Ugly Macro Factors Converge on the UK

POSITION:  Consistently negative bias this year and recently covered our short via the EWU


The pain is rising in the UK from a macroeconomic standpoint, with new data out today and Chancellor of the Exchequer Alistair Darling's downward forecast on GDP. Britain will likely not see modest growth until well into 2010. 


We've had a consistently negative view on the UK; just yesterday we covered our short position via EWU for a modest gain. The budget deficit is set to hit an estimated 11% of GDP this year and the trade gap in the fiscal year through March tripled to 90 Billion Pounds ($117 Billion). Also, jobless claims rose 73,700 in March to 1.46 million, the most since 1997. The FTSE is down -9.1% YTD. This is miserable absolute performance, never mind awful relative to countries socializing like the USA and Japan.


Today in his budget speech Darling said the economy will shrink 3.5% this year, far from the 1.25% contraction he forecasted in November of last year. While the downward revision did not come as a surprise to us, the announcement helps to confirm our negative bias towards the UK's leadership and its ability to right the economy.  The UK's statistic office, HM Treasury, which collects a selection of forecasters, helps to confirm Darling's number, albeit their average GDP came in at -3.7% for this year. According to the same estimates, the UK won't see positive growth until 2010, yet at a modest rate of +0.3%.  


As a measure of inflation, CPI rose 2.9% Y/Y from 3.2% in February Y/Y, confirming its downward momentum on a month-over-month basis. It's likely we can expect CPI to fall below the Bank of England's 2% target in Q2. While deflation is being felt throughout the EU, we believe that the UK's rate of decline will outpace its European peers.  Deflationary pressure tends to reverberate throughout an economy, including depressing earnings growth, consumption, home prices, and investments, while pushing up unemployment, savings rates, and bond yields to name a few.


One positive data point worth mentioning is housing. According to Hometrack national average prices, (see chart below) UK housing prices are improving. The rate of change on a year-over-year basis is declining and month-over-month there was a clear upturn in October of last year.  Despite the positive rate of change, we're of the firm opinion that the uptick in prices will take a considerable duration to hit Main Street, yet on the margin the data is positive.


While the question isn't if the UK will recover, but when and at what rate... until we see a more positive trajectory in that recovery, we'll continue to hold our bearish view.   


Matthew Hedrick


Ugly Macro Factors Converge on the UK - ukhousing

Weekly Sports Apparel Numbers Lookinig Good

Is anyone watching these SportscanINFO sports apparel numbers? Argue with the validity of the sample all you want (as I often do) -- but if it is a weak sample it is at least a consistently weak sample. The rising trajectory over the past 4-5 weeks does not want to stop.


Weekly Sports Apparel Numbers Lookinig Good - Industry Total Chart

Weekly Sports Apparel Numbers Lookinig Good - All Channels   chg

MCD – Something New to consider

McDonald’s is a very healthy company, with slowing trends and margin pressure around the world.  In summary, this was not a great quarter from MCD.  The company reported 1Q09 EPS operating EPS of $0.83 vs. $0.82 and the earnings benefited from a lower tax rate of 28.6% for 1Q09 as compared with 30.6% for 1Q08.


The march comps were basically in line with consensus estimates, but mark a significant slowdown from last year.  Globally, McDonald’s reported 4.1% same-store sales with the United States up 5.6%; Europe up 2.9% and APMEA up 5.4%.  The calendar shift/trading day adjustment varied by regions, ranging from -1.0% to -1.8% in March 2009. In March, Europe’s comps were negatively impacted by approximately 2% due to the change in timing of Easter-related school and business holidays from March 2008 to April 2009. On a consolidated basis, traffic increased 1.0% in 1Q09 vs. 3.2% for 2008 and was negatively impacted by 1% due to the leap year.    


Most notable and relevant to what we may hear from YUM is MCD’s commentary on China.  Due to employment issues in Southern China, McDonald’s reduced unit openings for the year from 175 to 150. 


McDonald’s also noted that same-store sales in China were negative for 1Q09 and got worse as the quarter ended.  Importantly, McDonald’s cut prices by 30% during the quarter to help mitigate the decline in traffic trends.  Needless to say this is very painful to McDonald’s margins during the quarter.


