The Economic Data calendar for the week of the 13th of February through the 17th is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.
Conclusion: The price of oil globally continues to march higher despite miles driven in the United States declining to levels not seen since 1999. The fact that oil climbs higher despite this bearish demand statistic is a bullish indicator as to the resiliency of the price of oil.
Positions: Long BTE and Long XLE
We have a bullish view of oil, which is primarily driven by monetary policy and limited supply. On the first point, dovish, or inflationary, U.S. monetary policy is a headwind for the U.S. dollar and tailwind for those global commodities priced in the U.S. dollar. Over the last three years the correlations of both WTI and Brent versus the U.S. dollar are -0.65 and -0.66, respectively. The FOMC’s decision to extend “exceptionally low levels” for the federal funds rate through 2014 further supports this bullish factor.
On the second factor of supply, in the chart below we highlight the trend in annual global oil production growth from 1966 – 2010. The trend is clearly that the world’s ability to grow year-over-year production has become increasingly limited in the last decade, especially versus the late 1960s and early 1970s when global oil production had a number of years of almost double digit year-over-year growth. Production from 2001 – 2010 grew at annual basis of only +0.94%, which is below the average annual growth since 1966 of +2.20%, but also occurred during a period in which the price of oil was up more than 400%. So, despite clear incentives to produce more, the world’s oil producers are seemingly unable to ramp production.
An emerging counter point to the bullish case for oil is declining demand for oil in the U.S., at least based on miles driven by U.S. consumers. In the chart below, we show finished motor gasoline supplied in the United States every week. As the chart shows, not only has this proxy for demand flat lined since 2004, but the most recent data points actually suggest meaningful year-over-year declines. In fact, in the most recently reported data from the Department of Energy, which was for the week ending February 3rd 2012, finished motor gasoline supplied was down -5.7% year-over-year. This data rhymes with the U.S. gasoline demand as reported by Master Card, which showed a -5.3% decline last week and the 24thstraight week of y-o-y gasoline demand decline.
From our perspective, we are seeing the real time impact of The Bernank Tax. The inflation of oil leads to, naturally, lower demand or use of gasoline, which is a headwind to economic activity and specifically consumption, which makes up 70% of U.S. GDP. Increasing energy prices also impacts consumer confidence. The most recent data point on this front is the University of Michigan Consumer Sentiment Survey, which today showed that current conditions sequentially declined to 79.6 in February versus 84.2 in January. Not surprising, given the The Bernank Tax, Brent is up almost 10% in the year-to-date.
Daryl G. Jones
Director of Research
Positions in Europe: Short EUR/USD (FXE)
Asset Class Performance:
It was another manic week with attention directed at Greece. But as Keith noted in today’s Early Look, Greece is but a tree within a forest of globally interconnected risks. Our note on 2/8 titled “Greek PSI Is NOT Getting Done” proved to be apt—Eurogroup Ministers withheld approval on a Greek bailout on Thursday (2/9) evening, citing that the country must come up with €325 million in additional cuts to this year’s budget, therein delaying a decision for yet another week. Here’s a “new” Greek timeline:
Sunday (2/12) – Greek government to identify €325 million of additional cuts to this year’s budget and get it through a Parliament vote on Sunday, along with a signed memorandum that will hold them to their commitments.
Wednesday (2/15) - Once this is done, the Finance Ministers will meet again and potentially sign off on the deal, although Jean-Claude Juncker says there are no guarantees a final decision will be made then.
Tuesday (3/20) - Greece’s €14.5 billion Bond Redemption due.
As we noted in our post “Greek PSI Is NOT Getting Done”, even if the Eurogroup approve the bailout terms, individual parliaments may call the issue to vote. For example, the German Bundestag plans to vote on the issue on February 27th, all of which suggests a final decision on PSI and a bailout could drift towards an 11th hour decision ahead of the country’s €14.5 billion bond due on March 20th.
We’re of the opinion that Eurocrats, led by the voice of Chancellor Merkel, want to work with Greece to preserve the union. For one, we think a weak EUR/USD is in the interest of Germany and Greece is an important export market. Secondly, our read on Eurocrats remains that they fear the domino effect: despite talk of ring-fencing Greece, they overwhelmingly fear far larger countries defaulting or leaving the union as a result of a Greece exit and therefore see it as a risk not worth taking.
