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Indefinitely Dovish

This note was originally published at 8am on April 25, 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 dove descending breaks the air with flame of incandescent terror.”

-T.S. Eliot, Little Gidding (1942)

 

“Little Gidding” was the final of four brilliant poems in T.S. Eliot’s “Four Quartets” which helped him win the Nobel Prize for Literature in 1948. Each of the four poems considers the lessons of history within the context of one of the four elements: air, earth, water, and fire.

 

The element of fire in the aforementioned quote is an important metaphor to consider when watching what the US Government is doing to the US Dollar. Through a deliberately dovish monetary policy to inflate, the US Federal Reserve is Burning The Buck.

 

Since the unaccountable bureaucrats at the Fed and their friends who are working for Groupthink Geithner at the US Treasury will be the last to call up a chart of the US Dollar Index (career risk management), we’ll do it for you, weekly, until this Currency Crash looks less likely:

  1. Week-over-week, the US Dollar Index was down another -0.91% last week to close at $74.11 = a fresh 2-year low
  2. Closing down for 13 out of the last 17 weeks, the USD Index has lost -8.6% of its intermediate-term value in the last 4 months
  3. Since President Obama and Treasury Secretary Geithner strapped on the accountability pants in 2009, the US Dollar is down -16.8%!

So who cares?

 

Evidently our Almighty Central Planners don’t. They don’t even talk about it… and neither do the kowtowing “blue chip” economists who allegedly analyze their Keynesian policies.

 

But, The People do…

 

With the US stock market up +97.8% from its March 2009 low, you’d think that the policy to get us paid with some equity market performance would make this country really happy about all of this. Not.

 

Why not?

 

Alongside last week’s Crashing Currency, here’s what the price of other things that trade predominantly in US Dollars did last week:

  1. Oil = +2.1% to $112.29/barrel
  2. Gold = +1.1% to $1503/oz
  3. CRB Commodities Index (19 Commodities) = +1.4% to 367

Nice. If you are long of The Inflation, that is…

 

If you aren’t, well – I guess the message for you from The Bernank is too bad. Take it in the pump – and like it.

 

Ben Bernanke’s incompetent forecasts will be center stage on this week’s Macro Catalyst Calendar with following events:

  1. Tuesday – New Home Sales (trending at record lows despite Bernanke begging you to lever yourself up with a “cheap” mortgage)
  2. Wednesday – FOMC interest rate decision (Indefinitely Dovish); and Case/Shiller Home Prices for FEB (train wreck)
  3. Thursday – Q1 US GDP (running at least 30% below Bernanke’s initial forecast - almost all of Wall St has cut their estimates)
  4. Friday – Michigan Consumer Confidence for April (making lower-highs); and April month-end markups (US equities)

How will The Bernank spin alchemy’s free money spool into an Indefinitely Dovish message on Wednesday?

 

He’ll flip the switch from saying there is no inflation to worrying the world about Growth Slowing As Inflation Accelerates. At $112/barrel oil (up +180% since Obama and Geithner took office in 2009), The Inflation at the pump is almost 2x that of the US stock market. Meanwhile, gold and silver are trading at all-time highs this morning (all-time is a long time) – so he’s going to admit he sees that, I hope…

 

And while hope is not an investment process, watching marked-to-market expectations in both the US currency and Treasury markets is. Both the US Dollar crashing and UST yields breaking intermediate-term TREND support of 0.71% this morning are signaling Bernanke will remain dovish. He’ll blame growth slowing (Q1 GDP report Thursday) and US housing being the train wreck that he and Greenspan helped perpetuate.

 

In terms of asset allocation, this still leaves me long of The Inflation (Gold and Oil), and long of relatively unlevered growth where I can find it (China and US Tech). Since the week of March 28th, I’ve taken down my Cash position from 52% to 40% - the updated Hedgeye Asset Allocation Model has the following composition:

  1. Cash = 40% (down from 43% week-over-week)
  2. International Currencies = 30% (Chinese Yuan, Canadian Dollar, British Pound = CYB, FXC, and FXB)
  3. International Equities = 9% (China = CAF)
  4. Commodities = 9% (Gold and Oil = GLD and OIL)
  5. US Equities = 6% (Technology = XLK)
  6. Fixed Income = 6% (US Treasury Flattener = FLAT)

Understanding full well that the US Dollar correlation-risk to just about everything that I am long is surreal at this point, I’ll just call this positioning out for what it is – an explicit bet that the Fed remains Indefinitely Dovish until the US Government is forced to face a US Currency Crash and all of the understood consequences embedded therein.

