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Framework of Greek Bailout Part II: Skepticism Abounds

Below we provide the main notes from tonight’s press release of EU Heads of State or Governments of the Eurozone and EU Institutions, including a Q&A, on the terms of Greece’s second bailout package.  To say the least, we’re extremely skeptical of the program providing anything more than another near term band-aid to European sovereign debt contagion. Perhaps the group’s insistence that Greece (and not the other PIIGS) requires an “exceptional and unique solution” was most concerning of all.



  • €109 billion of financing for Greece from the EU and IMF and an estimated €37 Billion contribution through VOLUNTARY Private Sector Involvement (PSI) of banks to reduce Greece’s debt through exchanging existing bonds for new bonds with lower interest rates and longer maturities. (unique terms to be drafted)
  • The European Financial Stability Facility (EFSF) is the vehicle for the disbursement of the new €109 billion package
  • On future EFSF loans to Greece, the maturities of the loans will be extended from the current 7.5 years (to date Ireland and Portugal are the only countries using the facility w/ these terms) to a minimum of 15 years, and maximum of 30 years with a 10 year “grace” period. [IMF also said Portugal and Ireland will be extended these terms]
  • EFSF interest rate terms will be reduced to 3.5% from 5-6% level, extended to existing and future loans to Greece, Ireland, and Portugal
  • The EFSF can intervene in secondary markets to buy up sovereign bonds (officially), whenever deemed necessary 

Other Remarks:

  • Public deficits in all EU countries will be brought below 3% (of GDP) by 2013 at the latest
  • Extension of a “European Marshall Plan” in which countries can give money (no explicit terms provided) to Greece to drive economic growth
  • Reliance on credit rating agencies should be reduced
  • Q&A Call-Out: Trichet insisted that Greece is not in selective default. When again questioned that the PSI is tantamount to a default through restructuring, as technically defined by the credit agencies, Trichet replied that today’s package shouldn’t trigger a credit event (default) with credit agencies (Throat clear).

Got Risk Management?


Matthew Hedrick


China’s Bottom Is Showing

Conclusion: We don’t think it pays to freak out about China’s manufacturing data just yet. The Chinese economy is progressing right along and we think broad-based concerns ranging from a sharp downturn in growth to a potential banking crisis are overblown. Moreover, a holding above our key risk management level would lead us to believe such consensus apprehension is close to being priced in.


Position: Long Chinese equities (CAF).


Overnight, a sub-50 reading (48.9) in HSBC’s preliminary July Purchasing Manager Index helped send Chinese equities down a full percent. Make no mistake; this was a very negative data point indeed. While it would be easy for us interpret today’s one-off data point in conjunction with today’s bearish WSJ article highlighting the “trouble” ahead for Chinese small-cap banks as a reason for us to book the gain on our long position in Chinese equities within our Virtual Portfolio, we prefer to apply a more rigorous process to risk management.


The quantitative setup for China remains favorable and we would expect Chinese equities to hold their TRADE line of support at 2,727. Should that line break and confirm itself, our models aren’t signaling any meaningful support below.


China’s Bottom Is Showing - 1


Regarding the economic data, we’ve been clear and consistent with our call for Chinese growth to “slow at a slower pace”. We continue to think Chinese growth continues to decelerate over the intermediate-term TREND. Both the market and the Chinese officials in charge of making up the data have been telling us that for over 18 months. The Shanghai Composite Index is down -14.2% since we introduced our bearish Chinese Ox in a Box thesis on January 15th of last year. Moreover, at 8% and 7% respectively, both the NDRC and the Politburo via its latest 5yr plan agree with our view of slowing Chinese economic growth – at least directionally (we don’t think China grows anywhere in the area code of 7-8% in 2011; we’re closer to 9-9.3%).


Of course, picking stocks (or in this case, markets) isn’t all about internalizing one’s own research. A great risk manger must also understand the other side of the trade – perhaps more so than their own. We get that the Chinese banking system could indeed face substantial headwinds over the long-term TAIL from a credit quality perspective. Though we do not agree with the prevailing belief, we fully understand the risks associated with a potential Chinese property market bubble.


According to Reuters calculations from official data, Chinese property price growth accelerated to +4.2% YoY in June, though down substantially from their peak growth rate of +12.8% in April ’10. We welcome the significantly less inflationary effects of mid-to-low single digits growth in Chinese property prices and do not think Chinese officials will tolerate a sustained breakdown below current growth rates over the intermediate-term TREND. This view is supported by the recent uptick in pro-growth commentary out of various Chinese officials. Rebalancing the world’s second-largest economy doesn’t happen overnight.


China’s Bottom Is Showing - 2


To the earlier point about a potential Chinese banking crisis, we are quick to point out that the loudest source making noise about China’s local government financing vehicle paper is noise in and of itself (Moody's). Ratings agencies are rarely leading indicators for anything of consequence. In fact, their poor track records and oft-late conclusions afford us much conviction that the risks associated with 10.7 trillion yuan of LGFV debt aren’t nearly as bad as Moody’s thinks they are. We would be remiss to pretend there aren’t any skeletons in the closet, but it seems rather aggressive to suggest that NPLs could grow to as much as 12% of total credit in the Chinese banking system.


China’s Bottom Is Showing - 3


China’s Bottom Is Showing - 4


Taking the other side of our bullish Chinese Cowboys thesis for a moment, we think the chart of China’s 5yr CDS is quite alarming and, given that 70% of LGFV debt matures within the next five years, we think this is a key duration to pay attention to. Still, there are a bevy of reasons we feel China’s pending “banking crisis” is likely to pass without any material damage – not the least of which is the likelihood that the central government relaxes its controls on LGFV bond issuance. Granting any ailing local government the ability to issue long-term paper will help the Chinese economy at large by smoothing out any potential asset/liability mismatch.


