My macro “call” for 2009 has had 2 parts – with two different durations:
1. Re-flation = 1H09’ (vs. Q408 prices)
2. Increasing Cost Capital = 2H09’ (on an absolute basis)
The first part of this call has to play out in order for the second part to – that’s why I made it a two part call. With the price of oil up for the last 6 weeks, consecutively, taking it +42% over that time period and +15% for 2009 YTD, we are already getting what we were looking for.
Obviously copper prices being +25% for 2009 to-date supports the same. As does the SP500 trading +8% so far for March to-date, reflating +5% from the November 20th low, and +18% from the March 9th low.
A lot of market pundits confuse the terms reflation and inflation – they are not the same thing. Reflation can occur on a day-over-day and/or a month-over-month basis. All reflation means is a sequential acceleration in the price of whatever you are measuring. I measure inflation on a year-over-year price change basis.
Issuing massive liquidity like the US Government has, in the end, will be inflationary. In between now and whenever we see inflation pick up on year-over-year basis (I think we could see that more obviously in Q1 of 2010), we’ll see 2-year yields on US Treasuries rise. They should effectively start discounting what it is that we are going to see on the inflation front, no matter how many Treasury bonds Bernanke says he’s going to buy.
At ZERO percent, rates in the USA are as low as they can go. The only place they can go from here (provided that we don’t turn this place into a Japan) is UP. Rates on 2-year Treasuries are already moving to higher intermediate term highs. An important line in the sand for 2-year yields is the intermediate TREND line at 0.88%. Trading above that line is where I’ll start to concede that reflation is running higher/faster. Trading below that line is where we should all be worried about deflation.
Queen Mary better turn higher, or deflation will have us all resorting to the unenviable investment position of having to pray. Reflation is the only way out of this mess.
Keith R. McCullough
CEO / Chief Investment Officer
With a maturity date of April 2, this Thursday, the deadline for Crocs to amend its credit facility is looming. Under the current agreement, the company has $22.4mm in borrowings, which is due Thursday if the company is unable to secure a new facility. It ended the year with $52mm in cash, so CROX will have had to burn through more than half of this during the quarter to risk not having enough cash on hand to fund its debt service. (Note: I wonder if the Bill and Melinda Gates Foundation – which owns at least 3.6% of shares outstanding – will let the company go under due to a near-term inability to fund short-term debt?)
Here’s how I look at it. I’m not saying that Crocs is a growth company. In fact, let’s assume the opposite. Let’s say that either the new CEO or a strategic buyer scoops up this company, takes the top line from the $847mm peak down to a core of $400mm and runs at a 10% margin (I can defend this rate six ways til Sunday). That suggests about $42mm in EBITDA. With no store openings, Crocs can sustain itself on $10-15mm/yr in capex – so we’re looking at about $25-$30mm in free cash.
At $1.19 we’re looking at an EV of $69.2mm. Do the math…the midpoint of the implied free cash flow ($27.5mm) suggests that internally generated cash flow can pay for the company in 2.5 years.
As the sun was setting at Bay Hill in Orlando, Florida last night, one of America's finest leaders reminded us that winning is ultimately born out of adversity. After reconstructive knee surgery and a 16 foot birdie putt sinking on the 18th, Tiger Woods is already back with a PGA Tour win. Leaning on his bad knee, Woods didn't ask for a bailout of that 17th hole bunker - he's an American who proactively prepares - and man is he tough to beat!
Unfortunately, the young men on the Yale Hockey team weren't so fortunate, but they learned an important life lesson in Bridgeport, CT on Friday night - if you want to win at the highest level, you have to be playing at your best. That's what this globally interconnected marketplace is demanding from us every day - these markets wait for no one. Winners and losers emerge every day.
The US stock market has proven that risk managers and traders alike have had ample opportunity to prove themselves to their investors in the last 2 months. At +11% for March to-date, the SP500 is UP as much as it was DOWN in February. Who has the winning strategy that can earn an absolute return in both up and down markets? The YouTubes are on, and we will most certainly see...
Friday's US stock market weakness was mostly price driven. This is no surprise - this market trades on price, not valuation. On a day-over-day basis, volume was down -32% versus that which we saw trade into Thursday's 3-week highs. After a +23% trough-to-peak squeezing of the Depressionistas temples, there was (and continues to be) plenty of room for US stock prices to deflate. Inclusive of Friday's -2% loss, the SP500 is still up a very relevant +20.6% from its March 9th low of 676.
Where are we headed next? Lower. While the Nasdaq is still trading +3% above what I call the intermediate TREND line (I am long QQQQ), the SP500 failed to hold its head above hers (827). With the Dow (I am short DIA) and the US Financials (XLF) broken from a TREND perspective, Tech and Consumer Discretionary can only carry this market on their backs for so long.
