The Macau Metro Monitor, February 6, 2013




China’s government will start taking action this month to clamp down on junket operators that bring gamblers from the mainland to Macau, the Times reported, citing unidentified people in law enforcement.  The action will involve police operations in six Chinese cities and is part of an anti-corruption campaign led by Xi Jinping, the Communist Party general secretary, the U.K. newspaper reported.  “The squeeze has already started on a small scale, but the operators themselves believe that something bigger is coming within the next few weeks,” The Times quotes an unidentified Macau gaming industry source as saying.



Consumers in Singapore were less confident in 4Q 2012, signalling a potential slowdown in consumer spending in 2013, according to a survey by global information and measurement company, Nielsen.

Melvin's Market

This note was originally published at 8am on January 23, 2013 for Hedgeye subscribers.

“What if this is as good as is gets?”

-Melvin Udall


That’s what Jack Nicholson asked a bunch of depressed psychiatric patients in one of the great scenes in American comedy (As Good As It Gets, 1997). Melvin Udall should be re-casted as a modern day money manager.


Obsessive-compulsive about this market, anyone?


Back to the Global Macro Grind


I don’t yet require psychiatric help, but with each passing day I am feeling more and more like a shrink. “Keith, do you really think growth is stabilizing?”… “This market can’t go higher with all this debt, can it?”…


Trust me, it goes on and on and on. I don’t get up at this hour every day to not tell you what I think. The last 2 months have been nothing short of fantastic for stocks – and, this time, the global growth fundamentals actually supported it.


Everything has a time and price. So the question remains, with the SP500 up double digits (+10.2%) now from where you could have bought just about anything lower (November 15th, 2012), is this as good as it gets?


Let’s start with Global Growth… “I’ve got a really great compliment for you, and it’s true.” –Melvin

  1. ASIA – high frequency growth data has been stabilizing for 3 months
  2. EUROPE – high frequency growth data stopped slowing in November
  3. USA – employment growth has been stabilizing for 3 months and Housing is ripping

What about inflation?

  1. ASIA – most CPI and PPI readings were relatively benign in October-December, but should pop up in January
  2. EUROPE  - since they are still dealing with stagflation, it’s all relative, but Brent Oil was cheaper in November
  3. USA – follow the CRB Index - down hard from SEP to NOV, heading higher, faster, now in January = #headwind

So, if policy perpetuated Inflation Slows Growth… and Food/Energy prices continue higher from here until whenever that whenever is, you have yourself the 1st major macro headwind to growth in the last 2-3 months.


If you think you are going to get sustainable (real inflation adjusted) economic growth with $115-130 Brent Oil, you might want to check the tapes on how that consumption growth movie ends.


Isn’t it appropriate and ironic, then, as our bailed-out overlords descend upon Davos this week, that the manic media no longer looks to broken sources for “growth forecasts.” They’ve enlisted JP Morgan’s Jaime Dimon this morning instead. He doesn’t have a macro model but is insinuating that the “foundation is set for 4% growth.”


Right, right…


To be clear, there’s a better chance that hockey is banned in Thunder Bay, Ontario than the USA seeing a sustained 4% GDP growth rate when Oil is above $100/barrel.


To Review: there are 3 stages of growth and inflation in our GIP (Growth/Inflation/Policy) Macro Economic Model:

  1. Slowing
  2. Stabilizing
  3. Accelerating

You don’t have to be a brain surgeon to get Muckernomics – it’s all about time and space. Try it on skates (or with a car) and you’ll get it. Cycles are processes, not points. And there are certain levels of inflation that slow growth inasmuch as there are others that help stabilize it (see our Chart of The Day).


Accepting this as truth would eviscerate the academic credentials of most Keynesians hanging out on your tax-payer dollars in Switzerland this week. Central planners of the Global Currency War still think that if you debauch the Dollar, you’ll see a meteoric rise in export demand (even though exports are only 9% of the US economy, and falling).


Back to Melvin’s Market… higher-highs (and in the case of the Russell2000, all-time highs) are flat out bullish, until they aren’t. If your catalyst shorting this market was Earnings Season, so far that’s what we call being wrong. The Financials led off with borderline excellent results, and now we’re seeing Tech (the market’s worst performer YTD at +2.15%) deliver some early morning bacon.


Since Apple (AAPL) is 17% of Tech (as a % of the Tech ETF, XLK), what it does tomorrow on earnings day really matters; especially after Google (GOOG) and IBM ripped last night in the post. Our quantitative signal on AAPL says to do nothing. It’s still in a Bearish Formation (bearish on all 3 of our risk management durations, TRADE/TREND/TAIL), so waiting and watching for the print is a choice.


