HedgeyeRetail Visual: CRI Coincidence?

CRI pulled its disclosure on wholesale pricing trends this quarter for “competitive reasons.” We don’t buy it – It’s no coincidence that they’ve added opacity here just as they comp against last year’s price increases…


CRI remains one of our top shorts following this morning’s print where it showed early signs of tail weakness.


See our quick take and follow up reports for additional detail:


"CRI: First Chink in the Armor"


"CRI: 2Q Report Card"


HedgeyeRetail Visual: CRI Coincidence? - CRI COTD


CONCLUSION: We continue to expect that global economic growth will be skewed to the downside over the intermediate term – both relative to current readings and also relative to currently-elevated expectations. Moreover, we would view the inflationary impact of any incremental LSAP program out of the Federal Reserve as a negative shock to reported growth figures globally – particularly when considering how weak the world economy is currently.


THEMES AT PLAY: Growth Slowing’s Slope, Deflating the Inflation [of Bernanke’s Bubbles], and King Dollar via The Last War: Fed Fighting.


If you’ve been following our highly-differentiated Global Macro research process over the last four years, you’ll know that we rarely anchor on company forecasts for guidance on economic growth. At best, we use them to vet our internal analysis of said trends. The logic behind applying such a limited weight to corporate executive guidance in our process is primarily three-fold: 

  • Like traditional sell-side economists, corporate executives carry a persistent optimistic bias, which typically leaves them reacting to – rather than preparing for – economic downturns;
  • Like traditional sell-side economists, corporate executives tend to streamline current trends into perpetuity when forecasting, often limiting their ability to appropriately risk manage any increase in the probability of exogenous events; and
  • Ironically, both entities (sell-side economists and corporate executives) rely on each other’s work in true circular reference nature when developing their own “independent” forecasts. 

As previously mentioned, we do occasionally find opportunities to vet our existing conclusions with company results and/or guidance. In this example, we focus on Caterpillar Inc. (CAT), which just reported a positive 11.31% surprise in 2Q EPS ($2.54 vs. $2.28). CEO Doug Oberhelman was particularly pleased with the results (all-time highs in revenues ($17.374B) and profits ($2.54/share)), as indicated in the press release: 

  • Reaction to Quarter: “I am very pleased with Caterpillar's record-breaking performance in the second quarter.”
  • Operating Guidance: “We have narrowed the outlook range for sales and revenues and raised the outlook for profit.  The sales and revenues outlook range for 2012 is now $68 to $70 billion with profit of about $9.60 per share at the middle of the sales and revenues outlook range.  The previous outlook for sales and revenues was a range of $68 to $72 billion with profit of about $9.50 per share at the middle of the sales and revenues outlook range.”
  • Economic Guidance: "While we're expecting a record year in 2012, we understand the world is facing economic challenges, and if it becomes necessary, we are prepared to act quickly as we did in late 2008 and 2009.  While we're prepared, the good news is, this doesn't feel like 2008.  Interest rates are low, central banks are prepared to inject more liquidity if needed, and housing is coming off lows, not a peak, and seems to be improving… While we will not hesitate to act if we need to, we believe that actions needed for better world economic growth for the future have already begun… I am cautiously optimistic about the world economy in 2013, very positive on the long-term prospects for global growth and excited about the role Caterpillar will play in making that growth happen.” 

We on the Hedgeye Macro Team “feel” far less optimistic about their quarter (top line growth slowed; margins compressed) and the slope of global growth over the intermediate-term TREND. As the table below shows (sourced from our 3Q12 Macro Themes slide deck; email us for an updated copy), we remain well below consensus growth estimates for a number of key countries and economic blocs globally.








