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VFC: Love Child


This P&L is jacked up like the love child of Conseco and Bonds. The margin and capital deployment story over our TAIL duration is in the top 10% of retailers. But there are still a few near-term questions around our TREND duration that we need answered before getting involved.




This VFC model is simply humming. It feels so odd for us to say that. After all, VFC is a portfolio of brands, and therefore should – in theory – not be able to meaningfully outperform the space as a whole. But low and behold, the company puts up 15% top line growth, and takes up guidance by 56% more than the 2Q beat, which is a bold move in this environment, And that’s before accounting for the addition of Timberland late in 3Q once that acquisition is completed. Furthermore, VFC is one of the few companies this quarter to show a significantly positive SIGMA swing – whereby the sales/inventory spread is compressing at the same time margin compares are looking more favorable. This is core to our TREND duration (three months or more).


We took our model out to 2015 (our TAIL duration = 3-years or less), as we think it’s warranted given the timeframe needed to most appropriately assess the potential for value creation at TBL. In doing so, VFC is one of the few companies that we have accelerating its operating profit margins with disproportionately less capital. Yes, some of this is driven from optimizing what has been a pathetically inefficiently-managed Timberland. But in the end, numbers don’t care about rationale. They are what they are.


Then why are we not more constructive on TBL? We’re asking ourselves the same thing.  The crux of it is that we’re modeling slightly lower core earnings in the back half than VFC is guiding. In the end, we think that they’ll hit aggregate estimates, but it will be because of opacity around the Timberland acquisition. Don’t get us wrong – we’re not suggesting numbers games here (as we often do with companies in this space). VFC has been so good with disclosure around the drivers in each of their businesses. But we think that the pricing trends in the denim business in particular are not sustainable. Note that Levi’s reported 7% domestic revenue growth in Q2 with more than half from pricing (VFC is planning for pricing to be up 8% for the year) and it’s launching its lower price point ($20-$30) Denizen brand in Q3. Moreover, it’s unlikely that competitors such as Gap and Rustler (WMT) are going to roll over and play dead.  This is by no means the end of the world for VFC. They’ll manage through it.


This is a name that has certainly surprised us – both in growth, profitability and ultimately the stock price. We’ve been covering it long enough to ‘get it’ that the management team is artful in beating expectations, and yet we still have been positively surprised.  The model today is telling us that 2013 earnings power is approaching $10. Does the stock look expensive now? Actually, the answer is No. Trading at about 13.5x next year's earnings and 8.5x EBITDA, which is fair for a name that has so many operating levers and drivers.  


Would we classify this as a freight train like Nike that is plowing through anything in its path? Not really. But it is akin to one of those steel roller coasters that is locked so tightly onto the tracks such that it can do all the loops and inversions without whiplashing its paying customers.


The bottom line is that there is much to like here for someone who invests according to our TAIL duration. But before getting involved, we need more certainty around the TREND, and the stock price to go with it.




Here are some noteworthy comments from the call on the current pricing environment:



  • Expect pricing to contribute 3-4% to full-year top-line growth, 2/3 of which will come from Jeanswear
  • “we are seeing a little less impact from pricing than initially anticipated.”
  • “Additional prices the increases will take place in the second half as planned.”
  • “Of course, this is great news to us, but it too early to predict the impact on 2012. I will tell you this.”
  • “our decisions around pricing , particularly for our US jeans businesses, have been good ones…we never contemplated fully offsetting cost with pricing.”
  • “Our initial price increases in both the mid-tier and mass channels have been successfully executed and as Eric noted earlier, we are encouraged by the results to date with first and second half unit volumes above last year's levels.”
  • “we're seeing some reduction in our fourth-quarter denim buys versus our costs in the third quarter, so that means in the first quarter of 2012, our cost our denim costs will begin to come down”
  • Q: Given price increases realized thus far, do you expect those to hold, or are you working with retailers to reduce prices as you look out (to 2012)?
    • A: “Again bear in mind that we did not take in our increases up all the way to cover our production costs so we think that was the prudent approach for all of the year and then going to next year we think that puts us in a good spot with our retailer community.” (i.e. No, we are not planning to lower prices)
  • Q: Any surprises in the pricing environment?
    • A: “No. So far the price increases that we expect to see, we're seeing.”
  • Could we be positive in terms of units?
    • “We're not anticipating that as we said very early in the year, that particularly in the second half in the first half units as we've said, it's been very positive for us. First half units in our US jeans business are up a couple percentage points over the first half of the 2010, so again, really like to see that. And that's great news.
    • But we still have a second half plan down in terms of second half units for the year, we were looking at a mid-single digit percentage decline in our US jeans business on those ongoing programs and we're still planning something more like that.
    • If the consumer response a little differently, could be a little better than that?
    • Sure.
    • But that's not how we have the numbers forecasted.
  • “In terms of jeanswear, we are having the unit increase in the first six months of the year a little bit better than we hope to given the price increase that we took and for the year, we're calling for a mid-single digit decrease in units. So we have a lot of erosion that happens in the back half of the year to get to the mid-single-digit unit decrease from where we started and from where we're starting with positive trends coming in. We have a lot of experience in price changing and all of our channels of distribution, and have a pretty good feel for what it might be like.”