China’s Bottom Is Showing - 5


Elsewhere, we see that China’s money market rates are indeed breaking out to the upside. Both three-month shibor and one-year swaps rates are making higher all-time highs of late. Whether this is a leading indicator for another Chinese rate hike or just indicative of the general tightness we’ve been seeing throughout the Chinese banking system remains to be seen. On one hand, our models suggest that Chinese YoY CPI has one more month of sequential acceleration left and that should get the market right freaked out about another - and most likely the final - rate hike. On the other hand, only 963 billion yuan of central bank bills and repurchase agreements mature in 3Q (vs. 2.1 trillion in 2Q), which means that in the third quarter the Chinese banking system will be as tight as it has been since 2008 from an incremental liquidity perspective (per China Merchants Bank Co.). Regardless, both outcomes are supportive of our call for Chinese inflation to decelerate on a sustainable basis in 2H.


China’s Bottom Is Showing - 6


All told, we don’t think it pays to freak out about China’s manufacturing data just yet. The Chinese economy is progressing right along and we think broad-based concerns ranging from a sharp downturn in growth to a potential banking crisis are overblown. Moreover, a holding above our key risk management level would lead us to believe such consensus apprehension is close to being priced in.


Darius Dale


SP500 Levels Refreshed: Risk Ranger Getting Extended

One of our three Q3 2011 themes is Risk Ranger.  The premise being that many asset classes will be range bound over the intermediate term as we get continued Policy Pong between the United States and Europe.  With the dramatic rally since the Gang of Six proposal three days ago, we can safely assume that an extension of the debt ceiling is now getting fully baked in to market prices.  


The SP500 is flirting with our TRADE resistance line of 1,344.  A close above that level would put our TAIL line in play at 1,377, but our view remains that the top end of the Risk Ranger range will hold.  An astute client asked us today if we believed in today’s move in the SP500.  The simple answer is that until fundamentals change in conjunction with a validation by price, our thesis remains intact.  As a result, we made the following moves in the Virtual Portfolio today: 

  1. Bought Silver (SLV)
  2. Sold Covance (CVD)
  3. Shorted Financials (XLF)
  4. Shorted the Euro (FXE)
  5. Shorted Spain (EWP)
  6. Shorted Italy (EWI)
  7. Bought Icon (ICLR)
  8. Sold Carnival Cruise Lines (CCL)
  9. Covered Grains (JJG)

In aggregate, we took advantage of an opportunity to lay back out some of our bearish bets on Europe, and take down exposure in the Virtual Portfolio by adding a net three new short positions.


While CNBC is trotting out the equity bulls today, the data and news flow with continues to urge caution and tight exposures.  The key points to highlight in that regard are as follows: 

  1. Unemployment claims remain above 400K, which means we will continue to see little to no improvement in the unemployment rate;
  2. Existing home sales fell and inventory grew to 9.5 months, the highest level since November 2010; and
  3. The Intrade contract on a debt ceiling increase by August 31st hit a new low at 72%.

Trade the Risk Range.


Daryl G. Jones

Director of Research


SP500 Levels Refreshed: Risk Ranger Getting Extended - SP500

Early Look

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We’re above the Street but so is the whisper.



We’re projecting IGT to come in 2 cents ahead of the $0.22 consensus EPS estimate for the quarter when they report next Tuesday.  We also think they could raise FY11 guidance by 5 cents or more with better international product sale revenues, revenue growth from growth in the global interactive division, growth in systems, and interest expense savings, offsetting weakness in the NA product sale market.


IGT management will likely spend a good portion of the call discussing their international business and Global Interactive Division.  Since April 27th, IGT has announced 8 deals – all of which are international, and 6 of which are related to IGT’s Global Interactive Division.  We expect that these deals will become meaningful starting in FY12 and that IGT may start putting more meat on the bone to outline the opportunity if not on this call then on its YE call next quarter. 


FQ3 Detail:


$219MM of product revenues at a 53% gross margin


“On the margins and Product Sales, I think you’re probably safe if you assume a run rate domestically of say 52%."

  • NA sales of $128MM
    • $64MM of box sales ($14k ASP, 4,550 new & replacement units)
      • “For the remainder of fiscal year 2011, we see very limited opportunities for new and expansion shipments in the for sale business."
      • “Given the current selling environment and volume levels, we expect average selling prices to rebound modestly from this quarter’s levels, mainly due to mix, but margins to be under pressure for the remainder of the year.”
    • $64MM of non-box sales
  • International sales of $92.5MM which includes the last quarter of Barcrest results (~$6MM of revenue and $2MM of gross margin)
    • $62MM of box sales (ASP’s of $12k, 5,200 units)
      • “We expect our International unit sales to keep pace with our North American sales for the remainder of the fiscal year, which is another testament to the strength of our global reach.”
    • $30MM of non-box sales

$273MM of gaming operations revenue at a 62% margin

  • EOP install base of 57,150 games
    • "For the remainder of the year, we expect our Gaming Operations’ installed base to continue its moderate growth.”
  • Average win per day of $52.50
    • “Our [Gaming Operations] yields should continue their modest sequential improvement, assuming normal seasonal trends continue.”


Other stuff:

  • $88MM of SG&A, net of $1.8MM provision for bad debt
    • “We expect a modest, upward trend in SG&A for the remainder of this year as we invest in people and processes necessary to take advantage of new business opportunities.”
    • $17.5MM of D&A
    • $52MM of R&D
      • “As far as R&D spend, I think we’re working hard to try and keep that relatively flat.”
    • $17MM of net interest expense
    • 36% tax rate

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



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