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Retail Macro Series #1: The Sourcing and Pricing Trade

Takeaway: Here's our first deep dive in a series of Retail Industry Macro topics. First up, sourcing costs vs pricing.

This is the first in a series of Retail Macro reports where we take a deep dive into some of the key sector-specific Macro factors that are driving fundamentals. We’re firm believers that you can’t simply look at POS data or a stream of made-up government data and use it in an investment process. Well, I guess you could, but you’ll probably lose money rather consistently.


Today combine everything from company-reported information, to bills of lading on imports, to specialized government office receipts to BEA/BLS data to tell us the truth about what’s happening with product costing and pricing behavior, how it’s impacting margins, and ultimately how it is represented in the stocks. We’re not going to make a sweeping macro call, but what we will do is isolate the key questions that need to be asked and answered in considering how inflation is impacting the dollars a company pulls out on its gross margin line. Note, there are 8 Exhibits in this report that are critical in understanding our analysis. If, for whatever reason you cannot view them, please reach out to us directly.


The unmistakable math is that we are on the wrong side of incremental change in sourcing/pricing's impact on the supply chain. We're currently at a run-rate of about $6bn per quarter. That might not seem like much in a $280bn industry. But keep in mind that the $280bn is revenue. It has 10% margins -- at best. So we're talking $6bn accretion to a $28bn margin figure. Something tells us that the CEOs in this business are not looking at the math like this, and are not asking themselves if it is sustainable. 


As we are squarely in the period where Average Unit Cost (AUC) is down while Average Unit Retail (AUR) is presumed to be holding up, we want to consider the following analytical build-up…


1)      Get The Cost Component Right. In looking at the cost component, PPI is irrelevant. That encompasses the apparel that is produced in the US, which is less than 5% of what we purchase. We need to look at the actual import cost, which is released by OTEXA (the Office of TEX and Apparel). But to take it a step further, you cannot simply look at PPI vs. CPI. ‘All percents are not created equal’. The simple fact is that the average unit retail is about $11, while the average unit cost is about $3.50. On an apples to apples basis, 1% of the former = about 3% of the latter. In other words, cost can be up 15%, or $0.53 per unit, and all it takes is about a 5% change in Price to generate $0.55 to offset the cost increase.

Exhibit 1) Need to look at dollar value spread between cost and price instead of percent change in both.
Retail Macro Series #1: The Sourcing and Pricing Trade - macro1

Source: BLS, OTEXA and Hedgeye


2)      Aggregate Supply Chain Impact Is Easy To Gage. When we can isolate the units shipped and the cost/price per unit, we can break down the economics of selling pretty easily. Specifically, we can gage the price/cost spread, and quantify how much money is either being inserted in, or detracted from, the apparel supply chain. We like to look at the 3 month trend, which shows prior 2-month shipments vs. current month retail. This appropriately accounts for the lag through which product is clogged up in the supply chain.

Exhibit 2) As is clear in this chart, we’re still clearly in the green as it relates to positive margin impact on retailers, but the trend has decidedly turned negative.
Retail Macro Series #1: The Sourcing and Pricing Trade - macro2

Source: Hedgeye 


3)      The 12-month trend is even more stunning. We’d argue that it is not as relevant as it relates to modeling immediate-term margins for the retail supply chain (i.e. retailers, brands, manufacturers), but as it relates to playing the BIG Macro trend where the group meaningfully outperforms and you make money regardless of what you own – that trade is probably done.
Retail Macro Series #1: The Sourcing and Pricing Trade - macro3

Source: Hedgeye, Factset, BLS, BEA, OTEXA 


4)      The Stocks Recognize This Relationship. To prove the point, let’s look at the relationship between the S&P Retail Index (RTH) and the Spread between Consumer Price and Retail Cost. The relationship is quite strong – though there have been certain points in different cycles when the market discounted the impact of inflation/deflation at different times.  But the discounting mechanism was clearly and definitely there.
Retail Macro Series #1: The Sourcing and Pricing Trade - macro4

