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TODAY’S S&P 500 SET-UP - May 16, 2011


The USD is now breaking out above the Hedgeye immediate-term TRADE line of $74.55 this morning. In terms of The Correlation Risk, this only enhances the probability that we’re going to see oil test $93 and a continued unwind of The Inflation trade.  The entire commodity complex (CRB) is now bearish TRADE and TREND, confirming what Copper has been signaling since mid-Feb when we started confirming that Global Growth Slows As Inflation Accelerates. As we look at today’s set up for the S&P 500, the range is 14 points or -0.51% downside to 1331 and 0.54% upside to 1345.




By week’s end the US Equity market saw one more sector (Industrials – XLI ) break our immediate-term TRADE line. That makes 4 of 9 Sectors bearish on our immediate-term TRADE duration (XLF, XLE, XLB, and XLI) and 3 of those 4 (XLF, XLB, and XLE) are also confirmed by bearish intermediate-term TREND breakdowns (which we flagged in a risk management note earlier in the week).


Tech (XLK) and Healthcare (XLV) remain our two favorite sectors on the long side (in that order of preference from last price).


Beta is starting to underperform as expectations for Growth Slowing get baked in.




THE HEDGEYE DAILY OUTLOOK - daily sector view








  • ADVANCE/DECLINE LINE: -1319 (-2118)  
  • VOLUME: NYSE 898.43 (-5.57%)
  • VIX:  17.07 +6.49% YTD PERFORMANCE: -3.83%
  • SPX PUT/CALL RATIO: 1.81 from 1.80 (+0.40%)



  • TED SPREAD: 24.02
  • 3-MONTH T-BILL YIELD: 0.03% +0.01%
  • 10-Year: 3.18 from 3.22
  • YIELD CURVE: 2.61from 2.65



  • 8:30 a.m.: Empire Manufacturing, est. 19.70, prior 21.70
  • 8:30 a.m.: NOPA oil, soybean data
  • 9 a.m.: Bernanke speaks on innovation/research in Washington
  • 9 a.m.: Total net, net long-term TIC flows
  • 10 a.m.: NAHB housing market index, est. 17, prior 16
  • 11 a.m.: Export inspections, corn, soybeans, wheat
  • 11:30 a.m.: U.S. to sell $27b 3-mo. bills, $24b, 6-mos. Bills
  • 4 p.m.: Crop progress, grains



  • State Street wants to expand by acquisition outside the US - FT
  • Netflix announces strategic multi-year agreement with Miramax; terms undisclosed
  • Wynn Resorts CEO Steve Wynn says company has not been investigated for violating Foreign Corrupt Practices Act - WSJ
  • Japan earthquake came at unfortunate time for car dealers like AutoNation - WSJ
  • Greece will plead for boost in its $155b bailout from European govts. in IMF talks clouded by arrest of Strauss- Kahn
  • Primedia, majority-owned by KKR, may announce deal to sell itself to TPG Capital as soon as today
  • A group of Canada’s biggest banks, pension funds made $3.7b bid for TMX Group, topping offer from London Stock Exchange




THE HEDGEYE DAILY OUTLOOK - daily commodity view




  • Speculators Cut Bets on Higher Commodity Prices by 15% in Week to May 10
  • China Said to Sell Soybeans to Cool Inflation at Fastest Pace Since 2008
  • Goldman ‘Most Constructive’ on Copper, Raises Outlook For Aluminum, Nickel
  • Steel Consumption May Improve This Year on Economic Recovery, Stemcor Says
  • Gold May Advance as EU Finance Mininsters Discuss Greece’s Financing Needs
  • Copper Drops in London Trading as Speculators Cut Holdings: LME Preview
  • Coffee Falls as Vietnam’s Production May Increase; Cocoa Prices Advance
  • Crude Declines on Concern Over Greek Bailout Talks, U.S. Economic Growth
  • Corn Advances for Third Day as Wet Weather Delays Planting in U.S. Midwest
  • Hedge Fund Gas Bets Tumble 26% in Commodity ‘Game Changer’: Energy Markets
  • Europe Commodity Day Ahead: Gold-Coin Sales at a High Show Rally Not Over
  • Sumitomo Metal, Sumitomo Corp to Invest $724 Million in Chile Copper Mine
  • Aluminum Stockpiles in Japan Advance 8.9% After Quake Disrupts Shipments




