I’ve been sitting here patiently waiting for new (lower) consensus numbers post the biggest sequential slowdown in orders (on a 2-year trendline basis) in nearly 10-years. The verdict is in, and unfortunately, consensus numbers are too high. Fourth quarter looks OK, but Nike will have a down year in FY10. I can model a positive ’11, but that barely gets back above last year’s high water mark.
To say that I believe in what this company is doing strategically to manage earnings and take share is an understatement. So few companies are managing so proactively. But these positive actions come at a cost, and that cost is that for the next 18 months, Nike will not be considered a growth company. That puts valuation back in the ‘tweener’ category. Not cheap enough for a value investor, not growth enough for a less valuation-sensitive growth PM, and certainly not appealing to a momentum investor given my view that it will be missing numbers more often than not – until they are reset 10% lower.
There’s a critical theme here. Nike is a company that grows in ‘bursts’ and after each one it resets for a couple years until it races forward again. Keep in mind that each time it ‘reset’ the world thought that the growth story was dead, and it was proved wrong. Check out the stock chart below. I identified 4 ‘bursts’ over 20 years. 1) ramp in US footwear. 2) US apparel. 3) Int’l growth. 4) Subsidiaries (Converse, Golf, etc…). Each of these bursts required a completely different organization. The next opportunity is globally integrated categories, regions, and products. This is massively complex – moreso than anything Nike has ever done. The good news is that it has been investing in it for 2 years. It has flexibility to shift around assets, and pare back excess to maintain margin and protect growth. But it won’t be pretty.
My prediction… My estimate of flat earnings will be proved wrong because Nike’s gonna buy something. Potentially something sizeable. The cash burning a hole in its pocket is generating $0.04 per share less in income now than a year-ago, and this company does NOT like to be perceived as anything but a growth company. Even though the recent Umbro deal – where Nike wrote off over 60% of the value just 1.5 years after buying it – might go down as its most value-destroying deal since Cole Haan, I don’t think that this will spook this management team from deploying capital to deals. If anything, I think it will reiterate what has always been the case with the Nikester – it does not do well when it buys broken or bruised assets. It needs strong brands, over which it can leverage its infrastructure to make stronger (like it did with Converse. My top picks? Lululemon (after it implements its ERP platform – Nike won’t get in front of that, Remember i2?) and Timberland. I also think Zappos would be a slam-dunk from an infrastructure standpoint, but I’m not holding my breath on that one.
So what’s my bottom line? The stock looks cheap. But it is only 2-quarters into a ‘resetting’ phase which could conceivably last 2 years. This name might be cheap for a while.
“I remember down in Houston we were puttin’ on a show when a cowboy in back stood up and yelled, Cotton-eyed Joe.”
At Research Edge, we don’t come to work Cotton-eyed (except for maybe the morning after the firm holiday party), but we do, in fact, have our Eyes on cotton.
Brian McGough, who is the Director of Research and Footwear and Apparel Analyst, recently sent a note to his clients highlighting the year-over-year declines in cotton pricing. His point, as it related to his coverage universe, was as follows:
“All in, let’s not forget that cotton accounts for about $5 in costs for a $100 garment at retail. We can debate up and down where in the supply chain any cost saves would show up – but quite frankly, I really don’t care at this point. We’ve had a 1.5 year cost headwind that is starting to ease on the margin. This will help everyone to some degree. It pains me to say this, because I have zero confidence in management or company strategy, but Gildan would be a disproportionate beneficiary to the reduction in cotton costs given that cotton is 35% of its COGS. If you want to play in that sandbox, then knock yourself out. I’m sticking with the winners like RL, HBI, UA (though it has zero cotton exposure – it competes with those that do), and LULU.”
The USDA announced last week that US cotton exports were up 23% for the week ending March 4th, which implies demand may be picking up. That said, the news from China continues to be bearish for cotton as noted by the U.S. Department of Agriculture: “China’s imports of cotton in the year through Aug. 31st may halve to 6.5 million bales from a year ago.” The most recent data point from China, released by the National Development and Reform Commission, was that China imported 93,000 tons in February, which was down 41% y-o-y. Since China is the world’s largest cotton importer, this data is very bearish as it relates to global cotton supply and demand, and future cotton prices. As outlined above though, low cotton prices are bullish for the margins of certain apparel manufacturers.
