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Interesting Industrial Insights - (Also Known As Late Afternoon Alliteration)

Conclusion: Our industrials team has highlighted some key inflections in Chinese rebar pricing, real defense spending and reinvestment by mining companies.

 

As many of you know, Jay Van Sciver recently joined Hedgeye as our Industrials Sector Head and launched a few weeks ago with his first key call being a negative view of the U.S. Airline Industry.  This call is obviously particularly timely with Goldman’s bearish initiation on the Airlines today. 

 

As part of their research product mix, our industrials team is publishing a daily “Industrials Indicator” note that synthesizes and emphasizes the key data points and events in the global industrials sector.  We thought a number of their recent call outs were also particularly relevant to the global macro space, so we have highlighted them below. (If you’d like to trial our industrial team’s work and/or speak to Jay email .)

 

1. Chinese Rebar Prices – For those that aren’t aware, rebar is reinforcement steel that is used in concrete and masonry structures.  Rebar is a critical component of any large scale construction projects – like highway bridges, parking garages, and so on.  Demand in 2012 has been anemic for rebar in China, which is reflected in the declining prices that are reflected in the chart below.

 

China produces 50% of the world’s steel, so to the extent we can consider rebar a decent proxy for steel demand in China, and we believe we can, this is somewhat ominous for the global steel market as China may look to increase steel exports in order to stabilize prices.  As well, the rebar price data is negative for iron ore, as China is the world’s largest importer of iron ore, which is the key steel input.

 

On a much higher level of course, steel and iron ore demand by China is a reflection of economic activity in China.  As economic activity softens, naturally demand for these products will soften and lead to price declines, as we are seeing the rebar market.

 

Interesting Industrial Insights - (Also Known As Late Afternoon Alliteration) - 1

 

2.The Mining Investment Cycle – Caterpillar (CAT) is probably the best proxy for the mining investment cycle since the start of the Millennium.  Over that time period, CAT has seen a stock price increase of 393% versus mere 16.9% for the SP500.  So, the mining boom has been good for CAT and its peers.  The question of course is how sustainable is this cycle going forward.

 

In the chart below, our industrials team looks at the capital expenditures of large miners versus their depreciation and amortization.  A company’s cap-ex should not greatly exceed the company’s depreciation and amortization unless growth is expected.  As the chart outlines, this was the case for much of the 1990s.  This isn’t totally surprising in commodity type industries where reinvestment occurs at the marginal cost. So, in theory, increased capital investment leads to higher production, lower prices, and decreased capital investment in the future.

 

Conversely, in the last ten years capital expenditures in the global mining sector have dramatically outpaced D&A expenditures, and on an accelerating basis.  In fact, in 2011 cap-ex exceeded D&A by an astounding $50 billion across the sector.   Clearly, commodity prices are in some form of an easy money-induced bubble, albeit increased demand from emerging growth economies is also a factor supporting the story underpinning market prices, but as our industrials team wrote:

 

“Mature, cyclical industries (mining is among the most mature) do not support high levels of growth investment in the long-run.”

 

Interesting Industrial Insights - (Also Known As Late Afternoon Alliteration) - 2

 

3. Real Defense Spending – The U.S.’s federal budgetary issues are really no surprise to anyone that does macro research or focuses on the U.S. Treasury market (or actually reads a newspaper).  Currently, the United States has ~104% debt-to-GDP, is running a deficit-to-GDP of ~9%, and ~40% of all deficit spending comes from borrowing.  To narrow the budget, spending needs to decline, with defense spending being a major focus.

 

In the chart below, we highlight real defense spending going back to 1962.  Two key points jump out from the chart.  First, defense is a highly cyclical industry.  There are periods of high real spending, typically during wars, and then spending declines following the war or with a change in administration. Secondly, defense spending on a real basis is at an almost all time high in the United States. Given the real level of spending and massive budgetary issues in the United States, it is difficult to envision a scenario in which the defense industry sees broad top line growth.  In fact, future years of declining top line are more likely.  In effect, it is an industry in which the “value trap” risk is alive and well – i.e. cheap stocks getting cheaper.

 

Interesting Industrial Insights - (Also Known As Late Afternoon Alliteration) - 3

 

Daryl G. Jones

Director of Research


MONETARY EASING EX GROWTH = CHEAP GETS CHEAPER

CONCLUSION: Our analysis of recent trends across a handful of key growth economies (using China, South Korea and Brazil as proxies in this note; there are many others) lends credence to our view that growth across Asia and Latin America continue to slow. More importantly, we are of the view that economic trends across each region will continue to deteriorate over the intermediate term – a conclusion strongly supported by our quantitative risk management models.


Q: What do Chinese equities, Korean equities and Brazilian equities all have in common?

 

A: Bearish Formations; cheap gets cheaper when growth is slowing.