McDonald’s management team noted that the decline in menu prices in China was due to signs that Chinese consumers were trading down from Western QSR down to Chinese QSR.  According to MCD, Meal prices for Chinese QSRs are close to 30-40% below what a traditional western QSR meal prices are.  Western style QSR has more to compete against that Chinese QSR, but food at home too.  Western QSR is a luxury for most Chinese consumers.  With higher unemployment and slower income growth, the typical consumer is going to look for cheaper alternatives.    


The most recently available CPI data for urban areas showing an average food cost decline of nearly 22% since last April.  So McDonald’s 30% menu price cut, is only keeping pace with alternative distribution channels. 


A key question now is; does a 30% price cut represent a sufficient inducement to consumers alarmed by economic contraction and job losses to spend money on pricey fast food at the same pace they did during better times?


 MCD – Something New to consider - china food


None of these data points are positive for YUM.  Importantly, YUM success is very closely aligned to how its China business performs.   Looking to when YUM reports 1Q09, I expect YUM to face similar challenges as YOY commodity pressures will be more severe in 1Q09 (vs. 4Q08) and the company is lapping 12% same-store sales growth and 33% operating profit growth.



Currently, YUM is trading at 8.3x NTM EV/EBITDA and the stock is up 6% in the past week and 18% over the past month.  Why?

Eric From JCP: 2 Notable Gems

My new teammate Eric Levine is feeding me the deets live from the JCP analyst meeting. There will be dozens of datapoints coming out of his thing. These are the two most important so far.


1) Costs out of China are down 2-3% for spring and 5-7% for fall. Check out my 3/31 post titled "Retail Narratives Don't Get More Powerful Than This." We believe that there are some companies - especially on the footwear side of retail (which is overexposed to China) that are benefitting from this disproportionately. This will start to show in margins around Oct/Nov.


2) All categories are seeing stabilizing trends - including JCP's Home business. We're not making a housing call by any means, but we've been positive on BBBY for the past 2 months, and have recently started the real deep dive on Williams Sonoma - which could be shaping up to be another big idea here. More to come on that front...

MCD: Penney's "Coming To America"

In the movie, I believe that they called it MacDowell's ... and I believe that investors are beginning to not believe McDonald's guidance.


See Penney's research note for the details, but seemingly America has voted here. Post a low quality earnings quarter, MCD is down another -2% today and breaking down through what I have as TRADE line support of $55.02/share. The TREND here remains broken altogether.


SBUX up +4% ahead of earnings that the Street disagrees with Penney on as well.


This man has Supersized Edge!



MCD: Penney's "Coming To America" - penney

CRI: More Layoffs? Not Good

I've been a long-term bear on Carter's due to the company's focus on maintaining EBIT margins in light of top line and gross margin pressure vis/vis cutting into bone on the SG&A line - instead of doing the opposite (i.e. take it on the chin with margin and get the right infrastructure in place to drive the business forward).  I started to turn more positive when Fred Rowan was ousted, and with the comp stabilization in the recent quarter under CEO Mike Casey (new CEO - former CFO - who I like).  But any confidence that the company in finally on track with proactively managing its brands for the 'New Reality' of retail was just stopped dead in its tracks.


CRI just announced with headcount reductions at Osh Kosh - again. Let's put this into perspective. At the time CRI bought Osh Kosh in 2005 it had 275 employees. By 2007 that was cut in half to 135 as a way to buoy margins in light of top line challenges and the absence of sourcing savings that padded for the prior 5 years.  Now it is laying off another 90 employees, and is consolidating another 10 into Carter's HQ. So basically, we're looking at 30 people (20 of which will be in consumer affairs, IT and finance) solely dedicated to growing a $300mm brand.


The momentum on the P&L looks quite good here, and the SG&A saves will likely help that near-term. I definitely would not be caught short this name here. But as the retail rally continues (which I think it will), there will be obvious candidates who have boosted earnings by cutting costs in and unhealthy and irresponsible way. CRI is one of them.


Get this name on your 'whack a mole' bench.


CRI: More Layoffs? Not Good - CRI employee chart

Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.