Conclusion: Real time data is continuing to suggest to us that inflation is set to accelerate, making inflation protection, via TIPS, a compelling addition to our Virtual Portfolio against the backdrop of rising inflationary pressures.
Position: Long Treasury Inflation Protection via the iShares Barclays TIPS Bond Fund ETF.
While Keynesian economics continues to support the resolve of Western officials to perpetuate short-term asset inflation, we continue to highlight the tax on growth that is rising consumer and producer price inflation, as well as accelerating inflation expectations. The price of crude oil remains a real-time quote for the taxation of global fixed capital formation, industrial production, and consumption.
Looking to the U.S. fixed income markets specifically, inflation expectations are indeed accelerating. The 5yr Breakeven Inflation Rates are being priced at 2.03%, up from +1.55% at the start of the year. This +24bps increase since the FOMC’s decision to extend “exceptionally low levels of the federal funds rate at least through 2014” on JAN 25 outpaces the +1bps move in the 27 days following Jackson Hole 2010. As such, on a relative basis, long-term inflation expectations are rising fairly rapidly.
Looking to nominal Treasury yields, both 2s and 10s are testing our intermediate-term TREND-lines of resistance. Just as we concluded in 1Q11, we contend these are not signals for accelerating economic demand, but rather a signal that bond market may be starting to price in this marginal shift in the outlook for the real returns of Treasury yields.
We tend to view inflation differently than the government measure of CPI, which has been altered a bevy of times in the past 20yrs (we believe this is done by design to limit Social Security cost-of-living adjustments). From our perspective, the best measure of actual inflation, as experienced by the consumer, is the spread between headline consumer price inflation and nominal wage growth. That is: what consumers have to spend versus what they earn.
On this measure, JAN ’12 registered as the first sequential acceleration since SEP ’11. In particular, that’s an explicitly negative data point for the 15.1% of Americans living in poverty, as officially defined by the Census Bureau. Accelerating headline inflation disproportionately impacts the lower end of the socioeconomic spectrum, as outlays for food and energy typically garner a higher share of that consumer's wallet.
All told, we continue to see the need for hedging our Virtual Portfolio against upside inflation risks, given the updated economic policies of the current U.S. administration and appointed officials. Our quantitative risk management levels on the TIP ETF are included in the chart below.
At Hedgeye, we monitor key global market, economic and political events, and assess the potential macro risk or reward that each of these events might have. One event in particular, the maturation of Japanese government debt in March, has us sitting up and taking notice. That’s because a significant amount of marketable Japanese government bonds (JGBs) mature next month, and those maturities may be a global macro risk that is currently being underestimated.
While Japan certainly does not face an imminent sovereign debt crisis, for the first time in many years, the fact that there’s even a mention of such a potential crisis is worth noting.
Again, we are not saying such a crisis will happen, but the perception around Japan’s sovereign debt load may be at an inflection for a number of reasons, including:
- Japan’s current account: For years, the country’s run a healthy current account surplus, but that’s no longer the case. As the current account erodes, strains will emerge as the country looks to finance its ever-expanding public debt.
- Possibility of a sovereign debt downgrade: If such a downgrade happens, it will trigger capital raises across the Japanese banking system to the tune of roughly $80 billion.
- Acceleration of inflation: Long-term inflation expectations could rise as the Bank of Japan (BOJ) may look to alter its mandate and dramatically increase its purchases of JGBs.
- Rapidly deteriorating government credibility: Most market participants worry that the Japanese government has no credible plan to solve the country’s fiscal woes.
In another sign of weakness, just today Japan reported its widest-ever monthly trade deficit. In the coming weeks, we will keep you abreast of other important events that will shape the future of the Japanese economy.
Mass (WMT) underperforms while high-end (M & SKS) charges on consistent with recent trends.
In light of HD’s strong quarter as well as M and SKS coming in better than expected, WMT’s underperformance is the clear callout from today’s earnings. Consistent with what we’ve been seeing across retail, inventory growth outpaced sales growth with HD the sole exception. That’s gross margin bearish for those companies not named HD. Interestingly, M cited a decision to hold onto cold weather apparel while SKS noted earlier receipts of Spring orders as a contributor to higher inventory levels at year-end - decisions don't that have the same risk profile. While HD and SKS both highlighted a more benign promotional environment, the mass channel continues to be highly price competitive and remains at greatest risk in the 1H from a margin perspective.
