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Italy’s Uneven Footing

Takeaway: Italy equities (EWI) look ripe for a correction as election indecision looms.

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With a recent spate of negative Italian data we thought it important to update the macroeconomic imbalances and risks in Italy. Below is a levels chart of Italy’s FTSE MIB index that we think is ripe for a correction given the looming election uncertainty.

 

Italy’s Uneven Footing - 11. ftse mib index

 

As a long-standing member of the PIIGS, one of Italy’s most immediate threats is the upcoming election – including the possibility of a power vacuum alongside the transition away from the current technocratic government of PM Mario Monti (and therefore the reform measures passed during his term).  This could jeopardize the stance of its sovereign and banking ratings. 

 

Despite all the noise from former PM Silvio Berlusconi that he’ll make another run as a candidate and speculation around Monti putting his hat in for another term, what’s clear is that Berlusconi and his PDL are trailing badly in the opinion polls.  Per Luigi Bersani of the Democratic Party (PD) is the current front-runner and despite Berlusconi’s comeback barks we believe he realizes that he personally has no shot to be elected PM. Yet, because a coalition government will have to be formed, Berlusconi may be thinking that the continuity of a Monti victory could bode well for the country’s health and that more politicking could garner more support for his party.  While Berlusconi’s positioning and utterance may not be clear, expect the risk spotlight to turn up as elections are pushed forward (likely on February 17th or 24th) and for Berlusconi's political gravitas to be less than it was in the past.   

 

Just today the Italian Senate approved 2013 budget law, which was largely expected.  The bill will go to the Chamber of Deputies for final approval, likely tomorrow. Once the budget law is passed, we expect Monti to resign and the risks ahead of February’s election to heighten investor behavior.

 

Risk has largely abated across Europe (especially the periphery) since the summer and particular following Mario Draghi September ECB statement (9/6) to buy “unlimited” sovereign debt via the OMT program. In fact if we look at the period since the beginning of September 2012 Italy’s 10YR is down -24% to 4.42% and Sovereign 5YR CDS is down -42% to 269bps over this same period, including Bank CDS down an average -18%. Meanwhile, the broader Italian equity market (FTSE MIB), despite volatile swings is up +8.6%.

 

Taken together, we see risk in both a pullback in equities as heightening of risk alongside election indecision and the sovereign banking feedback loop (along with Spain) given its high debt load (at 120% of GDP). 

 

Below is an update of the fundamentals we track, most of which continue to show slow to depressed levels, that suggest a return to growth may be further out than consensus currently forecasts.

 

Growth Slowing - As the data from Reinhart and Rogoff shows, when a country’s sovereign debt load exceeds 90% (of GDP) growth is dramatically impaired. We think the market will continue to punish Italy via higher servicing costs. We expect this red line to continue down and to the right and the country to underperform Bloomberg consensus expectations for -0.70% GDP in 2013.

 

Italy’s Uneven Footing - 11. italy gdp

 

Underperforming Growth - A major leading indicator for growth is derived from PMI surveys. As the two charts below indicate, Manufacturing and Services PMIs are well under the Eurozone averages and have been under the 50 line that divides expansion (above) and contraction (below) since mid 2011.  

 

Italy’s Uneven Footing - 11. italy pmi services

 

Italy’s Uneven Footing - 11. italy pmi manu

 

Labor Cost Inefficiencies - A major factor behind Italy’s slower growth profile is stagnation in its productivity, witnessed by higher unit labor casts, while wages, despite declines, have yet to turn negative. 

 

Italy’s Uneven Footing - 11. italy labor costs

 

Economic Confidence Survey - Has trended down since 6/30/11.

 

Italy’s Uneven Footing - 11. italy confidence

 

Retail Sales - Negative for 8 of 10 quarters reported this year and accelerating its decline over recent months.

 

Italy’s Uneven Footing - 111. italy retail sales

 

Industrial Production – Slowing and underperforming, continued.  A European Commission paper reviewing Italy noted that stagnation in production is the key factor behind Italy’s loss of cost competitiveness since the euro adoption. 

