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WEEKLY COMMODITY MONITOR

In general, commodities continue to gain in price with this past week bringing a more broad-based gain in week-over-week growth.  Many restaurant stocks are hoping for an abatement or moderation in prices ahead of 2H11 (having given up on 1H in many cases).  That notwithstanding, prices march higher.

 

Cheese prices merit a mention once again this week not due to any major week-over-week move but because of both DPZ and PZZA reporting recently.  Below, I provide some commentary on cheese from both management teams provided during their most recent respective earnings calls:

 

DPZ:

Yeah, so the forward curve and kind of looking at about three different sources right now have cheese actually easing a little bit through the rest of the year. We're at almost $2 right now. And so, our expectation is that we're going to see a little bit of easing, to give you on cheese. We've talked about this in the past, we've got a contract in place that basically reduces the volatility on cheese moves by about a third. So about two thirds of increases or decreases in cheese are passed through to our system.

 

I think the kind of consensus forecast out there right now for cheese are in the $1.70 to $1.75 range. And – you know so what you're looking at is kind of a $0.25 to $0.30 move and I think we've said in the past a $0.40 move in cheese is equal to a point at the store level P&L.

 

PZZA:

We expect the favorable impact of early year sales results to substantially mitigate the unfavorable impact of currently projected commodity cost increases, most notably cheese, throughout the remainder of the year.

 

DPZ is 95% franchised and, as such, management claims a degree of insulation from commodity costs.  Of course, to the extent that price needs to be taken and royalties slow, the company is not immune from inflation.  Add to that the inevitable impact of higher gas prices (up 6% week-over-week!) and inflation is meaningful to company and franchise revenues alike.

 

Looking at the chart below, the trend in cheese prices seems to be levelling out.  Nevertheless, even if cheese prices were to trend horizontally throughout the rest of the year, at it’s most benign, cheese price inflation would be 13%. 

 

WEEKLY COMMODITY MONITOR - cheese

 

Beef prices are a concern for almost all restaurant stocks.  Given the increasing demand for meat on a global basis, the impact of natural disasters,  the increase of corn prices and, of course, the downward trajectory of the dollar, beef prices look set to continue downward.  For steakhouse concepts like MRT, RUTH, and TXRH, this is a concern.  The concepts that are most able to pass on price to the customer will best weather this storm, while the concepts most dependent on price point and traffic for top line growth will likely suffer.

 

WEEKLY COMMODITY MONITOR - live cattle

 

Chicken wing prices definitely deserve a callout again this week.  The 5% week-over-week decline in wing prices spells further good news for BWLD margins.

 

WEEKLY COMMODITY MONITOR - chicken wing

 

Oil prices have been capturing all of the headlines of late and with good reason.  The obvious implications for retail gasoline prices in the United States impact consumer discretionary stocks and restaurants in particular.   As the chart below clearly shows, the inverse correlation between CBRL’s stock price and Oil over the past couple of weeks has been extremely high.  CBRL is especially sensitive to gasoline prices given that its customer is typically derived from highway traffic.  However, I suspect that other restaurant chains such as TXRH, CAKE, SONC, and many others will be impacted by this gain in prices at the pump.

 

WEEKLY COMMODITY MONITOR - cbrl oil

 

WEEKLY COMMODITY MONITOR - commodities  weekly 32

 

Howard Penney

Managing Director

 

 

 


FL: Slowdown Schmodown

Intraquarter speculation surrounding a meaningful slowdown in Foot Locker's sales trends is now confirmed to have been purely baseless.  This was another solid quarter with the reporting of 4Q EPS of $0.39 per share, a couple of pennies above the Street and a few pennies shy of our robust $0.43 estimate (our key difference came on the gross margin line where we were overly bullish). The key to the quarter was simply better sales in which comps came it at a robust 7.3% (Street: 5%, Hedgeye: 6%). Gross margins were up 214 bps, in line with guidance and expenses were leveraged against the strong topline.

 

Two highlights to note. First, management continues to control inventories, growing them at a fraction of sales growth. Inventory increased by 2.1% while total sales were up 5.1%. Recall that inventory growth is targeted at a maximum of 50% of the rate of sales growth. Second, the balance sheet continued to improve sequentially as the company substantially improved EBIT and subsequent cash flow over the past year. The cash balance stands at $696 million or $559 million net of debt. We expect share repurchase to become more meaningful in 2011.

