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THE RAMIFICATIONS OF JAPAN’S LOOMING GOVERNMENT SHUTDOWN

Takeaway: The political calendar poses a great deal of risk to the Japanese economy, JGBs and Japanese financial institutions over the next ~2 months.

Earlier today, Japan’s lower house of parliament (a.k.a. the Diet) passed a bill authorizing the sale of ¥38.3 trillion of JGBs to cover ~40% of already-approved FY12 expenditures, which began on APR 1st. While no set limit exists, this motion is akin to the US’s own statutory debt ceiling and, like our own debt ceiling, Japan’s deficit financing legislation allows for minority parties to have a say in the accumulation of sovereign debt.

 

Enter the LDP, Japan’s primary minority party in the more relevant lower house (House of Representatives – 120 of 480 seats) and a slight minority in  the upper house (House of Councillors – 87 of 242 seats) where no party has formed an outright majority. They have signaled as recently as last week that they will not approve the bill unless Prime Minster Yoshihiko Noda calls new elections, which would be roughly one year early, as they are officially due by AUG ’13. As it stands, neither party looks to dominate in the event of a snap election; both the DPJ and LDP have a paltry 13% approval rating per an Asahi poll released earlier this month.

 

This marks the latest political ploy for the LDP to regain political power in Japan, having recently backed off using the now-ratified VAT hike bill as collateral for Noda’s head. Members of the LDP remain broadly bitter about their party’s AUG ’09 defeat to the DPJ – which was architected by the now-defected Ichiro Ozawa – and they continue to look aggressively for opportunities to restore their long-time position atop Japan’s political hierarchy. Needless to say, we’d be remiss to dismiss these threats as mere political wrangling. Per Finance Minister Jun Azumi’s latest projections, the Japanese government will run out of cash sometime in October if this bill isn’t ratified in time.

 

The ramifications of a potential/actual Japanese government shutdown are three-fold:

  1. A potential sovereign default;
  2. A potential sovereign credit rating downgrade(s); and
  3. An associated $75-80 billion capital call across the Japanese banking system in the event JGBs are downgraded to single-A level by Moody’s and/or Standard and Poor’s, where the outlook is already “negative”.

To point #1, we do not see material risk of a JGB default over the intermediate term, despite debt service compromising roughly one-fourth of FY12 federal expenditures. Rather, we anticipate that Japanese lawmakers will either find a clause(s) within Japanese statue to completely circumvent a near-term default or they’ll cobble together some political compromise under the increasing scrutiny of global financial markets and ratings agencies. Either way, we don’t view a JGB default as a probable  risk over the next couple of months, as indicated by Japan’s sovereign CDS:

 

THE RAMIFICATIONS OF JAPAN’S LOOMING GOVERNMENT SHUTDOWN - 1

 

Unlike point #1, we do view point #2 as a heightened and increasingly-probable risk over the intermediate term. Per Takahira Ogawa, S&P’s director of sovereign ratings in Singapore, “political risk is the biggest negative for Japan’s rating”. In and of themselves, neither political risk nor an incremental downgrade of Japanese sovereign debt should do much to the historically-bulletproof JGB marketplace, which continues to have demand buoyed by surplus liquidity in the banking system that gets parked largely in JGBs for lack of better alternatives (second chart below). To this point, deposits at Japanese banks exceeded the aggregate size of their loan book by ¥173.2 trillion as of JUL; this spread, also known as the “Yotai Gap” is equivalent to 17.4% of the total amount of JGBs outstanding, creating a substantial amount of excess demand.

 

THE RAMIFICATIONS OF JAPAN’S LOOMING GOVERNMENT SHUTDOWN - 2

 

THE RAMIFICATIONS OF JAPAN’S LOOMING GOVERNMENT SHUTDOWN - 3

 

For additional drivers of JGB  market strength in the face of an overwhelmingly-consensus bearish thesis, refer to our MAR 2 presentation titled, “JAPAN’S DEBT, DEFICIT AND DEMOGRAPHIC RECKONING” as well as in our MAR 30 note titled, “DIGGING DEEPER INTO JAPANESE SOVEREIGN DEBT” and our JUL 27 note titled, “ARE JAPANESE GOVERNMENT BONDS POISED TO MAKE SOME NOISE”. Staying on top of which levers are at the most risk of becoming unsupportive on the margin are the key to staying ahead of a JGB market crisis, should one materialize over the long-term TAIL.

