its offers, American Apparel says it negotiated a special rate for its offer. The company declines to disclose the specific arrangement. <internetretailer>

Hedgeye Retail’s Take: With 10k consumers in NYC, 6k in LA, and 7k in Chicago purchasing the offer by 4pm yesterday, Groupon has once again proven it can drive traffic. While positive, it’s far cry from the success Gap experienced for its $25 for $50 deal back in August that drew close to 500,000 customers stores.


Top Brands of Chinese HNW Consumers - A Shanghai-based research firm focusing on the luxury goods market, FDKG, has carried out a study about China’s high net worth individuals and has compiled a top ten for the luxury brands that wealthy people in China like to buy. The top ten brands by ownership amongst Chinese net worth individuals are Louis Vuitton, Dunhill, Gucci, Ports, Dior, Armani, Hermès, Chanel, Zegna and Prada. The study examined the spending habits of almost 800 wealthy Chinese businessmen and women from across the country, whose annual income reaches RMB1m ($150,000) on average. Ken Grant, managing director of the consultancy firm, commented: “Our view is that the habits of wealthy individuals in this market remain embryonic but that this will not last for long. Now is the time for luxury goods businesses to seriously consider engaging with the Chinese market.” <FashionNetAsia>

Hedgeye Retail’s Take: While high fashion dominates the list, China’s growing wealth suggests early movers in luxury retail like Ralph Lauren have share to gain.


Forever 21 to 5th Ave - Forever 21 is out to prove it has universal appeal — from Fifth Avenue here to London’s Oxford Street. The chain today opens a 45,000-square-foot unit at 693 Fifth Avenue, formerly home to the tony Takashimaya, where spare merchandise was artfully displayed and fresh flowers bloomed in the first-floor floral shop. Now there’s a shoe salon and trendy items such as fake fur vests ($22.80), fake leather bomber jackets ($24.80), looped wool ponchos ($24.80) and one-shoulder velvet dresses ($19.80). Forever 21 has a temporary six-month lease. “We want to be on Fifth Avenue permanently,” said Larry Meyer, Forever 21 Inc.’s senior vice president. “We are focused on making this store work. We hope the economics work out.” In the meantime, the space is being marketed by Thor Equities, the building’s owner. “We’re negotiating now with 10 different retailers,” said Joseph Sitt, chief executive officer. “They [Forever 21] are one of the 10.” <WWD>

Hedgeye Retail’s Take:  Forever 21 remains the poster child for being the retailer with the MOST flexible retail strategy.  While we’re not sure how taking a location on 5th Ave and in former Mervyn’s locations creates much synergy, we do know that being private certainly helps. 


Swiss Watch Exports Still on the Rise - Swiss watch exports rose 18 percent in October to 1.6 billion Swiss francs, or $1.65 billion, fueled by sales of watches priced between 200 and 500 francs, or $206 to $516, the Federation of the Swiss Watch Industry said Thursday. "The main markets for the Swiss watch industry achieved better than average growth in October," the federation said. Watch exports rose 20.6 percent between January and October to 12.82 billion Swiss francs, or $12.16 billion. Dollar figures are calculated at average exchange rates for the period in question. Hong Kong, the largest market for Swiss timepieces, continued to achieve a sustained rate of growth, up 38.1 percent on the month. But China overtook it as the leading growth market with a rise of 42.6 percent in October. <WWD>

Hedgeye Retail’s Take: This continues to be a trend driven by currency arb and China’s growing wealth amongst the country’s young population.


The New Slim - Slimming down is all the rage today in the dress shirt and neckwear markets. Driven by demand from a younger consumer, shoppers are responding to narrower silhouettes in both categories, and manufacturers are responding by slicing material from billowy shirts and narrowing the width of their ties. Updated patterns in dress shirts and new fabrications in neckwear are also garnering interest as customers seek a quick and simple solution to update their wardrobes. “Both businesses have been good,” said Lou Amendola, chief merchandising officer of Brooks Brothers. “We’re selling ties that are more youthful in width and pattern, and on the shirt side, slimmer silhouettes are driving the business.” <WWD>

Hedgeye Retail’s Take: Whether by design or demand, less material is yet another way to offset higher costs. While this trend may indeed be more a function of macro dynamics than anything else, we wonder if the same opportunity is already exhausted for denim brands with skinny jeans now in Yr2.


Black Friday Expectations Optimistic - Talk of discounted toys, e-readers, appliances and even HDTVs has millions of Americans already mapping out their Black Friday plans and filling out their wish lists. According to a preliminary Black Friday shopping survey, conducted for the National Retail Federation by BIGresearch, up to 138 million people plan to shop Black Friday weekend (Friday, Saturday and Sunday), higher than the 134 million people who planned to do so last year. According to the survey, approximately 60 million people say they will definitely hit the stores while another 78 million are waiting to see if the bargains are worth braving the cold and the crowds. "The rules for Black Friday have changed significantly,” said NRF President and CEO Matthew Shay. “Instead of waiting until Thanksgiving Day to announce their promotions, many retailers are getting shoppers excited about Black Friday by offering sneak peeks of deals in advance, using social media to create buzz, or teasing upcoming deals on their websites.”  <NRF>

Hedgeye Retail’s Take: An increasing population of technologically literate consumers coupled with retailers embracing new e-commerce/mobile concepts are sure to keep consumers abreast of the latest deals – not to mention the flexibility to adjust promotions mid-stream if need be.


