“I’m a joker
I’m a smoker
I’m midnight toker
I get my loving on the run.”
-The Steve Miller Band
Technically speaking today is the last business day before April Fool’s Day. Last year, as some of you remember, I pulled off a decent prank as I removed Keith from his post as CEO of Hedgeye and we replaced him with the The Most Interesting Investor In The World.
For those of you that missed last year’s joke, I’ve posted the mock video of The Most Interesting Investor In The World directly below. Our readers that are in tune with popular culture will recognize that it is a spoof of Dos Equis Most Interesting Man In The World:
In my opinion, although perhaps it is because I wrote the script for the You Tube video above, the best line is:
“He shorts naked, with his clothes on.”
But to be even more fair, April Fool’s Day jokes can at times completely miss their mark, especially in times like this when global macro markets really need our utmost focus. So, this year, we are putting April Fool’s to the sidelines.
Ironically, or perhaps not, Steve Miller is from Wisconsin, which, setting aside the Republican primary battle, is really the current battleground of U.S. politics. As ABC News wrote this morning:
“While the national media attention has been focused on the upcoming GOP primary in Wisconsin, there’s another political battle gearing up in the Badger State, and it involves both Democrats and Republicans.
On Friday, the Government Accountability Board of Wisconsin is expected to certify the 1 million petitions turned in in January to recall Republican Gov. Scott Walker. With a special gubernatorial election pending, Democrats and Republicans in the state are bracing for a tight race ahead.
A special election is tentatively scheduled for June 5, with a Democratic primary to take place four weeks earlier, on May 8. (Those dates will be made official after the recall is certified.) Three Democrats have declared their candidacies – former Dane County executive Kathleen Falk, Wisconsin secretary of state Doug LaFollette and state senator Kathleen Vinehout.”
On many levels, the June 5 election will be a critical leading indicator for President Obama’s re-election chances.
On that front, President Obama currently has a 60.4 probability of getting re-elected based on InTrade. This correlates very closely with the Hedgeye Election Indicator (HEI), which currently shows a 62.3 chance of Obama getting re-elected. Our proprietary index is based on rigorous back testing. In effect, we’ve determined that there is a short list of real time market-based indicators that move ahead of President Obama’s position in conventional polls.
Setting all joking aside, in the Chart of the Day, I’ve flagged a note passed along yesterday by my colleague Darius Dale in which he wrote:
“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.”
So The Chart of the Day, no joke, shows that volatility, per Darius’s point, is at a very complacent level. In fact, this is a level that previous flagged both U.S. equity market and global equity tops.
The global macro action this morning is once again in Europe. Eurozone Financial Ministers are meeting in Copenhagen today (beginning at 11:30am GMT) and tomorrow to discuss strengthening the region’s firewall via EFSF/ESM. As well, Rajoy will present Spain’s 2012 budget this afternoon with a statement expected around 12pm GMT (deficit target 5.3% of GDP down from 8.5% last year).
If there is one key red flag this morning in Europe it is from Germany. Specifically, German February retail sales came in weaker at -1.1% month-over-month versus the estimate of +1.1%. Now, clearly, this is but one data point, but Germany is definitely the positive bell weather in Europe to focus on. Well, until Germany turns negative.
As it relates to our negative thesis on the Yen, this morning we had two supportive data points:
1. Japan Industrial production unexpectedly fell as strengthening yen hurt outlook for exporters earnings; and
2. Japan February consumer prices unexpectedly increased +0.1% year-over-year versus -0.1% estimates.
But data points, as always, are only data points. So, this morning I will leave you with one last quote from Steve Miller:
“The question to everyone’s answer is usually asked from within.”
Our immediate-term support and resistance ranges for Gold, Oil (Brent), and the SP500 are now $1, $122.25-124.67, and 1, respectively.
