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Contradictory Forces

“Sometimes I am two people. Johnny is the nice one. Cash causes all the trouble. They fight.”
 -Johnny Cash   


Maybe an educated Ivy League man like myself shouldn’t admit it, but I’m a fan of Johnny Cash.    But to be fair, even if he isn’t representative of elite American culture, Cash probably represents the contradictions of American life as much as any entertainer of the 20thcentury.


On one hand, he was certainly well known for his sins and bouts with alcohol.  On the other hand, he was a devout Christian who served his religion in many positive ways.   Perhaps the most positive way was in his willingness to give free concerts inside prisons.  The most famous of which was his performance at Folsom Prison in California from which the namesake song Folsom Prison Blues was produced.


In many ways, the contradictory nature of a personality like Johnny Cash (incidentally that was his birth name) very much represents the nature of the current global economy and, as a derivative, the global equity markets.


In Europe the key upcoming catalysts on the political calendar are the elections.  The European elections also represent the current contradictory nature of popular sentiment in Europe.  France, in particular, typifies this notion.  In France, both the extreme left and the extreme right gained substantial ground in the first round of elections.  Ultimately, though, it does look like the extreme left, the Socialists, will prevail and that Francois Hollande will succeed Nicolas Sarkozy as the next President of France.


The outcome of this election is meaningful and, in particular, will influence relations between Germany and France, two of the key decision makers in the European Union.  As well, make no mistake about it, a shift to the left in Europe will have implications for European growth and equities.  This is a point highlighted in the Chart of the Day today and an issue to keep front and center related to your European exposure.  That is, even as French equities are broken on all of our durations, they are still well above the lows reached in December of 2011.


Even if the results of French elections appear certain to some, the Greek elections appear to be much less certain.   Due to Greek electoral laws, no polls have been published since April 20th, but the most recent information from our contacts on the ground in Europe suggests that a majority between Pasok and New Democracy is increasingly unlikely.  This potentially puts the bailout package at risk and implies that Greek elections may be called again as early as this fall.


In the United States, the key upcoming catalyst is the labor report which is out this morning.  It is likely no surprise that Hedgeye is expecting a number that is more bearish than the expected 160,000 additions to non-farm payrolls.  As I wrote in a note yesterday:

  1. Our Financials Team noted this morning that initial claims over the past few weeks have been coming in even worse than they would have suspected, even as last week’s claim, as reported this morning, fell 23K to 365K.                                                                                                                                                                              
  2. The recent Challenger job report appears to support our view that the job market may decelerate.  Specifically, planned job cuts increased by 7.1% from March to April and 11.2% on year-over-year basis.

As always though, trying to front-run government statistics is a fool’s errand; rather, you should just be ready to embrace the uncertainty that will result after the labor report this morning.

To that end, I wanted to highlight a couple of recent additions to the Hedgeye Virtual Portfolio on the global macro front:


1.   Shorted French equities via the etf EWQ on May 1st– Our track record shorting France has been solid over the last two years as we have made money all ten times that we have shorted French equities.  With the upcoming shift to the left in France’s economy, we obviously don’t think this time will be different.


2.   Bought the U.S. healthcare sector via the etf XLV on May 3rd– On a basic level, the U.S. economy obviously looks pretty compelling vis-à-vis Europe, but as well we think there are some interesting potentially positive drivers in the healthcare sector.  To that end, our healthcare team led by Tom Tobin is hosting a call on physician utilization next Friday.  I’d recommend contacting our sales team at to get access to the call.


3.   Bought Brazilian equities via the etf EWZ on May 3rd– Just when everyone thought Hedgeye was bearish on all things emerging markets, we are getting long of Brazil.  A key driver of this position is that we expect commodity prices to decline. As an example Brent oil is bearish on TRADE and TREND durations.  Declining commodity inflation is positive for emerging growth economies like China and Brazil.


One of my favorite Johnny Cash songs is The Highwaymen and in particular this excerpt:


“I was a sailor. I was born upon the tide
And with the sea I did abide.
I sailed a schooner round the Horn to Mexico
I went aloft and furled the mainsail in a blow
And when the yards broke off they said that I got killed
But I am living still.”


As it relates to being a stock market operator staying alive to trade another day is, figuratively, likely some of the best risk management you can heed.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Contradictory Forces - Chart of the Day


Contradictory Forces - Virtual Portfolio

The Best and Worst of Times

This note was originally published at 8am on April 20, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.”

-Charles Dickens


First of all, sorry for the long quote this morning.  I’m sure after reading some of my more eclectic quotes and missives this week, you are all awaiting Keith’s return with bated breath.  But as I was contemplating the stock market this week and the earnings results that were released, somehow Dickens’ quote from “A Tale of Two Cities” seemed appropriate.


The SP500 opened Monday up near 1,380 and closed yesterday at near 1,378.  So despite the sizeable swings mid-week, the broad equity market has done nothing all week.  It seems Mr. Market, just like the Dickens’ quote, can’t decide:  Is growth slowing? Or is growth accelerating? Is Europe out of the woods? Or is sovereign risk accelerating in Europe?  Is China going to ease more? Or is inflation more of risk than growth in China?


We’ve been somewhat definitive on our views that we believe global growth is slowing sequentially, but the market hasn’t totally come around to accept the Hedgeye views just as of yet.  (I guess we will have to get Keith on CNBC more next week to preach the gospel.)  On the growth front, an interesting data point we recently picked up was that traffic through the Suez Canal was only up 1.2% for the month of February year-over-year basis and has been in steady decline for really the last year.  In the Chart of the Day, we show this trend and have combined it with a couple pictures of Hedgeye friend and former NHLer Jeff Hamilton.  As the pictures show, life as a pro hockey player is sometimes good and sometimes bad as well.


