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DKS: Shorting for a TRADE


Keith re-shorted DKS in the Hedgeye virtual portfolio today with the stock back up at its TRADE line of $37.99. Our thesis remains unchanged. While we don’t think the fundamental story is broken, we continue to be concerned near-term with the Street above management’s guidance for the quarter implying a sequential acceleration in business.


DKS: Shorting for a TRADE - DKS VP 6 23 11



R3: Get High




June 23, 2011








There’s No Such Thing As Bad Publicity? Maybe Not...


I wonder if Boston Mayor Thomas Menino realizes that he’s really elevating Nike’s marketing message rather than dousing the flame by his recent demand that Nike removes its ‘Get High’ and ‘F#%@ Gravity’-shirts from the store window at the Back Bay Niketown. This smells a bit like the launch of Nike’s ‘Just Do It’ campaign.  Most notably, the campaign focuses on the action sports consumer – surf, skate, and xtreme sports. Expect to hear a LOT about that at Nike’s analyst day on Tuesday.


R3: Get High - R3 2 6 23 11


Just as soon as we think that there’s no such thing as bad publicity, we see the picture below from our pals in the Great White North.  Probably not how LULU wants its brand advertised.


R3: Get High - R3 6 23 11




Li & Fung Buys Loyaltex Apparel, British Beauty Co. - Hong Kong-based sourcing giant Li & Fung Limited said Wednesday it has made a series of acquisitions including Loyaltex Apparel and British beauty company Collection 2000. Li & Fung, which has been embarking on a shopping spree over the past couple years, also said it has bought Thailand-based furniture company Exim Designs and TVMania, a European supplier of character-braded apparel with a license portfolio including Hello Kitty, Mickey Mouse, Barbie and Sponge Bob. Li & Fung reiterated that it has acquired Hampshire Designers, the women's division of Hampshire Group Limited in the United States. That deal was originally announced last month. Li & Fung said the turnover and pre-tax profit of the five acquired companies were about $660 million and $80 million respectively for the last year. <WWD>

Hedgeye Retail’s Take:  Think about it…this company has sales of about US$12bn. That’s predominantly at what we know as the COGS line over here.  You want to know what the boggest apparel company in the world is? Look no further.


Skechers Forms Branded Virtual Goods Partnership - Virtual Greats announced they will partner with Skechers to produce and distribute branded virtual goods in various online social media destinations. As one of the leading virtual goods sales and distribution agency, Virtual Greats has already secured distribution for Skechers' branded virtual goods with Meez.com and WeeWorld, two top social media sites for teens and women.A range of both Skechers Women's and Men's shoes from the 2011 collection, currently available in stores, will be offered in the online branded boutiques. While this first set of branded virtual goods will be fashion-based, plans for future Skechers-branded releases include enhanced avatar performance and fitness levels within the social gaming world, based on Skechers' fitness products. WeeWorld launched select Skechers assets at the end of May 2011, while Skechers-branded products premiered in Meez.com boutiques this month. <SportsOneSource>

Hedgeye Retail’s Take:  Tread lightly here. First fix the core problems, then worry about doing high-end limited distribution (and unprofitable) product. There will be a time to buy SKX. But simply not now.


New Fashion Push in Kmart Campaign - Kmart’s new soft goods advertising campaign has a tall order to fulfill: give the beleaguered retailer’s fashion and home businesses a new image that’s at once authentic and aspirational. Minneapolis-based ad agency Peterson Milla Hooks created a campaign that gives Kmart a new logo, new message and new vibe. “We felt [PMH] understood style and fashion and were creative out-of-the-box thinkers,” said Tara Poseley, senior vice president and president of Kmart apparel at Sears Holdings Corp. “We want to get out the message that we have amazing fashion.” PMH helped Target put the aspirational into its apparel, but Poseley claimed she wasn’t aware of the connection until after PMH was selected by Kmart. Clearly, Kmart is after the same effect. “We do want this be aspirational,” Poseley said. “That’s part of getting people to come into Kmart.”  <WWD>

Hedgeye Retail’s Take:  This is going to sound like a very arrogant statement, so excuse me. But Can you think of a more challenging job than being the head of apparel at K-Mart? “…we have amazing fashion…We want to be aspirational.” Yeah, and I (McGough) want to be in the starting lineup for the Miami Heat, but it’s not gonna happen.”


