Charming Bears

This note was originally published at 8am on April 07, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“I bear a charmed life.”

-William Shakespeare


How bearish are you? I know I’m bearish at a price, but I don’t think I am Bearish Enough. Some people on the Street might say they are bearish – but unless they run their own firm, I highly doubt they are bearishly positioned.


When I say Bearish Enough, I don’t mean whatever being “underweight” means. I mean having either 50-75% of your assets in cash and/or running with a net exposure of -20-30% net short. Those are not consensus positions. Neither, in most cases, are they allowed.


Does the market owe us a return? Do we have to chase yield? Or is this the biggest failure that hasn’t yet been realized by the institutionalization of our industry that’s coming down the pike – Too Big To Perform?


These are serious questions associated with a serious problem that has not been fixed alongside this +98% two-year inflation of the US stock market. When I started in the hedge fund business 12 years ago, the correlation of returns between funds was approximately 0.3-0.4. We made money in down markets (2000-2002). We didn’t whine. Since 2007, returns have reverted to the mutual fund industry’s 0.7-0.8. That’s a problem. It’s called over-supply.


In his illuminating interview with CNBC earlier this week, hedge fund pioneer Michael Steinhardt made this point in a way that only a man (without a boss) who has been in the hedge fund business since 1967 could - “it aint an elite business anymore.”


How charming…


No matter where you go this morning, there it is  - a massively understated correlation risk to global markets – the risk of everyone doing the same thing … at the same time…


Qualitatively, anyone who has managed real-time market risk prior to 2008 gets this. Quantitatively, for those of you who are new to this globally interconnected game of risk, here is some data to chew on this morning:

  1. Hedge fund net leverage in February 2011 hit its highest level since October 2007 (the last market top)
  2. Hedge fund net-long exposure to Commodities has eclipsed the prior 2007-2008 peak in 2011 (special thanks to The Bernank)
  3. Institutional Investor’s Bullish-to-Bearish weekly survey just tanked to one of its lowest Bearish readings ever

When we talk about ever, no matter whether it is in terms of leverage, asset class concentration, or net exposure, we think of ever as a very long time. I’m obviously in the business of getting paid by the industry, so I have no compensation incentive to walk you through this over-supply problem other than being right.


When I think about an investment and/or risk management idea (they aren’t the same things), my team’s baseline model has 3-factors: Supply, Demand, and Price (I learned that running a grass cutting business in Thunder Bay, not at Yale). Using that simple framework, this over-supply call and its related risks to market prices is a trivial one to grasp.


That said, as a practical matter, it’s not always easy to hedge this industry’s oversupply/correlation exposure in your portfolio. However, not having an easy answer to a big problem doesn’t mean that the underlying risk associated with that problem ceases to exist. Remember, the market doesn’t owe us anything. That’s why markets crash.


I’m not calling for a crash this morning, but I am explicitly flashing amber lights. I called for a correction and the heightening probability of a crash in mid-February – and I got both. The 6.5% correction came in US Equities. The crash came in Japan.


Now before you jump out of your screen at me on Japan – don’t worry, I get it - natural disasters aren’t things that you can “make calls” on. However, what you can do, from a risk management process perspective, is make calls on the increasing or decreasing probabilities that a person, company, or country is putting itself in to crash. Anyone want to be levered long of Charlie Sheen because he’s going up?


That’s been the slow moving train wreck associated with 1,000,000,000,000,000 YEN in Japanese sovereign debt (that’s what a quadrillion looks like in real-life). That’s Portugal this morning. That’s a debt-financed-deficit movie coming to an American theatre near you.


Everyone knows this now. That’s progress. Not everyone is allowed to be positioned for it. That’s risk.


I have a 27-factor Global Macro risk management model that dynamically re-weights for real-time market price, correlation, and volatility risks. I can show you the heat that’s associated with seeing what I see – it’s right here on my screen. If you want to shrug it off because you don’t understand it – that’s cool. I didn’t in Q2 of 2008 when I went to 96% cash. And I sure as heck won’t now. I started this firm so that I could be allowed to make these calls.


The most important question I need to ask myself on the way to my danger zone SP500 price level of 1342-1346, is why am I only in 43% cash today?


The last time I signaled this risk (February 14th, 2011), weekly sentiment on the Bear side of the II Bullish/Bearish survey had dropped -31% in a week to register a reading of 18% (in other words, only 18% of the pros in the survey admitted they were bearish in mid-February). Three weeks later, the SP500 lost -6.39% of its price inflation.