 

My immediate-term support and resistance lines for oil are now $109.12 and $112.91, respectively. My immediate-term support and resistance lines for the SP500 are now 1319 and 1339, respectively.

 

My personal thanks to Big Alberta for riding shot-gun for the team last week, and best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Indefinitely Dovish - Chart of the Day

 

Indefinitely Dovish - Virtual Portfolio


LIZ: Yes, It's That Simple

Maintaining guidance + comp momentum across all concepts is all McComb could ask for heading into tomorrow’s analyst day. LIZ remains one of our top long ideas.

 

 

There are going to be plenty of puts and takes to dissect coming out of tomorrow’s analyst day, but the bottom-line here is that maintaining guidance + comp momentum across all concepts is all McComb could ask for heading into the event. Here are the key takeaways from Q1 results: 

  1. Reaffirmed 2011 and 2012 EBITDA guidance. Simply confirming guidance isn’t noteworthy, but the fact that the company didn’t lower guidance for the umpteenth consecutive time is = positive. (don’t hold us to the exact number, but LIZ preannounced and/or guided down about 20 times over 20 quarters).
  2. Direct Brand comps are up across the board = positive.
  3. Focus on turning operating results at Mexx Europe appears to have shifted from product to right-sizing the store base.  Not only does this imply that product has improved, but closing stores is a more manageable task from both an operating and execution perspective = positive.
  4. Partnered Brands posted positive adjusted operating profit in the quarter in-line with expectations for the same at year-end = positive.
  5. Availability under the current credit facility contracted $100mm to $139mm. Yes, Q1 is the most challenging from a cash flow perspective, but leverage matters on this name more than most. = negative.

Net/net, in looking at Q1 results the positives outweigh the negatives = we like this one and continue to think that LIZ has one of the most positive asymmetric risk profiles in retail – still. We’ll provide additional color and thoughts following the analyst day tomorrow.

 

LIZ: Yes, It's That Simple - LIZ Comp Traj 4 27 11

Casey Flavin

Director

 

 


JNY: Short It

 

I never thought I’d say this, but I’m actually getting even more negative on JNY.  In going through today’s 1Q results (several times), I’m increasingly convinced that these guys either have an astounding poker face, or they simply and honestly do not know what is about to hit them. No one ever accused Wes Card and John McClain of being liars or deceiving investors, and nor will I. But the stress points in the model are more brittle than anytime I’ve seen at JNY in the 13-years I’ve followed it. My most recent thought had been that this is a company that is destined to earn between a buck and $1.50 in perpetuity. Now, barring a positive event that I cannot envision as hard as I try, I don’t think that JNY will ever earn over $1.00 per share again. With the stock at $14.95, the consensus likely does not agree with me.

 

What’s changed on the margin?

 

1)     My confidence in JNY’s ability to squeeze water from a stone. 

  • JNY discussed its Brand Optimization Process, which actually sounded rather encouraging at face value in a Six-Sigma-ish kinda way. But when you really peel back the onion, it simply does not synch with the company’s financial initiatives and capacity. In the quarter, Sales were up only 2% excluding Stuart Weitzman, and organic SG&A was flat. How many companies in retail have we ever seen go through a ‘Brand Makeover’ without a capital infusion, and have it actually work? In this business, it is near impossible to cut costs and build brand allure/grow revenue simultaneously. For the full year, they’re looking at only $25mm in incremental SG&A growth, which is simply not enough for a $3.7bn company. Perhaps they’ll argue that they already have in-house resources that can be shared (design, distribution, etc…), but I’d fire back and say that this jeopardizes existing brands.
  • Without success in its core, Jones will be Jones and simply buy more assets, right? Not so fast… It’s latest deal (Stuart Weitzman) is only 55% paid for – with the remainder due at the end of 2012. It is currently sitting at 33% net debt to total capital, and can’t take that much higher without putting this balance sheet at serious risk. That’s why we cringe when we hear about JNY bidding for assets like Jimmy Choo.

