Pundit Bias

This note was originally published at 8am on October 18, 2012 for Hedgeye subscribers.

“Wherever there is human judgment there is potential for bias.”

-Nate Silver


That’s a quote from an excellent chapter titled “Are You Smarter Than A Television Pundit” in The Signal and The Noise. Before he moves onto baseball, Silver does a nice job differentiating between quantitative versus qualitative opinions in the partisan media.


So you will need to adopt some different habits from the pundits you see in TV. You will need to learn how to express – and quantify – the uncertainty in your predictions. You will need to update your forecast as facts and circumstances change.” (pg 73)


If that sounds familiar, it should. This is all encompassing in Hedgeye’s founding principles of establishing Transparency, Accountability, and Trust through independent research. Journalists are not analysts. And only the great analysts in our profession embrace the uncertainty of there being a high probability of being wrong. It’s ok to say it like that. We’re not on TV.


Back to the Global Macro Grind


China’s 7.4% GDP report for Q3 of 2012 provides a great example of where we were wrong this morning. In our Monday research meeting we discussed what we thought was a heightening probability that Chinese GDP surprised on the upside. It didn’t.


Now if you turn on the radio or TV this morning, you’ll probably see something very different than what I just wrote (or what I have been writing on Twitter). Since most of these sources are journalistically driven, they obviously don’t have forecasting models. Instead, they anchor on other people’s content (the sell-side’s), which at times can be even worse than a journalist’s opinion.


“China beat”, “China has bottomed”, “China is not Spain” – scanning the Old Media’s headlines will get you spew like that. Whereas I we’ll just show you the data within our analytical framework:

  1. China’s Q3 2012 GDP of 7.4% slowed sequentially (quarter-over-quarter) from 7.6% in Q2
  2. China’s Q3 2012 GDP of 7.4% slowed -19% year-over-year versus 9.1% in Q3 of 2012
  3. China’s Q3 2012 GDP of 7.4% slowed more than the low-end scenario in our forecasting model of 7.6%

In other words, across our risk management durations (TRADE, TREND, and TAIL):

  1. TAIL (3 years or less) – China continues to slow, and surprise both its government and the world on the downside
  2. TREND (3 months or more) – China continues to slow, at an accelerating rate, sequentially
  3. TRADE (3 weeks or less) – China’s stock market just moved to immediate-term TRADE overbought on the news

Maybe China has “bottomed.” But I have no high-probability edge on that and neither do you. Or, let me say that more democratically – if you can send me a model that shows me why and how China just bottomed, I’m happy to look at how you’ve analyzed the Chinese government’s made-up numbers. I’m even happier to change my mind.


Made-up, or Madoff? Yes, both American and Chinese guys make up the numbers. And this makes it all the more difficult to make a macro forecast that something has “bottomed” or “topped” with a straight face. It might get you on TV however.


Having had to learn from all the mistakes I have made the hard way, the best risk managed opinion I can give you is that both tops and bottoms are processes, not points.


In forecasting “Principle #1: Think Probabilistically” –Nate Silver


“Instead of spitting out just one number and claiming to know exactly what will happen, I instead articulate a range of possible outcomes.” (page 61)


I don’t love everything Silver thinks, but I do love that. That’s the closest thing I have read in the last year to what we call our Risk Range. That’s what you see at the bottom of every Early Look - our immediate-term range of probable upside/downside (risk) – and I think most people would say that’s the most accurate and repeatable forecast we give you every morning.


So skip my rants and go to the bottom of the note - save yourself some time.


One more point on China - to get Commodities right, we think you need to get the Dollar, Supply, and Demand right. If you think China has “bottomed”, you’re going to have a very different long-term forecast than ours right now. The risks are rising that there’s a decade long-cycle of price and demand topping.


Everything that happens in Macro that matters most happens on the margin. And if the new long-term range of Chinese GDP growth is 4-8% instead of what it’s been (8-12% for the last decade), that could matter, big time.


If and when we get that wrong, we’ll write about it transparently and accountably that morning.


Our immediate-term risk range for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, Shanghai Composite, and the SP500 are now $1733-1761, $112.60-115.05, $79.01-79.69, $1.29-1.31, $1.73-1.83%, 2066-2139, and 1449-1469, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Pundit Bias - Chart of the Day


Pundit Bias - Virtual Portfolio


The Macau Metro Monitor, November 1, 2012




Macau GGR rose 3.2% YoY to 27.7 billion MOP (26.9 billion HKD, 3.47 billion USD).