 

MONETARY EASING EX GROWTH = CHEAP GETS CHEAPER - 1

 

MONETARY EASING EX GROWTH = CHEAP GETS CHEAPER - 2

 

MONETARY EASING EX GROWTH = CHEAP GETS CHEAPER - 3

 

With the latest reported growth generally slowing in each of those economies – on both a high-frequency and low-frequency basis – it’s fair to say that the recent rate cut cycles we’ve seen across China (-50bps), Korea (-25bps) and Brazil (-450bps) are merely indications that policymakers in each country are cognizant of the aforementioned trends and risks to growth globally (Europe; 112th  Congress).

 

Chinese growth – slowing:

 

MONETARY EASING EX GROWTH = CHEAP GETS CHEAPER - 4

 

MONETARY EASING EX GROWTH = CHEAP GETS CHEAPER - 5

 

South Korean growth – slowing:

 

MONETARY EASING EX GROWTH = CHEAP GETS CHEAPER - 6

 

MONETARY EASING EX GROWTH = CHEAP GETS CHEAPER - 7

 

Brazilian growth – slowing:

 

MONETARY EASING EX GROWTH = CHEAP GETS CHEAPER - 8

 

MONETARY EASING EX GROWTH = CHEAP GETS CHEAPER - 9

 

We highlight the following statements from policymakers from each country as supportive of our view that the negative trend in global economic growth has not turned the corner:

 

“Stabilizing economic growth is not only a pressing priority for China now, it is also a long-term arduous task.”

-Chinese Premier Wen Jiabao (JUL 11, 2012)

 

“The South Korean economy is growing less than expected and growth will be less than potential for a considerable time.”

-JUL 12, 2012 Bank of Korea Monetary Policy Statement

 

“The recovery of Brazil’s economy has been slower than anticipated… The world economy will have an impact that is either neutral or disinflationary on Brazilian consumer prices.”

-JUL 11, 2012 Central Bank of Brazil Monetary Policy Statement

 

As an aside, the Bank of Korea’s rate cut was a surprise to us as well as the market (KOSPI closed down -2.2% on the day; KRW/USD -0.9%). We titled our JUN 28 note: “WAIT ON SOUTH KOREA” as a coherent message that it wasn’t the right time to increase one’s exposure to the KOSPI Index. Judging by the market response since then (including today’s sell-off), that appears to have been a prescient call. More importantly, the “wait” has been extended in our view, as this new monetary easing cycle takes the relatively strong KRW story – a key component of our formerly-bullish, TREND-duration fundamental bias – off of the table for now.

 

Looking ahead, the next major catalysts on the growth front out of each country are as follows:

 

  • China:
    • TONIGHT: Chinese 2Q12 Real GDP, JUN Industrial Production, JUN Fixed Assets Investment and JUN Retail Sales data will be realized. Consensus expectations for China’s 2Q Real GDP growth have come in from +8.3% at the start of MAY to +7.7%, creating ample room for headline upside surprise risk. We are inclined to fade any/all associated rallies that do not eclipse TRADE resistance on the Shanghai Composite. Chinese policymakers have been guiding towards a negative slope of domestic economic growth since 1Q10; listen to them.
    • JUL 31: JUL Manufacturing PMI
    • AUG 2: JUL Services PMI
  • Korea:
    • JUL 25: 2Q12 Real GDP
    • JUL 29: AUG Business Sentiment Survey (Manufacturing and Services)
    • JUL 31: JUL Manufacturing PMI
  • Brazil:
    • AUG 1: JUN Industrial Production, JUN Trade Data and JUL Manufacturing PMI
    • AUG 3: JUL Services PMI
    • AUG 16: JUN Retail Sales
    • AUG 31: 2Q12 Real GDP; We’ve been calling for a bottom here and will look to confirm if there’s anything in the number that will cause us to revise down our 2H12 outlook for Brazilian economic growth.

 

All told, our analysis of recent trends across a handful of key growth economies (using China, South Korea and Brazil as proxies in this note; there are many others) lends credence to our view that growth across Asia and Latin America continue to slow. More importantly, we are of the view that economic trends across each region will continue to deteriorate over the intermediate term – a conclusion strongly supported by our quantitative risk management models.

 

Anecdotally speaking, in a 30-minute call earlier this morning with one of our sharper clients on the international equity investment front, neither he nor I could come up with a solid bull case for any of the major-to-mid-major economies across Asia or Latin America – the consensus “engines of global growth” per the overwhelming majority of sell-side economists and corporate CFOs. Either we’ve become contrarian indicators or the GROWTH/INFLATION/POLICY dynamics simply aren’t there to support an incremental investment(s) in either region at the current juncture. You know where we stand on that.

 

Darius Dale

Senior Analyst


Vegas Sucks

Sorry, but there’s really no other way to put it. We’ve been pretty bearish on MGM Resorts (MGM) with our estimates on the company’s numbers coming in way below the Street consensus. We may need to revise downward after the latest May data on the Vegas Strip. Basically, Vegas is performing poorly (and that’s putting it lightly) and even offering one of our managing directors a $24 hotel room at Excalibur. If that doesn’t scream of desperation, then let us know what does.

