Inflation Spreads: 13 not 12

This morning's CPI numbers make it increasingly tough for Bernanke to ignore inflation with CPI +2.7%.  But they'll be quick to latch on to the 1.2% excluding food and energy, Well... guess what Ben, we need to eat, and most of us need to heat our homes and use energy to get to work each day. We can't exclude it from our wallets.


Nonetheless, we look at the relative spread in consumer prices vs. import costs (reported by OTEXA) net of the % of apparel that is produced domestically.  In the end you get the chart below.  We refer to it often, because it matters.


At the start of this year, we came out of a 2.5 year period of having a 3-Standard Deviation positive spread between costs and consumer prices. Yes, this helped margins -- by about $3bn per year. For a $280bn industry with high-single-digit margins this is big. Even if I'm generous and give 'em a 10% margin, that's $28bn in normalized operating profit. $3bn on top of that PER YEAR for 2.5 years running.


Now we're 2-Standard Deviations in the other direction. Logically, not many people will debate that. But There are too many people I talk to who are already looking to 2H12 for an earnings rebound. They're a year too early.


Inflation Spreads: 13 not 12 - Margin Kitty





Today, April 15, 2011, 11am EDT


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Athletic Footwear & Apparel – The Egg Effect


Underlying trends for the athletic space were mixed last week due to heightened variability around the Easter shift. Athletic apparel decelerated while footwear rebounded – on the other hand, underlying (trailing 3-week) trends for apparel remain very positive while footwear is down low single-digits, but stable.


So, is it time to hit the panic button on footwear? No. Let’s consider the impact of the “Egg Effect.”


A lot has been made of this Easter shift, but at the end of the day what does it really mean for the space? In an attempt to quantify it, here’s the math:


The domestic footwear market is approximately $48Bn at retail, with a 45/55 split between athletic ($22Bn) and non-athletic ($26Bn) respectively. Footwear retailers contend that demand begins to ramp 3-weeks before the Easter holiday. However, based on our weekly athletic footwear data, there is a notable pickup only two weeks in advance over which weekly sales as a percent of total annual sales increase by up to 30-40bps (see the chart below). While non-athletic footwear is the greater beneficiary of the shift, our assumptions account for only a two week boost to error on the side of conservatism. Based on the seasonal surge during which weekly sales volume ramps from 1.8% of annual sales to 2.1%-2.2% heading into Easter, the shift equates to $200-$300mm in incremental Easter sales, or 12%-16% growth across the industry. With that pending demand in-store over the next two weeks and footwear down only 2-3% on a trailing 3-week basis in the face of this benefit last year, the underlying trend in footwear is in fact very much intact.


As for apparel brand performance, Adidas remains impressively strong along with solid mid-teen growth out of both Under Armour and VF (The North Face). Adi continues to be a steady share gainer with Under Armour improving nicely over the last couple of weeks driven by the incremental contribution from its new charged cotton product. Nike’s trend slowed on the week with ASPs declines still outpacing peers.


In footwear, brands rebounded across the board sequentially with Nike, Adidas, and Reebok the notable outperformers. An honorable mention for Under Armour with sales up 10% on the week confirming the positive sales trend seen in recent weeks. The sole negative callout is Skechers with sales down -25% and 280bps of share loss.


Before we bake in expectations for +20% growth in footwear next week, it’s important to realize that sales were up 21% last year before decelerating to the high single-digits. With that in mind, when looked at in aggregate we see a strong end to Q2 for footwear retailers.


Casey Flavin



Athletic Footwear & Apparel – The Egg Effect - FW App Agg Table 4 14 11


Athletic Footwear & Apparel – The Egg Effect - App Sales Table 4 14 11


Athletic Footwear & Apparel – The Egg Effect - App Table 4 14 11


Athletic Footwear & Apparel – The Egg Effect - FW Sales Table 4 14 11


Athletic Footwear & Apparel – The Egg Effect - FW MktShr Table 4 14 11


Athletic Footwear & Apparel – The Egg Effect - EasterShift FW 2011


Athletic Footwear & Apparel – The Egg Effect - FW App App 1Yr 4 14 11


Athletic Footwear & Apparel – The Egg Effect - FW App App 2Yr 4 14 11



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Notable news items and price action from the past twenty-four hours, including our fundamental view on select names.

  • CBRL was upgraded to “Buy” from “Neutral” at SunTrust Robinson Humphrey.  We maintain our negative fundamental view of the company as clear victim of gas price-induced demand destruction.
  • SBUX Greater China Chairman, Wang Jinlong, said on the sidelines of the Boao Forum for Asia that SBUX plans to have 1,500 stores in mainland China by 2015, nearly four times the current level.
  • Kraft Foods will introduce its Gevalia coffee brand to U.S. supermarkets in August after losing the rights to distribute Starbucks’ packaged coffee.
  • COSI gained 1.5% on accelerating volume. 
  • BWLD gained 2.8% on strong volume.  Documents filed with the SEC this week show that CEO Sally Smith, as a result of the company not meeting internal revenue and in-store sales goals, took a significant 18% pay cut in 2010.
  • EAT gained 3.3% on accelerating volume, closing at $24.69.



Howard Penney

Managing Director


This note was originally published at 8am on April 12, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The name of the author is the first to go
followed obediently by the title, the plot,
the heartbreaking conclusion, the entire novel
which suddenly becomes one you have never read,
never even heard of


-Billy Collins, Forgetfulness


Human beings are forgetful creatures.  Coaches the length and breadth of this country berate their players to never make the same mistake twice on the court, field, ice, or track.  In retrospect, having tried my utmost to follow this adage in my sporting – and later in my professional endeavors – I think “never make the same mistake ten times” would perhaps be a more realistic goal to set! 


