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CRI: Shorting

 

Keith just added CRI on the short side of the Hedgeye Virtual Portfolio. CRI remains one of our top short ideas across all durations, as outlined in our May 9th report “CRI: Short It”. Sales growth is slowing, underappreciated margin pressures are intensifying, and its largest holder is selling.  

 

We've included our May 9th note below.

 

CRI: Shorting - CRI TTT

 

5/9/2012 11:29 pm

CRI: Short it

 

Nearly all the factors that kept this stock grinding higher while estimates came down last year are either slowing, or flat-out reversing, on the margin. We really like the 3/1 odds on the short side.


We think Carter’s is shaping up as a short again. After nearly a year of perceived positive factors at its back, we think that opacity related to organic earnings power will be gone, and competitive challenges will emerge at a time when it is shifting away from harvesting its prior investments, and will need to put capital in to its model that will put a ceiling on margin improvement at a minimum, and likely create meaningful downside if our industry call for increased competition and margin pressure comes to fruition. With that, sales deceleration is a near certainty barring another acquisition, and valuation is sitting near the seven-year peak.


We say ‘shaping up as a short again’ with full awareness that it did not do what we thought it should have done in 2011. In fact, we went into 2011 with estimates for the year at $1.75 and the consensus at $2.40. By year’s end, the Street came down, and down and down by 21%, and CRI earned an adjusted $1.94 (before $0.15 Bonnie Togs accretion). Yet the stock literally defied gravity and went the exact opposite direction – gaining 35% for the year (vs. virtually flat performance for S&P, RTH and the MVRX).

 

If there’s one rule of retail investing that we’ve learned over time, it’s that earnings revision is the key factor in determining the direction of a stock. Pull up thefunction on your bloomberg. With 9 stocks out of 10, you’re going to see that the stock price tracks (or leads) earnings in a very tight band.  Take a look at NKE, AAPL, GIL earnings revisions vs. the stock (all courtesy of Bloomberg).

 

NKE...Check

 

CRI: Shorting - NKE for CRI

 

AAPL…Check

 

CRI: Shorting - AAPL for CRI

 

GIL...Check

 

CRI: Shorting - GIL for CRI

 

Now look at CRI. HUH?

 

CRI: Shorting - CRI for CRI

 

Whenever we talked to people about this name, we were given the same bull factors ad nauseam:

1)  The company had the toughest COGS comps in 2H11, in advance of which it took up prices by 10%. In doing the math, a 10% increase on a $10 product at retail almost entirely outweighs a 25% increase in a $3-4 product cost.

2)  At the same time, CRI was boosting its off-price sales from 1% of total in 2010 to 4% in 2011, and while this would ordinarily be dilutive to margins, it was enough to help leverage SG&A.

3)  While both of these two factors played out, CRI benefitted from the addition of the Bonnie Togs acquisition, which boosted sales by an average of 6% per quarter – again, a factor that (with some minor cuts to acquired SG&A) helped leverage SG&A at the greatest rate in nearly a decade.

4)  And how could we forget the ultimate response?  “The market is flat, I’m clawing to hang on to my return/loss for the year, and you expect me to short the stock of a company that Berkshire Partners is not-so-slowly taking private?

 

Now what have we got?

1)  The good news is that CRI starts to anniversary its higher product costs (that’s the bull case), but unfortunately, it starts to anniversary its pricing initiatives as well. It’s all too often that people adjust one without the other. There are, after all, two components to gross margin. Costs are forecastable. But prices to consumers – especially for a company where 40% of sales come from vertically-owned-retail – are DEFINITELY not.

2)  Off price sales should come down from 4% of sales last year, to about 2% this year. Yes, that’s good for gross margin. But on top of other factors impacting top line, it will make any form of SG&A leverage very difficult.

3)  Bonnie Togs is still there. But it is officially anniversaried. Now it and Carter’s each need to grow on their own without the benefit of basic acquisition accounting helping the situation.

4)  Expectations are lofty – at or above company guidance for sales and EPS.