This week’s drop in weekly Bear sentiment (week-over-week) was -32%. Only 15.7% of the Bears are left. How charming…


My immediate-term support and resistance levels for oil are now $106.16 and $110.98, respectively. My immediate-term support and resistance levels for the SP500 are now 1325 and 1342, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Charming Bears - Chart of the Day


Charming Bears - Virtual Portfolio

CHART OF THE DAY: $4 Gas - How Could We Ever Forget?



CHART OF THE DAY: $4 Gas - How Could We Ever Forget? -  chart


I guess we are not talking about explosive growth, but March was pretty strong and certainly improved sequentially.



Following up to our positive regional gaming note on 3/28/11, state gaming revenue releases have so far confirmed our positive assertions.  Illinois, Indiana, Missouri, and Iowa are in and with the exception of the perpetual laggard Illinois, March was a strong month for regional gaming.  Our two favorite names our PNK and ASCA and both are poised to beat Q1 estimates quite handily in our opinion. 


We are making it a habit to look at sequential revenue adjusted for seasonality instead of just looking at YoY growth given the extreme volatility over the past few years.  March 2011 was clearly a solid month on a YoY basis but more importantly was a step up sequentially.


The following charts show the recent trends of the mature regional gaming markets that have already released March gaming revenues.  We show actual gaming revenues as well as what was predicted by our model for each month based on the previous 3 months, adjusted for historical seasonality.  As can be seen, March was a much stronger month than the model prediction, indicating fairly significant sequential improvement in each of the markets presented.









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GIL: Deal Kinda Makes Sense

I could raise serious concerns about the timing and synergy opportunities for Gildan/Gold Toe. But there are strategic benefits, and stocks don't go down when estimates go up. Net/net: It's a positive near-term.  


Bull Case For The Deal

  1. Deceleration in Gildan’s top line starting in the quarter to be reported on May 11 is a near-mathematical certainty. And yes, they’ve locked in only 55% of cotton costs for 4Q – and it’s at $1.25 – with minimal hedging in 2012. There’s one easy way to get out of  your way of a collapse in operating profit growth – buy something. Regardless of whether people like us frown upon this practice, the reality is that it doesn’t matter. If earnings go up, the stock isn’t going down.
  2. I like the diversification factor ,which should improve stability and earnings predictability, which is something I’m willing to award a higher multiple. Specific changes are as follows…
    1. It cuts Broder’s ‘material customer’ risk by nearly half
    2. Lowers exposure to Latin America from a sourcing perspective (virtually all of Gold Toe’s product is outsourced to Asia – unlike GIL, which is all vertical in Honduras and Dominican Republic).
    3. Trades off capital intensity for working capital intensity. The latter gives a less painful spank when revenue declines.
    4. The deal actually gives Gildan brands that consumers know.
    5. Great CEO in Steve Lineberger, but vital that he to stays on. He’s an industry veteran who was vital in several iterations of HBI’s restructurings. If he ultimately takes on a higher profile role at Gildan, it could be meaningful.
    6. Even though it is a tiny percent of revenue, the fact that Gold Toe makes UnderArmour’s socks is solid. All the company needs to do is put a big UA logo on its IR marketing materials and it gets instant credibility (it makes socks for New Balance too).
    7. At the end of the day, the 7.2x EBITDA multiple isn’t half bad. We’ve seen assets in the intimate apparel space sell routinely for 3-6x EBITDA.  But if we give the company credit for synergies, we’re looking at a multiple closer to 5.5x.




Bear Case for Gold Toe

1)      The timing of the deal is very suspect, as noted in point #1 above. Examples where companies succeed in buying assets to shield organic revenue from slowing are few and far between.

2)      The company has been shrinking. Steve Schwarzman (Blackstone) has been trying to unload this puppy since early 2010 when it was $350mm in sales. Now it is $280mm. This revenue loss was mostly on the private label side – much of which was unprofitable. But overall, we like sales streams that are going up, not down.

3)      Schwarzman didn’t want it. Other financial buyers didn’t want it. No other strategic buyers wanted it.

4)      Why not pre-announce 2Q results with this deal? C’mon… the quarter ended 12 days ago and the Street’s revenue estimate is for 25% top line growth compared to guidance of 15%.

5)      It was pretty clear from management’s comments on the call that Gold Toe is just as wide-open to input costs as Gildan. They are relying on pricing to stick.  It might very well stick, but I don’t want to bank on it.

6)      Synergies are difficult to bank on.

  1. First off, management’s answer to the question asking for clarification on drivers for synergies was unacceptable.
  2. Second, they’ve got to be on the revenue side. Why? Really…do you think that there are ANY costs left to cut after years under Blackstone’s (or any PE firm’s) ownership? No.
  3. With a sub-12% SG&A ratio, Gildan is, and has been, one of the leanest companies around.
  4. There are no tax synergies, as the tax rate is going up, not down (to a whopping high-single-digit rate).
  5. Netting all this out, it suggests to us that synergies need to be manufacturing-related. Yes, GIL is extremely efficient with their manufacturing ops, but even without acquisitions, it has ‘manufacturing issues’ every few quarters.



