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GMCR: THE SLOW BLEED OF THE GREAT COFFEE BUBBLE

When we consider that GMCR has now declined for 10 days in a row and insiders are exiting the stock, it is easy to concoct a bearish story.  The question is: how bearish is bearish enough?  We think the stock could go to $25.

 

Green Mountain Coffee Roasters’ stock is one we have been wary of for some time.  Howard Schilit, renowned forensic accountant, mentioned the company in a highly insightful interview with Barron’s last weekend about accounting shenanigans.  Also over last weekend, we also got our hands on an amended Class Action Complaint filed against the company in the US District Court in Vermont.  It makes for fascinating reading and cites 14 confidential witnesses from many different tiers and roles within GMCR.

 

We can imagine a time when the senior management team at Green Mountain Coffee Roasters looked at each other across a table and said, “Starbucks is going to buy us one day”.  While that eventuality may materialize one day, our estimation is that it is more likely to occur in a bankruptcy context than any other. 

 

The first rumblings about GMCR’s accounting issues began in late 2010.  The company had acknowledged an overstatement of pretax income in September of 2010 and the SEC had notified the company of an investigation into its revenue recognition practices.  In 2011, when it became clear that Starbucks wanted to take a slice of the single-serve market, we were convinced that the Seattle-based titan would go it alone.  We were wrong then but, as time passes, our confidence is growing that our thinking was not a million miles off target. 

 

With a current market capitalization of $7 billion and sales of $4.2 billion, weighing the current fundamental risks leads us to believe that this company’s stock could go to $25 or even lower in short order.  We believe that there is a risk of inventory write-downs and other one-time but long overdue charges.  The overstatement of pre-tax income acknowledged in 2010, as we discuss in more detail later in this post, bore no relation to the company’s relationship with M. Block & Sons, GMCR’s single order fulfillment entity.  According to its website, M. Block is a leading provider of end-to-end supply chain solutions.  Our view is that some costs could arise from alleged improprieties outlined in an Amended Class Action Complaint filed against Green Mountain last week.  While our legal expertise is limited at best, the numbers corroborate with much of the detail in that complaint.  If even 10% of the allegations in the complaint are founded in truth, investors may begin to exit the stock en masse.

 

Before we begin this note in earnest, it is worth stating clearly that many of the points discussed in this post is merely alleged to be true, coming from the Amended Class Action Complaint filed against Green Mountain Coffee Roaster’s Inc., et al., at the United States District Court in Vermont and also various other sources where the information provided constitutes opinion. 

 

 

NOTHING TO BE ALARMED ABOUT

 

On September 28th, 2010, GMCR filed a form 8-K with the SEC announcing management’s discovery of an “immaterial” overstatement of pretax income related to an immaterial accounting error relating to “the margin percentage it had been using to eliminate the inter-company markup in its K-Cup inventory balance residing at its Keurig business unit”.  Having determined that the error arose in 2007, the company calculated the impact from that point through June 2010 as being $7.6 million in pre-tax income or, net of tax, $0.03 in EPS. 

 

Within the same filing, the company reveals that on September 20th, 2010, “the staff of the SEC’s Division of Enforcement informed the Company that it was conducting an inquiry and made a request for a voluntary production of documents and information.  Based on the request, the Company believes the focus of the inquiry concerns certain revenue recognition practices and the Company’s relationship with one of its fulfillment vendors. The Company, at the direction of the audit committee of the Company’s board of directors, is cooperating fully with the SEC staff’s inquiry”.

 

The lead plaintiffs allege that the company knew about the SEC’s investigation for months. A confidential witness, “CW1”, cited in the case, states that the company’s revenue recognition methods were being investigated by the SEC.  CW1 was a former GMCR distribution planning manager, according to the Complaint.  Said witness recalled that in November and December 2009, internal discussions regarding the company’s revenue recognition practices were held at company meetings attended by many senior GMCR executives including CFO Frances Rathke and CEO Larry Blanford.

 

Our contention is that the inventory control and revenue recognition issues are one and the same largely due to the influence GMCR had over its supply chain “partner” MBlock (more on this later).  The confidential witness, referred to above, claims to have confronted two superiors, VP of Operations Jonathan Wettstein and Director of Operations, Don Holly about the company’s inventory processing practices on numerous prior occasions, dating back as far as October 2009.  His views were expressed to no avail; the inventory processing practices remained the same, as we discuss later.

 

While it is not appropriate or possible for us to take a stance on whether or not management knowingly and willingly manipulated inventory and sales numbers, it is surprising to us that management would have assumed such a bullish stance during the 7/28/10 conference call, if indeed SEC investigators were already meeting with company representatives regarding accounting practices at the company.  The following statement from management during that conference call was highlighted by the Complaint as being particularly misleading given that future sales growth was being guided down at the same time:

 

“And at the same time we'll be building our retailer inventories as we get into the fall season, with the expectation that we are going to continue to exceed our own expectations on brewer sales.”

