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WEEKLY COMMODITY CHARTBOOK

Dollar weakness sent corn higher over the past week which is has dampened the performance of SAFM and also drove beef prices higher for the week.  There is still plenty of good news for restaurant companies with corn, wheat, cheese, rice, milk, and coffee all down double digits versus last year. Coffee and chicken breast prices were the biggest decliners on the week, of the foodstuffs that we track. 

 

General Overview

 

Chicken wing prices remain the standout item in our commodity monitor but a close second is the growing amount of red that we see on the table over the last few weeks. Increasing economic uncertainty and dollar strength is helping to bring down food costs for operators in the restaurant industry after a prolonged period of margin pressure in part due to rampant inflation in beef, dairy, coffee, and other items.

 

The chart of the CRB Foodstuffs Index versus the US Dollar Index, below, indexed from September 1stof last year, highlights the inverse relationship between the U.S. dollar and foodstuffs prices over the last nine months.  As a firm, Hedgeye has been of the opinion that a Strong Dollar translates into Strong Consumption in America, which helps the top line growth of restaurant companies but it is also helping to relieve margin pressure – as the chart below shows. 

 

WEEKLY COMMODITY CHARTBOOK - commod

 

WEEKLY COMMODITY CHARTBOOK - crb foodstuffs vs usd index

 

 

Gasoline Prices

 

Gasoline prices continue to decline.  The easing of pressure at the pump is having an impact on demand. According to AAA, US retail gasoline prices are now -5.5% year-over-year and consumers are responding.  Earlier this week, Mastercard reported that the gasoline consumed over the 4 weeks prior to June 1stwas -1.9% year-over-year, which is the smallest decline since 9/16/11.  Gasoline consumption has been negative, on a year-over-year basis, for 40 straight weeks as lower prices spur demand but the weak economy weighs on fuel purchases.

 

WEEKLY COMMODITY CHARTBOOK - retail gasoline prices

 

 

Beef Prices

 

Beef prices traded moderately higher over the last week as dollar weakness provided support.  Optimistic expectations for this year’s corn crops, as well as economic concerns, had been weighing on beef prices but mounting concern that dry, hot conditions across the Corn Belt are sending prices for the grain higher. Below, we detail some thoughts on several companies’ exposures to beef prices.

 

JACK: Jack in the Box is one of our favorite longs.  On May 17th, the company said that it expects beef costs to be up 5-6% versus prior expectations of high single-digit inflation.  While prices have gone up since then, we do not think that the company will have revised its stance, yet.  The company also said that, if beef prices were to continue to “stay low”, its guidance of 14.5-15% for restaurant operating margins might could have been conservative.  We think expect its restaurant operating margin to come in close to that target given the recent gains in beef costs.  Beef, which is 20% of the company’s spend, is the biggest wildcard in its commodity basket.

 

WEN: Wendy’s, like Jack in the Box, purchases fresh beef (20% of its basket) on the spot market. On May 8th, the company said that it expected beef prices “back up” by the fourth quarter and that its purchasing is pretty much “at market with a three months lag as you see the impact of market changes on beef”.

 

TXRH: Texas Roadhouse, as of April 30th, had pricing arrangements in place for well over 90% of its beef.

 

 

Chicken Wings

 

We have to highlight, once again, the resilience of chicken wing prices even as other commodities and protein costs roll over.  Our conversations and analysis continue to point to undersupply in the market which, given the price action, is not being addressed by the marginal increases in egg sets that the data is showing every week. As the chart below shows, egg sets are still declining at ~4% year-over-year.

 

WEEKLY COMMODITY CHARTBOOK - egg sets wing prices

 

 

Correlation Table

 

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


Industrials Chart of the Day & Sector Commentary

Chart of the Day

 

-          Chinese rebar futures markets not betting on stimulus working in construction

-          Rebar spot prices down about 20% Y-o-Y nominal

-          Worth watching to gauge informed local market expectations for construction activity/heavy equipment demand

 

Industrials Chart of the Day & Sector Commentary - chart1 rebar futures

 

 

Navistar Miss:  Navistar reported some very challenging results and the shares have sold off significantly today.  The lack of clarification on the company’s engine certification was particularly troubling.  Even after a period of significant underperformance relative to Paccar, Paccar still trades at a 23% discount to Navistar on an Adjusted EV/2011 EBITDA basis.  While this may reflect some concerns about Paccar’s SEC inquiry, that is a less significant business headwind than not meeting *2010* emissions targets in mid-2012.


Industrials Chart of the Day & Sector Commentary - chart2 adjev ebitda

 

 

Sub-Industry Performance

Industrials Chart of the Day & Sector Commentary - chart 3 sub industry performance 6 7


HedgeyeRetail: Chart of the Day; Cotton Bulls

Let’s quantify the Bull vs. Bear case for input cost benefits in 2H. The math works out such that the industry MUST hold price in 2H. Even a 1% decline in retail price will stress the supply chain. We think we’ll see more. 

