Portugal Shakes on Debt Dues

Conclusion: Portugal is shaking with a heavy load of its debt (principal + interest) for 2011 coming due over the next 3-4 months; this is combined with a credit rating downgrade this morning, and push backs on its austerity programs to narrow its high debt and deficit imbalances. Bailout cometh?


Positions in Europe: Long Germany (EWG); Short Spain (EWP)


As the spotlight returns to Europe’s sovereign debt and deficit issues, Portugal continues to melt. All the macro signals we follow suggest that Portugal will likely follow its peers Greece and Ireland and require a bailout to meet its fiscal imbalances.  The supporting evidence includes:

  • A hefty schedule of debt (principal + interest) that comes due in the months of March, April, and June (or ~ €16.1 Billion), accounting for nearly two thirds of its debt obligations for 2011 (or ~ €25.4 Billion).  So far the country has sold ~ €7 Billion in bonds of its €20 Billion target this year. (See chart below)
  • Portugal’s credit rating was cut 2 steps by Moody’s today to A3 (or 4 steps from junk), citing the country’s “subdued growth prospects” and “the implementation of risks for the government’s ambitious fiscal consolidation targets.”
  • Portugal’s Finance Minister Fernando Teixeira dos Santos acknowledged today that the country's current borrowing costs aren't sustainable in the medium and long term, according to the WSJ.

Portugal Shakes on Debt Dues - port1


The combination of a substantial near-term load of debt payments due with a downgrade of its credit rating suggests that the yield premium to issue Portuguese debt will continue to push higher, making it harder to finance its near-term issuance, all of which increases the probability that the country asks for outside support. In an auction of 12-month treasury bills today worth €1 Billion, the average yield paid was 4.331%, up from 4.057% two weeks ago. 


And the risk management signals that Portugal is near asking for a bailout include:

  • Sovereign CDS suggests the risk trade is definitely “on”, and has been for over a year. Since a year-to-date low in Portuguese CDS on February 3rd at 389bps, CDS is up 30% to 507bps. Like we saw in the case of Greece and Ireland, when the 300bps level was violated to the upside, a bailout of the country came within weeks. Portugal broke out convincingly from the 300bps level in early September of last year. (See chart below)
  • Like CDS, the risk premium to own Portuguese debt is also reflected by the government’s 10YR bond, which shows yields increasing 100bps year-to-date. 

Portugal Shakes on Debt Dues - pfinal


Finally, PM Socrates announced late yesterday that opposition lawmakers’ resistance to additional budget cuts announced last week to meet deficit targets threatens a “political crisis”.  Socrates and his Socialist party, which does not have a majority in parliament, has put forward an overly ambitious target (in our opinion) to cut the country’s budget deficit from 9.3% of GDP in 2009 to an estimated 7% in 2010, 4.6% in 2011, and to the EU limit of 3% in 2012. The government issued austerity measures in late September 2010 that included a 5% wage reduction for public sector workers earning more than 1,500/month, a hiring freeze, and an increase in VAT from 21% to 23%. Now the government is calling for new austerity plans to control operational and administrative expenses.


Today Socrates said that the plan for the new cost cutting measures would be announced before the EU Summit on March 24-5 and acknowledged that if the new austerity measures are voted down in parliament, his government would likely face early elections.


Given the political consternation about the size and shape of its austerity program combined with the near-term forces of rising debt costs into a schedule of sizable payments coming due and estimated -1.3% GDP in 2011 (expect tax revenues to be down!), we think the probability of a near-term bailout in Portugal has greatly increased. We can’t be certain of the position Eurozone leaders will take on Portugal in the days ahead, especially ahead of the EU Summit on March 24-5, but we’d expect the market to continue to punish Portugal as uncertain surrounds the collision of its fiscal and political imbalances and near-term debt obligations.


Matthew Hedrick



A hedge to interest rates, a strong BS and FCF, margin levers, and a countercyclical element to its growth profile should make IGT a much more defensive stock than its trading would indicate.