Source: Hedgeye, Factset, BLS, BEA, OTEXA 


5)      Reversion To The Mean is Likely, And Is Net Bearish. This one gets a bit more complicated. But in essence, it shows the change in the RTH compared to the change in the price/cost spread. In effect, as the line goes down, it means that either the market is underperforming the inflation spread, meaning that either a) the RTH is underperforming the inflation spread, or b) that the inflation spread is getting positive, but that the market does not care. There have been several notable moves, which are outlined below. But the punchline is that we just came off a 2-stage process whereby 1) both the stocks and inflation spread worked simultaneously, and then 2) the group stopped working, but it did not go down. Inflation spreads caught up partially to the already realized price performance, but to revert to the mean, spreads need to get meaningfully better, or the stocks need to head lower.
Retail Macro Series #1: The Sourcing and Pricing Trade - Macro5

Source: Hedgeye, Factset, BLS, BEA, OTEXA 


6)      Triangulating The Data…With More Data. Let’s slice and dice the data another way by triangulating it with container imports. Theoretically, if we know a) the average price per container at cost for every box coming into US ports, which we do (about $57,000 per container), and b) the average cost per garment coming into the US, then we know one of two things… 1) The change in mix, or 2) the load factor (the amount of stuff crammed into the box). Almost always, the difference is the load factor (which currently sits at about 16,300 garments per box). For the record, that ratio fluctuates greatly by category – women, men, footwear, athletic, baby, underwear etc…, and we have all that data and will have a future Macro Deep dive on it.   

What it shows us is that as unit costs rose due to the commodity bubble, shipment value actually came DOWN. We know that mix between subcategories did not erode during that time period, not did average price inter-category. What that tells us is that the Load Factor came down significantly. Remember that if you own a factory in Asia and you ship a container every Monday and Thursday, you don’t cancel the box simply because there’s less stuff to go into it. You ship it, but with less product in the hold.
Retail Macro Series #1: The Sourcing and Pricing Trade - Macro6

Source: Hedgeye, PIERS, OTEXA, BEA, Company Documents, Factset


7)      Strength Could Take Margins Higher. When we look at this Load Factor versus aggregated margins for every company in the industry, the relationship is simply unmistakable. The only problem for margins is that the Load Factor change is at peak. We agree that it could head higher from where it is today…
Retail Macro Series #1: The Sourcing and Pricing Trade - Macro7

Source: Hedgeye, PIERS, OTEXA, BEA, Company Documents, Factset


8)      But It HAS To Print Those Numbers To Satisfy The Bulls From Here. The market recognizes this relationship just as well as we do. Unfortunately, it suggests that the Load Factor change will remain about where it is today, or better,  and in no way discounts that we could see a slowdown in unit shipped.
Retail Macro Series #1: The Sourcing and Pricing Trade - MACRO8

Source: Hedgeye, PIERS, OTEXA, BEA, Company Documents, Factset

HBI: Look Elsewhere

Takeaway: HBI continues to reduce debt at an impressive pace, but it’s not cheap on EBITDA and there are other places we’d rather to be.


This was a less than inspiring P&L quarter for HBI with the EPS upside and beat coming entirely from lower SG&A and the outlook for Q4 below Street expectations. That said, we have to give credit where it’s due – this is a business that’s been managed for cash flow and it delivered with $287mm used to retire $300mm of floating-rate debt, and posted an extremely impressive SIGMA performance. With another $500mm in debt targeted next year, HBI will have its debt burden down to ~$1Bn by the end of 2013 if it hits its operating margin targets – half of where it was in 2010.


But this is a business now exceeding peak margins and trading at 9x EBITDA benefiting from a number of near-term tailwinds. While HBI has the majority of its pricing locked up through 2013, it’s corresponding volume is not certain, and this is not a business without risk. HBI is not a raging short in the absence of a catalyst (valuation – even for an overpriced stock) is not a catalyst, but there just isn’t enough potential reward for us to get more constructive at these levels.

