prev

Still Selling? SP500 Levels, Refreshed

POSITIONS: Long Utilities (XLU), Short Consumer Discretionary (XLY)

 

I Time-Stamp everything we do because I believe in transparency and accountability. Time-Stamping doesn’t mean we are always right. It simply means we don’t have to tell stories about nailing everything.

 

At 11:02AM EST on Friday my note said “Selling Green” at 1374 in the SP500. That was my immediate-term TRADE line of resistance then and it remains so now. Across all of my core risk management durations, here are the lines that currently matter most: 

  1. Immediate-term TRADE overbought = 1374
  2. Immediate-term TRADE support = 1363
  3. Intermediate-term TREND support = 1290 

In other words, what was immediate-term TRADE resistance is now support at 1363 – and if that support fails to hold, there’s no legitimate support to the intermediate-term TREND line of 1290.

 

Interestingly, but no surprisingly, going back to when we started the firm (2008) we have never NOT corrected to my intermediate-term TREND line after seeing an intermediate-term TREND top. Neither have we NOT seen VIX 15 being an explicit signal to sell US Equities.

 

Notwithstanding Growth Slowing could easily see US GDP Growth cut in ½ (Q4 to Q1), our risk management process has not changed.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Still Selling? SP500 Levels, Refreshed - SPX


European Banking Monitor

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .

 

Key Takeaways:

* Greece's debt swap was largely in line with expectations last week; on a week-over-week basis, we saw relatively little movement in several key risk indicators. Most of the series were essentially unchanged or continued on their pre-swap trajectories. European and US interbank risk receded further last week with the Euribor-OIS shrinking 4 bps week over week, while the TED spread shrank 2 bps. This is less of a catalyst for further upside now that both of these measures have largely renormalized.

 

 

Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 4 bps to 54 bps.

 

European Banking Monitor - 111. Euribor

 

ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  

 

European Banking Monitor - 111. facility

 

European Financials CDS Monitor – Bank swaps were wider in Europe last week for 31 of the 40 reference entities. The average widening was 2.6% and the median widening was 2.4%.

 

European Banking Monitor - 111. banks

 

Security Market Program – The ECB's secondary sovereign bond purchasing program bought €27 Million sovereign paper in the week ended 3/9, after three straight weeks of no purchases. The bank bought a mere €183 Million in the first two weeks of February, versus €2.2 BILLION in the week ended 1/20 and €3.8 BILLION in the week 1/12. When questioned in last week’s ECB press conference on the lack of buying over the last 3 weeks, Draghi only answered that the SMP is a non-standard measure that is “neither eternal nor infinite.” Clearly, with the some €1 Trillion injection of liquidity across the LTROs, the Bank is paring back buying and watching the results of sovereign bond auctions. The trend in 2012 continues to be banks issuing debt at lower yields compared to previous auctions. We do, however, continue to wonder exactly who is meeting this demand for PIIGS paper.  

 

European Banking Monitor - 111. smp

 

 

Matthew Hedrick

Senior Analyst


STRONG WEEK IN MACAU

No change to our full month GGR forecast of HK$24-26 billion, up 23-33% YoY.  

 

 

Average daily table revenues (ADTR) jumped to HK$790 million this past week, up from HK$776 million in February.  Month to date, ADTR is in-line with February. 

 

Remember that the comp is fairly easy as VIP hold % was the lowest in 2011.  Nonetheless, overall business levels should be considered very strong and above consensus expectations.

 

STRONG WEEK IN MACAU - macau5

 

MPEL appears to have lost a lot of share in the past week, no doubt due to hold, while Galaxy gained the most.  Relative to trend, MGM seems to be performing the best in March while MPEL and LVS are below.

 

STRONG WEEK IN MACAU - macau6


Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.

KORS Light

 

With KORS announcing that insiders are selling $1.24bn in stock in a secondary after a meteoric 148% rise in 3 months since the IPO, we’d like to shed some light into what you’re buying from management.

 

 

First off, we can argue all day that KORS is expensive. In looking at earnings and cash flow, there’s no way to justify where it trades. But great brands with incredible earnings momentum and conservative expectations will always look expensive. We have about another three quarters where yy compares will make fighting the tape a difficult battle for anyone on the short side here. But for anyone really buying it here, take a look at relative value. The comparisons are clearly out of whack to us.  

