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The Golden Haze: Gold Levels, Refreshed

POSITION: no position

 

We currently do not have a short position in Gold, but here are the 3 most important macro factors to consider before re-shorting it:

  1. First, the “fundamental” – Gold underperforms when real interest rates are positive and rising.
  2. Second, the correlation trade – Gold currently has a POSITIVE correlation with the US Dollar of +0.86, and while the USD is up today, this is the first day that it has been up by more than 50bps since the State of the Union address. Dollar down from here supports gold down.
  3. Finally, the risk management setup – despite today’s rally, Gold remains broken on both our TRADE and TREND durations with those lines outlined in the chart we have attached below. 

In conclusion, the call is to short gold as it scales back up toward $1371.

KM

 

Keith R. McCullough
Chief Executive Officer

 

The Golden Haze: Gold Levels, Refreshed - 1


HIGHLIGHTING THE RISKS TO GDP GROWTH IN 2011

The sequential improvement in 4Q10 GDP growth from 3Q came to +0.62%.   On the margin, this is a positive and it is important to note that net trade accounted for +5.1% of the sequential change in GDP growth for the quarter.  A significant inventory drawdown was the opposing big ticket item on the list, going from a contribution to GDP growth of +1.6% in 3Q to -3.7% in 4Q, thereby dragging the quarterly sequential change in growth by -5.3%. 

 

A noteworthy point to consider in the 4Q10 data is that the narrowing of the trade deficit contributed 3.4% to GDP growth, which ended up growing by a net +3.2%.  The 3.4% estimate is from the BEA and is based on two months of available data.  Given the time-honored tradition of government massaging of the data, I would submit that it is highly likely that the advance estimate will be revised at the end of each of the next two months.  The 4Q09 advance estimate ended up being high by 0.7% after all revisions were complete.  Clearly, if history is any guide, there is revision risk to the downside of 4Q’s GDP growth number.

 

Consistent with the “we see no inflation” theme in Washington, the reported inflation-adjusted (Real) annualized growth rate of +3.17% benefited from a relatively low annualized inflation assumption of +0.3% for the quarter, down from +2% in 3Q10.  This compares to the current inflation estimates, including the December year-over-year CPI numbers of +2.6% (up from +1.5% in 3Q10) and the PPI finished goods numbers for December of +4.0%.  Needless to say, a more realistic view of inflation would significantly diminish the +3.17% GDP growth the data currently shows if the +0.3% deflator proves optimistic.

There are also other potential red flags that need to be monitored:

  1. After five quarters of a significant inventory build-up, a reduced pace of relative inventory increase reduced the reported real fourth-quarter GDP growth rate by 3.70%.  This will continue to be a BIG headwind for 2011. 
  2. The net growth of Governmental spending has also reversed.  Governments on a local level are tightening their belts given the fiscal realities they are facing and electoral mandates they have been given to do so.  Whatever one’s political ideology, the political environment in Washington and the fiscal scorecard point to the trend in Government spending remaining a drag for some time to come.  This is in line with our Hedgeye Macro Q1 theme, American Sacrifice.
  3. After five quarters of being a drag, the quarter-to-quarter contraction in the quantity of imported goods and services was a net sequential positive of +4.9% to GDP growth.  The recent rapid increase in commodity prices (read: debauchery of the dollar) has caused a correspondingly rapid decrease in reported imports. Going forward, the sharp rise in commodity prices will limit the purchasing power of the consumer. If the 33% swing in the quarter-to-quarter price of imported goods is correct, real discretionary consumer spending could be in for a significant change in trajectory.
  4. About +0.83% of GDP growth came from a recovery in residential housing investment, which is reportedly now growing at a tepid +0.08% annualized rate. This was the second positive quarter for residential housing investment during the year, but only the third over the past four years.  With housing prices in a continued decline this will unlikely persist. 
  5. Consumer spending was reported to have strengthened by about +1.3%, with consumer goods now being shown to have an annualized growth rate of 2.26%.

 

Howard Penney

Managing Director

 

HIGHLIGHTING THE RISKS TO GDP GROWTH IN 2011 - gdp


CTRN: Relying On Uncle Sam

In a sea of sales upside, a dose of economic reality (and inequity) was brought to light from CitiTrends.  While certainly not a bellwether name like Wal-Mart, these comments are hard to ignore given the shear amount of consumers receiving some sort of government aid as a primary or supplemental source of income.

