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Currency Rodeos

“A national debt, if it is not excessive, will be to us a national blessing.”
- Alexander Hamilton


Like Keith, I’m a born and bred Canadian.  Despite my nationality of birth, after living in the United States for upwards of the last fifteen years, I can quite confidently say this is a great country.   At Hedgeye, we spend a lot of time critiquing the political leadership in Washington, DC in our research, but that shouldn’t be confused with a general critique of the United States. I’ll say it again, this is great country. 


In 1999, the 106th Congress passed a bill that allocated federal funds to renovate the Hamilton Grange, which was Alexander Hamilton’s family home.  In that bill, Congress indicated that this preservation was to “honor the man who more than any other designed the Government of the United States.”  At times, we’ve sided more with the Jeffersonian philosophy as it relates to governing, but there is no disputing Hamilton’s influence on the founding of this nation.  Indeed, as the first Secretary of the Treasury his words continue to have relevance in fiscal and monetary policy discussions.


Setting aside the discussion of the extent to which the government should be involved in our lives, I think we would all agree that government does have its place and can, with the right leadership, do great things.  In fact, to Hamilton’s point, based on a government’s ability to tax and borrow (if done prudently these don’t have to be bad words!) it can build infrastructure and provide appropriate social services, which make the outcome of any government debt a “national blessing.” That is, if its use is not “excessive”.


Late last week in our Q2 quarterly theme call, we called for a potential crash in the U.S. dollar.  Once again, we didn’t make this call because we lack American patriotism, but rather because of the fundamentals.  Stepping back for a second, though, we should frame up what exactly a crash means for a currency.


In the last 30 years, the largest annual decline in the U.S. dollar index was -18.5% in 1985, while the average decline for that period was 0.11%.  In the year-to-date, the U.S. dollar index is down -6.6%.  So, we are four months into 2011 and the U.S. dollar is already down close to 1/3  of its largest annual decline ever.  Our view is that the U.S. dollar could decline potentially another -5% through the course of the quarter and roughly -10%-ish through the course of the rest of the year.  If this occurs, it would be the largest annual decline for the U.S. dollar index in 30-years and that, my friends, is a crash.


This morning, we are seeing a continuation of this move with many currencies, once again, trading up close to a percent versus the dollar.  Interestingly, even in Europe, where sovereign debt woes continue to accelerate, the currencies are strong this morning with the British Pound up +0.92% versus U.S. dollar and the Euro up +0.73%.


We certainly get that being bearish on the U.S. dollar at this point isn’t exactly a contrarian call, but, to be fair, we’ve traded the U.S. dollar in the Virtual Portfolio 20 times since the firm’s inception and have been right 20 times. In addition, of the 46 currency positions we’ve taken in the Virtual Portfolio over the same duration, we booked a gain on 41 of them. Clearly, this isn’t our first Currency Rodeo. That said, according to a recent survey by Bank of America, all but 6% of their global clients are bearish on the U.S. dollar, which is not inconsistent with some of our internal surveys.  In addition, Barclays reported the commodity assets under management have reached an all-time high at $412BN.


Being long commodities is in many respects the same trade as being short the U.S. dollar, and we’d be remiss to not at least factor into our models that the investment community is leaning hard in one direction.  But the question remains: is consensus bearish enough on the dollar?  Our answer on this, until the facts change, is “no”.


As we analyze the U.S. dollar versus global currencies, we focus on three key factors: debt, deficit, and interest rates.  Currently, the U.S. dollar lines up negative on all three of these fronts, specifically:


1.  Excessive debt – In the last couple of years, it has become cool to quote Reinhart and Rogoff and bandy about sovereign debt-to-GDP ratios, so this isn’t new, but according to usdebtclock.org, the United States has a debt-to-GDP ratio of 96%.  This is negative for GDP growth, which is negative for the U.S. dollar as slower growth leads to longer term accommodative monetary policy and higher than expected fiscal deficits.  Further, the United States’ future debt trajectory is much steeper than any of its “AAA” peers (Canada, United Kingdom, Germany and France) due to a lack of a credible deficit reduction plan.  To add insult to injury, the politicians in Washington will once again debate increasing  the debt ceiling in mid-May while global currency traders watch real-time;


