FL: We’re Getting More Cautious…


Conclusion: There’s so much more to this story than the NBA. While there’s still much to like, the negative fundamental factors are lingering that the consensus might be missing.


It’s time for a serious update on Foot Locker.  With two upgrades today – largely timed around the mitigated risk of a hit from the NBA strike – we think that people are glossing over some larger issues. Some are bullish, but for the first time in two-years, some bearish factors are starting to enter the equation. From a TRADE perspective (30-days or less), this name is still in a bullish formation and is one of the more attractive retailers based on Keith’s models. But as we head into 2012 and look at how the fundamentals are stacking up, our bull-case is no longer a slam dunk by any means.


About the NBA strike… Ok, the risk is gone. I get it. But was there really any implied risk in FL from a strike in the first place? There’s a lot of noise week to week, but my answer is that – in aggregate -- the market has had this about right all along, and there really shouldn’t be a go-forward adjustment.


The timeline is important for a couple of reasons…

  1. The lockout started on July 1, but there was still perceived to be ample time to negotiate a deal. The stocks did nothing. But as talks cooled throughout July, FL underperformed the market by about 8%, and the broader retail space (MVRX) by 12%.
  2. Let’s not forget that the market simply melted down in August. On a relative basis, FL was a great place to be. By the time September 30 rolled around, FL had largely recouped all its losses (again, relative to the market and retail).
  3. Once the NBA cancelled the first two weeks of the season in October, the stock stalled, but only gave up 2-3%.
  4. But near the end of October, the market looked into the quarter, the health of its inventories, comp sales, ability to side-step basketball risk, and it was subsequently one of the better performing names in retail.
  5. Now we’re at a point where it has come full circle, and then some. It outperformed all relevant peers, comps, and broader benchmarks over the lockout period. Ironically, the only name that has performed better is Nike, which has greater basketball exposure. Yes, FL has printed good numbers in the interim, but at a decelerating rate relative to what we’ve seen in the past.

As much as Ken Hicks is running such a good ship and is rethinking the model, the fact is that the numbers simply get tough. We’ve had 10% comps over the past year, 40% EBIT growth, and seven consecutive quarters of improvement in the sales/inventory spread. It’s worth noting that over this precise seven quarter period, FL has beaten every quarter by a weighted average of 32%.


FL: We’re Getting More Cautious… - FL SIGMA


So what now? Product costs from the Nike’s of the world (even if only Nike) are being passed through to a far greater extent, and anemic levels of product in broader athletic channels will be refilled (note order books for all brands). FL will have a harder time keeping inventories in check, which definitely jeopardizes (peak) margins. Also, let’s not forget Europe, which is about 25% of sales, and is about 33% of EBIT. These stores are more productive and profitable than US counterparts. There’s a bit of a tug of war on the P&L between comp and SG&A, but net/net, the Euro had been a tailwind for the past 3-quarters.  Economies aside…it becomes a headwind in 1Q13 (Feb 2012). The Olympics in London might be a jolt, but it will need to be a big one to offset the impact of a weaker pan-European consumer.


But might the company be a victim of his own success?  Hicks delivered on his 5-year plan 3-years ahead of schedule. That in itself is so impressive – as has been the reward. Hicks made $2.475mm in cash last year ($1.1mm base with 125% target bonus – which he hit). That’s in-line with peers. The real kicker for him is in his incentive comp. He has 500,000 shares of restricted stock, and 900,000 outstanding options with strike prices between $10.1 and $15.1. The value of his vested equity at today’s $23 price is $8.6mm. The remainder vests by March 2013, and is worth approximately $21mm at today’s price. Every $1 fluctuation in FL’s price equals about a $1.2mm change in Mr. Hicks’ net worth.  While he is a very accomplished retail executive, I’m going to assume that with a history at JC Penney and Payless, this kind of wealth creation is a huge deal for him, and something that he won’t let evaporate.  This story is unlikely to crumble over the next 18 months when the rest of the options vest and the restricted stock balloon is up.  But a risk that can’t be ignored is that these numbers are just so big and comfortable, and that he becomes complacent running a slow moving company in a business that is sub-par at best. In other words, that he becomes Matt Serra. Not likely, but we need to monitor it.


