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Let's Do This

This note was originally published at 8am on January 22, 2013 for Hedgeye subscribers.

“C’mon! Let’s do this.”

-Ray Lewis

 

If Japanese policy makers really want to get nuts, they should sign Ray Lewis for the 2014 Money-Printing season. After taking down the Patriots this weekend, the 13x Pro Bowler is going back to the Super Bowl. It’ll be his last game. If Baltimore wins, it will be epic.

 

“You’ve got to go out and show them that I’m a different creature now than I was 5 minutes ago, cause I’m pissed off for greatness. Cause if you ain’t pissed off for greatness, that just means you’re okay with being mediocre.”

 

Yep. That’s what I am talking about Japan – some ole school Raven rants in those BOJ pressers.

 

Back to the Global Macro Grind

 

Evidently, the global currency market didn’t get the BOJ’s marketing message overnight. The Japanese Yen rallied a full +1% on the “news”, and Japanese stocks snapped immediate-term TRADE support for the first time in months. Isn’t a #QuadrillYen fun?

 

PM Shinzo Abe called the BOJ’s “2% inflation” targeting and asset purchase plan both “bold” and “epoch making.” That might sound like some serious stuff, but the new asset purchases don’t start until January of 2014 – so there’s this little thing called timing that people short the Yen today are getting Taro Aso’d by in the meantime.

 

If you didn’t know the Global Currency War is on, now you know. The Russians and South Koreans talked about it last week, and the President of the Bundesbank (Germany) is calling it out, explicitly, in the FT (Financial Times) this morning. If you want to show the world you are a “different creature”, you’re going to have to one-up The Bernank’s 2012 performance.

 

That’s no easy task – neither is seeing the US Dollar stabilize alongside weekly US economic growth data:

  1. US Dollar Index closed up another +0.6% last week and continues to make a series of higher long-term lows
  2. US Housing Demand (MBA weekly mortgage applications) ripped a +12.9% move, taking the MBA series to 205
  3. US Weekly Jobless Claims dropped to fresh new intermediate-term lows at 335,000

If what’s bad for a country’s currency is eventually really bad for that country’s real (inflation adjusted) economic growth, the opposite should hold true when a country’s currency stabilizes.

 

What if a stabilizing US Dollar became a strengthening one? How about strengthening the US Dollar +15% (from here) and hammering energy/food inflation next? Didn’t the President of the United States say “we, the people, are all in this together” now?

 

Can you think of a more galvanizing, progressive, and uniquely American marketing message than Strong Dollar = Strong America? I bounced it off the Keynesians in the Romney camp, and they didn’t get it either. But you, The People can get this – Yes You Can!

 

In other major global #GrowthStabilizing news:

  1. Chinese monthly data for December (Industrial Production and Retail Sales) accelerated versus November
  2. Chinese Exports for December ramped by +14.1% (versus +2.9% NOV)
  3. Germany’s ZEW Index (reported this morning) just hit a 2.5 year high (31.5 DEC vs 6.9 in NOV)

It’s been a while here, folks – but, setting aside the economic disaster that is Japan for a minute, we have the other 3 major global engines no longer stalling/slowing (USA, China, and Germany). That’s better than bad. And so is sentiment.

 

The problem with sentiment, of course, is that it tends to turn after markets move. And right now that’s precisely what many of my key sentiment indicators are starting to flag:

  1. US Equity Volatility (VIX) = immediate-term TRADE oversold at a 5-year low of 12.46
  2. II Bull/Bear Spread (Bulls minus Bears) = 3,090 basis points wide (53.2% Bulls, 22.3% Bears)
  3. Fund Flows (to US Equities, ex-ETFs) = +3.8B last week (versus +7.5B in the week prior)

In addition to last week’s -6.7% drop in the VIX, we’re seeing aggregate short interest in US Equities fall fast from their late November highs (that was a bullish signal) at the same time that NYSE Margin Debt rips to the high-end of its 5-year range (perma bulls lever themselves up on the long side at the end of a move trying to chase performance).