 

The Bullish case for retail in 2H12 is largely predicated on lower cost cotton flowing through the P&L and retailers gaining back a substantial portion of the margins lost last year. The Bearish case acknowledges that raw material costs account for ~40% of cost allocation with Cotton accounting for 20% at best.

 

Think of the following…

 

Retailers Price: $10

Retailers Cost: $5-6

 

Wholesale Price: $5-6

Wholesaler Cost: $3

 

Manufacturer Price: $3

Mftgr Cost: $2.00-$2.50

 

Then look at the following chart. See how much of the manufacturer cost is related to raw materials – it’s around 40%. If we assume that cotton is ½ of raw materials (it’s actually less), and that cotton-substitutes and synthetics account for the remaining 50% (which are down, but not as much as cotton), we’re looking at much different math. That means that raw materials (including cotton) could be down by 20% in 2H, and we’re talking ~$0.20 per unit. And that’s assuming that labor, etc… is flat. In actuality, labor, which is now closer to 15%-20% of total cost is going up 10-15% per year or better. That knocks the net benefit down to about $0.15.

 

So $0.15 per unit is nice. But a) every CEO in retail, wholesale, and manufacturing sees it and thinks they’re going to keep it. B) the average consumer price reduction being put in place by Johnson and the JCP team is ~40% at the everday price.

 

Off a retail price of $10, we’re talking costs of $3-$5 per unit. If we see consolidated prices come down even 3% in 2H, it will offset the cost benefit everyone is eyeing by a factor of 2. 

 

HedgeyeRetail: Chart of the Day; Cotton Bulls - Cotton COTD

 


investing ideas

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Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

Idea Alert: Buying BUNL

Positions in Europe: Long German Bunds (BUNL); Short EUR/USD (FXE)


Keith bought German Bunds via the etf BUNL in the Hedgeye Virtual Portfolio today. The etf is in a bullish formation, meaning the current price is above its immediate term TRADE and intermediate term TREND levels (see chart below). Buying BUNL takes our Fixed Income asset allocation to 12% versus 0% at the start of the week. We do expect German fixed income to remain a bet on safety. A threat to this positioning would be any indication from Chancellor Merkel of a softening line or full acceptance of Eurobonds.  

 

Idea Alert: Buying BUNL - 111. bunl

 

Our thinking about investing in Europe hasn’t changed: there’s a relative advantage to playing the capital markets of the stronger countries on the long side and weaker countries on the short side, at a price. We’re highly sensitive to price and well aware that there’s no simple equation to pair or hedge risk in Europe: political headline risk, even from the tiniest of countries in Europe, can roil country equity indices and influence yields across the continent. 

 

However, from a political timing perspective, we expect Eurocrats to evaluate the outcome of Greek elections on 17. June before embarking on deeper discussions around a fiscal union, Eurobonds, and a Pan-European deposit insurance, topics that should be central at the EU Summit on June 28-29.

 

Matthew Hedrick

Senior Analyst


CHART DU JOUR: REVPAR PROJECTION

  • We’re calling for moderating RevPAR growth assuming stable economic growth
  • A worsening jobs/GDP picture could pressure RevPAR even more
  • RevPAR tends to drive near-term sentiment

CHART DU JOUR:  REVPAR PROJECTION - UUP


LULU: Be Patient

Over our TAIL duration, LULU is arguably one of the cheapest stocks in retail. Unfortunately, stocks don’t trade on a 3-year duration. Those looking at near-term metrics see it as the most expensive. That = opportunity. Be Patient.

 

It’s hard to justify that a company that is comping 25% and growing top line at 53% should trade off when it beats the quarter and guides up (albeit slightly) on the year. But welcome to the world of high-expectations stocks. Even though margins were better than guided, the fact is that they were down, delevering into ONLY 47% EPS growth (you should read that with an element of intended sarcasm).

 

People who shorted this name at 30x earnings earlier this year got steamrolled because the reality is that it’s rare to find such a powerful brand with such Blue Sky growth (though we think UA gives it a run for its money and is cheaper). If it’s at 30x, why not 40x? 50x? Clearly this is not the right metric. What’s the right metric? From a TAIL perspective (our duration spanning 3-yeasr or less) we like EV/market opportunity.

 

This is easier said than calculated. If you look at LULU’s share of the Yoga market as it stands today, it is going to look expensive on every metric imaginable, and it will appear by all means a short. You have to believe that the company can grow the category, and take the brand into areas that we do not know exist yet. That’s where the biggest money has been made in retail – when brands consistently  do things that you never conceived as being possible.