Obviously this is but one data point, but this is literally the worst month of traffic through the Suez Canal since the end of the most recent global recession.  As well, the Suez is far from an insignificant indicator.  It is estimated that in total almost 8% of the world’s sea trade is transported through the Suez Canal.  So, this is a data point worth writing in the notebook.


Just as with the continued angst over the direction of global growth, there remains debate over the direction of Europe from a debt perspective.  Some, like Bank of America, are ready to call a bottom in Europeans debt woes as indicated by B of A’s positive call on European Banks this morning.   The actual sovereign market itself, as manipulated as it is, begs to differ though, as Spanish yields on 10-year government bonds are back above 6.0% this morning.


My brothers up in Canada are even getting into the European mix this morning.  Canadian Finance Minister Jim Flaherty came out publically yesterday to propose that non-European nations should have a collective veto when European nations come to the IMF to ask for aid.  Obviously, Flaherty sees what we see, which is that the likelihood of a Socialist getting elected in France means that “the ask” from Europe could soon get a lot bigger.


As well, you can’t really blame Canada (pun intended) for pushing back on continued carte blanche aid to Europe.  In 1993, Canada’s fiscal house was in terrible order and Standard & Poor’s rightfully downgraded Canada debt.  The Canadians then righted the fiscal ship the hard way by implementing a consumption tax and making tough budget cuts, by some estimates almost 20% across the board.  As Canadian Finance Minister Paul Martin said at the time, “Let there be no doubt about that. We will balance the books.”  There are some other nations that could use some of that Canadian fiscal resolve.  (Incidentally, we like the Loonie on the long side over the long term in part due to this.)


As usual during earnings season, we are going to have a note up on our website later today that discusses our view of the broad energy sector this earnings season.  One quote from the note is worth sharing this morning, which is as follows:


“The macro backdrop for the quarter is muddled – Brent crude averaged $118.70/bbl in the quarter, +13% YoY and +9% QoQ; NYMEX natural gas averaged $2.50/Mcf, -40% YoY and -28% QoQ; rig count growth slowed in North America to +12% YoY (vs. +19% YoY in 4Q11); and worldwide rig count growth slowed to +9% YoY (vs. +15% YoY in 4Q11).  Our proprietary US oil and gas inflation index shows that costs for producers were +8.1% YoY in 1Q12, the lowest level of inflation since 4Q10.”


To say that the energy pictures is currently muddled is definitely the Hedgeye understatement of the week, but the key fact I would point out is that natural gas is down 40% y-o-y and oil is up 13% y-o-y.  Thematically, those companies that use natural gas as an input, like certain industrial and chemical companies, are receiving the input cost boon of a life time. 

Meanwhile, any company that competes with the price of gasoline for the consumer’s wallet is certainly feeling the pinch.


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 $1633-1654, $116.71-119.34, $79.25-79.65, $81.12-82.67, $1.30-1.32, and 1356-1395, respectively.


Enjoy the weekend with your families,


Daryl G. Jones

Director of Research


The Best and Worst of Times - Chart of the Day


The Best and Worst of Times - Virtual Portfolio


TODAY’S S&P 500 SET-UP – May 4, 2012

As we look at today’s set up for the S&P 500, the range is 50 points or -1.91% downside to 1365 and 1.68% upside to 1415.   












  • ADVANCE/DECLINE LINE: on 5/03 NYSE -1194
    • Down from the prior day’s trading of -377
  • VOLUME: on 5/03 NYSE 844.17
    • Increase versus prior day’s trading of 8.20%
  • VIX:  as of 5/03 was at 17.56
    • Increase versus most recent day’s trading of 4.03%
    • Year-to-date decrease of -24.96%
  • SPX PUT/CALL RATIO: as of 05/03 closed at 1.57
    • Down from the day prior at 2.69 


  • TED SPREAD: as of this morning 38
  • 3-MONTH T-BILL YIELD: as of this morning 0.08%
  • 10-Year: as of this morning 1.93
    • Unchanged from prior day’s trading
  • YIELD CURVE: as of this morning 1.67
    • Unchanged from prior day’s trading 

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Nonfarm Payrolls, Apr., est. 160k (prior 120k)
  • 8:30am: Unemployment Rate, Apr., est. 8.2% (prior 8.2%)
  • 11:25am: Fed’s Williams keynote speech to California Bankers Association convention in Dana Point, CA
  • 11:30am: Fed’s Evans moderates panel on economic stability
  • 1pm: Baker Hughes rig count 


    • President Obama speaks to high school students in Va., 11:50am
    • House, Senate not in session
    • CFTC holds closed meeting on enforcement matters, 10am
    • CFPB Chief of Staff Meredith Fuchs discusses financial crisis at Forum for Sustainable and Responsible Investment, 11:05am
    • Treasury Secretary Tim Geithner and Secretary of State Hillary Clinton are in Beijing, attending U.S.-China Strategic and Economic Dialogue
    • U.S. Intellectual Property Enforcement Coordinator Victor Espinel speaks at Intl. Anti-Counterfeiting Coalition event, 9am
    • Postal Service board of governors meets on finances, 8:30am