They’re hosting an analyst meeting in March to outline the new strategic plan. It might be foolish to bet against them. I don’t like betting against good management teams (it’s a long time since I’ve said that about FL). But numbers don’t lie, and the order of magnitude of additional changes will be difficult to engineer. Sales per square foot should break $400 this year, and prior peak flirted with $362. Margins are peak, and let’s not forget that this is a zero-square-footage-growth retailer with 33% exposure to Europe.  


If the consensus numbers are right, and we actually think that they’re within a nickel of reality, then we’re looking at 14% EPS growth for next FY13, which is a sharp deceleration from the 61% FL is on track to print this year. The today’s two upgrades, there are officially no sells on the stock, and short interest remains relatively low at 6.1% of the float.



Brian McGough

Managing Director

FL: We’re Getting More Cautious… - FL Broker Ratings


FL: We’re Getting More Cautious… - NBA Strike Timeline FL


FL: We’re Getting More Cautious… - FL Levels




European Risk Monitor: Rumor Mill Europe

No Active Positions in Europe

Manic Europe is again trading on rumors out this weekend and the fumes of optimism that Europeans can issue a bazooka to cure the region’s structural ills in one blast. Our outlook is overweight Eurocrats dragging their feet to maintain the fabric of the Eurozone without answering the harder structural choices over the near term. Here we’d expect the EUR/USD cross and Europe’s equity markets to trend lower so long as there are no clear details or intentions of a bazooka in the works. (We covered our positions in the EUR/USD (FXE) and France (EWQ) in the Hedgeye Virtual Portfolio on 11/23).  


Remember, the German and ECB position remains that the ECB will not be a vehicle to leverage or expand the ECB and the Germans stand against the issuance of Eurobonds. However, we think these positions will have to be amended as there’s a lack of additional options: the IMF is not in a position to solely boost the EFSF and individual parliaments of the member states will not give the political vote to expand the taxpayer’s contribution to the facility.  


Official discussions of Europe’s next major step will begin as soon as tomorrow’s two day Eurogroup/ECOFIN Finance Ministers’ meeting and could focus on establishing a fiscal union, essentially a German-French and/or Brussels-based babysitter to monitor the fiscal (namely budget) choices of member states, basically the Growth and Stability Pact 2.0, with the intentions of actually being adhered to this time around. Other calendar catalysts to be aware of are:


2. December -  German Chancellor Merkel delivers a speech on the crisis to the lower house of parliament in Berlin

8. December -  ECB Interest Rate Decision

9. December -  EU Summit


Perhaps further down the road this fiscal union could be integrated/amended into the EU treaties, but this “Fast Track” approach would seek short-term implementation to send a positive signal to the market that Europe is on the road to improving its fiscal house with the fiscally stronger states calling the shots (in particular Germany).  Longer term, this fiscal union could be amended into EU treaties. However, we don’t think that a fiscal union alone will support a sustained rally in European capital markets, but will be one step in the right direction. Logistically there’s a ton of unanswered questions about such a fiscal union, so communication will be essential.


While it’s hard to size up the look and feel of this “Fast Track” approach, it’s clear that Eurocrats are feeling the pressure of tied hands when responding to the market’s movements. As the spotlight shifts towards the risks of the Eurozone’s larger nations of Italy and Spain and talk of Greece’s exit from the Eurozone, headline risk will continue to weigh substantially. Over the weekend it was rumored by the paper La Stampa that the IMF may make a €400B-€600B loan to Italy at below market rates of 4%-5%.  The IMF has squarely denied this article, and this rumor is easy to refute as the sum represents over half of the IMF’s existing lending capacity, nevertheless many European equity indices finished today’s session up +250 to 500bps and intraday the EUR/USD is bid up 0.50%.


