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Golden Handcuffs

This note was originally published at 8am on November 01, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“You know what it is? It is a golden handcuff, with the keys thrown away.”

-O. Henry

 

Keith and I are in San Francisco with our colleague, and one of the top young institutional salesmen in the business, Bill LeClerc, visiting some of our current and prospective subscribers. (We may also stop by the Googleplex for a quick game of roller hockey if Sergey and Larry accept the Hedgeye challenge.)  Having covered technology in the late 1990s and early 2000s, I know full well that there is something special about San Francisco, and I’m reminded of that on every visit.

 

Coincident with this visit, I’ve also been reading “Steve Jobs” by Walter Isaacson.  The story of Steve Jobs, and the creation of Apple Computer, is, in many ways, emblematic of the last thirty some years of business history in Silicon Valley.  Plenty of time has been spent rehashing Jobs’ incredible career and personal quirks, but I wanted to highlight one interesting quote from the book, which is as follows:

 

“Rod Holt, who had built the power supply, was getting a lot options and tried to turn Jobs around.  “We have to do something for your buddy Daniel, he said, and he suggested they each give him some their own options. “Whatever you give him, I will match it,” said Holt.  Replied Jobs, “I will give him zero.”

 

Now, I’m not about to psychoanalyze Steve Jobs, but I did find this excerpt interesting.  The Daniel in question, was Daniel Kottke, who was a college friend of Jobs and one of the first employees of Apple.  Unfortunately, Kottke wasn’t a high-enough level employee to be cut in on the option pool pre-IPO and Jobs, in a very dispassionate manner, wasn’t willing to make a “charitable” exception.  To Jobs, it seems, there were no free lunches.

 

Like global macro markets, Steve Jobs waited for no one.  At times Job’s personal drive was seen as extreme and insensitive, yet his success in innovation is difficult to compare.  As is widely known, Jobs was Buddhist, a long time vegetarian, and for much of his early career only showered once a week.  Despite these somewhat “liberal” tendencies, he created all of his businesses without the Golden Handcuffs of government intervention.

 

This morning we are seeing the downside of reliance on the Golden Handcuffs of government intervention.  Currently, major European equity markets are down across the board from -2.5% to -4.0%.  Leading the charge are Italian and Greek stock markets, down -5% and -6%, respectively. In terms of sectors, the European banking sector is at the forefront to the downside, with the major French banks down close to -10% across the board.

 

Certainly, this is crazy equity price action given that it seems like just yesterday that Europe was bailed out and saved from the sovereign debt contagion.  Well, actually it literally was yesterday, or at least late last week.  From the outset, we were suspicious of the Bazooka press release.  As Keith wrote last Thursday:

 

“In the end (and, in the end, this will not end well), I don’t think this concept of Bazooka Light will make a lot of sense to anyone who takes a deep breath and actually reads what it implies.

 

The timing and size obviously matter – but the timing (end of November? is subject to a hefty political debate) and the size is basically whatever the Europeans want the media to buy into the headline being.”

 

This morning the key question seems to relate to timing as there is news out that the Greeks will hold a referendum on the EU debt deal, most likely in the December / January time frame – along with a confidence vote on the government in the coming days.  It seems the Greek people, who according to reports yesterday have more Porsche Cayenne’s registered than tax payers making over $50,000 per year, want to take their time and think about the bailout.  Personally, I would probably want to think about the Golden Handcuffs before I put them on as well.  But as I noted above, global macro markets wait for no one.

 

In the Chart of the Day below, we’ve also flagged the widening spreads between Italian government bonds and similar duration German Bunds.  As of this morning, this spread is literally as wide as it has ever been.  Certainly, Greece is one thing, but Italy is the eighth largest economy in the world with debt-to-GDP at north of 120%.  Unfortunately, for those looking for good news, this widening of Italian yields is signaling that things are going to get worse before they get better in Italy.

 

To add insult to injury, we are receiving PMI measures this morning that are foreshadowing a further deceleration of growth in Europe. Specifically, Chinese PMI for October came in at 50.4 versus the estimate of 51.8 and U.K. PMI came in at 47.4 versus the estimate of 50.0.  Tomorrow morning, the rest of European PMIs are released. Stay tuned.

