The Week Ahead

The Economic Data calendar for the week of the 21st of March through the 25th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - cal1

The Week Ahead - cal2

Japanese Yen: Be Careful What You Wish For, Consensus...

Conclusion: History shows us that G7 intervention to weaken the yen has resulted in a significant uptick in inflation within Japan. In fact, if the G7’s plan to weaken the yen is “successful”, we expect the inflationary impact to be even greater this time around, particularly given Japan’s current staggering sovereign debt load and easy monetary policy.


Positions (TREND duration): Bullish on the yen and bearish on equities; OR bearish on the yen and JGBs. Getting ahead of the whims of central planners will be key to isolating the winning strategy here.


After just over a decade of inactivity on a collective scale, the G7 jointly intervened in the global currency market to help the ailing Japanese economy by weakening the yen, which is down nearly (-2.3%) on the day. In addition to today’s centrally-planned intervention, the G7 promised additional support as needed:


“We will monitor exchange markets closely and will cooperate as appropriate.”


In spite of yet another round of Almighty Central Planning perpetuating unprecedented volatility in yet another market, we remain positive on the yen over the intermediate-term TREND for now. That could change. While today’s intervention may have cooled off the speculative bid for yen appreciation (net yen shorts of Japanese households dropped -30% day/day), the fundamentals – repatriation and compressing interest rate differentials leading to unwinding of carry trades – remain supportive.


The expected acceleration in JGB issuance in the wake of this crisis (which, coincidentally, pushes Japan’s sovereign debt load above one QUADRILLION yen) has to be financed somehow, which is one of the supportive factors for the repatriation case (in addition to risk aversion and the need to finance rebuilding efforts).


Of course, the Bank of Japan could continue to provide “powerful” and “massive” stimulus, as pledged by BOJ governor Masaaki Shirakawa. They are currently already monetizing JGB debt at a rate of ¥21.6 TRILLION ($267.2B) yen annually, so what’s another ¥10-20 TRILLION yen in perpetual debt monetization?


The last time the world’s Almighty Central Planners decided to collectively intervene to weaken the yen as on August 15, 1995 (about a half a year after the Kobe earthquake). The yen went on to weaken (-29%) over the next three years until a reversal of that intervention scheme on June 17, 1998 sent the yen sharply in the other direction.


As with any Fiat Foolery throughout the course of history, the resultant yen weakness was accompanied by unintended consequences, as the deliberate currency devaluation resulted in a sharp spike in reported inflation on the island economy. As always, there are two sides to every trade.


The chart below shows YoY growth in Japanese Import Prices swung +1,860bps in the year following the initial intervention (July ’95: -3.5% YoY vs. July ’96: +15.1% YoY). In the 18 months beginning in Jan ’96, Japanese Import Price growth averaged +10.4% YoY. Eventually, these higher input costs manifested their way into reported inflation throughout the Japanese economy, with Japan’s Nationwide CPI peaking at +2.5% YoY in Oct ’97 vs. a deflationary (-0.6%) YoY just two years prior – a +310bps swing.


Japanese Yen: Be Careful What You Wish For, Consensus... - 1


This history lesson begs the following questions with regard to the current round of intervention:


Can the Japanese government’s stained finances handle backup in interest rates? Debt Service already consumes ~45% of the central government’s revenue.


Japanese Yen: Be Careful What You Wish For, Consensus... - 2


Can the Japanese consumer, after many years of price and wage deflation handle higher prices?


Japanese Yen: Be Careful What You Wish For, Consensus... - 3


Can Japan, which will need to procure raw materials from abroad to rebuild in the wake of the current disaster, afford an acceleration of imported inflation brought on by currency weakness?


Japanese Yen: Be Careful What You Wish For, Consensus... - 4


Can Japanese economy handle higher inflation, period? We don’t think so. This is why we stand counter to the current sell-side storytelling about “accelerated growth driven by construction and yen weakness”. The playbook for where Japan may be headed as a result of this current round of Big Government Intervention has a lot more factors than consensus’ simple two-factor, “buy the dip” model.


In fact, BOJ governor Shirakawa agrees, saying today that the government wants to avoid abruptly weakening the yen because it may bring about a back up in JGB yields. “That’s naturally the biggest fear for the government”, he says.


A worthy fear indeed.


Darius Dale


Good Nugget For PSS


Another good nugget out of the family footwear channel, which bodes well for our call on PSS. Consistent with our note earlier this week, we expect the comp diversion that has been present between PSS and the rest of its peers to continue to converge again in Q1 a positive for the company near-term.


Interestingly, in looking at the aggregated SIGMA chart of the four companies, the Sales/Inventory spread improved for all but one – BWS. With an additional ~$50mm of inventory related to the acquisition of American Sporting Goods added to the mix equating to a -4% impact to the Sales/Inv spread next quarter, Brown Shoe is going to be challenged to improve its spread near-term. PSS starts to go against very favorable SIGMA comps.


Good Nugget For PSS - FamFWComp Chart 3 11


Good Nugget For PSS - FamFWComp Table 3 11


Good Nugget For PSS - FamFW SIGMA 3 11


Casey Flavin


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Explosive slot revenue growth in Macau is a trend that has gone unnoticed.



We wrote a rather negative note on Macau slots a couple of years ago (“ASIAN SLOTS: SELLING HAGGIS TO VEGANS?” on 07/08/08).  At the time we were data dependent and the data didn’t show that the Chinese liked slots very much.  Since we’re still data dependent, we’d like to point out the huge growth in slot revenue and win per day per slot (WPD) generated in Macau since Q3 2009. 




