Half The World

“Half the world hates, what half the world does every day…Half the world lies, half the world learns…Half the world talks, with half the mind on what they say.”

 – Neal Peart


To suggest that these lyrics by Canada’s son Neal Peart apply to Wall Street would be all too appropriate.


There’s the buy side half, and there’s the sell side half.


But even within those groups, there are the big guys – with a big sense of entitlement – such as the Morgan Stanleys, Citigroups and BofAs of the world who use the Fed as their piggybank at our expense.  No, Hedgeye did not accept any TARP money and we won’t in 2012, either.


Similarly on the buy side there are the PMs and Analysts who have exclusive access to management teams to get inside info during ‘double secret one-on-ones’ at broker conferences.


And then there are the others who have to fight harder and rely on a tried and true investment process that will consistently generate positive returns across all durations without what we call “orange jumpsuit risk”.  We’re proud to call many of them our clients.


But as for the big guys, especially on the sell-side-half, it’s pretty amazing that despite all the resources, access and clout, there’s still such absence of any rigorous quantitative modeling of earnings and cash flow.


This translates into what we’ll call ‘entitlement to grow’. It’s what the sell side seems to bestow ad nausea to virtually every company in (and out) of the S&P.  


Sit next to any analyst – even someone considered halfway decent – while they’re building out a model. When plugging in a growth rate for a certain product, business line, or region, and ask them to build a bearish revenue case.  The chances are that they’ll take revenue growth closer to zero.


Then what about gross margins? Maybe they’ll take them down a few basis points . . . let’s say 50bps.


As for SG&A, here’s the real kicker.  Companies in retail give SG&A guidance – for the most part – as a percent of sales. That means, of course, that the sell side models it that way as well. But the guided SG&A ratios are simply the product of the company’s sales results from a largely predetermined SG&A plan. That sell-side “bear” will end up with margin deleveraging of around 50bps.


In reality (which is where we live) what happens if sales targets come in light – or heaven forbid – are actually down year on year?


SG&A is planned predominantly on a fixed basis. Roughly 60-70% of SG&A costs are headcount-related for the average retailer or brand.  Then there’s another 10-15% that’s marketing and R&D. The remainder is largely corporate (i.e. fixed). Are these expenses pliable? Yes, in part. Some can be flat-out cut, even if they shouldn’t be. But those that are certainly take more time than the cadence of revenue recognition.


So what’s the REAL bear-case?

  • Unemployment is still in the dog house, and there’s no near-term tax stimulus;
  • Consumer spending – which is 72% of our economy – is down 1-2%;
  • Zero percent 4Q GDP growth;
  • ‘Essential Spending’ which includes housing, food, energy, etc… +2-4%; and
  • Discretionary spending -5-7%.

If this is the scenario, can the Wal-Marts of the world do, ok?  Yes they can, which is why WMT is one of our top long ideas.  Nike, which has a structural advantage and is gaining share in a global duopoly in a GDP+ category?  Definitely.  Liz Claiborne, which has more asymmetric factors to outperform in a bad economy than almost anyone in retail?  Yes.


How about JC Penney, which is…well…it’s JC Penney? Absolutely not. The other key losers are those that are posting unsustainably high growth rates today, like Hanesbrands and UnderArmour (even though the latter is a great longer-term story).


Whether a company wins or loses is one thing, but being fully represented in expectations is another. If JC Penney’s sales square footage is -1%, comps are down 3-4%, gross margins are down 100bps+, and SG&A is growing by 3%, does anyone want to guess what that does to EPS growth? Do the math, it gets you to something like -125% -- or some other meaningless number when EBIT is wiped out entirely.


Is that dude whose shoulder you’re watching over running any of these numbers? My sense is that he’s probably not. Actually, my opinion is meaningless when the flat-out fact is that the consensus is looking for EBIT to grow for JC Penney in the high single digits over the next year.


So Mr. Ackman, do you believe +8% or -125%. Not exactly a delta I want to be looking at in this tape.


There’s this little thing called leverage. It’s a wonderful thing on the upside (circa 2003). But unfortunately, today it’s looking like 2008 all over again.


If you’re not part of the right half, get there… fast…


Keith’s immediate-term ranges for Gold, Oil, and the SP500 are now $1, $87.51-90.73, and 1148-1207, respectively.


Brian P. McGough
Managing Director


Half The World - Chart of the Day


Half The World - Virtual Portfolio

Additional Color on FW Sales

The big boys are crushing it, while everyone else takes it on the chin.


1)      As noted earlier Sales were flattish, as a 4.4% decline in units was entirely offset by better price points.

2)      Nike is crushing it. Share up nearly 500bps to 44.1%...simply amazing. Converse is the one exception.

3)      Some sequential deceleration from Reebok, but still 25%+ top line ain’t half bad… Also, Adidas US is more than picking up the slack.

4)      Will Skeechers ever hit bottom? The answer is yes, but not yet.