2)     Margin Risk Is Material

  • Inventories were up 28% (3.5x sales growth) which the company spelled out in great detail (kudos for the disclosure), 10% of this was JNY pulling forward business ahead of price increases. Another 5% was excess goods from prior season. That’s not good. While it’s commendable for JNY to pull forward product to manage costs, this does not pull forward the time during which customers will take delivery. Translation, JNY needs to take on greater fashion risk in exchange for COGS risk. They’ve proven to be quite adept at execution and supply chain optimization, but not quite on the fashion trend side of things. I don’t like this trade. Case in point from the Q&A…

- Question: “gross margin compression guidance in 2Q is a little bit wider than you had originally expected, now 150 to 200BPS vs. 150 originally. Why?”

- Answer:  Well, I think some of it is you just sharpen the estimate as you get closer and with the trends that we’ve seen and there’s still a heavy level of promotion and just the general kind of uncertainty with the consumer enables me to just sharpen it up a little bit. The current quarter’s always easier to do than the one after that, so...”

- They guided to 2Q revenue anywhere between -1% and +3%. If the current quarter is easier for them to forecast, what does it say for the back of the year?

  • JNY is talking about 1H10 being its toughest comparison of the year, when last year’s conditions were near-perfect. As a result, margin improvement will be back-end loaded. What?!? Is this really the year to bank on margin expansion in 2H? Management said that the consumer is not resisting price increases yet, but then noted that they have not really pushed much through yet.  They’ll be relying on significant price increases sticking in 2H to offset dd cost increases. Do I worry about Ralph Lauren sticking price increases? Nike? Guess? CK? No, no, no and no. Jones’ brands? Yes.

3)     Here’s a statement that bugs me… “We continued our strategy of focusing on our core competencies, controlling inventory, and identifying opportunities for cost efficiencies and savings in both our operations and in our supply chain.” If I’m going to invest in any business, I want a management team to have a clear, quantified and borderline cocky plan for how it is going to grow profitably and organically. That’s not what JNY is giving us. They’re doing the cost-cut dance, and are basing 2H growth projections on consumer confidence. Its gonna take more than Nine West espadrills and Jones New York Easy Care White Blouses to drive meaningful growth here.

 

4)     Cash Flow? They guided to $175mm or better. We need to see the company earn at least a buck in earnings AND have working capital as a source of cash. Best case, I think we’ll see one or the other. Realistically, JNY pulls out the stops to protect its balance sheet, but takes it on the chin on its P&L. This is where we’re most different. They noted that should the business climate erode from here, FY11 gross margins could be down 50-100bps. We’re at -200bps.

 

5)     Consensus Revisions: I really don’t care a whole heck of a lot where the consensus ends up on this name (doubtfully below our $0.78 and $0.85 for this year and next).  We’ve got a stock trading at $14.95 that will never earn over $1.00 again. Let’s also keep in mind that from a top-line perspective, NY just finished its last quarter of easy yy compares. This thing is the poster child for a company that NEEDS margin. Few people on the sell-side are big fans here, but there’s only 6% of the float short, which remains quite low for JNY.

 

JNY’s SIGMA Chart Looks Awful. Being Sucked Down and To The Left is Never Good.

 

JNY: Short It - JNY S 4 11

 

 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.65%
  • SHORT SIGNALS 78.63%

Everyone’s A Winner – Except Peru

Conclusion: We maintain our view that the current Peruvian election will serve as a catalyst for incremental economic liberalization throughout the region over the long-term TAIL. Furthermore, the potential for Peru to succumb to socialist rule is likely to be supportive of higher silver, gold, and copper prices over the long term.

