This note was originally published at 8am on March 16, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The downside to thinking statements are more complicated than plainly stated, is that what is plainly stated is more often than not the truth when arrived at the long way around.”

-Rob Shewchuk


Rob Shewchuk is a long time friend of Hedgeye and also many moons ago played junior hockey with our CEO Keith McCullough for the Pembroke Lumber Kings.  If the moniker Big Alberta fits me, I think it is fair to say that Big Ontario fits the 6’3”, cowboy boot wearing Rob Shewchuk.  Rob grew up in the mining town of Red Lake, Ontario and has parlayed his natural business instincts into becoming one of the top brokers in Canada, with a special focus on undervalued mining assets and emerging growth companies.


Rob and I were texting each other about a common business situation and he put on his Red Lake philosopher’s hat and sent me the above quote.  As a bachelor who is still in full dating mode, I’ll be the first to tell you that text messages can lead to confusion, but I think the message Rob was sending was pretty clear: keep it simple.


In investing, complexity negatively infiltrates the investment process in a number of ways.  One way is analysis paralysis.  Undoubtedly, we’ve all worked with analysts that are guilty of this crime of complexity.  The guilty analyst will have a 75 page spreadsheet analyzing a company down to the return on capital of the administrative assistant to the head janitor, but won’t be able to make a call on whether the stock is going up or down.  The analyst knows so much, he or she is in fact paralyzed and unable to make a decision.


The other crime of investing complexity, which is more to Rob’s point, is when an analyst complicates simple things, like say valuation.   A friend of mine from home says that when it is – 40 degrees Celsius out, you don’t need to ask how cold it is, you just know it is *expletive* cold.  The same could be said for valuation.  If a stock or asset is cheap, you shouldn’t have to argue it’s cheap, or justify that it is cheap.  The valuation will be plainly obvious.


Yesterday, to the last point, I wrote a research note on the valuation of the SP500.   Many stock market pundits are making the case that the SP500 is cheap based on future consensus earnings. Unfortunately, that analysis is not really all that simple, for the basic reason that consensus estimates are usually wrong.  In fact, according to a McKinsey study from 1985 to 2009, SP500 earnings estimates were higher than the actual reported number 92% of the time.


So, obviously when making the simple valuation call, it depends on the complexity of the underlying estimates. When looking at the valuation of the SP500, we prefer to use CAPE, or cyclically adjusted price to earnings.  CAPE is a metric popularized by Yale Professor Robert Shiller that looks at a market P/E that is adjusted for inflation and normalized for cycles.  Currently, CAPE is showing that the SP500 is trading 21.9x, which is the highest level since July 2011 and in the top quintile of market valuations going back to 1880 (before even I was born).


CAPE hit a 35-year low in March of 2009 at 13.4x. This also coincided with a low in other stock market valuation metrics and the bottoming of the market.  Stocks were, simply, and obviously, cheap.  As for now, it is neither simple, nor obvious.


As of late, we’ve been flagging and harping on another simple indicator of the equity markets peaking, which is the VIX.  The Chart of the Day today goes back exactly three years to the bottom in March 2009 and compares the SP500 to the VIX over that period.  As the chart shows, a VIX level of 15-ish has coincided consistently with a short term top.   To the simpletons at Hedgeye, that is a red flag worth emphasizing.  More simply, the VIX at this level signals that complacency is setting in.


Over the last 24 hours, we’ve made a couple of simple moves in the Virtual Portfolio that should inform you on our current positioning:


1.   Shorted Greece via the etf GREK – With “positive” catalyst of the Greek debt restructuring in the rear view mirror, Greek equities now have to deal with austerity headwinds and a population that is leaving Greece en masse.


2.   Shorted SP500 via the etf SPY – Selling the SP500 at our overbought line has a high historical batting average and at 1,401, the SP500 is overbought.  Yes, it can be that simple.


3.   Shorted consumer discretionary via the etf XLY – With oil prices and inflation accelerating, this isn’t good for growth or discretionary spending.   Historically, growth slows when oil reaches 5.5% of GDP. Simplistically, a Brent oil price of $116 equates to 5.5% GDP and Brent is currently at $123.