It’s no secret we like this sector long-term.  We like it near-term too when sentiment gets overly focused on the timing of replacement demand; like now.  Twenty years is not the new replacement cycle paradigm.


How can the new slot replacement cycle be 20 years?  Video poker has averaged a 13 year cycle historically and they only get replaced upon disintegration.  Even if we assume a 13 year cycle for all slots, that is a level 45% higher than the current 45k replacements.  Hence, our belief is that currentl replacement levels are simply not sustainable. 


We like the Big Three over the long-term but with all the risk out there in the world IGT might be the most defensive.  IGT and BYI should be market share gainers over the near term.  Favoring IGT is no more than a risk management move.  While BYI is probably better positioned over the long-term – not susceptible to prolonged participation market share losses - IGT has more margin levers over the near term and less risk with systems timing so it’s more defensive in an uncertain time.



  • Great balance sheet – only 2x levered
  • Free cash flow positive – around $1.40 per share this year
  • Hedge to higher interest rates – higher game ops margins due to jackpot annuity funding at lower net present values as interest rates rise
  • Benefits from budget deficits so countercyclical to some extent – states need money!
  • Near term margins levers


  • Trough replacement demand and new market growth currently
  • 40-50% increase in replacements just to normalized levels
  • Visible new market growth already but states and international budgets are in rough shape – casinos are now a politically palatable way to increase government revenues – we’ve seen it before
  • Combined we should see 20-25% CAGR EPS growth over a 3-5 year period – and that growth will be highly cash generative



March 16, 2011






  • Williams Sonoma noted that West Elm achieved record sales and profits during 4Q, marking a full year of upside relative to plan.  As a result., the company is gaining confidence towards an acceleration in store openings for the brand.  Unfortunately, the step up in square footage is likely to begin in 2012 with a chance for a handful of incremental stores to be added to the pipeline in 2011.
  • Despite rising costs on the magnitude of 10-15% of the back half of 2011 for Pacific Sunwear, management continues to highlight occupancy costs as the company’s single biggest challenge.  With these costs approaching 20% of sales, management has been meeting with landlords to work on some mutual concessions in order to alleviate such cost pressure.  While the meetings with all landlords are now complete, the company does not expect to know what the outcome of rent concession discussions will be for at least 30-45 days. 
  • In yet another example that the promotional activity in footwear remains benign, the management of BWS noted they expect zero BOGO days in Q1 compared to 5-weeks during the same period last year.
  • One of the more notable callouts from DSW was the increase in units per transaction the company realized in Q4 for the first time in over three years. With an average of 1.5 UPT prior to 2008, management highlighted an increase over the last few months to roughly 1.3. This may be as much an indication of consumer mindset as the company’s growing accessories business, which will also help drive this metric.



Japan Tragedy and its Impact on the Global Economy - Japan is just starting the long process of digging out from last week’s massive earthquake, but economists say the country’s plight is likely to have only a small impact on the global economic recovery. Using as guideposts other natural disasters, such as the 1995 Kobe earthquake and Hurricane Katrina in 2005, experts are predicting the disaster will slow Japan’s economy for a quarter or two until the rebuilding process stimulates activity in building and other sectors. Even though the earthquake and tsunami are estimated to have claimed more than 10,000 lives, the country’s economic slowdown is expected to trim only 0.1 to 0.2 percentage points off global economic growth this year. This assumes officials racing to shut down several damaged nuclear power generators are able to prevent widespread fallout — the fear of which has prolonged the initial phase of the disaster, rattled global markets and prompted some people to leave Tokyo. <WWD>

Hedgeye Retail’s Take: From a market perspective, the reality is that the magnitude of this devastating events impact is still a moving target near-term – from a retail perspective, the psychological recovery will remain the key factor.