Even with regard to that diluted standard, I am sure I have fallen short.  Nonetheless, I am going to make a bold statement to begin this Early Look in earnest: investors, being human, are forgetful.  Believing what they want to – or are paid to – believe, many commentators are pointing out the differences between “this time” and “that time”.  While there are differences; it is 2011 now and it was 2008 then, the similarities are also striking.  This earnings season could very well shape up to be the period where similarities become glaringly obvious.


Last night AA officially started the 1Q11 earnings season with a miss on revenues and beat on earnings; investors’ attention is turning towards the balance of the earnings season.  StreetAccount reported last week, for the fourth straight time, that negative preannouncements had outnumbered positive updates over the prior seven days. 


The market has been notably resilient in the face of major geopolitical unrest, natural disasters, and a veritable tsunami of freshly-printed Greenbacks originating from the epicenter of Modern-Day Keynesian Dogma: Washington, D.C.   Despite this, and besides the greasing of the market coming from the Free Money Fed policies, the outlook for the S&P 500 merits caution, if not outright divestment. 


Currently, in the Hedgeye Asset Allocation model, Keith has maintained near a 0% allocation to US Equities in recent weeks (though is currently at 6%) and is short the S&P 500 in the Hedgeye Virtual Portfolio.  Downward revisions to GDP numbers on a global basis are being coupled by endemic inflation in commodity markets as the US Dollar is debauched.  Hedgeye has been vocal that this current period represents a pivotal process in the market where growth slowing and inflation accelerating is being felt by corporations, citizens, and even bureaucrats alike.  The cycle of corporate earnings is peaking.  Tops are processes, not points.


The tone AA set is important, with a market cap of $19 billion and a business model that is tethered to the global macroeconomic climate.  AA represents a prism through which we can attempt to view part of the global economy.  The issues AA faces go beyond this quarter as the stock remains 64% below the peak set on 7/16/07.  Importantly, from a top-line perspective, we think AA will not stand as an outlier this earnings season.


Despite the recent optimism, much of it grounded in reality (for a change), surrounding the improving job market and the solid top-line environment evident in corporate earnings, AA’s quarter could be just the beginning of a string of corporate earnings that call the sustainability of the current trend into question.   Consistent with the past few quarters, FX tailwinds and various types of productivity gains will likely allow many companies to meet earnings expectations. 


Having said this, it is worth noting that the deep cost-cutting measures that were made in the midst of the Great Recession have left the majority of companies, on balance, leaner and needing less revenue growth to leverage fixed costs.  Nonetheless, with expectations high and inflation accelerating, revenue growth remains a key focus of corporate management teams.  If such a scenario plays out this quarter, it would corroborate quite neatly with Hedgeye’s view that margins – at the level of the past few quarters – are set to roll over.


In my view, expectations have already begun to moderate under the threat to profit margins from surging commodity and raw material costs, along with the shocks to the global supply chain from the earthquake/tsunami in Japan.  Alcoa’s management team’s statements confirmed this, as it stated, “earnings were curbed by a weaker U.S. dollar and higher energy and raw-material costs”.


As we proceed through this earnings season, I would argue that it is important to recognize the signs of demand destruction that is going to result from inflation.  Gas prices, thus far, do not seem to have impacted consumer spending as meaningfully as one may have thought, given that prices at the pump over the past couple of months have steadily risen. Perhaps the consumer is somewhat accustomed to high food and energy costs, having been there before, or at least has faith that prices will come down, be it by Centrally-Planned or Divine means? 


In the US, consumer behavior has not been as affected, as immediately as it was during the last spike in gas prices.  However, signs are starting to manifest themselves that Americans are not impervious to the effects of inflation, even if the Chairman of the Fed is.  Darden Restaurants’ Inc. CEO Clarence Otis opined on his company’s most recent earnings call that gas prices were “having a dampening effect” on Darden’s business.  Other casual dining companies have since echoed Otis’ comments, predicting that the almost-certain-to-be higher gas prices during the upcoming summer months will result in demand destruction that will hurt their profitability via the top-line.  


The case for inflation-induced demand destruction is playing out in the UK today. UK retail sales dropped by 1.9% (on a same-store basis sales declined 3.5%) in March as accelerating inflation squeezed households’ spending power at the fastest rate in 60 years; the decline is the biggest drop since the series began in 1995.  


It is not late 2007/early 2008, it is 2011, but lest we be forgetful, this is the same country that it was three years ago.  Gas prices at this level will matter on the corporate bottom line and, if one listens to the early indications from executives such as Otis, they already matter a great deal.


The Faithfully Forgetful may point out other differences between 2008 and 2011.  Housing was more of an issue then, someone might say.  At Hedgeye, we would argue that the housing markets of 2008 and 2011 are eerily similar in that not enough attention is being paid to the fundamental strength, or lack thereof, in the housing sector.  As our Financials Team has reiterated for months on end, housing is set to decline sharply throughout 2011.  This call is no longer a prediction; it has been playing out for months now as Corelogic, Case-Shiller, and New Home Sales data continue to highlight softness in residential real estate.   As always, feel free to reach out to if you would like to see the detail of Hedgeye’s Housing Headwinds thesis.


Rather than pointing out the obvious differences, I believe it is the similarities between this market and that of three-and-a-half years ago that are far more interesting.  A market showing resilience in an upward trend is encouraging for investors and so it should be.  However, a market barely breaking stride in the face of tectonic shifts in global geopolitics and parabolic price action in commodity markets exhibits a detachment from reality and should not be comforting to investors.  Having blind faith in the appearance of resilience, and forgetting how the story may end and has ended before, could prove a costly mistake.


Function in disaster; finish in style,


Howard Penney


FORGETFULNESS - EL 4.12.11 gas pump


FORGETFULNESS - Virtual Portfolio

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