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Is Consensus Getting Chinese (or Global) Growth Right?

Conclusion: We think consensus is finally starting to come closer to our bearish estimates with regard to China’s intermediate-term growth outlook. They are, however, not at all bearish enough, as evidenced by the muted reaction to China’s 4Q/December economic data in US equity trading. Global equities will continue to come under increasing pressure as China helps drag down global growth alongside its own domestic moderation. It appears as if US equities will come crashing in to the party late.

 

Growth Outlook

 

By now it’s no secret that we think US consensus is wrong on China; we’ve been outwardly bearish on China’s 1H11 growth outlook since 10/21 (see post: “China Sets the World Up for a CRASH”) and the Shanghai Composite is down (-15.3%) since it peaked just over two weeks later. To contrast, over that same duration, the S&P 500 is up +4.6% aided by near-manic hope of a “strengthening US recovery”.

 

While the merits of that can certainly be debated, what is becoming less contentious by the day is the slope of Chinese growth in 1H11 and perhaps beyond. 4Q10 GDP came in overnight at +9.8% YoY, a +20bps acceleration from 3Q10’s run rate. Chinese officials evidently see this as an intermediate-term top, aiming for +8% GDP growth in 2011 (on top of +4% inflation and +16% money supply expansion (down from around 20% in 2010)), according to a leak from the National Development and Reform Commision.

 

We also think 4Q10 is an intermediate-term top for Chinese growth because of our outlook for Chinese monetary policy – it’s going to get [much] tighter from here. China’s bond market foresees a similar outcome, as China’s 7-Day Repo rate jumped +347bps since the start of the week, indicating Chinese banks are hoarding cash in anticipation of further rate hikes and reserve requirement hikes.

 

Is Consensus Getting Chinese (or Global) Growth Right? - 1

 

Inflation Outlook

 

China December CPI came in in-line with the whisper number leaked yesterday, slowing from +5.1% YoY to +4.6% YoY; as an aside, the Shanghai Composite closed up +1.8% yesterday on the declaration. Today’s (-2.9%) move in the face of bullish growth data, bullish industrial production data, bullish retail sales data and moderating inflation data tells us investors are still concerned about the prospect for tighter monetary policy in China’s immediate future. They should be. With commodity prices continuing to accelerate on YoY basis and Real 1Y Deposit Rates remaining in negative territory, China’s fight with inflation is far from over.

 

Is Consensus Getting Chinese (or Global) Growth Right? - 2

 

Is Consensus Getting Chinese (or Global) Growth Right? - 3

 

Two inflationary data points that support this outlook are:

 

Chinese banks are still at it: Chinese lenders have reportedly lent over 1 trillion yuan January to date, according to the 21st Century Business Herald. That would be roughly ~15% more than the trailing 5Y average for the month (871.5 billion yuan) and 200 billion more than the PBOC’s target for the full month. If that’s the case, the PBOC will likely continue increasing bank reserve requirements, now done on a bank-by-bank basis, in their next monthly review. As the chart below shows, credit expansion is crucial to the slope of Chinese growth. That’s not surprising considering that 40-50% of Chinese GDP is Gross Capital Formation.

 

Is Consensus Getting Chinese (or Global) Growth Right? - 4

 

Cash surge in 1H11: Maturing central bank bills will flood the Chinese economy with cash in 1H11, adding to liquidity-based inflationary concerns. We’ve seen estimates around 1.2 trillion yuan coming due in 1Q11 and 869 billion yuan due in 2Q11. If that’s the case, the PBOC will either have to raise rates at future bill sells or continue hiking reserve requirements to prevent this influx of cash from filtering through the economy.

 

Side Effects

 

Aside from slower growth over the intermediate term brought on by tighter monetary policy aimed at quelling burgeoning inflation, there are other side effects that will negatively impact the Chinese economy.