 

With an Enterprise Value of $9.4bn, KORS compares to…

1)      COH at 21.2bn (44% of COH Value, with 16% of its’ cash flow)

2)      Both LIZ and VRA at about $1.5Bn respectively

3)      TIF’s $9.1bn (KORS is 3.3% ABOVE TIF EV!)

4)      UA at $4.8bn (UA offers better long term growth with less competition and lower risk)

5)      LULU at $10.1bn (I view this almost identical to UA in many ways. All Blue Sky here. UA looks better to me at this value dispersion)

6)      RL at $15.4bn. You believe that KORS is at 61% of RL’s EV? C’mon…

 

In an effort to shine some light on the composition of KORS’ runway, here is a look at how we see the KORS story playing out over the next few years:

 

Revenues:

 

We see KORS growing revenues at a 28% CAGR over the next three years as the company shifts its mix increasingly towards retail distribution and into the Handbags/Accessories category (see tables below). With the company still in the early stage of growing its store base at 231 currently and plans for 600+, retail will be the key driver of growth in addition to multiple drivers within each channel of distribution.

 

KORS Light - KORS RevMixTable

 

Retail:

 

The key to our expectation for a 36% CAGR over the next three years in retail revenues is predicated primarily on new store growth as well as increased productivity from both product expansion and extensions as well as a favorable tailwind from KORS’ store maturity/productivity curve.

  • Compared to other high growth concepts and established luxury apparel brands, at $1,280 per sq. ft. KORS already ranks among the most productive brands.

KORS Light - KORS SalesPSqFt RelChart

  • In looking at KORS’ long-term store growth targets, there are a few important considerations. First, the number of mall/lifestyle center locations available, and second, the COH roadmap.
  • There are nearly 1,300 U.S. malls and lifestyle centers over half of which are considered A or B locations. In addition to these 600+ mall/lifestyle locations, there are plenty of free standing stores available as well. After 15+ years, COH is up to 488 stores in the U.S. 
  • As part of their long-term planning, KORS has targeted 400 stores domestically just over 2x its current base of 188. Our sense is that KORS has no business being in a ‘B Mall’. So we think that their 400 US store target sounds about right. Keep in mind that existing stores are on ‘Main and Main’. Translation – as it relates to new store productivity, we’re inclined to think that this number trends down, not up. This is not to say that incremental dollars, ,or comps, will come down. But very simply that there will be a shift on the margin to a less productive asset. As long as the rent per sq/ft is in check, we’re ok with that.

 KORS Light - StoreGrwthvsCOH

  • Take a look at the store growth trajectory for KORS in conjunction with COH’s own store historical store growth footprint. Combined with the store productivity charts below, one can see the acceleration in store growth, and category expansion coupled with higher priced product that drove a 6-year period of 20% revenue growth from 2003 to 2008.
  • Given the breadth of product assortment not only in accessories (e.g. handbags, small leather goods, watches, jewelry, etc.), but also apparel, in addition to its smaller store format (KORS at ~2,000 sq. ft. vs. COH at ~2,500 in Year4) we think KORS can ultimately achieve similar levels of productivity ASSUMING NO MEANINGFUL DEGRADATION IN STORE LOCATION PROFILE.
  • We think this highlights the key issue with KORS. Category expansion will likely get it the comp it needs. New stores will get the growth – optically – that it needs. But does channel fill related to less desirable locations ultimately take down aggregate sales/square foot at a rate faster than its lease agreements allow it to lower costs?  We have to wait a year – at a minimum – to find out. But this is very key.
  • Our model has KORS coming in over $1,350 in sales per sq. ft. in F12 reflecting an accelerated path compared to COH at this stage due to its aggressive product expansion strategy early on, which played out for COH years later

KORS Light - KORS RevPSqFt ChartRel

  • In addition to square footage growth another key consideration is the store maturity curve, which is at an inflection point and will provide a multi-year tailwind to store productivity. Aside from a modest store base, the incremental store growth over the last two years will result in an acceleration in the maturity curve as illustrated in the chart below.
  • Based on typical industry peak productivity timelines, we assume that the average KORS’ store reaches maturity in its third year of operation after which it becomes mature.
  • Assuming new store productivity at its current rate of approximately 80% in Year1, 90% in Year2, and 95% in Year3, the base of mature stores operating at 100% productivity will increase from 32% in F12 to 59% in F15. This will result in a blended productivity rate of increase from 90% to 95% over that timeframe.