Conference Call-Outs 

GIL acquiring Gold Toe for $350mm – assuming no debt.

                2010 revs $280mm

                EBITDA $48.6mm


 Highlights from the Call:


  • can leverage GT brand to the mass market via Gildan's facitilities
  • Have already met with both UA and New Balance re the acquisition, both companies have already approved the continuation of licenses


  • Combined entity will have sock revenues of ~$500mm
  • Gold-Toe will complement Gildan's existing private label business
  • Senior Mgmt of GT will stay on with GIL
  • Also has long standing sourcing network
  • ~80% of product sourced from Asian contractors


  • $350mm purchase price equate to 7.2x EBITDA
  • Gold-Toe has so far been successful in passing through price


  • $10-$15mm in cost synergies:
  • Expect annual amortization of intangibles of ~$10mm
  • Tax rate expected to be close to 25%
  • Purchase price includes more than $100mm in operating loss carry forwards
  • Also unfunded pension liab's of $15mm-$20mm pretax
    • Expect the deal to be immediately accretive to EPS


  • Deal fulfills the 3rd leg of three-pronged retail marketing approach:
  1. Selectively pursue private-label brands from mass market retailers
  2. Develop the Gildan brand
  3. Look for brands or licenses in channel of distribution where GIL isn't


  • Positions Gildan as the largest sock provider in the world
  • Deal fills the void that Gildan had in terms of enhancing distribution = product for certain channels
  • Believe they will be able to significantly expand their distribution - "there is no overlap whatsoever"
  • Largest sock customer = ~60% of volume will now equal ~30% of aggregate volume of combined entity
  • Gold-Toe in department stores, sporting goods, national retail chains, and wholesale clubs whereas Gildan primarily in Mass channel
    • GT also adds brand design expertise



  • SKU rationalization:
  • GT has more SKUs than GIL


  • Financial Accretion:
  • Can assume 2010 EBITDA as a base from which to grow (even with some SKU rationalization)


  • Cost Synergies:
  • Primarily in manufacturing and distribution
  • Shifting some manufacturing to existing facilities in Honduras
  • GIL's ultimate capacity is 65mm dozen, had been producing 52mm dzn at year end - the difference will be used to accommodate GT product


  • License Deals:
  • Both UA and NB deals expire in 2013, but feel that they will be able to renew


  • Manufacturing Strategy:
  • Not intent to eventually manufacture GT product in-house
  • GT mgmt strength in outsourcing
  • GT's expansion into underwear - Gildan could manufacture in own plants
  • GT just launched the new underwear brand so still very new in the process


  • P&L:
  • GMs higher, SG&A somewhat higher than GIL's
  • Average ASPs for GT ~$4/dozen


  • Purchase price via cash v. debt?
  • Probably use about ~$200mm to finance the deal at ~1% (LIBOR + 75bps)


  • Tax impact of deal on consolidated rate will be to increase it to 5-6% from 3-4% currently


  • Cotton costs:
  • Already have passed through price increases they expect to offset higher cost of cotton
  • Have lower amount of cotton in product relative to GIL socks


  • Gold-Toe owned store base plan?
  • They do own roughly 29 stores - mostly in factory outlet malls
  • They're profitable for GT and GIL plans to continue to operate them going forward



Will report Q2 May 11th

NKE: Ditching the Money Losers


Nike announced this morning that it is closing down the Denver NikeTown. This is a good thing. For those of you that have not been in a NikeTown, they’re massive flagship stores that do nothing but hemorrhage cash.


That’s probably not an entirely fair statement, as running SOME of these stores  -- the ones that are strategically positioned in high-quality, high-traffic locations – help build brand awareness in a way that marketing dollars would otherwise be spent.

NikeTown Denver joins Costa Mesa and Honolulu as the mammoth stores closed over the past several years.  


The good news is that this really leaves only one major money-loser – which is NikeTown Portland. Why such a money loser? It disproportionately relies on tourists, as locals are going to know at least someone who works at Nike who can get them gear at the employee store at half price.  As it relates to tourists -- although Portland is a  beautiful city, it is not a travel destination like New York, Las Vegas or London. But in the end, it’d probably be both embarrassing, and politically unpopular for the company to close down its presence in downtown Portland.  


The positive impact here is less than a penny per share. So it really doesn’t move the needle. But it’s the kind of move Nike shareholders should want to see.  Most importantly, it does NOT signify a shift away from retail, but rather a step toward profit.


NKE: Ditching the Money Losers - NKE NikeTown 4 11


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