    • Revenue: Consensus at $2,370mm – ABOVE guidance of $2,300mm – $2,342mm.  
    • EPS: 2012 Consensus at $2.61 – ABOVE guidance of $2.51-$2.61                                        
      • Consensus EPS of $3.28 for 2013, and $3.63 for 2014. We’re at $2.70 and $3.00, respectively.                                                 
      • With all these other factors no longer in CRI’s favor, we have a tough time stomaching the premise that thechart on bloomberg maintains its scant correlation under these circumstances with a 20% earnings reduction.                                                           
      • If our estimates prove right, there’s no reason this stock can’t see the low-mid $30s. But under the most bullish consensus expectations, we still have a tough time getting this name in the upper $50s. We like the 3/1 odds of a short here.

 5)  And lastly…the “Berkshire is Buying” argument is pretty much dead in the water. Yes, they’re selling on the margin.

 

 

Historical context is important here...

 

We were asked a couple of weeks ago by a top client as to why CRI traded at such a high EV/Sales ratio (2.1x) circa 2005. Our answer sounded something like this:

 

This was when CRI achieved cult stock status. There were several factors, all related to post IPO action.

 

The pitch on the IPO was…

a)  Shift away from basics into playwear

b)  Shift from traditional dept store biz to serving 1) mass channels, and 2) company-owned retail.

c)  CRI had new arrangements with Li&Fung – through which it cut its sourcing costs by nearly 1/3 and passed right through to consumers in the form of lower prices to gain share.

d)  Remember that this period (ending April 2007 when LIZ went Ka-Boom) was easy for apparel retail. You could be an average brand and run at peak margins without much effort. The environment allowed CRI to sell into three completely distinct channels with like product without stepping on each other’s toes – and the Street was not only oblivious, but it also gave CRI’s multiple credit for this as a big positive.

e)  Then in 2005 CRI bought Osh Kosh. In the ensuing 2-years, they cut employee count from 400 to less than 100. Margins went up temporarily, before growth slowed and the story became outwardly and visibly broken.

f)  Pretty soon thereafter, people realized that this name was not infallible – that it can’t sell the same stuff through Target, Kohl’s, Macy’s and its own stores -- and that it can’t cut costs to keep margins high in the face of slowing growth.
g)  Fred Rowan (CEO) got fired in 2008, and since then, the Mike Casey era has taken hold. Definitely a better regime. But there was just as much financial engineering as anything else (he was former CFO). CRI had to button up policies due to a markdown irregularity accounting issue w KSS, as well as an exec being charged with fraud and insider trading by SEC in 2010. Nonetheless, it’s got a long way to go before it’s worthy of ‘cult stock’ status again. Our point is that today it is sitting at 1.25x EV/Sales. That’s well below the prior peak of 2.1x, but the old peak is just that…the OLD peak. It need not apply any more.


Playwear has nearly doubled as a percent of CRI’s total over the past ten years. ‘Baby’ is a very defendable business – the Carter’s brand goes a long way with a new Mom swaddling her newborn. But in the Playwear category, it competes with everything from Children’s place, to Old Navy, to JC Penney and Wal-Mart private label. Not a place to hang your hat on.

 

 CRI: Shorting - CRI category mix


European Banking Monitor: Flashing Red

European Banking Monitor: Flashing Red

 

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .


Key Takeaways:

  

* Default probabilities rising globally. European sovereign CDS widened across the board last week. Similarly, nearly all European Bank credit default swaps widened last week. Italian and French banks saw their spreads widen by double digits WoW. Domestic bank CDS followed suit. 

 

If you’d like to discuss recent developments in Europe, from the political to financial to social, please let me know and we can set up a call.

 

Matthew Hedrick

Senior Analyst

 

(o)

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European Financials CDS Monitor – Bank swaps were wider in Europe last week for 38 of the 39 reference entities we track. Notably, French banks widened dramatically. Societe Generale widened by 65 bps to 402 bps while Credit Agricole widened by 69 bps to 404 bps. The debt markets are casting their vote on the outcome of the French elections. Meanwhile, Italian bank swaps weren't far behind with increases of 48 to 97 bps week-over-week. Spanish banks were wider as well, though more modestly than their French or Italian counterparts.

