Still Bearish on Brazil

Conclusion: On an intermediate-term TREND basis, the tight grip of Stagflation continues to choke the Brazilian economy. Furthermore, we see Stagflation as a real risk to Brazil over the long-term TAIL.


Over the last few weeks we’ve been relatively quiet on Brazil, largely due to the data playing out in spades according to our expectations. Growth continues to slow and inflation continues to accelerate, which, in turn, incrementally slows growth.


As you may know, we prefer to analyze slopes rather than absolute values, believing that the 1st and 2nd derivatives of growth rates are often the best leading indicators for the absolute levels of future growth. On a marginal basis, economic conditions continue to deteriorate and we see little signs of reprieve on the horizon. With the Bovespa down over 8% YTD, it’s pretty clear to our Hedgeyes that Stagflation isn’t good for earnings growth in Brazil, nor the multiple the market is willing to pay for said earnings:


Still Bearish on Brazil - 1


While certainly a lagging data point, Brazil’s 1Q GDP report showed that YoY Household Consumption growth slowed -160bps to +5.9%. On a QoQ basis, Household Consumption growth slowed to +0.6% vs. a prior reading of +2.4% in 4Q10 – indicative of the measured slowdown in Private Consumption we had been calling for since November. Furthermore, our proprietary Brazil Consumer Misery Index suggests further downside to consumer spending trends is likely on the horizon:


Still Bearish on Brazil - 2


All told, though consensus estimates for Brazil’s 2011 GDP have come down alongside the government’s forecasts in recent months, we still see further downside to current projections. To the latter point specifically, the Finance Ministry late last month cut their 2011 GDP projection -50bps to +4.5% YoY, as well as increased their 2011 CPI forecast +60bps to +5.6% YoY. Further, the board reduced its 2012 GDP estimate by -50bps to +5% YoY, as well as its 2011-14 GDP projections to +5.1% YoY per annum vs. a previous forecast of +5.9%.


Whether or not this is function of the Brazilian government seeing what we see (the strong possibility that structural inflation takes hold in Brazil) remains to be seen. Time and more data will tell in that regard. For now, we remain bears on real-denominated debt as it becomes increasingly likely that the central government misses it’s deficit reduction target in the current fiscal year due to lower-than-anticipated tax receipts driven by slowing growth. Sovereigns can and do “miss” the numbers (see: Greece, Ireland, Portugal, US, etc.). In April, the Central Government’s Budget Balance missed expectations by 600M reals ($380M). We don’t see that as a one-off event.


While up measurably on a YTD basis, as well as since when we turned bullish on them in early November, Brazilian bond yields have been trending down of late, but that’s likely due to the fact that rate hike expectations are coming out of Brazil’s bond market as growth slows. That’s a dangerous place to be as an investor – buying/selling what you can vs. what you should. Specifically, two idiosyncratic mechanisms regarding Brazilian CPI and wages have us worried regarding the slope of Brazilian CPI for the long-term TAIL: 

  1. Price increases for Services (24.1% of the benchmark IPCA CPI) are automatically increased as a result of indexation, a process whereby past inflation is used as a benchmark for raising prices; and
  2. Brazil’s minimum wage (currently at 545 reais) is reset based on the previous year’s CPI plus the GDP growth rate two years prior. In 2012, that formula is likely to produce a gain of over +13%. The level of many key payments throughout Brazil – including government pension payments – are determined based on the minimum wage. 

Obviously, it’s too early to tell whether or not structural inflation once again takes hold of the Brazilian economy. It is, however, a situation we will continue to monitor closely – especially given the fact that the central bank has been very reactive in nature, rather than proactively quashing inflation in a prudent manner (recall that we highlighted this as a major risk to being long Brazilian equities back in November). If our hunches on the slope of long-term inflation in Brazil prove accurate, both Brazilian equities and real-denominated debt will become less attractive, on the margin, from a long-term perspective.


Stay tuned.