 

Mr. Draghi, welcome to the ECB!

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Golden Handcuffs - Chart of the Day

 

Golden Handcuffs - Virtual Portfolio



Great Inflations

“The fear of another great inflation remained with him all his life.”

-Niall Ferguson

 

Inflation is a centrally planned policy. Period.

 

History is littered with examples of governments devaluing their fiat currencies for short-term political resolve. Keynesians can call their goals “price stability” and “full employment” all they want. The People are starting to call that a joke. In the long-term, banning both gravitational forces and the truth about long-term prices will be difficult.

 

The aforementioned quote comes from an excellent book that I am in the middle of studying – Niall Ferguson’s High Financier – The Lives and Times of Siegmund Warburg. In the Post 1913 Federal Reserve Act Period (Chart of The Day), there are very few merchant bankers (not to be confused with central or too-big-to-perform bankers) who rival Warburg’s legacy.

 

What’s most interesting to me about Warburg (like it is with most revolutionary capitalists), is where he came from. Context and experience are some of the things I personally thank God for every day of my life. For Siegmund Warburg, context and experience are what made him the change that the British and American banking systems needed to see.

 

“I brought something to England which was a little bit different because I was a damn foreigner, a German Jew.”

-Siegmund Warburg (High Financier, page 233)

 

You don’t have to take my word for it on any of this. I’m just a Canadian who came to the American Financial Empire in 1995 and studied the source code of Keynesian economic dogma at Yale in my cutoff jean shorts.

 

Take Harvard’s word for it – Ferguson’s book has 104 pages of footnotes.

 

You don’t have to take Warburg’s word for it either – few in the Establishment of the British economic elite did after he became a British citizen in 1939. But when a post WWII debt-laden England resorted to debauching the British Pound, Warburg called them out on it, big time.

 

Great Inflations?

 

Warburg lived through Germany’s hyperinflation of the 1920s and the politicized central banking that perpetuated it. Today’s good ole boy network money printing is not a new strategy. We don’t have that hyperinflation (yet) either. But the manic financial media seems hell bent on cheering on its catalysts.

 

WTIC and Brent Crude oil prices are trading at $95 and $112/barrel this morning. Deflation? Pull up any long-term chart that doesn’t use 2008’s $150/barrel oil price as its anchoring point in the analysis (all-time high), and you’ll conclude what every man, woman, and child from Kenya to Vietnam already has – Keynesian monetary policies are exporting generationally high levels of food and energy inflation.

 

Warburg didn’t believe in trading prop, levering up his client deposits, or front-running client capital. His strategy was to simply keep his bank’s balance sheet liquid and conservatively positioned throughout the British and French currency devaluations of the 1950s and 1960s. He also avoided getting train wrecked by the US Dollar Devaluation that ensued under Nixon and Carter in the 1970s.

 

Warburg fundamentally believed that “inflation was primarily a political phenomenon caused by governments who do not have the courage to either reduce their expenditure or to cover it by taxation.” (High Financier, page 36). Sound familiar?

 

The sad and pathetic reality about Western Economic Leadership in the 21stcentury (read case studies of both Bush/Obama US Administrations, the 8 or 9 Japanese PM’s they’ve had in the last decade, or … uh, Europe!), is that this is all very familiar.

 

“To sin by silence when they should protest makes cowards of men.”

-Abraham Lincoln

 

The metaphor that Ferguson and I make between the British Empire’s peak (then) and America’s (potentially now) is a very important debate that needs to be had. If we repeat history’s mistakes, our children have no business forgiving the elephantine intellects endowed upon us from our Ivy League institutions.

 

In the late 1940’s and early 1950’s Warburg was at least as critical of British policy as Hedgeye and many others are of US fiscal and monetary policy today.

 

Then?

 

“By the September 1949 devaluation, which saw the Pound’s dollar value reduced by 30% from $4.03 to $2.80, his Wartime enthusiasm for Labour had waned significantly… he argued in a highly critical memorandum written in August of that year … The country was spending too much on defence. Profits and pay were on a much too high level… the employers indulge frequently in illusions as to the profits …” (High Financier, page 131)

 

Now?