2.  Long term deficit – This year the United States federal government will run a deficit north of $1.5 trillion dollars, which is more than 10% of GDP.  (This is slightly better than Sierra Leone.)  The real issue with the deficit is a lack of a credible plan to reduce the deficit going forward.  While many nations globally have already begun austerity programs, the United States has no plan and the recently approved $38 billion spending reduction for the duration of this year is only likely to have a real benefit of some $380 million.  President Obama has given June as the time frame by which he hopes to have an agreement on a long term budget, but our view is that based on how far apart the Democrats and Republicans are on the tenets of the plan, this time frame will be blown threw;


3.  Monetary policy bifurcation - Simply put, interest rates and perceived future interest rates move currencies.   Almost every major modern nation in the world has either tightened policy (witness Sweden and China most recently) or is reporting data that suggests tightening is imminent.  In contrast, not only is the United States still implementing Quantitative Guessing Part II, but recent signals out of the Federal Reserve suggest we could see a version of QE-lite after June, so we think the U.S. Dollar will fall victim to additional easing in the face of the world tightening.


In order to shift our investment view on the U.S. Dollar we need to believe that these factors will improve absolutely and relatively and, as of yet, it is hard to make that case.  Meanwhile, the U.S. dollar index continues to be in a bear market in our quantitative models.


Currently in the Virtual Porfolio we are long the Canadian dollar, long the Chinese Yuan, and long the British Pound. We covered our short position in the U.S. dollar (UUP) yesterday.   This isn’t about politics or patriotism, but risk management.


Enjoy the long weekend with your families.


Keep our head up and stick on the ice,


Daryl G. Jones

Managing Director


Currency Rodeos - Chart of the Day


Currency Rodeos - Virtual Portfolio


The Macau Metro Monitor, April 21, 2011




Traffic at Singapore Changi Airport saw a 7.5% YoY in March with 3,708,592 passengers.



Visitor arrivals totaled 2,190,865 in March 2011, +8.9% YoY.  Visitors from Mainland China increased by 18.6% YoY to 1,254,117, with the majority coming from Guangdong Province, Fujian Province and Zhejiang Province.  Mainland visitors traveling to Macau under IVS were 501,276, +18.9% YoY.





Macau CPI rose 5.46% YoY and 0.47% MoM in March.

Getting to the Puck

This note was originally published at 8am on April 18, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be.”

-Wayne Gretzky


Late last week Keith and I were in Boston meeting with clients on the eve of the beginning of the Boston / Montreal first round playoff series.  While Bostonians and hockey fans around the world are gearing up for the beginning of the NHL playoffs, money managers, as usual, are contemplating portfolio positioning for the upcoming months.


Whether your strategy involves bottom-up company analysis, top-down economic analysis, or a healthy dose of both, the objective is the same: to anticipate where the Investment Puck is going ahead of the competition.  To borrow from Mr. Gretzky, good money managers play the market where it is, great money managers play the market where it is going to be.


Currently, from a macro perspective, the primary focus of many money managers is attempting to determine the timing of the next move in monetary policy.  Given the high correlation between U.S. monetary policy, the U.S. dollar, and many global asset classes, this is the key area to focus.


To emphasize this point, in the Chart of the Day attached below, we show the correlation of Federal Reserve Treasury Purchases with the CRB index, which highlights the high correlation to loose U.S. monetary policy and inflation of many U.S. dollar-based commodities. 


While “fundamental” supply and demand certainly matters, if you are invested in oil, or oil related equities, keep one market quote front and center: the U.S. Dollar Index.  Over the past three months, the correlation between the U.S. dollar index and WTI Crude Futures is -0.86, while the correlation between the U.S. Dollar Index and Brent Crude Futures is -0.91.  Dollar down continues to equal oil up, and decidedly so.


In our presentation late last month titled, What’s Next For Oil?, we highlighted turmoil in the Middle East as a key factor supporting the price of oil.  Indeed, violence in Libya continued to escalate this weekend as the recent U.S. led NATO intervention so far seems largely ineffectual.  According to British Prime Minister Cameron this weekend:


“We have to ask ourselves, what more can we do to protect civilian life and to stop Qaddafi’s war machine unleashing such hell on his own people.”


