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Trust Mr. Market

This note was originally published at 8am on February 19, 2013 for Hedgeye subscribers.

“He knew that he had a gift: the power to make people trust him.”

-Evan Thomas

 

With the Chinese allegedly hacking US corporations and the Keynesians in an all-out currency war with the world’s savers this morning, what could possibly go wrong? The US stock market doesn’t seem to care. Do you trust it?

 

The aforementioned quote about old-school trust comes from an excellent leadership book I’m reading titled “Ike’s Bluff: President Eishenhower’s Secret Battle to Save The World.” Since I am finishing up our year-end review process, trust is a factor I thought a lot about while I was in London last week. The people you choose to work with either get it, or they don’t.

 

Americans believed in President Dwight Eisenhower, big time. He had the highest approval rating of any post WWII President, not because he gave the best speeches (he hated the teleprompter, and it showed) – it was because poll after poll revealed an endearing quality that the modern polarizing #PoliticalClass has not been able to achieve – the underlying trust of The People.

 

Back to the Global Macro Grind

 

I trust Mr. Market. I believe in his real-time signals. I trust that The People ultimately trust his scorecard too (he might be a she by the way). You don’t have to like someone in order to trust them.

 

You don’t get paid to play the market you’d like to have either. You get paid to play the game that’s in front of you.

 

That’s just too complicated for a dumb bunny like me.” –President Eisenhower (page 29)

 

Or is it?

 

At the end of the day, it’s all about your attitude. Sure, it really is hard to let Mr. Market humble you into the daily position of A) embracing uncertainty and B) accepting that risk doesn’t care about your positioning.

 

You can, however, dynamically (daily) risk adjust your positioning based on the highest probabilities that Mr. Market is giving you. Would you play any other game any other way? For us, since late November, that overall Global Macro position has been:

  1. Long US Dollar, Short Japanese Yen
  2. Long Equities (Asian and US specifically, not Europe)
  3. Short Gold and Treasury Bonds

I can be a dumb bunny too. That’s why I maintain a model that accepts dumb government policy as causal to currency moves. That’s also why we get currencies more right than wrong. Stocks, Bonds, and Commodities tend to react to big policy driven currency moves.

 

The US Dollar was up for the 2nd consecutive week last week (+1.8% over that time) and for the #1 concern my competitors are signaling as the US stock market’s greatest risk (inflation), Strong Dollar did what it should have done – it Deflated The Inflation:

  1. CRB Commodities Index = down another -0.9% last week (down -2.2% in the 2 weeks of Dollar Up)
  2. Gold = down another -3.5% last week to a fresh YTD low (down for the last 2 weeks as well)
  3. Silver = down -5.3% on the week and Food Prices deflated too (Cocoa -4.1%, Corn -1.4%, etc.)

Now a lot of people in this world (especially Americans) like it when the purchasing power of their hard earned currency appreciates. Others (like Venezuelans for example) don’t have a say in the matter. Their overlords debauch their currency whenever they please.

 

Eisenhower was lucky in that he was able to compete with British and French debaucherers of currency. These were weak governments who were addicted to debt and the cowardly messaging of #ClassWarfare. No one trusted that then – and they don’t trust it now.

 

Not all Equity markets like Commodity Deflation. Brazil’s Bovespa Index is the poster child for commodity exposure – it was down another -1% last week and is now down -5% for 2013 YTD.

 

What could really get this US and Asian Equity party started would be another blast higher in the US Dollar from here:

  1. Then Oil will eventually start to mean revert versus the rest of the CRB Commodities Index (which is breaking down)
  2. And Consumers, globally, will get a much needed TAX CUT at the pump

What’s actually quite amazing is that US Consumption hasn’t been hammered with Brent Oil trading up here at $117-118. In our GIP Model (Growth, Inflation, Policy), a Brent Oil price that is in a Bullish Formation is an explicit headwind.

