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Corn Cobbed

Position: Long corn in our portfolio via the ETF CORN

Conclusion: The global corn supply and demand imbalance looks to persist into 2011 as we are seeing limited demand degradation due to increasing prices.

This has been a tough year for those short of corn.  In 2010, world corn production is only up ~2%, while world stocks are down ~2% after declining almost 6% last year.  More noteworthy, is that this has been the third year in a row in which consumption has outpaced supply.   This shortage has been reflected in the rapid price move in last six months and in the year-to-date on a $ per bushel basis.


Corn Cobbed - corn table

In fact, as outlined in the table above, corn has had the most rapid price movement of any of the major grains in 2010.  The primary reason for this relates to two factors: weak crop yields in the United States and an inflection point in demand out of China.


Before moving specifically into these factors, in the chart below we wanted to highlight the history of corn imbalance for the past decade.  As the chart shows – while the consumption of corn globally has been growing driven by demographic growth, increased consumption, and the use of corn as an alternative fuel – production shows a slightly different story.  In fact, in the last decade we’ve had three shortages of corn, which are driven by the inability of production to keep up with consumption.


Corn Cobbed - corn2


In terms of world production share, the United States currently leads the pack.  In fiscal 2009, the U.S. grew almost 40% of the world’s corn, and was by far the largest grower, at over 300 metric tonnes.  In terms of exporters of corn, the U.S. exports the most corn, with just over 50% of the export market;  Argentina is the second largest exporter at about 14% of the export market.


Collectively, the United States and Argentina dominate corn exports.  The recent growing seasons in these regions has been weak, which is the critical factor as it relates to global supply and demand, and therefore price.  Specifically, Argentina is experiencing very dry weather, which will likely hurt yields for Argentine corn crops as December and January are the key pollination periods.   A similar weak growing season in the United States has led to the projection that U.S. corn stocks could drop to the 832 million bushel levels.


Corn Cobbed - corn3


As it related to demand from China, the Shanghai JC Intelligence recently increased its estimates for Chinese corn imports to 7.5MM metric tonnes, which was an increase of 22.7% from the groups’ last estimate.  This is an important inflection point, since up until last year China was a net exporter of corn and is now potentially poised to become one of the largest importers of the commodity.   Chinese corn demand will likely continue to increase despite the threat of monetary tightening, as the government is focused on curbing food inflation domestically and needs to import food stuffs to do this.


Speaking toward global grain demand, the Canadian Wheat Board recently announced that, “domestic demand remains solid, and it remains to be seen how much the price has rationed offshore demand.”  This was also verified by the USDA who articulated in their December 10th report that global demand remains strong despite accelerating prices. 


Collectively, the combination of resilient grain demand (irrespective of rising prices), difficult growing environments in Argentina and the U.S., and low stock levels in the United States appear poised to continue to drive corn prices higher.  In fact, corn stocks have not been this tight since 1, when the current stocks-to-use ratio was also in the 6% range.  Put more bluntly, absent demand destruction, we could run out of corn!


It seems the corn bears might be setting themselves up to be corn cobbed…


Daryl Jones

Managing Director


BWLD is not loved and many of our screens are flashing bearish for the stock.  A deeper look at the model yields some rather different conclusions.


Over the past month BWLD is down 6.4% versus the average full service casual dining stock up 7.1% and the company has caught two upgrades from the sell side.  Short interest is on the high side at 14% as a percentage of shares out, but declining steadily over the past two months.  At 6.5X EV/EBITDA, expectations are low for BWLD and a one multiple improvement in valuation implies $6.37 of upside, or 15%, from current prices.


We have been monitoring our screens lately and BWLD was flashing bearish on this name.  Insider selling, for instance, has been on the high side and Keith’s levels also confirmed a bearish outlook so we decided to dig into the model a little further.


I understand the bearish longer-term thesis on BWLD.  It has grown too fast.  I have expressed this view myself at length over the course of the past twelve months or so but the fundamental story over the next couple of quarters looks solid.  Also, pertaining to the pace of growth issue, my ROIIC outlook for BWLD is strong.  In the past two quarters, AUV’s have outpaced comparable restaurant sales partly due to the closure of 8 older underperforming stores and strong performance from store openings. 


On a less positive note, management did mention that franchise comparable restaurant sales were softer in 3Q due to the higher incidence of store openings in existing markets.  They did not refer to this as cannibalization, of course, but it certainly sounded like it to me!


