EWG: Why We Bought Germany Today

POSITION: Long Germany via the etf EWG


Despite GDP projections of negative 4-5% growth for Germany this year, we're bullish on the stimulus measures Chancellor Merkel and Co. have passed and believe Germany plays well as a long versus our short position on the financially levered and poorly managed countries of Switzerland (via EWL) and the UK (via EWU); the latter we just covered today.


Look for Germany to benefit from an uptick in export demand from China, especially if the Euro can stay below $1.32, and from Eurozone and US demand as the global recession moves out on the recovery curve.  In addition, the stimulus package may lead to economic growth that exceeds these dire expectations.


German investor confidence unexpectedly rose this month and the DAX is up 9.8% month-to-date, signaling that the pace of contraction is easing and the worst may be over, yet buyer beware. 


The ZEW Center for European Economic Research said its index of investor and analyst expectations for economic activity within six months rose to +13 from -3.5 in March, the highest reading since June 2007. Yet ZEW's gauge of current conditions fell to -91.6, the lowest since September 2003, from -89.4 in March.


Certainly the German economy looks to be improving, yet is not out of the darkness.  German industrial production fell 3.2% M/M in February, compared with a decline of 2.3% in Euro area, and improved sequentially over January's contraction of -5.9% M/M, according to Eurostat. The country's trade balance stood at +7.2 Billion EUR in January; exports declined 23% and imports fell 15% on an annual basis.


Although Germany's trade surplus is severely depressed from the previous year's surplus of 17.1 Billion EUR, the positive take-away is that despite declines in exports globally, Germany posted a positive balance.  In contrast, the UK posted a trade deficit of -8.9 Billion EUR in January and the majority of the EU came in with negative balances. 


German PPI yields a slightly unclear picture when examined on a monthly versus annual basis. The Federal Statistics Office said today that PPI declined 0.7% in March M/M and fell 0.5% Y/Y, after gaining 0.9% in February Y/Y. The numbers do help to confirm that inflation is slowing (as is the case across the EU) and that companies are either able to extend reduced energy costs to consumers or are forced to cut prices in response to waning demand. As PPI (and CPI) fall they'll put upward pressure on unemployment, which has risen sequentially on a monthly basis, currently at 8.6%  These fundamentals, especially from the Eurozone's largest economy, may help prompt the ECB to cut its interest rate from 1.25% when it meets next month.


Today Merkel met with finance and economic ministers to discuss a German "Bad" bank plan, which may be especially geared to its state banks (*Landesbanken). Proposals to clear some $1.1 Trillion of toxic assets from banks will be discussed in the next few days, which on the balance is positive.  As is often the norm, the Germans will take a "slow and steady" approach to a decision, with a government spokesman stating a decision could come shortly before parliament's July 3rd summer recess.


Matthew Hedrick


EWG: Why We Bought Germany Today - zewapr

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

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".

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