 

Jumping back to ramifications of Japan’s looming government shutdown, we view point #3 as laid out above as among the key catalysts for a JGB market crisis over the intermediate term. Per our calculations according to Basel II standards, Japanese banks would be on the hook for a $79.1 billion capital call in the event JGBs become a single-A entity (at the current exchange rate), after previously having to hold no capital against these assets. It remains to be seen how Japanese banks plan to react to this event; they could merely slow demand for other assets or they could materially slow their rate of JGB accumulation. Time will certainly be more telling here than we ever could; at any rate, we maintain that this is not a risk that should be glossed over by investors.

 

THE RAMIFICATIONS OF JAPAN’S LOOMING GOVERNMENT SHUTDOWN - 4

 

In addition to a changing risk profile of Japanese bank exposures, we also view a structural shift in long-term inflation expectations as a key catalyst for a JGB crisis; our latest thoughts here were previously outlined in the latter of the aforementioned research notes. To this point, the amount of JGBs held on the BOJ balance sheet now exceeds the total supply of banknotes in the country (¥80.96 trillion vs. ¥80.78 trillion), raising concern that investors will lose confidence amid fears of runaway inflation perpetuated by sovereign debt monetization – an event which has already happened twice in Japan: during the Great Depression and during WWII.

 

The BOJ counters that it does not include JGBs bought as part of its “transitory” asset purchase program in its calculus, allowing it to exceed the self-imposed “banknotes rule”. The obvious risk here is that BOJ Governor Masaaki Shirakawa loses credibility with the market; we suspect he knows this and that this has been a contributing factor to the BOJ’s unwillingness to acquiesce to incessant political demands for incremental monetary easing. At the current pace of accumulation (¥3.9 trillion per month in 2012; ¥2.8 trillion per month in 2013), the BOJ will have increased its ownership of JGBS by ¥44 trillion in the current fiscal year – more than the ¥40 trillion to be issued per the aforementioned FY12 deficit financing bill!

 

All told, we see three ramifications of a potential/actual Japanese government shutdown over the near term: a potential sovereign default, a potential sovereign credit rating downgrade(s) and an associated $75-80 billion capital call across the Japanese banking system in the event JGBs are downgraded to single-A level by Moody’s and/or Standard and Poor’s. Moreover, the confluence of these risks has the potential to perpetuate a meaningful back-up in JGB yields over the intermediate term – though, admittedly, this remains an improbable risk for the time being.

 

Stay tuned,

 

Darius Dale

Senior Analyst


The Spanish Numbers Game

Takeaway: Spain's GDP numbers and unemployment data paint a colorful picture of the country's economic turmoil.

Spain is quickly becoming the new “China” in terms of the economic data its been putting out. China loves revising GDP and employment numbers all the time and now Spain is joining in on the fun. It revised its GDP numbers on Monday, indicating it had increased 0.4% in 2011 instead of 0.7%. It also noted that its economy shrank by 0.3% in 2010 instead of 0.1%. Whoops!

 

 

The Spanish Numbers Game - Vin   Spain

 

 

Spain’s unemployment rate has continued to climb since 2008 and picked up swiftly in 2011, in line with the revised GDP numbers. Nearly one-in-four people are unemployed in the country as the unemployment rate hovers around 22%. If this is a sign of the kind of games Eurozone members are going to play in order to save face, the outlook for the rest of 2012 is quite grim.

 

Hedgeye Senior Analyst Matthew Hedrick lists several reasons why Spain’s situation will continue to worsen:

 

•             As many peripheral European counties continue austerity programs, growth will slow.

•             This will show up in missed deficit targets, often because they’re unrealistic targets (Portugal and Spain in particular).

•             And in missed growth targets, as austerity has a greater drag on growth and confidence than previously assessed.

•             Spain is one example of a country trying to dig itself out of a huge hole, struggling with huge unemployment rate figures (over 50% for youths), further downside in the property market, and major bank recapitalization needs (current pending funds from the EFSF)

•             We expect confidence and growth to be muted by the developments outlined above, and therefore growth targets to under deliver. This could be a theme throughout not just the periphery but much of Europe over the next quarters as the region’s sovereign debt and banking “crisis” has a nasty tail.


Ralph Lauren Gets A New CFO

Takeaway: The new CFO of $RL is ready to play ball, but can he smoothly transition from one industry to the next without a hiccup?

Ralph Lauren (RL) has just announced it has hired Chris Peterson, formerly of Procter & Gamble, as the company’s new CFO. Analysts on the Street see the hire as a positive for RL as does Hedgeye Retail Sector Head Brian McGough. Peterson winning the top finance position over a pool of thousands of prospects is a big deal considering that RL President Roger Farah runs an extremely tight ship. Consider it a vote of confidence.