 

But maybe that’s more of a headwind for those cheering on a weak currency in Europe. Enter France:

  1. France’s CAC40 snapped its immediate-term TRADE line of 3711 support in the last few weeks
  2. French Services PMI of 43.6 in JAN was god awful relative to A) itself (45.2 in DEC) or any other major country

So, the French have economic issues that, evidently, weren’t resolved with a 75% tax rate…

 

Now that their economic data really sucks again, the first thing their conflicted and compromised #PoliticalClass does is jawbones for a weaker Euro – then they tell the world they really didn’t do that at the G20 meetings, n’est-ce pas? But, with the CAC and the Euro breaking immediate-term TRADE support, who do you trust? Mr. Market doesn’t trust them.

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, USD/YEN, UST 10yr Yield, and the SP500 are now $1602-1652, $116.09-118.91, $3.67-3.72, $1.31-1.33, 92.53-94.38, 1.96-2.05%, and 1516-1524, respectively.

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Trust Mr. Market - Chart of the Day

 

Trust Mr. Market - Virtual Portfolio


TRADE OF THE DAY: CAF

Today we bought the Morgan Stanley China A Share Fund (CAF) at $23.93 at 12:40 PM EDT in our Real-Time Alerts. Buying China back on an immediate-term TRADE Oversold signal in the CAF. See Darius Dale's intraday note on China for details in risk managing the catalysts for this position.

 

TRADE OF THE DAY: CAF  - image001


Key Retail Macro Chart

Takeaway: Key Retail Chart: Apparel inflation spreads, which have a direct gross margin impact, are trending slightly positive.

Here’s a key retail chart. With the apparel industry at peak margins (both cyclical and secular) there is one chart we look at more than any other – and that is the group’s margins compared to the spread between industry buying costs and selling costs. The trend suggests that buying costs are trending below the change in retail prices (ie margin bullish). We need a lot to go right in order for this to sustain itself throughout 2013. But it’s a positive trend nonetheless.  

 

Key Retail Macro Chart - macro2

 

Key Retail Macro Chart - macro1


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BWLD BECOMING A LESS ATTRACTIVE ON SHORT SIDE

Buffalo Wild Wings is screening less conclusively as a short as chicken wing prices have declined dramatically over the last few weeks.  We believe that the “conversation” around BWLD’s main input cost has changed significantly and this has important implications for our short thesis.

 

Hedgeye’s macroeconomic outlook has differed from consensus of late but market prices are vindicating the stance that a stronger dollar, and the lower commodity prices that tend to accompany that, is boosting the purchasing power of the American Consumer. 

 

From Buffalo Wild Wing’s perspective, the implications of this are two-fold:

  • Top-line demand should benefit from the stronger dollar, overall consumption growth
  • Chicken wing prices should come down as a derivative effect of a stronger dollar, lower corn prices

We believe that issues at the company level preclude us gaining sufficient conviction on the top line to suggest buying BWLD, but some facts pertaining to our short thesis have changed.

 

 

Traffic Still a Potential Problem

 

We retain a healthy level of skepticism that Buffalo Wild Wings will ultimately meet consensus expectations.  While the consumer, overall, seems to be holding up well despite the payroll tax increase, casual dining is not a point of strength.  We doubt there are any restaurant companies, particularly within casual dining, that have the power to raise prices 6% year-over-year and not see a drop off in traffic growth.  Management has implied that tests have “gone well” with the changes in how portions are sized (by weight versus number of wings) but we believe that bulls may be underestimating the sensitivity of traffic to price increases.

 

 

 

Wing Prices Coming Down?

 

Over the last year we have heard management’s tone on commodity costs change drastically.  This thorn in the company’s side may finally be going away as prices seem to be steadily declining.  Management is aiming to bring cost of sales down to 30%, from 32% in 4Q12.  This is largely dependent on how comps trend but wing prices coming down should make this goal easier to achieve. 

 

At this point, it is difficult to know where wing prices will trend, but if prices were to continue to trend lower, it could have a dual impact of improving sentiment on the stock and supporting EPS expectations.

 

BWLD BECOMING A LESS ATTRACTIVE ON SHORT SIDE - bwld cogs vs wing prices1

 

BWLD BECOMING A LESS ATTRACTIVE ON SHORT SIDE - chicken wings

 

 

Call with questions.

