When Nike's futures are up, inventories are trending down AND it's coming off the worst Gross Margin hit in 10-years, it's tough to build a bearish margin story over the next year.
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.
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.
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.
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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?
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.”
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.
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.
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.
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
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