Retail: Biggest Spending Divergence Ever

Somehow, retail sales march forward while consumer confidence takes it on the chin. Without even making a call on the consumer, this trajectory is simply not sustainable.



Here’s the mother of all (facetious) revealing statements by the Hedgeye Retail team today. “When people are more confident, they buy more ‘stuff’, and when they’re less confident, they buy less -- or at least growth in spending slows.” 


Why then, may I ask, does the chart below exist? It shows the gap between (Bloomberg’s) same store sales composite and Consumer Confidence – the latter of which put in a 3-handle this morning for the first time since March 2009.


Simply put, we’re looking at the widest gap between confidence and spending in recent history.


Even if we ignore the gap for a minute -- and assume that because of some kind of secular shift about which I did not get the memo – the trajectory of these two items is just wrong.


The punchline is that either the delta in spending is going to revert back towards the path of consumer confidence (bearish), or confidence levels will sequentially uptick (bullish) to catch up with where the consumer has already decided to go.


There’s a ton of theories we can conjure up – like the weak housing market is keeping money out of new homes, which is giving people a more meaningful pot of gold (even if the aggregate pot is smaller than last year) to spend in stores. Maybe it’s the on-line effect where we continue to see more impulse purchases (ie Amazon Prime). While that's very real, that one’s a stretch as it relates to explaining away anything in the ballpark of what we're seeing today.


Either way, something’s got to give. Be careful what you own here.


We like the franchise US brands that avoid exposure to a meltdown in global markets, like TGT and WMT. We also like names with accelerating growth and RNOA due to company-specific factors, like LIZ, NKE, and AMZN.


On the flip side, we don't like names that are playing catch-up due to lack of investment in their business -- as well as those that have to compete with them. A better way to say that is that we don't like JCP, KSS, M, HBI, GIL, and after the print -- JNY and CRI. We also don't like UA, but for very different reasons. 


Retail: Biggest Spending Divergence Ever - 10 25 2011 10 40 23 AM

Source: Bloomberg






The ICSC chain store sales index fell 0.8% last week; year-over-year growth tumbled to 2.4%, its weakest performance since June. The result was disappointing given favorably cool weather and a declining gas prices.





THE HBM: MCD, GMCR, BKC, RT - subsector fbr




MCD: McDonald’s was reiterated “Buy” at Barclays Capital.


GMCR: Green Mountain Coffee Roasters was maintained “Buy” at Canaccord Genuity.


BKC: Burger King has a new burger and it looks like BK is trying to take on the "gourmet" burger chains.  At participating restaurants, customers can try the 5.5oz offering (pictured below).


THE HBM: MCD, GMCR, BKC, RT - new bkc burger





RT: Ruby Tuesday is entrusting Durham, N.C.-based McKinney with creative duties.  The switch is the second change for the fast casual chain in the past six months.


THE HBM: MCD, GMCR, BKC, RT - stocks 1025



Howard Penney

Managing Director


Rory Green


UA: Low Quality Beat


UA’s Q3 EPS of $0.88 came in above printed expectations of $0.83E, but the quality of the beat was low due to a $0.04 tax benefit. A real number was closer to $0.84. We were at $0.83, and true market expectations were for a number starting with a 9. This has been one of our top short ideas as the market is underestimating the margin risk for UA to right-size it's growth profile long-term. There's nothing in this release that makes us change that view.


Here are our key takeaways ahead of the 8:30 call:


What We Liked:

  • Incremental footwear revenues were the key driver of +42% top-line growth above our expectation of 37% with the difference in footwear alone accounting for an additional 5% growth. This supports improved trends that we’ve highlighted with recent share gains in the athletic channel with UA finally piercing the 1% market share mark.
  • Other SG&A spend (product innovation etc.) was up +36% consistent with last quarter and slightly higher than we expected. We would have liked to see marketing spend higher as well (see below), but at the end of the day UA needs cutting edge product to sell and this line drives that engine.