In the meantime, the SP500 is immediate-term TRADE overbought at 1496 inasmuch as the VIX is oversold at 12.19. So a big AAPL surprise to the upside might just give you what Melvin called his last word, “freak” – to the upside. And if they miss, people might just freak-out on that too.


If you think this market is crazy, join the club. There hasn’t been anything normal about this for years. Not seeing growth stabilizing when it did might be as crazy as buying is on green is crazy today or tomorrow.


Sell crazy someplace else, we're all stocked up here.” –Melvin Udall.


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, UST10yr Yield, AAPL, and the SP500 are now $1654-1692, $110.93-112.95 (Bullish Breakout for Oil), $79.41-80.14, $1.32-1.34, 87.71-90.61, 1.82-1.91%, $482-528, and 1475-1496, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Melvin's Market - Chart of the Day


Melvin's Market - Virtual Portfolio

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Chipotle Mexican Grill reported (pre-announced) 4Q and FY12 earnings after the close.  Comps and earnings were in line with consensus expectations and the pre-announced figures but some important metrics, which we flagged in recent research notes, inflected in the fourth quarter.  Below, we recap 4Q12 and offer some thoughts on 2013.  


From here, we remain reluctant to chase the recent move in the share price.  A significant reason behind that is that consensus is, in our view, too optimistic in its view of food and labor costs. See the second-to-last chart of this post for more on this point.



4Q12 Earnings Recap


Important Drivers:

  • Same-restaurant sales grew by 3.8%, year-over-year, in 4Q which was in line with preannouncement
  • The comp was driven by 3.8% traffic, 90 bps of price, offset by mix
  • The company opened 60 new units versus consensus expectations of 42
  • RLM decreased by 150 bps vs 4Q11 as food costs increased +130bps
  • Wage line delivered for the first time in over five years “as wage inflation, including promotional increases more than offset any leverage from the comp”. We think this is a trend





2013 Outlook


The broad guidance parameters are unchanged:

  • 165-180 new units in 2013
  • Flat-to-low-single-digit comp growth


Other points:

  • No decision on menu pricing but inflation “so far makes it more likely”,  Dairy and protein prices are likely to force management’s hand in this respect
  • Management seems reluctant to take price and hinder transaction growth
  • Management is trying to gain leverage from G&A
  • The international business is producing altogether different returns from that of the domestic market.  Volumes and returns are lower, with brand awareness taking some time to elevate to desired levels.


Key Metrics


The good news for Chipotle this quarter is that New Unit AUV Growth seems to be slowing at a decelerating rate.  This is a good sign for revenue growth and returns if the bottoming process plays out.




CMG LEVERAGE DRYING UP IN FY13? - cmg sales growth new unit volume growth



More of a concern is the margin side of the earnings equation.  Food costs are being guided to 33.5% to 34% and labor costs, long a source of margin, could now be turning higher. 


If management takes price, which seems likely given the earnings call commentary, then food as a percentage of sales could come in below guidance.  The worry is how great of an impact that will have on traffic.  


Consensus Metrix shows the sell-side expecting continued labor leverage in 2013.  We are less confident; the company’s hiring practices have come under scrutiny and cost of compliance, along with the stated driver of wage inflation, could drive labor costs higher going forward.


CMG LEVERAGE DRYING UP IN FY13? - cmg labor cost tailwind





Howard Penney

Managing Director


Rory Green

Senior Analyst



HBI: Financial Model Changing Again

Takeaway: After an incredible debt reduction and mgn recovery story over the past yr, $HBI needs to grow organicly, achieve new peak mgns, or aquire

Usually a company’s print will leave us squarely supporting either a bullish or bearish case. But in the case of HBI’s 4Q12, we come out right in between.


The Positives…

On the plus side, HBI is the poster child why you should never count against a company that is paying down its debt to drive EPS. We did not appropriately respect this factor, and it was a mistake. Over the past year HBI pas paid off nearly 40% of its debt, taking interest expense down by $40mm during a time when EBIT was off by $20mm (due to product costs). During that time period, HBI’s stock went from $22 to $38. Yes, the market was partially banking on a materials/pricing-driven margin recovery, but we’re hard pressed to find anyone who owned the stock who did not have debt reduction as part of their core thesis.


Management highlighted this many times on the call – arguably more than necessary. But when we step back and analyze the situation, we could see why. Back in 2006 when Sara Lee spun out Hanesbrands, it did so with a $2.5bn debtload and minimal cash. Rich Knoll wasn’t too happy about it back then, and has had the team  focused on reducing debt (balanced with sporadic bolt-on acquisitions) over the past six years. He’s finally got the end in sight. We give the team credit.