 

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst

 


BYD 4Q REPORT CARD

In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance

 

 

OVERALL

  • GOOD AND BAD:  Q4 was a big miss from consensus although relative to our estimates Borgata was the only real negative standout.  Guidance was also weak.  However, BYD made a big move in selling Echelon:  improves the balance sheet, removes the big overhang of a restart of that expensive project, and eliminates $16m in ongoing costs

 

 

WHOLLY-OWNED EBITDA

  • WORSE:  Ex Peninsula, wholly-owned EBITDA post corporate expense came in at $65.7MM.
  • PREVIOUSLY: "We expect wholly-owned EBITDA after the deduction for corporate expense to be in the range of $70 million to $75 million."

LV LOCALS TRENDS

  • SLIGHTLY BETTER:  Promotional environment has stablized.  BYD saw an improvement in trends starting in December and it has continued into 1Q.  Customer count is up; spend per visitor is down.  The higher end of database continue to do well.
  • PREVIOUSLY: "I wouldn't say that promotions have abated. I think they're at very much kind of the same state they were in through the summer. What we have seen is spend per visitor in the Las Vegas Locals segment flatten out."

MIDWEST AND SOUTH REGION

  • WORSE:  Visitiation and spend per visit were lower in the casual gamer segment.  The market remains very competitive.
  • PREVIOUSLY:  "Our Midwest and South region...is currently the healthiest region of the domestic gaming industry and the most robust part of our business."

ATLANTIC CITY

  • WORSE:  Sandy really hit AC hard with EBITDA falling 63% in 4Q.  Guidance was also well below the Street for Q1.
  • PREVIOUSLY:
    • "Atlantic City.... the... environment remains competitive. Weakness was concentrated in our table games business, where both volume and hold fell year-over-year. This accounted for almost the entire EBITDA shortfall. Still, there were encouraging signs as our slot and non-gaming business showed growth. Borgata remains the undisputed market leader and we expect it will be Atlantic City's premier destination resort for years to come."
    • "Revel spent a lot of marketing dollars, they were very aggressive in buying business, in trying to gain trial and gain some traction. We increased our promotional dollars slightly. If you look at some of our slot promotional credits, they're up slightly year-over-year, but not substantially, and not compared to what the rest of the market is doing."

DOWNTOWN

  • WORSE:  4Q revenues fell 2% YoY while EBITDA dropped 8% YoY, even though BYD gained 250bps in market share.  
  • PREVIOUSLY: "As expected, we saw growth resume in our Downtown business segment in the third quarter and we anticipate this positive trend will continue in the fourth."

LV LOCALS: PENNY DENOMINATION GAMES

  • SAME:  Introduced 1,000 new penny slot games in 4Q
  • PREVIOUSLY: "The Las Vegas Locals business remains extremely competitive...we're continuing our efforts to grow business from casual players. Penny denomination games are popular with these guests and are one of the few segments of the Locals market to show growth in recent months. So we've recently taken steps to ensure we are well positioned in this area and are nearing completion of the rollout of some 1,500 new penny themes across our Southern Nevada properties. Starting today we have begun to aggressively promote these new games. While we believe this initiative will be attractive to slot players, video poker will remain an essential part of our business, especially among our core players. We will continue to offer our guests what we believe is the most competitive video poker product in Las Vegas."

LOUISIANA/MISSISSIPPI

  • WORSE:  BYD took a impairment writedown of $17.5MM on its Shreveport facility.  Their 'best' property, Delta Downs grew 2% in state-reported gaming revenues in 4Q.
  • PREVIOUSLY: "We know that in certain markets like Tunica, Mississippi and Shreveport, Louisiana, there is a significant amount of competition both within the specific geographic market as well as within neighboring states. But I've got to tell you, I feel awfully good as to where we perform in those markets relative to our competitors that post those results. And you can see it in the revenue numbers that are published especially in Louisiana as it relates to Sam's Town Shreveport."

 


A Look Back at the Month in Consumer Staples

This note was originally published March 03, 2013 at 13:14 in Consumer Staples

February saw 4/7 sectors in our universe outperform the broader market (non-alcoholic beverages just underperformed the S&P 500 during the month).  Tobacco lagged on regulatory concerns and the protein sector suffered when TSN suggested that trends in the current quarter were weaker than originally anticipated.