What We Didn’t Like:

  • Inventories are still high up +63% yy on +42% revenue growth compared to +73% last quarter. The increase last quarter was attributed to the need to better service demand, an earlier build of ColdGear apparel for the fall/winter season, and the transition of hat’s and bag business in-house. Inventory levels up over 60% for the third quarter in a row has us increasingly concerned in the in the obvious -- which is the direction of Gross Margins. 
  • The absence of an initial 2012 outlook. The company provided its initial view on 2011 in its Q3 release last year and the year before management spoke to it in their opening remarks. If they don’t offer a view in their prepared remarks, you can rest assured they’ll be asked in the Q&A.
  • Marketing spend ratio of 10.4% was the lowest in 5-years. Sure, it’s due in part to higher sales, but we know that endorsement spending is up, which means that media and consumer facing marketing is down – not what we want to see as a 2012 revenue driver.
  • Apparel came in softer than we expected. This doesn’t give us any reason to think that our concern re Q4 apparel revs is unwarranted.  
  • We highlighted the growth in footwear, but timing is playing a role here. Yes, the latest running product is starting to gain traction – a definite positive after several years of disappointment, however the mention of “earlier y/y shipments of basketball product” indicates a shift at play here compared to a much higher level of sustainable demand.
  • The $0.04 tax benefit in the quarter – it boosts the headline number, but is meaningless to true underlying performance.

We’ll be back with more as warranted after the call.


UA: Low Quality Beat - UA S 10 11


Casey Flavin


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It's all about Las Vegas!  Just kidding. 



Macau may disappoint the Street but it all comes down to Singapore where expectations are all over the place.  We were initially worried that management had raised the bar too high on Singapore.  You may recall such comments as "Q3 VIP volumes at the end August had already reached Q2 levels".  However, at least one analyst tried to temper expectations yesterday as September hold percentage may have been a bit low.  Management has a lot of flexibility - and uses it - in determining the hold impact.  As usual, we will try and get you an impartial and unbiased estimate of the hold impact.  For now, we are somewhat agnostic on the stock going into Thursday's Q3 release.


Here are our projections:





We estimate that LVS’s 3 properties will do $1,143MM of net revenue and $364MM of property level EBITDA in 3Q11.  Luck did not smile upon LVS’s properties this quarter – with all three holding low in the 3rd quarter.  We estimate that low hold cost LVS $30MM in net revenue and $18MM of EBITDA on the VIP side.  We’re pretty sure some of that bad luck was offset by good luck on the Mass side, but we’ll have to wait and see until they report that detail.


We estimate that Sands Macau will report $318MM of net revenue and $87MM of EBITDA, which is 5% below the Street.

  • Net gaming revenue of $309MM
    • VIP Net table win of $136MM, negatively impacted by low hold
      • RC volume of $7.7BN, assuming 12% direct play and 2.6% hold
      • Rebate rate of 84bps or 32% of hold
      • Normalizing for hold, gross win would have been $18MM higher and net win would have been $12MM higher.  EBITDA would have been $7MM better.
    • Mass win of $146MM
      • $728MM of drop and 20% hold
    • Slot win of $27MM
  • Net non-gaming revenue of $9MM
    • Promotional expenses of $11MM or 3.5% of net casino revenues
  • $181MM of variable expenses
    • Taxes: $146MM
    • Junket commission and gaming premiums: $29MM
  • $4MM of non-gaming expenses
  • $46MM of fixed expenses in-line with last quarter

We estimate that Venetian Macau will report $671MM of net revenue and $229MM of EBITDA, which is 6% below the Street.

  • Net gaming revenue of $580MM
    • VIP Net table win of $230MM, negatively impacted by low hold
      • RC volume of $12.2BN, assuming 21% direct play and 2.7% hold
      • Rebate rate of 81bps or 30% of hold
      • Normalizing for hold, gross win would have been $19MM higher and net win would have been $13MM higher. EBITDA would have been $8MM better.
    • Mass win of $292MM
      • $1,120MM of drop and 26% hold
    • Slot win of $58MM
  • Net non-gaming revenue of $91MM
    • Promotional expenses of $24MM or 3.5% of net casino revenues
  • $325MM of variable expenses
    • Taxes: $265MM
    • Junket commission and gaming premiums: $47MM
  • $22MM of non-gaming expenses
  • $95MM of fixed expenses

We estimate that Four Seasons/Plaza will report $154MM of net revenue and $48MM of EBITDA, which is in-line with the Street.