 

Is it possible to have the expectation that one’s expectations are going to be exceeded? 

 

 

THE HIDE & SEEK INVENTORY METHOD

 

The “Class Period”, which is the stretch of time that the Action alleges that investors purchased GMCR’s common stock at inflated prices due to materially false and misleading statements, spans from 7/28/10-9/28/10.  At the center of the Action is the allegation that inventory was purposely accumulated with little or no regard for real demand for the product.

 

The confidential witness that claims to have approached management about the company’s inventory processing practices, CW1, outlined that management preferred a “standard deviation plus 3 [days’ inventory]” method versus the “ABC” method favored by the industry which categorized inventory as fast, medium, and slow moving items.  The witness stated to Wettstein that this method was “skewed” and would result in production of expired and expensive products to be produced solely to “carry-over” the inventory from one period to the next.  CW1’s input did not result in any change in policy, according to the Complaint.

 

Two other anecdotes, both of which – if true – are astounding, detail further improprieties that were carried out by GMCR, according to confidential witnesses cited in the Complaint.  CW1, stated, according to the Complaint, that “senior management stressed”, at weekly and bi-weekly meetings, “the need to continue to produce product regardless of whether or not the product could be sold.”  The resulting inventory problem was allegedly masked in two ways.  First, according to CW1, to “get rid of inventory” during audits, dated or expired coffee was loaded onto trucks and parked a few blocks away until after the auditors left the warehouse.  CW7, a lower-level employee in GMCR’s shipping department in Knoxville, Tennessee, corroborated CW1’s claims, adding that inventory was shipped to other company warehouses only to be returned untouched days later.  Additionally, CW1’s claims that expired coffee product was offered to pig farmers for inclusion in silage were strengthened by CW7 who said that he/she had witnessed vast amounts of product being dumped in land-fills near the Knoxville production plants. 

 

Why would employees, higher- and lower-level, have gone along with this strategy?  Why would M. Block have been so complicit in the alleged shenanigans?

 

 

FOLLOW THE MONEY

 

Money is the ultimate truth serum and, we believe, following the money helps to tie a lot of this story together.  Details within the Complaint as well as actual insider transactions by officers of the company seem to rhyme with the narrative of shenanigans that has been touted by Green Mountain detractors for the last eighteen months or more. 

 

Firstly, it is worth starting with M. Block, a company that was Keurig’s single order fulfillment entity.  In addition to taking orders for GMCR, M. Block also had as much as 500,000 square feet of warehouse space, storing both brewers and coffee.  Green Mountain was an extremely important client for M. Block; the Complaint states that prior to mid-2009, GMCR represented 20% of the company’s business.  After a nationwide contract was agreed in July ’09, however, that share 4quickly grew to 75%.  According to the Complaint, confidential witness six, or “CW6”, a former VP of Operations at one of the company’s roasters and a CPA, stated that the SEC was questioning the existence of an arms-length relationship between GMCR and M. Block and whether or not the transactions between the two companies could be recorded as sales.  David Einhorn’s recent presentation, the research behind which included interviews with current and former employees of GMCR and its partners, alleges that GMCR exploited the relationship with M. Block to engage in a “variety of shenanigans that appear designed to mislead investors and to inflate financial results.” 

 

Given the importance of GMCR to M. Block from a revenue perspective, it is clear that the incentive existed for the smaller, dependent company to comply with the practices of its client upon which it relied so heavily.

 

Lower-level employees, both within GMCR and M. Block (although Einhorn cites employees of M. Block as feeling like they worked for GMCR) were incentivized to follow senior management’s plan of attack, according to the Complaint.  CW1 states in the document that all employee bonuses were awarded annually and based upon the amount of product produced, not on the amount of product sold.

 

Furthermore, the Executive Compensation section of the fiscal 2011 10-K contains a definition (that was also in a proxy detailing the policy for FY10) of the “Annual Bonus Opportunity or Annual Cash Bonus” as “cash reward paid to executives on an annual basis; currently based on two financial metrics: net sales and non-GAAP operating income.”  If the company was able to manage revenue figures by simply ordering K-Cups from licensed third-party roasters and warehousing the inventory at M. Block’s facilities, as the Complaint alleges, it seems that the calculus behind executive level bonuses may have provided some incentive for senior officers to follow that strategy.

 

 

MANAGEMENT IN THE KNOW?