While the price of cotton appears to be troughing, we will need to see some sustainable fundamental evidence that supports either increasing demand, or decreasing supply, that will support a sustained price increase. As such, cotton may be a commodity to play on the short side against other commodities that will be more direct beneficiaries of the re-flation theme. This potential negative divergence in cotton is notable today with natural gas up 10.4%, West Texas Intermediate up 6.3%, gold up 7.7%, copper up 5.1%, silver up 13.9%, and cotton only up 2.95%.
We are currently long Oil via the etf USO and long the etn DJP, which mirrors the iPath Dow Jones-AIG Commodity Index.
Daryl G. Jones
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Today, in the shadow of the Fed’s 1 trillion DOLLAR bond purchase program, the BOJ’s 1.8 Trillion YEN a month program looks even more anemic. With the prospect of a weak dollar comes a return to the pain for Japanese exporters and the Nikkei retreated by 30 basis points.
For Japan’s leaders the pressure to find ways to stimulate the economy in the face of decimated demand from US and European markets is daunting. With an export industry that is dependent on big ticket consumer discretionary products, retooling for the current Chinese market is not a viable option and, although Chinese consumer spending is still growing (including a recent boost in car sales spurred by stimulus measures), buyers there are still years away from making up for the slack in high end US automotive and consumer tech sales. On the domestic front it seems increasingly unlikely that consumers will be convinced to start draining the savings they built up over decades of stagnation coupled with zero interest rates based on the historic low spending expectations included in the latest consumer confidence survey data. In the near term, all of these factors leave business leaders in Tokyo hostage to currency fluctuations.
As long as the dollar continues to weaken against the Yen, we expect key sectors of the Japanese equity market to remain under pressure and we will maintain our tactical short bias.
"You don't need a weather man / to know which way the wind blows."
An Inversion is the act of changing or being changed from one position, direction, or course to the opposite. In the art of using the breath to control the mind and body; the practice of Inversion allows for maximum brain stimulation.
The brain is responsible for processing all information we gather over our life time and blockages of blood flow to the brain can sometimes result in lack of clarity or something even worse. The inversion combats the lack of clarity by forcibly flushing old blood out of the brain cells, replacing it with freshly oxygenated, nutrient rich blood coming directly from its source, the heart.
Yesterday, Bernanke performed the economic equivalent of an inversion. It is very clear now where we are going, the Chairman put the US $ on its head giving some clarity to where we are headed.
At any given time at Research Edge we are managing multiple themes to help understand and invest in the global MACRO world. Of all the themes we are currently writing about none is more significant in the 2009 GLOBAL MACRO environment than the inverse correlation between the price of the US Dollar Index and US Equities. We call it "Breaking the Buck."
Our "Break the Buck" theme was made clear last week when the US Dollar posted its first week over week decline since the week of February 2, 2009. In the face of the US Dollar Index dropping -1.4%, the S&P500 powered ahead for a 10.7% move. The only other time this happened in 2009 was the week of February 2nd. In that week the US$ was down -0.66%, and it was also the last week the S&P 500 had positive performance of consequence, with the S&P 500 improving 5.2%. I don't need to repeat what happened yesterday.
In short, the consequences of Chairman Bernanke's actions and that of a weak US$ will inflate assets domestically and make US$ denominated debt more attractive to foreign buyers. The re-flating of US assets will help appease the Chinese, bolster the US housing market and shed a light at the end of the tunnel on the 14-month U.S. recession, which we have been calling the "Great Recession"!
"Breaking the Buck" has positive implications for anther consumer related theme we have written about - M E G A. If consumers can regain confidence that their Assets (A = 401k and home prices) will stop declining the world will be a better place.
At this point I know what you are thinking. No, this is not a long term solution! Re-flating assets has been tested and tried, and is an intermediate term solution. We will need to deal with the consequences down the road and yes, it ultimately could end badly. Right now, we remain short the US$!
As Chairman Bernanke is "Breaking the Buck," several other factors are starting to turn positive for the market. First, yesterday's move in the S&P 500 makes seven of the nine sectors bullish on TRADE and only one sector bullish on TREND; Technology (XLK).
The two sectors that are not bullish on TRADE (Healthcare and Utilities) appear to be are going nowhere; however, Consumer Staples (XLP) was the only sector to close down yesterday. Second, the VIX is broken on both durations; TREND and TRADE. Over the next week, we see the VIX breaking down through the 40 line, headed to 37.33. Third, volume was massive yesterday, up +47% day-to-day; the biggest volume day of 2009. In the MACRO models, the surge in volume is very bullish, highlighting conviction and is a signal that confirms the price move above our critical SHARK line. Along with volume, breadth (advance/decline line) continues to expand, as Industrials (XLI) joined the sectors in a positive TRADE. Yesterday, we covered our short on the XLI.