Darius Dale



Still Bearish on Brazil - 3


It may not last but ASCA seems to be bucking the negative economic data and should put up a blow out Q2.



ASCA looks interesting with the recent pullback.  We still think Q2 will be a blowout.  In the meantime, May state gaming revenues will be released starting later this week and we suspect they will generally surprise on the upside – similar to April – especially for ASCA.  Combined with April’s strength, May should provide confirmation of ASCA's terrific near-term earnings outlook.  We are currently at $0.52 versus the Street at $0.44 and our number is looking too low.  We believe analysts will be forced to raise estimates and there is still a lot of room for ratings upgrades. 


The following chart shows how our estimates match up against the Street’s:


ASCA: WHAT BAD ECONOMY? - asca final


State Gaming Revenues

We remain concerned about the macro picture in general but so far in Q2, ASCA has seen no impact.  One possible explanation for the recent strength could be the high grain prices which may be helping some of the Midwestern economies.  Of course, with significant operations in Iowa and Missouri, ASCA’s customers are certainly tied to farming.  Iowa, Missouri, and Indiana could all report May revenues this week, which represents 70% of the company’s property level EBITDA.



Expansion of gaming in Illinois is a real possibility and that would hurt ASCA’s East Chicago casino.  However, even if a bill is signed into law, the impact wouldn’t be felt for 3 years or so.  For ASCA, East Chicago is the least significant operation behind only Jackpot and supplies only about 12% of the company’s property level EBITDA.


Stock Trading Update

Keith bought ASCA in the Hedgeye virtual portfolio today.  He sees short-term upside to $22.19 and intermediate-term support at $19.24.



R3: AMZN, WMT, Hilfiger, RL



June  06, 2011






  • In a move that is likely to impact deal supply for daily-deal service providers like Groupon, Amazon announced Friday that it is launching AmazonLocal. The #1 e-retailer is leveraging its investment in LivingSocial to help source deals in local markets. The reality is that it won’t be long before retailers realize that AMZN is in the daily-deal game and is likely to be perceived as more attractive by most given the size of the online retailers’ audience at 120million customers compared to Groupon’s 83million.
  • In a move consistent with RL’s efforts to reintroduce and reinvigorate its denim business with the launch of Denim & Supply, the company is converting its men’s and women’s collection stores on Bleecker Street in NYC to an RRL branded store. While the line is slated to be distributed primarily in premium department stores, with denim at the heart of the RRL concept, we might get a glimpse of the new line here when it launches this Fall.
  • Add TGT to the list of retailers shifting their sourcing base away from china. According to a recent briefing, a company Managing Director highlighted that TGT has recently set up a procurement division to look into more cost effective options in Bangladesh and India. While not the first company to look into these countries, it could be one of the largest.



Amazon Nears Tax Deal with South Carolina - South Carolina legislators, reversing an earlier decision by the state House of Representatives, have approved a deal with Inc. that grants the world’s largest online retailer a 5-year exemption from collecting sales tax on purchases by South Carolina residents. As part of the deal, Amazon has agreed to bring about 2,000 jobs to the state and invest at least $125 million in its planned distribution facilities by the end of 2013, according to a spokeswoman for the South Carolina Department of Revenue. The House this week voted 90-14 to approve the deal, following amendments to the agreement worked out by both the House and Senate. The matter is now before Gov. Nikki Healey, a Republican, who has said she personally opposes granting Amazon and other retailers special exceptions to sales tax collection but that she wouldn’t block the Legislature’s action so as not to break Amazon’s original agreement with the state. <InternetRetailer>

Hedgeye Retail’s Take: A 5-year amnesty from having to collect online sales tax in exchange for local employment guarantees can be viewed as a victory in AMZN’s ongoing battle with states over this issue. It’s still just a matter of time until AMZN will have to ultimately comply, but having to face that reality in five years instead of potentially less than one is considerably more favorable for the leading online retailer if this passes, which appears likely.


