Surviving Storms

This note was originally published at 8am on October 31, 2012 for Hedgeye subscribers.

“It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is the most adaptable to change.”

-Charles Darwin


Suffice it to say, from a survival perspective, the last 48 hours have been humbling. As my generator teeters on running out of gas again this morning, I write this Early Look to you under a flickering light with a heavy heart.


We will move forward today. We will adapt and change. We will get through this together.


Yes We Will.


Back to the Global Macro Grind


Today is month-end for October (year-end for many mutual funds). Early morning futures are indicating we’ll get a lift into those month-end markups. Unfortunately, the broader risk management picture of Global Growth and #EarningsSlowing has not yet changed.


From The Bernanke Top (September 14, 2012), US stocks (SP500) and commodities (CRB Index) are down -4.3% and -8.1%, respectively. For October to-date, the SP500 is down -2% and the Tech Sector (XLK) is down -6%.


What will November bring?


I sincerely hope health and safety to the many of us who are in the dark here on the East Coast. But from a stock and commodity market perspective, hope is obviously not a risk management process.


On that score, because I’m really at a loss for words this morning – here are some risk management lines to consider that will be highly influential to US stocks and commodities in the coming weeks:

  1. US Dollar Index immediate-term TRADE breakout line of $79.57 (long-term TAIL support = $78.11)
  2. Euro (EUR/USD) long-term TAIL resistance = $1.31
  3. SP500 TRADE (1431) and TREND (1419) resistance
  4. Russell2000 TRADE (824) and TREND (846) resistance
  5. Tech Sector ETF (XLK) TRADE ($29.62) and TREND ($30.28) resistance
  6. Apple (AAPL) TRADE ($624) and TREND ($640) resistance
  7. US Equity Volatility (VIX) immediate-term TRADE support = 16.61; TAIL resistance = 19.05
  8. CRB Commodities Index TRADE (305) and TAIL (312) resistance
  9. Oil (WTIC) TRADE ($88.32) and TREND ($91.77) resistance
  10. Gold TRADE ($1735) resistance; TREND ($1699) support

At the same time, it will be important to monitor what the US Bond market thinks about risk. The 10-year US Treasury Yield has been as good a leading indicator as any on US growth in 2012 – here are the levels that matter most in our model:

  1. UST 10yr TRADE resistance = 1.81%
  2. UST 10yr TREND support = 1.72%
  3. UST 10yr TAIL resistance = 1.91%

In other words, if the 10yr yield can’t find a way to breakout > 1.91% in the coming weeks and months, the high probability situation in our model is that US growth will remain below 2% in Q4.


All the while, Chinese demand will be an open question. While our research and risk management views currently say that the “China has bottomed” crowd has no confirming data to support that claim, our views are always subject to real-time change.


Across risk management durations in our model, here are the lines that matter most on the Shanghai Composite:

  1. Immediate-term TRADE resistance = 2112
  2. Intermediate-term TREND resistance = 2151
  3. Long-term TAIL resistance = 2294

When an asset class is bearish across all 3 of our core risk management durations, we call that a Bearish Formation (when last price is above all 3 we call that a Bullish Formation). We don’t have to be bullish or bearish. We simply have to embrace uncertainty, change our minds, and adapt as the data does. That’s how we survive storms.


Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar Index, EUR/USD, 10yr UST Yield, and the SP500 are now $1691-1721, $106.21-109.97, $79.57-80.45, $1.28-1.30, 1.72-1.81%, and 1391-1419, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Surviving Storms - DXY


Surviving Storms - aa. vp

DKS: Not Much Room For Error

Takeaway: Nice print from DKS. But don’t chase it. The space should buoy the fundamentals. But NKE, FINL, FL are better buys. UA is better to sell.