 

All in this was another solid quarter, which marks the first anniversary of CEO Ken Hicks arrival. Tomorrow morning’s conference call will provide additional details on the company’s plans for 2011 as well as some high level guidance. It’s safe to say that skepticism surrounding FL’s sales performance within the quarter was speculation at its best.  Just one year into the multi-year turnaround process and we are now seeing evidence of real market share gains. We expect that this trend will continue as the benefits of merchandising, marketing, and inventory management strategies are clearly taking hold with both customers and the company’s key vendors.

 

Below we republish a list of questions we have heading into the conference call:

  • How big  was the 2011 increase in co-op advertising?  It appeared in 4Q that TV impressions were up substantially but at what (if any) cost?  How is Foot Locker measuring advertising effectiveness now that each of the major brands are firmly behind the company’s resurgence as the leading global seller of athletic footwear?
  • What is being done to jumpstart the performance of the company’s e-commerce platform?  When is store delivery and real-time store inventory locating going to be a reality? With double-digit EBIT margins even modest growth here could and should be meaningful to the bottom line.
  • How are the product trends in the US (running, basketball, toning) translating into Europe and Asia?
  • When can we see more House of Hoops-like collaborations with your vendors? 
  • If an NFL lockout occurs what impact may this have on this year?  Would this possibly help the impending launch of Nike’s NFL license given pent up demand may result from a NFL-free year?
  • What if anything will Allen Questrom be focused on with his recent board appointment? He has a history of changing company cultures and attracting human capital.  Will the organization see changes as a result?
  • What have been the biggest challenges so far in re-assorting the company’s apparel programs, both private label and branded?
  • What does a successful exclusive launch of UA basketball mean for future collaborations? (same for Li Ning? Is it significant enough to move the needle?)

FL: Slowdown Schmodown - fl 4q

 

Eric Levine

Director


IS GLOBAL STAGFLATION HERE TO STAY?

Conclusion: Today’s action in the Hang Seng Index lends support to a theory we’ve been pondering for the past few weeks: global inflation is likely to shift beyond mere commodity reflation born out of US dollar debasement into the dreaded “core” inflation readings that will incrementally stymie global consumption growth.

 

Recent Positions: Short Emerging Market Equities (EEM, EWZ, IFN, ESR); Short Consumer Companies w/ multinational sales and/or global supply chains (MCD, TGT, JNY, VFC, XLP, XLY); Short US Treasuries (SHY); Short Developed Nation Equities where sentiment is misaligned with the fundamentals (EWJ, SPY, XLI); Long Crude Oil and Oil Producers (OIL; PBR); Long Commodity Currencies (FXC).

 

One question we’ve been wrestling with lately is: “Where do we go from here?” – particularly as it relates to the US Dollar-debased commodity inflation you’ve been seeing on your screens for the last 3-6 months. On this morning’s Daily Macro Call, Keith mentioned he’d get more constructive on equities as an asset class (particularly US equities) if the US dollar were to stabilize above its TREND line of resistance at $78.98.

 

IS GLOBAL STAGFLATION HERE TO STAY? - 1

 

Playing devil’s advocate, one could make a compelling case that the boat has left the dock with regards to global inflation trends. As we’ve seen with accelerating “Core” CPI readings, particularly in Asian economies like China, Indonesia, and Thailand, companies globally are taking advantage of recent robust global growth trends and bullish growth forecasts to pass through COGS increases to consumers.

 

The US, China, Japan, India, Brazil are just a few major economies where consensus growth forecasts for 2011 are much, much too high relative to our models and the current Global Macro backdrop of accelerating inflation and higher interest rates.

 

Irrespective of the tired argument between the importance of “Core” vs. “Headline” CPI, the key takeaway here is that even if commodities start to back off their current highs (i.e. if MENA conflict stopped today and crude oil went back down to the $80-$85 range), there is a very high and underappreciated possibility that global inflation readings will continue to accelerate for two main reasons: 

  1. Corporations  – particularly public companies with FIFO accounting – will look to overly bullish global growth estimates as justification to pass through the last two quarters of COGS inflation through the supply chain to end-consumers in an attempt to protect both margins and earnings; and
  2. The recent global uptrend in public officials caving in to populist pressure to increase subsidies, transfer payments, and wages will continue to add to the demand-side inflationary pressure and exacerbate the current supply/demand imbalances of many commodities in the near term. Longer term, this artificial support of consumer demand is likely to result in additional price pass-through to end-consumers, which is likely to stymie consumption growth over the intermediate term. 