In our note on 2/9 titled “Tight-Lipped Draghi Goes Further Non-Standard” we discussed the marginal changes to the ECB’s growth outlook, namely to “tentative signs of stabilization in economic activity at a low level” versus “substantial downside risks”, and additional collateral changes (for more see the note). Additionally, the BOE met this week and kept rates UNCH but added £50 billion additional QE (in line with consensus) in response to very negative growth prospects.
Key Regional Data This Week:
Eurozone Sentix Investor Confidence -11.1 FEB vs -21.1 JAN
Russia CPI 4.2% JAN Y/Y (exp. 4.3%) vs 6.1% DEC
Germany Exports -4.3% DEC M/M (exp. -1%) vs 2.6% NOV
Germany Industrial Production 0.9% DEC Y/Y (exp. +4.3%) vs 4.4% NOV
Germany Factory Orders 0.0% JAN Y/Y (exp. -0.4%) vs -4.3% DEC
UK Industrial Production -3.3% DEC Y/Y (exp. -3.1%) vs -3.6% NOV
Greece Unemployment Rate 20.9% NOV Y/Y vs 18.2% OCT
Greece Industrial Production -11.3% DEC Y/Y vs -7.8% NOV
(2/8) Iceland Sedlabanki Interest Rate UNCH at 4.75%
(2/9) BOE keeps rates UNCH at 0.50%. The BOE adds 50B GBP in asset purchases/QE (as expected) to take the program to 325B GBP
(2/9) ECB keeps rates UNCH at 1.00%
CDS Risk Monitor:
On a w/w basis, CDS was largely down across European sovereigns, with Portugal leading the charge down for a second straight week, at -179bps to 1,154bps. Ireland saw the next largest drop at -18bps to 565bps (see charts below).
Keith shorted the EUR/USD via the eft FXE on 1/19 in the Hedgeye Virtual Portfolio and re-shorted the pair on 2/8 with the price bumping up against our immediate term TRADE resistance level of $1.32. We continue to think that the uncertainty around shoring up Greek PSI and bailout deals will drive this pair lower.
The European Week Ahead:
Sunday: The Greek government is to identify €325 million of additional cuts to this year’s budget and get it through a Parliamentary vote on Sunday, along with a signed memorandum that will hold them to their commitments.
Monday: Jan. Germany Wholesale Price Index (Feb 13-14); Jan. UK Consumer Confidence (Feb 13-17) and RICS Home Price Balance
Tuesday: Feb. Eurozone Zew Survey Economic Sentiment; Dec. Eurozone Industrial Production; Feb. Germany ZEW Survey Economic Sentiment and Current Situation; Jan. UK CPI and Retail Price Index; Dec. UK House Prices; Q4 France Non-Farm Payrolls and Wages – Preliminary; Q4 Greece GDP - Preliminary
Wednesday: (Tentatively) Eurozone Finance Ministers will meet and sign off on the Greek bailout should it pass the Greek Parliamentary vote on Sunday. Q4 Eurozone and Germany GDP – Advance; Dec. Eurozone Trade Balance; UK BoE Inflation Report; Jan. UK Jobless Claims Change and Claimant Count Rate; Dec. UK Unemployment Rate; Q4 France GDP – Preliminary; Jan. Russia Industrial Production (Feb 15-16); Q4 Italy GDP – Preliminary
Thursday: Eurozone ECB Publishes Feb. Monthly Report; Jan. Eurozone New Car Registrations; Jan. Russia Real Wages and Unemployment Rate (Feb 16-20); Q4 Spain GDP – Preliminary; Sweden Riksbank Interest Rate Announcement
Friday: Dec. Eurozone Current Account and Construction Output; Jan. Germany Producer Prices; Jan. UK Retail Sales
Extended Calendar Call-Outs:
29 February: 2nd 36-Month LTRO Allotment
25-26 February: G20 Finance Ministers Meeting in Mexico City. Decision on IMF loan of €500B expected.
29 February: Eurogroup Meeting to sign the endorsed agreement between the 17 on the Treaty for the European Stability Mechanism.
1-2 March: Signing of the Fiscal Compact by 17 Eurozone leaders together with the non-euro area leaders of countries willing to join. Further the group will reassess the adequacy of resources under the
EFSF and ESM rescue funds.
30 June: Deadline for EU Banks to meet €106 billion capital target/the 9% Tier 1 capital ratio.
1 July: ESM to come into force.
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Following a 30% tailspin just 2mo ago, the stock is back to pre-‘announcement’ levels. Despite the modest improvement, we think the risk/reward is still unfavorable given the current level of uncertainty and execution risk.