 

Last week, in a report we published titled, “Peruvian Crystal Ball”, we detailed how the current Peruvian election would serve as a catalyst for incremental economic liberalization throughout the region. The key claim supporting this thesis was that severe weakness in Peruvian financial markets would serve as a warning sign to the region’s leaders to avoid implementing socialist reforms:

 

“[The] sell-offs [in Peruvian assets] have the potential to destabilize the Peruvian economy and should be viewed as a warning sign to politicians throughout the region. Gone are the days of simply parlaying the poor vote into election victories – particularly at the highest office. As we are seeing currently, Latin American politicians must pay increasing attention to the desires of international investors, as well as the needs of the region’s growing middle class…we expect this trend to continue.”

-Peruvian Crystal Ball, April 19, 2011

 

Such potentially destabilizing “warning signs” have been loud and clear. In the last two months alone, Peru’s currency has lost (-1.9%) of its value (vs. USD). That’s tops among all currencies globally vs. the greenback and is only bested by the US Dollar Index’s own (-5.1%) decline. If you didn’t know, now you know – socialism is bad for a currency. Peru’s equity market (Lima General Index) tells a similar tale, plunging (-19.2%) over the last month – the largest decline for any equity index in the world over that duration.

 

Everyone’s A Winner – Except Peru - 1

 

The international flight out of Peruvian assets is being driven by the potential for the country to succumb to socialist rule in its June 5 run-off election. An Ipsos Apoyo poll released Monday showed the left-leaning Ollanta Humala had a six percentage point lead vs. his right-leaning opposition candidate, Keiko Fujimori (42% vs. 36%). A deeper look into the poll results show that Humala’s chances of victory are perhaps even stronger than the 600bps delta would indicate: 

  • Humala is rallying his target constituency – the Peruvian lower class – better than Fujimori is rallying her target constituency – the Peruvian middle-to-upper class: Humala garnered 44% of the vote outside of metropolitan Lima vs. Fujimori’s 33%; within Lima, Fujimori won over its middle-to-upper class voter base (as expected), but by a narrower margin (43% vs. 35%). Further, Lima represents only about 1/3rd of Peru’s aggregate voter base, meaning Humala has the majority of voters leaning in his direction;
  • 35% of all respondents said they would never vote for Humala vs. 38% for Fujimori;
  • Among the key issues holding these voters back, nearly 50% of all respondents believe Venezuela’s Hugo Chavez is financing Humala’s campaign vs. 68% who believe that Fujimori would pardon her jailed father, former Peruvian president Alberto Fujimori, who is currently serving a 25-year sentence for directing a paramilitary death squad; and
  • Nearly 2/3rds of respondents  said they are in favor of Humala’s proposal to change or replace the 1993 constitution introduced after then-president Alberto Fujimori dissolved congress and Peru’s courts in 1992. 

Net-net, it looks like Humala definitely has the momentum to succeed in this election. In our opinion, this is a major incremental change on the margin, given that there was the possibility that Fujimori could make a strong push in the polls if she does a good enough job scaring the Peruvian electorate away from Humala’s proposed socialist reforms. While there is still time for her to accomplish this mission, the net result of this poll suggests that accomplishing that task is less feasible than we anticipated.

 

The decreasing likelihood of a Fujimori victory points to a major shift in the mood of the Peruvian electorate towards wanting less of the same – particularly at the lower-income end of the spectrum. After having voted in incumbent Alex Garcia as “the lesser of two evils” relative to Humala in 2006, Peru’s lower class has grown increasingly fed up from the lack of wealth distribution created by the last 15-20 years of economic liberalization and robust GDP growth.

 

While Peru’s Real GDP has averaged +4.9% YoY per quarter since 1Q95 and its GDP per Capita has grown at a CAGR of +2.8% since 1995, its GINI Coefficient, a measure of income distribution, has risen +3.09 points over the same duration. This means that as Peru’s economy has grown throughout this recent era of economic liberalization, inequality from an income perspective has also increased. In Peru, the rich have gotten richer from an influx of international investment capital while the poor continue to watch the country prosper from an outsider’s perspective. As to be expected, this widening wealth gap has created a shift towards socialism on the margin in the political leanings of Peru’s aggregate voter base.

