Keith once again added URBN, one of our top TREND and TAIL long ideas, to the portfolio this morning as it fit his quantitative TRADE framework.
Draghi was once again tight-lipped on the progress of individual countries, stressing a balance between fiscal consolidation and growth policy as a way forward. Yet when faced with such questions as extremely high unemployment rates across states, especially among the youth, Draghi’s only response is there’s the need to rebalance a distorted labor market. Well how is that going to change over the longer term, or even improve over the intermediate term given the existing structure of the Eurozone? Draghi is quick to point to states giving up their fiscal sovereignty to Brussels, yet this is easier said than done. We see foot power (strikes and riots) and the job security of Eurocrats prevailing at the country level. Finally, again there is at best hope the LTROs will be a successful program, yet no evidence that loans are hitting the real economy.
We expect broader European data to turn further lower, which may put more pressure on the ECB to act on some of its non-standard measures next month. Remember, the SMP has been on hold for the last seven weeks.
At the Governing Council of the ECB meeting today, held in Barcelona, the ECB kept the interest rate on the main refinancing operations, and the interest rates on the marginal lending facility and the deposit facility unchanged at 1.00%, 1.75%, and 0.25%, respectively, which is in-line with consensus expectations.
Draghi did not drift far from last month’s statement. On the growth outlook he added that the “latest signals from euro area survey data highlight prevailing uncertainty.” And followed with “at the same time, there are indications that the global recovery is proceeding”. The ECB’s inflation forecast was in-line, namely that it would stay above 2% in 2012 and should fall below 2% in early 2013. Draghi was quick to cover both ends, saying “risks to the outlook for HICP inflation rates in the coming years are still seen to be broadly balanced. Upside risks pertain to higher than expected commodity prices and indirect tax increases, while downside risks relate to weaker than expected developments in economic activity.”
On the money supply he reiterated that the underlying pace is subdued, with the M3 annual growth rate at 3.2% in March vs 2.8% in February. Draghi noted the annual growth rate of loans to non-financial corporations stood at 0.5% in March while 1.7% to households, both slightly lower than in February.
You can find Mario Draghi’s Introductory Statement to the press conference here:
Highlights from the Q&A:
-Was there any discussion to cut interest rates? MD: No, found accommodative, despite uncertain background.
-Unemployment is high, austerity is not working. There has been a shift towards a growth strategy. Is this camp right? MD: I have no comment on specific statements. There is a need for a growth compact. There is no contraction between having both a fiscal compact and growth compact. We need to see fiscal stability. We have to have a fiscal union. We have to accept the transfer of national sovereignty to a central union, a transfer union.
-Is there another LTRO in the works? MD: No comment, we never pre-commit. With regard to the effects of LTRO, it’s too early to say they are vanishing. What we are really seeing is five things. 1.) We avoided a credit crunch, or one bigger than we see today. 2.) The supply of credit is much less tight than before the LTROs. 3.) A strengthening of the deposit base in several banks across countries, especially those experiencing most difficulty, which is also positive. 4.) The M3 growth pace has recovered from year-end. 5.) A significant drop in key indicators of financial markets: including a drop in volatility and repo rates.
-How do we weigh fiscal consolidation versus a growth strategy? MD: The 1970s were years of high deficits, high inflation, and recession, or stagflation. To get out of that, we learned you need to have structural reforms.
-With elections in France, Greece, and Germany this weekend, are you concerned on the rise of parties that are euro-critical? If Hollande wins, will fiscal compact be put into question? MD: No comment on any of this.
-There are calls for the ESM to directly support Spanish banks? What are your thoughts? MD: Such mechanisms like the ESM are useful but cannot replace fiscal consolidation or reforms. We didn’t have a successful experience with the EFSF; it fell short on expectations and needs, because it was created in a way that can hardly work. We think ESM can work better, but we want to make sure the ESM can be used if need be.
