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FDO: Idea Alert

Keith shorted FDO on today’s up-move – central planning isn’t quite the elixir of life should we see $5 at the pump. We remain bearish on the dollar store space; we don’t need Operating Margins to contract in order to build a short case but simply for the prior drivers of expansion to fade.

 

Last month, we had the pleasure of attending FDO’s analyst day where management left investors with something to be desired offering no change to its long term guidance which was initially provided back at the October 2010 analyst day calling for MSD comps, Operating Margin expansion and double digit EPS growth. Importantly however, with operating margins sitting around ~7.5% over the past 2 years and running flat to potentially down this year, it was notable that there was no clarification on the “operating margin expansion” guidance. When asked in the Q&A to elaborate on what that meant in terms of the magnitude of growth and timeline for expansion, CFO Mary Winston declined to provide additional detail and simply reiterated the qualitative drivers of improved profitability.

 

Over the past three years, the spread between FDO margins and DG margins, despite both reaching their respective peak levels, has expanded sequentially with FDO now running nearly 300bps below DG. With no additional insight into what levels of operating margins can truly be achieved over the next few years, what does “margin expansion” really mean for FDO as we sit 1 quarter away from a potential year of compression? We definitely think that FDO is a safer place to be on the short side than DG.

 

Here are some additional thoughts on our thesis:

  • Operating Margins have expanded from ~5.7% in 2007 to 7.5% in 2011. At the same time, while a drag on margins, an increase in consumables penetration (from 59% to 67% in 2011 and 68% YTD) has been a traffic tailwind. As an offset, FDO has drastically increased its private label offering from 4% to 25% today and while management expects to enhance its private label offering further, the rate of growth has slowed drastically. FDO does expect to double its private label offering by 2015 via an expanded assortment (which implies penetration just below 40% relative to 25% today), though we’re not so sure private label can continue to increase as a percent of sales as quickly as management expects especially considering the primary category to grow in is consumables.
  • Sadly, during the 5 years where margin expansion drove earnings, the percent of Americans on food stamps increased from 9% peaking at 15% last year. Should consumables penetration increase further without a correlated growth in consumers using food stamps as well as private label penetration, gross profitability will continue to deteriorate and strain earnings growth.
  • Capital expenditures are expected to run around 7% of sales this year following 3.7%, 2.5% and 2% over the last 3 years respectively due to reaccelerated store growth, an entire chain refresh set to be completed in 2015 and expanded DC capacity. These investments may not be timely given the deceleration in private label penetration and top line growth coming in below both internal and external expectations.
  • Finally, management highlighted at its investor day that digital would not become a meaningful part of the business in the foreseeable future. While the consumables business doesn’t necessarily cater to an online model as seamlessly as most other brick and mortar models, the missed opportunity for increased digital penetration to drive margin expansion through a lower cost structure is important nonetheless.

 

We continue to feel that with operating margins at peak, tailwinds fading, the inability to grow online and management teams offering no new insight into the drivers of future earnings growth, the dollar store space is not a safe place to be.

 

FDO: Idea Alert - FDO TTT


EMPLOYMENT DATA SUGGESTS NEAR-TERM STRENGTH FOR QSR

Employment data released this morning by the Bureau of Labor Statistics are a near-term positive for the restaurant industry, particularly Quick Service, as employment trends in Leisure & Hospitality held up in July.

 

Employment by Age

 

Employment growth among the 20-24 YOA cohort, which has been highlighted by several QSR management teams as an important source of demand, accelerated to 3.7% year-over-year in July from 3.4% in June.  The 45-64 YOA and 55-64 YOA cohorts saw sequential decelerations in their respective employment growth rates.  These demographics are important for casual dining and we will continue to monitor employment growth for these age groups as it has been a significant tailwind for casual dining over the last year.  Our cautious stance on casual dining sales trends, initiated in April, has been largely correct but the stocks traded with more resilience than we anticipated (led by Brinker).  We continue to like Brinker over the long-term tail as it takes share from the competition but macro concerns give us pause over the near term trade duration.

 

EMPLOYMENT DATA SUGGESTS NEAR-TERM STRENGTH FOR QSR - Employment by Age

 

 

Industry Hiring


The Leisure & Hospitality employment data, which leads the narrower food service data by one month, suggests that employment growth in the food service industry may stabilize in July.  On a sequential basis, the Leisure & Hospitality employment data registered a month-over-month gain of 27k (second chart below).  This is positive news for the restaurant industry, at least over the near-term.  Employment growth within the limited service industry saw a sequential acceleration in June while full service employment growth decelerated from May to June.