  • U.S. payrolls may have risen 160k in April as jobless rate remained 8.2%, according to economist ests.
  • Warren Buffett’s Berkshire Hathaway reports first-quarter earnings after the close of trading
  • Facebook said to meet today with its underwriters in New York to discuss planned IPO
  • Goldman Sachs, an AMR bondholder, said to be among creditors being lobbied by US Airways to back possible takeover bid
  • Yahoo! will review educational record of CEO Scott Thompson after investor Third Point, fighting for representation on company board, highlighted inaccuracy in his credentials
  • Wal-Mart’s board sued by California pension fund over mishandling of allegations co. bribed Mexican officials
  • Goldman Sachs said to plan starting electronic trading system for corporate bonds this month as bank adapts to regulatory changes, competition
  • RBS says it will pay back the last of its emergency aid from the U.K. government
  • Las Vegas Sands’s Singapore unit, Marina Bay Sands, said to have attracted Sumitomo Mitsui Banking, and about 10 other lenders to its S$4.6b loan to refinance debt
  • Data breach at Global Payments that may have exposed accounts to fraud may have affected at least 7m card accounts, exceeding earlier estimates: WSJ
  • CME Group requested and received 90-day extension for implementing margin changes for members announced May 2; rule will be enforced on Aug. 5
  • Juror in Oracle’s copyright-infringement trial against Google asked judge for guidance about not being able to reach unanimous verdict, raising possibility panel is deadlocked
  • BofA said to have held talks with lawyers for more than 1,000 former Merrill Lynch brokers, may lead to settlement costing hundreds of millions of dollars: WSJ
  • U.S. Air Force plans to restart competition on biggest defense contract, valued at as much as $6.9b, announced April 16 following protests from a dozen losing bidders
  • U.S. officials Hillary Clinton and Tim Geithner meet with Chinese leaders in Beijing
  • French Election, Chinese Trade, Buffett: Week Ahead May 5-12 


    • AES (AES) 6am, $0.27
    • AON (AON) 6:30am, $0.83
    • Buckeye Partners (BPL) 6:30am, $0.74
    • Spectra Energy (SE) 6:30am, $0.52
    • Sirona Dental Systems (SIRO) 6:30am, $0.69
    • PPL (PPL) 6:58am, $0.69
    • Brookfield Office Properties (BPO CN) 7am, $0.25
    • Church & Dwight Co (CHD) 7am, $0.61
    • Duke Energy (DUK) 7am, $0.36
    • ITT (ITT) 7am, $0.32
    • Pepco Holdings (POM) 7am, $0.24
    • Telephone & Data Systems (TDS) 7:02am, $0.36
    • Estee Lauder (EL) 7:30am, $0.34
    • Ameren (AEE) 7:54am, $0.24
    • Clear Channel Outdoor Holdings (CCO) 8am, $(0.08)
    • Exelon (EXC) 8am, $0.79
    • Madison Square Garden Co (MSG) 8am, $0.18
    • Spectra Energy Partners (SEP) 8am, $0.47
    • United States Cellular (USM) 8:01am, $0.43
    • Berkshire Hathaway (BRK/A) 5:15pm, $1,780  



OIL – we’ve been signaling this highly correlated immediate-term relationship between the US Dollar Index and oil prices for the last few weeks and our intermediate-term TREND lines for Brent ($119.17) and WTIC ($103.94) breaking have proven to be catalytic. Oil moves to bearish TRADE and TREND. That’s very new; bullish, on the margin, for US Consumption Growth. 

  • Soy Traders Most Bullish in Seven Weeks on Drought: Commodities
  • Oil Falls to 3-Week Low Before U.S. Jobs Data, Europe Elections
  • Gold Falls in London on Speculation Jobs Data Will Curb Demand
  • LME’s Abbott Predicts Multiple Takeover Offers as Deadline Looms
  • Copper Seen Falling on Concern About Strength of U.S. Employment
  • Soybeans Gain, Trimming Weekly Loss, as U.S. Export Sales Climb
  • Sugar Gains as Lower Prices Seen Spurring Demand; Coffee Rises
  • Copper Dominant Holding Is ‘Adding Fuel to Fire,’ Galena Says
  • Iran May Lose 9.5% of Oil Contracts as Asian Buyers Cut Imports
  • United Energy in Talks to Buy Canadian Producer for $1 Billion
  • India’s Quest for Coal Stalls as Red Tape Kills Mining Takeovers
  • CME Gets 90-Day Extension to Implement Member Margin Changes
  • Barclays Capital Commodities Head Roger Jones Said to Quit Bank
  • Soybean Traders Most Bullish Since March
  • Rice Prices Seen Under ‘Pressure’ on Ample Supply, FAO Says
  • Hedge-Fund Millionaire Diggle Targets $150 Million for Farm Fund
  • Coal at 18-Month Low Seen Lacking China Boost: Energy Markets










RUSSIA – the problem, of course, is that whats good for the US Dollar and the American Consumer is actually quite bad in the very short term for stock markets levered to Commodities (including, to a degree, the SP500 and Russell2000). Russia’s RTSI is the poster child of Petro-Dollar equity beta. Dollar stops going down and Russian stocks -13% since mid March.






CHINA – both the American and Chinese people have one very big thing in common – we like down oil prices. Chinese stocks (which we are long) love Deflating The Inflation. Shanghai Composite up for 3 consecutive days (w/ SP500 down 3 of last 4) to +11.5% YTD. There’s always a bull market somewhere!










The Hedgeye Macro Team


WRC: It’s In the Cosmos

Tough to find anything good about this quarter. Sales look flat-out bad. Bookings are ‘ok’ but in actuality are really only as good as mgmt credibility. Questionable. The biggest issue is cutting SG&A when 90% of cash flow is derived from other Brands’ content.