Retailers Upbeat on Fall Sales Outlook - It’s shaping up to be a good fall for men’s wear. After a strong holiday and spring, where men’s apparel sales outpaced other categories, Father’s Day provided another solid boost to business, buoying the spirits of retailers as they approach the start of the all-important fall and holiday selling period. Many merchants posted double-digit gains for the period, with casual sportswear items such as knit shirts, lightweight sweaters and shorts leading the way. Interestingly, many stores also saw strong sales of tailored clothing — proof that men are out there shopping for themselves. According to the National Retail Federation’s Consumer Intentions and Actions Father’s Day survey, conducted by BIGresearch, Americans were expected to spend an average of $106.49 on Dad, up from $94.32 last year and the most in the survey’s eight-year history. Total Father’s Day spending was expected to reach $11.1 billion. “Shoppers seem to be more excited when it comes to gift giving, an encouraging sign for retailers — and dads – everywhere,” said Matthew Shay, president and chief executive officer of the NRF. <WWD>

Hedgeye Retail’s Take:  Can’t really explain this one, other than to say that as punitive as we be about the spending habits of the American Consumer, they rarely sacrifice much in the gift-giving arena. It’s the incremental ‘purchase for me’ that is the make-or-break. Also, how in the world retailers could be upbeat on Fall sales outlook based on Father’s day is beyond me.


Zegna Adds Dimension to Shopping Experience - Why should e-boutiques offer a flat perspective on shopping?Virtually replicating in 3-D a two-story brick-and-mortar Ermenegildo Zegna store, with rooms to wander through and steps to mount, the Zegna in_STORE 3-D digital portal — which goes live tonight — is anything but. Developed with Hollywood-based visual-effects specialist James Lima, who consulted on the 3-D blockbuster “Avatar,” the Zegna e-store offers visitors a real-life spatial, visual and experiential shopping experience using immersive 3-D technology. Computer graphics in three dimensions were used to make the store look photo-real, with the same furnishings as in the brick-and-mortar Ermenegildo Zegna stores. The free Zegna in_STORE application will launch on iTunes and on Zegna’s Web site and Facebook page. It’s geared to iPads and iPhones, and other versions are due to be added in the coming months. <WWD>

Hedgeye Retail’s Take:  This is similar to Ralph Lauren’s ‘4-D’ reopening of the NY Flagship (with the fourth dimension being smell). Zegna sounds like it’s going even more Hollywood.




Transitory Oil Supply

Conclusion: History suggests that releases from the SPR lead to lower crude prices over the next three months.  Longer term, the potential disruption of marginal production will be supportive of higher prices.

To say we were surprised by the decision of the International Energy Association today to release oil from the Strategic Petroleum Reserve is an understatement.  In aggregate, the United States and 27 allies will release 60 million barrels.   The total releases by geography will be the U.S. at 30 million barrels, Europe at 15 million barrels, and Japan, Australia, New Zealand, and South Korea at 5 million barrels.


Ostensibly, the rationale of this release is to offset the disruption from Libya, which has reduced Libya oil production from 1.58 million barrels per day to 100,000 barrels per day as of May.  The 60 million barrels will offset the disrupted production from Libya for an estimated 40 days.  So, to borrow from Chairman Bernanke, this is only a "transitory" increase in supply.


Nonetheless, history suggests that a release from the SPR has been a catalyst for lower prices in the future.  The U.S. has released reserves from the SPR twice before, both times were bearish for crude prices – in 1991 during the Gulf War and in 2005 after Hurricane Katrina.  In both instances, crude moved lower on both the TRADE (3 weeks) and TREND (3 months or more) durations.  The two charts below highlight this point.


Transitory Oil Supply - oil3


Transitory Oil Supply - oil4


Longer term, though, the impact is probably less bullish for oil prices.  On a simple level, lower oil prices discourage marginal production.  In an increasingly energy-short world, this is not positive for supply in the long run.   As our Energy Team recently noted:


“Since 1965 global oil production has grown at 2.1% while crude consumption has grown 2.8%, and that gap is widening; currently, neither OPEC nor Non-OECD nations have the spare capacity to satisfy the developing world’s growing appetite for energy. Within the last ten years, non-OECD oil consumption has grown nearly ~4%, while over the same duration global oil production has grown less than ~1%. In short, artificially manipulating prices eventually leads to supply dislocations and that in the long-run fuels higher prices in the physical markets.”


Our long-term of view of an imbalance in the global oil market has not changed, but in the short term this release from the SPR could well be a catalyst for lower prices.  Our TAIL support line is currently at $89.76, if oil breaks that price sustainably, we would expect another leg down in the price of oil.  Prices are reflexive, afterall.


Transitory Oil Supply - oil dj


Daryl G. Jones

Managing Director

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If VIP can just hold steady in the face of the China tightening, even the back half of 2011 will show significant growth.