5)      UnderArmour up slightly, but for intents and purposes, it’s still a big zero.

6)      Check out Private Label footwear – trendline remains -40% vs. last yr.


Additional Color on FW Sales - FW brand data 9 7 11


Additional Color on FW Sales - FW Market Share 9 7 11



Three Charts to Flag

With the market rallying to higher levels, which will enable us to re-enter some of our key short positions, we wanted to flag a couple of key charts that continue to underscore slowing growth and heightened financial risk, globally.  The charts are as follows: 

  • Baltic Dry Index – Interestingly, in contrast to many leading indicators of global growth, the Baltic Dry Index, a gauge for global dry bulk shipping rates, is well off its year-to-date lows, which were reached on February 4th, 2011.  Despite this, on a year-over-year basis, the BDI is down more than 39% from levels in 2010.  While the BDI is obviously influenced by changes in the global dry bulked fleet, it remains a good proxy for global economic activity and has declined meaningfully year-over-year. 

Three Charts to Flag - 1

  • Indian Yield Curve – In the chart below, we looked at the difference between 2-year and 10-year Indian government bonds going back ten years.  The key flag here is that Indian yield curve recently turned inverted in August and, as of the most recent market prices is only marginally off the inverted level. The last time that the Indian yield curve was inverted was in mid-2008.  The time before that was February 2002.  The key commonality was that in both periods this was a leading indicator for slowing economic growth. 

Three Charts to Flag - 2

  • State Bank of India CDS – Currently, there is not an actively traded credit default swap market on Indian sovereign debt, but CDS on State Bank of India are a decent proxy for Indian related credit risk.  While certainly the majority of sovereign debt discussion is and should be focused on Europe, the CDS of the State Bank of India are signaling the potential contagion effects as the weak links of Europe continue to unravel, but also reinforces slowing growth, even in the emerging markets. 

Three Charts to Flag - 3


None of these change our overall investment perspective, but we believe are worthy to flag.  The key changes we made in the Virtual Portfolio today were: 

  1. Sold Covance (CVD)
  2. Bought Silver (SLV)
  3. Shorted Capital One Financial (COF) 

In sum, we are incrementally adding to shorts and precious metals in the corrective rally.


Daryl G. Jones
Director of Research

the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

No One Buying Footwear in Hurricane

Athletic shoe sales were flat for the week, as higher ASPs offset a unit shortfall.  Look for a rebound this week. If we don’t see it, we’ll be disappointed.


NPD data just released showed flat (+0.3%) top line growth for the week ending September 4. Units were down just over 4%, but higher ASPs entirely offset the shortfall. All said, it was good to see the retailers not cave in on price simply because people were buying power generators, batteries and hunkering down in their homes instead of buying shoes. Look for a rebound this week. If we don’t see it, we’ll be disappointed.


No One Buying Footwear in  Hurricane - FW sales vs. units


Brian P. McGough
Managing Director

Richemont: Less Great


There aren’t many retailers growing the top-line by +29% that Richemont pre-announced this morning, which is even more impressive given last year’s compares, but the fact of the matter is that sales are slowing on the margin. Here some additional takeaways:

  • Take a look at the SIGMA. Sales growth was impressive up +29% on top of +37% growth in the same period last year. While underlying 2Yr sales trends climbed steadily higher across all four regions, Europe was the only region to post sequentially stronger yy sales growth. Incidentally, Europe is also the company’s largest region accounting for ~38% of total sales.
  • While the pre-announcement only highlighted sales trends, keep in mind that input costs (Gold, Silver, etc.) have headed sharply higher up 40%-50% over the last 6-months. With a typical 3-4 month lag embedded in product costs, inventory value is headed higher at a faster rate than top-line sales trends suggest and is likely to result in continued contraction in the sales/inventory spread as well as margins.
  • Importantly, the preannouncement captures the first five months of F12 through August – a month that we feel strongly has seen a meaningful slowdown in high end spending in addition to seeing a backup of diamond inventory in parts of the supply chain.
  • Don’t mistake this as a negative call on Richemont. As was the case with TIF (which raised prices on its engagement ring business by 20%, which alone is 20% of sales) there are company-specific factors that might allow Richemont to wade through any kind of slowdown. But the fact is that this is yet another nugget related to the high-end consumer that we’d call ‘consistently inconsistent, ’ which is a negative divergence from the across-the-board strength we’re accustomed to seeing.


Richemont: Less Great - Richemont 9 11


Richemont: Less Great - Richmt RegSales Trends 9 11





A weekly look at commodity trends pertaining to our space.  Over the last week, dollar strength and concerns surrounding economic growth have helped drive overall commodity prices lower.




Beef prices led the way over the past week, gaining 2.6% along with rice and chicken in what was a muted week for the gainers.  To the downside, Milk led the way with a -12% move and grains, soybeans, sugar, and coffee also declined week-over-week.







