“You have to be the first one in line. That’s how leaders are born.”
Did global growth stop slowing in mid-to-late November? Is #GrowthStabilizing bad for Gold and Bonds? These questions are now rhetorical ones.
“When you want to win a game, you have to teach. When you lose a game, you have to learn.” -Tom Landry
Our congratulations to Ray Lewis and the Baltimore Ravens. #winning
Back to the Global Macro Grind…
US Equities were up for the 5th consecutive week and long-term US Treasury Yields continued to breakout to the upside last week (10yr Yield up another +6bps to 2.01%) as fund flows into US Equities continue to surprise on the upside.
How did this all happen so fast?
- Sentiment was bombed out in mid-November and short interest was high
- Fundamental global economic growth data steadily improved for 2 consecutive months
- Equity Fund Flows Followed…
The 1st two points of the process were trivial. We wrote about them every day. The last point about flows was the hardest to nail down. While we usually get the memo on flows after the fact, we do know what leads them.
Q: What leads people out of Gold/Bonds and into Equities? A: Growth Expectations.
- Gold made a long-term lower-high in mid November at $1755/oz (versus the all-time high in 2011)
- Gold snapped our intermediate-term TREND line of $1698 in early December
- Gold net long positions (futures and options contracts) crashed to 82,081 last week
Crashed? Yes. Last week the bulls (who had been buying Gold contracts the whole way down from October to January) capitulated, selling the net long position in Gold contracts down -24% wk-over-wk.
Despite Gold and Silver being down another -0.2% and -1.1%, respectively, this morning, from an immediate-term TRADE duration perspective this is obviously an interesting contrarian indicator. But what does it tell you about longer-term growth expectations?
What has the Treasury Bond market been telling you?
- 10yr US Treasury Yields made higher-long-term lows in November-December in the 1.57-1.61% range
- 10yr US Treasury Yield broke out above our intermediate-term TREND line of 1.73% in mid-December 2012
- 10yr US Treasury Yields are up another 5 basis points this morning (that’s a lot in a day) to 2.05%
At the same time, the HYG (High Yield) and Junk (JNK) Bond ETFs finally broke my immediate-term TRADE lines of support last week. With Investment Grade and Junk Bond yields up another +1.9% and +3.3% last week, that was new for this cycle (not new at turns in other major cycles).
The concept of buying “High Yield” debt (that has record low yields) is far from simple; especially if people start to bake in that Ben Bernanke’s money printing days are over. This is why we are so focused on the slope of growth expectations for:
- Global GDP Growth
- US Employment Growth
- US House Price Inflation Growth
All 3 of these factors can drive Gold/Bond prices down until people actually start to believe we could re-flate the Commodity Inflation Bubble (which peaked alongside Gold in 2011). Which, in turn, could slow growth (again). That’s why:
- CRB Commodities Index closing 1 point inside of our long-term TAIL line of 306 last week is a NEW concern
- Oil Prices up another +1.8% and +2.9% on WTIC and Brent last week are a mounting concern
- 5-year Breakevens up +6.5% last week in the US (Bernanke’s former inflation expectations bogey) matter too
Whether you were bullish or bearish throughout this 2-month move doesn’t matter anymore. Today is a new day. You are either first on the line to register what is changing on the margin in macro, or you are not. We’ll do our best to stand alongside you.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, 10yr UST Yield, and the SP500 are now $1, $114.19-116.87, $79.01-79.71, $1.34-1.36, 90.67-93.12, 1.96-2.11%, and 1, respectively.
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
This morning, the NY Post reported that Herbalife (HLF) was the target of a federal law enforcement investigation.
It appears that Pershing Square’s commentary was not the catalyst for this investigation, but rather a series of complaints that had been levied against the company over the course of a number of years.
We saw some sort of investigation as a virtual certainty given the high profile nature of the debate over HLF’s business model. We also suggested that the stock gets much more interesting on the weakness associated that headline, but not immediately. Bottoming is a process, and so are federal investigations.
Further, Pershing Square’s founder is scheduled to present at the Harbor Investment Conference on February 13th – it appears probable that his short position in HLF will be a (the?) topic of discussion.
Perversely, a lower stock price will ultimately work to the company’s benefit if it moves to buy back stock in aggressive fashion, as the company will be able to deploy it’s finite resources to repurchase a larger number of shares, which is what matters to the extent future news flow can be a catalyst for a short squeeze. We actually think it makes sense for the company to play possum here, and allow its stock to drift lower in the coming weeks.
