“We should not be waiting any longer.”
In one of the more suspicious central planning moves to-date, it appears that the new Italian Chief of Central Planning, Mario Draghi, is working on changing the date of Christmas.
Santa, as you can see, is really red. This whole thing about the Nasdaq and US Small Caps being down for 3 consecutive weeks in November (SP500 down -3%) has Bernanke’s central plan for reaching “escape velocity” from the chimney under fire too.
If Americans and Europeans change all of the rules and all of the dates, there’s really a lot we can do. You see, this is what these people fundamentally believe – they can save us from, well, just about any problem they perpetuate.
The aforementioned quote came from Santa Mario this morning where he started calling out the Germans in Frankfurt. “Where is the implementation of these long standing decisions?” Draghi asked.
Q: Qu’est ce qui ce passe avec Le Bazooka pour les banks? demanded Monsieur Sarkozy.
A: “If politicians believe the ECB can solve the problem of the Euro’s weakness, then they’re trying to convince themselves of something that won’t happen.” –Angela Merkel
Bad German Santa. Bad.
Back to the Global Macro Grind…
Yesterday I covered shorts and bought some of our Hedgeye Best Ideas on the long side (ask for the replay of our analyst team’s Best Ideas Call from last Friday), taking my net long position in the Hedgeye Portfolio to one of its most bullish leans in November (12 LONGS, 8 SHORTS).
That doesn’t mean I believe in Le Pere Noel or that a few Keynesians by the name of Mario are going to save me on the long side either. It simply means that I am doing what my risk management process allows me to do – Fade Beta.
Fading Beta means buying on red and selling on green. It’s not as complicated as figuring out the European catalyst calendar. It’s just math. I base these decisions on a model that I’ve built. I don’t have to ask my boss for permission to act on its signals.
The risk management signals aren’t perfect, but they’ve been better than being Bad Beta in November. We’ve booked 13 consecutive gains on the long side of the Hedgeye Portfolio and have gone 17 for 19 in November. Beats believing in Santa too.
Like all of you, I’m proud of my team and process when they are working together. I’m not a whiner. I celebrate winning. And hopefully that message is resonating with your process. At the end of the day, this business is all about the score. Winning matters.
Where do we go from here?
On the bounce, sell on green, again.
All low-volume rallies to lower-highs in Asian, European, and US Equities are to be sold until consensus fundamentally starts to come to grips with what the Germans are saying.
- If any European banks are going to be bailed out, German banks get to go first (Deutsche Bank, Commerzbank, etc).
- If any French or Italian banker thinks Lagarde or Draghi are getting them a priority pass ahead of German banks, they should think that through again…
- If and when all of these Greek, French, Italian, etc banks prove that they can’t raise money (read: secondaries in the public market), they have to tap their sovereign leaders first, then start begging for the EFSF funding.
Like intermediate-term tops in markets, the deleveraging of balance sheets is a process, not a point. There have been plenty of points in the last 3 to 24 months where pundits have made the call that “this is it – this is the bottom for the banks”, but the process of marking bank stocks and their equity values to market continues to trump all hopes.
Hope (and begging for Santa Mario), is not a risk management process. And “printing money”, according to Merkel’s spokesman on the economy this morning, “… at the end of the day means inflation…” and “every German is very much scared about inflation.”
As Ben Bernanke anchors on the 1930s (instead of the 1970s Stagflation), the German Zeitgeist is anchoring on the 1920s. Interconnected risk is not managed on one duration to suit the needs of one country’s central banking narrative over another’s. Interconnected risk is multi-duration, multi-factor, and global.
If you don’t get that yet, you probably still believe in Santa coming this November too.
My immediate-term support and resistance ranges for Gold (bought more yesterday), Oil (Bullish Formation and inflationary), French CAC (Bearish Formation), and the SP500 (Bearish TAIL; Bullish TREND) are now $1, $98.12-101.96, 3002-3146, and 1.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
FL reported a solid Q3 with EPS of $0.43 vs. $0.39E reflecting continued execution at the company level on top of strength in the athletic specialty channel. The company came in ahead of our expectations on every metric with the exception of SG&A.
Based on our model, we have Fx accounting for ~$7mm of the SG&A increase with the other $26mm reflecting a 9% increase in core organic spending and a continued sequential acceleration.
We’ll need to drill down exactly where these dollars went. If it was higher investment spend at the store level or into marketing initiatives like Champs and Europe to fuel growth, then we’re perfectly cool with that. But if it was deferred maintenance or higher incentive comp, then we’re not quite as jazzed.
Comps of +7.4% came in above consensus…again – though in-line with our 7.5% estimate. We’ll learn more about the composition of sales and just how Europe fared relative to e-commerce on tomorrow’s conference call.
Gross margins of +220bps came in better than expected and better than our above consensus +160bps estimate. With our model suggesting just over 100bps in occupancy leverage, we assume the balance can be chalked up to higher merchandise margins coming in better than the +90bps contribution realized in Q2. Having just faced the toughest comp of the year and with inventory growth in check, this is positive for FL’s Q4 outlook.
As for inventories, this is the first time since the company was renamed Foot Locker from Venator that the Sales/Inventory spread was positive seven quarters in a row. Having previously been what we called ‘Nike’s best off-balance-sheet asset’ FL was perennially in a position with a negative sales/inventory spread, and down gross margins.