 

In looking at LULU’s REAL market, we need to look at total high end sports apparel. The US Athletic Apparel Market is about $40bn at retail. Even Nike has only 10% share of that market. It’s massively fragmented. If we isolate to price points above $50 – which is pretty much where LULU lives, then we’re still looking at a $13bn market. Outside of the US, we think that the size is closer to 1.5x the US. So let’s say $30bn in aggregate.

 

Is LULU’s EV/Sales of 8.8x seemingly colossal? Yes. It’s a notch above KORS’ (unjustified) 8.5x, Chipotle’s 5.2x, UA’s 3.3x, NKE’s 1.9x and RL’s 1.8x.  But relative to addressable market size, it’s trading at 0.33x vs NKE at 0.60x, and RL at 0.45. The only name cheaper than LULU is UA, which is sitting at 0.15x.  You probably only care about this if you’re looking to really invest in the company as opposed to renting the stock. And this valuation certainly won’t prevent LULU from selling off as guidance is messy and the chart jockeys out there start eyeing the $61.33 200-day moving average (not our process…by the way). But the bigger picture view as to the premise that valuing LULU differently is definitely context worth considering.                   

 

Of course, ‘addressable market size’ is only important if a company has the team, vision, plan, capital, and allocation process to hit its goals. On our durations…

  • TAIL (3-Years or Less): There was nothing we heard on today’s call that changes our view that LULU does, in fact, have what it takes to take disproportionate share of the addressable market.
  • TREND (3-Quarters or Less): While we really like the company’s focus on innovation to lead demand instead of meeting it, the simple fact that they are not doing this already deserves a minor in the penalty box. Capped top line growth this year as LULU shifts its model won’t help its growth multiple near-term, nor will reinvesting better yy product cost deltas into innovation and material. These moves are for all the right reasons, but the market likely won’t care. The saving grace is that LULU’s SIGMA move this quarter was definitely positive, which offers up some Gross Margin support next quarter.
  • TRADE (3-Weeks or Less): The quarter is already out of the bag, so near-term factors are minimal. With growth acceleration and margin improvement on hiatus, our sense is that – as great a growth story as it is -- chasing it here is premature.

 

LULU: Sales Inventory Gross Margin Analysis (SIGMA)

 

LULU:  Be Patient - LULU SIGMA

 

Accountability and Outlook: Here’s a look at LULU’s variance between guidance and actual, as well as deltas in guidance for the balance of the year:

 

LULU:  Be Patient - LULU Deltas

 

Highlights from the Call:

 

Product Innovations vs. Chasing Near Term Sales:

- Shift in Thinking relative to last year- focused on avoiding buying in bulk to simply meet demand

- There is a brand cost associated with over ordering what people want today vs. focusing on what they will NEED down the road – near term focus results in markdowns

- Revenue upside will be limited as a result until Q4 with more modest comps mid-year (guided Q2 +LDD vs. +16E)

- Product innovation includes capsules (completed swim and commuter and planning new warm-wear, gym, cross-fit) as well as fabric infusions and technical investments

 

E-Commerce:

- +178% in 1Q12 reaching ~13% of sales vs. 7% in 1Q11

- Growth largely due to boost from transition to ATG platform last year

- Increases expect to be somewhat muted for the rest of the year with slightly lower penetration vs. Q1 in Q2/3 but will pop in Q4

- Seeing similar life span for products online and in store- not in the business of doing exclusives online

- Men’s penetration much lower online vs in store (overall 12% of sales in Q1)

- Expected to be accretive to long term GM target of 55% as penetration grows

 

Cost/Pricing:

- 85%-90% of the 25% Q1 comp due to increase in units with only a minor boost from pricing

- Cost improvements (primarily due to raw materials vs. labor) expected to be offset by investments in innovation

- Pricing product introductions to market but seeing improved margins on product as they are improved/innovated

- Seeing a better balance of full priced selling with more normalized markdowns driven by better inventory balance

 

International:

- Just launched E-commerce site in Australia (May); planning country specific launch in UK and Hong Kong later this year

- Canadian comps running MDD while US stores comping mid 30s (aggregate +25% comp)

- Brand recognition in New Zealand/Australia ~3 years behind the US but stores on track & comping well

- Yoga market continues to grow in Asia

- See both Europe and Asia attractive though Asia is more compelling

 

Full Year Guidance:

- Guidance updated to reflect Q1 outperformance through relatively unchanged- weaker Canadian dollar expected to be offset by strong store productivity & e-commerce

- Revenue upside limited until Q4 due to restrained sales chasing near term and focus on innovation

- Gross Margin expectations maintained around goal of 55% (-188 bps) due to higher product costs partially offset by more normalized markdowns from balanced inventory levels as well as occupancy leverage

 

 


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