 

But, but, but … if you don’t adjust them for inflation, ‘corporate profits are great’… and we continue to beg for The Bernank and/or the Italian Job from Super Mario, to cut, print, cut… beg, cut, print… print, bail, cut…

 

If you’ve been awake since 2006 and watched Big Government Interventions A) shorten economic cycles and B) amplify market volatilities, you get it. Great expectations for Great Inflations have become the root of the common man’s heartache.

 

My immediate-term support and resistance ranges for Gold, Oil, German DAX, and the SP500 are now $1, $92.66-94.86, 6105-6413, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Great Inflations - Chart of the Day

 

Great Inflations - Virtual Portfolio


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SBUX: GLOBAL GROWTH

EPS guidance was back-loaded for 2012 as coffee costs are expected to depress margins in the near term.  The top-line remains as impressive as ever.

 

Starbucks posted EPS of $0.37 for the fiscal fourth quarter of 2011 versus consensus expectations of $0.36.  U.S. comps came in at +10% versus expectations of 7%.  International comps gained +6% during the quarter versus the Street at +4.5%.   CPG revenues came slightly below the Street at $242.2mm but operating margin was 31.4% versus 28.4% expectations.

 

Starbucks remains one of our favorite long names and we continue to be long the stock in the Hedgeye Virtual Portfolio. 

 

Below are out top ten takeaways for the quarter: 

  1. EPS guidance was lowered for the first half of 2012 but full-year EPS was maintained.  Management emphasized that this was due solely to coffee cost pressures.  We view this as a slight negative but expect the company to achieve FY12 EPS guidance.
  2. Starbucks’ top-line remains strong and we would expect that to continue in FY12 as management diligently identifies and attacks new media of growth.  The My Starbucks Rewards program is gaining more and more traction.  There are now over 3.6 million active members, nearly 2 million of whom are gold level members.  In FY11, over $1.1 billion in purchases was paid for using the Starbucks card.  The mobile apps (iPhone and Android) are also gaining users.  At the end of September almost 1 million smartphones had registered Starbucks cards associated with them.  We believe that the mobile apps and other initiatives that add to the customer experience will continue to differentiate Starbucks and help boost sales.
  3. The U.S. business remains strong despite the soft economy, as the results show.  The fall promotions featuring Pumpkin Spice Latte and Salted Caramel Mocha and Taizo Chai tea beverage platforms helped drive 4Q sales.  Sales of the Pumpkin Spice Latte grew 44% year-over-year.
  4. In FY12 the company will open 200 locations and remodel 1,700 stores in the U.S.  This is the largest number of remodels ever carried out in one year. 
  5. The international business continues to present the company with growth opportunity as the company operates over 6,200 stores in 55 international markets.  Last week the 500thStarbucks was opened in China and the company still aims to have 1,500 stores open in China by 2015.  The pace of new unit opening will accelerate in 2012.  Margins in China are expected to continue to be in the near-30% range.
  6. The company is bullish on the prospects of its new bagged coffee offering, Starbucks Blonde Roast.  The company believes there is demand from roughly 54 million (40% of U.S. Coffee drinkers) domestic coffee drinkers who want Starbucks quality in a lighter, super premium roast coffee.
  7. The company is equally bullish on the prospects of its K-Cup business, which is expected to launch next week.  Management acknowledged that some cannibalization of the CPG business is likely but sees any impact as small and expects both businesses to growth over time.  Particular to single serve, the company noted that about 8% of households in the U.S. have a single serve brewer in their homes.  Their expectation is that that number will grow over the next five years, perhaps even triple. Starbucks anticipates that K-Cups will represent a greater-than-$1 billion business over time.
  8. Business in Canada had been soft earlier in the year but the fourth fiscal quarter brought a strong uptick for the company’s roughly 800 locations north of the border. 
  9. Business in Europe continues to be “a bit soft”.  “Over-time”, however, management expects the EMEA locations to progress toward mid-teen margins.
  10. Management’s projection for global store growth remains unchanged at 800 net new stores.  Roughly 400 of those will be in the Americas regions with licensed stores comprising roughly half of the new additions.  300 will be in China and Asia-Pacific (licensed will be 1/3 to 1/2 of new additions) and 100 will be in EMEA (licensed will be 2/3 of new additions).