 

One key area to watch is how Chinese corporations account for the slowdown in loan-denominated funding; as a result, we expect a shift to greater bond issuance. China’s bond market is relatively illiquid ($3 trillion in size), so a flood of issuance from Chinese corporations could send yields to new heights. To that point, yields on 10Y AAA Chinese corporate bonds have backed up +103bps from last year’s low on August 20th to 5.17% - near a 1Y high; the spread over similar maturity government debt widened +38bps from a 3Y low on November 5th to 119bps. To date, Chinese corporations have issued 91 billion yuan of debt, the most YTD since at least 2005.

 

No matter how you slice it, the cost of capital is on the rise in China, which will weigh heavily on CapEx-heavy industries and China’s highly speculative property market. Perhaps that’s another reason why growth in Chinese Property Prices has decelerated for the eighth consecutive month in December, slowing to +6.4% YoY from +7.7% YoY in November.

 

Is Consensus Getting Chinese (or Global) Growth Right? - 5

 

Chinese equities (and to a lesser extent, many Asian and emerging market equities globally) reflect the pending slowdown in Chinese and global growth; China’s Shanghai Composite is broken from a TRADE and TREND perspective.

 

Is Consensus Getting Chinese (or Global) Growth Right? - 6

 

Conclusion

 

All told, we think consensus is finally starting to come closer to our bearish estimates with regard to China’s intermediate-term growth outlook. They are, however, not at all bearish enough, as evidenced by the muted reaction to China’s 4Q/December economic data in US equity trading. Global equities will continue to come under increasing pressure as China helps drag down global growth alongside its own domestic moderation. It appears as if US equities will come crashing in to the party late.

 

Darius Dale

Analyst


SHORTING M $23.58

We maintain our bearish intermediate-term stance on M and JCP, despite the US Retail hype-gods telling us what they did in early 2008. KM shorting green.

 

 

Make no mistake, fundamentally, M and JCP face monumental hurdles in 2011. But here's a near-term factor that we think is driving the stock today. Here's a recap on Levine's note.

 

On a day where news out of retail land is scarce, the following brief statement/filing appears to be taking the mall anchors for a ride, to the upside:

 

Dillard's, Inc. (the "Company" or "Dillard's") intends to form a wholly-owned

subsidiary that will seek to operate as a real estate investment trust (the

"REIT"). Dillard's believes the formation of a REIT may enhance its ability to

access debt or preferred stock and thereby enhance its liquidity. It is

intended that various Dillard's entities (the "Dillard's Parties") will

transfer to the REIT interests in certain real properties (the "Properties")

currently owned by the Dillard's Parties, who will lease the Properties back

from the REIT under "triple net" leases.

 

We’ve been asked a couple of times what is driving the strength in the department store space, mainly Macy’s but it’s hard to ignore the strength in Sears and JC Penney.  Yes, Macy’s was stamped with a “buy” last night from Cramer but this is likely coincidence more than anything else.  The bottom line is the group is trading up in sympathy with speculation that each of this country’s mall anchors could/should employ a similar REIT subsidiary structure.  While in theory this could be viewed as a valid reason to unleash real estate value and separate the “operations” from the “assets” we have to question whether it makes sense for each of these companies.  The key differentiating factor between DDS and the others primarily surrounds the company’s “ruling family”.  The Dilliard’s themselves are still in complete control of DDS with voting rights that comprise 99.4% of the B share super-voting stock (which in turn is entitled to electing two-thirds of the board).  It’s also no secret that the Dillard family has long held interests in real estate (i.e entire malls) that Dillard stores operate in. 

 

Interestingly the company notes in the filing that they believe this strategy with enhance the company’s access dept or preferred stock markets.  This is clearly financial maneuvering at its best.  To our best knowledge the company is as mature as it gets and really has little true capital (i.e growth) requirements.  In looking at JCP specifically, we know that debt reduction is a company-stated top priority- even surpassing the desire to buyback stock.  So, if access to debt capital markets is a key reason for engaging in such a structure, does this even apply to JCP or the other levered mall-anchors?  Anything is possible for sure, but we’d be surprised to see the others following suit given their unique ownership characteristics as well as wide range of differences between each of the company’s operational strategies.