 

Everyone’s A Winner – Except Peru - 2

 

This sentiment was echoed to us by a very interested Peruvian national who we recently held a call with. Regarding the shift, he simply states, “People have grown impatient”, while also calling Peru a “glass ceiling economy”. Further, his words regarding the pending direction of the economy were very sobering indeed, saying flat-out, “I’m terribly sad; we we’re really making strides on a relative basis throughout the region… [a Humala victory] will set us back”. Additionally, his intel has led him to believe a Humala victory was perhaps more locked up than the market is currently pricing in, saying that 5 million-plus soldiers, their families, and friends are likely to vote for Humala after years of mistreatment by the central government (that’s roughly 16-17% of the population). Their opinions are not currently expressed in the aforementioned poll results, meaning that Humala might already be at or beyond the 50% needed to secure victory in the runoff election on June 5.

 

All told, it’s increasingly likely that Peru will succumb to socialist rule in the coming months. That has negative implications for the economy, given that an anticipated $50B in foreign mining, energy, and infrastructure investment stands to go the way of the dodo bird as Humala increases taxes and renegotiates existing contracts in an effort to increase the Peruvian government’s control of these industries. As a result, Peru’s economy is likely to suffer due to a lack of investment and higher taxes. Not to mention, the spectre of structurally elevated inflation remains a TAIL risk, given that much of the currency’s gains are, in fact, driven by foreign investment flows that are now in question.

 

While it’s clear that Peru stands to be the ultimate loser in this transition to a red regime, we do maintain our view that the economically liberal countries of the region at large will benefit from an increased propensity to lean to the political right, particularly when it comes to investment. If anything, Peru’s financial markets are a leading indicator for a potential long-term decline in Peru’s economic output and we’d be remiss to assume the region’s leaders aren’t taking notice. A Dilma Rousseff-led Brazil is one example where the potential for increased investor-friendly economic policies stand to benefit the country long term.

 

Shifting gears, the potential lack of investment Peru’s mining industry has two major implications going forward: supply in the silver, gold, and copper markets is likely to be structurally lower than current estimates suggest, as Peru is currently the #1, #6, and #2 producers of the metals, respectively. That’s a bullish data point for each of these commodities – particularly silver from a long-term headline risk perspective. Also, the investment capital that is currently projected to flow to Peru is likely to be redirected to places like Chile and Colombia, on the margin. The race to claim what was once Peru’s future economic prosperity just might officially begin June 5.

 

Darius Dale

Analyst



EAT: RISING ABOVE AND TAKING SHARE

Brinker reported a great quarter this morning which exceeded consensus expectations.  I think I have been one of, if not the most bullish analysts on this name yet Chili’s reported comps still beat my expectations also.

 

Brinker reported earnings this morning and reported diluted EPS of $0.46 came in slightly above consensus at $0.45.  EPS from continuing items came in at $0.45 cents, 22% higher than 3QFY10.  Chili’s company-owned same-store sales declined -0.7% during 1Q, on a calendar/53 week-adjusted basis.  The reported comp was -0.3%.  Consensus was anticipating a decline of -1.2%.  At Maggiano’s, company-owned same-store sales grew +4.1% during 1Q, on a calendar/53 week-adjusted basis.  The reported comp was +3.4%.  Consensus was anticipating a print of +3.0%.

 

Guidance for 4QFY11 may have been somewhat of a disappointment, given that consensus is at the high end of the range, but looking past the fourth quarter, the direction of the business is positive.

 

 

Same-store sales

 

EAT: RISING ABOVE AND TAKING SHARE - chili s pod 1

 

 

The improvement of same-store sales, relative to competitors in the casual dining space, was a key crux to my bullish thesis for Brinker and this quarter obviously further solidifies my confidence in the sustainability of the story.  As the chart above shows, the trend in comps at Chili's – particularly when one looks at the two-year trend – is clearly pointing higher.  Management has emphasized the importance of value and a high-quality guest experience for the health of the company’s top-line and, it seems, the customer is responding well to initiatives ranging from “Team Service”, improved speed of service thanks to food preparation initiatives, and new lunch menu items at affordable price-points. 