Early Look

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Moving Fast

“The world is changing very fast. Big will not beat small anymore. It will be the fast beating the slow.”

-Rupert Murdoch


A friend of mine in Connecticut just sent me that quote. Like most of us on the East Coast, he’s up and at it early this morning. Risk happened fast. Now it’s time to slap on a pair of jeans, fire up our generators, and take on the day.


In The Signal And The Noise, Nate Silver calls out what physicist Didier Sornette alludes to as the “fight between order and disorder” (page 368). That fight isn’t new. However, through chaos theory, we are beginning to understand it more clearly.


Not unlike the world and its weather, I think about the Global Macro marketplace as one of interconnected factors that are colliding within a complex system. “Complex systems like this can at once seem very predictable and very unpredictable… they periodically undergo violent and highly non-linear phase changes from orderly to chaotic and back again.” (Silver, page 369)


Back to the Global Macro Grind


For most things Big Beta, October was gnarly. We won’t know what the fallout looks like on the buy-side until it’s old news. But the new news is that buying high-beta stocks and/or commodities at the Bernanke Top of September 14th, 2012 left a mark.


That’s not to say there weren’t what perma-bull marketing pundits tried to sell you yesterday morning as a “hurricane Sandy buying opportunity.” You just need to be selective about what you buy and when.


In the US stock market alone, look at the S&P Sector performance divergences for October 2012:

  1. SP500 = -2.0%
  2. Financials (XLF) = +2.0%
  3. Utilities (XLU) = +1.4%
  4. Basic Materials (XLB) = -2.1%
  5. Technology (XLK) = -6.3%

Markets rarely make perfect sense to me but, from a research perspective, these Sector divergences did.

  1. SP500 = bearish TRADE and TREND, so pervasive weakness into month-end made sense
  2. Financials = that’s the 1st Sector you buy if you think Romney wins (his closing the gap was enough, for starters)
  3. Utilities = that’s the low-beta trade that we recommended downshifting to last month; we’re still long it
  4. Basic Materials = get the Dollar right (Romney momentum = anti Bernanke momentum), you get commodities right
  5. Technology = Growth and #EarningsSlowing (our Top Macro Theme for Q412) matters, in the end

Where to from here? Let’s start with the Hedgeye Asset Allocation Model:

  1. Cash = 58%
  2. Fixed Income = 21% (Treasuries, Treasury Curve Flatteners, German Bunds – we still like them all during #GrowthSlowing)
  3. International FX = 15% (Strong US Dollar, stick with it unless it becomes clear that Obama is going to win)
  4. US Equities = 6% (Utilities and Financials we think continue to work; buy them on red)
  5. International Equities = 0% (with markets like Russia moving back into crash mode (-19.1% since March) we’re in no hurry)
  6. Commodities = 0% (we’ve been calling it Bernanke’s Bubble since March – sticking with it)

The asset allocation model isn’t for everyone. It’s actually for me. It’s how I think about my own money and what I am willing to put at risk at a given time and price. Since I own a lot of Hedgeye stock, my Cash position is overstated. This is meant to be a product whereby I can signal when/where I’d be adding to or subtracting from big liquid asset classes, on the margin.


The most important principle in my decision making process is uncertainty. I embrace it every minute of the day and reserve the right to change my mind, fast. That’s not for everyone. And I get that. I also get that, sometimes, it’s better than being slow.


After all, that’s what Rupert Murdoch is alluding to in the aforementioned quote inasmuch as the world’s largest sovereign governments have been reminding you of, almost daily, for the last 5 years. While Too Big To Move can be a problem for you when you have an 80 foot tree hanging on power lines across your driveway, you still need to be fast to adapt and change.


Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, Technology (XLK), AAPL, and the SP500 are now $1, $107.41-109.09, $79.56-80.39, $1.28-1.30, 1.70-1.75%, $28.29-29.44, $586-616, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Moving Fast - Chart of the Day


Moving Fast - Virtual Portfolio


Takeaway: Consensus BKW US & Canada same-restaurant sales estimates are very aggressive and Burger King's system remains "Too Big To Fix".