After an astonishing growth rate of 58% in 2010, who would’ve thought Macau would be on track for 43% growth in 2011?  Not anyone who is being honest.  Maybe even more impressive is that 2H could grow almost as much as 1H, 41% vs 44%, despite tougher comparisons.


Could growth be more?  Certainly.  In fact, our 43% growth projection only assumes flat volume levels, seasonally adjusted, going forward from May/June.  In other words, we are not assuming any sequential growth.


Could growth slow?  Again, certainly.  As we wrote about in our 05/22/11 note “A VIP SLOWDOWN IN THE CARDS?”, VIP volumes could slow this summer due to the lagging relationship to China tightening.  We haven’t seen that yet as June volumes appear to be in line with May after the normal seasonal adjustment.  We will be watching the weekly data closely for any indication of a slowdown.


MPEL remains the best way to play Macau in our opinion.  With its valuation discount and low expectations and EBITDA estimates, the positive catalysts could have a big impact on the stock.  Some of these catalysts include progress on Macau Studio City, additional junkets at City of Dreams, a huge Q2 beat, and a smaller than expected impact from Galaxy Macau going forward.



Russia from 30,000 ft

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


Sizing up Russia is never an easy task. Political risk runs high, its banking industry is largely opaque, and the country’s outsized leverage to the price of commodities makes its economy sensitive to price cycles.


Of the fundamental risks to the economy, below we highlight rising inflation, mixed fundamentals, a downside price target on oil, declining oil production, rising tariffs that shun foreign investment, and over the longer term TAIL a declining population, judicial challenges, and the struggle to transform the economy beyond its leverage to commodities. In the past, we’ve recommended playing Russia via the etf RSX, which is overweight Energy (40%), Basic Materials (27%) and Financial Services (13%).


Our models suggest that Russia’s equity index (the RTSI) is broken on immediate term TRADE and intermediate term TREND durations (see chart below).


Russia from 30,000 ft - Russia RTSI


Based on the IMF, Russia has a growth profile of 4.8% this year and 4.5% next year and a budget deficit of 1% of GDP this year. However, stripping out oil and gas revenues, the deficit would be as high as 11% of GDP, which owes to Russia’s reliance on oil revenues to balance its budget and therefore increases its vulnerability to external shocks, namely the price of oil. It’s worth noting that the IMF forecasts are based on an average price for Russia’s crude blend Urals, the country’s main export blend, at $104 per barrel in 2011 and $103 in 2012. Given our bullish stance on the USD and our longer term downside level on oil (WTI) to $89, a sustained pullback in oil could bring Russia short of its forecasts.




Pressing Inflation


The real pressing threat in Russia remains its exceptionally high inflation rate. Inflation, as measured by the CPI, recorded 9.6% in MAY Y/Y, with food stuffs and other agricultural goods leading the upward charge. These prices, particularly on a year-over-year basis, have been significantly influenced by the severe drought in Russia last summer that affected the harvest of key food staples, like potatoes and grains. Domestic food price inflation coupled with the spill-over of global price inflation from its import partners to make up for lost yields have only further stoked prices.  Also, given that the consumer weight of foodstuffs in Russia’s CPI basket (similar to the other BRICs) is higher than for developed economies, like the US, inflation figures appear even loftier in comparison. 


Producer Prices, the input costs that typically drive up Consumer Prices, have remained elevated, at 19.2% in MAY Y/Y, off slightly from 20.2% in the previous month.


While Russia is poised to lift its grain export ban July 1st and the Central Bank has stated that it does not expect rising prices as more producers export more grain than they sell at the local market, it’s another risk worth considering.


The Russian Central Bank has hiked the main refinancing rate twice year-to-date (in February and May), currently at 8.25%, to stave off inflation. The Bank continues to state that as the year progresses inflation should fall to the Bank’s official target of 6% to 7%, but it has shown little indication on the timing of a hike. 



Mixed Fundamentals


Of the positive releases in recent high frequency data, MAY showed that the Unemployment Rate fell to 6.4% versus 7.2% in APR. and Retail Sales gained a healthy 5.5% Y/Y. Domestic investment in Russian business surged 7.4% in MAY Y/Y versus 2.2% in APR yet disposable income fell -7% and real wages increased only 2.6%, a signal that inflation is squeezing the consumer and wage inflation is not keeping up with the headline figures.