 

So, it’s all out there – the economic data; the price action; the sentiment indicators – and, no, they don’t always signal that you should be doing the same thing at the same time. But that doesn’t mean you don’t have to get out there every morning and get it. As Japan’s new ‘let’s get nuts’ prospect, Ray Lewis, might add: “Effort, is between you, and you, and nobody else.”

 

Our immediate-term Risk Ranges for Gold, Oil, US Dollar Index, USD/YEN, UST 10yr Yield, AAPL, and the SP500 are now $110.75-112.35 (Oil is back above TAIL support, bearish for Consumption), $1654-1692, $79.75-80.17, 88.58-90.61, 1.84-1.91% (Bonds continue to signal #GrowthStabilizing), $482-561 (into Earnings tomorrow), and 1471-1489, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Let's Do This - Chart of the Day

 

Let's Do This - Virtual Portfolio


JCP: Our Take On The Liquidity Debate

Takeaway: We're weighing in on JCP liquidity -- an issue that's quickly racing to the forefront of key risks, and opportunities.

JCP issued a release this evening vehemently defending against a letter it received suggesting that JCP is in violation of terms on 11% of the company’s debt. The letter came from a firm claiming representation of over 50% of holders of the 7.4% debenture due 2037 (one of 11 tranches of debt).  JCP argues that this is ‘completely without merit and intended to create self-interested trading opportunities in the market’. It’s impossible for us to know one way or another. But right or wrong there’s only one thing that’s certain – liquidity will be talked about more as a key issue with JCP. With that being a near certainty, we thought we’d stress-test our model to see where the risks are to this story.

 

Before going into the model, here's a few thoughts...

  1. First off, the letter was dated on 1/29/13. Based on today’s close, JCP is down 8.0% since the letter was written. That compares to -0.7% for the S&P, and -1.3% for the broader Retail group (RTH). Clearly, this is news to people reading the general tape – but the market has been acting on the event since last Wednesday.
     
  2. The claim is that JCP violated the agreement when it entered into its current inventory-backed $1.5bn revolver (which is expandable to $2.0bn) in Jan 2012 without providing for equal security for the debenture holders.   Why this would come out 13 months after the issuance is questionable – perhaps because liquidity was not a concern back then and now the bond holders are doing whatever is feasible (or unfeasible) to secure their capital if JCP faces a liquidity crunch in 2013.
     
  3. From a risk management perspective, the best we can do is assume that the claim is valid.
    1. In that case, a worst case scenario would be that the other 10 consortiums of JCP’s debt attempt to step forward and stake claim on inventories. But that, quite frankly, seems ridiculous. It would be a first for any retailer we have ever seen. Maybe we’re missing something, but we don’t see how unsecured lenders could think that they could stake claim over a secured asset.
       
    2. Perhaps a slightly more realistic scenario equity holders should keep in mind would be that the holders of $1.1bn in Senior Notes put the debt back to JCP, which could happen in the event of change in control combined with not meeting certain minimum rating standards. That certainly would not be possible based on what we’ve seen transpire thus far. Not even close.

 

We think that the key is to do a simple assessment of JCP’s cash, and cash flow needs under a bear-case scenario, and then do a simple check as to the company’s liquidity. Consider the following as it relates to sources of cash.

  • SOURCES: JCP ended 3Q with $525mm in cash, and the company stands behind its guidance that it will have $1bn in cash by the end of the year. We don’t buy it.
  • Traditionally, 4Q has the biggest cash flow build of the year. There has historically been 12%-17% incremental cash build as a percent of 3Q revenue.
  • That mold was broken last year, when JCP only generated 7.8% -- or $422mm in cash.
  • We assume that 4Q cash build comes in at only 3%, or just $100mm. That leaves JCP with $625mm in cash.
  • JCP has no debt maturities due until 2015 – and even then we’re just looking at $200mm.
  • JCP has $1.5bn in its revolver, and that is expandable to $2.0bn
  • All-in, JCP has between $2.1 and $2.6bn in sources of cash per our estimate.
  • If they miraculously hit their YE estimate of $1bn, then it bolsters the strength in JCP's liquidity materially.