Jumping back to CAT specifically, we offer the following analysis from our new Industrials ace, Jay Van Sciver, who recently launched coverage of that sector for Hedgeye with his hyper-contrarian bearish thesis on the airlines industry. To the extent you’d like to see more of his work and/or connect with Jay live, please email

  • “Despite the move up in CAT today, which we view as short covering driven, weak backlog trends support recent underperformance in the shares.
  • Backlogs declined for first time since 3Q 2009, as the company drew down backlogs in today’s “beat.” 
  • As shown below, months of backlog are highly correlated with CAT’s relative performance.
  • Implied orders (estimated as change in backlogs plus revenue) declined 3.0% y-o-y after posting 12.2% growth y-o-y in 1Q2012.  That is a significant deceleration.
  • Something has to give: orders will need to rebound, production will have to be cut, or backlogs will be drawn down.  The current macro data does not suggest a near-term order rebound to us.
  • CAT has been one of the primary beneficiaries of what we view as unsustainably high levels of resource capital investment.  Slowing activity in China is a risk to mining capital spending.
  • Though CAT has an excellent competitive position and a strong franchise, we believe that the shares are overvalued from a cyclically adjusted perspective. 
  • While the months of backlog is still relatively high, historically that has presented an exit opportunity.
  • Implied orders rates now trail revenue, as indicated by backlog declines.” 




In looking at their results from my coverage purview (Asia and Latin America), we highlight a couple key negative comments on China that may be flying under the radar to some extent: 

  • “Construction sales declined in the Asia/Pacific region, where a large decrease in China more than offset increases in other Asia/Pacific countries.
  • “The Chinese government has accelerated policy easing, with its second consecutive interest rate cut in July 2012.  Infrastructure spending is running behind the government's target, and we expect the government will introduce supplemental investment programs.
  • Sales in China were also weak during the second quarter of 2012 and were well below the second quarter of 2011, which was a strong quarter for sales in China.” 
  • “As we began 2012, our expectations for sales in China were higher, and we built substantial new machine inventory in the first quarter to support what is usually a seasonally strong quarter.  First-quarter sales were lower than expected, and we ended the first quarter with higher inventory in China.  We developed and are executing a plan for an orderly reduction of China inventory that includes lower production, merchandising programs to improve sales and the export of machines from China to other parts of the world.”
  • We remain very positive on long-term industry growth in China and our strategy to grow our business there.  Our plans for the remainder of 2012 reflect an orderly ramp down of production that considers our entire supply chain in China.  Given the current low rate of sales and the production ramp down, it will likely take the rest of 2012 to reduce inventory to appropriate levels. 

We highlight the following red flags: 

  1. The large YoY decrease in sales to China “more than offset increases in other Asia/Pacific countries”, suggesting to us that A) demand for industrial machinery in China is outright contracting and B) China, being the economic behemoth that it has become is large enough to offset sales growth from the broader region;
  2. They, like many sell-side prognosticators (that may or may not service CAT from a banking/advisory perspective), expect China to “introduce supplemental investment programs” (i.e. fiscal stimulus and/or a state-directed lending program). We remain on the other side of this view with respect to the TRADE and TREND durations (see compendium on China below);
  3. Despite “remain[ing] very positive on long-term industry growth in China” they plan an “orderly ramp down of production” with respect to their “entire supply chain in China” though year-end in hopes of repackaging that product and delivering it to other parts of the world. It remains to be seen if the region can accelerate their demand for industrial equipment with Chinese growth continuing to slow. Given China’s growing role in the industrial supply chain as an end-consumer of raw materials, we’ll take the other side of that bet… 

All told, CAT’s results and guidance on China rhymes directly with what we’ve been saying for months now. Moreover, CAT is not the first major industrial company to come out and talk down their Chinese growth expectations in recent weeks:


Sany Heavy Industry Co., China’s biggest maker of excavators, lowered its sales forecast for the equipment as slowing economic growth and government curbs on property market sap demand. Excavator sales may increase 10 percent this year, slower than a previous target of 40 percent, Vice Chairman Xiang Wenbo said in a July 11 interview in Changsha, Hunan province, where the company is based. Sany will still outperform the industry, which may see a fall in demand, he said. 

-JUL 13 via Bloomberg Professional


We continue to see signs of slowing growth in Fixed Investment in China (46.2% of Chinese GDP), which being exposed by the accelerated decline in rebar prices, as indicated in the chart below.