Cheese prices stayed flat week-over-week but have declined -17% since August 1st.  Prices have been extremely volatile this year but, for companies that have exposure to cheese prices (like DPZ, PZZA, TXRH, YUM and others), the recent leg down in dairy prices is encouraging.







Below is a selection of comments from management teams pertaining to cheese prices from recent earnings calls.


DPZ (7.26.11): “Given higher than originally anticipated cheese prices, we currently expect our overall market basket for 2011 will increase by 4.5% to 6% over 2010 levels. This was up from our previously communicated range of 3% to 5%.”


HEDGEYE: We recently highlighted the fact that DPZ’s last earnings call took place during a trough in cheese prices and we expected a change in tone from the commentary in early May.  It remains to be seen if cheese prices will remain above 2010 levels for the remainder of the year but CAKE’s guidance for inflation in 2011 recently became much more realistic, although not a sure thing.



TXHR (5.2.11): “We've also got a lot of flow in the dairy markets, in cheese, so there's other things beyond produce that do move around throughout the year.”


HEDGEYE: In 1Q09, TXRH called out favorable beef and cheese prices as being primary drivers of cost of sales being down 126 bps in the quarter.  Cheese was a contributor to a cost of sales increase in 2Q11, as we predicted.  For the remainder of the year, barring another (possible) spike in prices, TXRH could see some margin relief from lower dairy costs.



CMG (4.20.11): “As we move into 2011, we're expanding our use of cheese and sour cream made with milk from cows that are raised on open pastures rather than spending much of their time in confinement, as most dairy cattle do.”


HEDGEYE:  For CMG, the lower levels of dairy costs, if they persist, will offer some food costs relief on the company’s P&L.





Corn and wheat prices have been moving higher over the past couple of months as adverse weather conditions depress sentiment surrounding the upcoming planting season.  Russia increasing its grain exports is offering some relief as crops have been coming in worse-than-expected in the U.S. and Europe.   Besides the strength in the dollar, decreased demand as global economic growth concerns stemming from the accelerating European sovereign-debt crisis is also weighing on grain prices.


One interesting article we read today highlighted that Cropcast, a well-known agricultural weather firm, projected U.S. farmers will harvest 4.3% less corn than last year due to poor weather.  Cropcast cut its output forecast because it expects many acres planted with corn will not be harvested due to flooding around the Mississippi and Missouri rivers and a severe drought in Texas, said Don Keeney, senior agricultural meteorologist for Cropcast.







Below is a selection of comments from management teams pertaining to grain prices from recent earnings calls.


PNRA (7/27/11): “Just to note on the cost of wheat, in 2011 overall, the per-bushel cost will be about the same as 2010 due to our laddering purchasing strategy.”


“We are going to take price in the fourth quarter. This price will offset dollar for dollar the per-bushel inflation of wheat of approximately $3 a quarter that we're going to see in the fourth quarter of this year and then across next year”


“We do continue to expect significant inflationary pressures in 2012, 4% to 5% food inflation, $10 million of unfavorability on wheat costs, which means that we don't expect operating margin much better than flat to full-year 2011 in 2012.”


HEDGEYE:  Wheat costs have come down but it remains unclear whether or not the current easing of grain prices will continue.  Weak global demand and a stronger dollar are currently trumping the adverse impact on supply due to weather and fires in the U.S.  Slowing demand may also mean lower sales for PNRA, so it remains to be seen if margins improve from this effect, even if high wheat costs come down.



DPZ (7/26/11): “We're fairly locked in on our chicken, locked in on our wheat into – partway into next year.”


PZZA (8/4/11): “We're actually covered through Q1 from a contract standpoint. So from a supply chain disruption or even significant price impact we don't anticipate anything between now and the end of the year.”





Beef prices gained by 2.6% week-over-week as unfavorable conditions persist for cattle farmers.  The USDA has rated 90% of the pasture conditions in the Southern Great Plains as very poor.  To make matters worse, as the website CattleNetwork states, most livestock water sources are drying up or have reached a point where water quality is a major concern.  Beef producers are now being faced with a difficult proposition: liquidate the herd or maintain the herd until pastures are – hopefully – renewed in April or May of 2012 and take on the implied cost of feeding the herd with feed prices far higher than a year ago.  The following link walks the reader through the logic of the decision facing producers. [herd liquidation story ]





Below is a selection of comments from management teams pertaining to beef prices from recent earnings calls.


RRGB (8/11/11): “We're still buying ground beef on the spot market… If you recall, we said 5% to 6% commodity inflation on the last call and we dropped that to 5 to 5.5. Again, that's mainly ground beef driving that.”


HEDGEYE:  Live cattle prices are up 22% YoY and, we believe, will continue to be a negative for RRGB’s P&L going forward.



WEN (8/11/11): “That's one of the reasons why as we've talked about our margin guidance, we do not expect to see much relief on beef cost this year.”



Howard Penney

Managing Director


Rory Green