 

Sequential Moves

  • Leisure & Hospitality: Employment growth at +2.16% in July, up 7 bps versus June
  • Limited Service: Employment growth at 3.5% in June, up 42 bps versus May
  • Full Service: Employment growth at 2.6% in June, down 12 bps versus May

 

EMPLOYMENT DATA SUGGESTS NEAR-TERM STRENGTH FOR QSR - restaurant employment

 

EMPLOYMENT DATA SUGGESTS NEAR-TERM STRENGTH FOR QSR - leisure   hospitality

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 

 

 


ANALYZING THE JOBS REPORT THROUGH THE LENS OF THE GENERAL ELECTION: JULY 2012 EDITION

CONCLUSION: The JUL ’12 US Employment Report leaves much to be desired in the way of supporting the bullish narrative of US economic strength and continues to affirm our view that President Obama’s odds of being reelected may actually be lower than they appear at face value. That said, however, there are enough pockets of strength in this report to potentially keep Bernanke on the sidelines in the SEPT FOMC meeting.

 

To say the JUL US Employment Report was a bit squirrely would be an understatement. Both the Headline Non-Farm Payrolls number (+163k MoM) and Private Payrolls number (+172k MoM) came in well in excess of consensus expectations, though both saw downward revisions to the prior month (+64k from +80k and +73k from +84k, respectively). Given the increasingly squirrely nature of US government agency economic reporting and the simple fact that this is an election year where the economy is arguably the #1 issue among registered voters, we are not shocked to see the BLS’s now-infamous Birth/Death Model – a purely statistical forecast based largely upon prior leverage cycle highs in US employment trends – produced +52k “jobs” MoM in JUL ’12, which is good for the highest JUL total on record (data going back to 2000).

 

All that said, when you net out the effects of the NSA B/D Adjustment from the NSA NFP MoM figure and analyze that data series on a YoY basis to offset seasonality distortions, you actually end up with a faster rate of true job growth than we saw last month (+51k from -85k). That is a positive. Another positive that seems to be overlooked is the fact that the JUL Seasonal Adjustment effect of +1,367 Payrolls MoM is very much in line with historical trends, which suggest that fears of inflated Payrolls gains bandied about in various media reports (which may or may not have been written with the goal of prompting the Fed to unleash further QE) may prove to have been quite overblown.

 

ANALYZING THE JOBS REPORT THROUGH THE LENS OF THE GENERAL ELECTION: JULY 2012 EDITION - 1

 

ANALYZING THE JOBS REPORT THROUGH THE LENS OF THE GENERAL ELECTION: JULY 2012 EDITION - 2

 

Unfortunately for President Obama’s odds of being reelected – which appear to be making another lower-high at 56.8% on our proprietary Hedgeye Election Indicator – the positives stop there: 

  • The headline Unemployment Rate SA ticked up +10bps MoM to 8.3%;
  • The “actual” Unemployment Rate SA (based upon our calculations using a 10yr average Labor Force Participation Rate) ticked up +20bps MoM to 11.2%;
  • The percentage of the working age population that is unemployed ticked up +20bps MoM to 41.6%; and
  • The percentage of the working age population not in the labor force ticked up to +10bps MoM to 36.3% as more and more Americans simply give up on looking for work – which will become increasingly hard to find if US corporations continue to implement cost-cutting programs in order to boost earnings, shareholder returns and executive compensation (see PG earnings results for more details). Refer to our JUL 20 note titled, “HAVE US CORPORATE EARNINGS GONE TOO FAR?” for our detailed analysis on this controversial topic. On the aforementioned metric, the US economy is a mere 10bps shy of the all-time high of 36.4% during the Obama presidency (APR ’12). 

ANALYZING THE JOBS REPORT THROUGH THE LENS OF THE GENERAL ELECTION: JULY 2012 EDITION - HEI

 

In the four charts below, we compare Obama’s “score” on the US Labor Market to the previous three two-term presidents. The Strong Dollar presidents (Reagan and Bush) are represented by the solid line plots; the Weak Dollar presidents are represented by the dotted line plots:

 

ANALYZING THE JOBS REPORT THROUGH THE LENS OF THE GENERAL ELECTION: JULY 2012 EDITION - 3

 

ANALYZING THE JOBS REPORT THROUGH THE LENS OF THE GENERAL ELECTION: JULY 2012 EDITION - 4

 

ANALYZING THE JOBS REPORT THROUGH THE LENS OF THE GENERAL ELECTION: JULY 2012 EDITION - 5

 

ANALYZING THE JOBS REPORT THROUGH THE LENS OF THE GENERAL ELECTION: JULY 2012 EDITION - 6

 

All told, the JUL ’12 US Employment Report leaves much to be desired in the way of supporting the bullish narrative of US economic strength and continues to affirm our view that President Obama’s odds of being reelected may actually be lower than they appear at face value. That said, however, there are enough pockets of strength in this report to potentially keep Bernanke on the sidelines in the SEPT FOMC meeting.