          VFC: Love Child - VFC S 7 11


          VFC: Love Child - VFC GuidCad






          MCD will announce sales, along with 2Q11 results, before the market open on Friday, July 22nd.


          Recapping the quarter to date, we know April was a strong month beating expectations globally.  May on the other hand was not a very strong month for MCD sales.  Global comps came in at +3.1% versus expectations of +3.6%, U.S. comps were +2.4% versus consensus at +2.9%, Europe comps missed by a wide margin, coming in at 2.3% versus 3.8% expectations.  APMEA was the only division where comps beat consensus, coming in at +4.3% versus 4% expectations. 


          Compared to June 2010, July 2011 had one less Tuesday and one additional Thursday.  As a result, I would not anticipate any major calendar shift.  In my recap of the May sales results, I highlighted that there were several changes in the May press release from the April sales release.  Firstly, McCafe was not mentioned as a driver of comps in May but it was in April.  Frozen Strawberry Lemonade was highlighted but, as I stated last month, this product is drawing customers due to its low price point.  I remain skeptical of MCD’s focus on “beverages over burgers.”


          Consensus estimates have risen by 0.6% over the past three months, while the sell side still has a slightly bullish bias with 59.2% of analysts holding a “Buy” rating on the stock.  Interestingly, the short interest has risen steadily during the quarter, but still at very low levels. 


          My model is coming up with $1.27 for 2Q11 versus the Bloomberg mean estimate of $1.28.  Naturally, my estimate is slightly lower that the street due to a more conservative revenues estimate.  The big variable this quarter will be food cost and the impact on margins.  I’m currently modeling a 100 bps increase in food costs versus 70bps in 1Q11.  Without a big June comp figure, it’s hard to get significant upside absent any “one-time” items. 


          Below I go through my take on what numbers will be received by investors as GOOD, BAD, and NEUTRAL, for MCD comps by region.  For comparison purposes, I have adjusted for historical calendar and trading day impacts. 



          U.S. - facing a compare of +3.7% (including a calendar shift which impacted results by +0.0% to +0.3%, varying by area of the world).  Frozen Strawberry Lemonade was launched in May, comparing with the official national rollout of Frappes in May 2010.  May 2011 results came in lighter than expected.  The June compare is slightly more difficult but I am not anticipating any large miss this month.  Expectations have risen to a level that implies that MCD is “comping the comps” in June and July - something I did not think possible in January.


          GOOD: A print above 4.5% would be received as a good result, implying two-year average trends roughly 20 basis points above those seen in May.  Despite missing consensus, on a calendar-adjusted basis May results implied a sequential acceleration in two-year average trends of 75 basis points.  It will be interesting to see what drives the comp in June but, given the focus on beverages and the difficult compare in July fast approaching, I would expect the bulls to be focused on this.


          NEUTRAL:  A print between 3.5% and 4.5% would be received as a neutral result by investors given that the mid-point of this range implies two-year average trends, on a calendar-adjusted basis, in line with trends in May. 


          BAD: Same-restaurant sales below 3.5% would imply a sequential slowdown in two-year average trends raise significant doubt about the ability of MCD to match last year’s impressive top-line performance. 


          MCD: JUNE SALES AND 2Q EPS PREVIEW - MCD preview june



          EUROPE - facing a compare of +4.7% (including a calendar shift which impacted results by +0.0% to +0.3%, varying by area of the world).  Europe was a huge disappointment in May and, as the media has been highlighting constantly, the crisis in Europe has been gathering speed.