Gap Aims to Expand 1969 Line - Gap’s 1969 brand is embracing denim diversity. From her perch at loft offices in an industrial area here where the premium denim movement took root, 1969’s creative director Rosella Giuliani is orchestrating Gap’s premium collection’s efforts to stay in stride or ahead of the denim fashion curve by broadening its range of colors, fabrics and lengths. Her challenge is to keep the retailer’s denim relevant and continue the momentum of 1969, which started two years ago after a major rethinking of Gap jeans’ fit and positioning. The collection is considered a bright spot in Marka Hansen’s spotty tenure at the helm of Gap North America, which ended with Art Peck taking the reins last month. <WWD>

Hedgeye Retail’s Take: While the definition of premium denim may vary, at $59-$89 this line falls squarely into the substantial white space of sub $100 denim and will offer consumers something to consider come spring. Effectively marketing the line will be the company’s next challenge in rebuilding Gap's image as a denim destination once again.


Lucky Brand Founders Launch Civilianaire - Gene Montesano and Barry Perlman are going back to basics. The Lucky Brand founders have shed the managerial red tape, complicated global supply chain, ambitious retail rollouts and unrelenting pressure to improve the bottom line that typified their previous corporate existence at Liz Claiborne Inc. to build Civilianaire from the ground up. The new brand is based and made here, where Montesano and Perlman are fully in charge both financially and creatively of a staff of about six. The new line reintroduces familiar shirts and jeans from their past to a generation of postrecession consumers rejecting noisy designs in favor of a stripped-down aesthetic intended to transcend trends. <WWD>

Hedgeye Retail’s Take: Keeping the brand message defined and consistent was a challenge for the duo at Lucky, however it appears their new line is much less about fashion and more focused on classic vintage styling.


Adidas Launches New Campaign - On Wednesday the Herzogenaurach, Germany-based athletic brand launched “All Adidas,” its first major branding campaign since 2004’s “Impossible Is Nothing.”  The global TV- and Internet-focused campaign is meant to help the brand raise awareness with the high-school age consumer, a segment targeted under the Route 2015 plan to grow sales, Adidas America President Patrik Nilsson told Footwear News. “We’ve had a tremendous year already, so we’re now coming in and doing the biggest campaign we’ve done in America that tells the story of how diverse the brand is and inviting the consumer into the brand, to participate in what the brand really stands for,” Nilsson said.  The campaign, conceived by Adidas’ lead ad agency, Montreal-based Sid Lee, debuts globally with two TV spots (a 30-second and a 60-second version) and an extended two-minute version available online.<WWD>

Hedgeye Retail’s Take: The latest result of the company’s stepped up marketing efforts appears to be priming the pump for the much anticipated launch of outdoor this fall for which authenticity will play an important role. Given that the company’s roots are far deeper in sport, it will be interesting to see how the marketing message is crafted as we near the launch.


Court Holds SEO Firm responsible for Online Sales of Counterfeit Golf Clubs -  A federal court has ruled that a firm that provided marketing and web hosting services was financially responsible for the sale of counterfeit golf clubs by a client e-retailer. A federal judge in South Carolina entered a judgment against Bright Builders Inc. on counts of contributory trademark infringement and unfair trade practices for allegedly assisting in the construction and hosting of the e-commerce site Judge Margaret B. Seymour of the U.S. District Court for South Carolina ordered Bright Builders to pay $770,750 in statutory damages and Christopher Prince, owner of the web site, $28,250, according to lawyers for the plaintiff, Cleveland Golf Company Inc. Bright Builders and Prince did not immediately respond to requests for comment. <InternetRetailer>

Hedgeye Retail’s Take: The cost of business in partnering with a entity named – c’mon.