 

CitiTrends press release stated:

 

“The decline in December was due largely to a delay of the government's distribution of extended unemployment benefits until just before Christmas, a significant shortfall in sales of long denim, and a heavy promotional environment that included going-out-of-business sale events by a competitor.”

 

The company further articulates:

 

“Similar to fiscal 2008 and 2009, January sales were negatively impacted by a continued shift of income tax refunds due to a lack of refund anticipation loan availability for the Company’s customers. Comparable store sales began to decline 40% to 50% in the third week of January and continued at that pace until the Internal Revenue Service began sending refunds on January 28, 2011. Since that date, customers have begun shopping CitiTrends’ stores with their refund money and we anticipate an improvement in the sales trend in February.”

 

Call it a perfect storm of negative events, but this is the first example that we can remember in some time where government benefits (or lack thereof) have materially impacted a retailer’s topline.  Yes, this is the same company that benefited materially from post-Katrina government relief in 05/06.  Without question, the company’s core customer has been and clearly remains under pressure.  With extended benefits beginning to roll off at an accelerated rate, this may not be the last time we hear from retailers with a heavy reliance on transfer payments.

 

CTRN: Relying On Uncle Sam - ctrn2

 

Eric Levine

Director


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Dissecting Manufacturing PMI Further

Conclusion:  The Prices Paid component of the ISM Manufacturing Survey suggests that margin compression cometh, as this component accelerated from a December reading of 72.5 to a January reading of 81.5 and is likely heading higher. 

 

The Institute of Supply Managers came out with their Purchasing Managers Index (PMI) Tuesday and it came in at a solid reading of 60.8 for January 2011.  This was a sequential increase from the December 2010 reading of 58.5.  Further, this was the highest reading since May 2004.  There is no doubt that at face value this report was a bullish indicator for economic activity in the U.S. manufacturing sector. 

 

As a refresher, this survey is given to more than 400 purchasing managers around the country, who are chosen based on industry and geographic diversification.  The supply managers answer questions based on five subsectors: production level, new orders, supplier deliveries, inventories, and employment levels.  The supply managers are asked to answer “better,” “same,” or “worse” for each category, which the ISM then diffuses into an overall reading.  A reading over 50 typically implies an economic expansion. 

 

In conjunction with the reporting the PMI, the ISM reports a number of other surveys in its index with a key one being Prices Paid.  While Keith highlighted this immediately after the report, we wanted to take a deeper dive into this number. 

 

We show this below, but Prices Paid accelerated from 72.5 in December 2010 to 81.5 in January 2011.  This is up 353% since December 2008 and back to levels last seen in the summer of 2008 when oil was testing $150 per barrel.  While we won’t debate that the headline PMI number is, on the margin, positive as an indicator of economic activity, the Prices Paid component is worrying as it pertains to future corporate margins. 

 

Interestingly, the ISM also included five comments in their report from various survey respondents.  We’ve You Tubed these comments below as they are very indicative and supportive of what we are seeing in the economy. The comments are quoted below: 

  • "Continued weakness in the dollar is having a negative effect on the components we purchase overseas and increasing our material costs." (Transportation Equipment)
  • "Lead times are increasing significantly, and commodity pricing is starting to increase." (Chemical Products)
  • "January/February sales will be decent, and we see a strong March. We're cautiously optimistic but reluctant to hire." (Fabricated Metal Products)
  • "Business is still slow with no pick-up in sight." (Furniture & Related Products)
  • "We continue to see unexpected strength in many non-U.S. markets." (Fabricated Metal Products) 

While this is anecdotal, these were the only five comments in the release and they are quite telling – “negative impacts from the U.S. dollar” . . . “commodity prices increasing” . . . “reluctance to hire” . . . “business is slow.”  It seems the headline number may not accurately reflect the underlying business conditions.

 

The key issue with supply managers reporting higher prices paid is the potential impact on future corporate margins.  Historically, studies have shown a four quarter lag in margin compression after the Prices Paid component of PMI accelerates to current levels. In the second chart below, we’ve outlined broad corporate margins in the U.S. currently.  The takeaway is that they are currently near all-time high levels.

 

With an acceleration in commodity costs that is now being reflected in the Prices Paid component of the Purchasing Managers Index, it seems unlikely that near-peak corporate margins can be sustained.  A corollary to this point is, of course, that the forecasted 15% growth in 2011 for SP500 earnings is also increasingly unlikely as margins come in.

