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European Risk Monitor: At the Halfway Point? No Chance.

Positions in Europe: Short EUR-USD (FXE)

The Eurocrats will be kicking the can further down the road... Based on comments from this weekend’s EU Summit, the tea leaves suggest this Wednesday’s second Summit meeting will underwhelm market expectations. The read-through from this weekend is that the ECB remains firm in not playing ball—that is taking on balance sheet risk to support (leverage) the EFSF; banks are responsible for recapitalizing themselves; and no guidance on the haircuts (exact percentage) banks should take on Greek holdings. 


In order, this portends:


On the ECB:  So long as the ECB is not going to directly support bolstering the EFSF, we don’t see any hope of expanding the facility in short order. The most recent example is the grave effort it took (months) for member states to ratify the July 21st EFSF, which didn’t even boost the current size of the facility.


The ECB continues its sovereign bond purchasing program [SMP], buying €4.49B in the week ended October 21st (vs €2.24B Oct. 14) of program’s total €169.5B, however with 10YR yields on Italian bonds trading right at the 6%, we’re not optimistic that this program can contain Italy’s sovereign risk (more below).


On Bank Recaps: In typical Eurocrat form, comments suggest banks will be responsible for recapitalizing themselves. No measures were offered in the very likely case that not all banks can accomplish this (risk management?). If the market is going to feel comfortable with this “plan”, there will need to be firm mandates on the size, scope, and timing of these recapitalization, as well as secondary plans should the banks not be able to accomplish the recap themselves. What are the nationalization strategies? How will the EFSF contribute to support banks when such measures have never been clearly outline, and more importantly, the facility is undercapitalized to support banks and sovereigns across the region?  The web of cross-country exposures and derivative impact makes answering these questions all the more difficult.


On Greek Haircuts:  Sarkozy said that “on the question of Greece, things are moving along. We’re not there yet”. There’s still no specific guidance on the haircut international lenders should assume, at 21% (as proposal 3 months ago) or closer to the 50-60% range supported by the German camp. 


Remember, any haircut on Greek debt will be a technical default, so Eurocrats will continue to tip-toe around the subject/define it in all terms other than what it is, as to shield issues around the constitutionality of a default within the Eurozone, as there’s no specific language that provides guidance for debt default/”forgiveness” in any of the major treaties.   



Given the above we expect to be underwhelmed by Wednesday’s meeting to produce any form of a “Bazooka” to cure Europe’s entire sovereign and banking ills. For more see our note on 10/20 titled “Italy’s 10YR at 6.02% Ahead of EU Summit”. We’re short the EUR-USD (FXE) in the Hedgeye Virtual Portfolio for this very reason.  



Risk Metrics

As is typical for Mondays, below are our risk metrics across the sovereigns and banks. You’ll note that yields and CDS spreads on the sovereigns are continue to trend up and to the right, with critical focus now on Italy and Spain’s 10YR bond yield, the former which rose to 6.02% last Thursday. As a reminder, we flag the 6% level on 10YR government bonds as a historically significant level. When Greece, Portugal and Ireland broke through this level, yields shot up expediently and the individual countries required a bailout in short order. And this time around there’s no facility large enough to bailout Italy, which is sitting on €1.9Trillion of debt, or a Spain, or a large nation requiring assistance to prop up its banking sector. 


European Risk Monitor: At the Halfway Point? No Chance. - mh 1


European Sovereign CDS – European sovereign swaps widened slightly last week. Only German and American spreads tightened. American spreads tightened by 12%.  French swaps widened 6.4% to 192 from 180. 


European Risk Monitor: At the Halfway Point? No Chance. - mh 2


European Risk Monitor: At the Halfway Point? No Chance. - mh 3


European Financials CDS Monitor – Bank swaps were mixed in Europe last week, with swaps tightened for 21 of the 40 reference entities. Greek banks were the worst performers, as Alpha Bank A.E. and EFG Eurobank Ergasias S.A widened 30% and 15.2% respectively. German banks also saw deteriorations, with swaps widening an average of 7.5% WoW.


European Risk Monitor: At the Halfway Point? No Chance. - mh 4


Matthew Hedrick

Senior Analyst

UA: Unfavorable Risk/Reward Near-term


Conclusion: We continue to think that there’s a big duration mismatch here. When the short-term investment factors come to roost just as 40% sales growth numbers are incrementally slowing (still stellar, but what matters is on the margin), we think there will be a much better shot to buy UA lower.


TRADE (3-Weeks or Less):

We expect Q3 results to be in-line with expectations ($0.83E) when the company reports before the open tomorrow, but as we’ve made clear in recent weeks, we’re growing increasingly concerned that the Q4 outlook and initial 2012 commentary could be more cautious than expected. If it’s not, then we’ll be even more concerned, because based on all of our work, it should be.


Since 2Q when  inventories were up 74% and UA initially discussed ‘fulfillment issues,’ we’ve seen a material management shake-up on the Operations side of the house and ASP growth in the channel that has tracked below peers based on POS data and our research. In fact, based on Sportscan data, UA ASPs have recently declining while the rest of the industry is strongly positive. Coupled with our growing concern that Charged Cotton sales are tracking below expectations, earnings could be headed lower near-term. Footwear has pierced the 1% market share mark recently, which is positive. But we need to see that double before it really starts to matter. UA is a long ways off.