THE HEDGEYE DAILY OUTLOOK - daily currency view




  • European market are weak across the board
  • Eurozone April final CPI +2.8% y/y vs consensus +2.8% and prior +2.8%; Eurozone April final CPI +0.6% m/m vs consensus +0.6% and prior +1.4%
  • Russia breaking intermediate term TREND line as Spain did last week







  • Asian markets were weak lead by Vietnam and Hong Kong
  • India down another -1% to -10.6% YTD (we're short)
  • Japan March core machinery orders +2.9% m/m vs consensus (9.9%). April domestic CGPI +2.5% y/y. April-June core machinery orders forecast +10%. April consumer confidence 33.1 vs 38.6 in March.
  • Thailand was closed for a special holiday and will reopen 18-May. 











Howard Penney

Managing Director


MCD hosted a reimaging tour yesterday in Tampa.  McDonald’s is constantly focused on its brand position and customer experience and this shone through yesterday as management walked analysts through three restaurants in the Tampa area, detailing the improvements being made to restaurants through the reimaging/rebuilding multi-year plan.  These improvements range from a complete overhaul of the exterior and interior appearance and feel to the construction of side-by-side drive-through lanes to the installation.  The tour was impressive, insightful, and bodes well for the success of McDonald’s over the longer-term.







The first two restaurants of the tour were recently remodeled.  Both remodels were completed in 2010, as part of the total 200 remodels completed last year.  The intention going forward is for between 175 to 225 remodels to take place each year.  These remodels are comprehensive, including interior and exterior overhauls, a new “modernized” menu, and new POS systems.  Ultimately, management said, there is potential for roughly 4,500 restaurants to be remodeled over the coming years (compared to a total 14,000 system-wide U.S. restaurants.  MCD offers to pay for 40% of the franchisee’s total renovation cost which serves to incentivize rollout across the system.  In the case of early adopters, the company will pay 45% of total renovation costs for franchisees.  As this plan is carried out, management expects a sales lift in renovated stores and a “halo effect” as the proportion of the system that has been renovated reaches 50%.  This is an effect MCD has observed in Europe and Australia.


The targeted time-span for a remodel is 4-6 weeks.  The first remodeled restaurant we visited in Clearwater took 60 days but management expects this to come down as the plan for system-wide remodeling progresses.  The restaurants do not close during the remodeling process, rather the drive-through might remain open while the lobby is renovated and then, upon the reopening of the lobby, the drive-through would be closed or vice versa.  After reopening, remodeled restaurants experience a sales lift of 6-7% in excess of market.  Management did also say that the “Grand Opening” typically lasts for 13 months and consists of constant events and advertising to draw attention to the remodeled restaurant. 


The exterior overhauls are quite dramatic when compared to the appearance of the restaurants before the remodel.  The facades are far more striking and visible from the street.  The arcade design is more aesthetically pleasing but a combination of prominent signage and lighting maintains the “McDonald’s” feel.   The side-by-side drive-through has allowed for a significant increase in transactions-per-hour without any incremental investment in labor.  Using digital photographs to match cars to orders, restaurant staff can quickly and accurately take, receive payment for, and deliver orders far faster than before.  With a mere 20 seconds ordering time, a staff member in Brandon, Florida estimated that her restaurant saw an average of 120 transactions per hour during peak times versus 100 with the old drive-through format.  On one day, she said, 145 transactions were processed in an hour.   One challenge that management spoke of during the day was customers seeing long drive-through lines and deciding not to wait; this improvement clearly captures lost traffic and while we were standing beside one restaurant, it was noticeable that the cars were moving through the property rapidly.  Inside the store, too, workers focused on the drive-through derive benefit from an optimized booth for beverages.  The space for the expanded beverage capacity demanded by the addition of McCafe products was taken from the lobby.  Workers presenting food at the drive-through window have all beverages within easy reach.