Burger King’s 3Q12 earnings per share beat consensus estimates by $0.02 but the myriad adjustments and one-time items muddied the waters.  The company has been cutting its way to improved profitability but history tells us that this, as a sole driver, is unsustainable.


The performance in sales trends is what carries most weight for the Burger King investment thesis.  On that metric, the outlook is uncertain.  In the U.S., two-year average trends accelerated by 100 basis points, sequentially, from 2Q12 to 3Q12.  The U.S. constitutes almost 60% of the store-base.  As the charts below highlight, consensus is expecting a sharp acceleration in trends during the first half of 2013.  Holding current two-year trends level suggests negative same-restaurant sales trends for 1H13. 




BKW: NOT A QUARTER ROYALE - bkw us canada consensus


Same-store sales slowed on a two-year average basis in Latin America and the Caribbean and Asia Pacific (18% of the store base); flat in Europe, the Middle East and Africa. 



Outlook for Burger King


The overall BK strategy, according to management, is based on 4 pillars: Image, Menu, Marketing Communications, and Operations.  Below, we outline some thoughts on these initiatives and the progress that was made on each during the third quarter.





Remodeling the store base is the core focus of the “Image” initiative.  There was some good news in the quarter.  The number of Burger King stores in the USA needing to be remodeled is shrinking, but it needs to continue shrinking.  At the end of 3Q12, the system wide units had declined by 1% year-over-year and 0.2% sequentially.  Also, management announced that they received new commitments to re-image more than 350 restaurants in the United States and are on track to reach our target of having 40% of the US and Canada system on a modern image within three years.


The bad news, from our perspective, is that they did not disclose how many units were remodeled during the quarter.  The company outlined plans suggesting that almost 3,000 restaurants will be converted over the next three years.  The implication is that the Burger King system, in the United States and Canada, needs $350 million in capital every year for the next three years in order to complete the re-image program.


During the earnings call, management stated that its “analysis of remodels completed to date continues to reflect an average sales uplift of 10% to 15%, providing an attractive return to franchisees.”   Whether or not that target is achieved, even post-reimage Burger King store volume would be significantly below the competition.  


Hedgeye Conclusion:  We still believe that Burger King is “too big to fix”.



The Menu


Management stated that it is “seeing tangible results from the strategy to balance targeted promotions in premium limited time offerings.  This strategy is designed to shift our consumer profile and product mix, which we believe is key to driving positive, profitable growth for the BK system in the long-term … A key element of our strategy is to broaden the appeal of our advertising and bring a more diverse customer mix back into our restaurants. We saw further evidence of results on this front in our consumer segmentation data, which shows us that the change in marketing strategy has been successful and Burger King's mix of both women and customers age 50 or older increased.”


Hedgeye Conclusion:   Changing the menu at this point, and focusing significant amounts of resources and energy on it, is putting the cart before the horse.  It may require some attention to a degree, but is not going to lead Burger King to where shareholders want it to be.  Emil Brolick, at a lunch hosted by WEN at the outset of his tenure as CEO, stressed the importance of improving his company’s asset base over menu items for sustained market share gains.  We do not know any other QSR companies targeting customers 50 years of age and older and we think there is a reason why others are not focused on that demographic.



Marketing Communications


Management stated: “Our television advertising is increasingly focused on taste, which we think is a key differentiator for Burger King due to our flame-broiled grilling platform. This quarter, we used our advertising focused on limited time chicken offerings to create awareness around our broader chicken platform, including the Chicken Parmesan Sandwich, our new Popcorn Chicken, as well as wraps.”


Hedgeye Conclusion:  Burger King stepped up media spending in 2Q and 3Q to unsustainable levels.  We will see if the investment yields positive returns over the next few quarters but the current level of media spending will not continue. 





Management stated: “Speed of service slowed marginally with the introduction of our new products in early Q2 but has improved in the subsequent months, as coaches and crews in the restaurants accumulated experience with the new platforms and product builds. Our average speed of service is likely to remain somewhat higher than some of our peers due to our made-to-order service model, but we still have more work to do to reduce wait times and improve training in connection with the new product roll-outs.”


Hedgeye Conclusion:  Burger King’s service standards were significantly below the competitors before the introduction of new menu items.  Now, it seems, relative performance on those metrics is getting worse.  Adding complexity to the menu will likely impair any progress on this front.