This stock has not been performing strongly of late, relative to its peers, but our model seems to be telling a different story heading into the first half of 2011.  As with any model, the takeaways are only as useful as the assumptions my projections are based on but I am comfortable stating that the company’s 4Q and FY11 guidance may be slightly modest.  Management actually said that they were being conservative with 18% EPS FY11 guidance.  Currently, our conclusions arrive at 4Q EPS of $0.55 versus the street at $0.53 and we are estimating FY11 EPS of $2.55, a 21% year-over-year increase, versus the street at $2.47 and management’s guidance of an 18% year-over-year increase.


My assumptions assume relatively flat-to-slightly improved comp growth on a two-year basis.  For 4Q10, I am at +1% relative to the company’s guidance of at least flat comp growth.  Company guidance here is, in my view, conservative seen as flat comp growth implies a slowdown in two-year average trends of 40 basis points.  Given that October two-year average trends accelerated by 90 basis points, I am at ease with my comp assumption of +1%.  Management commentary around comparable store sales performance in October indicated that October comps were -0.7% but lapped a strong comparison of +5.9% for the same month of 2009.


Remodels are also buoying comparable restaurant sales, lifting comparable restaurant sales by 5% and the company is looking to carry out 20 remodels in 2011.


Here are some factors that are impacting same-store sales in 4Q10: 

  1. Christmas falling on a Saturday - management said could be slightly negative but could not quantify and was not even sure if it would be a negative
  2. BWLD increased media spend significantly in November and December (not reflected in the October numbers, which would suggest trends should accelerate from October, not decelerate)
  3. Slightly lower pricing impact in 4Q of +1.6% vs. +1.9% in 3Q
  4. The bigger picture issue are the trends in CD since October - good not great!


Restaurant margin should continue to increase in 4Q and 1Q as favorable year-over-year wing prices help.  Through the first two months of 4Q, wing prices were down 15% year-over-year (in line with the year-over-year decline in 3Q).  The company should experience the biggest year-over-year favorability in 1Q11 as prices peaked in 1Q10.  The comparison clearly gets more difficult from there and management did state that there is not much visibility on traditional wing prices.  However, given the peak levels reached in 2010, they would still expect slightly favorable prices in 2011.  Traditional wings account for 21% of sales.  Boneless wing prices should be flat year-over-year in 2011 as the company is contracted through March 2012.  Boneless wings account for approximately 19% of sales. 


The company is expecting to pay higher prices for alcohol in 4Q10 and FY11 than it paid in 3Q10 and this increase was highlighted by management as being part of the reason for the upcoming price increase in January.  Together with a new menu rollout in April, the price increase in January will account for a cumulative 2% increase in price for 1H11.  Largely due to that increase in the price of alcohol, there could be additional pressure on COGS in 4Q relative to 3Q, given that the price increase won’t take effect until 1Q11.  Overall, though, I would stress that COGS will remain quite favorable given the year-over-year declines of wing prices in 4Q.


Management is expecting some labor pressure as it expands its Happy Hour test in 4Q and then rolls it out in 1Q11 to all locations.  The company is also investing in labor training to improve speed of service at lunch.


BWLD also guided to some pressure in 4Q on the operating expense line.  Media spend is expected to be up about 25% year-over-year in 4Q10.  The company is expanding their radio presence in November and December (supporting Happy Hour among other things), and this expected to drive the high year-over-year increase in media spend.  2Q and 3Q saw more moderate year-over-year increases for this line item.


In terms of overall casual dining trends, Knapp Track sales trends for the category were disappointing in November, declining 55 bps on a two-year average basis.  BWLD is one of a rare breed in casual dining at the moment as it is looking at COGS favorability over the next couple of quarters.  For competitors depending on sales leverage to drive the bottom line, this latest Knapp data point is certainly bearish.  The risk to our +1% 4Q comp estimate is obviously that the industry may slow from a top line perspective but the COGS favorability means that BWLD is relatively less at risk from this impacting its bottom line. 


I would also refer to the Sanderson Farms 4Q Earnings Call commentary which indicated that demand for prepared foods was strong through the first week of November and then evaporated.  Demand for chicken in general also turned weak and this should benefit BWLD from a COGS perspective.


All in all, it seems that sentiment around this name is decidedly negative.  Insider selling is at an elevated level relative to most of its peers and short interest, while coming down over the past few weeks, remains high at 14% of shares out.  I think there is a strong chance that earnings could surprise to the upside for 4Q and FY11.