Gildan reported a modest beat after severely haircutting expectations some 35% last quarter. Just two months later, following a 30% tailspin, the stock is back to pre-‘announcement’ levels. It’s acting like the incremental pros in the quarter far outweigh the cons, we disagree. GIL is shifting its focus toward growing its own retail via Gold Toe and its international business. We expect this to cause transitional interruptions in the process, which the stock is does not currently reflect.
Let’s take a look at the key highlights at each end of the spectrum this quarter:
There are two additinal points to consider. First, management suggested that the Branded Apparel business (~25% of sales) could eventually achieve profitability similar to Printwear in the mid-20s. Its currently just about break even. If we want to paint a super bullish scenario and assume GIL is running at 25% margins (closer to 20% with corporate allocations) we are looking at $3+/sh in earnings power. We think the mere suggestion of this level of profitability was viewed positively if not flat out bullish, but there are a lot of questions between now and then that don’t appear to be appropriately discounted in the stock.
It’s also worth noting that the company hasn’t operated with this type of leverage since ’02-’03 when GIL shifted to its off-shoring model – they don’t have that lever anymore. Given that management didn’t repurchase any stock during the quarter, our sense is they aren’t comfortable running this thin. With the entire 1H generating negative FCF its will provide the company little financial flexibility while simultaneously looking to expand new growth businesses.
We fully acknowledge that there was an improvement in fundamentals on the margin, but not significantly enough to completely dismiss the impact of perhaps the most challenging six-month period in company history. We’re shaking out at $1.08 this year and $1.90 next year reflecting an 22x and 12.5x earnings multiple, and 14.5x and 10x EBITDA = not cheap.
These estimates are predicated on 13.5% revenue growth this year and 12% for next year reflecting the incremental revenue from Gold Toe, pricing in Branded Apparel, and growth of retail and international offsetting the impact of lower unit sales and pricing from destocking in the 1H. In addition, we are assuming gross margins of 16% in Q2 reflecting a sequential increase from Q1 due to the absence of an inventory devaluation (= 7pts), the impact of manufacturing downtime (=3-4pts), and higher unit volume. Similarly, with the closure of Rio Nance 1 at the end of Q2 and higher utilization, we have margins up to 24-25% in the 2H and up 450bps next year to 23.5% reflecting 300-400bps from lapping the interruptions of the 1H F12, higher utilization, and improved manufacturing efficiencies. While we expect SG&A growth (+20%) to outpace sales (+12%) in support of retail and international initiatives, we expect operating margins to expand 366bps in F13.
Despite the modest improvement, we think the risk/reward is still unfavorable given the current level of uncertainty and execution risk.
Here are our notes from the call:
Branded Apparel: +93%
GM: 2.1%; -2265bps
Will be lowest cost facility adding capacity and further manufacturing efficiencies in F13
Branded Apparel Margins:
Promotions / Price Reductions:
Wholesale Distributor Inventory Levels:
GIL Inventory Levels:
Mid-Tier & JCP:
Keith bought BYD in the Hedgeye Virtual Portfolio at $8.86. According to his model, the TRADE range is between $8.63 and $9.89, and the TREND support level for BYD is at $7.27.
Boyd Gaming has been a laggard in the regional gaming space past few year. The sentiment surrounding the name is negative - JP Morgan, Lazard, and Barclays recently downgraded the stock and short interest is very high. We’ll make this contrarian call due to better than expected performance in Locals Las Vegas and Atlantic City. A near-term earnings beat is likely and management should provide positive commentary on 2012, particularly as the LV Locals market starts to show consistent, albeit slow, growth going forward. Any catalyst should impact the stock meaningfully given the attractive FCF valuation and negative sentiment.
POSITION: Long Energy (XLE)
With the SP500 holding my immediate-term TRADE support line of 1337 this morning, I covered-the-dip.
We believe that hedge funds should hedge. That’s why I trust the process that has served me better than poorly in the last 4 years – it takes out (some of the) emotion. When you’re in the middle of February and the SP500 hasn’t had a down day of more than -0.57%, that emotion isn’t going away.
Across all of my core risk management durations, here are the lines that matter to me most:
My call has been that if we start to see Inflation Readings Accelerate and Growth Readings Slow, the SP500 will make a lower long-term high versus its 2011 closing high of 1363. Today, with all of the high frequency growth data slowing sequentially (China and US Consumer Confidence in particular), I’ll reiterate that view.
I’m covering SPY because 1337 holds. If it doesn’t, I won’t be sitting on my hands.
Keith R. McCullough
Chief Executive Officer
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