Henry Wadsworth Longfellow also had a great quote about simplicity (although he didn’t text it to me), which was: "In character, in manner, in style, in all things, the supreme excellence is simplicity."




Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Simpletons - 11. CHart of the Day


Simpletons - 11. VP 3 16


Receivables on the books of some concessionaires are on the rise. Indicative of more competitive conditions?



There are a number of possible explanations for why net receivables are escalating in Macau.  But as the following chart shows, there can be no doubt that they have moved higher, and not just on an absolute basis.  Net trade receivables as a percent of VIP volume were up at 12/31/11 on a YoY and semi-annual basis at Wynn Macau and Sands China. 


MGM’s receivables have been pretty consistent.  Surprisingly, MPEL has shown a fairly consistent decline, even at 12/31/11.  Of course, both MGM and MPEL have been aggressive in junket credit for the past 18 months or so but it is encouraging that their receivable levels have not indicated any uptick in recent quarters.  




Looking at just Wynn Macau and Sands China – the two mature operators who provide enough disclosure for analysis – one can see the pickup at 12/31/11.  On a YoY basis, the average receivables % almost doubled while they were up considerably sequentially.




So what’s going on?  There are several explanations:

  • More junket credit – We’re pretty sure this is happening with some casinos now advancing up to 3 months of commissions, up from the traditional 30 days.  We think MPEL, Galaxy, and MGM have been doing this for awhile but LVS began to offer similar programs to select junkets late in 2011.
  • More direct VIP credit
  • Lower reserving – WYNN's allowance for doubtful accounts as a % of gross receivables dropped from 41% at YE 2010 to 36% at YE 2011.  LVS indicated on their recent earnings call that its reserve against gross casino receivables was 27% at the end of 2011 versus 42% in 2010.

BBBY: E-Comm Threat Revisited


Here’s a solid overview of BBBY by my colleague Matt Darula.





Conclusion: The consensus call on BBBY is clear. That it is a well-managed company, but one that will face increased pressure from given the commodity nature of its product. That said, the roadmap is quite opaque, and though there will be pressure, no one is sure how much is at risk, and when it will begin to really impact numbers. We think that’s probably right, but our conclusion is that we’re seeing a meaningful bifurcation in BBBY’s business across durations. Our Home Furnishings Indicator suggests that BBBY will surprise on the upside with comps, and as such we’re a nickel ahead on the quarter. But then we have a sharp deceleration in earnings growth next year due to increased commoditization due to a disrupted organization that is not prepared for the magnitude of stress on its core from new competition. We conducted a lengthy, and accurate, overlap analysis (see end of this note) to assess the damage. The result… 93% at risk. We’d be selling on a strong quarter.  



Here’s Our View By Duration


TRADE: (Trade = 3 Weeks or Less)

BBBY Reports its fourth quarter and full year results April 4thafter the close. We expect fourth quarter earnings to be about a nickel ahead of consensus driven by a stronger than excepted 5% comp vs. 3.6%E (and guidance of 2-4%), partially offset by weaker margins from a more promotional holiday shopping season. Our home furnishings model has a 5 year correlation of 0.74 with BBBY comps. What’s notable is that this includes the period where BBBY was gaining share at the expense of Linens N Things. Excluding this gap, the relationship is even tighter. In maintaining the backtested spread, we’re looking at a comp of 5-6% out of BBBY. Earlier this month, WSM reported results that were in-line with original guidance – after they came out and preannounced a miss (that really never materialized). Lots of issues at WSM, and not a direct comp, we realize. But worth noting.


What’s notable is that our Sentiment Monitor has been rolling over as the stock hits all-time highs.  We usually see the opposite. BBBY has 16 Buy ratings, 12 Holds and only 1 Sell.  Short interest is sitting at about 3.2% of float, and while that seems low, it’s actually high for BBBY relative to its own history. The point is that over the past 5-months, BBBY lost 9 points on our Sentiment Indicator (i.e. people got less bullish) while the stock marched forward to the tune of 28%. Perhaps the market is looking for a beat. If so, no problem. It’ll get it. But if not, look out below. Two of the past three quarters have not had the greatest quality of earnings, and the price reactions have not been fun for the bulls.