The most forward-looking indicators of PMI Services and Manufacturing showed that Services have held up well each month year-to-date, with the most current reading at 57.6 in MAY vs 55.8 in APR. In contrast to Manufacturing, we expect the more domestic-oriented Services to hold up in the coming months. Manufacturing, on the other hand, may continue to tail off as the important export market of Europe remains mired in sovereign debt contagion. PMI Manufacturing fell to 50.7 in MAY vs 52.1 in APR and has trended down ytd, teetering just above the 50 line, separating expansion (above 50) from contraction (below).



The Mighty Petrodollar and the “One-Trick Pony”


One major concern to monitor in Russia is the so-called oil curse of oil-rich countries. While Russia should have learned its lesson from 2008-9, governments of oil-rich countries have a disposition to issue unjustified government expenditures (and therefore lower budget discipline) when oil prices are elevated due to optimism over the additional revenues from oil profits. Russia’s Finance Minister Alexei Kudrin has said that the “government expects the budget to remain in deficit through 2014 based on an average price for Urals crude oil of $75 this year and $78 in 2012. Russia may balance its budget this year if oil averages about $115 a barrel, or more than 50 percent above the government’s target price.”


As a point of reference, oil and gas exports accounted for roughly two-thirds of all Russian exports by value, with oil and gas revenue contributing ~1/3 of general government revenue. Further, reviewing estimates on the marginal tax rate on petroleum, the government pulls in an average of 90 cents on every dollar of exported crude selling above $25/barrel. [Note: under $25 the government also receives its share, albeit a proportionally smaller one on a tiered basis].


It’s Russia’s leverage to energy in particular that has lent our naming of the country a “one-trick pony.” In short, the chart below shows the tight correlations between the price of a barrel of oil, foreign direct investment in Russia, the RUB-USD, and GDP over the last 10 years. Over one year we see a correlation between RTSI and Urals Crude of 0.95 and between RUB-USD and Urals Crude of 0.91! So watch out as the USD strengthens against the RUB and oil falls! 


Russia from 30,000 ft - Russia Mixed



Given that we’re making a bullish call on the USD over the intermediate term, which should cool oil price appreciation, we’d expect to see even less foreign direct investment, and decreased oil revenues, and lower growth—all cause for concern on Russia’s economic outlook. 



Oil Constraints and Government Intervention


Over the last 12 months there has been much talk from President Dmitry Medvedev about diversifying the country away from its sole leverage to energy. Implicit with the goal is his understanding that the country is 1.) bumping against its outer bound of oil production, and 2.) that being solely reliant on energy leaves the country in a  vulnerable position to external disruptions.


To the first point, it’s worth noting that Russia A.) doesn’t have spare oil production capacity, and B.) the government has announced that it expects Russian domestic oil production to remain flat at roughly 10 MM bbl per year through 2020. Attaining production levels will be challenging as higher crude prices trigger higher oil export tariff rates which discourage foreign investment in Russia’s oil and gas sector that is essential for the country’s future exploration projects. Additionally, state limitations on foreign ownership rights in Russia’s oil and gas sector, lack of financial transparency and minority shareholder rights make investment in Russia a high risk venture.


Other Key Points To Consider, from our Energy Team:  

  • Export Tax: Russia has a punitive export tax levy upon domestic producers that seriously impairs operating cash flow to fund development investment.
  • Significant Spending: Flat production at 10 MMb/d will require capital spending of roughly $280 billion from 2010 to 2020.
  • Mature Fields High Depletion Rate: Traditional production areas, such as Western Siberia, are nearly 60% depleted, with high decline rates and high water cuts, requiring significant investment for secondary recovery efforts to maintain current production levels.
  • Capital Constrained: Russian companies relative to western peers have low dividend yields and low internal cash flow generation.

Russia from 30,000 ft - russia production 1


Russia from 30,000 ft - russia production


Recent Headlines on additional Energy levies

  • Russian government plans to increase tax burden on the country’s gas sector over the next three years, impacting Gazprom in particular. The tax burden on the industry will increase by 150 Billion Ruble ($5.4 billion) in 2012, by another 170 Billion RUB in 2013, and by another 185 Billion RUB by 2014 (from Platts, June 3, 2011). 


To the second point, there’s little evidence that private consumption can offset the loss of foreign investment. On a slight tangent, we’d also question grouping Russia in with the rest of the BRICs, for unlike the others, Russia shows no clear prospects for a domestic growth story, especially considering its declining population (more below) and lesser growth profile over the next couple of years so long as energy costs retreat from abnormal highs witnessed in the earlier part of the year.



Longer Term Headwinds


As mentioned above, Medvedev has called for the country to transition away from its sole reliance on energy to grow the economy, however it’s important to stress that this will neither be an easy nor quick process. In late March of this year Medvedev unveiled a 10-point program to make the nation more attractive to investors. The measures included removing senior officials from the boards of state companies they oversee, approving a state-asset sale program for the next three years and proposing a law on minority shareholders’ right to information.