Moreover, we can’t stress enough our counter-consensus stance on the outlook for Chinese policy, in that we believe the State Council is no hurry to introduce a meaningful fiscal stimulus package or a large-scale state-directed lending spree over the intermediate term. In fact, we wouldn’t be surprised if they were inclined to tighten the screws on the property market further (pending a potential second-consecutive monthly acceleration in property prices here in JUL). Refer to the following notes for our extended thoughts on the Chinese economy at this critical juncture: 

  • CHINA’S INCREMENTAL GROWTH SLOWDOWN CONFIRMED (MAY 23): While Deflating the Inflation remains a bullish catalyst for the Chinese economy, the lag between this event and the turn in both the reported growth data and growth expectations may have just increased. As such, we are of the view that waiting and watching for clarity is the best strategy in the immediate term for China.
    • As an aside, China’s Shanghai Composite Index remains in a Bearish Formation and is down -9.6% since we put out this initial bearish piece on the Chinese economy in this latest cycle. That is far and away the largest decline throughout the region over that duration and is vastly underperforming the regional median gain of +0.5% (same duration).
  • CHINA’S RATE CUT IS LIKELY A BAD SIGN OF WHAT LIES AHEAD (JUN 7): We don’t see the early innings of this Chinese rate cut cycle as a signal to get bullish on China’s economy or equity market at the current juncture. Moreover, we do not find it prudent for investors to increase their asset allocation exposure to commodities here.
  • CHINESE GROWTH: STICKING TO THE CENTRAL PLAN (JUL 13): We maintain conviction in our view that Chinese economic growth is not poised to meaningfully inflect over the intermediate term. Furthermore, we can’t stress how much the late-year transition in leadership or the growing official realization that the 2008-09 stimulus package and central plan (i.e. state-directed lending) contributed heavily to a rapid and potentially unhealthy expansion in credit (+96.6% since the end of 2008) may slow Chinese policymakers’ fiscal/regulatory response [if any] to an incremental deterioration in economic growth. Remember, Chinese banks have yet to see a material deterioration in credit quality (the industry-wide NPL ratio is at a measly 0.9%), so it’s not unreasonable to believe that Chinese policymakers could be saving their “bullets” for a potentially more worthy cause than a purposefully-engineered slowdown in Real GDP growth to +10bps above their official 2012 “target” of +7.5% (announced in MAR).
  • PONDERING CHINESE GROWTH PART II (JUL 17): Contrary to consensus speculation, we are of the view that Chinese policymakers are likely not readying a stimulus package to be announced and administered over the intermediate term that would be substantial enough to meaningfully inflect the slope of Chinese economic growth. As such, it would be prudent to fade any incremental Chinese stimulus rallies for the time being. 


Taking a 30,000 foot view of our active macro themes, a bevy of key economic and financial market data points across the globe have brought forth renewed concerns about the slope of global growth. A few of the more noteworthy recent callouts include: 

  • The US Treasury 10s-2s spread, a historically reliable leading indicator for the slope of US economic growth, has narrowed in recent weeks to 119bps wide – the tightest spread since JAN ’08!
  • Chinese, Japanese, Hong Kong, Thai, and Vietnamese Export growth figures each slowed in JUN (to +11.3% YoY, -2.3% YoY, -4.8% YoY, -2.5% YoY and +15.2% YoY, respectively).
  • In the Eurozone, the composite Manufacturing PMI ticked down in JUN to 44.1 from 45.1 (a 3yr-low) and the composite ZEW Economic Expectations Index dropped to -22.3 (the lowest since JAN). 



We could continue listing data points, but the point isn’t to belabor what has already been reported; rather, we continue to expect that global economic growth will be skewed to the downside over the intermediate term – both relative to current readings and also relative to currently-elevated expectations.


Moreover, we would view the inflationary impact of any incremental LSAP program out of the Federal Reserve as a negative shock to reported growth figures globally – particularly when considering how weak the world economy is currently. Catalysts on this front include: 

  • AUG 1: Federal Reserve FOMC Rate Decision;
  • AUG 23-25: The annual central bankers confab in Jackson Hole; and/or
  • SEP 13: Federal Reserve FOMC Rate Decision. 