The most notable thematic category callout is undoubtedly Home. Yes, HD posted big numbers this quarter, but more notable was WMT posting the first positive comp in the Home category in over 2.5 years and M also highlighting category strength.
Here are a few company specific takeaways:
WMT: Walmart posted its second consecutive miss in as many quarters for the first time in five years reflecting a sequential revenue deceleration across all businesses despite favorable layaway sales. Headwinds in the form of tougher top-line comps and higher gas prices will remain challenging near-term. In addition, higher inventory levels driven by international growth up 25% was not simply due to Fx and acquisitions, which accounted for only 6pts of growth in the quarter. Despite favorable gross margin comps over the next few quarters, this development is gross margin bearish near-term.
- Inventory growth (+11.7%) not just acquisition related; int’l +18.6% ex Fx and Acq.
- Called out strength in basics category in Apparel.
- Home category posted first positive comp in 2.5yrs.
- Repurchased 23mm shs in Q4 = 115mm F12 = 3.2% of F11 shares outstanding and remains on track to go private within the next 9-10yrs.
- 1Q13 guidance $1.01-$1.06 vs. $1.05E
- WMT US comps flat -to-+2%
- Sam's Club +3%-5%
- FY13 guidance $4.72-$4.92 vs. $4.90E
HD: Home Depot posted strong Q4 earnings of $0.50 ex items vs. $0.42E driven by notable top line performance with comps up +5.7% (vs. 2.2E). Strength in the top line was driven primarily by unseasonably warm weather (positive 200-250 bps impact in Q4) and resulted in a meaningful 200 bps acceleration in the underlying 2yr trend. The intermediate term setup over the next three quarters becomes progressively more favorable for both the top and bottom line with inventories well positioned into 2012 down 30 bps sequentially to -2.8% yy.
- HD leveraged SG&A nearly 100bps which, combined with gross margin expansion (+29bps vs. +26bpsE) drove operating margin expansion ahead of expectations +145bps vs. +68bpsE.
- Guided FY2012 EPS to $2.79 vs. $2.76E with the top line targeted to grow 4% vs. 3%E; Operating margin is expected to expand +50bps breaching the 10% margin rate one year ahead of the long term goal.
- 2012 promotional cadence expected to see no major differences relative to 2011.
- Management was “very pleased” with February trends Month-to date (Note: February comp is the most difficult in Q1 coming off 10% growth in January US store comp).
- 13/14 departments posted positive comps (8/13 outperformed the company average & 13/14 saw positive growth in total transactions) – Millwork sole negative underperforming dept.
- Positive comps in all 40 top US Markets- FL & CA saw 8thconsecutive quarter of comp growth indicative of widespread performance in markets less effected by weather related abnormalities.
M: EPS came in above expectations $1.70 (adj) vs. $1.65E driven by slightly better than expected gross margins (-33 bps vs. -50bpsE) and SG&A leverage.
- AURs +9%; Transactions +1%; UPT -4%.
- Starting to see impact of omni channel strategy benefit inventory turnover, which will be a key driver of gross margin expansion in ’12 as M enables nearly 300 stores to ship directly.
- Expect DTC to maintain current growth rates and exceed $2Bn in ’12.
- Q: Can you update us on price optimization?:A: “It's proven to be a little more complicated than we originally thought, but initial tests are looking good.” Needless to say, this initiative is not expected to yield benefits until 2H, but management appears to be hedging the magnitude a bit.
- Inventories were up +7.5% (down -2.1% seq) reflecting decision to hold onto cold weather apparel longer than usual. This could prove to be a savvy call, or added overhang in Q1. TBD.
- M Guided FY2012 EPS to $3.25-$3.30 vs. $3.27 and Comps +3.5% vs. +3.3E
SKS: EPS came in above expectations $0.17 (adj) vs. $0.14E driven by better than expected revenue growth (+6.8% vs. +4.5%E) and tight cost control (SG&A +4.7% vs. 15%E) offsetting weaker than expected gross margins (GM -21bps vs. -10bpsE).
- Categories of strength: women’s and men’s contemporary apparel, handbags, fine jewelry, fragrances, and men’s accessories
- NYC Flagship comps in-line with corporate avg.