KORS Light - KORS StoreMaturityCycle

  • All in we’re looking at a 36% CAGR over the next three years in retail revenues driven by new store growth, increased productivity from both product expansion and extensions as well as a favorable tailwind from KORS’ store maturity/productivity curve.

KORS Light - KORS IncrRev TablebyChannel

 

Wholesale:

 

At 46% of total sales, the wholesale channel is still a sizeable business for KORS. While we think retail will account for the majority of incremental revenue growth (65%-75%) over the next three years as noted in the table above, we expect wholesale to account for a meaningful 25%-30%. Our revenue contribution from this channel is driven primarily by new door growth and conversions. Consider the following:

 

New Wholesale Door Growth:

  • Over the last three years, wholesale door growth has averaged 345 per year ranging from 287 to 432.
  • We expect incremental annual door growth over the next three years to be in the range of 275-325 driven primarily through international expansion (2/3) as well as domestic additions (1/3).
  • As such, We think KORS can double its European store base over the next 2-3 years growing to over 1,000 doors.
  • We assume domestic doors will operate at a productivity level similar to new conversions (~$500k/yr) and international doors to operate at a rate of ~$150/yr. This lower rate of productivity is due in part to more limited category representation in many of these new locations which include specialty shops that typically carry only KORS’ ready-to-wear apparel for example instead of accounts/doors that carry apparel and accessories.
  • This would suggest a global wholesale door count of 3,250 by F15. As a point of reference, Ralph Lauren sells through nearly 10,000 wholesale points of distribution domestically and in Europe combined suggesting substantial opportunity for further growth.
  • We estimate that new wholesale door growth will account for 7%-12% growth in the wholesale business and 5-7% of incremental growth in total revenues.

Conversions:

  • There are approximately 1,800 doors in North America, roughly 1,000 of which are conversion targets. With ~250 conversions already completed there is an opportunity for at least another 750 wholesale door conversions.
  • The productivity of wholesale doors that are converted typically run 3x pre-conversion sales levels. With wholesale door productivity running at ~$200k annually in 2010, we assume new conversions are generating close to $600k per door.
  • Despite a target of at least 100 conversions per year, we expect that figure to be considerably higher and are assuming 150 conversions per year over the next three years - a rate that is likely to decelerate thereafter.
  • We estimate that wholesale conversions alone will account for 6%-10% growth in the wholesale business and 3-5% of incremental growth in total revenues.

E-Commerce:

  • Another thing to keep in mind is KORS’ e-commerce business, which is currently operated in partnership with Neiman Marcus and accounted for as wholesale sales. KORS sells product to Neiman’s at wholesale, which is in turn sold through michaelkors.com.
  • The company has been taking steps to bring the e-commerce business in-house. We estimate that KORS online sales are $30-$40mm at retail accounting for $15-$20mm in wholesale revenues. This implies e-commerce accounts for ~2.5% total revenues (at retail) slightly below where COH’s e-commerce business stands currently.
  • When the company brings this business in-house it will shift revenues from wholesale to retail, but improve profitability as well. While we do not have the exact timing of this eventuality accounted for in our model, we will adjust our numbers accordingly when this change is made.

KORS Light - KORS WhlsDoorContrib

 

Licensing:

 

Licensing accounts for only ~5% of KORS revenues, but ~17% of F12 EBIT. While not a key revenue driver, KORS has multiple avenues with which to grow its licensing business.

  • In conjunction with Fossil, watches is KORS’ most significant licensing business currently at approximately $300 in revenues at retail.
  • The other licensees of note are Estee Lauder for fragrance and Marchon for eyewear both of which are more modest businesses.
  • Fossil is also the exclusive licensee of KORS’ fashion jewelry line, which is the business with greatest upside potential in our view aside from watches. We think this could be another $300mm+ business for Fossil at retail.
  • We think the long-term opportunity for these four businesses could reach over $1Bn in retail revenues equating to $180mm+ in revenues for KORS. Assuming consistent ~60% profit margins, the license business alone could account for over $0.30 in earnings, or over $8/share in value over time.