 

Eric Levine

Director


Industry Insights from ICR Conf

 

We think that investors, in aggregate, walked away from this conference with the least amount of insight than at any time in all the years we attended. Why? Pardon the condescending tone here, but the companies simply do not have a clue, and therefore cannot lead the consensus.  Everyone wanted clarity on costs – but they did not get it. Hardly anyone we spoke with acknowledged the impact on earnings when heavily discounted product (due to weak demand) crosses the input cost barrier.  Management teams were generally dismissive when we discussed it with them.

 

Overall, we came away with a stronger view that estimates need to come down in most parts of retail (JCP, GPS, CRI and M). We’re incrementally constructive on the athletic space, where estimates should still head higher (FL, NKE, HIBB, KSWS).  On the margin, we’re less bearish on PVH due to management’s approach to managing risk. In addition, we’re also incrementally positive on WRC. We entered the conference incrementally positive on SKX. But we left squarely negative.  Please see other call outs below, and give us (or ) a shout if you’d like to discuss.

 

 

INDUSTRY COMMENTS

  • Overall most people we spoke with did not appear to get the “nuggets” they were on the hunt for.  “Is this companies cracking down on ’off the record’ comments or just that they have nothing to say”.
  • Increasing uncertainty re the impact of cost inflation and pricing power is resulting in duration elongation as many companies issued 5-year guidance outlooks/targets relative to year’s past.
  • Also, keep in mind the BIG issue here… Cost inflation is manageable and has a good enough window of planning and execution. But the problem will rear its’ ugly head at the end of the season, when the industry realizes that it has too much product (after 2 years of taking down inventories), and then excess discounting begins.
  • Most honest and thoughtful answer to the questions about cost pressure on sourcing came from URBN’s CEO:  “The way I see it, if you create good product that the consumer wants or must have, the cost pressure takes care of itself.  We’re in the business of creating products that our customers want.”  In other words, the consumer will pay for something if they really want it and the Street and many other companies are overly focused on defense, not offense.
  • Another positive came from PVH – who wasn’t even at the conference.  They are planning for costs to be up 10-15%. As such, they’re planning for units to be down 10-12%. It’s been a while since we heard a management team in this biz talk about buying in units. THAT’s the way to do it. Buying in dollars with little strategy around costs/ASP/units is a dangerous game. Unfortunately we need a LOT more companies to act this way – and that won’t happen. But this made me incrementally less bearish on PVH.
  • In a somewhat similar vein, PERY management suggested that consumers will be faced with the choice to either pay higher prices, or risk not having product from which to choose due to industry-wide inventory shortages. While the company is currently ordering ~10% fewer units in order to offset higher cost increases, our sense is the perception of tight supply is unlikely to drive consumer spending in 2011. Economic reality will trump perception all day.
  • Most talked about new (growth) story: SODA (Sodastream).  Expect Target distribution in ’11 as well as expanded products at BBBY.  Challenge is filling demand with high service levels.  Met the challenge with BBBY for holiday. 
  • URBN quotes:  “Our customer that shops all three channels spends 5x as much as the average customer with us”.  Perhaps this is why they are so excited to finally have a fully integrated multi-channel platform.
    • “The sourcing environment is the toughest we’ve seen in 17 years”.
    • “You will be happy with our inventory levels at year end”.
    • “We were never in low cost factories to begin with.  So on a relative basis, we’re just not seeing the increases in labor that others may be seeing”.
    • “Most of our costs are not in raw cotton textiles, but rather in trims, buttons, and embellishments.”
  • E-commerce and mobile initiatives were consistently one of the top topics of discussion. While many companies with sales below 5% of their total spoke to the continued opportunity for growth, Wolverine Worldwide with ~7% of sales coming from e-commerce stood out by highlighting their goal of achieving 15% of sales overtime.
  • Outlier Callouts:
    • While most footwear brands are quickly shifting production out of China, Skechers plans to continue to source over 90% of its production from China for the near-to-intermediate term.
    • While most companies are planning to leverage SG&A costs in order to offset margin pressures over the next 12-months, Deckers is planning to increase UGG marketing costs by 1.5% of sales in 2011.
    • At this point, most if not all retailers know exactly what cost increases they will face in the 2H of the year – whether it be high single-digit or low double-digit inflation, consumers and retailers are clearly waiting to see who blinks first.   
    • Most crowded breakouts: LULU, URBN, SKX, ARO, VFC, GES, PSS