 

Though the outlook for Peterson is bright, one concern we’d like to point out is the track record of executives moving from one industry to another – in this case, packaged goods to fashion. The businesses are fundamentally different as is capital allocation and meeting/beating Street expectations on various metrics. Here are three examples of other executives making the switch worth noting:

 

A)      Glenn Murphy: From Shoppers Drug Mart to Gap. Lately credited with the stock’s rebound. But financial engineering has been the main driver, until JCP ceded share six months ago at a time when, by chance, GPS got colors right.

 

B)      Ron Johnson: JCP from Apple. ‘Nuff said

 

C)      Paul Charron: Everyone loved the guy (Campell Soup), but in reality he destroyed LIZ.

 

We believe Peterson can buck the negative trend but will have to put in solid work. He has many challenges that lie ahead and if he can cut the mustard, Ralph Lauren will have a valuable executive on its hands that can help the company grow and move forward.


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Idea Alert: UA

Takeaway: We’re 8% ahead of the Street in the upcoming quarter reflecting strong top-line sales trends quarter-to-date.


Keith added UA again into the Hedgeye Virtual Portfolio. Again, true to our process, we (the analyst team) will have key ideas over long durations, and he will manage near-term risk by trading around the position. We recognize two different calls here at Hedgeye…1) the research call, and 2) the risk management call. A portfolio action usually occurs when those two calls match up, or change meaningfully on the margin. In this instance, there is no change to the research call.


TAIL (3-Years or Less): UA should put up $3bn in revenue by ‘14 – impressive given a $1.5bn print in 2011. That incremental top line breaks out as follows. a) $500mm in men’s, b) $300mm in footwear, c) $300mm in int’l, d) $250mm in women’s, e) $125mm in accessories.  It’s tough to find any name out there growing EBIT in the 25-30% range. This translates to over $2 per share in earnings at UA’s current margin structure (which we think is sustainable). Simply put, UA was built to be expensive.


A few more considerations on the TAIL call. There’s no fundamental reason why footwear should not attain share at least in line with lesser brands like New Balance, Reebok, Brooks, Saucony…Admittedly it has not happened yet, but will – the big risk is that it costs them more to do it.  When this accelerates, we pity anyone short this stock.


International is also next on the docket with the hire of Charlie Maurath.


All in, it’s true that it faces a stiff competitor in Nike, but barriers to entry here are immense, and UA has already invested to jump that hurdle. Few others have. In addition, UA has ~2x the Direct-to-Consumer exposure as Nike – that’s one of the benefits of building a business without a legacy wholesale model that’s dependant on dinosaur retailers to conform to its marketing plan.


TREND (3-Months or More): With sales in both apparel and footwear accelerating into 2H driving solid top-line growth, UA also has a bullish gross margin setup over the next four quarters. Headed into 2H, gross margins will face margin pressure from mix as DTC (-50bps) and footwear (-25bps) continue to grow offset by less promotional activity due to lower excess inventory levels compared to last year. In addition, the sales/inventory spread turning positive for the first time in eight quarters coming out of Q2 is very gross margin bullish.

 

The fact that UA has ~5% of sales coming from outside the U.S. actually plays into its favor with the strengthening USD. UA’s failure overseas has actually turned into a near-term benefit relative to competitors that operate globally and need to translate profits to US$.


TRADE (3-Weeks or Less): Near-term factors are mixed for UA. Our estimate is 8% ahead of the Street in the upcoming quarter reflecting strong sales trends reflecting share gains in both apparel and footwear. Apparel sales have continued to outpace the broader industry posting greater than 2pts of share gain quarter-to-date. Meanwhile, footwear sales have reaccelerated since early June reflecting the early success of the new Spine platform and launch of UA’s new basketball line.

 

On the flip side, UA just lost its SVP/Sourcing, which is not good. Also, DKS writing off its investment in UK’s JJB is not great for UA’s int’l growth given the relationship between the two.  We’re more concerned with perception than reality, but the facts can’t be ignored. When concerns are high, we’re buyers.


Idea Alert: UA - UA TTT

 

Idea Alert: UA - UA mkt sh


 

 


LVS: SINGAPORE “CONCERNS”

Is Singapore really as bad as the shorts say?

 

 

There has been some concern in the investment community recently surrounding next year’s performance by MBS.  Management has apparently been conservative, telling some that EBITDA may be flattish in 2013.  To this we say the following:  1) current Street consensus already reflects that assumption and 2) EBITDA will likely grow in 2013 despite management’s assertions.

 

It looks like Street consensus for MBS EBITDA is below $1.7 billion for 2013 on top of an estimated $1.6 billion for 2012.  That looks pretty flattish to us.  Following a disappointing Q2 in Singapore, Street expectations have come down.

