NKE: Its Hated

Takeaway: $NKE's setup today is unlike anything we’ve seen in a very long time - hated just when fundamentals improve. Be red.


Nike’s setup today is unlike anything we’ve seen in a very long time. It’s fundamentals are showing signs of stabilization, with a) an exceptionally strong footwear business offsetting week apparel in China and parts of Europe, and b) gross margins finally headed back up again after many quarters missing expectations, a) inventories getting back into balance with an outline. But at the same time we’re seeing the worst sell side sentiment Nike has seen in 14 years. 

It’s not enough for us to simply take those two factors and buy the stock. Last I check stocks on trade on a two factor model. Ours uses about another 25. Over the past three weeks we’ve been advising clients to trade around a range of $96 to $101, which is served us and them quite well. The problem however is that once Nike broke down through $96, a number starting with an eight is in play. From the fundamental standpoint I can point to zero reasons why it will get there.  But near-term irrational stock moves don’t happen based on fundamentals.


NKE: Its Hated - NKE TTT


Sentiment: So what has Sell-side sentiment so bad? Currently only 37% of the ratings are Buy. What’s funny is that if Wall Street coverage was accurate there would be a fairly even distribution of readings across the buy sell and hold spectrum. Nike however usually has a buy ratio between 90% and 100% percent. Just three months ago it’s ratio hit a recent low of 75% and has since been cut in half to 37%. Just put this into context this is a ratio that’s just slightly above that of JCPenney one of the worst companies and retail right now.


NKE: Its Hated - NKE JCP Sent


SIGMA: Those who track our Sigma analysis will immediately see that Nike has swung right up to quadrant four of our chart. This is a very critical move in that for the past nine quarters Nike’s positioning on this quadrant has moved either down or to the left, both of which are bad. Were often asked what the most favorable move is for company in this analytical framework, and the answer is clear. It’s the one that Nike just did. It’s when sales begin to grow faster than inventories and the rate of degradation in margins begins to ease. This is a prime set up for improvement into the sweet spot for the next four quarters. That’s when stocks work in retail.


NKE: Its Hated - NKE S


But again as noted from a risk management standpoint we have to be very careful here. The stock is clearly broken down below its key support level and will be looking to add it back to our real-time positions on red.

Here’s some other puts and takes in the quarter which we thought were notable:

  • This is more of a company fluff statistic but we still find it notable how every participating nation in the Olympics sent at least one woman and that 44% of all athletes were women in the Olympic Games. That is obviously great news for a secular trend of increased sports participation for women on a global scale. This helps Nike. Not next week, not next month, but a very big long-term positive.
  • China futures down six by no means is positive, but on the two-year run great it was actually a slight improvement from the +2% that Nike put up last quarter.
  • Nike Japan posted this +7% growth rate in futures which is the first time in forever that we’re seeing growth over there. Granted, “comps are easy” but Nike has been unable to “comp the easy comp” for the better part of a decade in Japan.
  • Gross margins compressed by -80bps reflecting benefit from pricing and cost initiatives that were more than offset by higher input costs for materials and labor and mix shift to lower margin businesses. However, the company did not highlight the impact of the expensing – as opposed to amortization – of tools and molds associated with its digital running gear. They could have ‘explained away’ a good 50bps of margin hit there.
  • In looking at regional performance:
    • North America revs came in up +23% (footwear +20%, apparel +26%)
    • Western Europe revs increased by +6% driven by running, basketball and football
    • Eastern Europe revs were up by +16% driven by Russia and Turkey and running
    • China revs increased by +7% with double-digit growth in running, basketball and action sports. Apparel was down -1%. Definitely gave the impression on the call that after the initial market-led slowdown, Nike is taking the initiative to tighten its order book to improve the quality of business. Two thoughts on this 1) Let’s give them credit. They might have stuffed the channel, but at least they’re taking the steps to unstuff it. 2) This is reminiscent of Nike circa 2000/01 when Nike had this same problem in the US market.  Its subsequent actions have had a lasting impact, and are arguably the bedrock for the numbers we see today.
    • Emerging market revs were up +22% driven by running, football, and sportswear. That said we were disappointed to see emerging markets futures come in at +9% on a reported basis (14% Constant Currency). Those are decent enough growth numbers, but the reality is that emerging markets should be putting up mind-bending growth figures.

In a note earlier this week “NKE: A Rare Glimpse,” we looked at the breadth of platform engines driving NKE’s top-line. Free and Dual Fusion are the fastest growing. In fact, these two platforms accounted for nearly half of NKE’s domestic growth over the past year. This is particularly notable given that the NKE Free platform only started selling through Europe less than 6-months ago (March/April), which we expect to continue to help offset persistent macro headwinds.


NKE: Its Hated - NKE PlatRevs


NKE: Its Hated - NKE IncrRev Plat



BKW: Dethroning The King

Takeaway: BKW has to deal with myriad factors including franchisees, higher commodity prices and competition from MCD, BKC and WEN.