-What do you say to the Spanish who say they see no reward after all this austerity? MD: The government of Spain has made significant efforts in policy reform, all taken in a very short time. We view that that measures taken, namely the LTROs, have been successful in avoiding a major credit crunch. We need time to see this money proliferate to the real economy; we can already see we avoided a much larger credit crunch. There has been much progress on fiscal front, and this is true for a variety of countries; now, perseverance is very important to reap gains.
Conclusion: Nike's press release on its Sustainability program should not be a stock mover. But it shows the evolution of how this started as a defensive strategy to combat perception about sweat shops, to being a commercial initiative across the organization.
Nike is on the tape highlighting its ‘Green’ initiatives, and is setting new targets for upping the ante on a go-forward basis. Some will simply ignore this as being PR nonsense. Others might get excited as it relates to new financial targets. Both will miss the point.
Quick aside: The timing is interesting, as it comes within weeks of the headlines of the WalMart/Mexico bribery fiasco, Reebok/India, and allegations of Nike/China (executive of China Soccer Assn accepted $273k -- $30k from Nike). These headlines get real big real fast, and are often blown out of proportion. Perhaps Nike went on offense in communicating these efforts (that were already in place) pretty darn quickly to avoid getting lost in sensationalistic headlines.
The key here is that new ‘Social Responsibility’ plan is not really new, but an evolution of something that’s been working. Hannah Jones, VP of Sustainable Business and Innovation at Nike, has pretty much been doing some iteration of this for the past 24 years. (this is not a gratuitous management shout out -- it matters). Make no bones about it, Jones has risen to the level where she is arguably the most influential woman at Nike – perhaps second only to Jeanne Jackson (VP Direct to Consumer).
Here’s a rough – and I mean very rough – timeline of Nike’s Sustainability effort.
1988: Hires Hanna to tackle several social issues as the head of Consumer Affairs in EMEA. Over time, one of these ends up being press about Nike's involvement with 'sweat shops'. So Nike is forced into a defensive strategy such that it is not the poster child for poor working conditions in Asia. By the mid 1990s, that’s pretty much done.
Late 1990s: Nike starts to weave Social Responsibility into its business model, specifically with factory management, transportation and logistics.
Early 2000s: Nike’s Supply chain blows sky high (remember i2/SAP and ensuing Foot Locker fallout?). Nike shakes the etch a sketch clean and adopts Lean manufacturing and other practices from more efficient product manufacturers.
2004: Promotes Hannah to head up Social Responsibility out of Beaverton.
2006/06: Social Responsibility evolves from being a defensive tactic, to a cost/working capital saving mechanism, to a business. Nike launches Nike Considered, a product that removed dangerous chemicals from the equation, took down solvent use by 80%, and dramatically improved the ease of assembly. See product below. Though this was a commercial product, think of it like a concept car (all about the design and process) on which future products with better mass appeal will be introduced.
Today: Job title has changed with the job function. Now VP Sustainable Business and Innovation. This is a Mark Parker touch. Everything needs to stem from Innovation. All new platforms need to synch with sustainability principles. The good news is that Sustainability usually means that the process is more efficient (ie less working capital), and to boot, the consumer is more likely to pay up for it. The best example here is the much awaited Nike Flyknit, which reverse engineers the construction of the shoe and results in a 5.6oz running shoe (the average runner is about 12oz)
THE EVOLUTION OF NIKE SUSTAINABILITY
Nike Considered (2005)
Nike Flyknit (June 2012)
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Jobless Claims Move Past 3 Weeks of Spring Break
Initial claims fell 23k last week to 365k (falling 27k after a 4k upward revision to last week's data). Rolling claims rose by 0.8k WoW to 384k. On a non seasonally adjusted basis, claims fell 40k to 330k.
Over the last couple of weeks, we have noted that the claims numbers were coming in even worse than we would have expected based on our thesis regarding distortions in the seasonal adjustment factors. This week's sequential improvement puts claims back on track with where we would have expected them to be based on the seasonality dynamics. For more information here, please refer to our note titled "Predicting Initial Claims: The Sine Wave Model". We continue to expect claims to have an overall upward bias for the next 2-3 months.