Since we all know where consensus is at regarding the current lofty global growth assumptions, we’ll just skip right to addressing point #2. A few specific examples of the recent global trend of increasing subsidies, transfer payments, and wages include: 

  • China: As the gov’t moves to rebalance the economy towards a greater reliance on domestic consumption, minimum wage hikes are anticipated in all 31 provinces for the second consecutive year, with key populations such as Guangdong, Beijing, and Shanghai are at the forefront of gains;
  • Indonesia: Plans to remove longstanding subsidies for fuel in March have been scrapped. In the past, the removal of such subsidies have led to protests which brought down Indonesian governments, such as the Suharto regime in the late ‘90’s;
  • MENA: Speaking of protests, Jordan, Algeria, Morocco, Yemen, Libya, and, perhaps most importantly, Saudi Arabia have flooded their economies with transfer payments to ward off current and future protesters (see: “Day of Rage” planned in the Saudi Kingdom on 3/11). Specifically, the Saudi royal family just announced a $37B benefits package last week in what may turn out to be a moot effort to prevent a domestic social upheaval;
  • India: In its latest budget (released Monday) the gov’t is attempting to boost incomes through greater income tax exemptions. Moreover, it is increasing subsidies for housing loans and allocating $1.44 TRILLION rupees for food and fuel subsidies. Additional subsidies are expected to be announced in the coming weeks.
  • Thailand: The gov’t just recently extended a program that provides free electricity and public transportation for the poor.
  • Brazil: President Rousseff just announced a R$2.1B ($1.3B) increase in funding for Brazil’s Bolsa Familia transfer program which will allow even more families to receive benefits. 

Perhaps more so than the other countries, Hong Kong’s capitulation on this front last night revealed an interesting takeaway as it relates this trend with respect to developing vs. developed economies. Given that most regard Hong Kong as a reasonably developed economy, it was interesting to see the Hong Kong gov’t give in populist demands for additional handouts because it lets us know that this trend may no longer be contained to largely-indigent developing nations like those of the MENA region, India, and China.

 

After Chief Executive Donald Tsang (the highest ranking H.K. official) was assaulted amid a wave of public protest yesterday, Financial Secretary John Tsang agreed to hand out cash, tax rebates, pension injections to the tune of HK$6,000 in each instance. This is in addition to his decision last week to wave public housing rents for two months and provide subsidies for electricity bills while talking up the dangerous inflationary pressures of providing cash handouts.

 

Addressing the media overnight, Tsang had this to say: “We find this is the best way to respond to demands from residents…”

 

We at Hedgeye also find this to be among the best ways to support our call for Global Inflation Accelerating. Perhaps that’s why the Hang Seng backed off its TRADE line of resistance hard overnight, closing down (-1.5%).

 

IS GLOBAL STAGFLATION HERE TO STAY? - 2

 

All told, we’ve been beating the table on Global Stagflation since October. Now that consensus has figured out the inflation component as oil trades above $100/bbl., our task is to figure out how to time consensus’ uncovering of the bearish growth factor on the short side of equities. If 2008 is any guide, they will kick, scream, and buy every dip on the way down – provided we’re headed there; ultimately, time and space will tell.

 

Darius Dale

Analyst


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Accelerating Athletic Apparel Trends Continue

 

Weekly athletic apparel sales continue to accelerate on a sequential basis, confirming a rebound in sales activity through the end of February.  Both the athletic specialty and family channels continue to strengthen while sales at the discount/mass channel slowed on the margin last week. Under the surface it’s worth noting that ASP’s decelerated in both the athletic specialty and family channel for the second consecutive week.  However,  unit volume more than made up for slight y/y ASP declines. Price increases in the discount/mass channel appear  to be curbing sales momentum a bit, as unit growth has decelereated each of the past few weeks.  Lastly, sales growth was robust across all regions with New England standing out as the only region to decelerate on a sequential basis. More noteworthy however, is the sharp rebound in the Pacific/Mountain regions that have been underperforming since mid-January.  As always, week to week weather patterns can certainly have a short term impact.

 

Accelerating Athletic Apparel Trends Continue - FW App App Table 3 2 11

 

Accelerating Athletic Apparel Trends Continue - FW App App 1Yr 3 2 11

 

Accelerating Athletic Apparel Trends Continue - FW App Reg 3 2 11

 

Casey Flavin

Director


Brazil: One Step Forward; Three Steps Back?