          GOOD: A print of 6% or higher would be received as a good result for Europe as it would imply a sequential acceleration in two-year average trends after for consecutive months of declines (calendar-adjusted basis).  Consumer confidence in Germany (Icon) improved during June, was flat in France, according to INSEE National Statistics Office, and gained in Spain, according to OPINA.  A continuing debt crisis is likely hampering expenditure but, to a degree, the situation is becoming a “new normal” and without changes “on the margin”, I don’t expect any impact on MCD’s business in the Old World.  Germany disappointed in May while France, Russia and the U.K. were highlighted as bright spots.


          NEUTRAL: A result between 5% and 6% would be received as a neutral result because it would imply two-year average trends only slightly above the disappointing results seen in May. 


          BAD:  A result below 5% would imply two-year average trends level with, or below, the disappointing two-year average trends seen in May. 



          APMEA - facing a difficult compare of +6.0% (including a calendar shift which impacted results by +0.0% to +0.3%, varying by area of the world).


          GOOD: A print of 5% or higher would be received as a good result as it would imply a sequential acceleration in two-year average trends.


          NEUTRAL: A result between 4% and 5% would be received as a neutral result because it would imply two-year average trends roughly level with May.  APMEA was the only region in the world where MCD comps outstripped consensus in May.


          BAD: Same-restaurant sales in APMEA below 4% would be received as a bad result because it would imply a slowdown in two-year average trends.



          Howard Penney

          Managing Director


          Rory Green



          European Portfolio Update: Shorting Italy (EWI); EUR-USD (FXE); Spain (EWP)

          Positions in Europe:  Short Italy (EWI); EUR-USD (FXE); Spain (EWP); UK (EWU)

          Keith’s taking the opportunity to re-short strength in European equities [Italy (EWI) and Spain (EWP)] and the EUR-USD (FXE) in the Hedgeye Virtual Portfolio this AM as the positions run ahead of themselves on optimism about “positive” bailout talks on Greece today at the EU Summit in Brussels.


          As we’ve said in multiple research pieces recently (for more, see our portal at Hedgeye.com), we see a long road ahead in Europe’s sovereign debt soap opera as European officials choose to issue short term solutions (band-aids) to much longer term fiscal imbalances.


          Should anything come of today’s talks regarding new concessions for Greece’s outsized debt—and at this point everyone is running on pure speculation—we believe the news will at best provide only a short term boost to capital market performance, particularly for the peripherally countries. Bottom line, we’re shorting today’s bounce (Italy’s MIB is trading up +4% intraday and Spain’s IBEX is up +3%) and the EUR-USD cross broke out above our TREND Line of $1.43 (+1.2%).


          European Portfolio Update: Shorting Italy (EWI); EUR-USD (FXE); Spain (EWP) - 1. A


          European Portfolio Update: Shorting Italy (EWI); EUR-USD (FXE); Spain (EWP) - 1. B


          One chart in particular that is worrying us is the coming debt maturities for Italy and Spain over the next 2-3 months.


          European Portfolio Update: Shorting Italy (EWI); EUR-USD (FXE); Spain (EWP) - 1. H


          Our intermediate term TREND levels on European equity indices are not just breaking across the PIIGS, but  also teetering around breakdown in Germany (DAX TREND = 7198) and broken in the UK (FTSE TREND = 5925), driven and confirmed by slower high frequency data (Services and Manufacturing PMI figures all slowed in July for Germany, France and Eurozone ave.) and pressing threats of contagion (especially as Italy and Spain push to the forefront) that even fiscally sober countries like Germany and Sweden are not immune to. 


          Matthew Hedrick


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          A legitimate beat and raise



          "Despite concerns about a slowdown in U.S. economic growth, during the first half of 2011 we've seen gradual improvements in consumer trends, though there continues to be month-to-month revenue volatility in several of the markets where we operate. With second quarter results exceeding guidance and expectations for continued positive operating momentum throughout 2011, we are raising our full year 2011 revenue and adjusted EBITDA guidance to $2.7 billion and $723.5 million, respectively."