In mid June Medvedev further unveiled at the St. Petersburg annual economic forum a $10 billion sovereign fund to stimulate domestic private equity and indicated plans for a $30 billion asset sale program to help lure investors and revive investment interest in the country. One asset considered for this program is OAO Sberbank, the country’s largest lender, in a transaction worth as much as $7 billion, while the government also asked Morgan Stanley, JPMorgan and Deutsche Bank to manage an IPO of OAO Sovcomflot, Russia’s biggest shipper.


At the core is Medvedev’s understanding that foreign capital is fleeing Russia based on the country’s reputation for government and business corruption. Russia is estimated to have total net outflows of $30 billion to $35 billion for 2011, roughly equal to the $35.3 billion of capital that left last year, according to the Central Bank. Countering this force is obviously critical, however our position is that short of oil reaching levels seen over the summer of 2008, we won’t see investors barreling into Russian investments.


A further consideration when sizing up Russia on the tail are the headwinds facing the country based on its grim demographic outlook.  The World Bank reported that by the end of 2009, 17.4% of the population (24.6 Million) will live beneath the subsistence level of $185 per month, about 5% more than before the global recession. The Economy Ministry said Russia’s working population will annually decrease by ~1 Million every year over the next three years, and the population has been in decline over the last 14 years, falling to 141.0 Million in 2010.





As inflation remains elevated, and the price of oil is squeezed with a rising US Dollar, we’re cautious on Russia’s investment outlook as the country is highly dependent on oil prices to generate revenue (and therefore balance the budget) and grow the economy. Longer term, the country will attempt to diversify economic growth, but this process will take many years and frankly we have our doubts on its success—changing a culture of corruption is after all a long road.


One of the largest threats is the flight of foreign investment over recent years.  The biggest impediment to foreign investment in Russia is its lack of a strong “judicial” system of judicial recourse not just for Russian domestics, but critically for foreign rights – shareholders providing foreign capital inflows. On this front we’re unlikely to see much (if any) near term change.


Further, Russia is in direct competition with other BRIC nations for foreign investment, so what is its competitive edge – the advantage that will prompt foreign investors to choose Russia over say China or Brazil that have more upside potential due to their more diversified economies.


Finally, demographic headwinds, forces not facing the other BRICs, play against Russia, and will force the need for more foreign investment and stronger ties with China, factors which Russia may not easily or directly be able to control.


In aggregate, these factors leave us cautious on Russia.


Matthew Hedrick



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




U.S. corn futures tumbled to the one-day limit on losses Wednesday and wheat futures fell more than 4% as concerns over low supplies eased.


According to the Financial Times, Google Executive Chairman Eric Schmidt is bullish on the growth of mobile payments in the coming year; he believes one-third of all restaurants and retail outlets will allow for mobile payments within the next year.




  • SONC reported solid 3QFY11 earnings after the close yesterday but, given that May and June saw slower trends, the momentum is unlikely to be quite as strong in this current fiscal quarter. 
  • Lavazza CEO Antonio Baravalle said that it is “premature” to say that the company will raise its stake in Green Mountain Coffee Roasters from 6%.  Lavazza will consider acquisitions in markets where it doesn’t already operate, including China.
  • JACK management sees potential for 2,000 stores in the U.S.
  • CMG announced yesterday that it is increasing its use of local produce.
  • DPZ - Domino's Pizza Enterprises Ltd is fast becoming one of Australia's top e-commerce companies with more than $1million in mobile sales recorded in one week. This milestone comes just one week after the official launch of Domino's Mobile Ordering Site which can be used to order pizza from any internet enabled mobile device. Domino's CEO Don Meij said topping the $1million in sales milestone in such as short space of time was an incredible achievement. - Foodservice.com
  • McDonald’s Corp.’s planned sale of its business in South Africa to Cyril Ramaphosa’s Shanduka Group is at risk because the suspension of part of a tax law in the country may lead to lenders withdrawing funds, Business Day reported, citing Shanduka spokeswoman Maureen Mphatsoe.





  • EAT - TableTop Media has signed a multi-year contract with ERJ Dining, LLC. and completed the first phase of deployment for its Ziosk touchscreen devices to 30 Chili’s locations in St. Louis, Chicago and Central Illinois.

  • CAKE’s Rock’s Sugar employees are being sued for sexual harassment 



TALES OF THE TAPE - stocks 623


Howard Penney

Managing Director

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