MCD REIMAGING TOUR - mcd drive thru





The interior renovations are, if anything, more striking than those of the exterior.  Sleek design, higher ceilings in some cases, flat screen TV’s, and communal seating represents a distinct shift in the standard customers are met with.  Most importantly, the speed and accuracy of service is enhanced in remodeled restaurants thanks to the new POS system.  A reduction in the number of screens staff needs to navigate, as well as a simpler operating platform that reduces training time, has caused roughly 10 seconds to be shaved off the service time. 


Overall, the improvements made to the restaurants serve to improve the customer experience, bringing improved service as well as a much-improved environment on the inside of the restaurant.


MCD REIMAGING TOUR - mcd interior




Scrape & Rebuilds


While rebuilds are obviously more disruptive and costly than remodels, management offered many reasons why they can be desirable from a long-term perspective.  Restaurants producing lower-than-expected volumes are relocated at a rate of ~30-50 per year but the company has found significant results in rebuilds which, more often than not, require some repositioning of the restaurant on the lot and/or an expansion in the total size of the restaurant.   This can accommodate the tackling of structural issues with water-pipes or power-lines that can exist with older stores.  The third restaurant we toured in Tampa was a very good example of the benefit that can be derived from rebuilds.  Rebuilds cost roughly $2.1 million, inclusive of $1.3 million for construction (split 50-50 between company and operator) and $1.1 million for fixtures, furniture, and equipment (operator covers this). 


Generally the difference between a decision to remodel or to rebuild hinges largely on the exterior.  Improving visibility of the restaurant to vehicular traffic is sometimes best achieved by moving the restaurant on its lot and we were able to see an example of this yesterday.   Please see an example of this below (first chart).  By reorienting the building so that it is perpendicular to the road, management improved the visibility of the restaurants to the road.  Previously, visibility on the north end was obscured by the play area.  The subsequent design, as the accompanying picture shows, incorporates the play area within the building, facing east, thereby not impeding drivers’ ability to recognize the brand immediately (second chart). 


A rebuild typically takes 90 days and requires the full closure of the property.  When reopened, sales increase by 15-20%.  Throughout the event, different members of the IR team maintained that no particular day part seen a disproportionate benefit from the new look and feel of the remodeled properties; the sales lift is broad-based in terms of guest counts.







Rory Green


The Week Ahead

The Economic Data calendar for the week of the 16th of May through the 20th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - cc1

The Week Ahead - cc2

Early Look

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FL: We Think They'll Beat on Comps

Foot Locker reports Q1 earnings next Thursday after the close, followed by a conference call on Friday morning. We expect a positive 1Q result with our model coming in at $0.46 ahead of the Street at $0.44. The key differential in our forecast is a +6.5% same store sales increase (vs. +5%E) with gross margins slightly ahead of full-year expectations offset in part by higher SG&A.  Our forecast for the year is $1.42 in EPS above the Street’s $1.34E.


Is it super cheap at 6.2x EBITDA? No. But we still think that after the call, this will slowly but surely convert some of the perennial perma-FL-haters’ into viewing this as a story that can manage double digit EPS growth and can buy back 30% of the float within 3-years. That’s not half bad…  While not our favorite stock, it is one we think should keep working in 2H.


Here’s a look at some of the key modeling considerations for the quarter:


Sales: +5.8% on a +6.5% comp - This represents a 2-year acceleration of about 300bps. A few factors to bear in mind…

a)      First and foremost, this is a period during which the ‘new’ management team should really start to execute. We’ve had the closure of poor performing stores, and a big merchandise push by the likes of Nike. While Toning, however, is a concern vs. last year the trends at retail from a POS perspective have been encouraging. Higher sales and ASPs at a point where the space needed to ‘comp the comp.’

b)      In looking at the results of the performance footwear categories to which FL is over-indexed (i.e. Running, Basketball, Casual Athletic, and Cross-Training), 1Q results look encouraging up +10% on +5% growth last year.

c)       In addition, athletic apparel has been strong up +9% in Q1. With the category growing as a percent of sales, we expect it be an additional driver and likely recipient of another positive management callout similar to Q4.

d)      Also, keep in mind that FX should be a factor here. About 19% of store count, 17% of square footage, and 15% of sales originate outside the US. Given the dollar having tanked vs. last year, it nets out to be around 1-1.5% FX benefit on the top line. 

e)      According to our blended comp chart, sales are up +4.3%. As you may recall, this indicator has consistently tracked sales within a +/- 2-3% range and has been low by -2.2% and -3.8% respectively over the last two quarters – a +6.5% comp suggests its low by -2.2% in Q1. It’s important to note the change at NPD as well since Q4 with the weekly data now including the department and family channels, which understates the performance in athletic specialty. In fact, according to the monthly data set (see chart below) athletic specialty (+6.9%) outperformed both dept (-6%) and family (-4.2%) channels significantly through the first two months of the quarter suggesting further upside to the +4.3% blended comp providing added cushion and confidence in our +6.5% comp estimate.