The company is looking to go up market driven by innovation (ComfortBlend underwear, slim fit t-shirts, and Smart Size bras) and that’s great if early shelf gains continue, but these initiatives cost money to support. HBI is now on its 3rd straight year of realizing $30-$40mm in supply chain savings one-third of which comes out of SG&A, which is noteworthy, but begs the question of just how much is left to squeeze. In addition, HBI will be reinstating its media spend next year ($10mm+), the benefits of which helped drive the beat this quarter. In reality, the investment should exceed what was simply held back in 2012 and will likely impact operating margins by -20bps-40bps next year.


Gross margin recovery driven by easing product costs and additional supply chain efforts will offset higher SG&A. A particularly strong SIGMA trajectory should support strong margins for the next two quarters, but we think operating margins beyond 10%-11% are simply not sustainable over time in this business. The only time HBI posted margins like that was when it was part of Sara Lee and preparing to go public. Now if HBI is willing to substantially ramp investment spending to drive double-digit top-line growth by taking pricing up with innovative basics while capturing shelf space resulting in top-line instead of cost reduction driven EPS growth then this story would be more attractive. But as it stands now, there is still uncertainty in the mid-tier channel and International is having execution issues that make it challenging to get above MSD revenue growth over the next two years.

At 9x and 8x F13 and F14 consensus EBITDA expectations, much of the potential reward scenario is already baked in at these levels. With the stock up +50% YTD and at 4-year highs, we need sustainable top-line acceleration or margin expansion to get more constructive – we don’t see it.


HBI: Look Elsewhere - HBI S




In preparation for WYNN's 3Q earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.




  • "Normalized is about 26% for that [baccarat] game."
  • "We have been able to hold the percentage we pay the junket operators to 40% plus 3% or so for complementaries, and our competitors are about 5 points ahead of us in terms of what they give the junket operators."
  • "The price war has extended into the mass end of slot markets....we always focus on how much junket commission that's given out, but we are actually giving out a lot more incentives now in slots and mass market to also buy back business."
  • "We are very conservative about credit....we don't use a rolling program.....it's 15 day credit on the 15th of the month."
  • "I don't think there is as much of a change between direct and junket."
  • [2nd half 2012 Cotai capex] "~$150 million on foundations over the next nine months to 12 months."
  • [Macau opex] "We're running between $1.3 million and $1.4 million per day before we take into account commissions or bad debt or anything like that. I expect that to continue. But, there will be continuous cost pressures, primarily driven through the pressures on payroll."
  • [Cotai timeline] "First is the foundation permit which is currently under consideration.  That will be forthcoming. We'll be driving pilings and digging and excavating with augers the great caissons of the high rise this fall. Once we get out of the ground that will take probably the better part of a year from now. Then, it goes very fast because it's just another important place building; it's pretty quick. The building permits are issued in stages as you submit final working drawings, specific construction documents that have very detailed stuff on them. And that's scheduled along with the rest of our construction schedule to go along in stages and phases that match the moment. And it results in about a 46-month schedule."
  • [Two major international retailers in Macau] "Now that's being done this summer and fall, and they'll be open, I hope, by Christmas or something like that. Maybe a little later."
  • "We built a new junket room that's going to be open for Christmas. Another retail space -  a small one for jewelry at the entrance of the casino."

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.


Today we shorted the iShares Dow Jones U.S. Home Construction Index Fund (ITB) at $20.64 a share at 3:22 PM EDT in our Real Time Alerts.


Some investors are too optimistic about the housing recovery and a lot are still long housing at these levels. Immediate-term mean reversion risk finally moves to the downside with market beta turning bearish. Another down day like today can do wonders for a short. We’ll watch and wait with this one.