 

 


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DDS: (D)riving (D)epartment (S)stores Higher

On a day where news out of retail land is scarce, the following brief statement/filing appears to be taking the mall anchors for a ride, to the upside:

 

Dillard's, Inc. (the "Company" or "Dillard's") intends to form a wholly-owned

subsidiary that will seek to operate as a real estate investment trust (the

"REIT"). Dillard's believes the formation of a REIT may enhance its ability to

access debt or preferred stock and thereby enhance its liquidity. It is

intended that various Dillard's entities (the "Dillard's Parties") will

transfer to the REIT interests in certain real properties (the "Properties")

currently owned by the Dillard's Parties, who will lease the Properties back

from the REIT under "triple net" leases.

 

We’ve been asked a couple of times what is driving the strength in the department store space, mainly Macy’s but it’s hard to ignore the strength in Sears and JC Penney.  Yes, Macy’s was stamped with a “buy” last night from Cramer but this is likely coincidence more than anything else.  The bottom line is the group is trading up in sympathy with speculation that each of this country’s mall anchors could/should employ a similar REIT subsidiary structure.  While in theory this could be viewed as a valid reason to unleash real estate value and separate the “operations” from the “assets” we have to question whether it makes sense for each of these companies.  The key differentiating factor between DDS and the others primarily surrounds the company’s “ruling family”.  The Dilliard’s themselves are still in complete control of DDS with voting rights that comprise 99.4% of the B share super-voting stock (which in turn is entitled to electing two-thirds of the board).  It’s also no secret that the Dillard family has long held interests in real estate (i.e entire malls) that Dillard stores operate in. 

 

Interestingly the company notes in the filing that they believe this strategy with enhance the company’s access dept or preferred stock markets.  This is clearly financial maneuvering at its best.  To our best knowledge the company is as mature as it gets and really has little true capital (i.e growth) requirements.  In looking at JCP specifically, we know that debt reduction is a company-stated top priority- even surpassing the desire to buyback stock.  So, if access to debt capital markets is a key reason for engaging in such a structure, does this even apply to JCP or the other levered mall-anchors?  Anything is possible for sure, but we’d be surprised to see the others following suit given their unique ownership characteristics as well as wide range of differences between each of the company’s operational strategies.

 

Eric Levine

Director


The Golden Haze: Gold Position Update

POSITION: Covering our short GLD position today

 

It never ceases to amaze me how universally accepted bullish cases can start to quickly come unglued. Gold has gotten us all paid since 2003 on the long side – we get that. But we also get that playing today’s risk management game has nothing to do with past results. Generally speaking, when real-interest rates are negative, gold outperforms. Not so much when they move, on the margin, from negative to positive.

 

Today, Gold is finally immediate-term TRADE oversold at or lower than $1348, so we’re covering the short position. That doesn’t mean we are no longer bearish on gold. Neither does it mean that we don’t reserve the right to get bullish on gold again if the professional politicians of the 112th Congress start to debauch the US Dollar again…

 

As a reminder, for accountability purposes, our recent moves in Gold have been as follows: 

  1. DEC 6th, 2010 sold our long position
  2. DEC 29th, 2010 initiated a short position
  3. JAN 20th, 2011 covered our short position 

Oversold is as oversold does, but as long as the intermediate-term TRENDs in both the USD and UST Yields continue to make higher-intermediate-term highs, I think gold will do the opposite. If these facts change, I will try my best to do the same.