New Bill Against Online Counterfeits - The Senate Judiciary Committee unanimously passed a bill on Thursday that would crack down on counterfeit merchandise and pirated products sold online by “rogue Web sites.” The bill, approved by a vote of 19-0, will advance to the Senate for a vote but it is uncertain whether the leadership will take it up in the truncated lame-duck session. If the Senate were to pass the bill, it would still not be enacted this year because there is no companion bill in the House. The bill will have to be reintroduced in the Senate next year, introduced in the House and pass both chambers before it can head to the president’s desk for his signature. Still, proponents of the bill saw the Senate committee’s approval as a big step in the right direction. “Today’s Senate action on legislation to combat online counterfeiting and digital theft is a major step forward for protecting American jobs and consumers,” said David Hirschmann, president and chief executive officer of the U.S. Chamber of Commerce’s Global Intellectual Property Center. The bill targets Web sites that primarily engage in online piracy and counterfeiting and are often foreign owned and operated. It would give the Department of Justice an expedited process to clamp down on Web sites dedicated to selling infringing goods and services and counterfeits, give authority to Justice officials to file civil action against domain names repeatedly selling counterfeits or providing online piracy and go after foreign site operators. <WWD>

Hedgeye Retail’s Take:  Score another one for the “brands” which have slowly but steadily been winning the war on counterfeiting.  We just wonder how this will play out for those brands actually looking to grow in China.  Bringing authentic goods into the largest counterfeit market on earth is certainly going to pose a challenge.  We’re pretty sure there is no “Senate Judiciary Committee” in China to deal with these issues.


Indian Workers to Strike - Apparel factories across India will close down today, the first such strike in the country’s clothing industry, to protest rising domestic cotton prices. The industry is seeking a total ban on exports of cotton yarn, the primary material used in the industry, which employs some 80 million Indians indirectly. In April this year, in response to pressure from the industry, the government banned raw cotton exports. Although that ban was later lifted, further export restrictions were put in place in October. “Because of cotton yarn exports, there is a serious problem of cotton yarn availability in the domestic market,” said the All India Apparel Export Promotion Council, an umbrella body that represents most apparel manufacturers. It added that its representatives across India, the world’s second-biggest exporter of cotton after the United States, would meet government officials to push for a ban. <WWD>

Hedgeye Retail’s Take:  One word (again). Inflation.


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Conclusion: The quadrant chart posted below portrays a clear picture of the current situation for restaurant stocks.  A disproportionately large number of companies are operating in “Nirvana”; comparable restaurant sales are growing year-over-year and restaurant operating margins are expanding year-over-year.   The valuation multiples in the chart are assigned by the Street and a clear relationship can be seen between valuation assigned and operational performance (different quadrants).


The following companies are currently operating in Nirvana as of the most recently reported quarter: CMG, BJRI, YUM, SBUX, MCD, PNRA, CAKE, DIN, TXRH, DRI, BWLD, RT, MRT, and PFCB.  With the exception of DIN, DRI, BWDL, and PFCB, all of these companies were in the same quadrant as of the prior reported quarter also.  On a NTM EV/EBITDA basis, the group is trading at an average of 9.4x.  If we remove CMG from the list the multiple falls to 8.9x.


I would like to highlight several names that are, in my view, facing a possible move out of Nirvana in the next quarter or two.  Yum China, TXRH, MRT, CAKE, BWLD, MCD, CMG, PNRA and RT are the primary names I am watching in this regard.


Yum China has performed will over the last number of quarters and exceeded my expectations.  That said, I firmly believe that the company will find it difficult to extend their stay in Nirvana more than another quarter or two.  As I posted earlier today in my note titled, “YUM – WATCH CHINA CONFIDENCE”, consumer confidence is a key driver of top line trends for Yum China and took a sharp turn down in the third quarter.  Where that metric trends from here is a key question going forward.  Additionally, McDonalds announced that the company has raised prices in China due to higher raw material costs.  If Yum experiences the same pressure, it could either translate into margin pressure or, in the event of an ill-received price increase, additional drag on sales.


TXRH and MRT are obviously highly exposed to rising beef costs and many companies in the restaurant space, in the Casual Dining and Quick Service concepts, have highlighted elevated beef costs as a key concern going forward.  Additionally, for Morton’s, layoffs (that many are expecting) in the financial sector could have an impact on sales trends.  This is not helped by the fact that a sharp step up in comparable restaurant sales from 3Q09 to 4Q09 will present MRT with a far more difficult compare in the last quarter of 2010.


