Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out?

Conclusion: Certainly, Italy isn’t Spain or Greece, but Italy does have a massive amount of debt, some €400 billion, that needs to be refinanced over the coming 12-months, which we believe is major pressure point for Italy.


Positions in Europe: Short EUR/USD (FXE)


With eyes focused on Spain’s recent €100B credit line to recapitalize its banks and investors digesting the results of the Greek elections over the weekend, we thought it important to contextualize the macroeconomic imbalances and risks in Italy. Italy has long been grouped squarely as a member of the PIIGS, and is a country we’ve persistently signaled as the largest potential risk threat in Europe, due in particular to the size of its economy, as the seventh largest global economy, the fourth largest in Europe, or the third largest in the Eurozone.


The main glaring risk threats that could propel Italy down the path to become Europe’s next domino is the size of country’s outstanding debt (at €1.9 Trillion or 120% of GDP); the mountain of debt it has to roll over in the next 12 months (nearly €400 Billion); and the market’s cracking credibility around PM Mario Monti’s ability to reduce the country’s fiscal footprint and spur growth.


Further, and as we show in the charts below, fear around Italy’s creditworthiness, which has recently been expressed by near cycle highs in sovereign CDS spreads and government yields on the 10YR, fall on some rather glaring negative fundamentals over recent quarters and years:  declining GDP over the last three consecutive quarters; a rising unemployment rate (especially among its youth); deterioration in labor market competitiveness; and increased competition for export goods to its key trading partners.  And while figures such as retail sales have held up relatively well (at least YTD compared to the Eurozone), we largely see the number supported by declines in the savings rate and the extreme growth in consumer credit, which we expect to revert to the mean; Service and Manufacturing PMI figures show a decidedly negative trend and we don't see the underperformance versus the Eurozone aggregate materially rebounding over the intermediate to longer term.  We also expect FDI to roll over in step with this contraction.


Specific to risk signals, Italy’s 10 year yield remains elevated around 6%, with 5 year CDS trading at 546bps, or just under Spain’s CDS at 614bps. We believe all this spells increased pressure on the Italian economy to grow over the next 3-5 years. Not only will Italy, like all EU members, see spillover effects from economic weakness throughout the region—as most countries main trading partners are fellow EU members—but the higher cost to service its debt will put more pressure on politicians to raise taxes to meet funding requirements, all of which will put further downside pressures on the overall economy.  And this comes at a time in which Monti’s credibility in parliament is shaking and foot power (strikes and riots) remains strong across a populous that is largely against austerity.


One savings grace to keep in mind when assessing Italy is that its public deficit stands at -3.9% of GDP as of last year compared to Spain’s at -8.9%. Italy may in fact be compliant with the Growth and Stability Pact limit of -3% by 2013, yet we think the road will be challenged.  When one combines the challenges of issuing austerity, the higher cost to service debt, and the spillover effects from struggling peer economies with a tighter credit environment, Italy is likely to shoot below its growth forecasts this year and next, while heightened default fears may call Eurocrats to act on a bailout that is greater than the capabilities of the existing bailout facilities. As we discuss in our conclusion, Eurobonds may be the only viable solution should the market’s fear of Italy’s sovereign and banking risks reach a precipice.  


By the Charts:

We think contextualizing the macroeconomic imbalances and risks in Italy can best be expressed through charts and select commentary:



Debt’s Drag - We begin by looking at Italy’s debt profile. At 120% (as a % of GDP) –the second highest in Europe behind Greece—its debt servicing load will equate to €400 Billion over the next 12 months alone.


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - CC. 1



Growth Slowing - As the data from Reinhart and Rogoff shows, when a country’s sovereign debt load exceeds 90% (of GDP) growth is dramatically impaired. We think the market will continue to punish Italy via higher servicing costs, and we do not expect the 10 year yield to dip materially below its current level of 6% over the intermediate term.  Italy has already seen three consecutive quarters of negative GDP. Over the last 10 years on an annualized basis, GDP has averaged 2%. We see Italy undershooting IMF growth forecasts of -1.8% in 2012 and -0.3% in 2013.