The 2-10 spread tightened 7 bps versus last week to 165 bps as of yesterday. The ten-year bond yield decreased 6 bps to 193 bps.
Financial Subsector Performance
The table below shows the stock performance of each Financial subsector over four durations.
Joshua Steiner, CFA
Quick Take. Just when you need to show real organic earnings growth...buy something.
GIL’s results were rather uneventful relative to expectations, but the actions on the print are perplexing. Most notably, the company acquired Anvil for $88mm – at the precise time that it anniversaries the Gold Toe acquisition. We’ve always had a bias against the direction this business model is headed, so we definitely don’t want to sound like we’re being fair. But is this for real? Seriously. This company has such a defendable base business as the low cost producer of t-shirts and fleece for the distributor channel. Buit then it pushed its way into mass channels (didn’t work), international (yet to work), bought Gold Toe (working so far, we think, but ROIC dilutive at best), and now just when we have an opportunity to see the real earnings power of the company, it gives us $200mm of additional opacity.
On one hand, buying $200mm in revenue for $88mm tells us that either a) the price is outstanding, or b) the brand is not making a whole lot of money. Its historical margins have gone from +20% in the industry hey-day in the early 00’s, to -20% later that decade.
When we do the math, we see that Branded Apparel printed a $122mm revenue number. Assuming Gold Toe is performing as management indicates ($85mm), then we get to core branded apparel sales of $37mm. That’s down 38%. Yeh… I could see why they’d want to do a deal.
Guidance is not entirely clear, but all-in, the year seems to be intact, though GIL is guiding down the 3rdquarter. The interesting note is that it appears that the Anvil acquisition is INCLUDED in guidance. We’ll hope (but won’t count on) the company giving us the details to decipher one component from the others on the 8:30am call.
OUR NOTE FROM EARLIER THIS WEEK
GIL: A BINARY CALL ON PRICING
Conclusion: Volumes are stabilizing. But playing the market share game in a commodity space in dangerous. 2H utilization should improve, but that's when GIL laps 30% growth largely from Gold Toe. Ultimately, this is all about pricing.
Volumes are stabilizing. But playing the market share game in a commodity space in dangerous. 2H utilization should improve, but that's when GIL laps 30% growth largely from Gold Toe. Ultimately, this is all about pricing.
1) Position in the screenprint channel: CREST data suggests unit sales have been coming in stronger than originally expected, running up +12% through February compared to management’s assumption of down -5%. The data suggests that the company is gaining share in the screenprint channel and we have no reason to dispute that. So, while margins will remain pressured, are likely to come in higher than originally planned. GIL's Q2 should reflect the third straight quarter of share gains after capacity constraints impacted share through most of last fiscal year, and GIL roared back with 25%+ cut in its price. In fact, Broder came out 5 weeks ago and noted that cotton is now priced at ~$1.00 for a t-shirt from ~$1.55 per pound at the peak, and almost all of it is being passed through to customers. In other words, margins in the supply chain remain tight. While Q2 typically represents GIL’s greatest share for the year, we expect 2H share to reflect incremental gains though we are still not convinced it will capture the 65% share in management’s plan as it competes against smaller players forced to be aggressive. If it does, GIL is likely to be buying it. Playing the market share game in a commodity space is wreckless.
2) Gold Toe contribution: Q2 is the last quarter of a full incremental Gold Toe contribution with the deal lapping in April. While there has been substantial opacity surrounding the performance of this business since its inclusion, management confirmed that it remains ‘on plan’ to deliver $0.20 in EPS this year. Gold Toe accounted for ~$85mm in sales in Q1 and is expected to generate a similar contribution in Q2, or +22% total revenue growth. In addition, ~$0.05 in earnings implies ~$6-$7mm in EBIT contribution in Q1 and similar amount to what we expect in Q2. We have no reason to think this business is not moving forward as planned. Though it's very important to remember that a 20%+ kicker to GIL's top-line goes away next quarter. That kind of opacity definitely helped over the past year. Bye bye.