 

We've also included a few Chinese banks for reference at the bottom of the table, and we will be soon rolling a table of Asian Financial CDS. The three Chinese banks we track showed week over week increases, but are generally trading in the low-200 bps range.  

 

European Banking Monitor: Flashing Red - cc. banks

 

Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread was roughly flat over last week, ending the week at 38 bps.

 

European Banking Monitor: Flashing Red - cc. euribor

 

ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing more from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  The latest overnight reading is €789.71B.

 

European Banking Monitor: Flashing Red - cc. ecb

 

Security Market Program – For a tenth straight week the ECB's secondary sovereign bond purchasing program, the Securities Market Program (SMP), purchased no sovereign paper for the latest week ended 5/18, to take the total program to €212 Billion.

 

European Banking Monitor: Flashing Red - cc. smp


BWLD: HAMMERTIME

We have been hammering home the BWLD idea since early January.  Our CEO Keith McCullough just shorted BWLD and we will be highlighting the BWLD idea on our best ideas call Wednesday May 23rd at 11am.  Contact Sales@hedgeye.com if you want to listen.  

 

The BWLD thesis: This stock is highly valued as it one of the few “growth” plays in casual dining.  The year-over-year increase in wing prices has a direct impact on EPS that we believe consensus is underestimating.  We expect negative FY12 EPS revisions over the next two-three months.

 

BWLD: HAMMERTIME - bwld


Daily Trading Ranges

20 Proprietary Risk Ranges

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

MACAU WEEKLY: BETTER BUT NOT GREAT

Lowering our May forecast to HK$25.5-26.5 billion or 8-12% YoY growth

 

 

Average daily table revenues (ADTR) increased slightly from last week, HK$714 million to HK729 million, but should’ve been better.  ADTR was actually down 6% YoY.  As a result, we are lowering our full month forecast to HK$25.5-26.5 billion, representing only 8-12% YoY growth.  At this time, we don’t know what kind of impact hold has played. 

 

MACAU WEEKLY: BETTER BUT NOT GREAT - MACAU1

 

For market share, LVS improved its monthly performance by 50bps but is still well below the 19-20% share it should be garnering following the opening of Sands Cotai Central.  MPEL’s share dropped to 12.3% which is 100-150bps below recent trend.  Galaxy continues to surprise on the upside as does SJM.  Wynn picked up some sequential share but is still well below trend.

 

MACAU WEEKLY: BETTER BUT NOT GREAT - MACAU2


THE M3: MACAU CPI

The Macau Metro Monitor, May 19, 2012

 

 

MACAU CONSUMER PRICE INDEX FOR APRIL 2012 DSEC

Macau CPI for April 2012 increased by 6.76% YoY and 0.61% MoM.


MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED

Key Takeaways

* Default probabilities rising globally. European sovereign CDS widened across the board last week. Simlarly, nearly all European Bank credit default swaps widened last week. Italian and French banks saw their spreads widen by double digits WoW. Domestic bank CDS followed suit. 

 

* Junk bonds signaling trouble. High yield rates rose 53 bps last week to 7.65%, underscoring increased risk in the market. 

 

* Muni debt default risk on the rise. The MCDX, our preferred measure of municipal credit risk, rose sharply last week.

 

* It has been a while since we've seen this many risk indicators flashing red on the short and intermediate term durations.  

 

* If there's a silver lining, our macro team's quantitative model shows that the XLF has 5.4% upside to immediate-term resistance and only 1.0% downside to immediate term support.

 

Financial Risk Monitor Summary  

• Short-term(WoW): Negative / 0 of 12 improved / 8 out of 12 worsened / 4 of 12 unchanged  

• Intermediate-term(WoW): Negative / 3 of 12 improved / 7 out of 12 worsened / 2 of 12 unchanged  

• Long-term(WoW): Neutral / 3 of 12 improved / 3 out of 12 worsened / 6 of 12 unchanged

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - Summary 2


1. US Financials CDS Monitor – Swaps widened for every domestic financial company reference entity we track last week. MS ended the week at 447 bps, up 45 bps, GS ended at 346 bps, also up 45 bps. 