 

It’s probably prudent for management to rein in the aggressive analysts.  The new IR function at LVS seems to be more conservative overall:  a longer and formal quiet period, limited access to property level managers, and a less aggressive tone.  The truth is, management probably has limited precision when it comes to projecting 2013 EBITDA.

 

We may not have perfect precision either but here is why we think EBITDA will grow next year.  Given the valuation and investor concerns, we think EBITDA growth at MBS will be a positive catalyst on the margin:

  • The locals business may indeed be flat or slightly down in 2013 but that represents 30% of visitation and likely less of revenues.  We’d be shocked if international visitors do not more than make up the slack.  It would likely take an Asian recession for that to happen.
  • Even if the market is flat next year, MBS should gain share.  Genting has greater exposure to the locals business.
  • MBS retail and room rates should be up significantly next year.
  • MBS should also continue to benefit from increased visitation to their Marina Bay area, resulting from:
    • MRT station: Opened in January right by the property (should benefit MICE)
    • Gardens By The Bay in Marina Bay: A $1 billion project that ppened 6/29/12
    • Deep water cruise terminal: Opened in early June of 2012

Down With Gold!

DOWN WITH GOLD!

 

 

CLIENT TALKING POINTS

 

DOWN WITH GOLD!

Gold sold off hard late yesterday and is continuing to fall this morning. When news hit the wire that Draghi wouldn’t be attending the Federal Reserve meeting at Jackson Hole, people got scared. Keith is bullish on the dollar and is of the belief that if you get the dollar right, you get a lot of other things right. That appears to be the case right now: dollar up, gold down. And if the Fed doesn’t save the world like Bruce Willis in the movie Armageddon, then gold is poised to fall a lot lower. That last point will be emphasized should Romney pick up some momentum at the Republican National Convention this week.

 

 

CENTRAL PLANNERS RUN AMOK

Sometimes, people get confused. It happens to the best and the worst of us and it can’t be helped at times. In the world of central planning, however, clarity is needed. It appears that some of them are of the belief that inflation is equal to growth. Nope. That’s simply not true. Take Venezuela’s intrepid leader Hugo Chavez for example. The stock market is up +153% year-to-date! That being said, their currency has been devalued to hell and back – that’s no fun for anyone, is it? Asset price inflation is not growth. Your head of lettuce going for $10.50 a pop and $50 a gallon gas is not growth.

 

 

MORE DOLLAR DEBAUCHERY

Courtesy of Keith, we’d like to point out the effects of beating up on the US dollar and how that’s affected stocks and commodities. See below:

 

“Here’s the update on what US Dollar Debauchery has done for this 30-day bull run in stocks and commodities (inverse correlations between USD Dollar Index and the big stuff people are speculating on)”

 

1.                    Gold = -0.85

2.                    Silver = -0.87

3.                    Oil (WTIC) = -0.81

4.                    CRB Index = -0.74

5.                    CRB Raw Industrials Index = -0.79

6.                    SP500 = -0.83

 

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ASSET ALLOCATION

 

Cash:               Flat

 

U.S. Equities:   DOWN

 

Int'l Equities:   Flat   

 

Commodities: Flat

 

Fixed Income:  Flat

 

Int'l Currencies: UP  

 

 

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TOP LONG IDEAS

 

NIKE INC (NKE)

Nike’s challenges are well-telegraphed. But the reality is that its top line is extremely strong, and the Olympics has just given Nike all the ammo it needs to marry product with marketing and grow in the 10% range for the next 2 years. With margin pressures easing, and Cole Haan and Umbro soon to be divested, the model is getting more focused and profitable.

  • 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

 

LAS VEGAS SANDS (LVS)

LVS finally reached and has maintained its 20% Macau gaming share, thanks to Sands Cotai Central (SCC). With SCC continuing to ramp up, we expect that level to hold and maybe, even improve. Macau sentiment has reached a yearly low but we see improvement ahead.

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

  

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THREE FOR THE ROAD

 

TWEET OF THE DAY

“Look at those long term charts today, what do you see? Read some interesting metrics about Cyclically Adjusted Price/Earnings ratios (CAPE)” -@jackstone104

 

 

QUOTE OF THE DAY

“If at first you don't succeed, failure may be your style.”–Quentin Crisp

                   

 

STAT OF THE DAY

Credit Agricole’s quarterly profit dropped 67% year-over-year thanks to troubles in its (drum roll, please) Greek and Italian businesses. It posted second-quarter net profit of €111 million compared with €339 million a year earlier.

 


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