Keep your head up and your stick on the ice,
Daryl G. Jones
Director of Research
TODAY’S S&P 500 SET-UP – March 30, 2012
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: -662 (238)
- VOLUME: NYSE 817.38 (0.04%)
- VIX: 15.48 0.06% YTD PERFORMANCE: -33.85%
- SPX PUT/CALL RATIO: 1.49 from 3.16 (-52.85%)
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: 41.22
- 3-MONTH T-BILL YIELD: 0.06%
- 10-Year: 2.16 from 2.16
- YIELD CURVE: 1.82 from 1.82
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: Personal income, Feb., est. 0.4% (prior 0.3%)
- 8:30am: Personal spending, Feb., est. 0.6% (prior 0.2%)
- 9:45am: Chicago Purchasing Mgr, Mar., est. 63.0 (prior 64.0)
- 9:55am: UMich Confidence, Mar. F, est. 74.6 (prior 74.3)
- 10am: NAPM Milwaukee, Mar., est. 58.0 (prior 58.6)
- 1pm: Baker Hughes rig count
- Secretary of State Hillary Clinton in Riyadh, Saudi Arabia, meets with King Abdullah regarding regional security and Syria
- President Obama travels to Maine and Vermont for campaign fundraising
- ITC holds meeting on the economic effect of the addition of certain products to the list of items eligible for duty-free treatment, 9:30 am
- FTC Bureau directors speak at antitrust conference, 8:15am
WHAT TO WATCH:
- Consumer spending probably climbed 0.6% in Feb., economist est., as Americans bought more cars
- FTC decision may occur today on Express Scripts and Medco Health antritrust law violation claims
- Research in Motion said it plans to refocus on business market, will consider partnerships and joint ventures
- BP said the U.S. govt. is withholding evidence that would show the oil spill in the Gulf of Mexico was smaller than claimed
- Wells Fargo and SEC lawyers told to meet to discuss documents related to a probe of mortgage-backed securities
- Pfizer judge certifies class action in Celebrex, Bextra suits
- Euro-area March consumer prices climbed 2.6%, more than est.
- Deadline for private-equity, hedge funds to meet registration requirements with SEC under Dodd-Frank
- Finish Line (FINL), Pre-Mkt, $0.81
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Copper Traders Most Bearish in Two Months on China: Commodities
- Gold, Poised for Quarterly Advance, May Gain on Weaker Dollar
- Oil Rises From Year’s Biggest Decline as Finance Ministers Meet
- Copper, Set for Quarterly Increase, Climbs as Equities Advance
- Soybeans, Headed for Quarterly Gain, Rise as Sowing May Stagnate
- Robusta Coffee Slides as Producers May Be Selling; Sugar Rises
- Carbon Like ‘Titanic’ Sinking on EU Permit Glut: Energy Markets
- Floating Windmills in Japan Help Wind Down Nuclear Power: Energy
- Gas Extends 10-Year Low as Inventories Gain More Than Expected
- Iran Sanctions Fuel ‘Junk for Oil’ Barter With China, India
- Oman Oil Output to Rise Next Month as Harweel Field Starts
- Japan’s February Oil Imports From Iran Fall 32.7%, METI Says
- Japan Expects Feed-Wheat Imports May Jump 82% Next Fiscal
- Copper Traders Most Bearish as China Slows
- GrainCorp at Lowest Valuation Seen Ripe for Plucking: Real M&A
- Stalin’s Siberian Enclave Revives as Putin Seeks Mines for China
- O’Neill Says He’s Not Convinced Oil Prices Going Up Further
GERMANY – February retail sales come in weaker at -1.1% versus the estimate of +1.1%.
JAPAN – Industrial production unexpectedly fell as strengthening yen hurt outlook for exporters earnings; and Japan February consumer prices unexpectedly increased +0.1% versus -0.1% estimates.
The Hedgeye Macro Team
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 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
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.
Here’s a solid overview of BBBY by my colleague Matt Darula.
BED, BATH & BEYOND: DURATION ANALYSIS
Conclusion: The consensus call on BBBY is clear. That it is a well-managed company, but one that will face increased pressure from dot.com 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.
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.
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 Amazon.com 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 dot.com competition. Dot.com 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.
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 Amazon.com. 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.
Higher Ticket = Higher Risk:
Overall, Amazon.com’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.
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 Amazon.com 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.
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