We conclude this piece with how we started this note – highlighting CAT’s cheery guidance, which anchors heavily on aggressive exceptions that the world’s central planners can and will “save the day” in the near term. Coincidentally, their current outlook in on this topic rhymes a great deal with their mid-2008 outlook – the last time they were forecasting record full-year Revenues and EPS while accelerating CapEx on hopeful expectations of incremental Polices to Inflate

  • 2Q12 Press Release: “Brazil started easing monetary policy with lower interest rates in late 2011, and we are now seeing improvement in our business there.  China has started taking action, and we expect that further monetary easing and investment initiatives in China should help economic growth in late 2012 and 2013… It will likely take some time for the Eurozone to fix its problems, but we expect that monetary easing by the European Central Bank, a commitment to resolve debt issues and more focus on economic growth should help stabilize the situation and lead to better prospects in the future… Eventually, we expect the U.S. Federal Reserve will resume expanding its balance sheet…”
  • 2Q08 Press Release: “Eventually central banks [in developed countries] will return to cutting interest rates… Many developing countries are experiencing increased inflation, and some have tightened economic policies. However, most counties have moved cautiously, and policies remain expansive. We expect strength growth in construction to continue… Strong sales outside North America are being driven by solid economic growth in the developing world, continued investment in infrastructure throughout much of the world and commodity prices for metals, minerals and energy levels that encourage our customers to invest.” 



The moral of this story is rather simple: don’t get caught offsides by buying into corporate hope.


Darius Dale

Senior Analyst


Here is some follow up to our earlier IGT note


  • Earnings
    • We think the low end of the range is likely, so $0.31-0.32 vs. guidance of $0.31-0.37
    • Management continues to defend the quality of the quarter with no acknowledgement that it was one of their worst in a long time.  They are adamant they will hit their annual guidance.
  • Stock buyback  
    • We still don’t have a good explanation on the terrible timing other than that it took a while for the Board to approve and perhaps the quarter’s results were not obvious at that point
      • The buyback was a Board decision and they only meet 4-6x a year so the timing was a bit disconnected with the quarter.  They still view the stock as an attractive value in the long term. 
      • We still think they needed the accretion.
  • North American product sales
    • Since IGT only has 2 buckets in product sales, used units fall into the box sale bucket and that’s where they have always been.  However, typically there are only 100-200 used unit sales per quarter vs the 1,000 used units recognized this quarter. 
    • The used units were old participation products that IGT had in its inventory so the ASP was low, but since they were already either entirely or mostly depreciated, the margin was high
    • The 500 deferrals in NA were primarily related to IGT’s Baton Rouge shipment.  Only 1/3 of their 400+ units were recognized in the quarter.
  • International product sales
    • The 500 deferral units were related to Peru and Argentina
      • In Peru, IGT has a new distributor that they have starting shipping to last quarter but haven’t been able to recognize the units yet
      • In Argentina, the new import restrictions put in place by the government in February 2012 have caused considerable delays for IGT’s products to clear customs.  There is currently a WTO suit against Argentina’s import-substitution policy and other restrictive measures put in place.
    • IGT still expects double-digit international shipment growth for the year
      • In 2011, they recognized 14,700 units.  YTD, they have recognized 10,300 units.  This implies F4Q recognition of at least 5,870 units.  Needless to say we are very skeptical.
      • Growth to come from APAC and Latin America
      • Expectation of recognizing the 900 units that have been deferred over these last 2 quarters should help
  • IGT expects to ship 3,000 units to Canada next quarter
    • If they do, 2012 shipments will represent 44% of their current awards from Quebec (7,200) and Atlantic Lottery (1,612)
    • There are still 3 other provinces to award replacements
  • North American non-box sales did not include recognition of the Revel system
    • IGT hopes to recognize revenues from Revel in FQ4

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Favorable tax adjustments make for tough comparisons at Blue Chip


  • For the last several quarters, BYD’s Midwest/South segment EBITDA was boosted by a property tax reversal stemming from a change in the assessed value of Blue Chip
  • BYD included the tax benefit in its adjusted EBITDA but wasn’t explicit about its inclusion in the earnings release - of course until now when lapping it made for a tough comparison
  • In their Q2 2011 release and conference call, they attributed the strong margins to good cost controls