CAKE’s average check problem remains a concern and comps are more difficult to lap in 4Q than they were in 3Q when the company barely comped the restaurant operating margin from the year prior.  Despite the implicit message embedded in the fact that customers are trading down to smaller plates and snacks, the company implemented a 1% menu price increase in August.


Food inflation could possible take CMG out of Nirvana.  In line with its “food with integrity” mantra, the company purchases its food on the spot market and is therefore vulnerable to volatility in the foodstuffs markets.  CMG is lapping declines in food costs of 218 and 207 basis points, respectively, in 4Q10 and 1Q11, respectively.  I would consider it more likely that the company would leave the Nirvana quadrant in 1Q11 than in 4Q10.  The same is true for MCD.  The company has not yet discussed inflation trends in 2011, but they are likely to trend higher with beef prices.  Like CMG, I see MCD likely falling out in 1Q11 due to year-over-year decline in restaurant operating margin.


I remain cautious, as I was a quarter ago, about RT’s ability to maintain its operating performance in Nirvana in 2QFY11.  As I wrote in my note titled, “RT: IMPROVING BUT THINGS SHOULD SLOW”, momentum will likely slow after the first quarter of FY11 for RT.  This could mean RT moving to the “Deep Hole” quadrant, negative comparable restaurant sales and contracting restaurant operating margins.


BWLD has been enjoying favorably commodity prices since chicken wing prices peaked in January and sales in the most recent quarter were an upside surprise to me.  As the commodity tailwind goes away, it may be difficult for the company to maintain margins in positive territory on a year over year basis.  Additionally, the company has many underperforming, lower volume stores to close down and this process of “right-sizing” may take some time. 


The “Deep Hole” quadrant is populated by companies that are operating with negative comparable restaurant sales and negative year-over-year changes in restaurant operating margins.  From a QSR perspective, MCD is causing a lot of pain for its competitors.  Additionally, higher protein prices will begin to be felt on the bottom line in the upcoming quarter.  This has been called out by several QSR management teams.  The following companies are currently in that category: SONC, WEN, JACK, KONA, and RRGB.  Emerging from this quadrant is quite difficult in that it requires patience; management teams cannot take short cuts or rely on short term fixes. 


RRGB is one company that I believe has been taking the wrong approach for several quarters now. They have been under pressure from a check average perspective and management was recently moved to state on their 3Q earnings call that “competitive encroachment” and the concept not being “differentiated” enough is negatively impacting the business. 


EAT, on the other hand, has emerged from the “Deep Hole” quadrant thanks to a measured plan on the part of management to increase restaurant operating margins and improve sales on a sustained basis.  The former has already occurred; EAT is now in the “Life-line” quadrant and – per my recent notes on the name – I expect sales to pick up in the upcoming quarters (EAT – A BADGE OF HONOR, 11/14) and move into nirvana by FY3Q11. 


Overall, a brief glance at the quadrant chart below is enough to tell anyone that restaurant stocks performed well over the last quarter.  However, this can only persist for so long and I expect to see a more even distribution among the respective quadrants of this chart over the coming quarters.




Howard Penney

Managing Director


After an impressive start to the year MGM’s baccarat share is on the decline.



Strip Baccarat volume rose 52% in Q3.  Juxtaposing those numbers with MGM’s reported 6% decline in baccarat volume for its wholly-owned properties would show that MGM (ex Aria) lost significant baccarat share in 3Q.  With this year’s opening of 50% owned Aria, some cannibalization should be expected.  However, MGM’s baccarat volume share with and without Aria has now declined for two straight quarters.


Our analysis indicates a 14% baccarat share loss from MGM’s share (ex Aria) of 38% in 2009.  In our note, “STRIP BACCARAT TOOK A BIG BREATHER IN SEPTEMBER” (10/13/10), we wrongly concluded that September baccarat volume on the Strip declined, assuming MGM maintained its sequential share.  What we didn’t realize is that MGM’s baccarat volume share (ex Aria) had fallen so much that it was not at all indicative of the overall Strip trend.  In fact, Strip baccarat volume actually grew YoY in September.  Moreover, the chart below shows MGM’s (including Aria) baccarat volume share fell below its share without Aria in 2009.




Aria’s baccarat volume share isn’t doing much better.  Although management said on the conference call that Aria had exceptionally strong baccarat play, we believe Aria lost baccarat volume share in 3Q.  Total table drop for Aria increased 48% in 3Q from 2Q.  If we assume Aria’s baccarat % share of Aria’s total table volumes remained at 44%, Aria lost 3% baccarat volume share in 3Q.  Since we know that on the Strip, baccarat % share of total table volume rose in 3Q, Aria’s share loss was probably not as steep. 


Baccarat was the one lifeline that kept Vegas from falling into the abyss during the financial crisis.  As seen in the following chart, baccarat volume has accounted for a higher % of total table volume over a two-year span.  If MGM’s wholly-owned property baccarat volume continues to move in the opposite direction of higher Strip baccarat volume, then its wholly-owned performance will be as depressed as Nevada’s tax coffers.



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