• run with the bulls

    get your first month

    of hedgeye free


FL: Going The Distance

SECTOR: Hedgeye Retail (@HedgeyeRetail)




Foot Locker has had its share of near-term problems as it struggled with sales and its European business. We’ve been bullish on the long-term TAIL duration of this stock as the company works its way around the European business climate and focuses on growth. We got bullish on the company before it reported Q1 earnings based on strength in domestic trends and came in above our consensus estimate.


With Q2, we expect the company to put aside any issues that have been plaguing it for some time, paving the way for a better second half of 2012. With domestic trends coming in well above expectations, we think that FL has the gusto to beat Q2 earnings estimates. Also, coming out of Q2, FL’s sales/inventory spread improved on the margin which is a positive for gross margins. Coupled with the top-line coming in ahead of expectations should result in materially higher EPS numbers this year and next. Basically, the best is yet to come for FL. Have patience with this one.



FL: Going The Distance  - FL growthchart

SBUX: The $100 Million Question

HEDGEYE ANALYST: Howard Penney, Managing Director of Restaurants (@HedgeyeHWP)




The recent acquisition of La Boulange Bakery by Starbucks (SBUX) raises some questions. First and foremost is the price of $100 million for a bakery chain that CEO Howard Schultz justifies through a growth strategy. The goal is to expand the La Boulange footprint by distributing its goods throughout Starbucks stores and making it a nationally known name. Bringing French baked goods to the masses is a strategy that has a high likelihood of working out, similar to how Americans have embraced Italian espresso.


SBUX: The $100 Million Question - SBUX bread



But the concern we have at the moment is distribution. In a note written by Maury Rubin’s City Bakery Daily, he outlines the issues related to the logistics of shipping and distributing freshly baked goods:


Many years ago, when Starbucks first moved into New York City, they asked if City Bakery would consider being a supplier of baked goods. I was completely interested, until I learned the required delivery schedule: orders needed to ship to a central location by 6pm to be sold the next day. In our bakery, then as now, we bake every thirty minutes all morning long. The goal is to have pastry on our counter that was in the oven within the hour when bought. For Starbucks, we would need to have baked 15-18 hours before the fact.”


Howard Schultz believes that the way La Boulange handles its logistics justifies the $100 million price tag. In reality, it will probably require further capital expenditures to keep the quality associated with La Boulange products after they are shipped since it is highly unlikely existing Starbucks stores will be retrofitted with the ability to produce baked goods.


BWLD: Shorting Wings

HEDGEYE ANALYST: Howard Penney, Managing Director of Restaurants (@HedgeyeHWP)




Buffalo Wild Wings has been on our short list for two weeks now. There are many drivers behind our bearish call, but a big one is the price of chicken wings. Chicken wings are simple, cheap and have great margins for restaurants. How do you think your neighborhood bar is able to get away with 25 cent wing night?


BWLD: Shorting Wings - BWLD Chickenwing



Right now, the price of a pound of chicken wings is about $1.80 when it should be more like $1.40 a pound based on historical data. The price of corn, which is what chickens eat, has skyrocketed as of late. As the cost to feed chickens increases, so will the price of the chickens eating said corn and being sliced and diced into delicious wings. We’d like to highlight a quote from our weekly Commodity Chartbook that lays out the situation behind the scenes with the buyers and suppliers of wings.


“It seems that the peak in wing price inflation may be in but, as positive as that sounds for BWLD, it may be a slow grind lower; wing prices are stubbornly hanging in north of $1.80 and management at food processing companies that we talk to are suggesting that rebalancing the relationship between chicken wing supply and demand may take some time.”

real-time alerts

real edge in real-time

This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.


Once upon a time someone remarked “bigger is better.” A lot of people would kindly disagree with the originator of that statement. Since 2007, the Federal Reserve and the European Central Bank (ECB) have been in a race of sorts to add as many assets to their balance sheet as humanly possible. Looking at the chart of the Federal Reserve’s balance sheet fluctuations below, you can see the original “bazooka” of $800 million that former Treasury Secretary Hank Paulson used in mid-2008. 