 

USES: Assumptions for uses of cash gets a bit more dicey, but let’s start with our P&L and Cash Flow modeling assumptions…

  • Let’s assume JCP does not earn one red cent until FY16. We’re modeling that it loses $1.0bn in EBIT through 2015. As noted many times, our more constructive view on the stock has been predicated based on the direction of the top line as opposed to profitability, as we think that revenue will pick up on the margin as JCP anniversaries an abysmal 2012 and changes over a third of its store base to a more productive mix by the end of FY13.
  • We assume that sales are down 35% in the upcoming quarter, and remain negative until the back half of 3Q14.
  • We’re modeling Gross Margins just under 35% by the end of 2015 – which is a full 500bp below where JCP is planning its business ‘longer term’.
  • Our SG&A estimate is bottoming out at $4.2bn. Quite frankly, this gives credit for the $900mm in net savings – and if there’s any area where we’re stretching it, this is probably it. JCP needs to invest in its stores.
  • Our EBIT decline estimate is almost evenly offset by $500mm+ in D&A per year.
  • We’re assuming that working capital – both inventories and payables move with the business. On one hand, JCP can’t be a pig and expect vendors to bolster its balance sheet. That jeopardizes its partnerships. On the flip side it’s sitting there with 98 days of inventory on hand – which is a level that can be chopped down. Every day is equal to about $25mm in capital.
  • We tack on about $800mm in cash needed to fund capex and new shops annually. That suggests that JCP will need to use somewhere around $1bn of its revolver ($800mm x 2) = $1.6bn - $625mm in cash on hand.
  • A key consideration is that the company has the option to slow down the cadence of the new store rollout.  Don’t get us wrong…That’s bad. But it is a way to help ward off a liquidity event to the extent that one approaches.
  • When all is said and done, we get to an extra $500mm-$1.0bn in cash available to draw under what we think is a beared-up model.

 

The punchline is that we can absolutely see why there’s all the concern about JCP’s liquidity – a $500mm-$1bn pad is not as much as we’d like to see for a retailer this size. But we don’t think that the concern should be the result of this evening's announced claim.

 

We think we’d need to see a cash balance at year-end below $600-$700mm to get concerned about JCP’s cadence of shop in shop rollouts for 2013. That would lead to either a) a slowdown in the rate of shop-in-shop additions, or b) the need to sell equity to keep the storytelling alive. We’d prefer the former, but due to management’s ego regarding growing the business, we can’t rule out the latter. For now we’re sticking with our modeling assumptions that shouldn’t require either. 

 

As the facts change so will we. For now, we're comfortable with the facts.


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YUM GUIDE DOWN A GAME-CHANGER

Yum! Brands announced FY12 EPS and gave game-changing guidance on FY13 that is leading us to capitulate on our long YUM idea. 

 

Stepping Back From YUM

 

In advance of tomorrow’s earnings call, we are stepping back from our long YUM thesis.  While our initial analysis, released in November 2013 as a Black Book, was sound, the chicken supplier issue was clearly unforeseeable.  With hindsight, our mistake was defending the stock at that point, rather than taking a more prudent approach.  The reasoning behind our decision was that the government’s investigation had ceased, the stock price had declined quite dramatically, and sentiment seemed to be setting up for a strong contrarian position on the long side over the long-term TAIL duration.

 

 

Growth Story Intact, Comp Sales the Big Issue in 2013

 

The important component of the YUM press release was the commentary from David Novak, the Chairman and CEO.  Important points regarding China:

  • Due to continued negative same-restaurant sales, mgmt not expecting EPS growth in FY13
  • Growth strategies unchanged, globally.  Still aiming for 700 new units in China this year
  • Same-restaurant sales declined 37%, including 41% at KFC and 15% at Pizza Hut

That the company is not revising its growth targets could mean that management’s confidence in the long-term prospects of its China business is high but, given the data in the press release, we think that the bottoming process could take several quarters. 

 

Our Black Book, which was published the week before YUM’s analyst day, included a sum-of-the-parts-analysis suggested a value of $88 per share.  On December 6th, during the analyst day presentation, management suggested a value of between $80-90.  As of now, it is much more difficult to value this stock.  Following the call tomorrow, we expect to have a better idea of how the business should fare over the coming quarters and years.