 

Perhaps the CEO of Whirlpool said it most succinctly yesterday on his firm’s earnings call:  “And finally, we expect raw material inflation to drive higher costs and therefore have an unfavorable impact on operating results.”

 

Indeed.

 

Daryl G. Jones 

Managing Director

 

Dissecting Manufacturing PMI Further - 1

 

Dissecting Manufacturing PMI Further - 2


HOT 4Q2010 CONF CALL NOTES

Stronger incentive and other fees and lower below the line items lead to a "blowout" this quarter.  1Q guidance is at the low end of Street while 2011 is raised.

 


“We ended 2010 with a strong fourth quarter, and momentum has continued into 2011. Our robust REVPAR growth is fueled by strong global brands along with sales and marketing initiatives. By containing costs we are translating these higher revenues into higher profits.”

- Frits van Paasschen, CEO

 

HIGHLIGHTS FROM THE RELEASE

  • "Worldwide System-wide REVPAR for Same-Store Hotels increased 10.1% (10.3% in constant dollars)" vs. guidance of 6.5% to 8.5%
  • "Management fees, franchise fees and other income increased 13.0%" vs. guidance of 4-6%
  • "Worldwide REVPAR for Starwood branded Same-Store Owned Hotels increased 10.1% (10.9% in constant dollars)" vs. guidance of 6.5% to 8.5%
  • "During the quarter, the Company received a refund from the IRS of approximately $245 million primarily for previously paid taxes and related interest relating to the settlement of a dispute regarding the 1998 disposition of World Directories, Inc."
  • "During the fourth quarter of 2010, the Company signed 37 hotel management and franchise contracts, representing approximately 8,000 rooms, of which 29 are new builds and eight are conversions from other brands. At December 31, 2010, the Company had approximately 350 hotels in the active pipeline representing approximately 85,000 rooms."
  • "During the fourth quarter of 2010, 23 new hotels and resorts (representing approximately 5,700 rooms) entered the system...Seven properties (representing approximately 1,400 rooms) were removed from the system during the quarter."
  • "Originated contract sales of vacation ownership intervals decreased 1.2% primarily due to lower average prices. The number of contracts signed increased 7.6% when compared to 2009 and the average price per vacation ownership unit sold decreased 7.0% to approximately $14,000, driven by price reductions and inventory mix."
  • "In December 2010, the Company received $75 million in connection with a favorable settlement of a lawsuit. The cash payment to the Company included the reimbursement of legal fees in connection with the matter."
  • 2011 Guidance:
    • Adjusted EBITDA: $975MM - $1BN (raised by $20-25MM; consensus $980MM)
    • WW SS Company Operated RevPAR (constant $): 7-9% (same as prior guidance)
    • WW Branded SS Owned RevPAR (constant $): 7-9%  (same as prior guidance)
      • margins: +150-200bps
    • Management, franchise and other income: +10-12% (raised by 1%)
    • Operating income from VOI & residential: $125-135MM (high end raised by $10MM)
    • SG&A: +2-3% (raised by 1%)
    • D&A: $325MM (decreased by $5MM)
    • Interest expense: $245MM (decreased by $5MM)
    • Tax rate: 25% (same as prior guidance)
    • EPS: $1.55 to $1.65 (raised by $0.10 to $0.11; consensus $1.57)
    • Capex:
      • (Maintenance, renovation, tech ex. VOI and Residential): $300MM
      • Investment projections and JV commitments: $150MM
      • VOI (ex Bal Harbor): Positive CF of $165MM
      • Bal Harbor: $150MM
    • Bal Harbor: Closings to commence in late 4Q11 but current outlook doesn't include any CF from potential closings but does expect revenue recognition in 4Q11. 
  • 1Q 2011 Guidance:
    • Adjusted EBITDA: $195MM - $205MM (consensus $206MM)
    • WW SS Company Operated RevPAR (constant $): 8-10%
    • WW Branded SS Owned RevPAR (constant $): 8-10% Management, franchise and other income: +12-14%  
    • Operating income from VOI & residential: $30-35MM
    • D&A: $78MM  
    • Interest expense: $60MM
    • Income from continuing operations: $43-51MM and an effective tax rate of 25%
    • EPS: $0.22 to $0.26 (consensus $0.24)

 