 

Italy’s Uneven Footing - 11. italy industrial prod

 

New car registrations - Yet another metric we follow. Here again, no surprise, underperformance vs the EU average. 

 

Italy’s Uneven Footing - 11. italy car reg

 

Smashed Piggy Banks - The Italian household savings rate moved from a high of 17.8% in mid 2002 down to 8.1% as of Q3 2011. The chart shows that Italians leveraged their savings in the upturn and in the downturn. The tapping of savings in the last three years demonstrates to pay off debt and the resilience of the Italian consumer to maintain previous spending levels. 

 

Italy’s Uneven Footing - 11. italy savings rate

 

Unemployment Hooking - Another grave dynamic is the underemployment across Italian youths at 37%. While short of the 50% for Spanish youth, combine “a lost generation” with Italy’s demographic headwinds of an aging population (near oldest in Europe) and you have a cocktail that puts great pressure on social services, and the debt and deficit loads in the years ahead. 

 

Italy’s Uneven Footing - 11. italy unemply rate

 

Matthew Hedrick

Senior Analyst 

 


WILL MEXICO CONTINUE TO WORK?

Takeaway: As a result of Nieto’s reform agenda, we think Mexican financial markets are likely to overlook cyclical headwinds in 1Q & continue higher.

SUMMARY BULLETS:

 

  • We think the momentum underpinning President Nieto’s economic reform agenda is likely to continue – particularly in light of the tri-party “Pact For Mexico” – and we anticipate Nieto and his cabinet to push hard for reforming the country’s struggling oil and gas industry in a way that may have broader positive implications for  Mexican corporations as a whole.
  • While it’s true that the country’s financial markets may be “priced to perfection” at the current juncture, we don’t necessarily find it prudent to short Mexican equities or the MXN on a pending cyclical erosion of the country’s underlying economic fundamentals in 1Q13. 
  • We do think Mexican financial markets may pull back to some degree, but we anticipate any weakness to be reasonably well-contained with respect to the intermediate-term TREND.
  • All told, absent any meaningful hiccups on the reform front (political risk runs high given that no party has an outright majority in either the Lower House or Senate and the PRI’s history of perceived corruption), we anticipate Mexico to continue to work for investors who have capital allocated to the  country’s financial markets.

 

As a point of process, whenever we begin to vet a particular country’s fundamental merits for investment (long or short), we first start off with our proprietary triangulation of the country’s trailing and future GROWTH/INFLATION/POLICY trends. When Mexico’s 4Q12 data is done being reported, it is likely to show a directionally positive delta from Quad #3 to Quad #1 on our G/I/P analysis, followed by a return in 1Q13.  

 

WILL MEXICO CONTINUE TO WORK? - 1

 

The former delta was good for an +8.6% move on the Dow Jones Mexico Stock Index from its late-AUG cycle-low to the current price of ~2,830. The latter (i.e. pending) delta could result in a -6.5% pullback to our TAIL line of support (from current prices), but we think any potential weakness is to be ultimately faded by long-term investors, as positive POLICY developments should continue to perpetuate positive headline risk and inflows of international capital into the Mexican economy.

 

Yesterday, Mexico’s Education Minister Emilio Chuayffet said that President Enrique Peña Nieto’s recently-proposed constitutional amendment to overhaul Mexico’s education system “responds to a justified public outcry for better education, ending practices that have diminished it.” Having Chuayffet on board with the agenda likely means Mexico’s new president will be able to garner the two-thirds majority required in  Mexican parliament to amend the country’s constitution (in addition to a majority of the country’s 31 state legislatures).

 

It should also be noted that the leaders of both opposition parties – National Action Party (PAN) and the Democratic Revolution Party (PRD) – have praised the agenda and will likely support the passage of the bill in good faith of their “Pact For Mexico” alliance, which is somewhat of a historic political development in the sense that all three main parties are on board with political cooperation.