For investors, we continue to think the best course of action right now is to do nothing. We have seen this play before when we covered the tobacco sector, and the day to buy the stocks is not the day the trial starts. Investors should recognize that this data point does get one substantial piece of negative news flow that we were anticipating out of the way, and therefore takes us one step closer to the day the stock becomes investable.
Finally, in order to offer some balance to our prior expert call on the subject of multi-level marketing, we are hosting Anne Coughlan – she is a professor at the Kellogg School of Management specializing in distribution channels. The call is tentatively scheduled for the 14th. Investors may recognize the name from the HLF investor day, held earlier in the year.
Bottom line, we view today’s news as wholly consistent with the way we see the saga playing out – we caution investors to remain engaged in the news flow, but on the sidelines for the time being.
Call with questions.
HEDGEYE RISK MANAGEMENT, LLC
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Yum! Brands remains one of our favorite names for 2013, despite the China controversy in January which, given the nature of the event, took many people by surprise. For people looking for a longer-term idea in consumer, we think they would be hard pressed to find a more attractive opportunity than YUM at these levels. YUM reports 4Q12 EPS on 2/4.
It’s only February 1st and, already, so much has happened in such a short period of time. Since YUM hosted its analyst meeting on December 6th, the following sequence of events has transpired (annotated in chart below):
1. 12/18-12/20: A story emerges that a Chinese chicken supplier had “used excessive additives in chicken feed”. We believe the stock has been punished three additional times for the same story being rehashed in the media news cycle since first emerging
2. 1/07: YUM guides down FY12 EPS and warns that, as a result of negative media exposure, KFC China significantly impact during last two weeks of the year
3. 1/10: YUM CEO issues online apology
4. 1/17: Argus downgrades to Hold. Xinhua publishes article stating that KFC supplier didn’t process sick chickens
5. 1/18: Shanghai vows “severe” punishment on KFC “violation”, according to the China Daily
6. 1/25: Bronstein, Gewirtz, & Grossman LLP announces a class action lawsuit against Yum! Brand. Xinhua says, “Shanghai finds excessive animal drugs in Yum Chicken”.
7. 1/30: Yum! Brands shares cut to market perform versus outperform at Bernstein
It is worth noting that, between the Analyst Meeting on December 6th and today, there has been a significant swing in consensus expectations for 4Q12, 1Q13, and FY13 EPS:
- 4Q consensus EPS on 12/6 was looking for $0.84 or 12% y/y growth. Now expectations are for $0.82 (9% growth)
- 1Q13 consensus EPS on 12/6 was looking for $0.84 or 6% y/y growth. Now expectations are for $0.80 (1% growth)
- FY13 consensus EPS on 12/6 was looking for $3.67 or 13% y/y growth. Now expectations are for $3.57 (10% growth)
Sell-side sentiment on YUM has changed drastically in the last six months. The percentage of buy ratings among sell-side analysts covering the stock peaked at just over 70% in May (29% hold, 0% sell). The latest reading is 55% buy, 41% hold and 3.5% sell.
It’s Not All China
News flow on YUM is focused almost exclusively on China and none of it is positive. The company needs to do its part to counteract the negative stories (often repetitive rehashes) to highlight the positive things that are happening within the company. As we highlighted in December, Yum! Brands is a resilient company because of its diversification. It is perceived to be a “China-stock”, and China is an important component of its future, but 42% of the company’s operating profits are derived from markets outside of China. Over time, this and other attributes have led to steady gains in its share price and consistent EPS growth while competitors such as SBUX have seen more volatility over the years.
Reaction to Chinese News May Be Overdone
The company has resolved its issues with the Chinese government and, as concern over the food scandal gradually dissipates, the company should be able to spend a greater portion of its time focusing on continuing to grow the business. We expect the management team to articulate a clear plan of action to reach out to the Chinese consumer, including the acceleration of new food introduction schedules in the market. It would also not be surprising to hear of an increase in the China division’s advertising budget with a view to reassuring the Chinese consumer that KFC is a trustworthy brand.
US Business Transformation From Class Clown to Teacher’s Pet
The US business is now a bright spot in the company’s press release, after years of disappointment. We expect Taco Bell, in particular, to be a positive with same-restaurant sales at roughly 6% versus consensus of 5.5%. On a consolidated basis, operating margins are expected to improve by 87 bps to 13.8%, driven by the US and YRI, offset by China. Seasonally, YUM’s business tends to produce its thinnest margins in the fourth quarter.
While surfing for some light weekend reading, I stumbled across an interesting article that appeared in the Review of Industrial Organization back in 2005 (yes, yes, I need to get out more). The title is “The Supreme Court and Beer Mergers: From Pabst/Blatz to the DOJ–FTC Merger Guidelines.”