Howard Penney

Managing Director


Rory Green



PVH/WRC: Finally

Takeaway: While the strategic and financial implications make a ton of sense – we see further upside from here.

 After nearly a decade of speculation, the timing finally aligned for PVH to capitalize on WRC’s operating shortfalls through 1H. With a business over-indexed to Europe and WRC in search of a transformative deal, Manny Chirico (CEO) moved in earlier this summer sealing a deal just 8-months into Helen McCluskey’s tenure. The reality is that a combined PVH/WRC makes sense and initial accretion projections are likely conservative. This is a win/win for both as the 22% increase in aggregate market cap today suggests, but we see further upside with $10 in FY14 EPS on the horizon.

  • Based on our estimates, Calvin Klein accounted for ~70% of WRC’s revenue base and ~80% of total EBIT. With the transaction valuing WRC at ~$2.9Bn and assuming a 5x EBITDA multiple for WRC’s Heritage businesses(Chaps, Speedo, and intimate brands Olga and Warner’s), the deal implies PVH paid a ~9.5x multiple for the CK business on FY12E estimates and under 8.5x FY13E pre synergies. This isn’t exactly a steal, but if you believe that WRC’s numbers are depressed, then it is attractive enough for a brand that has grown at a +13% CAGR at retail since it was acquired by PVH in 2003 and is expected to grow +8%-10% over the next 5-years.
  • At risk of stating the obvious for a deal so widely expected, the strategic fit here makes sense given that WRC is PVH’s biggest licensee. Layer WRC’s core business over PVH’s infrastructure while complimenting each company’s regional strengths – PVH in NA and Europe, WRC in Latin America and Asia. Not to be overlooked is the ability for PVH to control the presentation of CK in its entirety at retail, which should help reignite a struggling ~$700mm CK Jeans franchise.
  • With $100mm in costs targeted for elimination over the next 3-years as well as MSD-HSD revenue growth, PVH is looking to grow operating margins by nearly 50-75bps over each of the next 3-years.
  • With $1.00 in EPS accretion by 2015 likely conservative, investors will start looking at FY14 EPS approaching $10.00. With margin expansion under the combined entity expected to drive a high-teens earnings growth rate over the next 3-years, we think multiple expansion is likely. However, even if we simply take the upper end of PVH’s historical EPS multiple over the last decade of 16x, we’re looking at a $160 stock over the next 12-24 months suggesting a 20%+ annual return even after today’s 18% move.
  • Targeting early 2013 for closing the transaction.

Additional Highlights from the Call:

  • WRC operating teams expected to stay on to operate various brands with headcount reductions expected to be primarily in back office
  • PVH expects to pay debt down by $400mm/yr over the next 4yrs – focused on delivering as they did post Tommy deal
  • Looking to finance the deal with a $4.324Bn financing commitment in the form of both bank financing and unsecured notes
  • PVH will have more favorable leverage ratio post WRC deal (3.4x) than 2yrs ago when it bought Tommy (3.6x) – goal to get back down below 2.5x
  • With this deal PVH hurdles RL in retail second only to VFC in revenues
  • Deal shifts ~$100mm in WRC royalty revs to owned leaving a ~$170mm royalty base going forward
  • Plan to leverage Tommy’s European expertise to drive stronger CK apparel presence in Europe beyond today’s $1Bn in revs
  • Tommy growth opportunities via WRC’s Asia/Latin America presence upside to today’s plan – but don’t want to risk significant growth opportunity for CK by integrating Tommy too early (3-5yrs out)
  • Operate a $200mm Tommy business in Latin America today and $600mm Tommy business in through licensing
    partners that present an opportunity to integrate in the future
  • PVH assuming Chaps license (RL) does note continue re its accretion assumptions – currently in discussions with RL about this now
  • ‘no intention of selling it at this point’ – re strength of Speedo business.
    • Though ~$400mm+ PVH could get for Heritage business could help toward delivering if need be
  • WRC’s store growth plans under review. Underwear stores work, but would like to put underwear and jeans under same roof


PVH/WRC: Finally - PVH WRC 2


PVH/WRC: Finally - PVH WRC 3


PVH/WRC: Finally - PVH WRC 1


PVH/WRC: Finally - PVH WRC 4


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