 

It’s also important to note that Mexico’s education system ranks last out of 34 OECD countries for enrollment rates of high school-age students – despite having spent more of its public budget on education than all of the countries in the OECD's survey. All told, we think  President Nieto’s proposal to create an independent institute to evaluate schools and foster competition for jobs and promotions based on performance is structurally positive for Mexico’s long-term GROWTH outlook, as is the recently ratified labor bill.

 

That piece of legislation ended years of legislative impasse and will improve the stock of human capital in Mexico, as well as becoming a likely tailwind for wage growth stemming from a more competitive labor market; currently ~1/3rd of Mexican workers are in the informal sector. Specifically, the new labor regulations promote greater transparency in union leadership and union finances, as well as allowing temporary and trial-basis contracts, hourly wages, regulating outsourcing and limiting the amount of back-wages workers can collect if they win legal disputes with employers.

 

Notably, the aforementioned labor and education reforms should be taken in conjunction with President Nieto’s plan to balance the Mexican budget in the upcoming fiscal year, officially offsetting a +2.3% increase in spending with a projected +5% increase in non-oil tax collection (tax receipts from PEMEX alone account for ~33% of all federal income). It’s important to note that Mexico’s sovereign budget hasn’t been balanced since 2007, so anything in the area code of balance budget represents meaningful fiscal tightening that should prove supportive of further gains in the peso. The MXN is up +9.2% YTD vs. the USD as investors have increasingly speculated on Banxico, the country’s central bank, ending its 3.5-year streak of all-time low POLICY rates amid the YTD acceleration in Mexican consumer prices.

 

WILL MEXICO CONTINUE TO WORK? - 2

 

WILL MEXICO CONTINUE TO WORK? - 3

 

WILL MEXICO CONTINUE TO WORK? - 4

 

Regarding the point on non-oil tax collection, he’s planning to increase the government’s grip on other state-owned companies; to the extent his drive is incredibly punitive, we think the market could pull back in anticipation of further measures (a la Brazil). That said, however, we view that as reasonably unlikely at the current juncture, given his leanings on reforming Mexico’s oil industry – specifically allowing for greater private investor participation.

 

Such investment is very much needed to arrest the secular decline of the Mexican oil industry: crude oil production has plunged by nearly one-fourth from ~3.8M bpd in 2005 to ~2.9M bpd per the most recent data; over the last five years Petrobras has drilled 101 deep water wells on the strength of increased private sector participation while PEMEX has drilled only 18. PEMEX believes further investment in the deep-water wells across the Gulf of Mexico could grow prospective reserves by ~50%.

 

WILL MEXICO CONTINUE TO WORK? - 5

 

It’s worth noting, however, that PEMEX’s investment budget has surged +145% since 2006 while proven reserves declined from 16.5 billion barrels in 2006 to 13.8 billion barrels last year. In light of this, I do think public-private JVs are likely to be the most probable focus of any near-term reform(s). There’s also increasing chatter of removing the current gasoline subsidy, though anything on this front is mere hearsay for the time being.

 

All told, we think the momentum underpinning President Nieto’s economic reform agenda is likely to continue – particularly in light of the tri-party “Pact For Mexico” – and we anticipate Nieto and his cabinet to push hard for reforming the country’s struggling oil and gas industry in a way that may have broader positive implications for  Mexican corporations as a whole. Other broad avenues for investor-friendly reforms (i.e. areas that require increased political attention) are highlighted in the chart below:

 

WILL MEXICO CONTINUE TO WORK? - 6

 

While it’s true that the country’s financial markets may be “priced to perfection” at the current juncture, we don’t necessarily find it prudent to short Mexican equities or the MXN on a pending cyclical erosion of the country’s underlying economic fundamentals in 1Q13. We do think Mexican financial markets may pull back to some degree, but we anticipate any weakness to be reasonably well-contained with respect to the intermediate-term TREND. Our quantitative risk management levels for the Mexican equity market are included in the chart below.

 

Darius Dale

Senior Analyst

 

WILL MEXICO CONTINUE TO WORK? - 7


CCL 4Q REPORT CARD

In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance.