- Project Evolution – SKS’ shift towards becoming an omni channel retailer will account for $30mm of total $110-$120mm in F12 CapEx and another $8mm in SG&A.
- Within read-to-wear, full-price selling is currently below expectations and could pressure Q2 GMs if persistent when seasonal clearance occurs. Thought to be a fashion move away from more classic brands.
- More notably in aggregate across categories, full-price selling is back to or above pre-recession levels.
- Inventories +7.5% (up 1.3pts seq) reflect earlier receipt of Spring orders accounting for ~1.5pts of increase. Which would you prefer to have on-hand, leftover winter apparel or upcoming Spring product? The tale of the tape will be gauged by the thermometer in Q1 between SKS and M.
- Maintaining 8% Operating margin goal and believe they can get there with current store base.
- SKS expects FY 2012 comps to be +5%-7% vs. 4.8E with Gross Margin up modestly over 40.8% in FY11 vs. +17E and SG&A as a percent of sales to be flat
Casey Flavin & Matt Darula
Guidance didn't seem to match up with management's enthusiastic qualitative outlook.
"For the first time in several years, we reported revenue increases in each of our business segments during the quarter. As economic conditions strengthen in our core markets, we are confident that our strategy of keeping a tight rein on costs, generating profitable new revenues and diversifying our sources of cash flow will deliver bottom-line results."
- Keith Smith, President and Chief Executive Officer of Boyd Gaming
CONF CALL NOTES
- Improving economic activity across the country and their focus on cost control helped their results
- Good economic indicators in Nevada
- Last year was the second best year for visitation to Las Vegas
- Core employment in Vegas grew; unemployment declined 2% in 2011
- Saw a 6% gain sales in Nevada in November
- Florida legislation is dead for the quarter, but it was clear that any gaming expansion will give parity rights to existing operators
- While they believe that Federal legislation is preferable for online gaming, they will also go the state by state route if necessary and have already applied for a license in Nevada
- Las Vegas locals: Their margins are now identical to their largest competitor. STN grew revenues by 7% YoY but not EBITDA
- Optimistic about long term growth
- Expect that 2012 will be a year of revenue and EBITDA expansion
- Downtown: Flat EBITDA margin was due to $1MM fuel charge for their Hawaiian business
- New non-gaming businesses are moving to the area
- Smith Center will open its doors next month
- Fremont Street is seeing improvements - area "renaissance"
- Double digit gains in EBITDA at Delta Downs and Blue Chip
- Delta Downs' second best quarter
- IP: expect to generate additional savings in insurance, purchasing and utility costs. B Connected will also help drive their top line - on track to be rolled out in the 2Q12
- Borgata: Improvements driven by gaming growth.
- Cash ADR: $168
- B Connected Online: The most visited website of its kind. They are enhancing B-Connected 2.0; which will be ready in 2Q
- Debt: $2.6BN; $1.6BN under R/C. Leverage improved 1 full turn since early 2011 despite increased debt
- Secured Leverage: 4.2x vs. 4.5x
- Total Leverage: 6.70x vs. 7.75x
- Cash: $132MM
- $216MM maturity in April 2014 - expect to refinance it before it "goes current"
- Borgata: $75MM under R/C and $46MM of cash
- 2012 guidance:
- Corporate expense: $44MM
- D&A: $200-205MM ($135-$140MM to BYD; remainder Borgata)
- Stock Comp: $10MM
- Pre-opening: 4Q is a good quarterly run rate in 2012 - includes $1MM/month to Las Vegas Energy
- Interest expense: $160MM ($85MM for Borgata)
- Tax: 35%
- 1Q12 guidance:
- Wholly owned EBITDA: $88-93MM
- Borgata EBITDA: $32-34MM
- EPS: $0.05-$0.09
- Other income in the Q: accounting for the IP acquisition gain ($4MM) and the deposit for Dania ($6MM).
- Thinks that STN is buying revenue growth in the locals market with promotional spending
- Visitation was steady in the quarter, but seeing some growth in spend per visitor
- Sees 60% flowthrough on any revenue improvement in 2012
- Online gaming: were hoping that it would get attached to the payroll tax extension but it wasn't. Are hopeful that it can still get attached later this year
- They are waiting for their online gaming application license to be processed by Nevada and for what the ultimate rules will be in Nevada
- $25MM tribal contract/investment?