 

From the outside, it is impossible for anyone to know what management was thinking during the Class Period.  Looking at the insider transaction of Scott McCreary and Michelle Stacy definitely doesn’t instill much confidence. In the table below, we provide a timeline of events interwoven with color provided in the Class Action Complaint by witnesses. 

 

GMCR: THE SLOW BLEED OF THE GREAT COFFEE BUBBLE - GMCR sequence of events1

 

 

When we consider that GMCR has now declined for 10 days in a row and insiders are exiting the stock, it is easy to concoct a bearish story.  The question is: how bearish is bearish enough?  We think the stock could go to $25.

 

 

FUTURE RISKS

 

The primary concerns from us arising from this Complaint are as follows:

  • There is a risk that management may have been derelict in their duty to provide investors with forthright guidance on business trends that is supportive by reasonable basis.
  • It appears that there is a significant risk that the relationship with M. Block was not “arms length”.  Since transactions between the companies are being booked as sales, the relationship should be “arms length”.  The SEC is investigating.  A change in revenue recognition more reflective of reality could be just as bad for net sales growth as it has been good.
  • No restatement has yet been made pertaining to GMCR’s relationship with M. Block, per the company’s 2010 10-K.  We believe that there is a high likelihood that the inventory number of ~$600mm will need to be written down.  The question is, by how much?  David Einhorn thinks that as much as 33% of the inventory in M. Block’s warehouse could be expired.
  • Uncertainty risk is extremely high.  How much inventory does the company have?  Will it need to revise its entire storage and supply chain system under scrutiny and the looming probability of further class action law suits (if media reports are anything to go by)?

 

FINANCIALS – THE BIG UNKNOWN

 

One of the worst case scenarios for GMCR shareholders would be if management has been understating inventory which has resulted in margins being overstated.  The company is burning a tremendous amount of cash and taking on leverage to do it.  Taking it bit by bit, we can see that the return profile for this stock is not encouraging.  We see few reasons to own this stock beyond the size of the market and even that positive is greatly overshadowed by the plethora of negative risks facing the company.

 

 

INVENTORY

 

You can see in the chart below that inventories are extremely high.  Despite management’s bullish commentary on its “demand model” – that was based on what were likely inflated sales data – the sales-inventory spread has contracted for six of the last seven quarters.  There are far more questions than answers when it comes to GMCR’s inventory.  Did managers overshoot the mark when sales did not keep pace?  Is there a write-down coming?  We think there has to be.

 

As we mentioned earlier, Greenlight Capital thinks as much as a third of the inventory in M. Block’s facilities could be expired.  Our take is that there is a strong chance neither M. Block nor GMCR itself knows exactly what its inventory is worth.  Not to single out Pricewaterhouse Coopers, but none of the major auditing firms have been strangers to financial scandals over the past ten years.  Many have been blamed for not holding clients to a high enough standard of scrutiny during audits.  Yet PWC was compelled to make the following statement in a report that was included in GMCR’s 2010 10-K:

 

“We do not express an opinion or offer any other form of assurance on management’s statement referring to the Company’s plan for remediation of the material weaknesses in internal control over financial reporting.”

 

GMCR: THE SLOW BLEED OF THE GREAT COFFEE BUBBLE - GMCR sales inv

 

 

RETURN ON EQUITY

 

Between 2008 to 2010 return on common equity declined from 18.6% to 15.2%.  At the same time, EBIT margins surged from 12.1% to 18.2%.  Despite higher margins, the declining returns are due to asset turnover decreases for both accounts receivable and inventory.  In fact, inventory turnover has dropped from 5.2x in 2008 to an all time low of 3.7x in 2011.  Equally troubling is the company’s inability to convert reported net earnings into operating cash flows from 2008 to 2011. 

 

 

POOR ASSET BASE & LOW QUALITY BRANDS

 

The company growth by acquisition is only temporary and the assets the company bought (overpaid for) are of low quality relative to competing brands in the coffee space.

 

The first acquisition was in November 2009, when they acquired Timothy’s Coffees of the World Inc. The acquisition gave them the right to the little known Timothy’s World Coffee brand and wholesale business as well as licensed brands Kahlua and Emeril’s.   The acquisition also opened the Canadian market to GMCR.  Five month later, in May 2010, they bought Diedrich Coffee in a bidding war Peet’s Coffee.   This acquisition enabled the company to penetrate the Southern California market.  Included in this acquisition was Diedrich Coffee, Coffee People brands, and a perpetual royalty-free license in the U.S. for the Gloria Jean’s coffee brand, for use in K-Cup portion packs.  Peet’s was also sniffing around this acquisition so a big premium was paid.  In December of 2010, GMCR acquired LJVH Holdings, owner of Van Houtte and other brands, based in Montreal. 