          - Peter M. Carlino, Chairman and CEO of PENN



          • "With the recent opening of the sports bar and lounge at Charles Town, we have completed the property's expansion to complement our table game product offerings and have transformed this facility into one of the largest full amenity casinos in North America. In addition, Hollywood Casino Perryville had a successful opening last fall and we benefited from a month of operations from M Resort. Hollywood Casino Perryville generated $5.7 million in quarterly adjusted EBITDA and M Resort contributed $2.1 million of property adjusted EBITDA (excluding transaction costs) in the month of June. Overall, thirteen of our fifteen gaming facilities generated year-over-year adjusted EBITDA improvements and fourteen increased their adjusted EBITDA margins."
          • "In June, Penn National entered into an agreement to divest its joint venture interest in the Maryland Jockey Club as we believe its tracks will be well served under a sole ownership structure. Given that Penn National previously wrote down the value of this investment due to a goodwill impairment charge at the Maryland Jockey Club, we expect to record a gain from the sale in the third quarter. Going forward in Maryland, our focus will be on resuming live and simulcast racing at the now dormant Rosecroft Raceway in Prince George's County, which we acquired earlier this year, with the hope of eventually offering expanded gaming there, and building on the initial success of Hollywood Casino Perryville."
          • "M Resort recorded second quarter property revenue of $43.1 million and adjusted EBITDA of $5.6 million before the impact of transaction costs. This compares favorably to the prior year revenue and adjusted EBITDA of $41.9 million and $4.5 million, respectively. We are confident that our operating discipline, rationalized approach to marketing and active player database can continue to improve the property's financial performance over time."
          • "Hollywood Casino at Kansas Speedway and Hollywood Casino Toledo are expected to open in the first quarter of 2012 and first half of 2012, respectively, provided the required regulatory framework and approvals are in place"
          • "During the second quarter, we entered into a contingent agreement with The City of Columbus that called for annexation of the site of Hollywood Casino Columbus into the City of Columbus in exchange for water and sewer service and other considerations. The agreement was conditioned, among other things, on the sale of real estate previously purchased by the Company in downtown Columbus for $11 million and an acceptable settlement agreement with certain affiliates of the Columbus Dispatch. While neither of these conditions were satisfied by the July 19, 2011 deadline set forth in the settlement agreement, we believe that we have now reached an agreement in principle among all parties relative to the satisfaction of these conditions. We expect to complete the documentation of these matters shortly. In the meantime, construction has continued on our planned $400 million Hollywood Casino Columbus project, which we expect to open in the fourth quarter of next year."
          • Guidance:
            • Net Revenue: 3Q:$706.3MM; FY: $2,727MM
            • Adjusted EBITDA: 3Q:$197.4MM; FY: $723.5MM
            • EPS: 3Q:$0.53; FY: $2.16
            • Adjusted EBITDA includes a $20MM gain on anticipated closing of Maryland Jockey Club sale on Aug 1 
            • Extension of Casino Rama management contract
            • $10.6MM of pre-opening expenses with $2.4MM incurred in 3Q
            • D&A: 3Q:$53.4MM; FY: $213.3MM
            • Debt extinguishment charges of $18.6MM ($13MM non-cash) in 3Q
            • Stock comp: 3Q:$6.3MM; FY: $24.9MM
            • Tax rate: 38.2%
            • Share count: 107.4MM


          • Regional trends: Generally, they are seeing a stable environment with slight growth in some markets. The promotional environment remains rational.  The only strength is in the VIP segment (>$400 of gaming per day).  


