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WEEKLY COMMODITY CHARTBOOK

As the dollar strengthened last week, most of the commodity prices relevant to the restaurant space declined.  Continuing our callout from last week, beef prices are coming down meaningfully and yesterday’s headline on the USDA quarantining two farms over last month’s discovery of mad cow disease at a California dairy farm.  The publicity around Lean Fine-Textured Beef and BSE is not bullish for demand but, from what we have heard from companies, steak is still holding strong appeal for consumers.  Chili’s has been reaping strong rewards from its steak promotion.  As we wrote this morning in an email to clients and in our CASUAL DINING CAUTION note ahead of earnings season, we think the outperformance of casual dining versus the market is slowing and may even reverse if the employment outlook continues to deteriorate.  Tomorrow’s employment data for April will be important for our thesis.

 

WEEKLY COMMODITY CHARTBOOK - commod

 

 

Dairy costs continue to drop which is positive for CAKE, TXRH, DPZ, and PZZA. 

 

Domino’s called out diesel prices as being the most important factor for its commodity basket, not from a store level perspective, but in terms of the impact on its supply chain business:

 

“The biggest potential impact from gas prices is the effect it can have longer term on commodity prices. At the store level, franchisees may have to pay delivery drivers an increase in mileage reimbursement, but it's usually not a big impact in overall store costs. In our supply chain, we experienced the impact of diesel prices, but we also have fuel surcharges that help offset some of those costs. So while we do care about higher fuel costs, the direct impact to us and our system is smaller than many people assume.”


Wing prices were down -1.4% week-over-week but yesterday’s USDA Broiler Hatchery data did not tell us that the supply contraction is coming to an end today or tomorrow.  Although prices will peak later this quarter, it is important to realize that the year-over-year impact of wing prices is what matters for BWLD’s EPS.  We think the Street is underestimating this impact and overstating FY12 EPS growth by 6-8%.  Egg sets for the week ended 4/28 came in at 197k, which implied a slight sequential tick-down in the moving six-week average to ~198k and down 5% versus last year.  Egg sets are a leading indicator of supply.  Once the upswing comes, it likely will be another two months before supply and price are meaningfully impacted.  The chart below illustrates that over the last five years.

 

WEEKLY COMMODITY CHARTBOOK - egg sets

 

 

GAS PRICES WATCH

 

Gas prices declined -4.1% and we would call out (from our correlation table, below) that the 30-day correlation between gas prices and the USD is 0.9.  That correlation tends to fluctuate over time.

 

WEEKLY COMMODITY CHARTBOOK - gasoline prices

 

 

CORRELATION

 

WEEKLY COMMODITY CHARTBOOK - correl

 

 

CHARTS

 

WEEKLY COMMODITY CHARTBOOK - coffee

 

WEEKLY COMMODITY CHARTBOOK - corn

 

WEEKLY COMMODITY CHARTBOOK - wheat

 

WEEKLY COMMODITY CHARTBOOK - soybeans

 

WEEKLY COMMODITY CHARTBOOK - live cattle

 

WEEKLY COMMODITY CHARTBOOK - chicken whole breast

 

WEEKLY COMMODITY CHARTBOOK - chicken wings

 

WEEKLY COMMODITY CHARTBOOK - cheese

 

WEEKLY COMMODITY CHARTBOOK - milk

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


URBN: Buying

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.

 

URBN: Buying - URBN levels


May ECB Presser YouTubed

Hedgeye Comments:


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.

 

 

Prepared Remarks:

 

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:

http://www.ecb.int/press/pressconf/2012/html/is120503.en.html

 

 

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.

 

 

Matthew Hedrick

Senior Analyst


Early Look

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NKE: Insight on Sustainability

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) 

NKE: Insight on Sustainability - 5 3 2012 10 04 39 AM

 

Nike Flyknit (June 2012)

NKE: Insight on Sustainability - 5 3 2012 10 16 20 AM


INITIAL JOBLESS CLAIMS MOVE BACK IN LINE WITH NORMALIZED TRENDS

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.  

 

INITIAL JOBLESS CLAIMS MOVE BACK IN LINE WITH NORMALIZED TRENDS - Raw

 

INITIAL JOBLESS CLAIMS MOVE BACK IN LINE WITH NORMALIZED TRENDS - Rolling

 

INITIAL JOBLESS CLAIMS MOVE BACK IN LINE WITH NORMALIZED TRENDS - NSA

 

INITIAL JOBLESS CLAIMS MOVE BACK IN LINE WITH NORMALIZED TRENDS - NSA rolling

 

INITIAL JOBLESS CLAIMS MOVE BACK IN LINE WITH NORMALIZED TRENDS - s p

 

INITIAL JOBLESS CLAIMS MOVE BACK IN LINE WITH NORMALIZED TRENDS - Fed   Claims

 

2-10 Spread

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.

 

INITIAL JOBLESS CLAIMS MOVE BACK IN LINE WITH NORMALIZED TRENDS - 2 10

 

INITIAL JOBLESS CLAIMS MOVE BACK IN LINE WITH NORMALIZED TRENDS - 2 10 QOQ

 

Financial Subsector Performance

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

 

INITIAL JOBLESS CLAIMS MOVE BACK IN LINE WITH NORMALIZED TRENDS - subsector scoreboard 2

 

INITIAL JOBLESS CLAIMS MOVE BACK IN LINE WITH NORMALIZED TRENDS - Companies in subsector

 

Joshua Steiner, CFA

 

Allison Kaptur

 

Robert Belsky

 


GIL: Management Behaving Badly?

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:


Revenues:

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


2Q12: $500mm

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

 

Gross Margin:

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

 

Earnings:

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

 

Capex

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


 

 


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