With an unknown outcome Libyan oil production remains well below its full output of 1.8MM barrels per day, which supports oil prices.


On the other side of the ledger for oil, there are mounting bearish supply and demand data points.  Specifically, according a recent report from the International Energy Administration, oil consumption grew 2.6% year-over-year in Q1 2011.  This was a sequential slowdown from 4.1% year-over-year growth in consumption in Q4 2010.  Further, the IEA now expects oil consumption to grow 1.6% year-over-year in all of 2011 versus 3.4% for 2010.  In addition, crude oil stocks in the United States grew 0.5% year-over-year, which is near decade highs.  With the price of gasoline up 24.6% year-over-year, oil stocks should continue to build.


If you don’t believe the oil market is oversupplied in the short term, take it from the Saudis. This weekend the Saudi Oil Minister said the following in a press conference:


“The market is overbalanced ... Our production in February was 9.125 million barrels per day (bpd), in March it was 8.292 million bpd. In April we don't know yet, probably a little higher than March. The reason I gave you these numbers is to show you that the market is oversupplied."


This morning China increased the reserve ratio for their banks by 50 basis points to 20.5% and pledged there is more to come.  So unlike The Bernank who attempts to manage monetary policy via a press conference (according to the top article on Bloomberg this morning), the Chinese continue to proactively combat inflation.


Chinese tightening is incrementally bearish for commodities, to argue different is simply story telling. (Interestingly, the Chinese equity market closed up +23 basis points despite this incremental tightening, which is positive for our long Chinese equity position in the Virtual Portfolio.)


As bearish supply and demand data points continue to mount for oil and other U.S. dollar based global commodities, the increasing focus is on determining the direction of the U.S. dollar, which will be driven by U.S. monetary policy. So, where do we stand on the direction of monetary policy?  To some extent, it will depend on the data. 


We are quite confident housing has another leg down (email sales@hedgeye.com if you are an institutional prospect and want to talk to our Financials Sector Head Josh Steiner about his 100+ page negative thesis on housing).  Further, employment is seeing anemic improvement, which is mostly being driven by people leaving the workforce and will not see much improvement with U.S. GDP growth likely to come in lower than expected this year.  On both of these key fronts, Chairman Bernanke will have plenty of cover to keep rates low for an “extended period”.


Ironically, government CPI, which is not the best proxy for inflation in our estimation, may actually be the thorn in The Bernank’s side.  As we highlighted in our Q2 Theme presentation, CPI compares are set to get very easy in the United States.  In fact, June CPI last year was +1.1%, which is really the beginning of the easy comps.  Starting this summer it is likely that we see government reported data that looks inflationary and will make it difficult for The Bernank to remain perpetually dovish. 


As monetary policy begins to tighten in the U.S. and theoretically strengthen the U.S. dollar, the music will likely stop for the commodity rally in the intermediate term. This will create an investment opportunity of another kind if you are at the Investment Puck.  And as famed U.S. Olympic Coach Herb Brooks once said:


“Great moments are born from great opportunities.”


Keep your head up and stick on the ice,


Daryl G. Jones

Managing Director


Getting to the Puck - Chart of the Day


Getting to the Puck - Virtual Portfolio

Early Look

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TODAY’S S&P 500 SET-UP - April 20, 2011


As we look at today’s set up for the S&P 500, the range is 17 points or -0.93% downside to 1318 and +0.35% upside to 1335.






THE HEDGEYE DAILY OUTLOOK - daily sector view








THE HEDGEYE DAILY OUTLOOK - daily commodity view





THE HEDGEYE DAILY OUTLOOK - daily currency view





















Howard Penney

Managing Director


MAR still fell short despite the recent pre-announcement.  Q2 guidance was worse than consensus but not by much.



MAR’s discounted relative valuation and the recent negative sentiment surrounding the name could keep the stock afloat following today’s earnings miss.  Guidance could’ve been worse, quite frankly.  We think most lodging companies will struggle to make current Q2 consensus estimates.  Indeed, MAR gave Q2 guidance of $0.34-0.38, below the Street at $0.39 but we think the low end of that range is probably more appropriate.