BBBY: E-Comm Threat Revisited - HRM Home Furnishing Index


BBBY: E-Comm Threat Revisited - BBBY Sentiment


TREND: (Trend=3 Months or less)

A Big risk factor that BBBY faces over the intermediate term is the relocation and consolidation of its Farmingdale and Garden City, NY headquarters to Union, New Jersey. Farmingdale and Garden City are each ~40-50 miles from Union. That’s certainly enough to dissuade some of the current corporate employees from moving including members of BBBY’s buying department. The company expects the move to be settled by the second half of F12.


Aside from ‘hiccup’ let’s acknowledge the risk inherent when a company with a culture that is as strong as BBBY simply ups its roots to another tax jurisdiction (for employees, not the company). Good people will be lost, and there will be important shoes to fill. Some of what made the culture here so great will be disrupted. There is an obvious cost element – that management highlights for us, but it’s tougher to quantify the intangibles, not the least of which is lost revenue and productivity.


BBBY: E-Comm Threat Revisited - BBBY SIGMA


TAIL: (Tail=3 Years or Less)

BBBY was the primary competitor that ‘nudged’ Linens n Things into Chapter 11 in 2008 alongside the recession and bursting housing bubble. After 3 years of shrinking operating asset turns and margins eroding, BBBY improved both in 2009 & 2010. While BBBY’s aggressive expansion and promotional cadence was largely the nail in the coffin for LIN, many people overlook the pressure from the e-commerce home category. Our analysis below shows that Bed Bath and Beyond has a 93% product overlap with which exposes BBBY’s primary store format (85% of the 1174 stores) to online competitive threat.  In other words, it was not just BBBY that put LIN out of business, it was Amazon and other competition. is still hungry, and with LIN’s $3.5bn in revenue gobbled up by BBBY ($10bn in revs), AMZN and the like, it will still go after bricks and mortar opportunities.


While alternative store formats like Christmas Tree shops and Buybuy Baby are less at risk, we expect the long-term tail risk to amass as the consumer focus shifts to omni-channel. BBBY has already begun to reaccelerate capital spending as a percent of sales on new stores, remodels, IT enhancements & a new fulfillment center but this might be too little too late. While this may increase customer retention, our concern here is that BBBY will need to spend more to stand still.


Check out our BBBY Management Scorecard


The BIG ideas in retail come when a company’s triangulation of EBIT margins and asset turns both improve simultaneously. Check out the chart below. The three years leading up to 2008 were abysmal. So was BBBY’s stock performance. From ’08 through ’11,  we’ve got asset turns improving along with EBIT margins. That’s a big RNOA accelerator. Pretty simple. But once margins OR asset turns start to stall, then multiple expansion goes out the door. That’s where the TAIL call with this company is headed.


For the past three years, earnings growth has been near 30%. For the next three, we have it hovering in the single digits. Take a look at history, this company is not afraid to shrink its net income.


BBBY: E-Comm Threat Revisited - BBBY RNOA


Product Overlap:


What we did: We conducted a detailed analysis on the different plan-o-grams in different sized Bed, Bath and Beyond stores. Then we looked at overlap among a variety of store formats. Then we literally scanned each product, and compared to either a) the exact product online, b) a ‘pretty darn close’ product by the same brand – one with enough tweaks for BBBY to call it exclusive, when its really close to being the same thing, and c) a competing product in a more commodity category that can act as a substitute.


Out of the product sold through Bed Bath & Beyond stores, our analysis showed there was a 52% direct sku overlap with However, assuming a 100% overlap in generic categories, the overlap was 93%. As a result of exclusive brands sold throughout various categories in Bed Bath & Beyond stores, certain product categories (i.e towels) had a 0% sku overlap. In reality, consumers are more sensitive to branded purchases in categories like cookware and appliances but neutral when shopping for items such as towels and sheets - a white towel is a white towel. As such, it’s important to keep the sensitivity of the overlap in perspective.


