Eye On India: Whole Lot of Nothing, So Far...

Rate cuts in India have not yet created real liquidity ...


The reserve bank reduced benchmark rates by 25 basis points today, the 6th cut in 6 months.  Although the timing of the cut was a surprise to most economists, collapsing wholesale inflation and declining production levels had clearly left the potential more cuts by the central bank baked in. 


At this point, the big question is not when there will be more rate cuts, but rather when that liquidity will pass through to the real economy. To date, the spread between average commercial rates and RBI benchmarks have hardly contracted while growth of commercial credit continues to decline on a sequential year-over-year basis.


Eye On India: Whole Lot of Nothing, So Far...  - india1


Eye On India: Whole Lot of Nothing, So Far...  - india2


To date, our opinion on prospects for India's recovery has diverged wildly from Street consensus because of a fundamental difference in how we interpret internal demand there: While our competitors see strength in India's lack of export dependence, we see weakness in a dependence on an agrarian sector which currently keeps over half the population employed on a bare subsistence level. One thing that both they and we can agree on however is the need for credit liquidity to help drive internal demand.


With the election cycle in full swing (a complex, manual process that will take weeks to conclude) political tail risk takes precedence in our model, but we will continue to watch the Indian market closely for signals that government measures are having an impact. Until we see some confirmation of that, we will retain our short bias on the India equity markets.


Andrew Barber

COH: Beware The Trifecta

I can drive a truck through the bull case and the bear case on this name. The bulls are winning today on the ‘better than toxic’ results. We’re the first to respect the premise that going from ‘toxic to bad’ is a positive event. And from a modeling standpoint, I think that COH has much in its favor for the next year. But I have too many concerns and questions that still need to be answered before I can get bulled-up over the long-haul. If I gain such confidence, I certainly won’t regret having missed out on another 10-20% move in the stock, so long as it’s clear to me that it will not be cut in half.


Bull Case:  Coach is perceived to be one of the best brands in retail, with meaningful growth opportunity on a global scale. North American comps are getting less bad, with the latest quarter down only 4% yy in a horrible high end retail climate. That’s happening at the same time where we’re seeing a ‘financial’ trifecta on the P&L and balance sheet. Check out the SIGMA chart below, it shows how Gross Margins have been dropping like a stone as SG&A has gone right up in each of the past four quarters. This is at the same time both working capital was squeezed AND capex headed higher. Now each of those factors gets better on the margin for the next year barring a massive stumble by the company.  Tack on the new dividend announcement and accelerated stock repo and the stock looks cheapish at 6x EBITDA.


Bear Case: Comps getting ‘less bad’ will only take the company so far given a secularly challenged wholesale business, and the fact that the company is stepping up its efforts to cut costs out of the system. Yes, this helps ’09 optically, but will it be at the expense of ‘10/’11 revenue and Gross Margins?  Maybe, maybe not. But the risk will certainly remain, and with margins still at a lofty 30%, there’s no structural support that would preclude them from going much lower. The kicker there is that COH generates 26% of sales in Japan. While many people like the US diversification and the exposure to the Japanese luxury consumer, I’m not in the camp that likes such heavy exposure to an economy that is terminally ill.  And this all comes from a management team that does not ‘do macro,’ and has argued in the past that women still need six handbags apiece regardless of the economy. That part of the narrative scares the heck out of me. Has management changed its tune and embraced the cyclicality of its business? Yes. But I have zero evidence or confidence that they are proactively managing it.


COH: Beware The Trifecta - 4 21 2009 8 18 23 AM



Brian McGough


Geithner's Greenback

Poor Timmy is back on stage this morning, testifying in front of the US Government, and reminding us all that our Financial system (and those at the helm of it), have lost credibility. This guy's smugness is truly embarrassing.


In a perverse way, this is actually quite good for the REFLATION trade. As foreign sellers threaten to Break The Buck, assets will REFLATE. Dollar DOWN = everything else UP.


Geithner's Greenback - gman


Keith R. McCullough
Chief Executive Officer

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MCD - Rolling out the Angus Burger?

It’s being reported today that McDonald's (MCD) is planning to introduce its Angus burger nationally this summer.   The Angus burger is a premium burger (over $4.00 in some markets) with a larger patty and higher quality beef.  The size of the burger did pose some operational challenges for some franchisees. 

The timing of the launch Angus burger is puzzling at best.  First, franchisee are burdened with the complexity of rolling out the premium coffee initiative this summer.  To successfully accomplish the premium coffee strategy, incremental labor must be added to the store.  Second, no QSR chain that is focused on selling premium product is seeing increased traffic.  Third, a successful launch of any new product requires significant advertising support.  Without a significant increase in the overall ad budget, advertising dollars will need to be shifted away from what is currently working (breakfast and the value message) to support the new burger.  We already know the company has shifted some advertising dollars to support the launch of the specialty coffee business this summer. 