TREND (3-Months or More):

Relative to the +24% revenue growth UA comped last quarter, Q3 is up against a +22% compare after which comps get progressively tougher over the next three quarters. Core apparel growth appears to remain  healthy and even footwear is starting to pick up on the margin, but we have been getting increasingly concerned with sales of charged cotton relative to expectations.


Based on an incremental $60mm in sales expected from this new line it should account for roughly 7-8% growth in apparel – industry data suggests its running closer to 3-4%. Before we start citing any trends relative to industry data, we first have to highlight the fact that UA’s DTC, DKS, and TSA account for over 50% of UA’s distribution, which should also be its most productive. That said, we’d have to assume that sales of charged cotton has to be running at ~3x in those channels to be keeping pace with expectations – possible, but greater disparity between the channels then we’d like to see. In addition, ASPs for charged cotton have declined by ~10% over the past month perhaps indicating softer than anticipated sales. For perspective, if the category is tracking at adding an incremental ~6% growth to apparel it is likely to come in closer to $50mm in revs for the year vs. $60-$70mm suggested. That could equate to as much as a 2-4pt deceleration in top-line sales growth expectations in Q4 (consensus at +33%).


If the top-line is indeed starting to slow as we suspect, inventories could take longer to clear and margin pressures will prove to be greater than the company’s original margin adjustment in Q2. Now UA could feasibly pull back on SG&A – like it has in each of the past two quarters – to help hit earnings, but that would increasingly jeopardize the company’s ability to drive top-line growth in 2012. That’s not a trade off we’d like to see. In fact, given the money UA has spent on endorsements over the last year (Michael Phelps, Tom Brady, Lindsay Vonn, Kemba Walker, Derrick Williams (#2 NBA draft – ahead of Kemba at #9) along with retail store growth – it’s not a trade off we’re likely to see.


The punchline is that we’re willing to front UA the benefit of sales growth, OR margin. But certainly not both. Our sense is that the consensus will prove too bullish on one or the other. The Street might give the stock a pass so long as revenue comes in – even though it’s more expensive. For what it’s worth, the biggest pushback we get on a UA short is “I believe that they’ll ultimately grow, and if margins get hurt now, I can live with that. There’s just not much else out there I can own.”


TAIL (3-Years or Less):

We continue to like UA a lot using our TAIL duration – even though we would not buy at current prices. The reality is that this is a great brand, and the company behind it is going through puberty – and is handling the change quite well. But that does not mean that there won’t be operational snafus while the company finds it way in exploring new consumers (women), channels of distribution (DTC), products (footwear), and regions (anything non-US).  It’s currently in the midst of a big snafu that will take several quarters to resolve at a minimum.


In addition,  a new subtle long-term concern has crept into the equation for us. The reality is that Plank supercharged the footwear organization about 28 months ago, and we’ve really seen nada since then. This is simply taking too long. There are other power brands we’ve seen perennially fail over time in key categories (Columbia, Reebok, Adidas, Timberland). From where we sit, a perennial opportunity either means that a company is mis-executing, or is simply not spending enough money to get it done.


The reality with UA is that Kevin Plank will make the footwear business a real player. We’re pretty convinced there. But the question is whether he’ll have to invest more money in order to do that.


In people’s models, they have sales of 25%+ and margins of 10% that are creeping higher over time. I won’t debate the top line opportunity. But perhaps we should consider if the appropriate margin target here is closer to 8%. That’d definitely put a name trading at 40x+ earnings into a new perspective.



Key Issues re Earnings:

  • Top-line trajectory – especially in charged cotton, women’s and footwear
  • How much margin UA is giving up to clear inventories
  • Is current level of SG&A/Capex spend enough to build a real Footwear business
  • Initial 2012 Outlook

Earnings: While we’re in-line with estimates in Q3 ($0.83E), we are coming in below revenue expectations for Q4 at +28.6% vs. +33%E and earnings of $0.56 vs. $0.62E.


UA: Unfavorable Risk/Reward Near-term - UA apparel industry ASP 10 11


UA: Unfavorable Risk/Reward Near-term - UA charged cotton sales ASP 10 11


UA: Unfavorable Risk/Reward Near-term - UA storm cotton 10 11


UA: Unfavorable Risk/Reward Near-term - UA total charged cotton sales 10 11


UA: Unfavorable Risk/Reward Near-term - UA chrg ctn apparel contribution 10 24 11


UA: Unfavorable Risk/Reward Near-term - UA new shoe contribution 10 11


UA: Unfavorable Risk/Reward Near-term - UA 10 24 11


UA: Unfavorable Risk/Reward Near-term - UA Scorecard 10 11


Brian McGough & Casey Flavin 


Shorting: SP500 Levels, Refreshed

POSITION: Long Consumer Discretionary (XLY), Short Consumer Staples (XLP), Short SP500 (SPY)


Short high. On our way up to 1266, that is…


I was leaning long for the better part of last week (12 LONGS, 7 SHORTS on Thursday), and now I’m taking that net exposure right back to neutral (10 LONGS, 10 SHORTS). While it’s never easy to pick your spot from a beta perspective, I do not think this spot is very difficult to choose. 