 

SBUX: GLOBAL GROWTH - sbux pod1

 

SBUX: GLOBAL GROWTH - SBUX quadrant

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 

 


Weekly Latin America Risk Monitor: Heavy Lies the Crown

Conclusion: While a bullish catalyst in the long term (lower commodity-based inflation), King Dollar is weighing on Latin American economies and financial markets in the short term.

 

PRICES RULE

Latin America equity markets are getting rocked week-to-date, closing down -2.3% on a median basis. Declines are being led by Argentina (-7.3%), which remains our highest-conviction bearish thesis throughout the region’s equity markets. Latin American currencies are dropping as well, declining -1.5% week-to-date on a median basis vs. the USD. The Mexican peso (MXN) – a currency we’ve remained bearish on for 2+ quarters - is leading declines on both a short and intermediate term basis (down -3% wk-to-date; -13.6% in the last 6mo).

 

There hasn’t been much movement across Latin American fixed income markets in the week-to-date, though the broad-based declines in 10s/2s spreads is a signal to us that Slowing Growth hasn’t been fully priced in. Additionally, the -7bps week-to-date decline in Brazil’s 2yr sovereign debt yields on top of another -11bps decline in the country’s 1yr on-shore interest rate swaps signals to us that more rate cuts are likely on the way in Brazil. To that tune, the same 1yr swaps are trading a full -122bps below the 11.5% benchmark Selic rate. Colombia, which hasn’t begun to ease monetary policy after hiking +150bps YTD, are seeing their 1yr interest rate swaps trade down -26bps week-to-date – a full -311bps below the benchmark 4.5% minimum repo policy rate. All told, monetary easing across this region is incrementally supportive of our King Dollar thesis.

 

From a credit risk perspective, Latin American 5yr CDS are widening across the board, up +12.5% on a median basis in percentage terms. Deterioration is being led by Mexico, whose swaps have widened +14.2% (+18bps).

 

THE LEAST YOU NEED TO KNOW

Rather than delineate these data points by country, given the varying size and importance of these economies, we thought we’d try something different by grouping them by theme. Ideally, this should make it easier to absorb and contextualize anything of significance. Lastly, the callouts below are from the prior seven days:

 

Global Growth Slowing:

  • Brazilian industrial production growth slowed in September to -2% YoY vs. -0.1% prior, led by declines in durable and capital goods (down -9% and -5.5%, respectively).

King Dollar:

  • Brazilian giant Fibria Celulose SA, the world’s largest pulpmaker, posted the worst quarterly loss in company history in 3Q as the real’s (BRL) -16.9% decline vs. the U.S. dollar during the quarter increased the cost of servicing dollar-denominated debt in local currency terms. We’ve been aggressively hitting on the global side effects of a bullish buck breakout and Fibria’s 3Q earnings report is merely a microcosm of what’s happening internationally (see: Vale, Bharti Airtel, Turkish Airlines, etc.). Emerging market commodity-heavy and capital-intensive industries remain at most risk of underperformance, due to the double squeeze on revenues and debt service expenses. The latest YTD price action across the MSCI EM sector indices is supportive of our view.
  • The capital flight situation in Argentina has taken a turn for the worse, largely due to the recent spate of Big Government Intervention (forced corporate repatriation and banning certain forms of dollar purchases and requiring approval for others at a ~15% acceptance rate) following Fernandez’s landslide presidential victory. As an aside, in a effort to secure victory, she literally doubled public spending in September ahead of the October election. Slowing peso depreciation via selling dollars has pushed the country’s FX reserves down nearly -10% YTD to $47.4 billion – threatening to dramatically constrict the Fernandez’s plan to use $5.7 billion of these reserves to service international debt payments in 2012. As of now, Argentina’s “free and available reserves” (as defined by statute) are only $2.5 billion. The peso needs to drop another -7% from the current spot rate (holding the monetary base and FX reserves flat) to make her debt service scheme legally permissible – unless she decides to change the rules again!

Sticky Stagflation:

  • Peruvian CPI accelerated in October to +4.2% YoY vs. +3.7% prior. Recall that when we put out our note titled, “Shorting Peru” in mid-July, we said that Peru is one of the few economies globally that could have inflation accelerating through the end of the year. That still looks to be the case now.