Keith shorted Burger King (BKW) in our Real-Time Positions this week. The quantitative setup fell into place, with BKW trading near the top of its TRADE range and our bearish fundamental thesis remains intact. We covered the short on the 26th and booked a gain.



BKW: Dethroning The King - BKW levels



Our Bearish Fundamentals Thesis:


Burger King Worldwide is a stock we have been bearish on since the deal was announced. We remain negative on TRADE, TREND, and TAIL durations. The title of our first note (4/10/12) on BKW was "Too Big To Fix?". In that note we expressed skepticism that the myriad issues that had dogged the chain for a decade had been conclusively resolved - without necessary capital investment - by the new owners over the 18 months prior to its most recent IPO. 


A conference call we held following our initial note on Burger King was called "The Latent Risks of Heavily Franchised Business Models" and discussed deep issues affecting the Burger King franchisee base. We calculated that operators within Carrols franchisee base pay out roughly 50% of their store-level cash flow back to the franchisor. The takeaway is that there is very little cash flow available for the franchisee to invest in his/her own business.


Other issues include:


1. Probable continuation of higher beef prices over the next few years due to supply issues

2. "Obamacare" could also add to financial strain on system in coming years

3. McDonald's is aggressively protecting its share from WEN and BKC


Takeaway: Dairy prices moving sharply higher is a negative for $DPZ, $TXRH, $CMG, $PZZA, and $CAKE

As the US Dollar gained, many soft commodities that we track as part of our process declined during the last week.  In line with our macro process of paying attention to Correlation Risk, those commodities with the tightest inverse correlation to the US Dollar Index posted the sharpest week-over-week declines.


Summary View



Coffee prices have been gaining on speculation that government stimulus measures in China will buoy consumption within the country – the world’s top consumer.


Cheese prices have been rising sharply of late, gaining 7% over the last week as speculation mounts that milk production is set to slow substantially in 2012/2013.  Dairy prices are, to varying degrees,  a negative for TXRH, CAKE, DPZ, PZZA, and CMG.


Corn prices declined 4% week-over-week as the USDA is set to release the Grain Stocks report tomorrow.  Grain exports data this morning was bearish for corn prices with 400 metric tons sold in the last week versus expectations of 150k-200k.  Demand destruction is evident not only in the export sales miss but in the rising stocks of ethanol versus a year ago.  Stocks of ethanol are showing strength as production slowed over the past week.  The DOE Fuel Ethanol Inventory Index is up 26.5% year-over-year.   Slowing demand for corn through ethanol production is bearish for corn prices.   The huge export sales miss is the main callout for corn over the last week.  It seems that ethanol producers and farmers are waiting for lower prices before demand kicks in again.


COMMODITY CHARTBOOK - ethanol inventory production



Gasoline Prices


Gasoline is rising as concerns grow that refinery shutdowns in the Atlantic Basin will further reduce stockpiles on the East Coast.  According to Bloomberg: “Prices climbed the most since June 29 as Europe’s largest refinery, Royal Dutch Shell Plc’s 400,000-barrel-a-day Pernis plant in the Netherlands, is conducting maintenance until early November.  Supplies on the East Coast, including New York Harbor, the delivery point for futures contracts, were the lowest since October 2008 last week, Energy Department data show.”












COMMODITY CHARTBOOK - crb foodstuffs












COMMODITY CHARTBOOK - chicken whole breast


COMMODITY CHARTBOOK - chicken broilers











Howard Penney

Managing Director


Rory Green



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Not Good: SP500 Levels, Refreshed

Takeaway: Bernanke’s broken promise continues to deliver short-term, no-volume, asset price spikes – not economic growth.

As the data changes, we do. Or at least that’s what we aspire to do. In this business, changing your mind is sometimes characterized as a lack of conviction. That’s why I built my own firm. I can change my mind as quickly or slowly as the process instructs.


Being bullish because the market is going up is one thing. I get it. But being bullish and suggesting the economic data supports it is not truthful – at least not as of this week. Bernanke’s broken promise continues to deliver short-term, no-volume, asset price spikes – not economic growth.


Given how the stock market ramped, this morning’s Chicago PMI reading of 49.7 for September is flat out awful. So was a -7.2% y/y Durable Goods print for August. Our US GDP #GrowthSlowing call (intact since March) is now clocking a -68% sequential decline in GDP from Q411 (4.1% to 1.3%).


Across our risk management durations, here are the lines that matter to me most:


  1. Immediate-term TRADE resistance = 1451
  2. Immediate-term TRADE support = 1430
  3. Intermediate-term TREND support = 1419


In other words, 1430 support looks good until it doesn’t. If it breaks, we should see the more important level of 1419 tested during what will be the worst quarter for SP500 revenues and earnings since 2008.