BBBY: E-Comm Threat Revisited - BBBY overlap summary


Higher Ticket = Higher Risk:

Overall,’s pricing was ~1% less than Bed Bath & Beyond’s in store prices. This varied dramatically across each shop with Amazon’s pricing most competitive in the higher cost categories. As consumers shift their spending more and more online, the greatest risk in the home space will be realized first in higher ticket categories including small appliances, cookware & luggage. We realize it will take longer for consumers to purchase smaller ticket items like picture frames, table settings and basic kitchen needs online but as companies continue to offer free shipping and put a greater emphasis on the online shopping experience and browsing tools we expect this to change.


BBBY: E-Comm Threat Revisited - BBBY AMZN


Bed Bath & Beyond/Amazon Product Overlap Methodology:

Our product overlap analysis pertains to the Bed Bath and Beyond concept only (993 of the current 1174 BBBY store fleet). Within the Bed Bath concept, the brick and mortar locations are primarily between 20K to 50K square feet with the sku count per store varying based on the size of each individual box as well as the market. We estimate that the sku count range in the Bed Bath and Beyond concept is between 10K-20K per store. BBBY’s primary concept has a distinctive merchandise presentation that is relatively homogenous across all stores and is designed to segment the store into more focused specialty “shops” that are used to channel the product offering by category. There are about 20-30 “shops” in each Bed Bath and Beyond store. The variability in “shops” across each location is another driver of overall sku count given the product density of each section. Most stores begin with the “Small Appliance,” “Kitchen Basics,” & “Cookware” sections which are relatively dense in sku count and end with the “Rugs” & “Towels” shops which house fewer skus. Conversely, less stores have a “Decorative Pillow” & “Luggage” section which are far less dense(see image below). We scanned ~150-200 skus per shop using the I-Phone app for overlap and price comparisons in 20 “shops” (spread across multiple locations) to estimate the online threat (~2500 skus overall).


Further driving the product offering in each store is the site manager selection - only 30% of the sku count in each store is fixed at a regional level with the remaining 70% selected by the store manager from a pre-established catalog to cater to the local market/consumer. While the 70% variability typically creates a differentiating product mix by “shop” in each location, the brands and categories remain consistent.


One unique quality that differentiates the Bed Bath & Beyond store format is the “walkthrough” layout that defines a start and end to the store and requires shoppers to pass each “shop” before hitting the register. Take a look at our store mockup below based on the Port Chester, NY store. This is one clear advantage to the concept given many trips to these stores that were originally intended for individual purchases can potentially be converted into a multi-item basket. This however can only happen as long as customers continue to shop the stores - once that single item purchase goes online the opportunity cost could be exponential.


The 93% overlap in Bed Bath & Beyond’s product offering with Amazon poses a risk that while fundamentally long term, will play out over time as the consumer gradually evolves into an omni-channel shopper and ultimately chooses to shop from the comforts of their living room.  


BBBY: E-Comm Threat Revisited - BBBY Blueprint


BBBY: E-Comm Threat Revisited - kitchen basics small appliances


BBBY: E-Comm Threat Revisited - Cookware and Luggage


BBBY: E-Comm Threat Revisited - BBBY towels and rugs



Brian McGough

Matt Darula

Lower Highs: SP500 Levels, Refreshed

POSITIONS: Long Utilities (XLU), Short Industrials (XLI) and SPY


I know people just want to get to month and quarter end but, like last year, and basically all 3 major draw-downs we saw in US Equities from the Q1 tops to Q3 lows (2008, 2010, and 2011), the next few weeks are likely going to be some of the most critical of the year.


Pro-cyclical Sectors (Energy, Basic Materials, and Industrials) are leading to the downside. Their respective highs for the year look very different than Apple or the Financials. Growth Slowing, globally, is not new to us – but it’s definitely looking like consensus has to pay more attention to it now that the VIX has gone from 14 to 17 on a 25 point SP500 drop.