A Bright Future for Daily Deal Sites - Deal-of-the-day sites, often featuring a group buying component, have taken off over the past year, with startups like Groupon getting big fast and major internet properties like Google and Facebook looking for their own ways to get in on the action. Consumer spending on deal-a-day offers is poised to grow more than 35% to reach $3.9 billion in the US by 2015, according to a March 2011 forecast by BIA/Kelsey. Deal sites like Groupon, LivingSocial and others have become popular among users who are getting accustomed to receiving deals packaged conveniently in one daily email, eliminating the need for hunting around on the web.< eMarketer>

Hedgeye Retail’s Take: There’s a point at which consumers are going to limit the amount of deals they’re willing to be subject to on a daily basis, which doesn’t appear to be taken into account in this straight-lined approach.


R3: WSM, PSUN, DSW, BWS - R3 3 16 11



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Chicken gains on the week as the usual suspects reverse their direction and decline week-over-week.


This past week was a week of deflation for commodities.  Events in Japan, and the ongoing concerns regarding the implications of the tragedies,  have put pressure on commodity prices across the board.  Cheese, corn, coffee, and wheat, are all up between 40% and 90% year-over-year but declined sharply in the last week.  This will offer some encouragement for restaurant operators and shareholders that commodity inflation may be moderating.  Chicken (broilers and wings) gained on the week but year-over-year inflation is not a concern for the protein. 


Cheese prices declined 10% week-over-week.  As the chart below shows, cheese prices remain elevated and restaurant companies with exposure to cheese.  Below, I provide some commentary on cheese from both management teams provided during their most recent respective earnings calls:




"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."



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.  The downward move of cheese over the past week will raise hopes that a price increase can be avoided. 


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%. 




Corn’s decline over the week was largely focused on corn importers in Japan delaying purchases in the wake of the disastrous events unfolding there.  Corn is a key input for the livestock and poultry businesses and, at +73%, remains a headwind on a year-over-year basis but has declined abruptly on the news from Japan.




Chicken wing prices definitely deserve a callout this week.  While the gain in prices was muted, at +0.5%, it is possible that this signifies the end of a longer downward trend in chicken wing prices as concepts like DPZ shift to chicken and increase demand for the commodity.






Howard Penney

Managing Director

Quake or Correction?

This note was originally published at 8am on March 11, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“We learn geology the morning after the earthquake.”

-Ralph Waldo Emerson


Emerson was an American Patriot who championed individualism during the mid-19th century. He was born in 1803 in Boston, Massachusetts and lived his life out loud during a time of great American leadership. I don’t think he’d care so much for today’s Big Government Interventions.


Today, not unlike any other day, we’ve woken up to the risk management reminder that the world is grounded in uncertainty. From Japan’s earthquake to the Saudi “Day of Rage”, not matter where you go, there it all is…


The morning after risk should have been proactively managed is as crystal clear as the mirror you have to look in every morning. Those who are Perma-Political obviously don’t like to do that so much on mornings like this. Sadly, the modern day Japanese, European, and American bureaucrat lives a life of finger pointing as opposed to introspection.


I’ll get to answering the Quake or Correction question about the US stock market by the end of this note, but I really think that there’s  a much more critical long-term leadership question that we need to be asking ourselves of the government we should be governing this morning.


If we want to make this country Japanese in its fiscal and monetary union, that might be fine for the sake of a 2-year stock market trade – but not in preventing a long-term societal Quake.


The Ralph Waldo Emerson years were very formative in terms of how Americans thought about self-directedness and individual liberties. During Emerson’s adult years, Andrew Jackson was the President of the United States (1829-1837). Like all of us, Jackson had plenty of faults associated with living in the moment, but one of them wasn’t accepting the tyranny imposed by a socially elite Big Central Bank.


In fact, “after the First Bank of the United States was established by Hamilton, followed by a Second Bank put in by pro-bank Democratic-Republicans after the War of 1812, President Andrew Jackson managed to eliminated the Central Bank after a titanic struggle during the 1830s.” (Murray Rothbard, “The Case Against The Fed”, page 73)


On the banking front, Jackson’s battle against Big Central Planning was won against a young Princeton economist by the name of Thomas Biddle, who was serving in a quasi-Bernank seat as the president of the Second Bank of The United States. It gives me chills to think that Big Princeton Keynesians like Paul Krugman and Ben Bernanke have generated so much political power with the same academic dogma since.