Cycle or no cycle, this is a different company.
We’ll have more to add following the call.
DNKN announced the pricing of its secondary today at $25.62.
This announcement is very convenient as whispers point to same-store sales trends continuing to accelerate in the fourth quarter. We have been hearing that K-Cups are partly responsible for the improvement in trends. A skeptical analyst would say the timing is perfect for the insiders to sell.
Insiders are selling into strong top-line trends following Dunkin’ Brands reporting what seemed to be a strong quarter but in truth was boosted by one-time gains. While same-store sales are important, they are less important for DNKN, which is a predominantly franchised business, than growth in points of distribution (PODs). On this metric the company has not updated the investment community on the backlog trends in 2011. We only know what happened in 2010. Again, a skeptical analyst would question why there is not more disclosure on this important metric.
Going back to the IPO, the timing of the sale of DNKN by insiders could not have been done at a better time. The IPO was initially priced at the peak of the coffee bubble see chart below. At that time the bubble was accented by the staggering valuation of GMCR which has since seen its multiple drop by 66%.
Do you think the collapse of the coffee bubble prompted "the insiders" to ask the underwriters to waive the 180 day lockup restriction. Do you think the collapse in GMCR valuation had anything to do with it? I do! The Green Mountain story turned out to be based on less-solid foundations than initially thought and we believe that Dunkin Brands will play out the same way over time.
If you are buying the secondary you are paying 15x NTM EBITDA for DNKN. This represents a 46% and 30% premium to GMCR and SBUX, respectively.
Given that SBUX is a far superior company with a proven track record and global growth coming from multiple channels of distribution, I believe that SBUX should trade at a premium to DNKN not the other way around. If DNKN were to trade at a 10% discount to SBUX it would suggest there is 49.6% downside in DNKN today to $12.91. Even trading at the same EV/EBITDA (NTM) multiple as SBUX would imply an almost 40% decline to roughly $16.
The DNKN premium is due to what the Street believes is "white space" growth west of the Mississippi. To accomplish this goal, management must build a backlog of stores that will allow them to open 500 stores per year beginning in 2013, up from a projected range of 220-240 in 2011. Importantly, the company has not updated the investment community about the backlog.
Prior to the secondary, only 21% of the company was in the hands of the public. After tonight, roughly 37.5% of the company will be freely traded.
Following the secondary there are a few reasons to be concerned.
- There will be less pressure on the massive numbers of underwriters to prop up this stock - the fees have been collected
- The increased liquidity will make it easier to short the stock
- Financial performance will become a focus and to date it's been marginal at best.
The K-Cup story is stealing the limelight at the moment when it comes to Dunkin’ but once the focus turns to other topics, specifically of the growth strategy, execution will be what matters most and for that fact we remain bearish.
We’re more concerned with the potential for a junket commission war between the operators.
We believe LVS may have struck a sweetheart deal with Neptune which may be more attractive (to Neptune) than the best junket deals with Galaxy, MPEL, or MGM. Whether other junkets demand the same deal from other concessionaires (there are no secrets) remains to be seen. It seems likely, however, that market wide commissions and commission advancement are likely to escalate. How much will that constrict margins? Will Wynn follow suit? Could the junkets negotiate as more of a consortium? We will try and answer these questions in a later note. This note deals with another area of concern: receivables.
After Genting Singapore reported a large spike in their provision for bad debts last week (as seen in the chart below), credit issues once again became the topic de jour amongst the gaming community. Existing fears of a VIP slowdown have made investors already on edge. We’re not dismissing either issue but the numbers don’t provide a lot of basis for concern. In addition, we think it’s interesting that the investment community only seems concerned with these charges when they occur at an Asian-based operator. Wynn has several quarters with large spikes in their provision for doubtful accounts but no one seems to lose a wink of sleep over these. Namely in 4Q 2010, Wynn Macau took a $10MM charge which they simply explained “was a function of business volumes… in particular in our direct program in the fourth quarter.” In 3Q08, Wynn Macau took a provision of $19MM as well.
As the chart below shows, MPEL’s receivables as a % of direct play, while decreasing, are higher than the comp set. We believe that this is a direct reflection of the lending that goes on in their premium mass segment.
The 3rd chart shows that while Genting’s receivables as a % of direct play have been increasing, they do not look out of whack with what MBS reports, although we would be concerned if the upward trend continues.
POSITION: Long Utilities (XLU) and Healthcare (XLV); Short Housing (ITB)
Into the close yesterday, I got longer. On this morning’s rally off the lows, I tightened that net exposure right back up. Managing risk around a range is the process. That’s not new.
What is new (every day) is the uncertainty implied in the range. In order to handicap uncertainty, we use a multi-duration, multi-factor approach that helps us contextualize what different investors across different durations are most likely to do next.
As of 11AM EST, here’s what I see in the SP500:
- The long-term TAIL remains entrenched (1269)
- The Intermediate-term TREND range (1) is trade-able
- The Immediate-term TRADE is under selling pressure (no support to 1221)
Going long into a weekend with no European catalyst that I can see isn’t for me – but that’s just me. I currently have 10 LONGS and 9 SHORTS.
Keith R. McCullough
Chief Executive Officer
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