Conclusion: Rousseff’s lack of actual cuts her latest “austerity” package is supportive of Brazilian inflation on the margin. Like India, this lack of fiscal resolve places more onus on the central bank to curb inflation going forward – a marginal negative for Brazilian equities for the intermediate-term TREND. Furthermore, we detail how current gov’t practices may lead to a long-term structural inflation problem going forward.

 

Position: Short Brazilian Equities via the etf EWZ; Long Petrobras via PBR.

 

Ahead of today’s central bank meeting, where a +50-75bps Selic rate hike is fully anticipated by economists and traders alike, we thought we’d share with you perhaps more sobering news regarding the outlook for inflation in Brazil over the intermediate-term TREND – sticky, sticky, sticky.

 

Recent developments have us in the more hawkish camp relative to consensus on Brazilian interest rate policy over the aforementioned duration. This is primarily due to the fact that our analysis of the “prudent’ fiscal policies oft-bandied about by Brazil’s new chief, Dilma Rousseff, leads us to conclude they are much less prudent than is commonly believed by market participants.

 

Rousseff may have won over a few investors who were concerned about Brazil’s accelerating inflation (including us, on the margin) by standing pat on her bid to limit the increase in the nationwide minimum salary to R$545. More recently, she vowed to cut R$50B from the government budget to help contribute to the stated goal of bringing down inflation toward the government’s target of +4.5% YoY (the latest official CPI reading had inflation at +6% YoY in Jan). Details regarding the cuts were released yesterday.

 

Regarding said cuts, there is certainly less meat to them than is perceived by consensus. Accounting changes, delays in legal settlements, pure fraud (in the case of the Minha Casa, Minha Vida R$5B “cut”), estimated savings from downward revisions to subsidy payments (which we don’t buy in the face of accelerating inflation), and “cuts” that were never intended to be part of the budget in the first place amount to roughly R$40.6B in “savings”, according to the publication O Estado de Sao Paulo.

 

That R$40.6B compares with R$13B of “actual” cuts, such as the suspension of procurement programs and public sector hiring freezes (which one can make the case aren’t actually cuts, per se). All told, Rousseff’s grand strategy to dampen Brazilian inflation and interest rate expectations (to limit the real’s gain) is more smoke and mirrors than perhaps perceived by many market pundits (the Bovespa is trading up nearly a full percent on the day).

 

Perhaps even more sobering from a long-term perspective is Brazil’s return to the public accounting and budget tricks that accompanied Brazil’s struggles with hyperinflation in the past. The Treasury, in the form of direct loans, is making capital contributions to the state-owned bank BNDES – widely known to be responsible for underwriting loans to Brazil’s state-owned and highly-favored private enterprises at rates that are a fraction of Brazil’s benchmark Selic rate.

 

More simply, the Brazilian gov’t is issuing debt and not recording it on the public coffers, instead opting to record the funds on its books as loans which are to be amortized back to it in the future. The main issue with this is that it allows the gov’t to run a separate budget (via influencing BNDES’ lending activity) that is parallel to the official budget, which Rousseff and Finance Minister Guido Mantega are “working hard” to cut.

 

BNDES, which used to be self-funding, has loaded up on R$300B in such capital injections since 2008, and the latest projections from BNDES regarding Brazil’s infrastructure investment needs through 2014 are somewhere around R$3.3 TRILLION. While not all of this will be funded through misrepresented gov’t debt, the staggering sum underscores the potential for Rousseff & Co. to be unable to reduce such funding to BNDES should the Brazilian economy’s bout with inflation worsen materially from here.

 

It’s worth noting that a) Brazil hosts the World Cup in 2014; b) Brazil hosts the Olympics in 2016; and c) Brazil’s largely unpaved, undeveloped roads and woeful energy generating capacity all contribute bottlenecks and rising prices throughout Brazil’s domestic economy and in the global economy via commodity exports. This means the Brazil won’t be able to meaningfully reduce the credit creation associated with the country’s MASSIVE financing needs over the next 3-5 years.

