The Nike/Street historical expectations pattern is unique to say the least. It crumbled down in Nike’s 3Q. Two consecutive broken quarters isn’t probable.
Beat, temper, beat, temper, beat… We see this day in, day out – especially in retail. The worst offenders are the junky companies that guide to declining y/y EPS, and then come out, beat it and beat their chest. For example, a company that earned $1.00 last year will guide toward $0.60. Then they come out and actually report $0.80. Still a gnarly quarter with earnings down 20%, and yet there’s no shortage of analysts who will hop on the conference call and congratulate the management team for beating numbers as if they just won the Stanley Cup.
Nike is interestingly different. First off, they don’t give guidance. They give us the info and let us do our jobs. That said, there is a clear precedent for managing expectations – these are two very different things. Clearly, the consensus (including us) got it wrong this quarter. Very wrong. Ironically, management’s tone hadn’t really changed over the course of the year. But this quarter was clearly the exception. Check out this analysis…
It looks at each of the past 10 earnings periods and on a rolling 2-quarter basis shows, a) where estimates were 2-quarters out before a print, b) how that estimate changed after the print, and c) where the actual number came in. Sounds confusing, but the chart below should help visualize.
In Nike’s case, there’s a pretty clear trend of Consensus expectations being at a given level, then coming down after management’s comments. There are two things that makes it different from many other companies. 1) Its earnings actually grow, and 2) More often than not, Actual EPS comes in ahead of where estimates were 4-months prior.
The Street landed at $1.16 for 4Q vs. original expectations of $1.27. Is Nike going to come in ahead of the prior expectation? Probably not. But we don’t think it will miss our $1.20.
Position: Short Sugar via the ETN SGG
We added a short position in sugar via the ETN SGG in the Hedgeye Virtual Portfolio. This move may seem surprising as we have been frequent buyers of sugar, which is up +28.6% over the last six months. We have entered five long positions in SGG since June of last year, with our cumulative performance netting a +22.14% gain while riding an inverse correlation to a weakening dollar.
However, that correlation has changed quickly. Although sugar has a -0.79 inverse correlation to the US Dollar over the past year, it has a +0.24 positive correlation to the dollar over the last six weeks. As a reminder, we remain bearish on the US Dollar over all three of our durations: TRADE, TREND, and TAIL. While sugar’s inverse correlation to the US Dollar is broken, we see this as a nice opportunity to be short the soft commodity.
This comes against a bearish supply backdrop in which the world is well-stocked with sugar – one of the few soft commodities that we can currently say that about. The USDA recently projected world sugar production in the 2010-2011 growing season to be 8% greater than the 2009-2010 season, totaling 164 million tonnes.
A short position in SGG was added into the portfolio at $84.63. From a quantitative perspective, sugar is broken and bearish on the immediate term TRADE and intermediate term TREND durations, with upside resistance at $90.92 and no downside support.
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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:
“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.
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.
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:
- Coal (+1.2%) – energy inflation;
- Mining (+0.9%) – precious metals reflation;
- Chemicals (+0.6%) – energy inflation pass-through;
- Banks (+0.5%) – widening yield curve; and
- Oil & Gas (+0.5%) – energy inflation;
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.
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.
- 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)
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
- 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
- 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
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
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