Despite the company’s recently revised lower guidance, Q1 results still missed consensus EBITDA by 5% and EPS by a penny.  Q1 also fell short of our EBITDA estimate by 3% and came out a penny short of our EPS estimate.  Here is the detail:


  • System-wide RevPAR growth came in a little below management’s revised down guidance:
    • The company expects its worldwide systemwide 1Q RevPAR to increase approximately 7%, at the low end of the company's 7 to 9% 1Q guidance”
  • Total fee revenue was $9MM or 3% below our estimate with most of the miss coming from opaque incentive fees
    • Base fees were just slightly below our estimate and franchise fees were $2MM light or 2% below our estimate
    • Incentive fees of $42MM which only grew 5% YoY, missed our estimate by 15%. In 2010 incentive fees grew 18% and 1Q2010 was an easy comp, since incentive fees fell 7% YoY.
    • Fee revenue of $279MM came in $1MM below the low end of management’s original guidance
  • Owned, and leased, corporate housing and other revenue fell 11.5% below our estimate but margins came in $4MM higher. 
    • While MAR didn’t disclose the branding and termination fees in the quarter, they did attribute the increase in margins primarily to higher branding and termination fees which have 100% margins. Excluding those fees, we believe owned and leased margins would have been negative.
    • Owned gross margins of $20MM came in at the low end of management’s initial guidance
  • While timeshare contract sales were disappointing (and in our opinion, the most important indicator and predictor of business health), segment results managed to handily beat our expectations.  This is partly attributed to the elimination of losses from the residential and fractional business that dragged down comparative results in 1Q2010.
    • Segment results of $35MM came in at the low end of management’s initial guidance



Q2 2011:

  • RevPAR is largely in-line with street expectation
  • Guidance of $0.34-0.38 falls short of the Street’s $0.39.  Low end of that range is more likely in our opinion.


  • Guidance was largely unchanged aside from:
    • Fee revenue guidance as taken down by $5MM from prior guidance
    • “Compared to full year guidance issued in February 2011, the company expects stronger performance at European owned and leased hotels and higher termination fees, offset by a $10 million decline in results in Japan.”
    • Adjusted EBITDA $15MM lower
    • SG&A was $15MM higher


Chipotle posted 1Q11 earnings after the market close.  Comps once again were strong, and EPS came in slightly above expectations.  Margin contraction, showing up for the first quarter since 4Q08, was what stood out most.


CMG once again topped street expectations, printing 1Q11 diluted earnings of $1.46 per share and 12.4% comparable restaurant sales growth versus consensus at $1.44 and 9.4% for EPS and comparable restaurant sales, respectively.  However, unlike the previous eight quarters, this 1Q11 raised some clear issues for the company: slowing sales trends and accelerating inflation.


Management maintained its prior guidance of 135-145 new restaurant openings for 2011 and an effective tax rate of approximately 38.3%, however, full year comparable restaurant sales growth guidance was raised to “mid-single digit growth” from “low single digit growth” a couple of months ago. 



Comparable-restaurant sales growth


As the chart below indicates, comparable restaurant sales grew 12.4% in 1Q11.  This implies sequential growth in the two-year average trend of 110 basis-points.  The comp was primarily driven by traffic during the quarter, with price adding 0.7%.  Also contributing to the top-line growth was an online promotion ran in conjunction with the America’s Next Great Restaurant television show where customers who viewed a video promotion could visit Chipotle and receive two burritos for the price of one.  In excess of a million customers visited Chipotle restaurants to redeem the offer.  Management estimated that the promotion, running for two weeks, added nearly 1% to the overall comp in 1Q.


While management raised guidance from “low” to “mid” single digit growth for the year, 1Q comparable restaurant sales growth was so far in excess of guidance that the increase in annual guidance does not alter my view on where comps will likely be for the remainder of the year.  Maintaining two-year average trends roughly flat with the trend in 1Q (excluding the online promotion) over the next three quarters implies a steep step-down in comparable restaurant sales growth over the remainder of the year. 