 

We can make a lot of qualitative comments on these brands, and we do not believe that they were great acquisitions by any means, but looking at GMCR’s asset base at the moment is not encouraging.  Over 41% of the company’s assets are intangibles and goodwill.  Consistent with a company that has, in our view, been more concerned with superficial improvements than making substantial strides in the underlying business, GMCR is depreciating these assets over a period of 10-15 years when a much shorter period would be more appropriate.

 

The Current Assets don’t look much better.  At the end of FY1Q12, 48% of Current Assets is comprised of inventory, which is up 125% year-over-year.  As we have stated several times in this note, we think this inventory number needs to be written down.  Accounts receivable is up 73% year-over-year also.

 

GMCR: THE SLOW BLEED OF THE GREAT COFFEE BUBBLE - GMCR assets

 

 

CASH BURN GIVING BULLS HEARTBURN

 

The confluence of all of these factors – the excessive inventories, poor assets, and sub-par returns – is that the company burns cash.  We see the faulty yardstick – inflated demand – that management has used to run its business as being at the root of this problem.  The “demand model” has led the company to announce a staggering 135% increase in capital spending for FY12 versus FY11.   We have the company burning $935mm during the two year period FY11 and FY12.  If the capital markets decide to tighten the company’s access to capital it could be catastrophic.  How many companies in history have grown earnings over the long run while burning cash?

 

The cash conversion cycle cuts through the noise and offers a clear gauge of how effectively the company is managing inventory, accounts receivable, and accounts payable. 

 

GMCR: THE SLOW BLEED OF THE GREAT COFFEE BUBBLE - gmcr cash conversion cycle

 

 

Looking at the chart below, we can see that the proportion of earnings yielding cash is not a positive sign for the company.  Having a cash burn rate that is within the limits of available resources is not necessarily a negative but we feel that GMCR is going to test the goodwill of the capital markets if its cash flow generation does not improve.  With capex set to go through the roof in FY12, we don’t see that improvement coming about any time soon.

 

GMCR: THE SLOW BLEED OF THE GREAT COFFEE BUBBLE - GMCR cash earnings yield

 

 

CONCLUSION

 

We are not legal experts but think that the looming possibility of further Class Action law suits coming down the pike does not bode well for GMCR.  Just this past Monday, for instance, Faruqi & Faruqi, LLP, a national law firm, announced that it is investigating potential wrongdoings at Green Mountain Coffee Roasters.  The financial outlook, irrespective of any legal struggles in the future, is also dire.  Favorable debt and equity markets have allowed this company to live on borrowed time – and live well.  With competition increasing and the high probability that capital-raising is set to become more difficult as time goes on, we believe that GMCR’s party is over.

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


JOBLESS CLAIMS FALL SLIGHTLY, BUT REMAIN POISED TO CLIMB MATERIALLY

Initial Claims Fall Slightly

Initial jobless claims fell 2k to 357k last week, though after a 4k upward revision to the prior week's number the reported WoW decline is 6k. On a rolling basis, after the revisions the series fell by 4k to 362k. On a non-seasonally adjusted basis, claims fell 12k to 311k.

 

We continue to expect claims to rise meaningfully over the coming five months as the seasonal adjustment factors turn from tailwind to headwind. This will be an overhang on Financials through the Spring and Summer months. In our last claims note, we noted that the S&P and claims had converged. These two series are highly cointegrated, meaning that they move together over long periods of time but are susceptible to short-term divergences. As such, based on our expectation for claims to rise ~40k in the coming months, we expect the sector to come under growing pressure.

 

JOBLESS CLAIMS FALL SLIGHTLY, BUT REMAIN POISED TO CLIMB MATERIALLY - Rolling

 

JOBLESS CLAIMS FALL SLIGHTLY, BUT REMAIN POISED TO CLIMB MATERIALLY - Raw

 

JOBLESS CLAIMS FALL SLIGHTLY, BUT REMAIN POISED TO CLIMB MATERIALLY - NSA

 

JOBLESS CLAIMS FALL SLIGHTLY, BUT REMAIN POISED TO CLIMB MATERIALLY - NSA rolling

 

JOBLESS CLAIMS FALL SLIGHTLY, BUT REMAIN POISED TO CLIMB MATERIALLY - S P2

 

JOBLESS CLAIMS FALL SLIGHTLY, BUT REMAIN POISED TO CLIMB MATERIALLY - Fed2

 

2-10 Spread

The 2-10 spread widened 3 bps versus last week to 188 bps as of yesterday.  The ten-year bond yield increased 3 bps to 223 bps.