MCD’s U.S. same-store sales growth remained surprisingly strong throughout 2008 despite the tough economic environment. The company states that half of this comparable sales growth has been driven by traffic with the remainder coming from increases in average check. The growth in average check in 2008 was driven solely by MCD’s 3%-4% price increase, which was partially offset by negative mix contribution in each quarter.   One obvious explanation for MCD’s negative mix in the U.S. is that customers are trading down to the Dollar Menu, which has also helped to support traffic growth. 


I recognize that the problem with an average check is you have a lot of different transactions in there. MCD’s breakfast business, which carries a lower average check, continues to grow faster than the rest of the day’s business.  This hold true with drinks too.  Last summer, the $1 sweet tea promotion was a huge success and the drip coffee is up more than 30%. 


The point to all this is that in 2008, the incremental consumer that was going to a McDonald’s was there for the “value” not “premium” products. 

MCD - Rolling out the Angus Burger? - angus


IGT spent $130 million more in 2008 on SG&A and R&D than it did in 2006, on a big slot revenue decline and flat total revenues.  Why can't IGT revert back to its 2006 cost structure?  The answer:  IGT needs a push.  We don't yet know if Patti Hart is the right person although she certainly brings a fresh and more importantly, unemotional perspective.


The following chart compares various margins for IGT, WMS, and BYI.  On the surface, it appears that IGT's margins are reasonable and the company's cost structure is not necessarily bloated.


IGT: COST CUTTING POTENTIAL - slot margin comps


However, the next chart shows that SG&A and R&D spend is up 23% and 26%, respectively, in just 2 years on a big decline in product sales. 




IGT indicated that it has already cut $115 million in costs in the past year so the obvious question is how much more is left?  Fortunately, those cuts were made at the production level and more than offset the usual margin decline associated with declining volumes.  Gross margin would've otherwise cratered with sharp decline in units.  Instead, product margins have expanded in the face of dismal sales as can be seen in the following chart.  Some of that is increased non-box sales (higher margin conversions, software, etc) and higher pricing, but also reflects the $115 million in cost cuts.  IGT's manufacturing is running at about 35% capacity, leaving a lot of margin on the table until replacement demand reaccelerates.  Since IGT owns its manufacturing plant and has made the production cuts, margins are likely to follow volume from here on out.  




It is in SG&A and R&D where the real opportunity lies but management needs to be aggressive.  We think it is reasonable to expect $100-130 million more in cost savings out of these areas:

  • $75MM gets them back to 07 levels, $130MM back to 06
  • Should take 6 quarters to achieve the cuts, seems like they know where some will come from, and are feeling their way around the others - the new CEO could expedite this
  • $15MM of the $100MM will show up this quarter, and it should be visible in SG&A and perhaps R&D
  • New R&D projects will now require demonstrable ROI
  • First round of cuts are in place and are a kind of "restructuring" - cleaning house to do things better rather than just get across a goal line

The bottom line here for IGT is that the cost cuts will offset some of the top line pain but earnings are likely going lower.  Slot sales will be abysmal with new and expansion units for the industry down 53% and 49% in calendar 2009 and 2010, respectively.  Replacement demand probably won't improve until 2H 2010 at the earliest.  The upshot for IGT is by that time the cost structure should hopefully be very lean and more appropriate for a 40% share company versus the historical 60-70%.  IGT will be in good shape in terms of flow through when replacement demand finally "normalizes".