 

My updated TRADE and TREND lines of resistance for Gold are in the chart below at $1387 and $1373, respectively.

 

KM

 

Keith R. McCullough
Chief Executive Officer

 

The Golden Haze: Gold Position Update - 1


R3: AMZN, TJX, DDS, BWS

R3: REQUIRED RETAIL READING

January 20, 2010

 

 

 

RESEARCH ANECDOTES 

  • It didn’t take long for Amazon’s investment in livingsocial to result in a deal.  Yesterday livingsoical featured a $20 Amazon giftcard for $10 which resulted in 1.3 million cards purchased!  This beats the previous social/local coupon record in which Gap sold $11 million worth of Groupons.  While the total value of the Amazon deal is unlikely to move any needle, it’s interesting to see the online retailer using new methods to universally promote given that the company is historically known for its everyday low price strategy and targeted promotion.
  • Green manufacturing takes a step forward with the impending introduction of Levi’s WaterLess jeans.  The new denim pants use 11 gallons less water to manufacture conventional jeans, for a reduction in water consumption of 26% to 96%.  A normal pair of jeans takes about 11.1 gallons to produce as a result of the washing process which spans three to ten cycles!  Perhaps it’s just coincidence but the new “line” arrives just at a time when costs are on the rise and “content” will be more important than ever to facilitating pricing power.
  • In an effort to five fashionistas, bloggers, and consumers a sneak peak at what’s in-store for Spring, TJ Maxx and Marshalls offered a live spring/summer preview in NYC.  The event featured a wide range of merchandise that is likely to be available over the coming months, complete with price comparison signage highlighting the massive savings on like-items between the offpricer and traditional department stores.  We suspect the pricing message is about to get louder as cost pressures mount.

OUR TAKE ON OVERNIGHT NEWS

 

Dillard's to Form REIT - Dillard’s Inc. — a family-run but publicly traded department store chain known for going its own way in areas of corporate policy — plans to spin off some properties into a real estate investment trust and then lease the properties back. Real estate investment trusts, or REITs, bring certain tax benefits that aren’t available in other corporate structures. The Little Rock, Ark.-based firm has doors in 29 states and, according to last year’s annual report, owned 241 of its 309 stores. <WWD>

Hedgeye Retail’s Take: With the Dillard’ family in complete control of DDS, this is just another chapter in the clever structuring of the pubicly traded, but family run business.  Regardless of the REIT structure, has anyone noticed the company’s high single digit holiday comps?

 

Brown Shoe Reportedly Looking at Acquiring American Sporting Goods - Brown Shoe Co. Inc. is said to be in talks to buy American Sporting Goods Corp., but analysts are undecided if the purchase will be good for the Missouri-based firm. According to a report by Sporting Goods Intelligence, Brown Shoe may pay $150 million, which BB&T Capital Markets said is as much as 10 times the earnings potential of ASG. ASG, the parent of Avia, Ryka and several other brands, reportedly had sales of $220 million last year and earnings in the range of $10 million to $15 million. The California-based company has been on the market since 2005, and has gone through at least two unsuccessful formal auction processes due to the relatively weak stature of its key brands in an increasingly concentrated athletic market, according to the note. <WWD>

Hedgeye Retail’s Take: While it can be argued that acquiring brands falls into one of management’s key priorities for 2011 (i.e. people and product) – integrating a deal could easily prove to be more of a distraction. That said, adding a few athletic brands to the BWS portfolio could be viewed favorably with more exposure to one of the more robust categories within the space.  