 

JOBLESS CLAIMS FALL SLIGHTLY, BUT REMAIN POISED TO CLIMB MATERIALLY - 2 10

 

JOBLESS CLAIMS FALL SLIGHTLY, BUT REMAIN POISED TO CLIMB MATERIALLY - 2 10 QoQ

 

Financial Subsector Performance

The table below shows the stock performance of each Financial subsector over four durations. 

 

JOBLESS CLAIMS FALL SLIGHTLY, BUT REMAIN POISED TO CLIMB MATERIALLY - Subsector Performance6

 

Joshua Steiner, CFA

 

Allison Kaptur

 

Robert Belsky

 

Having trouble viewing the charts in this email?  Please click the link below. 


THE HBM: PNRA, DPZ, MCD, BKC, YUM, TXRH, RT

THE HEDGEYE BREAKFAST MONITOR

 

Hedgeye Restaurants Alpha – our best fundamental ideas

 

LONGS: SBUX, PFCB, EAT, YUM

SHORTS: DNKN, BWLD, WEN, DPZ

 

RESTAURANT STOCKS IN THE HEDGEYE VIRTUAL PORTFOLIO

 

LONGS: PFCB, EAT, JACK, SBUX

SHORTS: MCD

 

MACRO NOTES

 

Consumer

 

Initial jobless claims came in at 357k versus 355k consensus and 363k the week prior (revised from 359k).

 

THE HBM: PNRA, DPZ, MCD, BKC, YUM, TXRH, RT - moving claims

 

Commentary from CEO Keith McCullough

 

Reality bites – Top 3 Most Read (Bloomberg) = 1. US Stocks Drop 2. Spain Extreme Difficulty 3. Commodities Drop On Fed:

  1. SENTIMENT – whether it was our go to move (selling gross Equity/Commodity/Beta exposure at VIX 14-15) or the II Bull/Bear Spread survey which hit a fresh 3yr high before yesterday’s fall (+3,150bps Bull Spread = 53% Bulls; 21.5% Bears), it was all out there. Plenty Hedge Funds got squeezed out of their short positions right at another intermediate-term top.
  2. GERMANY – one of the most critical leading indicators for Global Growth Slowing is the DAX and the correction there is instructive (-5.7% from the March high) given that Germany’s fiscal and employment situation is much better than the USA’s right now. The immediate-term TRADE line for the DAX is now broken (6978); for the USA, the equiv SP500 line = 1390.
  3. COMMODITIES – kaboom! USD + UST Yields up = Gold down. That we know. What we don’t know is how quickly Deflating The Inflation will help Global Consumption. We’ve seen this big beta Commodity crash 3x coming out of Q1 in the last 4yrs. We call it the Correlation Risk, and it matters. Energy stocks (XLE) = down -7.8% for April to date!

Buying the Financials and selective Consumer Discretionary on red. Rising 10yr yield and getting Bernanke out of the way = good for both.

KM

 

SUBSECTOR PERFORMANCE

 

THE HBM: PNRA, DPZ, MCD, BKC, YUM, TXRH, RT - subsector

 

 

QUICK SERVICE

 

PNRA: Panera Bread was initiated Outperform at Credit Suisse.

 

DPZ: Domino’s new advertising campaign is centered on telling customers “no” – referring to its artisan pizza line that has, according to the company, no need for substitutions or additions.

 

DPZ: Domino’s UK & Ireland’s stock, ticker DOM.LN, has been sinking like a stone since the company reported SSS last week.

 

MCD: McDonald’s won dismissal of a 2010 lawsuit over deceptive marketing of its Happy Meals.

 

BKC: Burger King was forced to pull its Mary J. Blige advertisement after it was not received well.

 

YUM: Taco Bell is looking to get into e-commerce, according to adage.com

 

 

CASUAL DINING

 

TXRH: Texas Roadhouse is partnering with Snagajob to recruit, hire, and manage its hourly workforce.  Are labor margins not up to standard? Why this move?

 

RT: Ruby Tuesday reported 3QFY12 EPS of $0.18 versus consensus $0.16.  Same-store sales were down -5%.  The company sees same-store sales at company-owned restaurants declining by 4-4.5% in FY12.

 

THE HBM: PNRA, DPZ, MCD, BKC, YUM, TXRH, RT - RT POD1

 

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

Casual Dining down on accelerating volume.  Are the stocks catching up with reality that sales are slowing? RT says a -5% SSS “primarily due to the double-digit year-over-year competitive ad spending with combined aggressive value promotions by our competition.”  Between conversions and store closures the Ruby Tuesday’s brand is in a slow and steady decline.  A net positive for Chili’s (EAT)

 

RRGB: Following its analyst meeting, RRGB was the worst performing stock.  We believe that the team’s strategic vision of broadening its appeal to more adult consumers is failing to gain traction.