 

 

CCL 4Q REPORT CARD - C

 

OVERALL

  • WORSE:  We expected CCL to give 2013 yield guidance around 3.5%, below Street expectations of close to 4% yield growth.  So 1-2% yield growth guidance is indeed very disappointing. Softening trends in Germany and UK continues to drag down the outlook for Europe.  Higher 2013 capacity growth rate from 3.4% to 3.6% is not helping.  Although we do see positive longer-term catalysts, today's selloff is warranted and at 16x forward PE, valuation continues to be a stretch given all the uncertainties. 

2013 COSTS

  • SAME:  ex items, 2013 net cruise costs ex fuel guidance of 1-2% is in-line with previous guidance
  • PREVIOUSLY:  
    • "These unique factors alone will drive our unit costs up 1.5% to 2%. Therefore, I am expecting overall unit costs, excluding fuel, to be higher in 2013 compared to 2012."
      • To begin with, we are expecting that Costa will fill their ships in 2013, which will lead to higher food and other unit costs associated with this higher occupancy. This will simply be a reversal of the occupancy-driven unit cost reduction in 2012. 
      • Our insurance costs will be higher in 2013. 
      • We are anticipating charges relating to a closed multiemployer pension plan for certain British officers and crew. The multiemployer pension plan accounting rules require us to expense our contribution to unplanned deficits when the invoices are received."
      • Our increasing emerging market deployment for Japan by Princess, for China by Costa, and for Australia by Carnival Cruise Lines will also increase our costs. 

COSTA

  • SAME:  The outlook on Costa remains bright.  Occupancy is expected to return to normalcy but pricing will not have a full recovery given the weak economies in Europe.  
  • PREVIOUSLY:  "Beginning in the second quarter of 2013, we expect Costa's revenue yields to nicely increase year-over-year against these easier comparisons for the last year's second quarter. We are very pleased with the progress that Costa has made, and our expectation is that Costa's financial performance will continue to improve as we move through 2013."

CAPACITY

  • WORSE:  2013 capacity growth forecast increased from 3.4% previously to 3.6%. Capacity guidance in FQ1 is increased to 4.2% from 4.1% previously.
  • PREVIOUSLY:  "Fleet-wide capacity for 2013 is expected to increase by 3.4%: 4.1% in Q1, 3.2% in the second quarter, 3.8% in Q3, and 2.4% in the fourth quarter."

BOOKINGS

  • WORSE:  European bookings continue to be very close-in.  But even bookings in some of the relatively less weak European economies (e.g. UK, Germany) are experiencing a closer in pattern.
  • PREVIOUSLY:  "For certain brands it's still pretty close-in. You're starting to see some evidence of it pushing out more recently because of the recent increase in bookings over the last quarter. But it's still closer-in than it has been historically. And that's been the pattern. We're seeing it more in the European brands, but we're also seeing a little bit of it, but not quite as much, in the American brands."

ON BOARD YIELD

  • SAME:  Similar to 2012, onboard spend 2013 guidance will be ~+2% with increases in all the major categories.
  • PREVIOUSLY:  "For certain brands it's still pretty close-in. You're starting to see some evidence of it pushing out more recently because of the recent increase in bookings over the last quarter. But it's still closer-in than it has been historically. And that's been the pattern. We're seeing it more in the European brands, but we're also seeing a little bit of it, but not quite as much, in the American brands."

EUROPE OUTLOOK

  • WORSE:  The U.K. and Germany economies are getting softer.  Yields in those markets will be lower and the booking curve has tightened in those countries.  CCL also has higher capacity growth in Europe than its competitors, particularly in Germany. 
  • PREVIOUSLY:  "I would say that U.K. and Germany has held up better than we expected in the last two conference calls I would say a little bit, while Italy, France and Spain struggled....We like the European demographics. We like the market. We think the market is still considerably underpenetrated relative to other developed markets, so we like our investments in Europe from a long-term standpoint and once we get through these difficult economic challenges that we're experiencing, especially in Southern Europe.... I think we'll start to see some stabilization and some very positive results for the company longer-term."