 

Darius Dale

Senior Analyst


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 80.64%
  • SHORT SIGNALS 78.57%

EQUAL AND OPPOSITE REACTIONS

EQUAL AND OPPOSITE REACTIONS

 

 

CLIENT TALKING POINTS

 

HOLLER AT THE DOLLAR

We really like the US dollar, it’s true. We’re of the belief that the commodity bubble that currently exists (have you checked our grains or precious metals lately?) will pop and prices will come down as the dollar rallies. Currently, we’re long the USD Index but that could soon change as we manage the risk and the range. Bernanke can only keep the illusion up for so long before someone pulls back the curtain and reveals the reality of this dog and pony show.

 

 

LET’S ALL MAKE STUFF UP

The absurdity associated with today’s media is at an all time high. Yesterday, the news that the ECB wasn’t going to do anything hit at 7:45am. But the media said “Well, let’s wait until Draghi says something at 8:30!” And we did and guess what? He didn’t do anything new. Report the news and don’t worry about the outcomes. That should be the media’s job. We didn’t see a lot of people discussing the intraday reversal of Spanish equities, which were up 2%, then closed down -5.2%. Sheesh.                           

 

 

FALL OF THE ROUNDTABLE

We did an analysis of what’s going on at Knight Capital Group (KCG) with our Managing Director of Financials Josh Steiner and CEO Keith McCullough. We highly recommend taking the time to listen to the call, which examines Knight’s fate and counterparty risk on Wall Street.

 

URL: http://app.hedgeye.com/media/513

 

 

_______________________________________________________

 

ASSET ALLOCATION

 

 Cash:          DOWN                        U.S. Equities:    UP

 

 Int'l Equities:   Flat                        Commodities:    UP

                                  

 Fixed Income:  UP                         Int'l Currencies: Flat

 

 

 

_______________________________________________________

 

TOP LONG IDEAS

 

JACK IN THE BOX (JACK)

This company is transitioning from cash burn to $75mm annual free cash flow generation thanks to completion of a reimaging program and refranchising of JIB units. Qdoba is the leverage; a maturing and growing store base will bring higher margins. We see 8.5% upside over the next 6-9 months.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG            

 

FIFTH & PACIFIC COMPANIES (FNP)

The former Liz Claiborne (LIZ) is on the path to prosperity. There’s a fantastic growth story with FNP. The Kate Spade brand is growing at an almost unprecedented clip. Save for Juicy Couture, the company has brands performing strongly throughout its entire portfolio. We’re bullish on FNP for all three durations: TRADE, TREND and TAIL.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG

 

LIFEPOINT HOSPITALS (LPNT)

We continue to expect outpatient utilization to pick up in 2H12 alongside stabilization in acuity with ortho and cardiac/ICD volumes supporting both pricing and inpatient admissions growth. Births should serve as a tailwind into year-end, recent and prospective acquisitions offer some upside to 2012/13 numbers and the in place repo offers some earnings flexibility. With European and Asian growth slowing, we like targeted domestic revenue exposure as well.

  • TRADE:  NEUTRAL
  • TREND:  LONG
  • TAIL:      LONG

  

_______________________________________________________

 

THREE FOR THE ROAD

 

TWEET OF THE DAY

“RAJOY: `I TAKE NOTE' OF ECB WORDS, OTHER EU STATES SHOULD TOO. The Spanish 10 Year especially” -@zerohedge

 

 

QUOTE OF THE DAY

“Honesty is a good thing, but it is not profitable to its possessor unless it is kept under control.” – Don Marquis

 

 

STAT OF THE DAY

$3.09 billion. The amount of the loss recorded by the Royal Bank of Scotland (RBS) in the first half of the year.

 


GOOD KNIGHT AND BAD VIBES

KNIGHT: The Roundtable Falls

Knight Capital Group, one of the big players in retail brokerage order flow and market making on the Street, lost $440 million this week and is scrambling for funding after a “technology screw up” that caused the firm to screw up quotes for NYSE-listed stocks. We don’t believe that they will be able to get more than $60-80 million in funding and will be forced to go into bankruptcy or reorganization of some sort.

 

Knight’s counterparties are no longer routing order flow or using algos with the company. The entire Street has shunned them. This has really hurt confidence with investors, similar to the events of the flash crash and MF Global. The Financials SPDR (XLF), has been down significantly after big events like the aforementioned, and this will likely happen.

 

There will most likely be some kind of hearings in Washington or some kind of investigation. The Knight event will no doubt be used as fodder for regulation, particularly the Volcker Rule. We’ve been bearish on Morgan Stanley for some time and question how Knight will affect them. Counterparty risk affects the firm quite a bit but there hasn’t been a huge flight from the firm.