  • Net gaming revenue of $131MM
    • VIP Net table win of $78MM, negatively impacted by low hold
      • RC volume of $4.4BN, assuming 41% direct play and 2.7% hold
        • This would mark the second sequential quarter of YoY declines.  We expect that 4Q will see a turnaround in VIP volumes with Neptune opening up its rooms any week now and then Sun City opening by year end.
    • Rebate rate of 89bps or 33% of hold
    • Normalizing for hold, gross win would have been $7MM higher and net win would have been $5MM higher. EBITDA would have been $3MM better
    • Mass win of $42MM
      • $119MM of drop and 35% hold
    • Slot win of $11MM
  • Net non-gaming revenue of $23MM
    • Promotional expenses of $10MM or 7.5% of net casino revenues
  • $78MM of variable expenses
    • Taxes: $66MM
    • Junket commission and gaming premiums: $9MM
  • $7MM of non-gaming expenses
  • $20MM of fixed expenses




We estimate that MBS will produce $785MM of net revenue and $434MM of EBITDA this quarter, which is 10% higher than the Street.  Based on our tax revenue through August, we believe that the Singapore market is on track to do S$2BN of revenue this quarter and MBS has a good shot of capturing more than 50% of the GGR this quarter despite lower sequential hold.

  • Net gaming revenue of $634MM
    • VIP Net table win of $223MM
      • RC volume of $14.7BN, up 43% YoY and 20% sequentially.
      • 2.8% hold – the average hold for MBS since opening has been 2.7%
      • Rebate rate of 1.23%
      • Normalizing for hold, gross win would have been $7MM higher and net win would have been $5MM higher. EBITDA would have been $3MM better.
    • Mass win of $275MM
      • $1.3BN of drop and 22% hold
    • Slot win of $136MM
      • $2.5BN slot handle, 5.4% win rate
  • Net non-gaming revenue of $151MM
    • Promotional expenses of $40MM or 21% of non-gaming revenues
    • $65MM of hotel revenues
  • $143MM of variable expenses
    • Taxes: $135MM
  • $208MM of fixed & non-gaming operating expenses, up a little from $201MM last quarter




We project LVS’s Las Vegas operations will produce $318MM of revenue in 3Q11 and $80MM of EBITDA, which is 4% ahead of the Street.

  • $104MM of net casino revenue
    • Slot win of $36.2MM flat QoQ
      • Handle down 37% YoY to $418MM but up sequentially from $412MM
      • Win %: 8.7%
    • Table win of $83MM
      • -5% YoY table drop ($453MM), 18.3% hold
  • Gross gaming revenue of $119MM and a rebate equal to 3.3% or $14.7MM compared to $15.6MM last quarter
  • $214MM of net non-gaming revenue
    • $106MM of room revenue
      • RevPAR: $164 (up 6% YoY)
        • Occupancy: 88%
        • ADR: $187
  • $126MM of F&B, Retail and other revenue, up 15% YoY
  • Promotional expenses equal to 15% of gross gaming revenue or $18MM
  • Gaming taxes of $8MM and total operating expenses of $230MM, down slightly from $232MM last quarter




We estimate that Sands Bethlehem will report 3Q11 net revenue of $110MM and EBITDA of $28MM

  • $70MM of slot revenue, $30MM of table revenue


  • D&A: $206MM
  • Rental expense: $10MM
  • $50MM of corporate and stock comp expense
  • Net interest expense:  $51MM

CHART OF THE DAY: Irrational Expectations


CHART OF THE DAY: Irrational Expectations - Chart of the Day

Irrational Expectations

“Hope is nature’s veil for hiding truth’s nakedness.”

-Alfred Nobel


In one of the more ironic moments of 2011, Professor Tom Sargent from New York University won the Nobel Prize of Economics.   Sargent was awarded the Nobel Prize for his work on rational expectations.  In effect, this is the theory that postulates that policy makers cannot systematically influence the economy via predictable policy changes.