Report Card: D-  WRC missed on the top line even after setting expectations for a year over year decline. In addition to the expected decline in wholesale results however, which was amplified in Q1, European sales were down(-13%) and Korea (1/3 of Asian business) experienced a sharp sales decline driven by double digit comp decreases. Additional markdowns in the sportswear channel as well as continued macro economic uncertainty in Europe & Korea will offset the expected 2H recovery. Although Underwear bookings (37% of sales) are flat and management does not expect a slowdown in replenishment, it’s pretty tough for us to bank on what management says.  


All in, just about every piece of WRC’s businesses disappointed, and inventories remain very much out of whack (5th consecutive quarter of a negative sales/inventory spread below -10%). SG&A was down 5%, which helped cushion the blow. But we can’t imagine that PVH or RL – whose brand names account for nearly 90% of WRC cash flow, appreciate such meaningful SG&A cuts when the business is down. There’s still plenty of sales and gross margin risk here. We’re not going to fall on our sword and chase it.


What Drove the Miss?


This was largely a revenue miss, (-7%) vs. -1E.


  • Sportswear (52% of sales & 42% of EBIT),  was originally expected to be down $25-30mm in Q1; sales materialized down ~$40mm (-11%) which contributed ~6 points to the 7% sales decline in Q1
  • Underwear (37% of sales & 47% of EBIT), was about flat in the quarter
  • Heritage (11% of sales, 12% EBIT) down 10% largely due to planned reduction In lower margin sales (note: every sale any company ‘walks away from’ is usually one where it is simply undercut in price, or someone else simply has a better value proposition).
  • By Geography, US and EUR were the biggest contributors to sales decline both down 13% (US =40% of sales, EUR 20%)
  • Asia +9% (Korea, ~1/3 of Asia, DD comp decline with sales down 6%)
  • Mexico, Central & South america +3%
  • Canada -2%
  • GM down 112bps due to product cost inflation, costs +7-10% vs prior expectations of +5-7%
  • SG&A down 5% (deleveraged 80bps) resulting in EBIT margin -190bps


WRC: It’s In the Cosmos - WRC SIGMA


Deltas in Forward Looking Commentary


In order to properly measure performance relative to original expectations, we look at management’s 2012 guidance headed into the quarter as well as the key deltas in Q1 results vs. expectations :



First Quarter Guidance:

  • 1Q12 revs expected to be down primarily as a result of $25mm reduction in US sportswear sales to off price and value channels MISS: Revenues came in down 7% Driven by increased markdowns as well as weakness in Europe & Korea in addition to decline in off price sales

Full Year Guidance (Former Guidance in Black. Revised in Red):

  • EPS $4.20-$4.45 REDUCED: now $4.000 to $4.25
  • Revenues: +MSD (4-6%) REDUCED: now flat to +2%
  • Gross margin expansion UNCHANGED Continue to expect product costs to be flat YoY
  • First half to be challenged by cost inflation and currency headwinds with stronger 2H12 UNCHANGED
  • Product costs expected to be up 5-7% in 1H, down 7-10% in 2H WORSE: Product costs +7-10% YTD but will be down 7-10% in 2H
  • SG&A as percent of sales expect to increase in 1H12 due to restructuring of the business but improve in 2H UNCHANGED: Will continue to invest in growth initiatives but have levers if sales slow
  • Expect to add nearly 150,000 square feet of new space in 2012 ( have identified 60,000 square feet) REDUCED: now planning 120K square feet
  • Will be skewing new square footage towards ASIA and emerging markets until there are signs of improvement in Europe UNCHANGED


Highlights from the Call:



Revenues: -7% below original expectation due to Markdowns in US Sportswear, Soft retail comps, Weakness in Europe & Korea

  • Now anticipate these trends to continue through 2012
  • International sales (60% of revs in Q1) down 3%
  • Growth in Asia (+9%) and Latin America (+3%) offset by Europe
  • China led Asia, +30%
  • International growth was offset by Korea (1/3 of Asia) down 6% despite some market share gains
  • Europe: down 13% due to continued macroeconomic stress
  • Growth slowed in Germany, France, UK
  • US: Revenues down 13% primarily due to sportswear  which included $30mm reduction in value channel sales and markdowns in Calvin Klein

Retail: +7%

  • Added 39K feet
  • Comps down 2%
  • Latin American comps +DD
  • Europe comp flat
  • Asia comp down 5%
  • Planning to add 120K of square footage this year

Calvin Klein: (-7%)

  • Growth in underwear & DTC offset by declines in US and European wholesale jeans
  • CK underwear +3% with DD growth in US and Asia
  • Men's +7% with launch of bold
  • Jeans: (-11%) reflecting reduction in value channel sales
  • Women's down DD

Heritage (Speedo)

  • Most revenue decline reflected planned elimination of low margin sales


  • Increased markdowns to clear fall/holiday impacted results
  • Spring summer merchandise sell troughs are more encouraging






Full year

  • Expect Net revs to be flat to +2% (+2-4% constant currency)
  • Expect EPS to be in the $4.00-$4.45 range


  • Expect 2Q revenues and earnings to be down YoY (less so than first quarter)
  • Planning comps to be down
  • Will continue to invest in growth initiatives which will increase SG&A YoY
  • Products costs up 7-10% will continue to impact the bottom line


  • Expect improvement in all key operating metrics
  • Product cost headwind becomes tailwind with costs down 7-10% driving gross margin expansion
  • 2H Regional Growth Expectations:
  • Expect LSD in US in 2H
  • Latin America and Asia expect return to DD in 2H
  • Expecting a decline in Europe in 2H




New Store Productivity:

  • Korea having significant impact on comps and thus overall retail group
  • Additional square footage dependent upon timing and location which is included in overall retail projections