 


The Other Side

This note was originally published at 8am on July 20, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“If one side of every transaction is wrong, we have to ponder why we should think it’s not us.”

-Howard Marks

 

Yesterday afternoon, as I was flying back to New York from California, I was watching the market go against me by -0.12% (I’m short the SP500 at 1375). It’s never easy taking The Other Side of a market up move. Being a successful short seller in this business is the ultimate game of survival. Your skin needs to be thick, and you need to be able to take a punch.

 

I’ve made thousands of short sales in my career. Each time feels different. Feeling in this profession is what you’re not supposed to do. But you do. You’re going to feel the love when you are right. You’re going to feel shame when you are wrong. No matter what you are feeling, the best advice I can give is to keep searching – keep asking yourself what you’re missing.

 

Mr Macro Market is usually pretty good at reminding you when and where you could be wrong. That makes our search easier. Embracing the uncertainty that each and every dynamic risk management factor throughout each day brings is at the core of what I do. As Howard Marks wrote in his recent June letter: “Active management has to be seen as the search for mistakes.”

 

Back to the Global Macro Grind

 

The Other Side of the bear case for the SP500 is the current bull case – bailouts. Yesterday’s US economic data was awful. US Leading Indicators (LEI) slowed -0.3% in June versus +0.4% in May. Existing Home Sales for June dropped -5.4% and weekly US jobless claims shot straight back up to their YTD highs of 386,000.

 

So, on the “news” the market sold off and went red for an hour or so, but quickly recovered and went green as more #BailoutBull calls for Qe5 re-surfaced. In conjunction with the Bernanke Begging, the US Dollar went down, Oil went straight up, and all was well in the land of another no-volume stock market rally to lower long-term highs (-12% from the 2007 peak).

 

So what’s on The Other Side of the other side? What happens if the Global Macro and US Economic data goes bullish? Would that make me more wrong being short the SP500 (and Oil, we shorted that at yesterday’s highs too)? Or would that just make me wrong on my research view which, in turn, takes out the #BailoutBull and makes me more right for the wrong reasons?

 

Who knows…

 

Regardless, this is starting to sound all too complex for we commoners being centrally planned by the 112th to simplify.

 

The Other Side of the bull case for this SP500 rally to continue has 3 core factors:

  1. PRICE – SP500 immediate-term TRADE overbought anywhere > 1375
  2. VOLATILITY – VIX immediate-term TRADE oversold anywhere < 16
  3. VOLUME – continuing to register the nastiest volume signals ever in my model

That last factor was easily the most controversial topic I debated with clients in CA this week. Since US Equities continue to see outflows, where is the stock market’s bid coming from? I say short covering. And the ultimate question we need to answer this morning is how much of that do we have left?

 

The good news is that short interest data is trivial. Darius Dale highlights one way to look at long-term short-interest as today’s Chart of The Day. What you’ll note in this chart is that short interest as a % of the NYSE shares outstanding has been oscillating between 3-5% since this whole gong show of free money bailouts started in late 2007.

 

What you’ll also notice is that short interest spiked back up to 3.86% in June 2012, but that it came from a relatively low place (on a 5 year basis) for the 4-6 months prior to that. Yes, Beta Hedgies short low and cover high.

 

Are the consensus hedge fund short sellers covering high when the VIX goes low, again? I can literally see it in each security I am bear hunting in. Where I could be wrong is if I am hunting in the wrong neck of the woods. If I am right, eviscerated short interest looks like it’s turning into a huge market liability. Markets fall fastest after the consensus shorts have covered.

 

Where else could I be wrong on this? All over the place. What if short interest is absolutely ripping to the upside (4-5% of total shares outstanding) here in July? What if no one has covered any of their shorts this week? What if it really is different this time and 15 VIX is a cover all your shorts signal?

 

Only time will tell. But, in the meantime, I can assure you of this – very few PMs understood this in Q4 of 2008. Remember when every fundamental #GrowthSlowing short seller was being dared to cover their shorts in fear of the next central plan? Remember “shock & awe” rate cuts and Hank Paulson’s “bazooka” daily whip around in the market?

 

I do. And so does Santayana: “Those who cannot remember the past are condemned to repeat it.”

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Italy’s MIB Index, and the SP500 are now $1556-1591, $102.28-108.79, $82.75-83.94, $1.21-1.23, 13,468-13,703, and 1354-1381, respectively.

 

Best of luck out there today and have a great weekend,

KM

 

Keith R. McCullough
Chief Executive Officer

 

The Other Side - Chart of the Day

 

The Other Side - Virtual Portfolio


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