Buying China

Conclusion: It’s increasingly likely that slowing growth and additional tightening may be priced in, thus Chinese equities look poised to benefit in an inflationary or disinflationary environment.


Position: Long Chinese equities via the etf CAF.


On Friday, we opened a position in Chinese equities within the Hedgeye Virtual Portfolio for the first time since closing a long position in late September of last year. The recent weakness in the wake of Japan’s crisis provided a buying opportunity, as the Shanghai Composite remains bullish from an intermediate-term TREND perspective:


Buying China - 1


“Why buy China?” one might ask, given our outlook for the Chinese economy remains “growth slowing as inflation accelerates”.  Simply, put, the answer to that question is a question in and of itself: “What price does one pay for slowing growth?”


With a handful of sell-side firms following the Chinese government in revising down their 1H11 Chinese growth assumptions, we are inclined to believe the bear case on China is getting increasingly priced in. In fact, we were among the few to be appropriately bearish on Chinese equities in early 2010 and since we introduced our bearish Chinese Ox in a Box thesis on Jan 16, 2010, China’s Shanghai Composite Index is down nearly ten percent (-9.8%), including a peak-to-trough decline of (-26.7%) recorded on July 5th.


We get the bear case on China, so naturally, our next risk management tasks are to figure out whether that’s fully priced in and if the market is leading us to a reacceleration in Chinese growth. Addressing the latter point specifically, there are signs that China is indeed entering a bottoming process from a growth perspective.


YoY growth in Chinese Exports, Retail Sales, and Money Supply (M2) all slowed to multi-year lows in February (in part due to the timing of the Lunar New Year). While there may be further downside in these series in the coming months, the intermediate-term risk/reward setup is skewed to the upside for the first time in several quarters.


Buying China - 2


From a financial market perspective, we see that China’s 12-month interest rate swap contract (which exchanges fixed payments for the seven-day repurchase rate) backed off its high of 4.04% on Feb 21 to 3.4% today. The key takeaway here is that the Chinese bond market’s expectations for additional tightening have receded. While still elevated relative to the 1.99% we saw on Aug 25, the slope of this trend remains positive for Chinese growth expectations on the margin. Whether today’s +18bps gain is the start of a newfound trend of expectations for incremental tightening relative to current projections remains to be seen. For now, the trend is moving in the right direction.


Buying China - 3


We’d be remiss to not mention the impact of inflation on Chinese equities. Prior to the current rally which began on Jan 25, Chinese equities had sold off from their Nov 8 cyclical peak on fears of accelerating inflation leading to aggressive tightening of monetary policy. With three interest rate hikes and six announced reserve requirement hikes since late October, a great deal of tightening may indeed be in the rear view. This opens the door for those Chinese stocks which benefit from higher levels of inflation to outperform. An analysis of industry contributions to the Shanghai Composite’s current +8.7% rally confirms this: 

  1. Coal (+1.2%) – energy inflation;
  2. Mining (+0.9%) – precious metals reflation;
  3. Chemicals (+0.6%) – energy inflation pass-through;
  4. Banks (+0.5%) – widening yield curve; and
  5. Oil & Gas (+0.5%) – energy inflation; 

Buying China - 4


Buying China here is certainly not without risk, however. Given that the current rally is highly levered to accelerating inflation, any disinflation in real-time commodity prices (via USD strength) may prove detrimental. Consider the following correlations to the Shanghai Composite Index over the past two months: 

  • Brent Crude Oil: r = +0.86, r² = 0.74;
  • Gold: r = +0.89, r² = 0.79;
  • Silver: r = +0.93, r² = 0.87;
  • Chinese Yield Spread (10Y sovereign yield less 1Y Benchmark Lending Rate): r = +0.82, r² = 0.67; and
  • US Dollar Index: r = (-0.66), r² = 0.43. 

What could also happen in a disinflationary scenario, however, is that the outperformance shifts from inflation-positive names to consumer and industrial stocks, keeping a bid under the market at large – particularly because many investors have likely chosen to remain on the sidelines due to the current round of tightening. At any rate, given that it’s increasingly likely that slowing growth and additional tightening may be priced in, Chinese equities look poised to benefit in an inflationary or disinflationary environment.


Darius Dale




We’re at a point where most Retail investors know who Li-Ning is (largest local athletic brand in China), but that’s about it. Management gave some good insight on the Chinese market as they see it, which definitely impacts US companies.