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - CC. 2



Debt Maturities High - Italy has an extremely aggressive debt schedule to roll over in the next 12 months. The remaining 2012 debt due (Principal + interest) = 70% of GDP. This compares to 49% for France; 45% for Spain; 23% for Germany in the remainder of 2012. On June 14th Italy sold its max target of €4.5 billion of 3-7-8 year bonds, however the 3 year averaged a yield of 5.3% vs 3.91% on May 14th, or a 36% premium in one month! We’d expect a similar trend of filling demand through higher yields into year-end should we not see any “bazooka” from Eurocrats. 


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - CC. 3



Too Big to Fail? - The answer to this question is unequivocally YES under the present bailout facilities. If we consider Italy’s outstanding debt and tack on another €272.7 Billion of borrowing from the ECB (chart below)—without even mentioning the potential bailout needs for Italian lenders crippled with sovereign holdings—it’s apparent that the remaining funds of the EFSF (around €200 Billion) plus the €500 Billion from the ESM that is expected to come online on July 1, 2012 (assuming, in particular that Germany’s Parliament signs off on it on June 29th), is undercapitalized to handle an Italian bailout, and fallout across the region from the failure Italy. [EFSF guarantees: Germany 29.07%; France 21.83%; Italy 19.18%; Spain 12.75%]   


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - cc. 4



Deficit Dual – Italy’s deficit stands at -3.9% of GDP as of 2011. This rate, compared to Spain’s -8.9%; Ireland’s -13.1%; Portugal’s -4.2%, and may be the country’s a saving grace.


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - CC. 5  2



Fiscal Consolidation – However, Italy’s path forward on fiscal consolidation has been anything but clear and orderly. The corruption and standstill of the Berlusconi government was obvious; yet the technocrat government of PM Mario Monti is also marked by disunion.  For one, while Monti has promised the market big fiscal cuts, they’ve yet to all be ratified by the Italian Parliament. Below we present the web of promises.  On June 15th the Italian government moved forward with a package worth €80 Billion to spur economic growth, including selling states assets and reducing public spending. 


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - cc. 6



Risky Profile - Italy is showing a similar risk profile to Spain. Here we chart the spread over German bunds.


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - CC. 7



Underperforming Growth - A major leading indicator for growth is derived from PMI surveys. As the two charts below indicate, Manufacturing and Services PMIs are well under the Eurozone averages and have been under the 50 line that divides expansion (above) and contraction (below) for more than 10 and 12 straight months, respectively. 


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - CC. 8



Labor Cost Inefficiencies - A major factor behind Italy’s slower growth profile is stagnation in its productivity, witnessed by higher unit labor casts, while wages, despite declines, have yet to turn negative. 


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - CC. 9



Industrial Production –Slowing and underperforming continued.  In a recent European Commission paper reviewing Italy, the report noted that stagnation in production is the key factor behind Italy’s loss of cost competitiveness since the euro adoption. 


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - CC. 10



Trade Balance Improvement – On a positive note, since early 2011 Italy has become less and less of a net importer. 


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - cc. 11



Exports Mismatch – However, export growth has also slowed, providing less of a benefit to the top line. 


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - cc. 12



Export Breakdown – Italy has high specialization in textiles, clothing, metal, and minerals, but due to the relatively small size of Italian firms, Italian exports to its main EU trading partners have found increased competition over the last decade.  Further, its increased share in non-EU countries (particularly Eastern Asia) has yet to reap full benefit.   [Main export partners: Germany = 13.1%; France = 11.6%; Spain = 5.3%] 


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - cc. 13



New car registrations - Yet another metric we follow. Here again, no surprise, underperformance vs the EU average. 


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - cc. 14



Smashed Piggy Banks - The Italian household savings rate moved from a high of 17.8% in mid 2002 down to 11.6% as of Q3 2011. The chart shows that Italians leveraged their savings in the upturn and in the downturn. The tapping of savings in the last three years demonstrates to pay off debt and the resilience of the Italian consumer to maintain previous spending levels. 


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - cc. 15



Consumer Credit Drying Up – As the pace of consumer credit has slowed, retail sales have still remained resilient, especially in the year-to-date period. Here Italy has shown a positive divergence over the Eurozone since the start of the year based on a 3 month average compared to the previous year.  We chalk this up the sticky levels of consumer credit, and continued draining on savings.  