  • Some of the cuts through variable expenses associated with retail particularly in Asia
  • Overall tight cost control in the quarter whether it was new hires, replacements, etc.
  • None of the pullbacks expected to have impacted any long term investments
  • Continue to be levers to reduce SG&A if need be
  • Will be making investments in core strategic plans and initiatives

Gross Margin:

  • Will continue to see FOB costs in 2Q, but in 2H, retail mix and low costs should push GM higher
  • Expect to lift gross margin in 2H considerably

Off Priced sales reduction:

  • Full $30mm took place in 1Q


  • Really pleased with the results in China with revs +30% in the Q over 50% last year
  • Total retail +20%
  • Did see some falloff in foot traffic in particular in Shanghai and Beijing with impacted comp results overall
  • Expect traffic trends to improve
  • Continue to focus on presentation at POS, visual merchandising at a store fixture level, improving service, etc.
  • WRC remains bullish on China- no intent to pull back on new store openings


  • Know in the first quarter WRC performed slightly better than competitors and gained market share
  • Saw a significant improvement in march which is expected to continue
  • Believe they are now outperforming the department store competition
  • No new store square footage plans in Korea as of now
  • Roughly $200mm business
  • Major change in the quarter was a DD comp decline


  • Continued to grow in Northern Europe, Germany up slightly, UK flat, France up slightly however trends slowed from Q4
  • Spain and Italy continued to be down DD, expect these trends to continue
  • Continue to actively explore new relationships in Europe

Women's CK

  • Had great results on colored denim- sell through better than some of past launches but only 10% of women's business
  • For Fall, have a major replenishment program planned on denim, increasing penetration on denim where in the past WRC has pulled back and focused more on lifestyle

Latin America:

  • Constant currency revs +10%
  • Have been investing in infrastructure to really build up the platform for long term growth
  • Brazil down slightly in the quarter on top of +55% increase in last year
  • Planning Brazil to be up currently for the same year, HSD-LDD growth rate there

Positive wholesale results in 2H:

  • Combination of visibility into bookings (primary reason for driver) as well as product initiatives
  • Large portion of the business is from Chaps which is largely booked already for 2H
  • Expect CK sportswear to decline in 2H in wholesale based on fall bookings and product launches in the US and Europe

Forward bookings

  • Chaps up substantially with bulk of 2H growth through Chaps
  • Seeing increases in golf and outdoor that are looking strong for 2H
  • Underwear is roughly flat (large portion of the business is replenishment)


  • US replenishment is up DD in the US
  • Not seeing any inventory reductions that aren't relative to sales
  • Seeing a slowdown in replenishment in Europe

2H Comparable store sales expectations:

  • Expect low positive comp stores sales in 2H reflecting improvements from tactical initiatives
  • Up against lower comps in 2H11
  • Expect accelerated growth in total retail in 2H through productivity improvement in non comp stores, additional square footage
  • April comps down as expected due to Easter shift
  • Off to an incredibly strong start in May

Retail Operating Margin

  • Current forecast shows GM continues at a 4 wall basis of over 65% near 68%
  • Expecting a 20% contribution margin on a full year basis


  • Expect a slight increase of out the door price in the Fall
  • Quality and value of the product is going to be enhanced
  • Have not been any price increases in the Spring, did take some up in the Fall which carried over and there has not been any resistance to pricing

Costing (Inflation)

  • Costs up 7-10% depending on the category
  • Seeing similar reductions in 2H, expecting costs to be flat YoY
  • Anticipating LSD increases on an annual basis go forward via labor rates, material costs, etc.

Reduction in 2H marketing:

  • Reductions in marketing spend will closely reflect change in revenue growth/declines

Women's marketplace:

  • Great deal more competitors in women's with new entrants frequently
  • Highly fragmented category
  • Need more insight into the consumer which is particularly true in the consumer
  • A piece of 2H spending is on additional customer analytics

M&A Potential:

  • No change in the strategy- believe there is a significant organic growth opportunity
  • Will evaluate opportunities as they arrive but priorities rest in the current business and execution of plan

Share Repurchase:

  • EBITDA approaching $350mm, generating $270-280mm in Free cash
  • Have 189mm authorized to repurchase
  • Using share count of ~43mm for guidance

CK Bridge:

  • Still delivering product throughout 2012 and will not impact Q1 or Q2 and may have slight impact in 2H
  • Not expecting this to have any significant impact on operating results



What the Heck Is Going On In Brazil?

Conclusion: We see limited downside in the Brazilian real over the intermediate term and, thus, remain bullish on Brazilian equities given the erosion of this headwind. Further, along with China, we view Brazil as the safest place to be in the EM space, from a fundamental perspective, over the intermediate term.


Virtual Portfolio Position: Long Brazilian equities (ETF: EWZ).


In recent weeks, Brazil’s Bovespa Index – a market we’ve explicitly favored on the long side since SEP ’11 – has come under a fair amount of selling pressure in recent weeks (down just over 9% from a MAR 13 cycle peak). We attribute this largely to weakness in the Brazilian real, which is down roughly -12% vs. the USD from a late-FEB cycle peak. The key issue here as it relates to the Brazilian equity market is two-fold: 

  1. An increasingly subdued outlook for currency appreciation/an outlook for outright depreciation limits the appeal of Brazilian assets to international investors.
  2. A weaker currency – particularly vs. the USD – drives up the cost of servicing international debt as well as expenditures on FX and interest rate hedging for Brazilian corporations. All of this acts as a headwind to earnings growth. 