Key Highlights:

-          Discounting at retail on the rise due to higher inventory from international brands

-          Suppliers see labor costs increases of 10%-15%+ persistent ‘in coming years’

-          Li Ning seeing retail orders down high-single-digit in Q3 likely representing trough in near-term sales trends

-          Int’l growing near 50%. But still only 1.4% of sales. (Shouldn’t it be growing 300%?)

-          Competitive front between domestic and international competitors remain Tier 2/Tier 3 cities.

-          We’re 9-months into their stepped up marketing plan to kick-start top line.


(2H F10 results)

Sales: +15%

Inv: +28%


SIGMA – significant negative move to Quad 4




-          Despite increased investment spending, the company leveraged SG&A by 30bps in 2010 while gross margins remained flat on +13% sales growth


-          The company’s new ‘Brand Revitalization’ is one of the key initiatives underway (launched in June 2010) to both reinvigorated the top-line, but also offset cost inflation – marks a bit of a restart for the company which started mid-year. 

  • At the Channel level – rationalizing distributor operated store exposure, while also implementing wholesale discount policy of 3-points to those that can achieve specified GM hurdles of 46%-47%.
  • Easy growth stage for retailers to simply open new doors is over, they now have to focus on profitability
  • Company now in second phase of consolidating single store distributors, which is also taking place within the marketplace as the industry consolidates due to increasing competition among retailers
  • Have not seen an notable uptick in new customer additions so far in the first 6-9months of brand revitalizing efforts

-          Outlook for retail expansion (~400 stores in 2011) suggests a deceleration compared to recent history of 1000 stores in 2008 and 2009 and 666 in 2010. 

  • As at 31 December 2010, there were 7,915 LI-NING brand retail stores in China, net increase of 666 stores for the year

-          While Int’l sales grew 49% in 2010, it still only represents 132mm RMB – 1.4% of total sales


Market Outlook:

  • Expect 13-14% market growth this year vs. 30%+ prior to ‘08
  • Li Ning has relied on opening new store growth in the past, this is changing

Changing Chinese Consumer: – trading up

  • 40 cities fall into main stream - Tier 1 category
  • Tier 2 - Tier 3 cities are moving towards a main stream market from more of a basic market, sub Tier 3 cities still considered basic markets – less attractive opportunities
  • Growth rate in lower tier cities will be higher than upper tier cities in the intermediate-term


  • Competition with international brands most significant in Tier 2 - Tier 3 cities
  • Most Chinese brands are trying to grow via channel expansion (new door growth 800+ excluding Li Ning), but that is slowing
  • Accelerated retail discount rates have been resumed as international brands have returned to prior inventory levels while retailers are looking to remain lean and more efficient – particularly in Tier 2 - Tier 3 cities

Cost Inflation:

  • labor costs increases in 1H of 2010 to now have been rising at irrational level
  • In speaking with suppliers, they are of the view that labor costs will continue to rise at a +10%-15% pace over ‘the coming years’
  • RM costs also expected to continue to climb near-term


  • Company could shorten the value chain shifting towards more retail from a branded manufacturer, reducing expenses a la Nike and Adidas
  • b/c of cost structure and in china, the company has chosen not to move to this structure – will have to decide on one of the two paths once the market becomes mature in the future



-          According to data so far in Q3, retail orders are down high-single digit yy, but believe this is likely to be the bottom for the year with reacceleration in Q4 – will be concentrating efforts on sell-through

-          Expect positive MSD same-store growth for the full-year driven by sales in Tier 2 cities  - down from double-digit growth last year

-          Could see consolidated company GMs trend downward if recent RM cost increases continue



-          After several years of preparation beginning in 2007, the Group kicked off the brand revitalization campaign for the LI-NING brand in July 2010 to mark the brand's 20th anniversary.