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - cc. 16



Unemployment Hooking - Another grave dynamic is the underemployment across Italian youths at 39%. While short of the 50.2% for Spanish youth, combine “a lost generation” with Italy’s demographic headwinds of an aging population (near oldest in Europe) and you have a cocktail that puts great pressure on social services, and the debt and deficit loads in the years ahead. 


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - cc. 17



Square Stagflation - While we expect inflation to moderate into the back half of 2012, sticky stagflation (and negative real yields) has been a theme across much of the globe as energy prices remain elevated in the weak dollar environment. 


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - cc. 18



Risk Lines in the Sand - From a risk perspective, we turn to both government yields and CDS spreads. Both are tracking hockey stick moves. 


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - cc. 19



Spreads Pressure Banks - Finally, we show that Italy’s 10s-2s spread is not helping the banks and is another indication of the dampened growth outlook by investors. We’ve shown the timing of the two 3 month LTROS, in December ’11 and February ’12, respectively as reference points. Interestingly, while the first LTRO gave a boost to the spread, the market to a negative reaction the increased liquidity from the 2nd LTRO, as the insolvency of banks became the focus and it was not clear that “the injection” was actually being circulated throughout the economy, witnessed by extremely high levels of euros being parked at the ECB’s overnight deposit facility.  


Italy Isn’t Greece or Spain, But Is Italy Next To Be Bailed Out? - cc. 20



It’s no great secret that risk has shifted quite precipitously from peripheral to peripheral over the course of the last two years (with the longest stay in Greece) in what has been called Europe’s sovereign debt and banking crisis. However, when we discuss the bailout needs of Italy, the largest economy of the PIIGS, we’re talking about risks (disruptions) to continental and global economies that inevitably lead one to the question: Is Italy too big to bail?


Over the last years we’ve seen Eurocrats, under the support of Troika, coming to aid the sovereigns at every step: Greece, Ireland, Portugal, and now Spain. Unfortunately, we think Italy is far too large to rescue. In short, we believe the only way out over the intermediate term is the issuance of Eurobonds, a position the Germans are against, and rightfully so in our eyes for they do not wish to take on Italy’s credit risk.


After all, why would a German give an Italian use of his credit card carte blanche?


Clearly, Europe’s back is against a wall, as member countries are unlikely to post more capital upfront for bailout facilities (and here the IMF may have to take on a much larger role outside of its mandate). But what we fear, and the market may not understand, is that there is no “bazooka”, no panacea, to cure Europe’s collective sovereign and banking risks in one shot. Surely, the threat of an Italian default leads us down a road of even higher uncertainty on Europe’s go-forward, all of which portends that the downside in European capital markets is not fully priced in. 


Could the next two years look like the last two years? We think the answer could be a qualified yes, however making such calls is reckless given that the direction of Europe changes on a nearly daily basis.  For now, the fate of Italy, along with the rest of Europe, will be wrapped in the hands of Eurocrats. The main topics on the table include: a Fiscal Compact; a Pan-European Deposit Insurance; Eurobonds; a European Redemption Fund; the terms of passage of the ESM (and EFSF); and a European Financial Transactions Tax. There’s obviously a lot on the table; we do believe that Eurocrats wish to maintain the exiting Eurozone fabric. We’ll be monitoring the developments at the Eurogroup and EcoFin meeting on June 20-21 and the EU Summit in Brussels on June 28-29 to take our cues.



Matthew Hedrick

Senior Analyst

WEN: Who sold out now?

When a founder leaves his or her company, people begin to raise eyebrows. And here at Hedgeye, eyebrows have been raised over Wendy’s. In short, the sons of Jim Near, who helped turnaround the company by pushing the Dave Thomas image in the late 1980s through the 1990s, sold their 30 restaurants in Texas back to the company for $19.8 million.


Why is this a concern? Because Wendy’s has been struggling with its image for some time now. The Near family was essentially the closest thing to the Thomas family that Wendy’s had having been involved with WEN since 1974. Now that they’ve sold out, no one knows what lies ahead for the company. The five year performance chart of Wendy’s’ stock price is indicative as to why no one wants to stick around.