It seems the trend of Macau as a slot market has gone largely under our and the Street’s radar screen.  However, this trend has very positive long-term implications for the operators and the slot suppliers. 


Not only are slots the highest margin revenue stream in Macau but there are no government caps on number of slots like there is for tables.  It’s not like slots aren’t already important. We estimate that LVS and WYNN will generate $190 million and $175 million, respectively, in EBITDA (before fixed cost allocation) from slots in Macau in 2011.  That represents over half of the total EBITDA generated by LVS and Wynn at their properties in Las Vegas.


In Macau, there has been virtually no replacement cycle given the youth of the properties.  That will change in the next few years.  For the suppliers, that means a double boost for revenues:  replacement slots and satiating the increased demand from patrons.


In addition, win per day per slot (WPD) generated in Macau since Q3 2009 has soared.  The following chart compares WPD in the Macau and Las Vegas Strip markets.  After trailing the Strip by a wide margin, Macau finally caught up in 2009 and then separated big time to the upside.  It is clear that 14k slots is not sustainable in Macau.  The number of slots in Macau could almost double and still maintain the Strip average for WPD – and that’s without any growth.  With visitation up 15%, GDP up almost 10%, and growing Chinese penchant for the slot product, we don’t see why slot revenue won’t continue to grow well into double digits.




Short-The-Rip: SP500 Levels, Refreshed...

POSITION: no position in SPY


This email may or may not make people happy, but 30 handles higher in the SP500 from what we called a Short Covering Opportunity, I’m going to call this for what it is – an opportunity to Short-The-Rip.


It’s probably ok to call it that… kind of like “Buy-The-Dip”… but on the other side…


It’s been a long week and I am running out of jokes and the SP500 should run out of immediate-term TRADE steam as it hopes for 1292 on anemically low volume.


PRICE/VOLUME/VOLATITY readings in my model remain bearish, but from a price. Manage your risk in this new bearish trading range of 1253 to 1292 for now and if the facts change, I’ll try my best to signal it if I’m so lucky to see it when it matters.


Have a good weekend,



Keith R. McCullough
Chief Executive Officer


Short-The-Rip: SP500 Levels, Refreshed...  - 1


Given the recent volatility in the commodity markets, particularly with milk and cheese prices up approximately 48% and 36% year-to-date, respectively, I decided to take a closer look at the CAKE model.  As of the company’s fourth quarter earnings call on February 10, CAKE had contracted 60% of its food needs, including “virtually” all of its proteins.  The company is still exposed, however, on its dairy, fresh fish and some cheese requirements.  All in, management guided to 3% cost inflation for the year, up 4% in 1H11 and up 2% in 2H11.  This guidance includes the expectation that some of the current price levels on its non-contracted items will abate as the year progresses.  Cheese prices fell 10% last week, but with prices still up about 44% year-over-year and milk up about 53% year-over-year, there remains significant risk to the company’s full-year commodity cost outlook, particularly during the first half of the year.


We already know that top-line trends suffered early in the first quarter as a result of bad weather, which management said impacted first quarter comp trends by 1%.  The company guided to flat to +2% comp growth in 1Q11, below the full-year expected run-rate of 1-3%.  This softer start to the year will only magnify the commodity pressures during the first quarter.   Management implemented a 0.7% price increase during the February/March time-frame, which will result in a 1.4% price impact by the end of the quarter relative to only 0.5% of price during the fourth quarter.  This higher pricing should help to offset some of the increased margin pressure during the first quarter but negative mix has worked against the company’s pricing initiatives recently; though average check did improve sequentially during the fourth quarter. 


Management guided to $3 to $5 million of additional savings, primarily on the labor and operating expense lines, and tighter G&A controls to offset the expected incremental $0.05 per share of commodity costs relative to the company’s prior guidance and as a hedge against higher than expected commodity costs going forward.  To that end, management’s full-year EPS guidance of $1.55 to $1.70 seems achievable.  I am currently at $1.64 per share (the street is at $1.65 per share). 


The first quarter, however, could be a little rough given the negative weather impact and tough commodity environment.  I am currently modeling $0.31 per share, below the street’s $0.33 per share estimate but within management’s 1Q11 EPS guidance range of $0.29 to $0.33.  I am expecting restaurant-level margins to decline about 90 bps during the quarter.  The company is facing its most difficult restaurant-level margin comparison during the first quarter on a YOY bp change basis.  Although I think the company will continue to get leverage on the labor expense line, it will likely not be enough to offset the sharp increase in commodity costs.  It is important to remember that about 90 bps of the company’s fourth quarter labor expense favorability as a percentage of sales was due to one-time items that will not repeat during 1Q11. 


CAKE should continue to face commodity pressures during the second quarter and for the balance of the year, but the YOY comparisons get a little easier as we progress through the year.  Cost of sales as a percentage of sales declined 70 bps during 1Q10 and then increased 20 bps, 50 bps and 100 bps in 2Q10, 3Q10 and 4Q10, respectively.  These easier comparisons, combined with my expectation for the company to achieve leverage on the labor and other operating expense lines for the year, should translate into higher restaurant-level and operating margins for the balance of the year.  This YOY margin growth relies on continued same-store sales improvement, but given recent industry trends as measured by Malcolm Knapp, the company’s full-year comp guidance of 1% to 3% does not seem out of reach; though it does assume a sequential acceleration in two-year average trends.









Howard Penney

Managing Director


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