Across my core risk management durations, here are the lines that matter most right now: 

  1. Immediate-term TRADE resistance (was support) = 1404
  2. Immediate-term TRADE support = 1388
  3. Intermediate-term TREND resistance = 1312 

In today’s chart I provide the scarier side of lower long-term highs in context (i.e. where we are within the context of not only the Sovereign Debt Cycle crisis, but the SP500’s all time high). The risk associated with this chart certainly isn’t “cheap.”


What have we learned about market multiples in the last 4 yrs? Cheap gets cheaper when Growth is Slowing.



Keith R. McCullough
Chief Executive Officer


Lower Highs: SP500 Levels, Refreshed - SPX


This may not be the best career risk management move, but BWLD is a story that we are still grappling with.  The company could be facing a staggering 20% increase in COGS during 1Q12, yet all research and commentary on the stock seems to skirt around this risk.  Are sales trends really that strong, and are they continuing to be as strong heading into 2Q, even given the drop off of the weather benefit and the slowing of the casual dining segment from February to March.


Don’t Mention the Wings


At the Telsey Advisory Group Spring Consumer Conference, Buffalo Wild Wings management had the following to say about commodity inflation:


“Commodities continue to receive a lot of attention these days. We have a long history of successfully managing our business and believe with our strategic focus on guest experience and operational excellence, our ongoing sales trends and unit level execution, and the benefit of a 53rd week, we will overcome rising commodity costs and achieve our net earnings goal.”


Here is what the company had to say on the same topic on the 4Q11 earnings call:


“We believe that with our strategic focus on guest experience and operational excellence, our ongoing sales strength and unit-level execution, and the benefit of a 53rd week, we will overcome rising commodity costs and achieve our 20% net earnings growth goal for 2012.”


Clearly there is a script that this management team is sticking to.  On the date of the 4Q11 earnings call, wing prices were up 75% year-over-year.  Now, they are up 98% year-over-year.  As our sensitivity table shows, below, based on guidance provided in the most recent 10-K, assuming a tax rate of 34% and shares out of 18.5 million, there could be a ~$0.70 impact to 2012 EPS from wing price inflation alone.  The question is, how much of an impact is consensus baking in?  Is the Street assuming blockbuster top-line and realistic COGs or are they assuming a large decline in wing prices during 2H12? 





Today at the Columbia Investment Management Association Conference, David Einhorn was quoted as saying that “Sometimes it’s a conspiracy to misinform people.  Wall Street has this agenda”.  We’re not saying that this is the case here, but we find it alarming that such a pertinent factor as commodity inflation is for BWLD over the next 3-6 months is barely being paid any attention.  The top-line story has been fantastic and we underestimated that in 4Q11’s results.  However, the lack of flow through was a worry to us then and is an even more acute worry now; inflation is only becoming more of a factor as time passes.


Perhaps the company can leverage labor, lighten up on G&A, and trim some fat elsewhere.  The reality is, however, that part of this company’s story is the growth story and G&A spending cuts may hamper growth efforts.  Labor leverage is definitely an available strategy but we do not see sufficient gains coming from that line to offset COGS significantly.


There is some risk to our bearish stance; the level of pricing that management is planning to take in the face of inflation pressures has not been determined.  Depending on how complicit consumers are with this price increase/increases, our view may change. 


The benefit of the 53rdweek is another offsetting factor.  At this point, the Street seems to be giving management 100% credit that it can manage through this period and meet investor expectations.  While the company has managed through inflation historically, investor expectations have not always been met.



Another Concept?


On another concept, management had the following to say:


We are also considering the possibility of acquiring or developing an additional concept to maintain our position as a high-growth restaurant company for the long term.”


We know never is a long time but never, in our recollection, has there been a restaurant company successfully transition from an original concept into two concepts while maintaining its growth profile concurrently.  Comments like the above statement from management make us weary.  Any transaction for Buffalo Wild Wings to acquire a growth brand is almost certain to be dilutive to EPS and the company lacks the cash flow to grow two concepts without taking on further capital.


Our EPS estimate for the year remains below consensus.  We are not satisfied that the risks to the company’s outlook are fully appreciated. 