GM: +85bp

Even though ASPs have been hanging in there, we cannot ignore the interim hit at Nike last quarter and in its May quarter. That pain will be shared. But the reality is that with a +6.5% comp, the occupancy leverage combined with better merchandise margins here is meaningful. We expect the later to be the primary driver of gross margins in the quarter driven primarily by further improvements in mix and more modest promotional activity due to both higher ASPs and inventories that remain in check and continue to grow at a rate below management’s target of 50% of sales.


SG&A: +2%

Management suggested that Q1 would come in below full-year SG&A growth expectations of +1-2%, Given the strength in the dollar, we’ll assume the higher end of the range.


FL: We Think They'll Beat on Comps - 1


FL: We Think They'll Beat on Comps - 2


FL: We Think They'll Beat on Comps - 3


FL: We Think They'll Beat on Comps - 4


FL: We Think They'll Beat on Comps - 5

Chinese Bull Riding

Conclusion:  We remain bullish on Chinese equities as the bulk of Chinese and global economic data continues to come in in-line with our estimates. In the note below, we expand our comments from the Early Look today and dig deeper into our investment theme, Year of the Chinese Bull.


Position: Sold our Chinese equity exposure (CAF) on 5/10 due to it being immediate-term TRADE overbought; looking to buy it back on sale. Long the Chinese yuan (CYB).


Inclusive of today’s +1% move, Chinese equities are down -6.1% since reaching a cyclical peak on April 18. While we are not currently long China, as we booked a gain in the Virtual Portfolio on our long CAF position on 5/10, we’d much rather have the Chinese equity market validate our research by outperforming and continue to believe that over the course of 2011 it will do so.


Obviously, though, markets never do exactly what they are supposed to do – irrespective of our modeling outputs, forecasts, and analysis of sentiment. “Markets wait for no one”, Keith likes to say. As such, we thought we’d take the opportunity to highlight one of, if not the most, important skills risk managers must possess in these highly volatile times – the ability to separate the IDEA (research output) from the INVESTMENT (the price you pay to express the research output). Being married to an idea at every price is among the greatest mistakes many investors make; as such, timing and price remain the dominant factors in our models.


We like Chinese equities on the long side. That’s our IDEA, which is being driven by a muti-factor thesis that is best summed up as follows:


1. Chinese growth, while slowing, is slowing at a decelerating rate. In our models, the bottoming of the economic cycle is equally as bullish as the topping process is bearish.


As we called for at the beginning of 2010 via our Chinese Ox in a Box thesis, the rate of China’s YoY GDP growth has slowed from +11.9% in 1Q10 to +9.8% in 4Q10, marking a -210bps slowdown. Even with adopting our model’s most bearish scenario, we see Chinese GDP slowing at only three-quarters of that rate. Within our models, the bottoming of growth rates is a key indicator to increase long exposure to certain economies – a factor which gave us conviction to get long US equities in early March ’09.


2. On a relative basis, Chinese growth rates will widen vs. the rest of the world, creating the illusion of incremental value to growth investors – value we think the market will pay a higher premium for.


From 4Q10 to 1Q11, Chinese YoY GDP growth slowed -10bps. The rate of US YoY GDP growth, on the other hand, slowed by a factor of 5x that of China’s. We’ve been appropriately bearish on US economic growth since the start of the year and we see the current trend of weak domestic growth data continuing over the intermediate term at a magnitude that exceeds China’s own slowdown. Moreover, the US is not alone in this regard – we maintain that growth in the EU, Japan, Brazil, India, and other key emerging markets will slow at a rate greater than China’s over the intermediate term. As China prepares to exit the economic “penalty box”, the large majority of the world’s economies are on their way in.