CRI: 2Q Report Card


Conclusion: Strength in Carters' wholesale drove the beat this quarter – and we’ll give them that, but that alone isn’t enough to support a stock with such lofty expectations. Importantly, with little delineation and differentiation of product by channel, stronger wholesale performance is actually competing against CRI’s own retail. In fact, this has been reflected by the decline in new store productivity. With Carter’s retail accounting for nearly 2/3 of 2H revenue growth and ~50% of CRI’s top-line in F13, the company is increasingly reliant on increasing the volume of less productive stores. It should come as no surprise then that store growth has continued to increase over each of the past two years at +14% and +17% in F11 and F12 respectively up from +10% in F10. This is simply not sustainable. Assuming CRI maintains this rate of growth, it would hit its ~600 store opportunity threshold by F14 – then what? We think it will have blown up it's wholesale business long before then -- there's your risk. 

Lastly, the timing of management choosing to go dark on AUR disclosure for “competitive reasons” headed into 2H just smells bad. With product cost pressures now turning to a tailwind down -10% in 2H, the company will have to continue to post solid gross margin results for EPS to meet or exceed current guidance. The opacity in AUR disclosure does little to increase confidence in that regard.

All in, we’re reducing our 2H EPS numbers by $0.05 to $1.45 primarily reflecting higher SG&A spend (e-commerce and marketing) offsetting stronger trends at wholesale. At the time of writing this note, consensus was at $1.84 for 2H and $2.67 in F12 and $3.38 in F13. We’re at $2.40 and $2.95 respectively. If our estimates prove correct, this name has another 25-40% downside from these levels.


CRI: 2Q Report Card - CRI S


Accountability and Outlook: Here’s a look at CRI’s variance between guidance and actual, as well as the outlook for 2H vs. expectations:


CRI: 2Q Report Card - CRI Table


Highlights from the Call:

Comp trends:

  • +1% in each of the brands
  • Carters:
    • April: -3.4%
    • May +2.2%
    • June +3.9%
  • Oshkosh:
    • April: -1.9%
    • May: +6.
    • June: Roughly flat
  • Expect a 2 point shift into Q1 primarily due to Easter shift and unseasonably warm temperatures
  • Current comp trends tracking to plan
  • Not seeing a traffic problem and of the 33 remodels to date, see sales upside due to traffic

AUR Trends:

  • Pulling back on disclosure for competitive reasons
  • "But we continue to make good progress on pricing"

Carter's Wholesale:

  • No customers have seen any major issues with their business resulting in any shifts in demand
  • 4 out of top 5 customers had growth in excess of 10% in 1H
  • Continue to receive positive feedback
  • Have moved Christmas up and could potential see goods in stores within a month
  • Outlook for the business is good

2H Guidance:

  • Didn’t feel the need to increase guidance every 3 months, but have a good growth plan in sales and earnings for the year 
  • First half was far better than envisioned
  • 2Q is the least significant quarter of the year with 2/3 of profitability in the remainder of the year
  • Contniued decline in off price sales will impact 2H wholesale results


  • Second full year of doing business online
  • 1mm square foot DC just north of Atlanta
  • Product is flowing in- wont be shipping out until later this year
  • Margin benefit will be significant- pay a healthy premium to third party provider
  • Carters e-commerce would reach near a 10% operating margin

Direct Sourcing:

  • Previously worked with Li and Fung as a sourcing agent
  • Goal is to be complete over a 5 yr timeframe
  • Canada currently does direct sourcing and the margins are higher
  • Have hired a very talented team over the past 5 years to head up the intiaitive

Product cost outlook:

  • Outlook is good and continues to be good
  • Fall cost for both brands are down about 10% after being up 20% last fall
  • Still not back to normalized levels from 2 years ago
  • Seeing visibility in spring 2013 which could be down 10%
  • Level of clearance sales is down meaningfully which is benefitting margins
  • Off price sales might be half of what they were last year

SG&A Outlook:

  • Directionally, SG&A will rise as a percentage of sales
  • As the business evolves the GM will improve but SG&A as a % of sales will increase
  • Largely driven by Canadian ops, DTC, e-commerce, etc.