KORS Light - KORS LicTable

 

Gross Margins: 

  • The shift towards retail as a percent of total distribution will be a natural tailwind for gross margins over the next 3-5 years at a minimum. Here is a look at the magnitude of this tailwind assuming constant margins for retail and wholesale isolating the mix shift.
  • Sales growth outpacing inventory growth this past quarter is gross margin bullish despite what appears to be  management conservatism in looking out to next quarter. We are modeling margin expansion to continue next quarter (+100bps) and for the next three years up +98bps in F13, +75bps in F14, and +50bps in F15 driven largely by this significant mix shift tailwind.

KORS Light - KORS GM Mix

 

SG&A:

  • We expect SG&A growth to remain at accelerated levels relative to revenue growth over the next three quarters due primarily to growing corporate costs including added headcount to build out an e-commerce team, higher rent expense related to store expansion, wholesale conversion costs, new warehouse management system expenses, and increased international marketing to raise brand awareness.
  • We expect one of the more variable pieces of SG&A spend over the next two years will be international marketing spend in an effort to raise brand awareness. As noted on the latest earning call, sales hit an inflection point when brand awareness broke through 50%-60% domestically. In Europe, KORS brand awareness currently stands at ~35%. We think the company will invest aggressively to grow awareness overseas.
  • As higher productivity rates and new store growth continues to leverage KORS’ existing infrastructure, we expect the company to realize SG&A leverage in the 2H driving modest leverage in F13 as well as the following two years.

With gross margin expansion and SG&A leverage, we expect KORS to expand EBIT margins by 4pts over the next three years from 17% currently to over 21% by F15 resulting in 30%-50% earnings growth during that timeframe. We are modeling EPS of $1.01 for F13, $1.37 for F14, and $1.77 for F15.

 

Free Cash Flow:

 

Capital spending is higher in F12 at ~9% of sales relative to a more normalized range of 6.5%-7.5% in recent years to support the transition of a new warehouse and related equipment, store growth, and additional investment in IT infrastructure. As a result, we expect FCF to be ~$25mm in F12. We expect additional capital spending related to the new warehouse and international corporate infrastructure to keep F13 CapEx elevated (~8% of sales) as well before returning to a more historical rate thereafter. As a result, we expect KORS’ FCF yield to rebound to 5% in F13, 6.5% in F14, and over 8% in F15.

 

 

Casey Flavin

Director

 

 


THE HBM: GMCR, MCD, RUTH

THE HEDGEYE BREAKFAST MONITOR

 

MACRO NOTES

 

Commentary from CEO Keith McCullough

 

Greece, slowly, but surely falling off Most Read (Bloomberg) news wk-over-wk; China and Global Growth Slowing back in vogue:

  1. CHINA – worst Trade Deficit in 22yrs (let’s call that ever – and ever is a long time) at -$31.5B after last week saw that big sequential drop in Chinese IP growth (to 11% vs 14% in JAN despite Lunar shift). Growth Slowing. Chinese stocks looking for a rate cut.
  2. ISRAEL – someone knows something or someone thinks they do – what I can’t see here makes me call it out as the Tel Aviv25 Index not only moved to red for 2012 YTD last week, but is down another full 1% this morning (down -4% in since Feb 21). Iran?
  3. USD – the most important (and bullish on the margin for US Consumption Growth) recovery in the last few weeks has been the US Dollar Index recovering its intermediate-term TREND support of $79.36. With short-term Treasuries (2yr) breaking out above 0.26% TREND support and Gold struggling relative to oil, I’m out of Gold for now. Considering the short side GLD and looking to buy USD back.

VIX 15-17 range has proven to be the right zone to take down both gross and net for the last 4yrs.

 

KM

 

 

SUBSECTOR PERFORMANCE

 

THE HBM: GMCR, MCD, RUTH - subsector

 

 

QUICK SERVICE


GMCR: Green Mountain Coffee was downgraded to Neutral from Buy by BofA on Friday. The price target was lowered to $63 from $70.

 

MCD: McDonald’s featured in a Barron’s article this weekend where “the Trader” column detailed why the stock may be overpriced. 

 

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

GMCR: Green Mountain declined almost 16% on accelerating volume as SBUX announced the arrival of its new brewer and David Einhorn said that Green Mountain’s install base has no “true protection”.

 

SBUX: Starbucks gained 2.9% on accelerating volume.

 

 

CASUAL DINING

 

RUTH: Ruth’s Chris announced 10% buyback of its 10% convertible preferred stock.  Retiring the 10% convertible preferred stock cost the company $60.2mm in cash which was funded by its $100mm senior revolving credit facility.  This move prompted Jeffries to raise its PT by $1 to $8.