- It's in California, but they are in very early stages and aren't ready to report anything further
- IP D&A was $4.8MM in 4Q
- Are not planning on announcing any acquisitions over the next few months
- Revenue growth in the locals LV market is modest. Thinking low single digit growth for 2012.
- IP synergies: Labor saving changes were implemented in January
- Insurance renewal in 2Q
- Think that they will be in excess of $5MM
- All of their key management employees are still there at Borgata, but they have lost some employees to Revel
- Margaritaville Casino is scheduled to open with no hotel rooms in Biloxi. Don't see it impacting their business given the challenging location of the property.
- They will provide more disclosure on the IP results in their 10k
HIGHLIGHTS FROM THE RELEASE
- Las Vegas Locals: "All four major properties in the region posted year-over-year EBITDA growth, as we improved operating margins by 170 basis points despite a heightened promotional environment."
- "EBITDA at the three Downtown properties rose 7.2% during the fourth quarter; however, this strong performance was offset by significantly higher fuel expense associated with the Company's Hawaiian charter service."
- "Regional results reflect the acquisition of the IP, as well as strong operating performances at Blue Chip and Delta Downs. The IP contributed $44.6 million in net revenues and $8.4 million in EBITDA to regional results following our acquisition of the property on October 4."
- "Borgata continued to lead the market, achieving an all-time record market share of 21.2% in the fourth quarter."
Conclusion: Absent confirming quantitative signals, we contend that China’s surprise RRR cut is not a leading indicator for broad-based monetary easing in China over the intermediate-term. Moreover, we think it’s important to note that the potential for Chinese growth to reaccelerate due to easier monetary policy is structurally impaired absent a removal of curbs within the property sector.
Over the long U.S. weekend, China surprised us by lowering its benchmark Reserve Requirement Ratio (RRR) for major banks by -50bps to 20.5%. This marks the second time China lowered RRRs in the past three months (we saw a -50bps cut in early DEC as well).
We are surprised by the decision for two reasons:
- The breakout in global energy prices since the Federal Reserve pledged [at least] an additional year of easy money (Brent +9.8%; WTI +5.5%) has been quite pronounced and looks to erode a fair amount of intermediate-term downside in Chinese inflation statistics. In the PBOC’s defense, global food prices remain a holdout and that should keep a lid on China’s intermediate-term CPI outlook for now (CRB Food Index -0.4% since 1/25); and
- Over the past 2+ months, expectations of monetary easing in China have clearly inflected, as evidenced by the slopes of 1yr O/S Rate Swaps, 1yr Sovereign Yields, and relative pricing in the FX Forwards markets.
Not surprisingly, Chinese equities (as measured by the Shanghai Composite Index) closed up in the two trading days following the cut, putting the index at 2,381, or 99bps above our TREND line of 2,358.
We need to see this [potential] TREND line breakout confirmed by further price/volume/volatility data in the coming weeks. A sustained breakout would signal to us that Chinese officials have more coming down the pike in terms of policy easing than we would expect given the two reasons we laid out above.
Interestingly, in conjunction with the RRR announcement, Jin Qi, an assistant governor at the PBOC, did say that “monetary policy will remain prudent in the face of a grim international situation, price pressures, and imbalances in the domestic economy.”
Referring to the aforementioned imbalances, Chinese Premier Wen Jiabao said recently that China will not take its foot off of the brake with regards to the property sector. It is our view that until such curbs are lifted, monetary easing in China will have a limited effect on reflating growth – particularly given the share of fixed-asset investment as a driver of the Chinese economy and the headwinds facing household consumption (accelerating inflation pressures) and net exports (decelerating demand).
Lastly, we show the chart below to help contextualize where China is in its easing cycle. Looking back to the last time China embarked on monetary easing (‘08/’09 period), China used its various money supply levers in different order; of particular note, China lowered its benchmark lending rate (mid-SEP and early-OCT) and deposit rate (early-OCT) prior to lowering RRRs in mid-OCT. The reversal signals to us that it may be prudent to not expect a similar trend of broad-based easing over the intermediate term at the current juncture.
All told, absent confirming quantitative signals, we contend that China’s surprise RRR cut is not a leading indicator for broad-based monetary easing in China over the intermediate-term. Moreover, we think it’s important to note that the potential for Chinese growth to reaccelerate due to easier monetary policy is structurally impaired absent a removal of curbs within the property sector.