To point #1, net foreign inflows into the Bovespa Stock Exchange were negative in MAR (-R$1.29B) and for a large portion of APR, where late-month buying saw the month finish with a net positive inflow of R$474M – just 36.6% of the previous month’s outflows. Additionally, aside from the Argentine peso (currency of a country with a host of serious issues to contend with), the Brazilian real screens most bearishly from a market perspective over the NTM across our investable EM coverage universe.


What the Heck Is Going On In Brazil? - 1


What the Heck Is Going On In Brazil? - 2


What the Heck Is Going On In Brazil? - 3


To point #2, Brazil has the second-highest real interest rate in the developing world at 3.76% (behind Russia’s 4.30%); this forces a great many domestic borrowers to turn offshore for sources of cheaper capital – particularly in the USD debt market, where Brazilian issuers have sold a record $27.35B of USD-denominated debt in international markets in 1H12. Those repatriated inflows have slowed dramatically in recent weeks, however, with only $1.75B of that coming since the end of MAR.


What the Heck Is Going On In Brazil? - 4


We interpret that last nugget in two ways – one negative and one positive: 

  1. It suggests international capital markets are drying up – which they indeed are. Per Bloomberg, global issuance of junk-rated USD-denominated debt fell -27% MoM in APR as those bonds fell -1.1% (per a Credit Suisse index) – good for the largest monthly decline since NOV. No junk-rated Brazilian company has been able to price a deal since Magnesita Refratarios SA’s MAR 30 sale of $250 million worth of notes.
  2. Brazilian corporates, which rushed to take advantage of the window of opportunity afforded them in the global low-volatility environment at the beginning of the year, simply have lower near-term borrowing needs. Brazil’s lowly $1.6B worth of APR issuance contrasts with a record $15.5B of issuance out of Asian corporate borrowers for the month – many of whom may be accelerating issuance to get ahead of what we’ve identified a probable breakout in global volatility/widening of credit spreads over the intermediate term. Net-net, the Brazilian real, which has underperformed every EM currency (vs. the USD) over the last three months appears to have limited downside from a capital inflows perspective, given that Brazil has front-run a slowdown in the repatriation of international capital that looks to impact other EMs in the coming months. 

Getting back to point #2 above, we look no further than the recent string of bad operating results out of companies like Vale SA (world’s largest iron ore producer), Fibria Celulose SA (world’s largest pulpmaker) and Telemar Norte Leste SA as proof of what weakness in the BRL/USD cross has done to corporate profits in Brazil. In fact, in the three quarters through 1Q12, YoY growth in Bovespa EPS (which has averaged -39.6% in that time frame) has trailed YoY growth in revenues and EBITDA by an average of 5,877bps and 2,809bps, respectively – largely highlighting the impact interest payments and other non-operating expenses have had on corporate earnings in Brazil.


What the Heck Is Going On In Brazil? - 5


Importantly, as the currency’s decline slows and finds a bottom (likely well ahead of other EM currencies), we anticipate that the erosion of this massive headwall (“headwall” > “headwind”) will become a pseudo tailwind, on the margin, for Brazilian equities. The next few paragraphs detail why we think the Brazilian real has limited downside from here (vs. the USD, relative to other EM currencies) over the intermediate term.


Looking to our proprietary G/I/P analysis, our predictive tracking algorithms suggests Brazil’s monetary easing cycle will trough here in 2Q12 and likely shift the central bank’s policy bias to neutral through the remainder of the year.


What the Heck Is Going On In Brazil? - BRAZIL


Central Bank President Alexandre Tombini has presided over -350bps of interest rate cuts since we first signaled that their policy bias would shift to dovish in AUG ’11. Thus, it appears increasingly likely that his board is close to entering a period of respite in order to judiciously monitor the pass-through effects of these previous rate cuts. Further, given the mere 25bps of proximity the Selic currently has to its Financial Crisis trough of 8.75% (an all-time low), we think incremental cuts may be viewed as an unwanted signal of fear and/or desperation out of the central bank that could threaten its credibility – especially given the politicized nature of the aforementioned rate cuts (essentially at President Rousseff and Finance Minister Mantega’s constant urging).


What the Heck Is Going On In Brazil? - 7


Per the central bank’s own survey (latest poll conducted on APR 27), domestic inflation expectations over the NTM are far from far tame, having increased each week since mid-FEB. This jives with our long-term view on the domestic inflationary pressures within the Brazilian economy; there’s simply too little slack throughout several key areas in the economy to convince market participants that “everything’s under control” from a long-term inflation expectations perspective. We walk though this topic in great detail in our 75-slide Black Book on Brazil titled “The Roadmap for Investing in Brazil”; please email us for copies in the event you missed it come through live in AUG ’11.


What the Heck Is Going On In Brazil? - 8


Additionally, recent weakness in the BRL/USD cross is eroding the currency’s marginal strength relative to global food and energy prices – which serves to threaten reported inflation statistics to the upside in the coming months. Notably, the IGP-M inflation index, which has been known to lead the benchmark IPCA CPI index by 2-6 months, bottomed in MAR. While we don’t see material upside in Brazil’s headline inflation rate over the intermediate term, this data point is in support of our model’s view that Brazilian CPI bottoms here in 2Q and accelerates in the back half of the year – likely preventing the central bank from reaching the midpoint of its inflation target of +4.5% (+/- 200bps), which it has repeatedly promised to accomplish by year’s end.