Lastly, the M&A cycle which started in Healthcare has now moved rather convincingly to technology. We think the Technology M&A cycle is just beginning and two ways to play it are by owning Yahoo! (YHOO) and Monster Worldwide ( MWW).
As we wrote about on March 10th, to gain Alpha in the current environment, you need to beta shift away from the "safety play." Over the past month, the top three performing sectors are the XLF (Financials), XLY (Consumer Discretionary) and the XLK (Technology). The corresponding beta on those three sectors is 1.8, 1.4 and 1.1, respectively. Yesterday, with a beta of 0.64, the XLP (Consumer Staples) showed a massive negative divergence. Driving incremental performance in the high beta sectors are numerous examples where fundamentally, things are looking less bad in 1Q09 from 4Q08. We continue to like early cycle Technology, Consumer Discretionary and Gaming stocks.
Function is disaster; finish in style.
RSX - Market Vectors Russia-The Russian macro fundamentals line up with our quantitative view on a TREND duration. Oil has benefited from the breakdown of the USD, which has buoyed the commodity levered economy. We're seeing the Ruble stabilize and are bullish Russia's decision to mark prices to market, which has allowed it to purge its ills earlier in the financial crisis cycle. Russia recognizes the important of THE client, China, and its oil agreement in February with China in return for a loan of $25 Billion will help recapitalize two of the country's important energy suppliers.
DJP - iPath Dow Jones-AIG Commodity -With the USD breaking down we want to be long commodity re-flation. DJP broadens our asset class allocation beyond oil and gold.
XLK - SPDR Technology-Technology looks positive on a TRADE and TREND basis. Fundamentally, the sector has shown signs of stabilization over the last several weeks. Semiconductor stocks, which are early cycle, have provided numerous positive data points on the back of destocking in the channel and overall end demand appears to be stabilizing. Software earnings from ADBE and ORCL were less than toxic this week and point to a "less bad" environment. As the world stabilizes, M&A should pick up given cash rich balance sheets in this sector and an IBM/JAVA transaction may well prove the catalyst to get things going.
EWZ - iShares Brazil- The Bovespa is up 6.9% YTD. President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt -leading to an investment grade credit rating. Brazil cut its benchmark interest rate 150bps to 11.25% on 3/11 and will likely cut again next month to spur growth. Brazil is a major producer of commodities. We believe the country's profile matches up well with our re-flation theme: as the USD breaks down global equities and commodity prices will inflate.
EWA - iShares Australia-EWA has a nice dividend yield of 7.54% on the trailing 12-months. With interest rates at 3.25% (further room to stimulate) and a $26.5BN stimulus package in place, plus a commodity based economy with proximity to China's H1 reacceleration, there are a lot of ways to win being long Australia.
USO - Oil Fund- We bought oil on Friday (3/6) with the US dollar breaking down and the S&P500 rallying to the upside. With declining contango in the futures curve and evidence that OPEC cuts are beginning to work, we believe the oil trade may have fundamental legs from this level.
CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +24.4% for 2009 to-date. We're long China as a growth story, especially relative to other large economies. We believe the country's domestic appetite for raw materials will continue throughout 2009 as the country re-flates. From the initial stimulus package to cutting taxes, the Chinese have shown leadership and a proactive response to the credit crisis.
GLD - SPDR Gold- We bought gold on a down day. We believe gold will re-find its bullish trend.
TIP - iShares TIPS- The U.S. government will have to continue to sell Treasuries at record levels to fund domestic stimulus programs. The Chinese will continue to be the largest buyer of U.S. Treasuries, albeit at a price. The implication being that terms will have to be more compelling for foreign funders of U.S. debt, which is why long term rates are trending upwards. This is negative for both Treasuries and corporate bonds.
DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.
EWJ - iShares Japan - Into the strength associated with the recent market squeeze, we re-shorted the Japanese equity market rally via EWJ. This is a tactical short; we expect the market there to pull back when reality sinks in over the coming weeks. Japan has experienced major GDP contraction-it dropped 3.2% in Q4 '08 on a quarterly basis, and we see no catalyst for growth to return this year. We believe the BOJ's recent program to provide $10 Billion in loans to repair banks' capital ratios and a plan to combat rising yields by buying treasuries are at best a "band aid".