We sold most of our Tech names in our virtual portfolio into Goldman getting amped up on the semis on Thursday. Some of what Rebecca Runkle calls "Tech Spec" was re-flating too expeditiously (Monster Worldwide (MWW), Red Hat (RHT), etc...), so we sold those as well. No, there are no rules against buying them back! While the XLK (Tech) is +3% for 2009 to-date, and we are still long the ETF in our Asset Allocation Portfolio, it's not going to be a winner every day. Everything has a time and a price.
There are 3 out of 9 sectors in the S&P that are bullish on both an immediate term TRADE and longer term TREND basis: Consumer Discretionary (XLY), Basic Materials (XLB), and Tech (XLK). No these aren't themes - these are quantifiable TRENDs that story tellers start to build investment themes around. The most obvious one that all of three of these sectors have in common is that they are what most investors recognize as "Early Cycle" stocks.
In this 2009 global market battle, being early is a heck of a lot better than being late. The old "event driven" momentum model of the levered long days has rendered the Fast Money strategy of buying high to "sell higha" somewhat useless. What we want to be doing here in a Bear market is simply buying low (early), and selling high (late). The strategy has been around for centuries, it's actually not that complicated.
What is complicated is understanding why President Obama let Timmy Geithner out of this room yesterday. On a busy market day, it's hard enough to trust his mug while it's on television, never mind when thought leaders in this country can actually take the time on a Sunday to listen to what this man is actually saying. I'll let the media get you up to speed on what he said specifically, but I can assure you of this - the world doesn't trust this guy as far as Rick Wagoner can throw him.
Away from Obama throwing out the embattled CEO of GM overnight, the global economic community seems perfectly happy to toss whatever they owned for a Bear market TRADE right back under the bus this morning. As Geithner moves to try selling Americans on "Cash for Trash", most of us are cool with tucking our very own hard earned cash under our beds and hoping that his days leading this country out of this financial mess are soon over...
Hope, of course, is not an investment process. Neither is betting against the true American leaders in this country, like Tiger Woods. In a world where everyone who won't exist without a bailout is whining for more easy money leverage - it's time to start looking in the mirror and focusing on winning without the foot wedge. Play by gentleman's rules and do whatever it is that you need to do to get that win on the tape - because no matter where you go out there today, there those marked-to-market scores will be.
Always be at your best - stay hedged - and always make your portfolio structure tough for Big Government to beat. My downside support levels for the SP500 are 801, then 760. Manage risk (or trade) around those levels proactively.
Best of luck out there fighting the good fight today,
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 via a quicker decline in asset prices. 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 producers and suppliers.
QQQQ - PowerShares NASDAQ 100 - We bought QQQQ on Wednesday (3/25) on the pullback. We believe the NASDAQ has moved into a very bullish tradable range and is breaking out from an intermediate TREND perspective alongside the more Tech specific XLK etf.
USO - Oil Fund- We bought oil on Wednesday (3/25) for a TRADE and are positive on the commodity from a TREND perspective. With the uptick of volatility in the contango, we're buying the curve with USO rather than the front month contract.
EWC - iShares Canada-We bought Canada on Friday (3/20) into the selloff. We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's large government recent history, and believe next year's Olympics in resource rich Vancouver should provide a positive catalyst for investors to get long the country.
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.
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.
GLD - SPDR Gold- We bought gold on a down day. We believe gold will re-assert its bullish TREND.
DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.
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 down versus the USD at $1.3169. The USD is down versus the Yen at 96.7600 and up versus the Pound at $1.4119 as of 6am today.
XLI - SPDR Industrials- We shorted it on 3/26; industrials remain broken on a TREND basis.
EWL - iShares Switzerland - We shorted Switzerland for a TRADE on an up move Wednesday (3/25) and believe the country offers a good opportunity to get in on the short side of Western Europe, and in particular European financials. Switzerland has nearly run out of room to cut its interest rate and due to the country's reliance on the financial sector is in a favorable trading range. Increasingly Swiss banks are being forced by governments to reveal their customers, thereby reducing the incentive of Switzerland as a tax-free haven.
LQD - iShares Corporate Bonds- Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back. Moody's estimates US corporate bond default rates to climb to 15.1% in 2009, up from a previous 2009 estimate of 10.4%.
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 to attain its 2% inflation target. Unemployment is on the rise, housing prices continue to fall, and the trade deficit continues to steepen month-over-month.
DIA -Diamonds Trust-We shorted the DJIA on Friday (3/13) and Tuesday (3/24).
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-Consumer Staples was the best sector on Friday (3/27), showing that low beta can actually work on a down day!
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.