 

 

THE HBM: PNRA, DPZ, MCD, BKC, YUM, TXRH, RT - stocks

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

F3Q12 WMS PREVIEW

In-line should be good enough.

 

 

We’re not as bullish on the stock as we were in mid-March when the whisper was that WMS was going to miss another Q.  The stock was trading at sub-$22 then so expectations for the quarter have probably risen.  However, we think there are still quite a few people expecting a FQ3 punt yet there is a decent chance they make the number.  Our EPS and revenue projections of $0.44 and $193MM, respectively, are in-line with consensus.

 

We estimate product sales of $121.5MM and $62MM of gross profit, boosted by recognition of the Ohio units that were deferred last quarter.

  • 6.3k new units sales at $16.4k
    • 4.1k domestic units
    • WMS will likely recognize Ohio shipments in the March quarter.  We believe IGT will defer recognition of their Ohio shipments until the casinos are licensed and ready to open.  The operators have “provisional licenses”/“letters of acceptance” which give them authorization to receive slot machines but are not fully licensed so there is some room for interpretation on whether manufacturers can recognize the revenue this quarter.  Of the 957 deferred units shipped by WMS in December, we are fairly confident all of them were to the PENN and CZR’s Ohio casinos; implying a low 20’s share which should be viewed positively by investors. 
    • 2.2k international shipments, up QoQ but down 6% YoY
  • $18MM of parts, used machines and conversion kit sales
    • 4.4k conversion kit sales
    • 2k used machine sales

Gaming operations revenue and gross margin of $65.5MM and $51.8MM, respectively

  • Flattish sequential EOP install base of 9.3k but a sequential decrease in the average install base
  • A small sequential improvement in win per day, mostly benefiting from seasonality
  • Incremental revenue growth from portal application and the UK casino
  • Their approvals of titles and game rollout are proceeding on schedule - Clue has been featured in several of the CZR’s properties for over a month now.

Other stuff:

  • R&D of $24MM
  • SG&A of $33MM
  • D&A of $21MM
  • $2MM of interest and other income
  • 36.5% tax rate
  • 55.8MM diluted shares 

THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – April 5, 2012


As we look at today’s set up for the S&P 500, the range is 15 points or -0.43% downside to 1393 and 0.65% upside to 1408. 

                                            

SECTOR AND GLOBAL PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

THE HEDGEYE DAILY OUTLOOK - 3

 

 

EQUITY SENTIMENT:


SENTIMENT – whether it was our go to move (selling gross Equity/Commodity/Beta exposure at VIX 14-15) or the II Bull/Bear Spread survey which hit a fresh 3yr high before yesterday’s fall (+3,150bps Bull Spread = 53% Bulls; 21.5% Bears), it was all out there. Plenty Hedge Funds got squeezed out of their short positions right at another intermediate-term top. 

  • ADVANCE/DECLINE LINE: -1838 (-949) 
  • VOLUME: NYSE 832.49 (1.87%)
  • VIX:  16.44 4.98% YTD PERFORMANCE: -29.74%
  • SPX PUT/CALL RATIO: 1.89 from 1.67 (13.17%) 

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: 39.79
  • 3-MONTH T-BILL YIELD: 0.07%
  • 10-Year: 2.18 from 2.22
  • YIELD CURVE: 1.84 from 1.88

MACRO DATA POINTS (Bloomberg Estimates):

  • 7:30am: Challenger Job Cuts (Y/y), Mar.
  • 8:30am: Jobless Claims, week of Mar. 31, est. 355k (prior 359k)
  • 9:10am: Fed’s Bullard speaks in St. Louis
  • 9:45am: Bloomberg Consumer Comfort, week of Apr. 1
  • 10am: Freddie Mac mortgage rates
  • 10:30am: EIA natural gas
  • NOTE: Friday: U.S. unemployment/payrolls report, 8:30am 

GOVERNMENT:

    • Mitt Romney, Rick Santorum hold campaign events in Pennsylvania, site of Republican primary on April 24
    • President Obama signs “Jumpstart Our Business Startups” Act, 2pm 

WHAT TO WATCH:

  • Gap, Macy’s among U.S. retailers reporting March comp sales, Retail Metrics est. +3.3% gain; Zumiez beat est., Costco missed
  • U.S. sales of Nokia Lumia 900, which debuts this weekend, seen at below 1m in 1st 3 mos: analysts
  • U.S. said to be near settlement with Simon & Schuster, HarperCollins, Hachette on e-book price contracts with Apple
  • Phil Falcone said he may consider voluntary bankruptcy for LightSquared
  • AT&T faces strike this weekend from 40,000 workers
  • IBM bought 20% stake in the technology unit of Brazilian billionaire Eike Batista
  • Blackstone agreed to buy 69 warehouses valued at about $800m from Dexus Property Group
  • Dick’s Sporting to make GBP20m investment in U.K.’s JJB Sports, entitled to nominate up to 2 non-exec. directors to JJB board
  • Toshiba, Hynix considering joint bid for Elpida, Nikkei says; Micron Technology seen as preferred bidder
  • JPMorgan CEO Jamie Dimon used his annual letter to shareholders to rail against “contrived” and confusing financial rules that he said may stymie lending
  • Rambus appeals $3.95b California antitrust trial loss to Hynix, Micron
  • Great Wolf gets $6.25/shr cash offer from KSL Capital, topping Apollo’s bid
  • DirectTV reaches agreement to carry Tribune television stations, ending 4-day blackout of 23 local outlets
  • 3D Systems to replace Taleo in S&P Smallcap 600 effective at end of day
  • FRIDAY: U.S. may report tomorrow that employers added 205k jobs, unemployment rate remains at 8.3% 

EARNINGS:

    • Pier 1 Imports (PIR) 6 a.m., $0.48
    • CarMax (KMX) 7:30 a.m., $0.40
    • Constellation Brands (STZ) 7:30 a.m., $0.39
    • RPM International (RPM) 7:30 a.m., $0.01
    • Schnitzer Steel Industries (SCHN) 8:30 a.m., $0.32
    • WD-40 (WDFC) 4 p.m., $0.54    

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)


COMMODITIES – kaboom! USD + UST Yields up = Gold down. That we know. What we don’t know is how quickly Deflating The Inflation will help Global Consumption. We’ve seen this big beta Commodity crash 3x coming out of Q1 in the last 4yrs. We call it the Correlation Risk, and it matters. Energy stocks (XLE) = down -7.8% for April to date! 

  • Gold Traders Bearish for First Time in 2012 on Fed: Commodities
  • Oil Trades Near Seven-Week Low on Renewed European Debt Concern
  • Cocoa Extends Drop as Ivory Coast Rains Return; Sugar Retreats
  • World Food Prices Climb for Third Month as Oilseed Costs Rise
  • Soybeans Rise, Set for Second Weekly Gain on Brazil Crop Concern
  • Gold May Gain as Drop to Near Three-Month Low Spurs Purchases
  • Palm-Oil Stockpiles in Malaysia May Reach Seven-Month Low
  • Cooking-Oil Imports by India Surge on Local Prices, Tax Risk
  • Copper May Advance as Economists Project Firm U.S. Employment
  • India Billions Secure Afghan Mines in Challenge to China Drive
  • China May Approve Vale Vessels to Stop in Ports: Daily
  • World Cotton Output to Fall After Prices Plunged, Ecom Says
  • BP Pursues Namibia Crude Amid No Known Discovery of Oil: Energy
  • Gold Traders Bearish for First Time in 2012
  • Palm Oil Heads for Fifth Weekly Advance on Soybean Crop Concerns
  • Rubber May Decline 8% as Rally Loses Steam: Technical Analysis
  • Ship Smog Seen as Next Target to Clear Hong Kong Skies: Freight 

THE HEDGEYE DAILY OUTLOOK - 4

 

 

CURRENCIES 

 

THE HEDGEYE DAILY OUTLOOK - 5

 

 

EUROPEAN MARKETS


GERMANY – one of the most critical leading indicators for Global Growth Slowing is the DAX and the correction there is instructive (-5.7% from the March high) given that Germany’s fiscal and employment situation is much better than the USA’s right now. The immediate-term TRADE line for the DAX is now broken (6978); for the USA, the equiv SP500 line = 1390.

 

THE HEDGEYE DAILY OUTLOOK - 6

 

 

ASIAN MARKETS 

 

THE HEDGEYE DAILY OUTLOOK - 7

 

 

MIDDLE EAST


THE HEDGEYE DAILY OUTLOOK - 8

 

 

 

The Hedgeye Macro Team

 

 


Roped In

This note was originally published at 8am on March 22, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“In the contest between inflation and deflation, the rope is the dollar.”

-James Rickards

 

I’ve finally jumped into a book I’ve been really excited about, James Rickards’ “Currency Wars”, and the preface does not disappoint. From a risk management perspective, I couldn’t agree more with the aforementioned quote.

 

Rickards takes the currency debate right up the middle on the Chairman of the Federal Reserve reminding us that “by printing money on an unprecedented scale, Bernanke has become a twenty-first century Pangloss, hoping for the best and quite unprepared for the worst.”