Unfortunately, after the Jefferson-Jackson libertarian ideals of free markets were fortified via democratic vote, the Civil War came (where Jackson obviously had plenty of accountability issues to deal with on another topic -  slavery) and bankers who hoped for Big Government Intervention capitalized on the crisis.


The phrase “Not Worth a Continental” is derived from the same strategy that the Japanese will look toward to solve for event risk in their economy today – issuing fiat paper. During the American Revolution, that’s exactly what the Continental Congress did (print money) – with the bigger problem being that those Continental dollars were non-redeemable in gold (neither are trillions of Yens).


“The common phrase, “Not Worth A Continental” became part of the American folklore as a result of this runaway depreciation and accelerated worthlessness of the Continental dollars.” (Rothbard, “The Case Against The Fed”, page 29)


Now getting back to living in the today, if we don’t want this country to be hostage to event risk like Japan is this morning (I mean economically), like any good American household or company, we need to get this American balance sheet problem fixed. There comes a tipping point where you can’t print money to internally finance a recovery from a natural disaster, or God forbid, a war.


I’m not being alarmist. This is a very serious matter that history certainly has taught us to respect. Ask the German bankers like Paul Warburg who constructed both the German Reichsbank (founded in 1876) and, to a degree, the US Federal Reserve (founded 1913), how being hostage to The Inflation associated with an addiction to printing money ends when calamity strikes…


Back to the risk management Question of The Day: Quake or Correction?


I’ll grind through the levels here and keep this answer as tight as it needs to be. After all, you should be asking a firm who called for this Asian and US stock market correction for the levels to manage your way out of it…


As a reminder, we’ve been calling for a 3-6% correction in both US and Japanese Equities since Valentine’s Day:

  1. JAPAN - This morning’s selloff in Japan makes the cycle-peak-to-drop correction in the Nikkei -5.6% since February 21, 2011
  2. USA - Yesterday’s pounding of US stocks (4th down day in the last 5) makes the cycle-peak-to-drop correction in the SP500 -3.6% since February 18th, 2011

My immediate-term TRADE and intermediate-term TREND targets for the SP500 are now:

  1. SP500 immediate-term downside support = 1283
  2. SP500 intermediate-term downside support = 1265

So, I say Correction. The Quake is already another historical event. Let the Perma-Bulls learn from that again, on the morning after.


Go Yale Hockey in The Haven tonight (Game 1 of the playoffs against St Lawrence), and best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Quake or Correction? - emerson


Quake or Correction? - 3 11 2011 8 02 17 AM

Old School Wall Street

This note was originally published March 16, 2011 at 08:36 in  

“A good player plays where the puck is. A great hockey player plays where the puck is going to be.”

-Wayne Gretzky


Just over three years ago, we started Hedgeye with the philosophy that the research business should be transparent, accountable and trustworthy.   At the time, many of our Old School Wall Street critics derided us for naively entering the investment research business with a simple philosophy.  Needless to say, three years, forty five employees, and hundreds of clients later, Hedgeye isn’t such a novelty.  Neither are our core values.  


We’ve made a few enemies amongst the Old School Wall Street crowd over the course of the past few years, but we’ve made many more new friends, some of whom we are now honored to count as subscribers to our research.  Yesterday, it seems, we made a new enemy in Peter Boockvar, the Sales Trader /Equity Strategist from Miller Tabak.  Boockvar, it seems, is not so crazy about transparency.


At Hedgeye, we are fond of an expression called “YouTubing”. This expression means to analyze and, sometimes, critique, the public comments of politicians, executives, and market commentators.  “YouTubing” is not meant to be a personal attack, but rather a critique related to the substance of those views articulated.  In the Web 2.0 world, if you make public comments, you should expect to be “YouTubed”.  As a firm, we make many public comments, and fully expect to be held accountable to them.