Given the volatility of the rumor mill we’re pleased with our decision to cover the EUR/USD on 11/23 near our oversold level of $1.32.  We see the EUR/USD trading up to an immediate term resistance level of $1.34 and should it run through $1.37, we’d change our bearish outlook.


Below we present our weekly risk monitors.


European Equity and Currency Moves – European markets today largely made up for loses last week, however week-over-week (Friday-over-Friday) indices fell 3-5% with negative divergence from Italy’s MIB -8.5%; Greece’s Athex -6.8%; and Austria’s ATX -6.5%.  Over the same duration, the EUR/USD was down -2.1%.


European Sovereign Yields – European 10YR yields were mostly higher last week. Of note is the sustained move of German yields. The 10YR was up +41bps week over week to 2.30%, a clear risk signal that even the region’s fiscally strongest nation is under threat.


Greek yields declined -115bps as the sovereign debt spotlight shifted more squarely on Italy and Spain.  Portuguese yields widened the most, +209bps to 13.38%, followed by Italy (+39bps to 7.09%). To round out the PIIGS, Spanish yields rose +6bps to 6.62%. As always, we’re keying off the 6% Lehman line as a critical breakout line. Italy and Spain have held tight above the 6% for the last five weeks.


In its SMP bond purchasing program, the ECB bought €8.6 Billion in secondary bonds last week (vs €8.0B in the week prior), taking the total program to €203.5 Billion. Look for Super Mario (Draghi) to increasing buying alongside heightening Italian yields.


European Risk Monitor: Rumor Mill Europe - 1. yields


European Sovereign CDS – European sovereign swaps mostly widened last week. German sovereign swaps widened by 15.3% (+15 bps to 111.5) and American swaps by 7.8% (+4 bps to 55.5).


European Risk Monitor: Rumor Mill Europe - 2. cds


European Risk Monitor: Rumor Mill Europe - 3  cds


European Financials CDS Monitor – A Sea of Red. Bank swaps were wider in Europe last week for 35 of the 40 reference entities. The average widening was 5.4% and the median widening was 16.1%.  Bank swaps remain below 300 in Norway, Sweden, Switzerland, and the UK.  Across the 29 banks in Austria, Belgium, Denmark, France, Germany, Greece, Italy, Portugal, Russia, Scotland, and Spain, there is only one bank with swaps trading below 300 bps. While no one needs reminding that the systemic risk in the European banking system is extraordinarily high, this morning's data serves as a reminder nonetheless.  


European Risk Monitor: Rumor Mill Europe - 4. banken


Matthew Hedrick

Senior Analyst

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We like to think about stocks on three different durations TRADE (three weeks or less), TREND (three months or more) and TAIL (three years or less). 


For WEN we are cautious on TRADE and TREND, but positive on the TAIL. 


Over the past month, Wendy’s has traded up 6% on the back of the uptick in comparable restaurant sales coming from the launch of the new burgers.  Generally, we believe that the company is headed in the right direction but there are still some issues that are pose a headwind for a sustained improvement in same-store sales. 


In the short run, we still believe that new CEO Emil Brolick’s will need to put his stamp on the company’s strategy and stop working through the legacy issues of his predecessor.  We expect him to further refine his approach to fixing the brand at the February analyst meeting.


While the recent uptick in comparable store sales is nice to see, we believe that any sustained performance is going to require an upgraded asset base. 


On my recent visit to Phoenix, I got a detailed tour of one of the company’s remodeled stores in that market.  Currently the company has the four remodel prototypes in five different test markets – Pittsburg, Virginia Beach, Toronto, Columbus and Phoenix.