  1. The TAIL (1266) remains broken
  2. The TRADE (1) is now immediate-term overbought
  3. The Catalyst (EU Summit decisions Wednesday) looks like it could very well be bearish relative to expectations 

Every market has a time and price that bakes in some level of expectations. The heartache usually occurs for the largest amount of people at the most unfortunate time. While the Pain Trade has been higher since the SP500 moved to bullish TRADE 2 weeks ago, now I think it could move to lower – in a hurry.


Immediate-term TRADE support at 1218 is what I’m looking for. If that breaks on event risk, there will be a sharp 40-50 points of SP500 downside risk that appears very quickly. If 1218 holds, just cover shorts there and trade the range.



Keith R. McCullough
Chief Executive Officer


Shorting: SP500 Levels, Refreshed - SPX

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China’s vast manufacturing sector expanded moderately in October to snap three months of contraction, assuaging fears that a hard landing is imminent in China.




U.S. companies’ hiring plans reflect the worst employment outlook since January 2010 as demand is slowing, according to Bloomberg news.





THE HBM: DNKN, MCD, CBRL - subsector fbr





DNKN: Dunkin’ Brands has appointed Joe Uva to the Board of Directors.  Mr. Uva was most recently President and CEO of Univision Communications, Inc.


MCD: McDonald’s UK boss was interviewed in the Telegraph.  The article is positive, with the head of McDonald’s in the UK highlighting 22 consecutive quarters of UK sales growth as evidence of the company’s success.




CBRL: Cracker Barrel’s biggest shareholder, Biglari Holdings, has boosted its stake to 9.9%


THE HBM: DNKN, MCD, CBRL - stocks 1024



Howard Penney

Managing Director


Rory Green



Our stance on BWLD remains intact; the company’s most recent quarter was strong from a comparable sales perspective but coming commodity inflation is set to change the landscape meaningfully.


Buffalo Wild Wings posted stronger comps than we were anticipating largely due to the unlimited wings lunch promotion.  With the 3Q cost of traditional chicken wings having been as low as it was ($1.16 per lbs or 18% lower than 3Q10), offering such a promotion had an impact on margins that was easily offset by the incremental traffic generated.  However, this strategy is unsustainable and does nothing to convince us that the stock’s current level is sustainable. The most important part of this thesis is that chicken wing prices are heading higher and will likely become a headwind half-way through the first quarter of 2012.


At the Sanderson Farms Investor Conference in New Orleans last week, there were detailed presentations given by various members of the SAFM team as well as Sue Trudell from Express Markets, Inc on the Broiler Industry and Tim Brushnan from Brock & Associates on the grain market.  The most important take away from the meeting from BWLD’s perspective is that chicken (and wing) prices are most likely going higher. 


The insight on the broiler industry was particularly telling; chicken wing prices are expected to move significantly higher during the winter and into the Super Bowl.  While Trudell did not think that wing prices were going to reach ’09 peak levels, her company’s analysis is anticipating prices touching $1.50 and staying above 2011 levels for the majority of 2012.  Joe Sanderson, giving his take on wing price trends, anticipates $1.45 per pound by the time the Super Bowl rolls around.  It is also worth noting that the chicken wing prices forecasted during the presentation were “conservative” in their assumptions.  It is possible that 2012 could pose significant challenges for BWLD from a cost of sales perspective.


For the first three quarters of 2011 wing prices for BWLD have averaged $1.22, $1.02 and $1.16 per pound, respectively.  For context, if chicken wing prices were to average $1.50 during the first three quarters of 2012, that would represent year-over-year wing price inflation of 23%, 47%, and 29% during 1Q, 2Q, and 3Q, respectively.  From a commodity perspective, 2012 is shaping up to be a very difficult year for BWLD.  






Howard Penney

Managing Director


Rory Green



The Macau Metro Monitor, October 24, 2011




Visitor arrivals increased by 17.8% YoY to 2,166,627 in September 2011.  Visitors from Mainland China surged by 39.3% YoY to 1,246,256.  Mainland visitors traveling to Macau under the IVS totaled 449,098, up by 31.7% YoY.   On the contrary, visitors from Hong Kong (582,025); Taiwan (101,047); Japan (35,623) and the Republic of Korea (26,677) decreased by 2.7%, 0.6%, 12.1% and 9.5% respectively; however, visitors from Singapore (23,118) registered a notable increase of 36.2%. 





September passenger movement at Singapore's Changi Airport increased 12.5% YoY to 3,817,720.



Singapore's CPI slowed to 5.5% YoY growth in September, down from 5.7% growth in August.  Economists were expecting a 5.7% print.  The Monetary Authority of Singapore's core inflation rate eased to 2.1% YoY in September, down from 2.2% the previous month.



Secretary Tam said the government is preparing a new package of measures, including an increase in food supply sources, to curb inflation in Macau.  Macau CEO Chui Sai On will unveil the full package in the November policy address.

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