Deflation Day

"Only the wisest and stupidest of men never change."
Having played plenty a Canadian Junior Hockey Night cage match in the Bear's Den of Smith Falls, Ontario (instead of glass behind the end boards, they had chicken wire), I can assure you that I am definitely not the stupidest of men. Most guys who I chirp at with these morning investment missives will assure you that I am neither the wisest!
Ah, if you can't have fun playing this game, what's the point in waking up at this un-Godly hour and playing it at all! That said, even after taking my US Cash position back up to 62% on Friday, yesterday wasn't much fun for me. My Asset Allocation Model lost -1.05% on the day, largely because I got smoked out of my hole with a 12% allocation to Commodities. The Buck broke out, and it broke my bank.
When we did our Q2 Macro Trend call a few weeks back, I gave explicit levels on the US Dollar. I outlined a critical resistance line of 86.33 on the US Dollar Index as being my line in the sand. With that crystal clear in my rear view mirror now, yesterday's meltdown in everything other than yellow rocks (Gold was +2.4% on the day) was proactively predictable. Yes, we're long TIPs and sold out of our long positions in China, Canada, and Russia, but we still lost money, and that's unacceptable.
In conjunction with the 19 component CRB Commodities Index closing down -3.6% on the session, the SP500 got tagged for an even larger loss of -4.3%. Thankfully, I have shunned everything US Financials (XLF was -11% on the day), and have opted to stay away from being long any index with Financials in it (XLF, SPY, DIA, etc...). Regardless, on DEFLATION Day, I still took it on the chin with the 13% exposure I have to US Equities via the XLK and XLY (Tech and Consumer Discretionary ETFs).
So what to do from here? Well, as usual, the plan is that the plan is going to change. As market prices and the risk/reward embedded within them changes, I will. Only the bravest of men and women stepped up and bought additional US or International Equity market based exposure yesterday, and for that, if they get paid on this morning's US market open, I salute you. I think we have at least one more round of selling left in this thing.
Although I'm not sure what he'll have to say about this, I have never thought of my Dad's primary job as being brave - neither is mine. Notwithstanding that my cushy job up here in New Haven is nearly as dangerous, Dad's job as a firefighter, and mine as a stock market operator, is to proactively manage risk/reward.
I put up an intraday note to our Macro clients yesterday telling them that I was going to wait. With the SP500 breaking down through an important immediate term momentum line at 846, the 815-819 intermediate TREND base of support is now in play. Waiting may not seem brave, but neither is losing a toe for the sake of being in a hurry. If anything has held true for the last 18 months, it is that patience pays a big performance premium.
The entire way up to that 874 line in the SP500 I was rightly pressed by our clients and prospective ones as to why I wasn't choke full of US Equity exposure. On the way up to the top of a proactively predictable trading range, those questions get harder to answer. On the way down however, I rarely hear a peep...
Peeping is what people do who are trying to get a look-see on something that they probably shouldn't. When it comes to the inverse correlation of the US Dollar versus virtually everything else that's asset based on your screens, there is hardly any peeping required. Dollar UP = DEFLATION. If you need a chart to show you this more succinctly, we can send you one. For the guys and gals up in Boston last week, we called it The Green Monster.
In 1999 I worked on the "sell side" at CSFB, then I moved to the "buy side" for the next 8 or so years... and now I like to think that I am on the right side. I am in the business of being right, or being fired - and I like that. It keeps me awake.
Being long is one thing. Being wrong is completely another - and I don't need to stick around to see the reruns of how this movie went post mid-January when the US Dollar caught a bid again. If the Dollar goes up, I think everything else is simply going down.
The good news now (if you're long anything other than cash and gold that is) is that at 86.59, the US Dollar Index is overbought from an immediate term TRADE perspective. If the US Dollar fades here, it will put in another lower high, and that, on the margin, will be bullish for anything that you'd like to see REFLATE.
Just remember, what you'd like to see, and what the malfeasant of our Financial system still hope to see... may not be what you end up seeing. Peeping isn't cool, and neither is a risk management model that doesn't have the ability to change as the macro factors embedded within it do.
Best of luck out there today,


EWZ - iShares Brazil- The Bovespa is up 18.3% YTD and continues to look positive on a TREND basis. President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt -leading to an investment grade credit rating. Brazil has managed its interest rate to promote stimulus. The Central Bank cut 150bps to 11.25% on 3/11 and likely will cut another 100bps when it next meets on April 29th. Brazil is a major producer of commodities. We believe the country's profile matches up well with our re-flation theme: as the USD breaks down global equities and commodity prices will inflate.

XLY - SPDR Consumer Discretionary-TRADE and  TREND remain bullish for XLY.  The US economy is showing faint signs the steep plunge in economic activity that began last fall is starting to level off and things are better that toxic.  We've been saying since early January that housing will bottom in 2Q09 and that "free money" for the financial system will marginally improve the US economy in 2H09, allowing early cycle stocks to outperform.  The XLY is a great way to play the early cycle thesis.

EWA - iShares Australia-EWA has a nice dividend yield of 7.54% on the trailing 12-months.  With interest rates at 3.00% (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.

XLK - SPDR Technology - Technology looks positive on a TRADE and TREND basis. Fundamentally, the sector has shown signs of stabilization over the last six+ weeks.   As the world demand environment becomes more predictable, M&A should pick up given cash rich balance sheets in this sector (despite recent doubts about an IBM/JAVA deal being done).  The other big near-term factors to watch will be 1Q09 earnings - which is typically the toughest for tech, along with 2Q09 guide.  There are also preliminary signs that technology spending could be an early beneficiary of the stimulus plan.

TIP - iShares TIPS- The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%.  We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

USO - Oil Fund-We bought more oil on 4/20 after a 9% intraday downward move. We 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.  

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. 

GLD - SPDR Gold-We bought more gold on 4/02. We believe gold will re-assert its bullish TREND as the yellow metal continues to be a hedge against future inflation expectations.

DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.

VXX  - iPath VIX- The VIX is inversely correlated to the performance of US stock markets. On 4/20 the VIX shot up 15.5% intraday, an overcorrection we want to be short as we believe US indices will make higher highs and the volatility is currently overbought.

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%.

SHY - iShares 1-3 Year Treasury Bonds- 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.

EWU - iShares UK - We shorted the UK on 4/08. 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 see recovery. GDP declined 1.5% in Q1 and unemployment  is on the rise.

EWL - iShares Switzerland - We shorted Switzerland on 4/07 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.

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 up versus the USD at $1.2970. The USD is up versus the Yen at 98.2010 and down versus the Pound at $1.4582 as of 6am today.

EWJ - iShares Japan -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".

XLP - SPDR Consumer Staples- Consumer Staples broke down through TREND line support, closing under the TREND line by a dime. This group is low beta and won't perform like Tech and Basic Materials do on market up days. There is a lot of currency and demand risk embedded in the P&L's of some of the large consumer staple multi-nationals; particularly in Latin America, Europe, and Japan.

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