We were asked several times today if we’d chase DKS on today’s print. The answer is No. In order to buy it here we need to be able to argue a sustainable 5-7% comp growth rate over the next 2-3 quarters to get to the earnings upside needed to justify a $50 stock. Recall that with DKS’ prime locations and escalating rent minimums, it generally needs a 3-4% comp without excessive discounting to leverage occupancy costs.

While we wouldn’t buy it, we wouldn’t short it, because the fundamentals of the athletic space in the US are simply too good, and should continue to be that way through at least the first half of 2013. As it relates to DKS, the times investors have really made money long and short have been when the company’s comp performance has deviated meaningfully from these levels. It’s quite difficult to argue either of those right now. Yet, at least.

With the completion of this year, DKS is likely to complete the best 3-year comp run in its public history. The only period that comes close was ’05-’07 – but that was a) a relatively solid economy, and b) just after its top competitor (Sports Authority) was just taken private and handed market share to DKS. Are we going to tack on ANOTHER year – especially when Golf Galaxy is going against some particularly hard compares? We’d consider it…but our concern is that the consensus is already there.


Yes, there’s more than just comps. We know that. The company is getting more efficient, it is doing a better job branding itself with key vendors, and just put up a 47% growth rate albeit off a low base accounting for ~2pts of top-line growth (though the 2-year change held steady vs 2Q levels). Also, DKS just put in its new AZ DC that should facilitate another 300 stores (50% growth from here). That is not to say that we NEED 900 stores, but the company can certainly get them if it so chooses. But at 17x next year’s earnings, would we rather own DKS, NKE, or RL? You can pretty much take your pick (within a point or so). That’s a no brainer for us. We’ll take content over distribution in this space in a heartbeat.

We’d look elsewhere – specifically NKE, FINL and FL – in that order for long  exposure here. If you have to short something, we’re still compelled to hang on to our UA short thesis here – as the company is going to incur some near-term pain in order to achieve the longer-term share gains that we definitely think will come.


Takeaway: The Street is not bearish enough on MCD.

We believe that the bulls on McDonald’s are basing their stance on some dangerous assumptions in FY13.  We have been looking for a reason to get long McDonald’s but believe, at this point, that 9% earnings growth in 2013 is unlikely to materialize. 


If history is any guide, the aggressive move to value will not be effective in over-riding investor concerns next year.  Back in October 2002, Jack Greenberg, then-CEO of McDonald’s, embarked on a “price war” after seeing his company report 10 months of declining same-restaurant sales, bringing back the Dollar Menu from a five-year hiatus.  At the time, as today, it was hoped that the Dollar Menu would help reverse a negative trend and lead to positive same-restaurant sales, but that did not materialize at the time and has failed to materialize so far in 4Q12.  Consumer perceptions of value are constantly changing; we don’t expect McDonald’s current strategy to achieve its objectives.


Management has been unwilling to concede that any factors, other than the macro environment, are weighing down earnings growth.  We are working on a more detailed analysis of the company’s outlook and will be publishing on that in mid-December. 


While McDonald’s is not reporting 4Q12 results for another two months, we are expecting one of the worst earnings reports from the company since the turnaround began in 2004.  We have come to the conclusion that the street is too optimistic on what MCD can earn in 4Q12 and in 2013.  In 4Q12, food, labor and other expenses are all working against company in what could be one of the worst quarters in the company’s recent history.

  1. We have MCD 4Q12 revenues of $6,754 million vs. consensus of $6,874
  2. Restaurant level margins of 17.1% vs consensus of 17.8%
  3. Operating margins of 29% vs consensus of 30.4%
  4. EPS of $1.29 vs consensus of $1.33

We are currently expecting 2013 to be another no-growth year for MCD EPS.  The Street is expecting a snap-back in EPS to $5.81, or 9% higher than 2012, versus our estimate of $5.27-5.30.


Howard Penney

Managing Director


Rory Green




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Flight To The 10-Year

The 10-year Treasury yield is currently hovering around 1.58%, nearing the August 2012 low of 1.48%. As growth continues to slow and the stock market weakens, investors are buying up Treasuries like it's going out of style. If the S&P 500 can't hold 1364, look for the 10-year to get pushed even lower.