At a minimum, it is an interesting retrospective on the history of the beer industry in the U.S., with mention of some venerable beer brands (Hamm’s, anyone?).
The paper argues, compellingly, I believe, that the review of mergers and associated antimerger rules needs to progress as “economic understanding” progresses. Word of warning, the article is bone dry, so a cup of coffee next to your computer is very much in order. On the plus side (for you), I had to read the whole thing (yay me?). It was also written prior to the merger of Anheuser-Busch and InBev, but the findings are still very much relevant. Let’s get started.
“The first antimerger action in the beer industry was taken by the Antitrust Division in 1958 against the industry’s leading firm, Anheuser-Busch. Anheuser-Busch had purchased the Miami brewery of American Brewing Company. The government successfully argued that this merger would eliminate American Brewing as an independent brewer and end its rivalry with Anheuser-Busch in Florida.”
What’s interesting here is that the government appears to have a long history of thinking (and acting) locally when examining beer markets. What is also interesting is that Anheuser-Busch completely abandoned acquisitions as a means to growth for over two decades subsequent to this unsuccessful deal. Instead, Anheuser-Busch spent its time and capital building efficient brewing capacity across the country (Florida included). Anheuser-Busch’s market share leadership has been undisputed since 1957.
“Bottom line: mergers have not made much of an imprint on the structure of the brewing industry, and have not resulted in market power for merging partners. The most active merging firms, Stroh and Heileman, eventually failed. Much of the increase in concentration in the past three decades was due to the growth of Anheuser-Busch, Miller and Coors, whose expansion has been largely internal.”
The DOJ has taken the beer industry before the United States Supreme Court twice - U.S. v. Pabst (1966) and U.S. v. Falstaff (1973). In both cases, the mergers were seen as anti-competitive, for different reasons in each case, but thinking that largely reflected the belief that mergers that took place in an industry with an existing trend toward industry concentration were anti-competitive.
“The mid-1970s saw the beginnings of a radical shift in antimerger enforcement doctrine – a major change in what Bork (Judge Robert H. Bork) called “the economic rules.” In response to the work of Bork and others, the Chicago School of economics gained ground, and its focus on economic rigor in legal reasoning and an emphasis on consumer welfare as the goal of antitrust enforcement had a significant influence on antitrust law.”
This change in thinking ultimately led to the adoption of the DOJ-FTC Horizontal Merger Guidelines, where the focus shifted from simple concentration of market share to a discussion of “market power”. Market power was defined as “the ability profitably to maintain prices above competitive levels for a significant period of time.”
“Contrary to the precepts of Pabst and Falstaff, under the Guidelines, ‘although large market shares and high concentration by themselves are an insufficient basis for challenging a merger, low market shares and concentration are a sufficient basis for not challenging a merger.”
The paper concludes with the following:
“Increases in concentration in brewing are neither the result nor the cause of market power. The reasons, rather, are benign: the exploitation of scale economies and the demise of suboptimal capacity; new or superior products; changes in packaging and marketing methods; poor management on the part of some firms; and the strategic use of product differentiation. As a consequence, Anheuser-Busch, Miller and Coors no longer face an array of robust domestic brewers. Brands like Schlitz, Pabst, Old Style, Stroh, Ballantine, Schaefer, Falstaff, Olympia, Rheingold, Ruppert, Blatz, Lucky Lager, Hamm’s, and the firms that produced them, are gone or are shadows of what they once were. But the big three domestic brewers now face significant import competition, in some cases from large brewers with operations in many countries, and significant competition from specialty brewers.”
We would add to that last point that brewers are also facing competition from wine and spirits makers, as beer continues to lose share of liver as a multi-year trend. The DOJ gave little thought to the substitutability of these products.
Interesting stuff, and intuitively compelling. As we pointed out in our prior note, we believe a critical and honest examination of the fact pattern in the proposed Anheuser-Busch InBev/Modelo transaction would support the notion that the transaction be allowed to proceed as contemplated. The idea that Modelo’s 50% control (through Crown) of 6.5% of the U.S. market has been some mitigating factor on pricing across the rest of the 94.5% doesn’t exactly ring true to us, particularly in light of what has been an extraordinarily benign pricing algorithm throughout history.
Further, we don’t believe that the DOJ gave any credit to the indirect nature of the control that ABI will have over Crown, preferring to call it a façade. We believe that the parties are talking, and will continue to talk. Both STZ and BUD make sense when the deal gets done, with STZ seeing the greater upside potential in the near-term, but also more downside in the event of incremental negative news flow.
Enjoy your Sunday,
HEDGEYE RISK MANAGEMENT, LLC
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