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst

 

 


TRADE OF THE DAY: CJES

Today we bought C&J Energy Services (CJES) at $22.72 a share at 3:15 PM EDT in our Real-Time Alerts. C&J Energy Services has been Hedgeye Energy Analyst Kevin Kaiser's Best Idea since his presentation on it on November 16th, 2012. Buying it on red. 

 

TRADE OF THE DAY: CJES - TOTD


What UK Retail Trends Mean for US Stocks

Takeaway: Hedgeye gets a rare look into the UK retail market and its implications for US companies.

On today’s Retail expert call, we were joined by retail expert Stacey Widlitz, head of SW Retail Advisors.  Stacey is a recognized expert on retail trends with a unique perspective on both the US and the UK markets.  Operating from her base in London, Stacey provided our clients valuable insights on some key retail names last quarter.  In today’s conference call she shared her insights on the Christmas season and the changing face of UK retail.

 

Stacey saw the Christmas season and the fourth quarter generally flat year-over-year in terms of sales.  November was a disappointment in the UK and retailers started discounting both early, and aggressively.  A key takeaway is that the UK consumer has generally been used to much higher price points than we see in the US, and there has not been a broad culture of discounting in the UK.  Stacey believes that is changing and this Christmas season looked a lot like the US season in terms of promotions.  One point that worked in favor of the UK retailers was that they came into the final quarter with tightly controlled inventories.  Nonetheless, what Widlitz calls the “Americanization of the UK consumer” forced many stores to run US-style holiday promotions.

 

Widlitz noted heavy promotions at many leading department stores, with fragrance and cosmetics giveaways, and 20%-50% discounts common across the sector – she says Gap ran their discounts as high as 75%.  Retailers were taken by surprise as customers stayed away from early season discounts, coming back Yankee-style to scoop up bargains, many of them waiting until the day after Christmas – in the UK it’s called “Boxing Day” and is a separate occasion for gift giving.  Widlitz says the UK consumer has figured out the waiting game, and retailers have to play along with the new rules.

Another key theme is the pricing disparity of international brands which often are priced the same in pounds sterling as in US dollars.  Widlitz says Kors handbags are significantly more expensive in the UK – a bag that costs US$ 400 in New York costs 400 pounds sterling in London – equivalent to US$ 630.  UK customers have figured this out and some now buy expensive fashion items on-line in dollars and have them shipped to friends in the US.  London retailers have to figure out how to compete in this environment, and Kors, for example, discounted earlier, and more heavily than in the past.

Widlitz says Hilfiger was among the more successful stores, running “some of the leanest promotions around,” discounting only large sizes and left-over odd pieces.  The higher price point and the cachet appear to still hold appeal for local fashinistas.


Widlitz was most positive on Victoria’s Secret, whose London flagship store appears to be one of the most successful major retail apparel outlets.  Traffic continues strong and with a high conversion rate – folks who come to look, then stay to buy.  Widlitz believes VS is hitting a real void in the retail market, as the only competition for lingerie is either low-market department store lines, or very high-end boutiques.

 

A major theme that will determine the future of retail is the strength of the Asian tourist trade.  High-end accessory retailers look to Chinese consumers to provide demand.  They will need it.  One of the stark differences this year was the lines waiting to get into boutiques such as Prada and Louis Vuitton: there weren’t any.  Last year there were lines out the door at these upscale shops.   Retailers are counting on Asian tourist trade to bolster sales at their highest-end outlets, amidst concerns the domestic accessories market may be close to saturation.  Luxury brands view London as the bridge to bringing Asian tourist demand to the US, so these sales figures will be closely watched.

 

Widlitz believes the biggest new opportunity may be in off-price retailing.  The UK does not have malls, and with the “high street” retail mentality, most operators appear not to be aware of the attraction of this segment.  Widlitz singled out TJX as doing “phenomenally well” with an off-price strategy.  The outlet village concept is catching on, she says, and could be huge.  

We are pleased to have access to Stacey Widlitz’ unique coverage and analysis.  The Hedgeye Retail team will continue to monitor overseas developments for their impact on the domestic market, and for their implications for stock prices in their segment. 


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