Channel Acquisition:

  • Establishing a sourcing team in Hong Kong to support international partners
  • Opening a third party logistics center in Hong Kong
  • Now product will go from Asia to Hong Kong without going to Georgia first
  • Earning impact is immaterial


  • Girls product offering is working which had been the weaker component over the years
  • Gender split is 50/50 for OshKosh; girls is currently running at a slightly higher percentage with girls outperforming

Gross Margin:

  • Majority of upside was driven by Carter's business
  • Child of mine has been a  good margin performer
  • Started to ship fall product and costs are down about 10%
  • Inventory position is dramatically better than a year ago
  • Will continue to see a mix shift benefit
  • At wholesale, customers are focused on maintaining strong pricing via product offering, brand presentation and ease of shopping

Canadian Comps:

  • Cobranded comps +5%, nameplate comps -12%
  • Experienced a significant pull forward in demand into Q1
  • Overall first half was down about 1.5% due largely to outerwear and warmer weather


  • Planning for pricing to be flattish in 2H
  • Spring 2013 pricing will be similar to Spring 2012 pricing

14% pretax margin goal:

  • Current business is much different relative to 2010
  • Expect it will take 4 or 5 years to get back there


  • OshKosh bookings ex off price down slightly


  • Down slightly in the quarter
  • But the quality was more significant
  • Conversion is up at record highs

OshKosh Mall initiative:

  • Looking for the best real estate- not avoiding malls where product is already being sold



MCD: What’s In A Dollar (Menu)?

McDonald’s is shifting around its menu in an attempt to wean customers on to its Extra Value Menu. At first glance, a shift in menu pricing may not seem like a huge deal for a company the size of McDonald’s. But the move could leave investors hungry for returns as inflation costs and a general disdain for higher prices being passed on to consumers hit the stock price.


McDonald’s (MCD) reported its second quarter earnings this week, noting that earnings had declined 4.5% due to FX risk, namely a stronger US dollar. The company produced a profit of $1.35 billion, or $1.32 per share, compared with a profit of $1.41 billion at $1.35 a share during the same time last year. This was a disappointment for investors to say the least.


So as we look at what lies ahead for MCD in Q3, there’s a very important shift occurring that we believe could negatively impact earnings down the road. That shift is the pricing structure of the menu at McDonald’s. Like many other fast food restaurants, McDonald’s has had a “Dollar Menu” for some time now. Consumers are used to it being there and can get behind something that costs a buck. In this era of inflation and higher commodity prices, however, it remains unprofitable to operate the Dollar Menu.



MCD: What’s In A Dollar (Menu)? - CPI home away from home



In an effort to compromise, MCD went and created the “Extra Value Menu,” which includes the following : 20-piece chicken McNuggets, double cheeseburgers, chicken snack wraps, Angus snack wraps, medium iced coffees and snack-sized McFlurries, plus up to four regional options.


This falls in line with the overall change in pricing structure of the McDonald’s menu, which now consists of four different tiers (combos are excluded): Premium: $4.50-$5.50+ / Core: $3.50-$4.50 / Extra Value Menu : $1.20-$3.50+ / Dollar Menu .

In summary, McDonald’s has taken more costly items like burgers and soft drinks off the Dollar Menu and shifted them to the new Extra Value Menu, replacing them with cookies and ice cream. Believe it or not, there’s a lot of risk in taking away cheap burgers and fries from customers, as Hedgeye Managing Director of Restaurants Howard Penney explained in a note from earlier this year:


We see this as a big risk for MCD.  If customer preference is to have the drink and fries as part of the dollar menu then there is a risk that this change negatively impacts customer satisfaction.  The company told us that a “mini-combo meal” offering may bundle the fries, burger, and drink but a decision has not been made on that yet.  Still, ordering the $1 items individually is being taken off the table.”


Americans are still reeling from the effects of inflation and are opting for items on the cheaper menus instead of the $6-8 combo meals on the core menu. That puts a squeeze on McDonald’s profits and is a factor that cannot be ignored come this fall.  With the company taking price in the U.S. of 3% versus last year, in line with the BLS’s Food Away from Home CPI measure and below Food at Home CPI, customers may be less impressed by McDonald’s value proposition that in years past.

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