Intraday yesterday Keith tweeted the following via @KeithMcCullough:


“If Boockvar is long Nikkei and short Yen here, now he knows why no one will ever give him money to manage”


This was in response to an appearance by Boockvar on CNBC yesterday, where he discussed his case for Japan. That video is here:  (if the link doesn’t open, copy and paste it into your browser)


A paraphrase from his appearance was:


“Japan is going to want to print their way out of this. Therefore you want to be long their equities, and short their currencies and short their bonds.”


It seems Boockvar’s thesis is that printing money will lead to increasing interest rates in Japan, which will lead to an increase in Japanese equities.  In fact, he also made a bullish call on Japanese equities on December 31st, 2010 on CNBC, which he articulated in this clip: (if the link doesn’t open, copy and paste it into your browser)


Thesis drift, anyone?


Needless to say, Boockvar’s response to Keith’s public critique was less than hospitable and was topped off by calling Keith some not so nice names in a private communication.  Boockvar’s use of schoolyard epithets does nothing to enhance his professional standing in our eyes.  Now, we don’t mean to pick on Boockvar, he just typifies a gang we call Old School Wall Street, and this is just the latest example of how rattled they get by real-time accountability.  Twitter on!


Since articulating a coherent view in 140 letters on Twitter can be challenging, we want to restate our position on Japan. Our bearish view on Japan is something we began articulating in Q4 of 2010, in a thesis called Japan’s Jugular.   A key highlight of this thesis is, in contrast to Boockvar’s view, that printing money will have just the opposite impact.  It will lead to increased debt, slowing growth, and declining equity prices.  In fact, in 18 years of Keynesian experimentation, from 1992 to 2010, Japan had on average +0.85% year-over-year GDP growth.  Over the same period, the Nikkei 225 returned -55%  No, Mr. Boockvar, this time is not different . . .


Naturally any good contrarian is looking for a buying opportunity given the dramatic sell off in Japan over the past few days.  We would caution against this, despite the relief rally this morning, for two reasons:

  1. Unknown unknowns – The derivative impact of the earthquake has been damage to the nuclear power infrastructure in Japan.  At this point, there is limited information from which to evaluate the real impact of this damage, in particular at the Fukushima Dai-Ichi plant, where this morning it was reported that a second reactor may have ruptured.  The point is, we have no idea how this will end and be resolved.
  2. Known knowns: The Japanese economy reached a negative inflection point last year when its pension plan began selling assets to fund pension obligations.  This highlights two key components of our negative thesis on Japan: demographics and debt.  Japan has both the oldest population in the world, with ~22.7% of the population 65 years of age or older, and is the most indebted developed nation, with a debt-to-GDP ratio of 205%+.  The risk is that this tragedy only accelerates negative growth in Japan due to an inflexibility created from almost two decades of Keynesian policies.

Of course, there will be an opportunity to get long the Japanese recovery trade eventually. As always, duration matters; however, after the January 17, 1995 Kobe earthquake, Japanese equities lost (-24.7%) before bottoming out nearly six months later on July 3. The Nikkei 225 did not break even until nearly 11 months later on December 7 of that year.


Now a public service message to Peter Boockvar and Friends:


This is the new Wall Street where accountability and transparency matters.  While your long term track record is cool, let’s just start with the last three years.  For the record, every single position we’ve take in the Hedgeye Portfolio since inception is on our website for the world to see.  We encourage you to do the same.


Next time you want to challenge someone to head down to the schoolyard for disagreeing with your thesis, add me to that list.  My email is  My friends call me Big Alberta, and I’ll be waiting at the puck for you.


Keep your head up and stick on the ice,


Daryl G. Jones


Old School Wall Street - Chart of the Day


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