The Concerns…

After the debt reduction, we really couldn’t find a lot to get excited about. Consider the following.

1)      Operating margins in the last two quarters came in at 13%, and guidance for next year has margins at new peaks. This level pegs HBI in line with brands like Under Armour, and within a point of Nike. We know that the businesses are different, but as a simple litmus test we wonder if HBI can consistently operate at a level above those brands.

2)      The company noted that a 3-4% digit top line growth rate can be leveraged into double digit EPS growth ‘for a very very long time’. This is consistent with past statements. But with margins at new peaks and the de-leverage story nearly complete, it has to come in large part from top line growth. That’s harder to bank on than deleverage for a company in this business.   

3)      We give the company credit for investing an extra 3-4% in SG&A in 2013 in advertising – which is something we’ll almost always applaud. But aside from that, there wasn’t much mentioned in the way of major initiatives to drive the top line. We heard a lot about driving efficiency, but ultimately the top line is what will get us excited given that HBI is operating above peak margin levels.

4)      Management discussed acquisitions in the context of growth – which is fine. After all, it’s worked for them in the past. Put we’re incrementally concerned that we might need to rely more on deal activity.


In the end, we think that the company is being managed well, and that that the risk of being blown up in this position near-term is not significant at 11x a doable FY13 number. But on the flip side, we simply struggled to find anything that makes us excited to buy this name after such incredible (and well deserved) performance.


We don’t think we’re alone in the group of people that wants to see -- in much greater detail -- how HBI is going to drive its financial model on a go forward basis when it hosts its investor day later this month. 

A Longer View of Ag Equipment

A Longer View of Ag Equipment


  • North American Tractor Market in Units:  Looking back, North American agricultural equipment has had quite a run since the period of underinvestment in the 1980s.

A Longer View of Ag Equipment - d1


  • Increasing Horsepower & Productivity:  Tractors have increased in horsepower at roughly 3% a year for some decades and a high-end tractor today is roughly 50% more productive than it was 10 years ago, according to Deere.  If the unit sales are horsepower adjusted, the recent gains in equipment sales become even more noticeable.

A Longer View of Ag Equipment - d2


  • At the Trough (FY 1986): “Depressed conditions in the North American agricultural industry continued in 1986, as retail demand for farm equipment declined for the fifth consecutive year….The Company’s sales and production were significantly lower in 1986, and the level of North American dealer inventories of farm equipment was reduced considerably.” DE FY1986 10K
  • At the Last Peak (FY 1975):   “Retail demand for large farm tractors and harvesting equipment for wheat, corn and soybeans remained very strong during 1975….More recently world prices for food and feed grains and other agricultural commodities have increased sharply….causing additional acreage to be brought back under consolidation.” – DE FY1975 10K
  • Closer to Peak? (FY 2012):  “Relatively high commodity prices and strong farm incomes are expected to continue supporting a favorable level of demand for farm machinery during the year [2013].…Industry sales for agricultural machinery in the United States (U.S.) and Canada are forecast to be about the same for 2013 in relation to the prior year’s healthy levels” – DE FY2012 10K
  • DE v. AGCO:  We spent time earlier this year pursuing AGCO (which reported this morning) as an alternative to Deere.  AGCO has much less exposure to the US market, which we view as closer to peak demand than trough.  While European tractor sales may be less “toppy,” the market has bounced and is heavily and awkwardly subsidized, among other problems.   If we had to make a bet for the next 5 years, we would guess that AGCO outperforms DE.  Fortunately, we don’t have to bet – at least not yet.
  • No Easy CallCurrent sales of combines and tractors are likely well above replacement demand.  The North American Ag equipment market could boom for years more, driven by greater use of biofuels, high commodity prices, aging farmers, healthier farmer balance sheets and other factors.  We suspect that is what is priced into many of the Ag equipment share prices.  However, history suggests that tractor sales could stagnate or even decline in coming years.  That risk does not look priced in.  We find it easier to get on board with depressed cyclicals that are showing signs of recovering and are in great industries. That is where we usually find value.  DE and AGCO both have strong franchises in consolidated, well-structured industries.  However, from a cyclical perspective, we have a tough time getting on board and that excludes the uncertainty from currencies, crop prices and exports discussed here.   


Bonus from DE 1975 10K: “It is believed that coal and electricity will become more important fuels in the future, and coal has been substituted for natural gas in a number of operations.”  How times change.



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