 

As a reminder to The Ben Bernank and his central planning followers, hope is not a risk management process.

 

Back to the Global Macro Grind

 

On Tuesday, I bought back my Strong Dollar position via the UUP. Yesterday, I sold my only remaining long Commodity position (Oil), taking my asset allocation to Commodities back down to ZERO percent.

 

Even though he’s never traded a Global Macro market with his own capital at risk in his life, Bernanke would probably smile when considering my 0% strategy move. The man likes zeroes.

 

The Zero Bound, or a 0% “risk-free” rate of return, concept is littered with unintended consequences. If you don’t believe that, ask the Japanese. They’ve had 20 years of anemic economic growth and will have 25% less people living in Japan come 2050.

 

If you do believe in the globally interconnected risk associated with the world’s reserve currency, you probably get why this entire “contest between inflation and deflation” comes down to what Bernanke/Geithner do to US Dollar policy (monetary and fiscal). When it comes to commodities inflating/deflating the CRB Index (19 commodities) has a 60-day correlation to the US Dollar of -0.64%.

 

Correlation? Yes Keynesians of the academic gridiron, unite! Correlation Risk in markets doesn’t always imply causality. But sometimes it does.

 

So why get long the US Dollar right here?

  1. It’s going up today, and we know performance chasers just love a good chase
  2. It is breaking out above our intermediate-term TREND support line of $79.33 again
  3. It has fortified its base, holding our longer-term TAIL support line of $76.11
  4. The Japanese Yen has moved into crash/crisis mode (bullish USD/YEN)
  5. The Euro continues to fail at $1.33 resistance as European Growth Slowing continues

Got Growth Slowing?

 

Apparently consensus doesn’t want to agree with us on this yet. In a note earlier this week I highlighted the Credit Suisse call to action that “economic momentum indicators suggest global and US growth is still well above consensus” – and while the people I used to work with there are good people, that call on growth is simply just wrong this morning.

 

1.   ASIA: China and India, in particular, are showing glaring signs of Growth Slowing sequentially here in March. Whether it was India’s stock market down another -1.8% overnight (down -6.1% since the Feb YTD top) on a mounting deficit problem or both the Shanghai Composite and Hang Seng snapping their respective immediate-term TRADE lines of support in the last week as China’s PMI (HSBC) was printed overnight at a fresh 4-month low – it’s all there. #GrowthSlowing

 

2.   EUROPE: Inflation Slows Growth; particularly when Europeans have to deal with Brent Oil prices of $122-127/barrel – never mind being bent over a barrel by that sneaky little Keynesian critter called debt (which structurally impairs long-term growth). Looking at Europe’s PMI numbers for March, here’s what the river cards look like:

 

Manufacturing:

A)     France 47.6 MAR (exp. 50.2) vs 50 FEB

B)      Germany 48.1 MAR (exp. 51) vs 50.2 FEB

C)      Eurozone 47.7 MAR (exp. 49.5) vs 49 FEB

 

Services:

D)     France 50 MAR (exp. 50.3) vs 50 FEB

E)      Germany 51.8 MAR (exp. 53.1) vs 52.8 FEB

F)      Eurozone 48.7 MAR (exp. 49.2) vs 48.8 FEB

 

Now we all know that Swiss turned American bankers can get creative in their accounting, but by our Canadian-American math, this morning’s Global Growth data is well below consensus.

 

How about US Growth?

  1. It has never NOT slowed with oil prices over $100/barrel (that’s why the FEB ISM number dropped 3% from JAN)
  2. Since 71% of US GDP = Consumption, real (inflation adjusted) growth slows, big time, when inflation accelerates
  3. Q4’s US GDP print of 3.0% carried a 0.86% Deflator; that deflator should double or triple in Q1

In other words, our Global Macro Model will not be surprised if US GDP growth gets cut in 1/2 , sequentially, from Q4 of 2011 to Q1/Q2 of 2012. If we don’t see a Strong Dollar (like we did in Q4) soon, you’ll see weakening US Consumption.

 

So that brings me to a comma, instead of a full stop. If you are staying one step ahead of me, you’re going to ask if Strong Dollar would get me more bullish on both US Economic Growth and US Equities. The answer to that (as it was every day in January 2012 up until Ben Shalom Bernanke decided to debauch the Dollar on January 25th), is yes.

 

Whether our almighty central planners like to admit it or not, we’ve all been Roped In. This “contest between inflation and deflation” has been called “risk on and risk off.” But risk is always on – especially the globally interconnected stuff. Risk never sleeps.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, and the SP500 are now $1623-1671, $122.12-124.89, $79.33-80.58, and 1395-1409, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Roped In - Chart of the Day

 

Roped In - Virtual Portfolio


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