-          Endorsements: During the year, the Group announced the sponsorship of world-class track and field athletes including Jamaican sprinter Asafa Powell, and the top Norwegian javelin thrower Andreas Thorkildsen. In August 2010, the Group signed up NBA rookie, Evan Turner. The Group will continue to upgrade its arsenal of sponsorship resources by signing up more world-class sports stars as well as up-and-coming athletes


-          the planned "LI-NING Logistics Centre", a fully automated warehouse of more than 50,000 sq. m. in Jingmen Industrial City designed to enable the Group to adapt to the needs of the market in a timely manner, has been completed and is scheduled for trial operation at the end of 2011




Casey Flavin






The report below was originally published at 10:30AM EST by Josh Steiner and Allison Kaptur of our Financials Team, which does the bulk of our firm's work on housing. Below, they provide a detailed update to our 1Q11 Macro Theme of Housing Headwinds Part II. While consensus scrambles to figure out inflation's impact, we think it's worth highlighting a form of deflation that will limit the consumer's ability to absorb price increases in 2011. If you are a qualified institutional investor and would like to hear more about their work on the fins, rates, credit, housing and financial regulation, please email .


Existing Home Sales Fall; Median Price Hits Lowest Level Since 2002

The National Association of Realtors reports that February Existing Home Sales fell -9.6% MoM (-2.8% YoY) to 4.88M.  Inventory rose 3.3% MoM to 3.49M, equating to a months supply of 8.6 months.  Last month, we highlighted Corelogic's concern with the accuracy of the NAR report.  Corelogic believes that NAR sales volume data is overstated by 15-20%.  A detailed explanation of this argument is provided below.


Meanwhile, the NAR reported that February saw the lowest monthly median price for Existing Home Sales since 2002 at $156,100, which is down 32.2% from the highest median price ever recorded of $230,300 in July 2006.  February's median price fell -5.2% YoY.  This number is not seasonally adjusted, and the seasonal pattern shows median prices typically increasing from now until June, which is the typical seasonal peak.  












Corelogic Casts Doubt on NAR Data

We have been noting for some time the increasing divergence between Existing Home Sales and MBA Purchase Applications.  For example, Purchase Application volume was 24% lower in 2010 vs 2009, but Existing Home Sales volume was only 4.6% lower.  Purchase Application volume was 24% lower in 2009 than 2008 as well, but Existing Home Sales were actually 5% higher.  We had been attributing this discrepancy to changes in the cash segment of the market, but it appears that the NAR's data may be faulty.  According to Corelogic, the NAR data has diverged versus Corelogic, MBA, HMDA, and Census data since 2006, and the gap is widening.




Says Corelogic, "There are several reasons for the divergence, including benchmarking drift, more sales going through MLS systems due to consolidation and a lower share of for sale by owners (FSBO) home sales. Net, NAR’s existing home sales data are overstated by about 15% to 20%." (emphasis added)


The NAR is currently reviewing its analysis, and is expected to restate the last several years of data.  The restatement may occur sometime this summer.  


What are the implications of a 15% to 20% overstatement of Existing Home Sales?  Fortunately, our home price model relies on MBA Purchase Application data as a measure of demand, not NAR Existing Home Sales data, so we conclude that our model is intact. For reference, our demand-based model now suggests 20% downside in home prices from current levels, with a predicted range of 10-30% downside. Any model that relies on NAR volume data may lead to incorrect conclusions.  


Joshua Steiner, CFA


Allison Kaptur

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Huge week boosts our March revenue estimate to HK$18-19 billion.




Macau surged again this past week generating HK$623MM in table revenue per day versus HK$524MM the previous week.  For the month to date, table revenue per day averaged HK$581MM for a total of HK$11.6 billion.  Due to the strength, we are upping our March forecast to HK$18.0-19.0 billion, representing 37-40% growth over last year.  We are hearing the Mass floors at most casinos have been very busy which should be good for margins.


In terms of market share, the local guys are stealing the show.  SJM and Galaxy’s market share has been surging, both well above the 3 month average.  The three US operators have all fallen below trend.  MPEL is holding its gains achieved over the past three months.








March 21, 2011






  • In one of the first earnings revisions attributed to the tragedy in Japan, Billabong has lowered its June fiscal year-end outlook. After originally guiding towards flat sales, the company is now expecting top-line deterioration to the magnitude of 2%-6%. Interestingly, Japan only accounted for only 4% of global sales and 3% of EBITDA as of FY10. While roughly two-thirds of Japanese profits  are typically booked between March-June, it appears that Japan is perhaps one of only a few regions coming in below expectations.
  • After a successful test last year, Home Depot is bringing back its ‘Spring Black Friday’ event with the first of four weekends in select markets this past weekend. With door buster discounts as high as 50%-75% off select items, the company will post offers on Facebook every Friday now through the end of May in an effort to rebound from the lowest level of Lawn and Garden sales in over a decade last year.
  • Following weeks of speculation regarding Apple’s interest in retail space within Grand Central, the latest news suggests that the retailer has pulled out of negotiations. With this deal now at, or near an end, the question remains where Apple will look to anchor its latest flagship in the Big Apple.    