3) Input Cost/Pricing impact: While the inventory GIL is selling through at ~$0.95 cotton is closer to current prices, it’s still 35%-40% below where the company likely secured the inventory based on the typical 6-9 month production cycle. Lower prices in the screenprint channel (~70% of revs) continue to pressure margins slightly offset by HSD price increases in the Branded Apparel. We’re modeling gross margins of 16% below consensus expectations of 17% and -1100bps below year ago levels.
All in we are shaking out at $0.21 in EPS for the quarter with higher revenues of $521mm lighter gross margins relative to the Street. We’re assuming gross margins of 16% in Q2 reflecting a sequential increase from Q1 due to the absence of an inventory devaluation (= 7pts), the impact of manufacturing downtime (=3-4pts), and higher unit volume. Similarly, with the closure of Rio Nance 1 at the end of Q2 and higher utilization, we have margins up to 24-25% in the 2H and up 450bps next year to 23.5% reflecting 300-400bps from lapping the interruptions of the 1H F12, higher utilization, and improved manufacturing efficiencies. While we expect SG&A growth (+20%) to outpace sales (+12%) in support of retail and international initiatives, we expect operating margins to expand 366bps in F13. For the year we’re shaking out at $1.10 and $1.93 next year reflecting a 26x and 15x earnings multiple, and 16.5x and 11.5x EBITDA.
GIL Forward Looking Commentary from 1Q12 call headed into 5/3/12 (2Q12) Conference Call:
Full year: $1.9bn
Printerwear Business: $1.3bn
Branded Apparel Business: $0.6bn
2H industry demand expected to be flat YoY when demand fell (-8%) in 2011
Assuming market share of 65% in the US Distributor Channel
Assuming 5% decline in industry shipments from US wholesale distributors to US Screenprinters in 2Q12
Expecting Strong Growth in Printwear due to penetration in international markets and some inventory destocking by distributors in the U.S. wholesale channel, and also increased market share
Pricing: Printwear Pricing expected to be slightly lower than Q1 for the balance of the year
Every 1% change in net selling prices for Printwear impacts projected EPS for the balance of fiscal 2012 by approximately U.S. $0.09
Pricing will reflect 4th quarter increases for the balance of the year which did not reflect full pass-through of high cost cotton
Cotton Cost: In line with 1Q12 and significantly higher than 2Q11
2H costs expected to be significantly lower than 1H based on cotton futures
Inventory at peak cost expected to be consumed early in 3Q12
Full year: $1.30
Second Quarter: $0.20
Higher cotton YoY expected to impact Q2 ESP by ~$0.70
Partially Offset by manufacturing efficiencies & Gold Toe
For every 1 million dozen change in demand for activewear, EPS is impacted by $0.05
Full Year: $100mm
Free Cash Flow:
Full Year: $75-100mm
Inventories: Expect to end F12 with unit volume slightly higher vs. last year
Rio Nance V: Will become the lowest cost facility for Activewear & Underwear
Expected to be fully ramped up by the end of F12
Expect additional production capacity and manufacturing efficiencies in F13
Temporarily retiring Rio Nance 1 at the end of 2Q12 and evaluating the modernization of Rio Nance 1 which would provide further cost efficiencies in the future
This note was originally published at 8am on April 19, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Show me a good loser, and I’ll show you a loser.”
Losing sucks and there is basically not much to debate beyond that. In the investment world, losing means you lose both your family and client’s hard earned capital. It’s almost a double whammy in terms of managing the emotions related to losing in that sense. If it were just you losing an individual tennis match at the country club, that’s probably cool on some level. But when you make a bad investment, you actually have to put the accountability pants on and answer to both your clients and your family.