RACE TO THE BOTTOM: The Fed vs The ECB - FED balancesheet1



From there, when we have gone one direction: up. When things go wrong and the US doesn’t like it, we slap it on the Fed’s balance sheet. And despite constant asset sales, including the Maiden Lane portfolios that we built from the sewers of AIG, we have yet to reduce the Fed’s balance sheet in earnest.


The same goes for the ECB, save for the huge 2008 spike. It has been a gradual climb into 2011 upon which everyone else in the world realized that Greece, Spain, Italy, etc. were all corrupt, out of money and needed bailouts. So now the ECB has a bigger balance sheet from the Fed and Italy has yet to official default or come begging for a bailout yet. Expect the pain to keep coming as the balance sheet continues to rise at the ECB.



RACE TO THE BOTTOM: The Fed vs The ECB - ECB balancesheet



If we accept that the future direction of the size of the central bank’s balance sheet is a decent proxy for either more hawkish or more dovish monetary policy, then there are a couple of scenarios:


1. QE3 is imminent – In effect, the currency market is pricing in incremental quantitative easing from the Federal Reserve.  Based on the most recent commentary from the Federal Reserve, this seems to be an unlikely scenario in  the intermediate term as they did nothing last week but extend Operation Twist.  In effect, this action is merely equivalent to not tightening.


2. QE3 is not imminent and intervention in Europe continues – If the monetization of debt / lender of last resort continues to be an ECB led activity, the balance sheet of the ECB should continue to expand.  Given the situation in the European banking system, this seems a very likely scenario.  In fact, as we’ve highlighted, Italy and Italian banks are the next potential shoes to fall in Europe with massive pending maturities and accelerating credit default swaps.  It is highly likely that the ECB will continue to have to step up and support its banking system.


Welcome to 2012: the year of the bailout. 


Initial Claims Are Actually Rising

Initial claims fell 1k last week to 386k. Incorporating the 5k upward revision to the prior week's data, claims fell 6k. Rolling claims fell 0.75k WoW to 387k. On a non-seasonally adjusted basis, claims rose 4k. NSA rolling claims are improving at a rate of ~8% YoY. 


Our Thoughts

There is a serial upward revision bias to this data driven by its calculation methodology, but upward revisions normally average 2-3k per week. The prior week's 5k upward revision paints a misleading picture of improving claims. In reality, claims continue to drift higher. This is consistent with our thesis regarding seasonal distortions in the data. We expect seasonally adjusted claims to rise through August before reversing.
















The 2-10 Spread

The 2-10 spread tightened 3 bps versus last week to 131 bps as of yesterday.  The ten-year bond yield fell 3 bps to 162 bps. 






Financial Subsector Performance

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






Joshua Steiner, CFA


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. 


Cheap Talk

This note was originally published at 8am on June 14, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“My own view is that he will speak eloquently, but that words are cheap, and that the record of an individual is the basis upon which you determine whether they should continue to hold on to their job.”

-Presidential candidate Mitt Romney


Since starting Hedgeye almost four years ago, many of our readers have a hard time discerning the political leanings of the firm.  At times we’ve been accused of being Democrats and in other instances we’ve been accused of being Republicans.   In reality, while individuals at Hedgeye have personal political leanings, and we encourage them to get involved in the process, as analysts we are completely objective about politics.  Our job is to analyze the economic policies of politicians and come up with a view of their ultimate impact on asset classes and prices.


I highlight the quote above not because I necessarily agree with Romney, but rather because I want to highlight that the political debate is going to only accelerate in the coming months heading into the nominating conventions and ultimately the general election in November.  Romney’s statement above is very accurate in one sense, this election, as they usually are, will be about the performance of the incumbent and the economy under the incumbent.


Later today President Obama will be giving a speech that will be the beginning of his campaign’s attempt at taking back the economic debate.  Based on early previews, Obama is likely to focus less on the last three years, a time in which he will claim he shored up the economy, and more on the future prospects for the U.S. economy.  As it relates to the future, Obama will attempt to juxtapose Romney, a wealthy private equity investor, with middle class Americans.   The insinuation being that Romney’s policies will only enrich the wealthy, while Obama will help the middle class.