What the Heck Is Going On In Brazil? - 9


What the Heck Is Going On In Brazil? - 10


If Tombini’s cutting-edge SAMBA (Stochastic Analytical Model with a Bayesian Approach) forecasting techniques start to jive with our own quantitatively-based G/I/P outlook and support a marginally-hawkish shift to a neutral policy stance, we would expect Brazil’s interest rate and FX markets to respond accordingly. The one wild card here remains Finance Minister Guido Mantega and his politicized drive to weaken the real to protect Brazilian manufacturers and exporters from what he and President Rousseff have publically identified as a “currency war” beget by a “very adverse; very perverse” flood of international liquidity stemming from a developed-world “monetary tsunami” (i.e. QEs, LTROs, APPs, etc.).


As highlighted earlier, the slowdown of inflows of foreign capital/demand from Brazilian corporations to issue abroad largely coincided with Mantega’s broadening of the scope of the country’s financial transactions (IOF) tax in FEB. The new requirements force Brazilian corporations to pay 6% on international loans proceeds with maturities up to five years (from one year and then three years prior). This is on top of a 6% tax rate on foreign investor proceeds from investment in Brazil’s domestic fixed income market, a 6% tax rate on foreign investor’s margin deposits for futures contracts, and a 6.38% tax on foreign credit card purchases.


On positive in all of this is that Mantega has been known to completely rescind iterations of the IOF tax, as he did with the IOF tax on foreign investor equity transactions back in NOV. His own commentary leads us to believe he’s likely to reverse his harsh stance against currency appreciation alongside any confirmation/urging from the central bank in the coming months:


“We established regulatory measures exactly for that, to add and take away. The IOF is one of those, we introduced it, then we can take it away when it’s no longer needed.”


All told, we’re buying Brazil for a trade here, though our bullish fundamental outlook suggests we could hold it for longer if the quantitative setup shifts in our favor. Our proprietary risk management levels for the iShares MSCI Brazil Index Fund are included in the following chart:


What the Heck Is Going On In Brazil? - 11


Lastly, before we conclude this note, we wanted to share with those of you who follow Brazil closely our own “nuggets” which Moshe Silver, Hedgeye’s Portuguese-speaking Chief Compliance Officer, mines the Brazilian local press each day for relevant economic and political commentary. We always find local market color to be additive to our research process, so we wanted to share with you a few of his more interesting callouts from recent weeks: 

  • SELIC and savings – on the heels of yesterday’s cut in the SELIC rate to 9%, O Globo columnist Miriam Leitao presents an analysis of the effect of reducing the SELIC rate on personal savings in Brazil. She says that fluctuations in the SELIC rate can drive average returns on investment funds below the returns on normal savings accounts. Profits from investment funds are taxed at rates ranging between 15%-22.5%, while savings accounts are not subject to tax. Leitao quotes a study that finds 16 out of 20 scenarios in which a passbook savings account has a better return than average securities investments, with the SELIC at 9%. If there were a rush to passbook savings accounts, writes Leitao, funds available for real estate lending would swell, as banks are required to make 65% of savings account assets available for real estate loans. The government has to be careful, says Leitao: if they make savings accounts too attractive, it could disrupt the market for public debt, which is largely owned by investment funds and banks. Leitao says the government will have to find a workable resolution to this situation. Without it they will be in a bind and unable to continue to lower rates.
  • President Rousseff to announce savings policy – Brazil’s president Rousseff is set to announce new government policies covering personal savings accounts. Reported in Veja, President Rousseff looks set to upset a large number of her citizens as she announces changes to passbook savings accounts designed to reduce the profitability of the accounts. Observers say Rousseff is forced into this – introducing a wildly unpopular policy in the middle of an election year – because reducing the profitability on savings accounts is the only way to prevent “a stampede” of investors out of the fixed income investment funds, which are seen as critical to enabling the government to roll its billions in federal debt issues. According to Veja, there are 10,800 private funds, which invest principally in government paper. 22% of these funds invest in federal debt – but they represent 65% of the total R$ 1.85 trillion invested.
  • Central bank cautious on rates – the latest central bank COPOM monetary policy committee minutes released this week said “given the cumulative effects and in view of the policy measures implemented to date, any further monetary easing should be undertaken with moderation,” leading observers to say further rate cuts will depend on the pace of recovery in Brazil’s economy. 
  • Transportation – President Rousseff proposed a R$ 32 billion package for urban transportation projects, saying funds should especially be directed to metro projects – again, though not explicitly stated, it is clear the country’s major cities do not have sufficient urban transport facilities for the World Cup.
  • Tax breaks for industry – finance minister Guido Mantega said payroll taxes will be reduced starting in July in the textile, auto parts, aerospace, footwear, and capital goods sectors, among others.  Mantega also said subsidies will be increased for the manufacturing sector and for exporters who have suffered because of the appreciation of Brazil’s currency. 
  • Social spending at record high – the government’s Minha Casa, Minha Vida (“My House, My Life”) cash transfer program spent at record levels in the first quarter of 2012, laying out more than R$ 5 billion, which is more than five times the spending for the same period a year ago, and nearly half the budget allocation for this program over the next three years.  It was not reported how the government intends to account for expenditures going forward, but we remind readers that off-budget facilities that are routinely applied to social programs, a “spend today, figure it out tomorrow” approach that Brazil still has not managed to shake.
  • Government to capitalize banks – Brazil’s major state owned banks, Caixa and Banco do Brasil, are discussing cuts in the rates in their credit lines.  As part of the government’s program to reduce banking spreads, the treasury is contemplating additional financing if the cuts in credit spreads affect the banks’ capitalization as required under Basel 3.  The issue of government guarantees becomes more important for Brazil’s private banks.  Before the 2008/2009 financial crisis, state-owned banks had issued about 30% of total credit.  That is now up to 43%.  Private banks have suffered greater rates of delinquencies and defaults.  If the credit spreads are to be brought down further, they fear they will not have the profit cushion to permit them to operate.  