Howard Penney

Managing Director


Sports Apparel & Footwear Sales Strong Again

Athletic apparel and footwear sales were solid again this past week during what is typically the slow(er) period between Thanksgiving weekend and holiday sales leading up to Christmas. Underlying trends remain strong in both athletic footwear and apparel despite even more challenging comps suggesting last week’s positive results were not anomalous, but in fact evidence of continued strength in consumer spending – particularly in the athletic channel. Here are a few callouts from the week:

  • Sales improved across all three channels with athletic specialty retailers continuing to outperform both the family and discount/mass channels with the later decelerating on a sequential basis while sales at family retailers improved on the margin.
  • Footwear sales are exhibiting high price elasticity in the face of increased ASPs though broadly speaking pricing has firmed curbing what appeared to be heightened promotional activity in the first week following Thanksgiving weekend. Meanwhile pricing at athletic specialty retailers continues to register up MSD suggesting more full-priced selling, less discounting, or most likely some combination thereof relative to other channels.
  • New England significantly outperformed other regions up +23% for the third time in the last four weeks. The negative callout on the week was the Pacific region registering the most anemic growth yet still positive. These results were in stark contrast with four straight weeks of significantly improved sales on a relative basis.
  • Unseasonably colder weather, particularly in the southeast last week (good for HIBB) have clearly been a positive driver of apparel demand month-to-date and does not seem to be abating near-term. This has been evident in the outperformance of outdoor outerwear and VF’s The North Face, which has been crushing it of late.
  • Despite recent narrowing between the performance and non-performance footwear growth spread, it’s widening once again on a trailing 3-week basis driven by diverging yy trends over the past 2-weeks stressing the importance of merchandise mix at the retail level – more favorable for FL & FINL.

Sports Apparel & Footwear Sales Strong Again - FW App Ind 1Yr 12 16 10


Sports Apparel & Footwear Sales Strong Again - FW App Ind 2Yr 12 16 10


Sports Apparel & Footwear Sales Strong Again - FW App Ind Table 12 17 10


Sports Apparel & Footwear Sales Strong Again - FW Perf v NonP 12 16 10


Sports Apparel & Footwear Sales Strong Again - Weather 12 16 10


Casey Flavin


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Europe’s Bailout Mechanism: Much Discussion for Little Result

Position: Long Germany (EWG); Short Euro (FXE), Short Italy (EWI)


Today European leaders announced at their two day summit in Brussels that a permanent debt-crisis mechanism will replace the current temporary package of €750 Billion that expires in mid-2013.


Importantly for German Chancellor Angela Merkel, who largely has the support of French President Nicolas Sarkozy, the EU’s constitutional Lisbon Treaty was amended to meet her demand that lending to fiscally “troubled” nations come only as a last resort. The two words added to the treaty to pacify Merkel were “if indispensable” in the clause:


“The Member States whose currency is the euro may establish a stability mechanism to be activated if indispensable to safeguard the stability of the euro area as a whole. The granting of any required financial assistance under the mechanism will be made subject to strict conditionality.”


Our read-through is that the clause accomplishes very little, given the very near to intermediate term sovereign debt risk for such countries at Portugal, Spain, and Italy.  While it importantly recognizes the necessity of a “debt-crisis mechanism” for the future of this union of countries, much confusion still surrounds who will determine when financial assistance is “indispensable”, how it will be funded, and how much will be allocated, especially given the uncertainty surrounding bank liabilities throughout the region.


It’s also worth note what was NOT decided on at the summit. In particular, Luxembourg PM Jean-Claude Juncker had pressed for a joint Eurozone bond and ECB President Jean-Claude Trichet voiced support for adding additional funding to the €750 Billion fund going into the meeting. Neither were formally agreed or disagreed on.


To the former point, it’s our guess that states such as Germany and France won’t agree to take on the risk of a collective Euro area debt obligation – there’s no benefit to them, but rather downside risk to their own credit standards.  To the latter point, we believe we’re likely to see further monies thrown at the Eurozone’s sovereign debt crisis before the temporary package expires.


In Europe we’re concerned about the bank liabilities in the peripheral countries that are not largely understood/quantified and the market implications should members of the “PIIGS” come up short in meeting their targeted deficit and debt reduction levels over the next three years, the probability of which we think is high. Weaker growth prospects will put pressure on incoming tax receipts, while governments continue to get pushback (strikes) over austerity to issue spending cuts. This is a dangerous equation when trying to reduce a budget.


Further, deficit reduction plans are lofty:  Greece is attempting to cut from -15.4% of GDP in 2009 to -9.4% in 2010 and Portugal from -9.3% in 2009 to -4.6% in 2010. Equally, we think there’s a fair probability that any one of the PIIGS end up revealing that their previous numbers were fudged, a case we’ve already seen with Greece revising up both its debt and deficit figures for 2009. On this score, Italy could be contender.


Certainly such scenarios could require additional bailout monies over the intermediate term to arrest a plunge in a country’s capital markets. In any case, we expect government bond yields to reflect this risk. As the chart below shows, despite bailouts in Greece (May) and Ireland (December), yields across peripheral countries have remained elevated, and most recently are breaking out.