 

Widened the most WoW: SLM, MTG, AIG

Widened the least WoW: UNM, ACE, TRV

Widened the most MoM:  MTG, RDN, JPM

Widened the least MoM:  UNM, ACE, TRV

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - US CDS

 

2. European Financial CDS - Bank swaps were wider in Europe last week for 38 of the 39 reference entities we track. Notably, French banks widened dramatically. Societe Generale widened by 65 bps to 402 bps while Credit Agricole widened by 69 bps to 404 bps. The debt markets are casting their vote on the outcome of the French elections. Meanwhile, Italian bank swaps weren't far behind with increases of 48 to 97 bps week-over-week. Spanish banks were wider as well, though more modestly than their French or Italian counterparts.

 

We've also included a few Chinese banks for reference at the bottom of the table, and we will be soon rolling a table of Asian Financial CDS. The three Chinese banks we track showed week over week increases, but are generally trading in the low-200 bps range.  

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - Euro CDS 2

 

3. European Sovereign CDS – European sovereign swaps also widened across the board last week. Spanish sovereign swaps widened the least on a percentage basis (+2.3%) to 554 bps, while Irish sovereign swaps widened the most by 15.8% to 712 bps.

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - Sov CDS table

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - Sov CDS 1

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - Sov CDS 2

 

4. High Yield (YTM) Monitor – High yield rates rose sharply last week, increasing by 53 bps to end the week at 7.65% versus 7.11% the prior week.

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - High Yield

 

5. Leveraged Loan Index Monitor – Following high yield's lead, the leveraged loan index posted its sharpest decline since mid-2011, dropping 23 points last week 1652.

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - Leveraged Loan Index

 

6. TED Spread Monitor – The TED spread rose 1.5 bps last week, ending the week at 38.8 bps versus last week’s print of 37.3 bps.

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - TED spread 1

 

7. Journal of Commerce Commodity Price Index – Commodity prices continued to cool off reflecting the strengthening dollar. The JOC index fell 3.3 points, ending the week at -11.1 versus -7.8 the prior week.

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - JOC index

 

8. Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread was roughly flat over last week, ending the week at 38 bps.

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - Euribor OIS

 

9. ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing more from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - ECB

 

10. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1. Last week spreads widened, ending the week at 167 bps versus 152 bps the prior week.

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - MCDX

 

11. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production. Generally speaking, higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion, though there are supply dynamics at play as well. Last week the index rose 3 points, ending the week at 1141 versus 1138 the prior week.

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - Baltic Dry

 

12. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure.  Last week the 2-10 spread tightened a dramatic 16 bps to 143 bps.

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - 2 10 spread

 

13. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 5.4% upside to TRADE resistance and 1.0% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - XLF macro

 

Margin Debt - April: +0.93 standard deviations 

We publish NYSE Margin Debt every month when it’s released. NYSE Margin debt hit its post-2007 peak in April of 2011 at $320.7 billion. The chart below shows the S&P 500 overlaid against NYSE margin debt going back to 1997. In this chart both the S&P 500 and margin debt have been inflation adjusted (back to 1990 dollar levels), and we’re showing margin debt levels in standard deviations relative to the mean covering the period 1. While this may sound complicated, the message is really quite simple. First, when margin debt gets to 1.5 standard deviations or greater, as it did last April, it has historically been a signal of extreme risk in the equity market - the last two times it did this the equity market lost half its value in the ensuing period. We flagged this for the first time back in May 2011. The second point is that margin debt trends tend to exhibit high degrees of autocorrelation. In other words, the last few months’ change in margin debt is the best predictor of the change we’ll see in the next few months. We would need to see it approach -0.5 to -1.0 standard deviations before the trend runs its course. There’s plenty of room for short/intermediate term reversals within this broader secular move. Overall, however, this setup represents a long-term headwind for the market. One limitation of this series is that it is reported on a lag.  

 

The chart shows data through April. 

 

MONDAY MORNING RISK MONITOR: FINANCIALS FLASHING RED  - Margin Debt

 

Joshua Steiner, CFA

 

Allison Kaptur

 

Robert Belsky

 

Having trouble viewing the charts in this email?  Please click the link at the bottom of the note to view in your browser. 

 

 


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