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Lodging is a highly cyclical space and it tends to be an early cyclical mover. Many investors believe that 2009 numbers are “trough” and therefore deserve a higher multiple. For most lodging companies, especially owners of hotels, we would argue that 2010 will be a materially worse year than 2009. However, our EBITDA estimate for MAR is only 5% lower than 2009, mainly due to the following:
- MAR should still experience a nice benefit from room growth, as many of the hotels under construction today are already financed and will open
- MAR owns/leases few hotels – so there is less of the flow-through issue
- Over 50% of the rooms in MAR’s system are limited service, which is more “defensive” than Upper Upscale and Luxury segments. Ritz Carlton represents only 4% of MAR’s system rooms
- Only $850M or so MAR’s debt is getting refinanced in the next 3 years, with only the credit facility being likely renegotiated by YE 2010, so the mark-up on interest won’t be as painful for MAR as many other companies in the space
MAR is trading at 10.5x 2009 and 2010 EBITDA. Consistent with the last year, we are still below the Street consensus EBITDA estimates, by 4% and 10% for 2009 and 2010, respectively. On a P/E basis I have them at roughly 19-20x. To put current valuation in context we looked at where MAR has traded over this last decade based on actual forward results. See the charts below.
We believe that MAR’s P/E multiple troughed in 2008 at 14x our 2009E EPS estimate of $0.91. Using historical achieved EPS, P/E troughed at 14x in 2003 when the stock hit $14.43. EV/EBITDA multiples also troughed at 7.5x in 2003. The average forward P/E ratio over this time frame was 27x. However, if we exclude 2000, 2007 (peak take-out speculation) and 2008 (Street expectations were massively too high for 2009) the average is closer to 22x. The average forward EV/EBITDA ratio over this time frame was 13x. However, if we exclude the same periods as above the average is 11.5x.
The takeaway here is that current valuations are above trough valuations and are not significantly out of line with historical multiples. The problem though is that the road to recovery from this cycle may be slower and longer than most investors anticipate:
- Many of the cost cuts are not permanent
- Occupancy needs to stabilize before ADR begins to recover and we are nowhere close to that as Q1 is the first quarter where ADR will take a meaningful hit
- Flow through from ADR is much worse than Occupancy
- Higher group rates booked in early 2008 and 2007, will roll off the books in 1H09, and be replaced with lower rated AAA, AARP, airline crew, and OTA merchant bookings, which will then take a while to roll-off again when things improve
- When most of the 5 yr 2006 & 2007 CMBS financing roll in 2011 & 2012, companies will experience a huge markup on their cost of borrow. Same goes for financings put in place from 2006-1H2008
While MAR looks to be one of the best positioned, i.e. most defensive, lodging companies, the sector has had a huge run. Until occupancy stabilizes, the stocks are unlikely to sustain rallies, at least that’s been the historical precedent (see our 01/29/09 post “A GIRAFFE FROM HEAD TO TAIL”). Given our outlook, this space should be rented for near-term catalysts and not owned. For MAR the catalyst was Capex cuts (which we got) and improving investor sentiment. Now that we’ve achieved a 35% move in the stock since 3/6/09, there appears to be little reason to stay with it.
I’ve been noting for the past month my view that retail’s cash flow trajectory will meaningfully improve in 2H.
Last week’s earnings revisions challenged my view, as outlined in the chart below. This was largely the result of revisions at Nike, and to a lesser extent Abercrombie, and Ross Stores.
My confidence level remains high, however, as commentary from these companies are contributing to the factors that I think will cause cash flow to bounce. Again -- I am NOT making a call on the consumer, but am simply modeling that the delta in the negativity of consumer spending (less toxic is good in my model) occurs simultaneously with stabilizing gross margins, and a cost-reduction cocktail of absolute SG&A and capex cuts. (See my March 5th note “I’m Getting Fundamentally Bullish” for more quantification).
The big question heading into 2010 will be who cut costs because they could, vs. who cut because they should. We’ll see plenty of weak companies cutting into bone this year, and they’ll be the next shoe to drop.
I’m drawn to the quality companies today who I know are investing in the right places for the right reasons, such as Ralph Lauren, Under Armour Lululemon, Hibbett, and (dare I say) Liz Claiborne. Hanesbrands also fits the bill. I don’t like those who are cutting in all the wrong places, such as Ross Stores, Iconix, Sears, Carter’s, Jones and Gildan. The challenge here is that this latter basket of companies will also show a reversal in cash flow trends, temporarily masking the damage they are doing to their base business. I’ll be working closely with Keith to game the sizing and timing on these fundamental ideas when the group looks more ‘shortable’ and/or when the near-term fundamentals for each of these names present an opportunity.
I’m sitting here having my morning coffee going through last week’s bankruptcy filings. This quote from the CEO of Active Wallace almost made me choke on my bagel.
“The swift and dramatic downturn in the local economy had a major impact on our business in the 3rd and 4th quarters of 2008. The preemptive cost cutting initiatives that we took throughout 2008 were not enough to protect our investments...”
Ok…I’m not a retail CEO, so I don’t purport to be able to do this guy’s job better than him. But the statement referring to “cutting costs to protect investments” is flat-out ridiculous. Maybe if you cut costs and reinvest in your brand then this works. But when you cannot cut a leg off a bar stool and expect it to stand on its own.
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