 

Given this setup, we can foresee a scenario whereby inflation once again becomes the major structural issue in Brazil it once was – particularly if the gov’t continues stoking domestic demand via capital injections to BNDES and if Rousseff, Tombini, and Mantega continue to resist upward pressure on the real. For now, we’re willing to bet they’ll avert such a dire scenario via long-term real appreciation – one of the reasons we remain bullish on Brazil’s currency for the long-term TAIL.

 

From a more intermediate-term perspective, the high(er) frequency data (particularly much of the manufacturing and consumer data) continues to support our view of the Brazilian economy as being in a state of marginal stagflation as growth slows while inflation accelerates. In this regard, Brazil is not unlike the global economy at large. As the Bovespa rallies today into another lower-high, we continue to caution against buying Brazilian equities here (w/ the exception of PBR); if you’re bullish on Brazil’s long-term growth story, buy it later at a better price.

 

Brazil: One Step Forward; Three Steps Back? - 1

 

Moshe Silver

Managing Director

 

Darius Dale

Analyst


Carving Turkey

Conclusion: We do not see a buying opportunity of Turkey’s equity market given looming energy uncertainty.

 

Positions: Short Emerging Markets via the etf EEM and Brazil (EWZ)

 

Turkey’s main equity index, the ISE 100 got crushed yesterday, falling -4.2%, while the etf TUR fell -5.5%.  Today the ISE is trading flat, however we caution that one main factor that may significantly influence Turkey’s overall equity performance is its dependence on foreign energy.

 

To meet its consumption needs, the country imports ~ 93% of its oil and ~ 97% of natural gas, according to the EIA. While Turkey receives economic benefit as an important energy transit state (with supplies originating in Russia, the Caspian Sea region, and the Middle East for delivery primarily in Europe), the fact remains that given the present uncertainty in the oil producing nations of the Middle East and North Africa (MENA) and Turkey’s extreme foreign energy dependence, Turkish stocks should continue to underperform so long as global supply and production remain uncertain.

 

A look under the hood (and as the charts below present), recent Turkish fundamentals show:

 

1.)   Growth Slowing - GDP has slowed sequentially over the last 3 quarters, with difficult year-over-year comps from here on out.  Turkey is clearly one country that has been the recipient of the pullback in the emerging market trade over the 6 last months. We’re explicitly short the emerging market via the etf EEM and Brazil (EWZ) in the Hedgeye Virtual Portfolio

 

2.)   Inflation Slowing – bucking the trend of most global economies, inflation (as reported by the CPI) has slowed in Turkey over the last 4 months on a year-over-year basis. As the chart below shows, comps will remain difficult for much of 2011, so CPI may decline over the next months. However, our focus is on the country’s primary tax, energy, especially given the prospect for further unrest from its suppliers, and therefore higher prices. We’re less concerned about possible declines in the headline CPI number, for now.

 

3.)   Trade Deficit Widening – The country ran a trade deficit of -$7.3 Billion in January. While the country has consistently run a trade deficit over the last 10 years, the trend is widening, and is certainly one macro factor that will eat into overall growth.  50% of its exports are destine for Europe (in particular Germany, France, Italy), arguably a relatively stable market. However almost 30% are destine for MENA, and obviously the demand from this region is a huge unknown.  [For reference, manufacturing is the country’s largest component at 91.7% of total exports].

 

In reference to today’s Early Look penned by my colleague Daryl Jones, Turkey also has a relatively young population, with median age of 28.5 years (World median = 28.4 years), according to the CIA Factbook.  Currently, total unemployment in Turkey is 11% and local purchasing power is down with the Turkish Lira down -16% vs the USD or -15% vs the EUR since a high on 11/4/10.  Surely it could be argued that Turkey has a more stable government than many in MENA and therefore is less likely to see uprisings. That withstanding, from a market perspective we think Turkey has more downside risk than upside potential so long as the fate of rulers and governments throughout MENA remain uncertain.

 

Therefore, we do not see yesterday’s pullback in the ISE as a buying opportunity, and think the index, which is down -18% from its top on 11/9/10, could fall further. We’re also taking risk management cues from rising CDS spreads (Turkish CDS is on a steady rise since Oct. 2010 and currently at 175bps) and rising yields (Turkey’s 10YR government bond yield has blown out since the beginning of the year, currently at 9.5%) . In the last chart below we show our resistance levels on the ISE. 

 

Matthew Hedrick

Analyst

 

Carving Turkey  - Tur1

 

Carving Turkey  - Tur2

 

Carving Turkey  - Tur3

 

Carving Turkey  - Tur4


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