Sears’ Turf Wars Campaign - In a retail world which is polarising between “value” and “specialty”, many department stores have reacted by dumbing down their offer and embarking on broad-based discounting programs. The upshot, in Australia at least, is that the line between “department store” and “discount department store” has become increasingly blurred. So it’s refreshing to see a venerable US department store bucking the trend with a sharp, category-specific, competitively-focused campaign. Sears, that bastion of US retail, has just launched a new promotional initiative for the Northern Hemisphere Spring called “Turf Wars”. As indicated by the theme, it’s a tough-talking campaign that “names names” (in a tongue-in-cheek way), urging consumers to shop for their lawn and garden products at Sears, rather than The Home Depot or Lowes (the big-box home improvement competitors in this category). <InsideRetailing>

Hedgeye Retail’s Take: What’s interesting here is that we’re starting to see more retailers and brands call out their competition in ways that etiquette of the past would disallow. (Note the New Balance running campaign vs. Nike).


Van Heusen to Diversify into Non-Apparel - Van Heusen, a part of Madura Fashion & Lifestyle, the branded apparel business of the Aditya Birla Group, is targeting the non-apparel space as a future growth engine.  Van Heusen is a leading premium lifestyle brand straddling the premium apparel range with a turnover of Rs.650 crore and it is now planning to increase its presence in the premium non-apparel space currently dominated by multinational brands. From a small presence in men's ties and belts, the company's non-apparel business plan includes an entry into men's footwear, eyewear, watches and luggage. It will also enter the women's shoes and bags segment. Speaking to this correspondent, Ajay Ramachandran, Brand Head, Van Heusen, said, “we see a good demand for these products and over the next five years, expect the non-apparel business to contribute around 10 per cent of our targeted Rs.2,000-crore turnover.” <TheHindu>

Hedgeye Retail’s Take: Little impact on P&L. But we continue to be won over on the margin with how Manny is running this ship. All these little initiatives are going to add up to something meaningful one day soon.


Crocs Develops Lightweight Sneaker for Men - Crocs Inc. stepped out of its element when it launched a brand of high heels and other women's shoes that looked nothing like its iconic bright, lightweight clogs. Now it's doing it again, with a line of seven-ounce sneakers for men. The Niwot, Colo.-based company has no intention of abandoning its signature clogs, beloved by some and loathed by others. But it's pushing to become a shoe brand for all seasons and buyers, chief marketing officer Andrew Davison said. This summer Crocs plans to extend the sneakers to women and offer women's shoes made with more translucent materials, while maintaining its ideals of lightweight, odor-resistant, fun, casual footwear, Davison said. "The next couple of seasons, you'll see us push the boundaries of what a casual shoe is," he said. <Forbes>

Hedgeye Retail’s Take:  There’s a big difference between pouring a few tons of plastic pellets into a vat and popping out those Crocs we’ve grown to know and love to hate. Getting into more of a lifestyle business means one thing – complexity. The process from design, procurement, marketing, manufacturing, and logistics means that Crocs will see a meaningful change in its cash conversion cycle. We think that this is going to be one of the keys to whether they can make this work.


A Struggling Wal-Mart Turns to Its Core  - After attempting to appeal to a wider variety of shoppers backfired, discount giant Wal-Mart Stores Inc. now is mired in its worst U.S. sales slump ever. I think we tried to stretch the brand a little too far,' says William Simon, Wal-Mart's chief for the U.S.  But William Simon, the former Navy officer put in charge of the flagging U.S. division last June, says he is confident that the lumbering giant can reverse its fortunes after seven consecutive quarters of domestic sales declines at stores open at least a year. Part of his strategy includes returning to the "Every Day Low Prices" formula Wal-Mart popularized, after the company in recent years veered away from offering low prices across the board and instead discounted some items while raising prices on others.  Mr. Simon says he hopes this will win back some of Wal-Mart's core customers—households earning $30,000 to $70,000 a year—which the company has been losing to upstart dollar-store chains. <WallstreetJournal>

Hedgeye Retail’s Take: The only thing notable in this article is that it is in the WSJ. We still think that with inflation on the rise in 2010, and consumer spending remaining challenging at best, Wal-Mart has its job cut out for it.