 

A Look Back at the Month in Consumer Staples - Sector performance YTD

 

This month we added something new - we took a look at the sector’s performance by P/E quartile – unsurprisingly, the 3rd quartile (P/E ratios between 16-20.7xs) had the strongest monthly performance (HNZ was in this quartile).  The HNZ transaction drove multiples broadly higher in large cap staples name, several of which traded in the same P/E range – CL, CLX, PEP.  MDLZ was the weakest performer during the month and the only negative performance within that P/E quartile.

 

A Look Back at the Month in Consumer Staples - Monthly PE by Quartile

 

Similarly, within the 2nd P/E quartile (P/E ratios between 13.3 and 16.0x), HNZ appeared to have been the primary driver of monthly performance – CPB was the best performer in that quartile (+12.1%).  The quartile’s performance also benefitted from KMB (+5.3%) and GIS (+10.3%).

 

The 1st P/E quartile (P/E ratios less than 13.3xs) was all about STZ (+36.7%) – the quartile would have been up 1.7% but for STZ.  A second of our preferred names, (STZ, at the time, being the first) ADM, was a significant contributor to the quartile’s performance, +12.4% on the month.

 

Higher multiple names in the sector had a good month was well, with SAM (+10.8%) and BNNY (+17.0%) the best performers.  Multiples expanded across all quartiles as prices continued to move higher and estimates for 2013 were lower to unchanged coming out of Q4 earnings season for most sectors (protein being the notable exception).

 

A Look Back at the Month in Consumer Staples - Beginning End of Month PE by Quartile

 

A Look Back at the Month in Consumer Staples - EPS Revision Chart

 

Consistent with a broad-based rally in the consumer staples sector, there hasn't been a significant divergence between high and low beta names.  If anything, lower beta names have outperformed in the wake of the HNZ acquisition, likely setting the stage for some mean reversion in lower beta names as the takeout speculation wanes.

 

A Look Back at the Month in Consumer Staples - Beta Chase 3.3.13

 

This is a familiar chart for those of you who have been following our work - it is also the chart that keeps us broadly cautious across the sector.

 

A Look Back at the Month in Consumer Staples - Staples Forward PE 3.3.13 

 

The anomalous relationship between the XLP and the 10 year that has existed since 2009 persists...

 

A Look Back at the Month in Consumer Staples - XLP vs. 10 year 3.3.13

 

...despite the fact that the yield of the XLP has become marginally less attractive (combination of the yield on the 10 year creeping up and the price performance of the XLP).

 

A Look Back at the Month in Consumer Staples - Yield spread

 

Some clients have suggested to us that the move up in the group post-HNZ has been short-covering - the data doesn't appear to bear that out.

 

A Look Back at the Month in Consumer Staples - Short Interest February

 

Finally, our "XLP vs. Economic Surprise" chart suggests that continued strength in the economic surprise index could signal a pause for the staples sector.

 

A Look Back at the Month in Consumer Staples - XLP and Economic Surprises 3.3.13

 

Where does that leave us?

 

We are going to focus on three charts - overall sector valuation, "beta chase" and economic surprise.  These suggest to us that we could see a pause in the staples sector as sentiment surrounding the broader economy improves, valuation becomes more relevant and takeover speculation recedes.  We would look for relative underperformance in the lower quality, lower beta names that have seen a move up in the wake of HNZ (TAP, GIS, CPB).  Our most/least preferred list remains relatively unchanged:

 

Most preferred

  1. ADM - play on upcoming crop year (BG should work as well)
  2. BUD - least expensive large cap staples name (replaces STZ on our preferred list due to unfavorable risk/reward)
  3. CAG - valuation remains compelling, estimates remain too low
  4. NWL - valuation + stealth housing play

Least preferred

 

  1. KMB - robust valuation plus deteriorating earnings quality (CL works here as well)
  2. TAP - valuation support but zero business momentum
  3. GIS - run up post-HNZ is unwarranted (CPB eventually, but not yet).

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