Wal-Mart Greets Holders With More Buybacks - Wal-Mart Stores Inc. sought to reassure investors Friday that its shares remain a compelling value despite two straight years of slumping U.S. sales by disclosing a new $15 billion share buyback plan. With Wal-Mart's shares stuck in a rut, the discount retailer has been returning more of its excess cash to shareholders by buying back shares. Last year, it acquired $13 billion of its shares. The purchases can increase per share profit by reducing total shares outstanding, a strategy employed by numerous retailers since the recession and generally embraced by analysts. Wal-Mart's annual meeting, hosted by actor Will Smith, above, drew 16,000 to Favetteville, Ark., on Friday.Beyond that, Wal-Mart divulged little new about how it is trying to right its wayward U.S. business during its annual shareholder meeting here. Before 16,000 investors and employees who packed the University of Arkansas basketball arena at the crack of dawn Friday, Wal-Mart executives accentuated the positive, touting the company's expanding international operations and resurgent Sam's Club warehouse club business. <WallstreetJournal>

Hedgeye Retail’s Take: No surprises here. The $15Bn repurchase authorization is the third of that size in as many years. With the company struggling to find catalysts to drive shares higher near-term, it is likely to remain focused on share repo and dividends to create value for shareholders.


Tommy Hilfiger Group Signs Deal With Marc Fisher Footwear - The Tommy Hilfiger Group has inked an exclusive licensing deal with Marc Fisher Footwear to produce the brand’s men’s and women’s shoes in the U.S. and Canada. “Marc Fisher Footwear has expertise in design and sourcing,” said Annie Marino, executive vice president of licensing at Tommy Hilfiger, which introduced footwear as a category in 1995 and has produced all shoes in-house since 2009. “In working with them, we are looking forward to furthering the development of our footwear business.” The first collections, which will be introduced at the August Fashion Footwear Association of New York trade show and roll out for spring, will include full ranges of men’s and women’s offerings with retail prices starting at $29 (every shoe is priced at less than $100). For women, styles include flip-flops, sneakers, sandals, pumps, wedges, boat shoes and ballerina flats. The women’s collection will be expanded into boots for the following season. For men, the assortment includes flip-flops, slip-on dress shoes and brogues, sneakers, boat shoes and lightweight boots. <WWD>

Hedgeye Retail’s Take: The PVH/M relationship gets another step closer with the line exclusively available only at Macy’s. A quick look at Hilfiger’s whopping 15 style footwear offering for women after nearly 20-years since launching the category and it becomes abundantly clear the brand is in need of some outside help to grow the category. The new line will also target a new customer altogether with ASPs as high as $300 and less than 30% priced below $100 currently.


Eurazeo Acquires 45 Percent Stake in Moncler - Moncler SpA has decided to pull the plug on its IPO. The hot Italian outerwear brand said it signed an agreement with Paris-based investment fund Eurazeo to sell a 45 percent stake for 418 million euros, or $611.5 million at current exchange rates, and postpone a listing on the Milan Stock Exchange, which had been planned to take place by the end of June. The transaction values the company at 1.2 billion euros, or $1.76 billion, representing a multiple of 12 times EBITDA last year. In a statement, Moncler said it believed the sale to Eurazeo was "the best way to pursue the growth of the group and enhance the value of its brands to enter the bourse in the future."  <WWD>

Hedgeye Retail’s Take: Buying the brand at 12x EBITDA after Carlyle  doubled its stakes in less than three years comes is not when PE firms typically step in as reflected by the fact that Eurazeo is said to be the only financial firm to hold discussions of a non-IPO alternative with the brand. While Eurazeo’s portfolio consists primarily of tech and business service related brands, the commonality here appears to be several businesses with large store footprints. This competency will prove useful given Moncler’s growth aspirations and where Eurazeo could add its value as it targets China and the U.S. near-term.