 

The company highlighted the substantial impact on comps from the new line of combos on the lunch menu.  While traffic at lunch moved from negative mid-single digits to positive, there was also an expected impact on mix resulting from a lower check.  Preference for these $6/$7/$8 items were higher than anticipated based on test results and management said that it will continue to work to balance top-line growth and profitability.  In my view, as the company continues what is ultimately a reintroduction of the new Chili’s to the casual diner, traffic growth is paramount so as to raise awareness of a much improving restaurant chain.  When asked about the prospect of raising prices during the Q&A, the company reiterated its prioritization of traffic which, I believe, is the correct strategy for Chili’s at this point in time.

 

Besides the trend, merely comparing the language and tone of Brinker’s earnings call versus the earnings calls of peer companies that have reported of late underscores the progress Brinker is making.   As I wrote in my restaurants earnings preview on Monday, Brinker would not point to gas prices as an excuse and that alone sets it apart for the earnings season so far. 

 

 

Operating Margin

 

EAT: RISING ABOVE AND TAKING SHARE - EAT pod 2

 

 

Restaurant operating margins grew 152 bps year-over-year.  Cost of sales decreased 127 bps driven by a more profitable value offer in January and menu improvements.  There was also a 50 basis point improvement due to a favorable impact from menu pricing and other items.  Commodity costs were unfavorable in the quarter to the tune of 10 basis points.  Labor improved 60 basis points in 1Q.  Team service continues to perform well, contributing roughly 100 basis points in savings.  1Q included the first phase of the kitchen retrofit program which will optimize the labor component of food preparation.  This should reduce labor costs and cost of sales through food waste reduction.



Reimaging program

 

The company estimates that the reimaged restaurants are seeing a lift of approximately 100 basis points from a margin perspective.  Changes in the kitchen were rolled out late last quarter and it is expected that the impact of that will gain additional traction over time.  In terms of the margin enhancements that are projected to come from the kitchen retro-fits, it will take time – perhaps into FY13 – for the benefit to flow through the system.  The Oklahoma City reimage test has been encouraging for management and has prompted a move to expand the reimaging program to additional markets.

 

 

Share Repurchases/Capital Expenditure


During the 3QFY11, the company completed an additional $107 million share repurchase (4.5 million shares).  Year-to-date, the company has spend $357 million on share repurchases (18 million shares).  Total fiscal 2011 capital expenditure is expected to by approximately $80 million.  Capex in 2012 is projected to be $170 million.

 

 

Outlook

  • The company offered conservative EPS guidance of $0.43 to $0.47 but remains confident in doubling EPS in five years.
  • From a commodity perspective, the company is currently 92% contracted through the end of the year.   4Q is expected to bring slightly unfavorable cost of sales.  The company is 54% contracted through the end of calendar 2011 and anticipates roughly 100 basis points in commodity pressure for fiscal 2012. 
    • Beef remains the most significant inflationary pressure in EAT’s commodity basket.  In August, the current contract expires and, if renewed at current prices, a new contract would likely involve a significant increase in inflation. 
    • The company is hoping to renew its chicken contract at a more favorable rate given deflationary pressures in the chicken market.
    • Dairy costs are contracted and management believes that the company could expect favorability in fiscal 2012 if the contract was renewed.

 

Sentiment and Valuation


A conversation I had last year with Guy Constance comes to mind.  “A badge of honor” is how he described the label of being the least favored casual dining company from a sentiment monitor I wrote in November (“EAT – A BADGE OF HONOR”, 11/14/11).  Below, I am including a chart on sell side sentiment for Brinker.  I expect this to change markedly in the coming quarters.  From a valuation perspective, EAT remains attractive.   At 6.7x EV/EBITDA NTM, I believe there is room for that multiple to expand. 

 

EAT: RISING ABOVE AND TAKING SHARE - eat ratings chart

 

EAT: RISING ABOVE AND TAKING SHARE - casual dining sell side ratings

 

EAT: RISING ABOVE AND TAKING SHARE - casual dining ev.ebitda

 

 

Howard Penney

Managing Director


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