TRADE OF THE DAY: ITB  - image001

What’s Next For Agriculture Prices? (Corn, Wheat, Soybeans and Protein)

Takeaway: Join us for our Expert Call with Professor Darrel Good on Monday, October 29th at 1:00pm EST.

On Monday, October 29th at 1:00pm EST, the Hedgeye Macro Team and Restaurants Team will be hosting a Agricultural and Consumer Economics Expert Call with Professor Darrel Good of the University of Illinois. Good has been part of the faculty since 1976 and took part in developing a comprehensive farm risk management website (www.farmdoc.uiuc.edu). His efforts are now focused on the performance of grain futures contracts as well as corn and soybean yield trends. 


Topics will include: 

  • Supply side - planting intentions and farmer's economics
  • Demand side - key drivers of demand - ethanol, protein, consumption (domestic and abroad)
  • General long term trends to think about for farming - utilization, fertilizers, seed evolution
  • Thoughts on USDA projections, and their historical accuracy and what the implications are now
  • View on supply, demand, key drivers and prices next year (or next 6 - 12 months) for:
    • Corn
    • Wheat
    • Soybeans
    • Cattle
    • Chicken

Current subscribers of our Macro and/or Restaurant verticals will receive the dial-in information automatically, if you have any further questions please email .


Good's Background

Darrel Good has a comprehensive understanding of agricultural markets and their economic implications.

"There was a time period in the early seventies when grain markets changed dramatically," said Good. "Russia started importing grain, prices just exploded to the upside and there was renewed interest in markets and prices. I was hired to help develop a very extensive educational program in marketing and risk management."  

  • Professor in the department of Agricultural and Consumer Economics, is marking his 33rd year with the University of Illinois
  • Developed, along with two other faculty members at U of I, a seminar called "Price Forecasting and Sales Management"
  • One of the founding members of the farmdoc team
  • Writes one of the featured newsletters on the farmdoc site, Weekly OUTLOOK , and he is a primary contributor to the AgMAS section
  • Current research includes:
    • Evaluation of the pricing performance of agricultural market advisory services
    • Evaluation of USDA production and price forecasts
    • Evaluation of pricing performance of Illinois corn and soybean producers  


Takeaway: On balance, the storytelling for owning US stocks up here is not supported by the data.



  • All told, we continue to see a lot of storytelling as to why investors should remain long of US equities here. Unfortunately, that storytelling is not completely supported by the data.
  • In fact, our analysis suggests that the consensus long-term bull case for owning US equities up here (“stocks are cheap”, “investors are underweight equities”, “dividend yields are compelling”, etc.) actually leads investors right to one of the most supportive theses for meaningful equity market weakness over the intermediate-to-long term.
  • That thesis is: stocks are not cheap (on a cyclically adjusted basis), fund flows are likely to continue favoring fixed income in lieu of equities and one of the core reasons why dividend yields are so compelling is because of the low interest rate environment perpetuated by ZIRP, which, perversely, perpetuates a shift of even more flows into fixed income funds to supplement slowly compounding returns. We show data to support each of these claims in the note below.


On AUG 6, we published a note titled, “DEBUNKING THE STRUCTURAL BULL CASE” in which we attempted to stress test some of the common long-term supportive theses for owning US stocks – including investor asset allocation, demographics and corporate earnings. The conclusion of the note was rather simple:


“We see downside risk in the US equity market over the intermediate term as the structural bull thesis is riddled with shortcomings.”


That view, which was published at ~1,400 on the SPX, remains our base-case scenario – a scenario that continues to be well-supported by our cyclical concerns (per our 4Q12 Macro Themes; email us for replay materials):


  • #EarningsSlowing
  • Bubble #3
  • Keynesian Cliff


Mutli-factor, multi-duration scenario analysis remains a core tenet of our Global Macro research process. In expanding upon our longer-term work, we use the prose and charts below to incrementally debunk the structural bull case for owning US stocks up  here.