Counterpoints:

  • Brazil’s manufacturing PMI ticked up in October to 46.5 vs. 45.5. Contracting still, but at a slower rate, which is positive on the margin.
  • Chilean industrial production growth and retail sales both accelerated on the margin in September to +5.2% YoY (vs. +1.7% prior) and +9.6% YoY (vs. +9.1% prior), respectively. Too bad it’s November and global crude prices have increased +6.5% since then (Brent). Thank Fed-head Tarullo for his late-October QE3 comments. 

Darius Dale

Analyst

 

Weekly Latin America Risk Monitor: Heavy Lies the Crown - 1

 

Weekly Latin America Risk Monitor: Heavy Lies the Crown - 2

 

Weekly Latin America Risk Monitor: Heavy Lies the Crown - 3

 

Weekly Latin America Risk Monitor: Heavy Lies the Crown - 4

 

Weekly Latin America Risk Monitor: Heavy Lies the Crown - 5

 

Weekly Latin America Risk Monitor: Heavy Lies the Crown - 6


ASCA 3Q CONF CALL NOTES

Is this the most underappreciated company in gaming?

 

 

“Ameristar had another record-breaking quarterly financial performance, with new high water marks hit for Adjusted EBITDA and Adjusted EPS in a third quarter and the best trailing 12-month Adjusted EBITDA in the Company’s history,”

 

Gordon Kanofsky, CEO

 

 

CONF CALL NOTES

  • Had river flooding in the quarter at Council Bluff
  • Excluding the buyback, their EPS would still have been up 11 cents or 52% YoY
  • Reduced their promotional expenses significantly which has helped the flow-through at their properties
  • Guided to a 25% tax rate last quarter which they weren't unable to take and it's unclear that they will be able to take them.  Their tax rate this quarter was fairly normal.
  • Retired $63MM of debt in the quarter
  • Used 65% of their Adjusted EBITDA to buyback debt
  • 3.83% interest rate at quarter end based on the leverage grid
  • $10-11MM non-cash interest expenses in 4Q
  • Will only make one mandatory principal repayment at 4Q given their seasonal FCF needs in the quarter

 

Q&A

  • Corporate OH - why so high in the quarter and why is next quarter stock comp expense so high?
    • Had some one time refinancing expenses and some personnel changes that occurred. 
    • 4Q stock comp expense is also at a higher than normal run rate.  Board has made a decision to extend options from 7 years to 10 years which adds a $3MM charge in the 4Q. The board has also seen fit to establish a retirement program for options which also added $3MM of one time expense 
  • They have cut $60MM of expenses permanently from their cost structure and believe that is why they are seeing such good flowthrough. Have seen some modest net revenue growth.
  • There are some hold changes that caused the volatility in East Chicago - the fact that the slot floor is fresh helps them. The new casino is 40 miles away.
  • There are some "copycats" out there in regard to their marketing campaigns but it's clearly not impacting them. Having better and fresher product helps. 
  • Kansas City is 25 miles from their property - they haven't made comments on the anticipated impact from that opening

 

HIGHLIGHTS FROM THE RELEASE

  • "The year-over year improvement in net income is mostly attributable to efficient revenue flow-through driven by operating and marketing initiatives."
  • "Notably, Council Bluffs improved year-over-year Adjusted EBITDA by $1.7 million (11.1%) on net revenue growth of $1.9 million (4.9%) while overcoming some operational inconveniences from flood conditions."
  • "Our East Chicago property achieved a 16.1% year-over-year increase in Adjusted EBITDA despite a new competitor opening in Des Plaines, Illinois during the quarter."
  • Net Leverage was 5.15x
  • 3Q Capex: $19.1MM
  • Stock buyback: Repurchased $0.2MM shares at $2.7MM in the 3rd Q and $0.3MM shares for $5.1MM from 10/1-11/2
  • Guidance for FY11:
    • D&A: $104.2 to $105.2MM
    • Interest expense, net of capitalized interest: $106.4 to $107.4MM (incl. non-cash  expense of approx $6.3MM)
    • Tax rate: 41-43% (also for the 4Q)
    • Capex: $65-70MM (predominately maintenance)
    • Non-cash stock-based compensation expense: $22.3 to $23.3MM

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