3. Valuation is supportive; relative to their own historic ranges, Chinese equities are truly cheap.


The last time Chinese growth was accelerating on a relative basis to the rest of the world (2009), the Shanghai Composite peaked at 26x NTM Earnings. Today, they closed at roughly half that (13.2x). While we certainly aren’t making the call that they are going to return to the “bubbly” valuations of 2007 (38x), we do see upside here from a valuation perspective, although valuation is never a catalyst.


4. Mean reversion (to the upside) remains a supportive factor in our quantitative models when factoring in last year’s weakness (down -14.3% in 2010).


The Shanghai Composite finished 2010 down -14.3% and at one point was down -27.9% intra-year. We continue to flag mean reversion as supportive here, as the bear case (slowing growth, accelerating inflation, rate hikes, etc.) continues its transition from “on the horizon” to “in the rear view mirror”. Accordingly, in the latest Bloomberg Global Investor Poll Survey, the percentage of respondents identifying China as the “Market Offering Investors the Worst Opportunity Over the Next Year” dropped -400bps to 16% from January to May. As the bear case becomes fully priced in, we expect this trend to continue in our favor.


5. The net result of the PBOC’s proactive tightening is that we’re very likely to see Chinese domestic inflation peak in the very near term and begin an elongated trend of deceleration, which would alleviate market fears for further tightening.


In line with our forecast, Chinese CPI and PPI slowed in April to +5.3% YoY and +6.8% YoY respectively. In our recent work on China, we have been calling for the start of an elongated down-trend in Chinese reported inflation. As a result, we continue to maintain our view that China is near the end of the tightening cycle, with any additional measures likely coming in the form of less-malignant reserve requirement hikes and currency appreciation.


To the latter point, the PBOC increased reserve requirements yesterday +50bps – the fifth such measure YTD (vs. only two rate hikes). Meanwhile, the Chinese yuan continues to trade within 10-20bps of its all-time high (CNYUSD) and we see the uptrend continuing over the intermediate and long term. If China’s April trade balance shows us anything ($11.4B vs. $3.2B consensus), it’s that Chinese exporters are perhaps more resilient than consensus and/or the Chinese government believes. As such, we should continue to see additional yuan appreciation as the government gets increasingly comfortable with its impact (or lack thereof) on the Chinese economy.


Chinese Bull Riding - 1


Net-net, recent action in China’s interest rate swaps market (lower-highs), its interbank loan market (lower-highs), and its currency forwards market (higher-highs) is supportive of our view that the pace of Chinese rate hikes has slowed dramatically and that vast majority additional tightening will be expressed via the currency market and reserve requirement ratios.


Chinese Bull Riding - 2


From an INVESTMENT perspective, the data is supportive of us remaining bullish on Chinese equities and we will continue to manage risk around this exposure. With this summer’s Global Macro backdrop shaping up to be particularly ominous, we will likely continue to keep this and many of our other long ideas on a short leash.


Darius Dale



Some of it was hold related, but Wynn stole the show in Q1.



As we all know, Wynn Las Vegas/Encore had a great quarter even when normalizing the high hold.  The following chart shows Wynn’s big jump in EBITDA share among the big four Las Vegas operators:  WYNN, LVS, MGM, and Caesar’s.  MGM’s share, including half of Aria, held steady from Q4, although 40% is disappointing relative to previous quarters.  LVS’s new promotional strategy does not appear to be paying off as it saw its EBITDA share drop 400bps to 10% in Q4.  Yes, low table game hold % hurt EBITDA but slot hold % was unusually high and table and slot volume still fell 13% and 36%, respectively.




While we don’t have RevPAR data from Caesar’s, the following chart analyzes the relative quarterly RevPAR of MGM, Wynn Las Vegas/Encore, and Venetian/Palazzo.  Relative RevPAR has been remarkably stable over the past few quarters.  The only noticeable call out is the 6% and 5% fall off of LVS from its Q1 2010 peak the last 2 quarters.




In LVS’s defense, their RevPAR has been more volatile than the other 3 big Vegas Strip operators as can be seen in the following YoY RevPAR change chart.  However, the company’s big Q1 lag as even MGM moved significantly into positive territory is disconcerting and once again brings their promotional strategy into question.



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