The new Wendy’s store I saw was very impressive, but it’s unlikely to be the “end” version of what the official remodel will look like.  The company needs to strike a balance between counteracting the competitive threat of McDonald’s and that company’s remodel program with a realistic level of spending.  The Phoenix remodel looked like the company spent upward of $400,000 on the remodel and the company estimates that the sales lift from the investment was 35-45%.  One of the highlighted improvements emanating from the new look and feel is that the company is seeing more people come in during the afternoon day-part with their mobile devices.  Yes, mobility and WIFI are key drivers for expanding the usage of the dining room during non-peak periods.   


The company is 6-9 months away from communicating lessons learned from the new remodel testing initiative.  The timing suggests that any real impact on the store base will begin sometime in 2013.  We feel (and the company agrees) that any sustained competitive advantage in the burger category will only come along with a much needed asset base upgrade.  In the short run, improvements in same-store sales will need to be driven by the new burger campaign and any other new products the company develops. 







Howard Penney

Managing Director


Rory Green



Bounce: SP500 Levels, Refreshed

POSITION: Long Healthcare (XLV)


I didn’t think we’d bounce this high, this fast. Good thing I’m not short SPY and/or any S&P Sector ETF. Now we can re-populate our short book.


What would stop me from selling in this 1194-1203 range? Time and price.


The SP500 would need to close above and hold 1203 (TREND resistance) through Friday’s US Unemployment Report. On top of this morning’s miss on monthly New Home Sales (307,000 versus 313,000 expected), there’s a good chance that the high-frequency US economic reports this week also miss (Consumer Confidence tomorrow, PMI Wednesday, ISM Thursday, etc).


Across our core 3 risk management durations, the SP500 remains in a Bearish Formation (bearish TRADE, TREND, and TAIL): 

  1. TAIL = 1270
  2. TREND = 1203
  3. TRADE = 1233 

Immediate-term TRADE oversold (support) is now 1170. Below that, no support to 1139.


Take your time selling. Today’s close will be a more important signal than this morning’s open.



Keith R. McCullough
Chief Executive Officer


Bounce: SP500 Levels, Refreshed - SPX


November Gross Gaming Revenue estimate revised upward to HK22-22.5BN, +31-34% YoY.



Average daily table revenue jumped this past week to HK$775MM, up from HK$698MM the rest of the month and only HK$664MM last week (Grand Prix).  With only 3 days left in the month, total November GGR (including slots) should be in the HK22.0-22.5 BN range, up 31-34% over last year.  Despite the likely double digit % drop from October, we would consider November a solid month.  Remember that VIP hold % was high both in October 2011 and November 2010 and November is typically a seasonally slower month than October.


For market shares, LVS continues to gain share, as expected.  Neptune went live at Four Seasons on November 1st and Sun City recently opened 24 VIP tables.  Also, the company began advancing commissions to some junkets for up to two months which should spur volumes.  We estimate LVS’s share in the past week increased to 16.3% - almost to the pre-Galaxy Macau level.  However, we would've expected higher by this point which probably means VIP hold is a little low.  WYNN’s MTD share continued to improve sequentially, gaining 60bps from last week but still remains below recent trend.  In terms of hold, we believe LVS is holding low so they haven't gained as much share as they should/will, while WYNN is holding high which would explain why share has recovered a little bit since the beginning of November (1st two weeks share: 11.6%; last two weeks share: 14.5%).


As a reminder, while we are still bullish on Macau revenues, we remain concerned with the potential for more aggressive junket commissions/credit in the market.  WYNN is definitely at risk here with their low commission structure.  WYNN and Four Seasons overlap with Neptune, Sun City, David, and one other junket.  Also, in terms of quality and service, Four Seasons is the most direct comp for Wynn/Encore.


Given the recent poor performance of the Macau stocks and lower expectations, we think they could rally over the near-term (trade basis) but the prospects of a junket war temper our intermediate (trend) enthusiasm.


NICE WEEK IN MACAU - macau nov

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