CONF CALL NOTES

  • Results suggest that the lodging recovery has held steady in an uncertain world. Remain cautiously optimistic about the near term prospects and bullish on their long term prospects.
  • Continue to work hard to drive their hotels past former peak levels
  • Rising consumer confidence is reflected in their VOI business in higher tour and close rates
  • Feel like the Aloft is doing the same for limited service that W did for tiered upscale hotels
  • 90% of Westin's pipeline is outside the US
  • St. Regis has doubled its footprint in just 2 years
  • Business travel remains strong with 90% occupancy rates in most major markets.  This is a travel intensive recovery.
  • Group business is also strong; they are beginning 2011 with pace up double digits. Booking windows are slowly starting to lengthen. December crushed the all time record for group business.
  • Business travelers account for 75% of their business
  • Leisure travel has also been robust, affording them the option to cut out some expensive distribution channels - like the opaque ones
  • What will make or break 2011 is rate.  Expect rate to drive 50% of RevPAR gains. 
  • New corporate rates will be up high single digits
  • RevPAR is tracking double digits in January across the US
  • Expect some slowdown after the World Expo in Shanghai but haven't seen any slowdown as RevPAR was up 24%.  Australia is very strong. Japan is the only soft spot.
  • Starwood branded rooms in Asia are up 80% since 2005
  • Despite the concerns about Spain, their business was very strong, helped by the W Barcelona
  • Hedged 50% of their Euro exposure
  • Middle East was the only region that was down. Have 16 hotels in N Africa which are likely to be impacted in 2011 - account for about $10-12MM of fees
  • Local inflation is hurting their owned hotel margins in Latin America. Their US$ based hotel rates aren't going up as fast as hotel costs.
  • VOI business is stable. Delinquency and default rates are stable and improving.
  • Hope that Bal Harbor will be 65-70% sold by the time closing starts
  • 1 pt of RevPAR = $15MM of EBITDA
  • Expect to open 70-80 hotels in 2011 with 50% outside the US
  • Why aren't margins higher?
    • High inflation in emerging markets
    • Pre-opening costs at owned W London
    • Revenues lag RevPAR
  • Several significant renovations in 2011
    • Westin Gaslamp
    • Grandin Florence
    • Sheraton Kaui
  • $245MM from refund, $75MM from legal settlement + proceeds from JV sale
  • Moving rapidly towards achieving an investment grade rating - hopefully by end of the 2011

Q&A

  • Group pace at this point is driven more by volume than by rate but as the new business comes in, they will benefit more from rate
  • US incentive fees are not a large number - relatively a small % of their hotels are paying fees. Only in the Middle East and Africa, incentive fees haven't grown.
  • Latin America is the only international place where they price in US dollars
  • Why did incentive fees grow 39%?
    • Powered by Asia, it was good in the US from a very low base. There are a few things that impacted the quarter but won't elaborate.
    • Lean ops helped them
    • Don't expect to continue at a 40% clip
  • Headcount - they are continuing the approach of flat headcount aside from large growth opportunities like in China
  • Real estate market has only partially recovered. Real buyers are from well capitalized REITs and high net worth buyers. You aren't seeing the PE funds back yet though. REITs are looking for stable assets in gateway cities. 
  • There isn't a whole lot of seasonality
  • Thinks that about 1/3 of hotels are paying incentive fees in NA and in international are 70%
  • 10 of their 16 hotels in N. Africa are in Egypt
  • For the full year, fees in ME & A was 12% of their total fees
  • Over 60% of their hotel base was either opened or recently renovated over the last 3 years
  • Not a large % of their business comes from expensive online channels - total OTA bookings are only 5%
  • General thoughts on the timeshare?
    • Starting to believe that it's starting to improve. Delinquencies are going down. So the business is in a rebound although perhaps not a rapid one

TGT: Trend Brewing?

Despite January expectations that were gradually ratcheted down, Target’s results were once again disappointing.  This marks the second month in a row where internal projections called for a low to mid single digit increase and results failed to materialize. 

 

Interestingly, there remains a major divergence between the growing, P-Fresh driven performance in the food and consumables category and the rest of the store.  Unfortunately, grocery induced traffic does not appear to be leading to an acceleration in discretionary spending at this point.  While two months doesn’t make a trend, scrutiny surrounding the company’s topline initiatives centered on 5% rewards and P-Fresh is on the rise. Over time, these strategies should work.  However, sales expectations need to be taken down in the near term.  Management’s guidance for low single digit increases in February is a start, but this is clearly not the 4+% comp trend we were originally expecting to see for most of 2011. 

 

TGT: Trend Brewing? - TGT matrix

 

Eric Levine

Director


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