Marimekko to Expand in U.S. Online - Marimekko, the Finnish design house, is moving ahead with its U.S. expansion plans, opening a flagship here, launching an e-commerce site, and extending its collaboration with Crate & Barrel.  In addition, the company seeks to enter new retail partnerships for clothing and accessories and increase its presence in home furnishings stores.  The flagship will open this fall in Manhattan’s Flatiron District in the “Toy Building,” at 200 Fifth Avenue. With nearly 4,000 square feet of selling space, the store will mirror the recently opened flagship in Helsinki. Both stores are designed by IMA, the Japanese architectural firm, in cooperation with Marimekko’s own store design team. The world of Marimekko products will be displayed, with new merchandise showcased each season.  <WWD>

Hedgeye Retail’s Take: No threat


European M&A Activity Heats UpEurope appears to have caught the M&A fever again.  The last six months has been a lively period for European mergers and acquisitions activity, culminating in the blockbuster $6 billion-plus transaction by LVMH Moët Hennessy Louis Vuitton for Bulgari earlier this month that followed a rash of private equity deals. Overall, and boosted by the LVMH deal, M&A activity in Europe in the fashion and luxury space over the last six months has approached $10 billion — and all signs are the momentum will continue throughout the rest of the year.  “There’s been a pickup in activity over the last several months. It’s been very substantial. Right now luxury is back [and] banks are starting to lend again,” said Richard Kestenbaum, partner at Triangle Capital LLC. “There are signs that firms who have capital are waiting in the wings wanting to do something.”  In the Bulgari deal, LVMH was able to double its watch and jewelry division through a single acquisition.  <WWD>

Hedgeye Retail’s Take: Is it us, or does this snippet scream 2003-2007? We’re not suggesting that all deals will be bad. But when executives tout that they “doubled a business” with a given acquisition, it is usually a bad sign.


The Aftershock for Retail Companies in Japan - As fears mount about Japan’s economy slipping into a recession, footwear firms are struggling to keep stores operating normally in the region. While every company said last week they are most concerned about the safety of their employees amid growing threats of a nuclear crisis, execs noted that business has been disrupted to varying degrees. Kobe, Japan-based Asics Corp., which derives about a third of its revenue from its domestic business, experienced light damage in certain facilities and distribution centers, including cracked walls and broken windows in its business office in Tokyo. And not all 57 stores in the country are fully operational, said Gary Slayton, Asics’ VP of marketing. “Our infrastructure and supply chain haven’t been disrupted. <WWD>

Hedgeye Retail’s Take:  The ONLY consolation from a business perspective is that there are very few businesses outside of the lux market that have had any success in Japan in a pretty long time. This is actually a pretty good time for better-managed companies to invest capital.




European Risk Monitor: Bank Swaps Tighten Ahead of EU Summit

Positions in Europe: Short Italy (EWI); Short Spain (EWP)


Below we include our weekly Risk Monitor for European bank CDS. Banks swaps in Europe were mostly tighter week-over-week, tightening for 32 of the 39 reference entities and widening for 7.


European capital markets continue to be volatile given existing global concerns (in particular the results of the earthquake and tsunami in Japan and unrest in MENA) and domestic issues (existing sovereign debt imbalances across states; indecision from the BoE and ECB on adjusting monetary policy to reflect inflation pressures; the second round of Bank Stress Tests; and the likely consummation of dovish agreements at the comprehensive EU Summit this week (March 24-25) – in short, a larger and more generous social net to bailout/protect ailing member states).


To the last point, European equity markets could likely trade with a positive bias anticipating that the EU Summit will calm near-term bailout/default fears. In particular we’ve highlighted Portugal as one country on watch as it goes up against a hefty schedule of bonds coming due over the next 4 months (see our portal: Portugal Shakes on Debt Dues on 3/16).


In the Hedgeye Virtual Portfolio we’re short Italy via the etf EWI and Spain via EWP. Our position remains that despite initial attempts at austerity, these two countries should break longer term under their bloated sovereign debt and deficit imbalances. In both cases, we tactically shorted the etfs on a bounce last week. We view the EUR-USD currently overbought, with immediate term TRADE levels of $1.39 - $1.41.


Matthew Hedrick



European Risk Monitor: Bank Swaps Tighten Ahead of EU Summit - cds

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