Howard Penney

Managing Director


Rory Green




Defining Asymmetry: Investor Complacency At Multi-Year Lows

Conclusion: Measures of investor complacency are signaling to us asymmetric risk from an intermediate-term perspective. As such, we’re either at/near a cyclical top in “risky assets” or we’ve achieved “escape velocity” and are entering a new era of investing. We believe this is the key market debate to focus on.


After recently shifting out of being long the Inflation Trade from an asset allocation perspective, we’ve been loud in recent weeks highlighting the risks to real GDP growth, both domestically and internationally. Further, we continue to anticipate those risks (namely higher input cost inflation in the absence of commensurate employment and wage growth) to roll through the global economic system and slow growth on a lag. At these market prices (SPX = ~1,400; MSCI All-World Country Index  = ~160) we find there is asymmetric risk to the downside.


Of course, that risk is mitigated if we have reached “escape velocity” (to borrow the Fed Chairman’s own academic theory within the soft science of macroeconomics). At Hedgeye, we are inclined to defer to the math backing hard sciences, like physics, for example. Central plan as they may, we remain of the view that economic gravity can’t be arrested in perpetuity. Furthermore, we continue to hold steadfast on our views that Big Government Intervention does two things:

  1. It shortens economic cycles; and
  2. It amplifies market volatility.

Speaking of market volatility, we’ve been in print lately flagging the risk to U.S. equities that is a CBOE SPX Volatility Index at/south of the 15 level (closed at 14.26 on Monday). Specifically, as we’ve seen over the last ~4yrs, VIX-15 has been key contrarian indicator to fade consensus bullishness at cyclical equity market highs:


Defining Asymmetry: Investor Complacency At Multi-Year Lows - 1


Broadening our read-through on volatility as a measure of investor complacency, we’ve created a proprietary cross-asset class volatility index that uses an unequally-weighted average of the following volatility indices:

  • CBOE SPX Volatility Index (VIX);
  • Merrill Lynch U.S. Treasury Option Volatility Estimate Index (MOVE);
  • CBOE Oil ETF Volatility Index (OVX);
  • JPMorgan G7 FX Volatility Index; and
  • JPMorgan EM FX Volatility Index. 

On this score, the Hedgeye Global Macro VIX is at levels last seen since early OCT ’07. Note: that date is coincident with the all-time peak in U.S. equities amid consensus faith that “shock and awe” interest rate cuts and other modes of central planning would ultimately prove effective in delivering a shallow, manageable domestic growth slowdown.


Defining Asymmetry: Investor Complacency At Multi-Year Lows - 2


At such levels of consensus complacency, we feel it is prudent for investors to pick sides and make a call on which is the more probable of the following two scenarios:

  • Scenario A: We’re at/near a cyclical top in assets perceived to be generally more risky (equities; HY credit; EM currencies and debt); or
  • Scenario B: Measures of volatility will trade sustainably around these depressed levels for the foreseeable future, as we’ve entered a new era of global growth and financial market returns (akin to the mid-90’s and early-00’s).

You know where we stand. At a bare minimum, we think you should be having this debate with your respective teams.


Lastly, and certainly not to mine for contrarian data points, but the following anecdote is worth flagging for those of you who aren’t yet familiar:


The latest II Bulls/Bears Survey Spread (% Bull less % Bears) came in at 2,900bps – good for the widest spread since APR ’11. Per Keith’s commentary on yesterday’s Morning Macro Call:


“This is the other problem with [no] volume. We all know there’s no inflows into U.S. equities… there also isn’t going to be any more short covering. If this is how low the bears can go, this is what perpetuates the crash. Ben Bernanke’s policies have [many] unintended consequences… one of the big ones is that it gets the short sellers out of the game. They can’t efficiently cover stocks and keep that bid alive, so you get these real big draw-downs. That’s what we’ve seen: 1Q08, 1Q10, 1Q11. Are we going to have one in 2012? We’ll see…”


Measures of investor complacency are signaling to us asymmetric risk from an intermediate-term perspective. As such, we’re either at/near a cyclical top in “risky assets” or we’ve achieved “escape velocity” and are entering a new era of investing. This is the key debate we feel investors must focus on at the current juncture.


Darius Dale

Senior Analyst

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