Losing is also part of the big boy’s game of being a professional stock market operator. We lose, we analyze the loss, and then we adjust and improve. Or, at least, that is how it is supposed to work. In reality, though, most investors, and people generally, tend to overweight and over-emotionalize their losses. While winning is great, losing is painful. This occurs in part to our culture where losing, to Lombardi’s point above, is broadly characterized as a bad thing. I’m here to tell you it’s not. In fact, losing is a chance to improve.
This morning Spain sold €2.54 billion of 2 and 10-year bonds. On one hand, Spain won. They sold more than the maximum target of €2.5 billion. As well, the bid-to-cover was 2.42 versus 2.17 in the last auction in January. Yields, on the other hand, have ticked up since January from 5.4% on the 10-year to 5.74% in this auction. (Incidentally, the actual market yield is higher.) But, still, mostly a win, right?
Well, not so much. The European sovereign debt market is hardly a market anymore. Government intervention is enabling these auctions to be “successful”, but the stark reality remains that the monetary union has failed. The key evidence of this is in interest rate differentials. In the Chart of the Day, we show the spread between Germany and Spain interest rates going back three years. In a successful monetary union, the rates at which the key players sell sovereign debt would be comparable. Unfortunately, at least for monetary union enthusiasts, this is not the case in Europe.
The more unfortunate fact in Europe is that while the market is attempting to do its job and price sovereign debt according to appropriate sovereign risk, there is no currency mechanism to adjust and aid these beleaguered sovereigns. In theory, what should be happening is that the Spanish currency should naturally adjust to reflect its weak fiscal and economic situation, which then, over time, would boost Spanish exports and subsequently boost the Spanish economy as Spain’s goods become cheaper.
Unfortunately, Spain, and really all nations in the Eurozone, has a currency that reflects the strongest members, but doesn’t have the commensurate ability to borrow at low rates. In effect, the weaker economic nations in the Eurozone are all structural losers. So, then, it should be no surprise that the Socialists are about to take over the government of France.
As an aside, my favorite quote about socialism comes from Winston Churchill, who said:
"The inherent vice of capitalism is the unequal sharing of blessings; the inherent virtue of socialism is the equal sharing of miseries."
It is sad that the structural issues of the Eurozone are forcing the people of the France to choose the equal sharing of misery via socialism versus rolling the proverbial bones on the upside of capitalism.
Although Keith is on a much deserved vacation this week, he was kind enough to flag to me the fact that both copper and long term yields in the U.S. continue to signal an ominous outlook for global growth. Copper has basically been going down in a straight line over the past thirty days. Meanwhile, the 10-year yield on U.S. Treasuries remains below our key line of resistance at 2.04%. Call it reflexivity if you will, but typically these two market prices are good leading indicators for the direction of economic activity.
You may not believe Chinese officials when they say they will temper growth, and you may not believe the tempered growth numbers from China when they get reported, but the price of copper does not lie. I can tell you the shareholders of Freeport McMoran (FCX) are starting to believe it. FCX, one of the world’s largest copper miners, is down 20% in a straight line since February 1st, despite trading at less than 5x trailing earnings.
Speaking of earnings, our retail Sector Head Brian McGough did an excellent job summarizing his views of earnings for retail this quarter. While the full note can be found at ( www.hedgeye.com ), the key takeaway was as follows:
“a) The current consensus earnings growth forecast for the next 12-months is 23%. We have not seen this kind of growth since we came off of recessionary earnings numbers in 2010.
b) The market is giving this earnings growth a 17x p/e. We’ve only seen that kind of multiple five times in 3-years, but always at times when the group was still clearly under-earning. Who are we to say that it is NOT under-earning today? But to make this case, we need to see a considerable upshift in consumer spending alongside another decline in raw materials costs. We don’t like that call.”
To paraphrase Brian, I think he is saying that the asymmetric risk / reward in retail is not tilted towards the upside in retail land this earnings season.
But enough about losing, go out there and get wins on the board today!
The immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, Japanese Yen (vs USD), Euro/USD, and the SP500 are now $1628-1653, $116.91-120.45, $79.23-79.64, $81.11-82.31, $1.30-1.32, and 1378-1394, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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