Strong Brands Win at Register - Labels with a strong brand message continue to draw consumers to the cash register. According to the 2011 Fashion Brand Index by Brand Keys Inc., 29 percent of U.S. apparel buyers gravitated toward brands with a distinct point of view when deciding what to buy. These include Ralph Lauren, Armani, Calvin Klein and Brooks Brothers, among others. “With every fashion option, from black T-shirts to the latest couture, brand meaning is increasingly a larger factor in the buying decision,” said Amy Shea, executive vice president of global brand development for the New York-based brand and customer loyalty research firm. “This fits with what we are seeing, not only in fashion, but across all the product/service categories we track. Those brands that actually stand for something are being sought out by consumers…when it comes time to decide which brand to buy.”  Seven years ago, fewer than 3 percent of apparel purchases felt fashion brands and logos were important, but that number jumped to 14 percent in 2009 and doubled, to 28 percent in 2010. This year, it has inched up to 29 percent. <WWD>

Hedgeye Retail’s Take: Contributing to this trend is the fact that many higher quality brands have stressed that they’d rather have to take up price than lower quality – something we’re starting to see from the more marginal players/brands in the market due to higher product costs.



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European Risk Monitor: Headline Risk Prevails

Positions in Europe: Long Germany (EWG); Short Spain (EWP)


Below we show our weekly European Risk Monitor charts that indicate more of the same trend: default risk across the European peripheral—especially in Greece, Ireland, and Portugal—is elevated to levels that defy historical examples, including a breakout above the 300bps line in CDS that has expediently led to default.


As we’ve been noting in our research, despite the inability of the PIIGS to see material improvement in their fiscal imbalances via austerity measures, the EU along with the IMF continue to subsidize country shortcomings, which portends some combination of additional bailout packages, more favorable debt terms, and support in the common currency over the intermediate term. We stress that Eurocrats will ultimately Extend & Pretend to insure the union of unequal countries remains intact. This includes sugar coating words like restructuring and kicking the debt can further down the road.


Given, we see intermediate term TREND support for the EUR-USD around $1.40, with immediate term TRADE line resistance up at $1.46.


Headline risk remains a governing (and volatile) factor across Europe. Over the weekend we got confirmation that Greece will receive its next loan tranche from the IMF, which is contributing to the EUR-USD swift upward move today. Additionally, news from Portugal that the opposition Social Democrats defeated the ruling Socialists under PM Jose Socrates is positive for the region and currency on the margin.


Matthew Hedrick



European Risk Monitor: Headline Risk Prevails - cds1


European Risk Monitor: Headline Risk Prevails - yields 2


European Financials CDS Monitor – Bank swaps in Europe were mixed to wider last week.  20 of the 38 swaps were wider and 18 tightened:


European Risk Monitor: Headline Risk Prevails - t1

European Risk Monitor: Headline Risk Prevails - t2

European Risk Monitor: Headline Risk Prevails - t3


Late Friday, Becker Drapkin Management LP and Carlson Capital LP formed a group holding 5.6% of RT, with the intention to nominate three people to the board of Directors.  Other that the wanting board representation, their strategy to create shareholder value was not made public.  RT put out a canned response saying the board and management "are committed to maximizing the long-term value of our company for the benefit of all of our shareholders and are always open to hearing the views and opinions of shareholders as to how the board and management can continue to create such value."


I had been thinking at $9.50 RT might be interesting again on the long side, but I did not have the catalyst to see what would get the stock going again.  As of Friday’s close, RT was trading at 5.6x EV/EBITDA, which represents great value, but without a catalyst it’s a value trap.  The question is this: do we now have a catalyst from which we can see some upside.


From where I sit, there are three key reasons why RT might be attracting some activist shareholders.

  1. Attractive real estate assets and the potential for G&A rationalization.
  2. The company recent sales trends have put into question management current strategy.
  3. The CEO of RT is a controversial figure in the industry.