The challenge that Obama faces, especially if he uses only rhetoric and has no new tangible plans, is that the middle class has very much struggled under his Presidency.   The two statistics that the Romney camp repeatedly cites, which are largely accurate, are that no net new jobs have been created under Obama and that median household incomes have declined somewhere in the range of $4,000 per annum under Obama.


In the Chart of the Day, we highlight our proprietary Hedgeye Election Indicator (HEI).  The HEI is driven by real time economic price data that correlates closely with polls and ultimately establishes a probability of an Obama re-election.  In line with Romney’s statement that talk is cheap as it relates to economic performance, the HEI bears this out as it has declined to its lowest level in five months at 54%.  As the economy goes, so goes Obama’s re-election chances.


In Europe this morning, we are getting increasing evidence that not only is talk cheap, but action itself is cheap.  Specifically, Spanish 10-year yields touched 7.0% overnight.  This is a 91 basis point increase from Monday morning’s bailout lows.  It seems the attempt at containing European sovereign debt issues by adding more debt, without long term structural reform, is actually now being perceived as mere talk by the market, even if the Eurocrats see it as action.


Later today we will be publishing a note on Italy.  As much of the media attention is rightfully focused on the pressure points of Spain and Greece, Italy is the third largest economy in the Eurozone , so a much bigger problem than Spain, and its yields and CDS are starting to trade in line with Spain at 6.3% on the 10-year and 554 basis points on 5-year CDS.  With a 120% debt-to-GDP, it should be no surprise that adding more debt in Europe to bail out Spain is not a positive catalyst for Italy.


The unintended consequences of failed European bailouts are not only being seen in Italy’s sovereign debt markets, but also broadly in European companies.  This morning the Swiss banks are getting punished.  Credit Suisse is down -8.0% after the Swiss National Bank said they need a “marked increase” in capital this year to prepare for possible escalation of Euro-zone risks.  The Swiss National Bank also recommended that UBS boost capital. 


On a more micro level, our Restaurant team led by Howard Penney will be hosting a call on the restaurant industry’s franchise model, and its latent risks, with restaurant finance expert John Hamburger (yes, that is his real name). The crux of the debate is as follows:


“The interests of franchisees and franchisors do not always align; in fact, in today’s environment of tight capital supply for small businesses and increasing competitiveness among restaurant companies, they can sometimes diverge.  Through franchising, franchisors gain more stable cash flow, protection from swings in variable costs, and lower expenses.  In turn, franchisees, ideally, gain operational expertise from companies and brand recognition while assuming much of the operational risk of the business.  Most of the decision-making authority pertaining to the business remains with the company and, in difficult business conditions, this can be a source of contention.


As franchisors seek to grow royalty fees, decisions made by corporate restaurant executives in the past few years have tended to focus on promotional strategies and capital-intensive store and process alterations.  Of course, as long as the consumer and financing environments cooperate, this behavior may not meaningfully impact the franchisee’s bottom line.  However, with the backdrop of a fragile economy, volatile commodity costs, tight access to capital, and increasing labor costs, there is a potential for friction.  The addition of any controversial business decisions that magnify franchisees’ difficulties all but guarantees disharmony between management and the franchise community.  Examples over the past few years are numerous, from Kentucky Grilled Chicken at KFC to bun toasters at Wendy’s to 99 cent double cheeseburgers at Burger King.”


So, in effect are the perceived benefits to the franchisee really just talk?  If you are an institutional investors and would like to join the call and trial our restaurant vertical please email sales@hedgeye.com.


As it relates to talk and action, I will leave you with one last quote from President Roosevelt:


“The man who really counts in the world is the doer, not the mere critic-the man who actually does the work, even if roughly and imperfectly, not the man who only talks or writes about how it ought to be done.”




Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1586-1633, $96.11-98.85, $81.91-82.46, $1.24-1.26, and 1305-1322, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Cheap Talk - Chart of the Day


Cheap Talk - Virtual Portfolio

the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.