EWU - iShares UK -The UK economy is in its deepest recession since WWII. We're bearish on the country because of a number of macro factors. From a monetary standpoint we believe the Central Bank has done "too little too late" to manage the interest rate and now it is running out of room to cut. The benchmark currently stands at 0.50% after a 50bps reduction on 3/5. While the Central Bank is printing money and buying government Treasuries to help capitalize its increasingly nationalized banks, the country has a considerable ways to go in the face of severe deflation. Unemployment is on the rise, housing prices continue to fall, and the trade deficit continues to steepen month-over-month, which will hurt the export-dependent economy.
DIA -Diamonds Trust-We re-shorted the DJIA on Friday (3/13) on an up move as we believe on a Trade basis, the risk / reward for the market favors the downside.
EWW - iShares Mexico- We're short Mexico due in part to the country's dependence on export revenues from one monopolistic oil company, PEMEX. Mexican oil exports contribute significantly to the country's total export revenue and PEMEX pays a sizable percentage of taxes and royalties to the federal government's budget. This relationship is unstable due to the volatility of oil prices, the inability of PEMEX to pay down its debt, and the fact that PEMEX's crude oil production has been in decline since 2004 and is down 10% YTD. Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.
IFN -The India Fund- We have had a consistently negative bias on Indian equities since we launched the firm early last year. We believe the growth story of "Chindia" is dead. We contest that the Indian population, grappling with rampant poverty, a class divide, and poor health and education services, will not be able to sustain internal consumption levels sufficient to meet targeted growth level. Other negative trends we've followed include: the reversal of foreign investment, the decrease in equity issuance, and a massive national deficit. Trade data for February paints a grim picture with exports declining by 15.87% Y/Y and imports sliding by 18.22%.
XLP -SPDR Consumer Staples- It performed terribly yesterday, closing down as a sector despite the market melt-up.
SHY -iShares 1-3 Year Treasury Bonds- On 2/26 we witnessed 2-Year Treasuries climb 10 bps to 1.09%. Anywhere north of +0.97% moves the bonds that trade on those yields into a negative intermediate "Trend." If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yield is inversely correlated to bond price, so the rising yield is bearish for Treasuries.
UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. The Euro is up versus the USD at $1.3496. The USD is down versus the Yen at 95.7400 and down versus the Pound at $1.4291 as of 6am today
As restaurant companies have become more focused on eliminating costs to offset the challenging sales environment, this type of cost cutting earnings beat has become more common. Yet, DRI is one of the few casual dining companies that has not scaled back on new unit growth. Instead, DRI’s FY09 capital expenditures are expected to total about $575 million, up 34% from FY08. This capital spending number includes about $80 million of costs related to the company’s new corporate headquarters, but even excluding these costs, capital spending is expected to increase 15% from 2008 levels.
Most other casual dining companies have been able to cut costs as a result of their having slowed down new development and capital spending, which enables them to cut back on resources and eliminate the inefficiencies associated with new unit growth. DRI, on the other hand, was able to achieve such substantial cost savings on top of its continued unit growth. The company stated that it was able to mitigate the impact of sales deleveraging on margins, primarily as a result of aggressive cost reductions, which lowered costs by $10 million in the quarter. Management said these savings were achieved earlier and were of greater magnitude than it initially expected. Acquisition synergies also helped to lower costs in the quarter. The company anticipates that annual acquisition synergies will level out at about $55 million with much of those savings already in place.
Relative to DRI’s prior FY09 guidance, the company is expecting better operating margin performance a result of improved leverage of its food and beverage, labor and restaurant expenses. And, this is based on only slightly better 2H09 same-store sales growth at Red Lobster, Olive Garden and LongHorn Steakhouse of -1.5% to -3% from its prior guidance of -2% to -4%. Although I was happy to see the company achieve these substantial cost savings in the quarter and improve its restaurant margins in 3Q09 by over 280 bps on a sequential basis from the second quarter, I am somewhat wary of the company’s ability to continue to deliver such incremental savings on a go forward basis as the company maintains its unit growth targets. DRI did slightly lower its FY10 new unit growth expectations to 53-65 from about 70 in FY09, but this is still significant growth in today’s environment. Despite my reservations around DRI’s ability to further materially reduce costs, I continue to believe that DRI will outperform its competitors, largely as a result of its nationally recognized brands.
There was some concern communicated on the earnings call about DRI’s declining gap to Knapp trends in 3Q to about 3% for its Red Lobster, Olive Garden and LongHorn Steakhouse concepts on a blended basis from 5% in 2Q. Such a decline signals that DRI is potentially losing share to its competitors, which is never a good thing. This 5% outperformance in 2Q, however, followed a 2.7% spread in 1Q so although there has been variability quarter to quarter, I think it is important to note DRI’s consistent outperformance, most notably at the Olive Garden.
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