FUEL EFFICIENCY

  • BETTER:  Fuel efficiency will be 5% in 2013, higher than previous guidance of 3%.  Historically, CCL has reduced fuel consumption by 2-3% per year.
  • PREVIOUSLY:  "We're working very hard to reduce consumption and we believe that we can continue to do that at significant levels, and I think next year we'll do it
    again is my perception...we're looking at 3% for the year."

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PCAR: Turning A Loss Into A Gain

Over the past year, Navistar (NAV) has lost considerable class 8 market share in the trucking sector. In August, Industrials Sector Head Jay Van Sciver noted that Navistar would likely lose significant market share following quality and strategy challenges. In turn, PACCAR (PCAR) is poised to pick up the pieces, turning Navistar’s loss into PACCAR’s gain by picking up market share that Navistar lost. PCAR will likely see the benefits of higher market share in 2013 and the stock remains one of our top long ideas.

 

PCAR: Turning A Loss Into A Gain - NAV


Idea Alert: FNP -- Go Long Now

Takeaway: We’re adding $FNP to Hedgeye's Virtual Portfolio as the quantitative setup and catalyst calendar synch with our bullish fundamental view

We’re adding FNP to the Hedgeye Virtual Portfolio as the near-term quantitative setup and catalyst calendar synch with our bullish intermediate and long-term fundamental view. Our estimates remain double the consensus for the next two years.

 

We think that the pre-ICR update is likely to be favorable, and that we’re more like than not to see a 25% upwards positive revision beginning by the time the company reports its fourth quarter in early January.

 

The crux of our call around FNP is that this is an out of favor stock with more unrealized value than perhaps any other name in retail. It has Kate Spade, which is one of the best growth stories in global retail today and is worth over 40% above where the stock is today based on our assumptions. Then it has Lucky Brand, which we view as an annuity. It is one of the few denim brands that might not take a big swing at the fences each year, but has muted fashion risk and it consistently contributes cash flow to cover roughly half of the parent’s capex. Then…there’s Juicy Coture. We think that the break here is not temporary, but that they have a customer problem that will be too much to overcome. That’s when bad news is good news because we think that CEO McComb has low tolerance for having his crown jewel (Kate) weighed down by the ugly red-headed stepchild.

 

Our point is that the chance is low that Juicy is still part of the company in six months’ time. We don’t think that having a new COO (hired last month) impedes this decision. In fact, it allows McComb to run the parent, not the sub, and also makes the bench more attractive for a buyer.

 

If we assume that Juicy gets a paltry $160mm on a $500mm revenue base, then we get to a scenario where 45% of FNP’s debt is gone and it takes any concern about the balance sheet right along with it.

 

Perversely, we don’t think that there will be as much value added if Juicy is fixed – but in the end, we think that the only risk to Juicy is no volatility. Improvement is good. Erosion is good (ie it gets sold). Status quo is like Chinese water torture.

 

But that's already priced in to the stock, and status quo on a third of the business while one third acts as an annuity, and the other third continues as one of the best growers in retail is not exactly a bad place to be. Our aggregate value for the company today – using a very realistic ‘sell it now’ price for Juicy is $20 per share, and we think that either corporate action or the upwardly revised earnings power of the company will get it there in 2013.

 

Idea Alert: FNP -- Go Long Now - 12 20 2012 11 18 59 AM


Jobless Claims: Happy Holidays

Jobless claims rose 18k to 361k last week, but the 4-week rolling average declined 14k to 368k bringing us back to pre-Hurricane Sandy levels. If we examine state data for NY, NJ and PA, the areas most affected by the storm, they’ve fully re-normalized. Despite the first rise we've seen the past five weeks, we expect claims data will continue moving lower in the coming months thanks to a seasonality distortion tailwind (i.e. holiday help). Add in the positive growth we’ve seen in the housing market recently and financials like Bank of America (BAC) and Citigroup (C) should benefit from the data.

 

Jobless Claims: Happy Holidays - 1 normal

 

Jobless Claims: Happy Holidays - 12 normal

 

Jobless Claims: Happy Holidays - 3 normal


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.64%
  • SHORT SIGNALS 78.57%
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