Flight To The 10-Year - 10yearust

KORS: Freight Train Keeps Rolling

Takeaway: Growth like this is tough to find in retail. KORS may look expensive, but we would argue that 25x next year’s earnings is cheap.

Growth like this is tough to find in retail. 2Q results were solid across every line of the P&L again this quarter. Most notably, underlying 2yr sales growth accelerated both in retail comps (+45%) and at wholesale (+75%) with Europe (+97%) a source of strength (yes, not a typo) outpacing domestic growth (+45). 3Q guidance had some concerned pre-market, but the company has established a track record since the IPO of setting a reasonable bar, issuing a positive preannouncement intra-quarter, and then topping higher expectations. We think KORS’ 2H outlook suggests much of the same and expect this one to keep working higher into year-end.

The longer-term growth story predicated on store growth, wholesale conversions, handbag and accessories mix shift, and e-commerce and international penetration is still very much intact. Store rollouts and wholesale conversions continue to track ahead of plan and are likely to drive continued outperformance over the near-term. We still don’t love the inventory levels (+90%), but the sales/inventory spread improved sequentially by +16pts to -15% in the quarter – notable and favorable for gross margins. With the sales/inventory spread negative for the third consecutive quarter now, we think it reflects KORS' aggressive store rollout, but is a risk worth noting as we head into holiday shopping season. With gross margins coming in well ahead of expectations, improved inventory levels, mix, and decision not to engage in competitor promotions, we think outlook for a contraction in 2H gross margins will prove conservative.


All in, we’re shaking out 10% above the high-end of initial Q3 and FY EPS guidance at $0.44 and $1.65 respectively and $2.15 for FY14. That’s over 100% EPS growth this year and +28% growth next year. KORS may appear expensive, but for a high end brand with this kind of share gain and growth trajectory, we would argue that 25x next year’s earnings is cheap.

Accountability and Outlook: Here’s a look at KORS’s variance between guidance and actual, as well as outlook for F13 vs expectations:


KORS: Freight Train Keeps Rolling - KORS OUtlook table



A victim of its early success: most metrics down YoY 



Singapore’s gaming metrics continue to decline in Q3 as gross gaming revenues fell to the lowest level since 2Q 2010.  For comparison, Macau hit a new quarterly record in 3Q.  Q3 hold in Singapore was 2.27%, the lowest quarterly hold rate ever and way below Singapore’s historical hold rate of 2.99%.  Hold in 3Q 2011 was 2.90%.  If we use 3% to normalize VIP revenues in 3Q 2012 and 3Q 2011, GGR would have been S$1.77BN, which is down 14% YoY and 3% QoQ. 


3Q gross gaming revenues fell 23% YoY and 9% QoQ to S$1.57 billion.  Not since MBS’s grand opening has revenues been this low.  RWS GGR share rose 1.6% QoQ to 50.8%.




RWS gained 3% points in net gaming revenue share to 47.3%.  This is the 2nd consecutive quarterly gain for RWS.




Total property EBITDA experienced its 2nd consecutive YoY and QoQ decline to S$629 million, falling 29% YoY and 14% QoQ.  RWS’s EBITDA share jumped 5.6% points to 48.3%.




For the 4th consecutive quarter, RC turnover declined YoY.  RC turnover was S$27.6BN, down 25% YoY and 1% QoQ.  RWS’s RC share was 46.6%, down 0.8% points QoQ, marking the 3rd consecutive quarter of declines.




Mass revenue was flat QoQ as hold reached a new high of 23.52%.  Market shares were basically unchanged. 




Mass drop fell QoQ (6%) for the 1st time.  RWS gained 1.4% points in share to 46.8%.




Slot win slipped 4% QoQ and slot win per slot per day reached a record low of S$718.  RWS gained 1.1% QoQ in slot win share. 



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