However, it is worth noting that assuming these two-year average trends going forward could prove aggressive.  The one-year comps required to such a trend would imply comparable restaurant sales growth of roughly 7% for the year.  Furthermore, management struck a cautious tone on the earnings call when addressing the top line.  Firstly, compares become progressively more difficult over the next three quarters, as management pointed out.  Secondly, most of the effective 0.7% price increase that was on the menu in 1Q rolls off during 2Q.  A price increase in the Pacific region stores, including California, of about 4.5% has brought menu prices there in line with the rest of the country.  The Pacific region has the highest cost of business for CMG than any other region.  Although prices have been increased in this market, management stressed that the company plans to wait until the third quarter to assess the impact of inflation and customer reactions to a possible price increase.





Inflationary headwinds starting to move the needle


Management maintained its cautious tone when transitioning to discussing costs.  Food costs are obviously front-and-center for restaurant companies at present but, given CMG’s largely unlocked commodity basket, the topic is particularly pertinent for this stock.  During the first quarter, food, beverage and packaging costs increased to 32% of sales (roughly 175 basis points year-over-year).  Sequentially, food costs increased approximately 100 basis points, as a percentage of sales, and management estimates that about 60 basis points of this was due to higher tomato and produce costs due to the freeze in Mexico and Florida.   The remaining 40 basis points relates to underlying inflation in items such as beef, chicken and avocados. 


While the effects of the freeze in Mexico and Florida will fade as we roll through the year, other factors will “more than offset” this benefit in the second quarter, according to management.  The most significant pressure that was highlighted was on avocados which, it was estimated, will add 50 to 60 basis points to food costs during 2Q due to a lower harvest than expected.


As the company considers its options on price in the third quarter, depending on how commodity costs impact margins over the summer months, it is important to note that the current growth in comparable restaurant sales is driven almost entirely by traffic.  The extent to which a price increase adversely impacts traffic will obviously require the close attention of management.   Clearly if management’s concerns around commodity costs are well-founded, the likeliness of a price increase seems to have heightened significantly since the 4Q10 earnings call.


One interesting aside is that corn prices, highlighted by CMG as a driver of meat prices during the 3Q10 earnings call, continue higher.  During the last earnings call corn was trading at $7 per bushel, currently the grain is trading at $7.43 per bushel. 



Labor cost uncertainty


Chipotle has generated plenty of headlines this year due to an ongoing federal investigation into the company’s hiring practices.  Clearly I do not know how that will flush out, but the hiring and retraining of new employees, immigration experts, improved software systems to monitor documentation of workers, and other related expenses are not likely to help labor margins.  It is encouraging to hear of new kitchen initiatives that will be margin accretive from an energy and labor perspective, but there is clearly some uncertainty surrounding the potential outcomes of the current investigation.  Management was reluctant to even address a “worst-case scenario” outcome of the labor scandal.





Timing the 2011 Headwinds


During the 3Q10 earnings call, management stated that margins at CMG can be maintained “so long as we continue to see some comp growth – and we typically need something mid-single digit – generally with normal inflation”.  1Q11 saw margins roll decline year-over-year with a better-than-expected comparable sales number of +12.4%.  With a far tougher compare in 2Q (8.7% in 2Q10 versus 4.3% in 1Q10), comps will likely slow significantly and – as management highlighted – commodity pressures will almost certainly be greater.   I would expect 2Q food costs, as a percent of sales, to increase by 200-300 basis points versus the year prior. 


With slowing comparable restaurant sales and increasing costs, the decision to pass on price to the customer is a momentous one.  Management assumed a confident tone when assuring investors and analysts on the earnings call that Chipotle has pricing power, and that independent surveys support that view, but this is difficult to know until the price increase is implemented.  The impact may vary from market to market and much could depend on the macro environment at the time.  With gas prices and consumer confidence going in the wrong direction – up and down, respectively – it is certainly a risk.  Following  a couple of years of stellar performance and a seemingly teflon business model currently being awarded a 19.5x cash flow multiple by the street, CMG is playing a high-stakes game.


Howard Penney

Managing Director


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