Europe’s Bailout Mechanism: Much Discussion for Little Result - chart1m


While the region ratcheted up “emergency” measures in the form of a decision yesterday by the ECB to increase its capital base by €5 Billion to €10.7 Billion over three years beginning on December 29th, the reality remains that the union of unequal states (Eurozone) will continue to be plagued by divided opinion on policy, including who’s funding its crisis.  We expect underperformance from Europe’s peripheral countries that should also weigh to the downside on the Euro versus major currencies.


Today, European equity markets closed in negative territory with underperformance from the peripheral markets. Equally, the EUR-USD is taking a beating today and flirting with our TRADE line of support at $1.31. We see TREND resistance up at $1.34 (see chart below).


We sold our position in Spain (EWP) today with the immediate term TRADE oversold. We remain bearish on the intermediate term TREND.


Keep your risk management pants on,


Matthew Hedrick



Europe’s Bailout Mechanism: Much Discussion for Little Result - eur usd PNG

Brazil: A Leading Indicator for the Global Economy?

Conclusion: Looking under the hood of the Brazilian economy and stock market, we see more confirmation of accelerating inflation and slowing growth on a global basis. Given, we expect both bonds and equities to underperform as asset classes in 1H11.


Position: Bearish on Emerging Market equities and bonds heading into 1H11.


The “accelerating growth” storytelling around rising bond yields of late gets stopped dead in its tracks once you pull up a chart of Brazilian equities. Since the U.S. dollar bottomed on 11/4 (coincidentally the day we went long UUP), Brazil’s Bovespa index has lost (-7.1%) of its value alongside the dollar’s +6.1% rise.


Of course, one would think with a rising dollar that Bovespa would come under pressure as its two largest constituents Petrobras and Vale suffer from declining crude oil and copper prices. Unfortunately for conventional wisdom’s sake, that hasn’t been the case: crude oil is up +1.4% and copper is up +5.1% over the same duration.


Given this underappreciated divergence, we posit the following explanation for the Bovespa’s underperformance:


 Slowing growth perpetuated by global tightening as a result of accelerating inflation brought on by QE2. Better translated as: QG = inflation [globally] = monetary policy tightening [globally] = slower growth [globally].


The Brazilian economy is well past step one (YoY CPI accelerated to a 21-month high of +5.63% in November) and the market is pricing in steps two and three currently. Looking at Brazilian interest rate futures, we see Brazil’s bond market is anticipating a +25bps rate hike in January and an additional +175bps hike(s) by January 2012.


Brazil: A Leading Indicator for the Global Economy? - AA


From a growth perspective, we recently saw 3Q10 GDP growth came in a full 250bps slower than 2Q10 at +6.7% YoY (after a +40bps revision to 2Q10). We expect growth to continue to slow over the next 3-6 months, a call aided by incredibly difficult comparisons starting in 4Q10 (+5% YoY in 4Q09, +9.3% YoY in 1Q10) and fiscal and monetary policy tightening (the central bank already hiked reserve requirements on 12/3 and set the stage for further “macro prudential” measures in the minutes of its latest meeting).


In recent reports, we’ve made note of Brazil’s late reaction to combating inflation, with the takeaway being that we’re likely to see an expedited tightening cycle in 1H11. Should growth continue to slow materially (as we expect), we could see the central bank handcuffed on the margin, which is obviously not good for Brazilian consumers, who have had to increase their financing of food expenditures through credit (~34% of supermarket sales) to keep pace with accelerating food inflation.


Looking at the Brazilian consumer from a broader lens, we see that Brazil’s Unemployment Rate hit a record low in November, ticking down (-40bps) to 5.7%. Consumer credit expansion hit a record high in November, climbing +6.2% MoM and growth in consumer delinquencies hit a five-year high in November, climbing +3.5% MoM.


Brazil: A Leading Indicator for the Global Economy? - B


In short, the Brazilian consumer is increasingly employed, levering up at record levels and not paying it back. That is a sure-fire recipe for accelerating inflation, which is why we think a meaningful tightening cycle is in Brazil’s intermediate-term future.


We aren’t the only ones who think so: the Bovespa is broken from both a TRADE and TREND perspective and it continues to make lower-highs. Further, it recently backed off its TREND line hard – an explicitly bearish quantitative signal.


Brazil: A Leading Indicator for the Global Economy? - A


From a broader perspective, Brazil’s outlook rhymes with what’s going on across much of Asia (including China and India) – the region many investors consider integral to global growth. The Ber-nank may be able to inflate U.S. real GDP growth by understating CPI, but the rest of the world isn’t buying the hoax.


Don’t be swindled; have a great weekend.


Darius Dale


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