 

Tony Fisher Appointed Head of Target Canada - Target Corp. has promoted Tony Fisher to the new post of president of its Target Canada unit. Fisher, with Target since 1999 and vice president of merchandise operations since his promotion last year, will be responsible for “building the team, establishing the headquarters and leading the day-to-day operations” of the company’s expansion into Canada, details of which were disclosed last week. <WWD>

Hedgeye Retail’s Take: While this is a large opportunity for TGT over the next 3-5 years, expect numerous announcements to trickle out as the team, infrastructure, and strategic plans begin to take form.  This will be a long, methodical process and one that will not accrue overnight benefits. 

 

SKNL and Li & Fung Eye JA Apparel  - JA Apparel Corp. could have a buyer in the wings at last. The owner of the Joseph Abboud and Joe by Joseph Abboud brands has been on the market since 2006 but is coming under closer scrutiny as potential buyers kick the tires, according to market and financial sources. Two prospective buyers said to have signed confidentiality agreements are SKNL International, the owner of HMX Group, and Li & Fung, the Hong Kong-based conglomerate. <WWD>

Hedgeye Retail’s Take: With both bidders entrenched in sourcing, it’s clear that the synergy lies with marrying a well known US mens brand with lower-cost, efficient manufacturing.  Interestingly, a purchase by SKNL would mark one of the first brands to be bought by an Indian retail/textile conglomerate.  On the Li & Fung side, this would be just another step in building out the company’s diversified content portfolio.

 

Nau Introduces QR Coded Hangtags - Urban + Outdoor apparel maker Nau will showcase how QR codes can be used on hangtags to help outdoor specialty retailers engage smartphone users in their stores by directing them to branded websites and away from price comparison sites.  Nau will showcase key styles labeled with QR codes designed by ExtraTags, a company launched earlier this year by the man who helped build Amazon.com's outdoor business. The demo at Nau's booth (#30049) comes as Nau and its sister company's Horny Toad and Lizard Lounge launch a blog to help specialty outdoor retailers improve their merchandizing and share best practices.<SportsOneSource>

Hedgeye Retail’s Take: Even before mobile price comparison has been fully adopted, we’re beginning to see moves to divert attention away from price and towards content.  With smartphones essentially turning in to personal POS’s, will charging stations become commonplace in the mall? 

 

Usablenet and PayPal Team Up to Ease Mobile Checkout - Mobile commerce technology provider Usablenet Inc. has teamed with eBay Inc.’s PayPal to integrate the online payment company’s Mobile Express Checkout with Usablenet m-commerce sites, mobile apps, tablet apps, Facebook applications and kiosk systems. Consumers with PayPal accounts enter their user name and password and then buy with one touch; the system uses the consumer’s stored default shipping and billing information.<InternetRetailer>

Hedgeye Retail’s Take: Paypal’s involvement in the mobile transaction landscape is likely to ease consumer fears regarding security, or more aptly the lack thereof over mobile devices. While a step in the right direction, it’s going to take far more to get most consumers over the hurdle in this regard.

 

TSA to Open Largest Store in U.S. - The Sports Authority plans to open a 56,000 square-foot in August to open in Orland Hills, IL, representing its largest store in the U.S. The store will be located in a site of a former Circuit City and an Office Max. Orland Towne Center owner Tony Youshaei, speaking to the Orland Hills Patch, described the new store as a "flagship" for the national chain. The new store will represent a relocation. A 40,000 square-foot Sports Authority store now operates in the Orland Park Place shopping center, next to a Dick’s Sporting Goods store.  When the Orland Park Sports Authority will close for the relocating has not yet been determined. < SportsOneSource>

Hedgeye Retail’s Take: Within a year of launching its smaller S.A. Elite concept, Sports Authority comes out with its biggest store yet. While contrary to the company’s growth initiative in smaller format stores, empty Circuit City boxes are more readily available while smaller footprints continue to be more challenging to line up.

 

 


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