 

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

RUTH: Ruth’s Chris gained 6.8% on accelerating volume.

 

THE HBM: GMCR, MCD, RUTH - stocks

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


Complicating Life

This note was originally published at 8am on February 27, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“You should know that correcting your intuitions may complicate your life.”

-Daniel Kahneman

 

That’s just a great risk management quote from Chapter 18 of “Thinking, Fast and Slow” – Taming Your Intuitions. While the Storytelling about oil prices, what caused them, and what they mean to your portfolios can be creative, it can also complicate your life.

 

Complicating Life for the small some of us whose life will not change by prices at the pump is not what I mean. I’m talking about the most obvious of obvious of life’s complications – what’s in your wallet versus what you need to buy to feed your family.

 

While that may be the most intuitive statement of the year for the rest of the world’s consumer population, on Wall Street we are often numbed to believe that making the most obvious of obvious calls on markets and economies isn’t “smart” enough.

 

Back to the Global Macro Grind

 

One obvious call that we pounded on last week is that Global Consumption Growth has never not slowed with oil prices running north of $100/barrel. We’ll reiterate that very simple fact this morning. I couldn’t have repeated it enough in February of 2008.

 

Barron’s Mike Santoli did a nice job of bringing back those 2008 memories this weekend when he pointed out that the price of Brent Oil has not traded below $100/barrel for 269 days. Make that 270 days now. The longest streak (ever) prior to this was 110 days in 2008.

 

2008 and 2011 are the years that the willfully blind at both the Fed and Sell-Side groupthink-tanks would like to just forget. That’s why we like to remember them. When Growth Slowing happens every few years after the price of oil ramps, there’s something obvious Complicating Life for those of us who don’t hang our hats about being “dead” in the long-run.

 

To review the Dollar Debauchery, Oil Up trade last week:

  1. US Dollar Index was down -1.3% to $78.35
  2. Brent Oil price was up +4.9% to $125.47
  3. WTIC Oil price was up +6.4% to $109.77

And, of course, the headlines into the weekend were that Oil was rising because the “economic recovery” was picking up steam…

 

Then, a not so funny thing happened on the way to the pre-market US Futures forum this morning. Stocks fell down … because of “rising oil prices” … but, uh… oil prices this morning are falling…

 

Got Storytelling?

 

The sad fact of the matter is that many market participants need oil prices to rise to get paid. That’s just a sad fact for the country, not for absolute returns. At +25.2% and +21.8%, respectively, Russian and Venezuelan Equities are 2 of the Top 3 performing Stock Markets in the world for 2012 YTD. These are called Petro-Dollar markets – awesome, right?

 

It really is awesome if you are long Inflation Expectations Rising. The problem with that is 2 fold:

  1. That, ultimately, leads to Growth Expectations Slowing
  2. Most people on this earth are short inflation in their wallets

The other thing here Complicating Life is that our industry chases prices at tops and sells bottoms:

  1. CFTC data for last week shows bullish Commodity Options contracts up +7.3% week-over-week
  2. At 1.03 Million call options on commodity inflation, that’s the biggest number since the week of September 13, 2011
  3. From the CRB Index’s September 2011 high to its October 2011 low (292) we saw a -14% crash in commodities

Yes, Commodities Crashed. That was last year, remember?

 

Last year, post Qe2, expectations continued to build for a Stronger Dollar. So commodities crashed. Period. Commodities didn’t fall because growth expectations were slowing. US GDP Consumption Growth rose steadily as the price of oil fell with US GDP going from 0.36% in Q1 to +2.8% in Q4 of 2011.

 

I’m not saying it’s easy being a Macro man trying to navigate the whip-saw of Big Government Interventions. If I have written this 100 times I have said it 1,000 times over – cheap money Dollar Debauchery policies A) shorten economic cycles and B) amplify market volatility.

 

What I am saying is Ben Bernanke’s Policy To Inflate to 2014 is Complicating Life for the rest of the world’s consumption.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), Oil (WTIC), US Dollar Index, and the SP500 are now $1749-1797, $120.78-126.21, $105.44-110.66, $78.38-79.11, and 1357-1370, respectively.

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Complicating Life - Chart of the Day

 

Complicating Life - Virtual Portfolio


the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

next