 

 

Vegas Sucks - VEGAS 3mo

 

 

The Strip’s gross gaming revenue fell 18% year over year in May. That’s a huge drop. Baccarat is struggling and slots ruled in the month of May. It’s looking pitiful out there and MGM is going to have a rough quarter.

 

Here’s the story, by the numbers:

 

•             Slot handle fell 7% off of a relatively easy comp

•             Slot win lost 3% despite higher than normal hold

•             June hold may be below normal due to end of month on Saturday

•             Baccarat  (bacc) win fell 47%, on hold of 8.2% (TTM: 12.5%); baccarat volume fell 22%

•             Table win ex bacc fell 18% on below average hold of 10.3%;

•             Table volume ex bacc grew 2%

•             Hold-adjusted total win was -11%


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.33%
  • SHORT SIGNALS 78.51%

HedgeyeRetail Visual: FNP Levels For Top Long

 

On our Q3 Themes earlier today, we highlighted FNP as our top long here. We think it’s a gift at this price. With the stock below $9.50, it equates to Kate Spade trading below 11x 2013 EBITDA alone.


The chief concerns weighing on the stock here is how Juicy is tracking and the slowdown in global luxury. Juicy is a 2H story and Fall product just hit shelves this week so a bit premature perhaps, but keep in mind that Juicy accounts for less than 10% of EBIT - it does not make or break this story. As for the global slowdown, it’s reality. But this is a massively underappreciated budding global growth story that can buck the Macro backdrop.


With $1 in earnings power and a sub-$10 stock, we can’t find a better risk/reward setup in retail.

 

HedgeyeRetail Visual: FNP Levels For Top Long - FNP TTT

 

 


Industrial Indicator: CAT & Mining Investment Bubble

Chart of the Day

  • Current levels of capital investment by miners is at bubble-like levels
  • If D&A represents an estimate of maintenance capital spending, current capital spending is heavily skewed toward increasing output
  • Mature, cyclical industries (mining is among the most mature) do not support high levels of growth investment in the long-run

 Industrial Indicator: CAT & Mining Investment Bubble - Mining Capital Spending

  • Caterpillar has outperformed, with a millennium-start to date total return of 393% vs. 16.9% for the S&P 500
  • Caterpillar’s success is heavily dependent on this explosion of investment by miners.

 Industrial Indicator: CAT & Mining Investment Bubble - cat rel spx

 

Upcoming Events:  Truck OEM Black Book

 

Industrial Indicator: CAT & Mining Investment Bubble - perf 71212


Notes From Our Q3 Retail Call

Q3 RETAIL THEMES:

Not a lot of buys in retail. On the short side: Macy's, Carters. On the long side: Fifth and Pacific (formerly Liz Claiborne), Nike.

 

JCPenney: Let’s beat a dead horse, shall we? Consensus is finally in: JCP is not performing well. Spain is 13% GDP relative to Eurozone, JCP is that to retail. Their impact on the industry is huge. Their strategy is to taken an item that sold last year for $100 and mark it to $25. They get consumers to appreciate that and want them to come to their store all the time. They need great product and aren’t there yet.

 

 

Notes From Our Q3 Retail Call - Q3RETAIL slide1

 

 

Over the past 5 years during the recession, the consumer sought out more discounts. Moms used to go into Macys and bring a ton of coupons and wait for an item to get marked down. That’s hard to ween people off of.

 

What brands are JCP putting out there for you to buy? Which are stuck by the bathrooms?

 

Why can’t JCP go bankrupt? It can. Who cares about Bill Ackman and what he thinks – remember Borders?

 

Kohl’s: Going head to head with JCP. Over past two months, getting creamed by competition. Turnaround needed on operating asset turns. The stock is cheap on next year’s estimates? Not a chance. It can go lower.

 

Dollar stores: Very negative outlook. (pg 20) Relative to the S&P 500, massive earnings growth in 2010. We don’t think comps will grow and the same goes for new stores –do we really need more dollar stores?

 

 

Notes From Our Q3 Retail Call - Q3RETAIL slide3

 

 

Food stamps also have a huge impact on margins for dollar stores. A ton of people are on food stamps and the surge in those receiving food stamps during the recession definitely helped dollar stores grow. Since January 2011, we’ve had salaries decline year over year. Consumption is up, however. We need more spending, less saving. We are well below consensus on earnings announcements going forward. Big drop in stock prices coming.

 

Capital intensity: Retail at sky high valuations. High returns relative to other industries. Peak margins. Stable earnings. We’re about 8 quarters into a decline in capital reinvestment period yet sales are up at a healthy level. If we’re coming off an investment period and we want to harvest, a few thing need to happen: the consumer needs to be strong or the company needs to put capital into capital expenditures (capex), which will hurt margins. Or they can have their top line rollover.

 

We like companies investing in all the right areas. Those who want to grow e-commerce sales who want to grow 10%-50% online because eventually, that’s where everyone’s going to go.

 

Notes From Our Q3 Retail Call - Q3RETAIL slide2

 


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