This idea, of course, flies in the face of the current philosophy of the leading central bankers around the world and, in particular, Chairman Bernanke.  In the guise of transparency, not only does Chairman Bernanke foreshadow most of his moves, but he now also holds a quarterly press conference to further alert the market as to his future intentions.  Undoubtedly, wherever he is now, Alfred Nobel is finding this moment in economic history somewhat ironic.


The concept of “too big to fail” has now wholly pervaded the economic landscape.  Sargent, as the key proponent of rational expectations, has some interesting thoughts related to failure.  His views likely do not reflect “the conscience of a liberal”, like those of his Nobel Laureate counterpart Paul Krugman, but they do offer some interesting counterpoints to the current debates in economic policy circles.  In a June 2010 interview with the Minnesota Fed, Sargent made a number of noteworthy comments relating to the European debt situation, specifically:


“Remember that under the gold standard, there was no law that restricted your debt-GDP ratio or deficit-GDP ratio. Feasibility and credit markets did the job.


Here is what went haywire. In the 2000s, France and Germany, the two key countries at the center of the Union, violated the fiscal rules year after year.


So, a number of countries at the European Union economic periphery—Greece, in particular—violated the rules convincingly enough to unleash the threat of unpleasant arithmetic in those countries. The telltale signs were persistently rising debt-GDP ratios in those countries.


The banks located in the center of the euro area, France and Germany, hold Greek-denominated debt, so a threat of default on Greek government debt threatens the portfolios of those banks in other European countries. Because it is the lender of last resort, now it is the ECB’s business.


France and Germany stay “holier than thou” from beginning to end, and always respect the fiscal limits imposed by the Maastricht Treaty. They thereby acquire the moral authority to lead by example, and the central core of euro-area countries are running budgets that without doubt are balanced in a present-value sense. Therefore, the euro is strong. The banks of the core countries,  so the banks in France and Germany are not holding any dodgy bonds issued by governments of dubious peripheral countries that have adopted the euro but that flirt with violating the Maastricht Treaty rules.


In this virtual history, the ECB could play tough and let the Greek government default on its creditors by renegotiating terms of the debt. For the euro, letting the Greek bondholders suffer would actually be therapeutic; it would strengthen the euro by teaching peripheral countries that the ECB means business.”


In Sargent’s models the threat of failure is critical, whether it be for institutions, countries, or individuals, because it is exactly this threat that will shape future behavior and reform.


Relate to Sargent’s comments, one of the more surprising global macro moves since the start of October has been the sharp rally in the EUR-USD going from a low of 1.31 in early October to 1.39 this morning.  This is an expedited move of more than 6% in about three weeks.  In the highly correlated world of global markets, this expedited move has had an impact. In the same period,

  • Brent Crude Oil is up +11.9%;
  • West Texas Intermediate Crude Oil is up +21%;
  • Copper is up +14.1%;
  • SP500 is up +14.1%; and
  • Euro Stoxx 50 is up +12.1%

One of our key three themes for Q4 is Correlation Crash.  So far, on the expedited move up in the Euro, and down move in the dollar, the crash has been to the upside this quarter.  The more accelerated the move to the upside, though, the more increased the risk for an eventual correction to the downside.  A risk that heightens every day in our notebooks.


Our view has been that the recent surge in the EUR-USD is a function of both short covering, which obviously builds upon itself, and also Irrational Expectations as it relates to outcomes in Europe.  The best fundamental support we can point for our views is in comparing yields on Italian 5-year government bonds versus the comparable duration German bunds.  Given this spread is at its widest point in the last decade, the read-through, despite some recent manic moves in global markets, is that the European situation is far from solved.


The theory of rational expectations would suggest that by bailing out Europe in ever-growing increments, market participants will begin to expect ever-growing bailouts, which, over time, should negatively impact the EUR-USD.  Further, the continued safety net created by European officials won’t adequately underscore the fiscal sobriety that is ultimately required in Europe for a truly healthy currency.  It is akin to bringing a drunk friend water and comfort food every morning after his drinking binge.  In doing so, you are not exactly encouraging his or her sobriety.


In the short term, market prices can bring us hope, but they are often “hiding truth’s nakedness.”


Daryl G. Jones

Director of Research


Irrational Expectations - Chart of the Day


Irrational Expectations - Virtual Portfolio

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