Before we go any further, it’s important to note that we are not perma-bears; nor do we have a bone to pick with the US equity market. Rather, we continue to register high levels of asymmetric PRICE risk across domestic stocks – particularly relative to the fundamental DATA – and view exercising caution as the prudent thing to do here. Any sell-side strategist can come  up with a 1,001 reasons why you should buy stocks hand-over-fist here; we suspect clients are looking for a more holistic view.



Nor are they particularly expensive, either. Using data from Yale Professor and author of Irrational Exuberance, Rober Shiller, we chart the US equity market’s cyclically adjusted price-to-earnings multiple on both a nominal and real basis going back to JAN 1881. The latest readings (OCT ’12) are 24.1x and 21.4x, respectively. Moreover, the latest readings are each -0.5 standard deviations relative to their respective 10yr averages – i.e. not at all expensive by any means, but also not particularly cheap either. We would consider a “cheap” market multiple to be in the area code of -2 to -3 standard deviations oversold.









Looking at the first chart, one would be keen to notice that the US equity market’s multiple on a cyclically adjusted basis has been in secular decline (i.e. making long-term lower-highs) since its late 1999/early 2000 top. There are obviously a number of reasons for the development and continuation of this long-term trend; we agree that sentiment, money supply, the velocity of money, savings rates, asset allocation decisions, earnings growth and other catalysts have all played a factor.


One catalyst that is perhaps less discussed on a broad scale, but remains blatantly obvious to us is demographics. As the following chart shows, the percentage of the US population that is generally inclined to reallocate funds from the equity market into fixed income products has grown rapidly since that peak. The data certainly supports what the storytelling implies: as baby boomers continue to age en masse, they will increasingly be inclined to shift their portfolios from capital appreciation mode to capital preservation/cash flow mode, at the margins.




It’s important to note that this phenomenon will remain a structural headwind to the US equity market’s multiple and fund inflows for quite some time. We’re already seeing undeniable evidence of this via mutual fund flows, which have been overwhelmingly in favor of fixed income funds at the expense of equity funds since the start of 2009 – despite the US equity market being up over 100% “off the lows”!





Perhaps the aforementioned headwinds are precisely why Bernanke remains staunchly committed to ZIRP (now pledged through mid-2015). Acting as an artificial levee, Bernanke may be attempting to hold back the flood of capital that would otherwise be inclined to ditch the equity market(s) for the perceived safety and income of bond funds.


On the bright side of the ledger, the Federal Reserve’s easy monetary policies have been great for corporate balance sheet repair and earnings growth – both of which have been very supportive for dividend expansion. Equity investors continue to tout dividend growth/yields as a key reason to remain long of US equities; it’s worth noting that we agree that both catalysts are indeed supportive. Also supportive has been the boost to investor sentiment and the prices of “risk assets” into and through previous iterations of QE/OpTwist.


All that being said, however, we are inclined to argue that the hole being burned into the consumer’s income statement due to a lack of yield on interest-bearing assets might actually compel baby boomers to shift even more of their savings out of equities and into fixed income funds if they are seeking to hit some predetermined target for savings at retirement (i.e. they need to front incremental capital to fixed income funds because those interest-bearing investments now compound at slower rates; see: Japan). This view is supported by the fact that dividend income growth has demonstrably failed to keep pace with the decline in interest income in recent years, rendering total personal income receipts on assets off -26.7% from their 1Q08 peak in real terms.





All told, we continue to see a lot of storytelling as to why investors should remain long of US equities here. Unfortunately, that storytelling is not completely supported by the data. In fact, our analysis suggests that the consensus long-term bull case for owning US equities up here (“stocks are cheap”, “investors are underweight equities”, “dividend yields are compelling”, etc.) actually leads investors right to one of the most supportive theses for meaningful equity market weakness over the intermediate-to-long term.


Darius Dale

Senior Analyst

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