Darius Dale

Senior Analyst


The title of this note may be a little harsh but there is a chance that it is not.  Some are betting that there is more pain to come and some are buying the stock on account of the "massive" 50% decline.  We are not buyers here and see potential for, if anything, further downside.   We see no reason to own this stock besides the size of its market and that lone positive is overshadowed by the plethora of negatives and possible future negatives facing the company. 


“It ain’t what you don’t know that gets you in trouble.  It’s what you know for sure that just ain’t so.”

-Mark Twain


There are a lot of red faces among the sell-side analysts covering Green Mountain Coffee Roasters.  Anyone in the business can empathize with those putting forth a mea culpa to clients today but still, even after last night’s “surprise”, Mark Twain’s aphorism is worth bearing in mind.  What investors knew “for sure” has caused a wild ride in this stock over the past 18 months.  Giving management the benefit of the doubt, despite huge cash burn and recurring accounting concerns, was a leap of faith that has proved costly for many. 


We wrote a note on April 5th stating the following: “The question is: how bearish is bearish enough?  We think the stock could go to $25.”  In that note, “GMCR: THE SLOW BLEED OF THE GREAT COFFEE BUBBLE”, we highlighted several things we didn’t know for sure and the worrying harmony that existed between the most negative scenarios in our model, insider selling, and allegations outlined in a Class Action Complaint filed against the company.  The financials, we said, were the “big unknown”.  To a large extent, they remain so.  The emperor has fewer clothes than the market thought.  Does he have any at all?  We think Green Mountain has a business, and is a going concern, but there could be more pain in store.  With management’s credibility essentially vaporized over the course of a staggeringly poor showing during last night’s earnings call, the unknown unknowns are taking more mind-share among investors.


These unknowns are like landmines; there are difficult to see until it’s too late.  We think an accordingly prudent approach to this name is appropriate; investors should take a "show me" approach to management's projections, given the reputational blow that this company has inflicted upon itself.  If one of these still-buried landmines blows up, not only would that pose a problem in and of itself, it could set off others.  As sales disappoint, disgruntled shareholders are likely to add their voice to class action complaints and other investigations.  There is potential for it to get ugly. 



Still-Buried Landmine: Accounting Shenanigans


Given management’s hour long fumble last night, the question that people are asking is what type of internal controls the company has in place.  When prodded about what factors were behind the “moderating” sales growth, CEO Larry Blanford provided a telling response: “I think all of us are trying to take into account the – kind of these underlying factors and we’re still trying to understand them.  So that’s the honest answer.” 


Whether that is actually an honest answer is a risk; suspicions we referenced in our April 5th note about Green Mountain’s compensation structure being levered to net sales could hold an explanation.  Has the company been managing revenues by ordering K-Cups from third-party roasters?  The calculus behind executive level bonuses may have provided some incentive for senior officers to follow that strategy. 



Still-Buried Landmine: The Demand Model was Not a Model To Begin With

Six months ago, on November 9th, Green Mountain’s CFO Frances Rathke said the following on her company’s “demand model” and its efficacy: “as we noted in our remarks, we’ve had it tested now by outside experts and we, as well as the experts, feel it’s a very accurate and predictive model.  So, I think, overall, for fiscal '11, the portion pack volume came in very close to what the model predicted, and I think, once again, we were comfortable that we can rely on this as we go forward, into fiscal '12 and the future.”


We cannot reconcile that statement with what the CEO said last night: “over the last several quarters we have seen a dramatic increase order volatility, which comes, we think, from the dynamic growth of our business, the expansion of brands and varieties in our Keurig Single-Cup brewing platforms and demand shifts between our channels.”  Time will tell whether or not there was any real model in place besides the model that dictated executive compensation as being a function of sales. 


This dramatic shift in tone has shaken the conviction of the firmest believers in the Green Mountain story and rightly so.  The company clearly has a very poor handle on the demand for its product and the sales-inventory spread (chart below) is illustrating a company in dire straits.





Still-Buried Landmines: Capital Requirements, Capacity Glut, Margin Contraction


Despite the myriad concerns facing the business, management continues to invest a staggering amount of capital into its business.  Its capital expenditures for 2012, projected at $525-575mm versus $630-70mm prior, and beyond are aimed at supporting the future growth of the business, per the company’s most recent 10-K filing.   Of this2010 guidance for capital expenditures, $165 million will be invested in increasing packaging capabilities related to the Keurig K-Cup brewer platform, $65 million will be invested in packaging capacity related to the Vue brewer platform, and the balance is spread between expanding the physical plants, coffee processing and other equipment and investment in information technology infrastructure and system.  It is clear that the company will still be burning cash in FY12. 


Our question is, given that its capex is aimed at future growth, to what end will this cash be burned?  If the growth outlook is changing and the company obviously cannot offer a lucid picture of what demand is looking like for their product, how is ~$550mm in capex arrived at?  The changing demand outlook has caused management to alter its capex outlook but will the company also be burdened by over-capacity?  Given that the company has been building capacity in anticipation of future demand growth, is moderating demand about to saddle the company with underutilized assets?


Finally, it seems possible that further write-downs could be on the way which would further weigh on margins.  What are the chances that management came clean on all of the company’s problems at once yesterday?  There are clearly too many questions still hanging above this stock and the management team is not inspiring confidence in anyone.


Is it “all priced in”, as some amazingly resilient bulls want to believe?  We think there are too many risks that that just ain’t so.



Howard Penney

Managing Director


Rory Green


Early Look

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