WEN: Who sold out now? - WEN


  • Marriott’s 1-yr forward NA RevPAR guidance has been directionally accurate but its forecasting error is high
  • MAR's 12M forward RevPAR projections overshot in down markets and have historically been conservative during recoveries
  • 2012 initial guidance has already followed the historical pattern of being too conservative as MAR has already raised the mid-point of their guidance range from 6% to 7%
  • The guidance that MAR gave last night for 2012-2014 (+6-8%) seems aggressive on the surface but it's not out of line with growth during last recovery period (2004-2006) which averaged just under 8% 


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BBBY: Straight Outta Comps

Bed Bath and Beyond (BBBY) is a company that is doing well in terms of same store sales (SSS). Our estimates indicate that BBBY comps (increase in SSS) will come in at +6.5% versus the consensus expectation of +4.1% when the company reports Wednesday. Essentially, it looks like BBBY will once again beat the Street.


However, there is one major problem for BBBY and that is e-commerce. Considering that BBBY and have 93% product overlap and the love online shoppers have for Amazon, online growth remains a concern. BBBY’s inability to penetrate the online sector will surely haunt the company as it reports in future quarters.


BBBY: Straight Outta Comps - BBBY compschart



Let us be clear: we have not been bullish on JCP for some time now despite calls from “legendary investor” Bill Ackman that this company has legs. With the departure of President and Head of Merchandising Michael Francis, the credibility of this company is shot to pieces.


Francis was only at the company for 9 months and took a nice paycheck along with it – not a bad trade. Any morale that was left in this company has left the building. Confidence in the company has eroded both publicly and privately. After all, last we checked, no one is looking to purchase sweater vests. CEO Ron Johnson’s turnaround plan is progressing, but this is a huge setback.


Hedgeye Retail Sector Head Brian McGough has outlined four issues with the company that are plaguing JCP:


Make no mistake, this is an unmitigated disaster, for four reasons. 1) Francis just hired a merchandising organization. Now he's out. What does that tell the troops as it relates to organizational stability? 2) He probably did not get canned because 'he was smoking plan.' 3) What happened to a long-term plan? 4) ) Most notably, this blows Johnson's credibility, which was already hanging by a thread after how poorly he handled the 1Q release, and sold stock before the event.”


For those that can wait out the next five years to witness Johnson’s almighty plan, we salute you. We implore you to watch the above video when McGough appeared on CNBC back in December of 2011 and essentially schooled the Street on what was really going on behind the scenes at JCP. 


There may be one other restaurant analyst covering Wendy’s that attended an analyst meeting held by the late Jim Near. 




Mr. Near worked at Wendy’s for twenty-one years and was appointed COO by the founder of Wendy’s, Dave Thomas, in 1986 to help turn the then-ailing restaurant chain around.  At that point, the restaurant was suffering from failed attempts to launch breakfast as well as declining morale within the Wendy’s system.  In 1989, Near was named CEO of Wendy’s and the legacy of his six-year tenure was encouraging Dave Thomas to become the face of the company; advertisements featuring Thomas became highly successful.  Near and Thomas died in 1996 and 2002, respectively, and the company has struggled to replace the considerable impact they both had, individually, on the business.



Getting Out


On June 11, 2012, Wendy’s International, Inc. completed the purchase of 30 Wendy’s restaurants in the Austin, Texas area from David and Jason Near, two sons of Jim Near, for $19.8 million in cash.  Wendy’s International agreed to lease the real estate, buildings and improvements related to 23 of the acquired restaurants from the Sellers and to assume the leasehold interests in the real estate, buildings and improvements related to the other 7 acquired restaurants.


The Near family has been involved with Wendy’s since 1974 when Jim Near purchased his first Wendy’s franchise.  There could be numerous reasons why the family is selling but we believe that it could be a sign of the times given the family’s deep ties to the chain.  Beyond Jim Near’s intimate involvement in the evolution of the company, his son David Near was named as Chief Operations Officer of the Wendy’s brand in 2006 by then-CEO and President Kerrii Anderson.





Part of the Wendy’s turnaround efforts will be centered on the company buying back stores from underperforming franchisees who cannot afford to carry out the reimaging program.  We see it as a possible negative that one of the most significant families in the company’s history is selling out.  It’s certainly a headline that the folks in Dublin would like to have avoided.



Howard Penney

Managing Director


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