Keep moving out there – markets wait for no one,



Keith R. McCullough
Chief Executive Officer


Not Good: SP500 Levels, Refreshed - 9 28 2012 10 51 18 AM


Takeaway: We expect BYI to provide a bullish outlook to investors and back it up with strong content at next week’s G2E

As many of you know, Todd has been in Vegas the last 2 days getting a preview into the week ahead.  After a half day of meetings in Las Vegas, a clear cut highlight was a very positive meeting with BYI.  Management was very bullish about their content for G2E and also about the outlook for all segments of their business.  We think this optimism will show through when half of the investment community attends G2E next week.


We’re usually sober regarding the pre-G2E commentary and glowing press releases regarding each company’s upcoming G2E exhibits.  What’s different for BYI is that this historically reel spinning slot supplier is going to display mostly video content that has apparently been getting great feedback from customers.  Remember that approximately 80% of units shipped are video and unbeknownst to most investors, BYI’s recent slot shipments have also been around 80% of total.  So their video content is already driving higher share recently and with what they are going to show at G2E, will likely increase their high teens overall share.  This is not your father’s Bally Gaming.


The stock has done well, certainly relative to its competitors.  However, the valuation is not excessive and forward estimates look like they may need to go higher.  We are not making a call on the September quarter – we’re essentially in-line – but G2E should be a big near-term catalyst along with the announcement of a big award from Western Canada. 


Consensus for the BYI’s FY2013 is $3.17 and company guidance is $2.95 to $3.30.  We think that consensus is achievable and beatable depending on the timing of the IL rollout and Western Canadian Lottery unit shipments.  We already know that the award for Manitoba and Saskatchewan has been awarded but given the politically sensitive topic of spending money on slots when the economy is in a funk, the government has been “sitting” on the announcement.  At least one of the suppliers that has been awarded part of the contract for 10,000 slots has told us that they expect the units to ship by September 2013.   We estimate that BYI’s allocation of the award was between 1,000-2,000 units, which could boost earnings by $0.09-$0.18/share.  


On September 25th, BYI announced contracts for 4,000 VLT shipments to IL which they expect to be deployed over the next 24 months.  In additional, 3,000 VLTs will be connected to Bally Multi-connect, an enterprise wide centralized accounting and management system.  Our understanding is that roughly 50% of the 4,000 units will be sold and the balance will be on lease arrangements.  Every 1,000 units that BYI sells into IL should contribute 8 cents to earnings. The Multi-Connect link will add to BYI’s already material base of recurring revenue from its central system products.



Notes from our meeting with management:



  • They are very bullish about their video content.  After 15 G2Es, we can say their bullishness was significantly more than normal.
  • Grease was their best WAP launch ever; then Michael Jackson exceeded that.  NASCAR coming out in Q4 2013.


  • IL 50/50 units between leased and for sale
  • 1,600 VLTs over 3 or 4 quarters to Atlantic Lottery starting in September Q
  • Won’t disclose how much of a RFP from Western Canada (Manitoba and Saskatchewan) they got but our sources indicate that the award of 10k machines will be announced soon and BYI got a very healthy share


  • Excited about their systems business as well
  • Ontario is big systems contract – not signed but going to happen
  • BC is 25k units
  • Systems maintenance growth rate 15%
  • Systems services provides 4-8 million per quarter in revs
  • Balance sheets restricting service revenues as casinos want to convert but can’t – good news is that is changing
  • 30% penetrated world-wide on systems

Wide Area Progressives

  • No policy to cap WAP outside of a few small deals where they got something else in return – they are adamant that they are not materially capping their upside on WAPs despite what the investment community and competitors say
  • 600 games on Cash Connection include MJ and Grease at 6/30/12 but 1,500 is their goal.  We think they are well on their way to exceeding that goal.


  • Columbus won’t be recognized until FQ2
  • Slot hold increase industry wide might be due to lowering player odds and then giving it back in rewards
  • CZR starting to buy a little more slot product
  • Margins:  48-49% by the end of the fiscal year for product margin – conversions will be the next leg up

Get Shorty: Rolling Over

Takeaway: Fundamentals are rolling over like US durable goods, so we think an opportunity to short some expensive stocks is coming up very soon.

Post-Bernanke party, when stocks have ripped 50-100% higher in just a few months, energy is one place where we’re looking for short ideas. Fundamentals like durable goods, growth and demand are beginning to roll over and with stocks at expensive prices, we think there’s room for a pullback. Growth is still slowing - remember that.


S&P500 revenues will be +2.2% YoY in the 3Q – adjust that for inflation and real revenue growth has gone negative.  And lately many companies are missing estimates and guiding lower, so the forward outlook is not much better. The question is how high of a multiple can some of these companies trade at in terms of price-to-earnings? 20x? 60x? 100x? Things seem to be getting worse in the market and the economy, not better.



Get Shorty: Rolling Over  - image002

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