          • PA has seen some migration towards electronic table games which helps margins. They don't have a lot of competitive pressure given their location. When and if revenues start to improve they will see margin improvements.
          • Took over M Resorts on June 1st. The local gaming market in the locals Las Vegas market continues to be challenged. Continue to see strength in group and convention. Marketing roll-out in 3Q.  2Q isn't as seasonally strong as 1Q.
          • Toledo: 1MM population base - compares to 1.2MM at Penn National (PA) with similar income demographics. Penn National is a good proxy for margins when you adjust for respective tax rates
          • View on bill to expand gaming in IL. Governor is struggling with passing the expansion bill given the VLT passage. There is ongoing dialogue - they think will not be resolved until the fall. They don't think that the VLTs will have any impact on the existing casinos since there are already illegal machines out there.
            • Governor can veto the package once it's delivered to him
            • He can try to structure a new deal with the legislature when they return in the fall
            • The opening of the 10th license in IL will also provide some additional tax relief
            • Do not think that the bill in its current form will get passed
          • Expect that OH VLTs will get passed in September but it will take at least 18 months to open the new facilities
          • Lawrenceburg market continues to show slight declines. The riverboats have impacted SE Indiana.  They are looking at ways to continue to rationalize costs. Don't expect Cinncinatti to open until 2013.
          • Charles Town will lose some business when Arundel opens - especially the convenience business. All they can do is make their property more competitive as they have done with the recent improvement. Their customers will still be allowed to smoke while MD facilities are smoke free.  Also the high tax rate in MD allows them to offer a more complete entertainment experience. The don't expect much impact on Perryville from Arundel until if and when the Baltimore facility opens
          • In the process of putting in a one card solution at Kansas Speedway to take advantage of cross marketing. They will also take advantage of cross marketing in Ohio.
          • They are interested in opportunities in Asia when and if they arise
          • Discussions in MA will begin after Labor day
          • In Florida, the expansion bill failed
          • They are done making investments in Lawrenceburg. They are in discussions with the city about partnering to build a 150 room hotel. They have the ability to open smoking on their floors which Cincinnati will not when they open in 2013.
          • If they are able to move the racetracks - there's a $150MM capital investment requirement plus $50MM license fees. It's unknown if there will be a premium for relocation
          • There haven't been any internal modifications to the way they look Ohio investments but they did reach an agreement for additional payments
          • Cash:$322MM  Debt: bank debt: $1.518, capital leases: $5, bonds: $325+250 = $2.1BN at June 30th
          • Capex: $59MM (14.6MM maintenance; $15.2MM on Kansas; $37.9MM of project capex)
          • Capitalized interest was $1.27MM in 2Q; $1.750 in 3Q and 6.2MM for the 2011
          • Depreciation at M should be roughly $1.75MM per quarter. Originally they thought it would be a lot higher.
          • They are not interested in the AC market
          • Wouldn't want to go over 5x on a gross leverage level
          • M Resorts - 4 growth drivers: Locals market, S. California market, Penn regional database, and group and convention business.  Their database is already contributing 3-4% of occupancy. They do think that there are facets of the business that can improve without the locals business improvement. They are also looking at optimizing marketing.


          PENN beat us for Q2 and we were well above the Street. Outstanding quarter with revenues and EBITDA exceeding expectations.  PENN beat Q2 consensus by almost $10MM in EBITDA and us by $6MM.



          Guidance for the second half of the year was also raised.  If we excluded the $20 million gain and pre-opening expense from guidance, it appears that PENN raised EBITDA guidance about $17 million from prior.  New 2011 EBITDA guidance was $723.5 million or $715.1 million after the above non-operating adjustments.  Consensus was $694.9 million or $704.3 million after adjusting for the Q2 beat.  Thus, PENN provided 2H guidance $10.8 million above the Street ($715.1-704.3), of which $2m falls in Q3.


          Here are the property results:




          Initial Claims Rise 10k WoW (13k After Revisions)

          Initial unemployment claims came in at 418k last week, up from 408k the prior week (revised from 405k).  1.75k of the claims were attributable to the Minnesota government shutdown.  This is down from the prior week, when 11.5k of the claims arose from Minnesota government employees.  On a rolling basis, initial jobless claims fell 3k week over week to 421k.


          We've stated many times that our analysis shows rolling claims must reach a level of 375-400k on a sustained basis for any improvement in the unemployment rate to occur. We've also noted the relationship between Quantitative Easing and jobless claims, pointing out the fact that when QE is in effect it tends to lower claims and vice versa. Given that QE ended 3 weeks ago, we're not surprised to see rolling claims bounce along sideways. This is also an interesting takeaway for the broader market and the XLF as we also show below the relationship between those two benchmarks and jobless claims. 


          While there are many systemic risks facing the market right now from Europe to the Debt Ceiling to the Housing market, we come back to jobless claims time and again as the ultimate best read on what matters most for lenders. If jobless claims aren't improving this is a major overhang for the space, and when you add in weak home prices it paints an especially challenging picture for the group.












          2-10 Spread Close to Flat WoW

          The 2-10 spread, which we track as to gauge NIM pressure, was 1 bps wider WoW at 255 bps.  The spread is currently running 4 bps tighter than 2Q.  






          Joshua Steiner, CFA


          Allison Kaptur


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