THE REAL ESTATE - Of the 656 Company-owned and operated Ruby Tuesday restaurants as of June 1, 2010, RT owned the land and buildings for 48% or 320 restaurants, owned the buildings and held non-cancelable long-term land leases for 215 restaurants, and held non-cancelable leases covering land and buildings for 121 restaurants.  The company also owns its Restaurant Support Services Center in Maryville, Tennessee.  The potential value from the Real Estate could approach $5-$6 per share, but – as is often the case – the narrative likely makes for a better story than what the reality of monetizing the assets would be.


CURRENT SALES TRENDS - RT reported a decline of 1.2% in same-store sales for 3Q11, using the weather, the economy and higher gas as an excuse for the recent shortfall in sales.  As a result, 2-year trends decline by 220 bps in the quarter.  Clearly, the improvements in the trends at Chili’s and Applebee’s are having an impact on RT top line results.  The idea of trying to provide “an ultimate $25 high quality casual dining experience” for $15 is not resonating with consumer when Chili’s is

focused on selling lunch for $6. 


CREATING SHARHOLDER VALUE - Managements’ key strategy for increasing shareholder returns is through new concept conversions; converting low volume Ruby Tuesday restaurants to other high-quality casual dining concepts.  The strategy is to run the entire company on what's right for each individual market instead of being a strong regional brand.  As Sandy Beall said on the most recent conference call “it’s more of a roll-up or collection of communities in our company.”  I’m not sure the use of the term “roll up” is appropriate or one that conjures up a high quality strategy to create shareholder value.


I take this strategy to mean that management wants to make the Ruby Tuesday concept less competitive in the marketplace, with fewer units which mean less convenience for consumers and the concept’s share of marketing voice will be declining.  Essentially, management does not put a lot of value in the Brand Ruby Tuesday’s, so why should the investment community?  Put another way, if you are Chili’s or Applebee’s, you are thrilled that there will be fewer Ruby Tuesdays.  I understand the thought behind improving the productivity of the existing assets, but it’s hard to see how RT will build any scale with the current approach.


The other part of the company’s strategy to create value is through increasing revenue and EBITDA through franchise partner acquisitions.  Overall this has limited upside, due to the fact that market is not placing a very high multiple on the cash flows of the existing Ruby Tuesdays business so why increase you exposure to that business. 


I think the current group of activists share holders has an uphill battle from here although, depending on your broader market view, buying RT under $10 could yield some positive returns.  As you can see from the charts below, the biggest issues RT faces is the stiff competition coming from Chili’s and Applebee’s.  In a zero-sum game if the #1 and #2 brands are taking market share, a substantial piece of that probably coming from Ruby Tuesday’s. 


The rhetoric from the activist group will definitely put a floor on the stock around $10 and the bull case will anchor on how they are able to influence Sandy Beall and management’s strategy.  The upside may be limited, depending on how Sand Beall behaves following the press release on Friday.  My gut reaction tells me that he will put up a fight and does not want to be pushed around.  Sandy has controlled this company, and the board, for years so giving up some control will not be easy decision for him.  I would think that bringing some fresh thinking to the board will be good news rather than bad, but whether or not Sandy Beall agrees with me is the only thing that matters.







Howard Penney

Managing Director


Notable news items and price action from the restaurant space as well as our fundamental view on select names.

  • SBUX was raised to “Outperform” at BMO Capital Markets.  The price target is $45 per share.
  • THI has reached an agreement with former President and CEO Don Schroeder “with respect to his relationship with the company”.  Schroeder is assuming an advisory role.  Under the terms of the agreement, he will also receive C$7.5m severance.
  • WEN Chief Marketing Officer Ken Calwell, has been hired as president of Papa Murphy’s International, which operates the Vancouver, Washington-based take-and-bake pizza chain.
  • DRI, CBRL, RUTH, DIN and BJRI traded lower on accelerating volume.  In QSR, COSI, SBUX, and JACK also underperformed on accelerating volume.
  • Late Friday Becker Drapkin Management LP and Carlson Capital LP formed a group holding 5.6% of RT, with the intention to nominate three people to the board of Directors.  I will have a note on RT out shortly....



Howard Penney

Managing Director

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