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Will Russia Save Cyprus?

Below is an update on how we see the developments in Cyprus playing out after the Cypriot parliament yesterday firmly rejected the levy on bank deposits with 36 votes against, 0 in favor and 19 abstentions. 

 

In short, we see Cyprus turning to Russia for a larger loan to support both its current government budget obligations and to fulfill the Eurozone’s demand that the country contributes €5.8B to the bailout. Should Russia not play ball, there’s no clear fallback plan, yet we expect some form of compromise from the Eurocrats (Eurozone heads and the ECB) due to the group’s biggest fear, contagion. Given today’s market action we think participants have already priced in some form of a deal getting done.

 

Here’s how we think these two scenarios may develop in finer detail.

 

1.       Russia Offers Additional Loan Guarantees:

  • Cypriot Finance Minister Michael Sarris was in Moscow today meeting with his Russian counterpart.
  • This is a critical meeting given that beyond the leverage Cypriot banks have with Greece, Russia has the most skin in the game (an estimated total exposure of €60B, €20B of which in deposits, a sum  roughly equal to the size of Cyprus’ annual GDP).
  • It’s appears likely (in hindsight) that the Eurocrats did not work at all with Russians (which is saying something about geopolitical relations) to limit the failed step it made in issuing a deposit levy.
  • It’s clear that Eurocrats (especially German Chancellor Merkel who is preparing for an election in September) chose this deposit levy option to pander to their constituents by throwing “less” in total bailout funds. However, their game theory in issuing a bank levy and in not consulting with the Russians was squarely wrong. 
  •  No outcome was reached with the Russians today but press reports have indicated that Cyprus asked Russia for a five-year extension of an existing €2.5B loan (maturing in 2016), along with a reduction in the 4.5% interest rate.  We believe this loan will be primarily used to fund the government operations which could not be paid for otherwise. 
  • We suspect that Cyprus will also ask for funding to cover the €5.8B that the Eurozone has asked it to contribute in order to receive a €10B loan.
  • Given Russian interests in having a location outside of Russia to bank (be it to launder money, obfuscate assets, remove assets from Russian territory, etc.) and its potential interest in exchanging more favorable loan terms for physical Cypriot assets (in banks and energy), we think there’s a high likelihood that Russians write the checks the Cypriots request.

2.       Cyprus Calls the Eurocrats' Bluff on Bailout Terms:

  • However, should Russia not write the check, and the Cypriots balk on contributing to the bailout, the Eurocrats will quickly be on their heels with the threat of capital flight and with it bank failure.
  • Just today ECB Executive Board member Joerg Asmussen stoked the fire by saying that banks in Cyprus are not solvent without them being quickly recapitalized via a bailout program. Current ECB rules do not allow national central banks to lend to insolvent banks. So the pillars supporting the banks could give way if deposits walk.
  • Remember, Eurocrats thought they had the upper hand in issuing these deposit levies. While the Eurocrats may ultimately still have the upper hand, as both the Cypriot government and its people do not wish to live in a failed state (much like the Greeks), they too may be testing the waters to call the Eurocrats’ bluff in just how serious they are about the terms of the bailout loan.
  • To buy time and prevent assets from fleeing, it appears that the banks in Cyprus are unlikely to open until next Tuesday (Monday is another official bank holiday), and could be closed all next week depending on the developments. 
  • Should the Eurocrats’ bluff be called there could be renewed discussion around imposing haircuts on debt holders of the major Cypriot banks, however given the Eurocrats initial misstep, this option may too be off the table.  

Bottom line: 

 

If Russia doesn’t step up to aid Cyprus, look for the Eurocrats to be forced to compromise on the loan terms as their biggest fear remains contagion. The optimal outcome for both the Russians and the Eurocrats is for this issue to be resolved so that both sides can largely “get back to business.”   A longer impasse may result if Russia doesn’t play ball in writing a larger loan in which case we think only time will tell just how the Eurocrats come to a concession.  

 

We continue to think that this ‘crisis’ in Cyprus will be short lived; today’s market action is also supporting this view. However, taken together with Italian election uncertainty, we believe the events will continue to put downward pressure on the EUR/USD. We’re signaling an immediate term lid on the EUR/USD of $1.30.

 

 

Matthew Hedrick
Senior Analyst
HEDGEYE RISK MANAGEMENT

 


Carnival: Going Down with the Ship?

Takeaway: Sentiment isn't at the bottom of the sea, but Carnival's brand image may be sinking.

Carnival Cruises’ brand image seems to be sinking faster than its damaged ships.

 

Carnival’s image had not yet recovered from the sensational Costa Concordia tragedy when last month’s engine-room fire aboard the Triumph left passengers stranded for five days without food or functioning toilets.  Since then there have been three additional ship mishaps, leading the line to cancel a dozen planned cruises.

 

Carnival also had less-publicized incidents recently such as the on-board outbreak of gastroenteritis (Holland America) and an on-ship robbery that left two passengers dead (P&O Cruises).

 

Through all this, we hear a constant stream of reassurance from both management and travel agencies: these are one-off incidents, a horrible series of coincidences, Carnival ships are safe.  And while this may be largely true, the company is a long way from re-establishing its credibility. We would not urge trying to scrape this badly damaged name off the sandbar until there is a significant recovery in perception – which may be a long time coming.

 

We understand the “Wall Street whisper” number is looking for CCL to beat its EPS guidance.  Still, even if they manage to come in at the high end of their guidance range of $1.80-$2.10 a share for 2013, this stock has run aground.  Investors looking to bottom fish in CCL risk seeing themselves marooned.

  

Carnival: Going Down with the Ship? - ccl


Birther Nation

Takeaway: We examine the connection between an increase in birth rates and the pace of economic activity.

Hedgeye’s Health Care sector head, Tom Tobin, is out in front of what looks like a major demographic trend.  Tobin’s analysis of US birth data suggests a connection between increases in the birth rate, and improved economic activity.  In short: people who feel secure in their economic well-being are more likely to start, or increase, families.

 

Tobin ran a survey of OB/GYNs regarding expected birth trends for 2013 in four regional markets with varying economic trends during the Great Recession – Houston, Denver, Tampa, and Cleveland.  In Houston, the strongest market, birth rates never went negative, while in Cleveland, the weakest market, births have yet to recover.  However, preliminary survey results suggest a positive trend in births in each of the four markets for 2013; a first since the Great Recession started.  Tobin notes there is also a positive correlation between birth trends and employment of women – suggesting a hidden source of strength in the economy. See the chart below.

 

On balance, our Birth Recovery theme – the “expecting expectation” – is a positive data point for housing, and for economic recovery in general.  Most analysts appear to be unaware of this key metric. 

 

Birther Nation - Birth model 1Q13  2


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Housing's Parabola

Takeaway: Here's some more evidence that supports our case that housing is a lot stronger than many think.

Financials sector head Josh Steiner put out a posting in December plotting two possible trajectories for housing growth: “linear,” and “parabolic.” 

 

Steiner says the market sees Linear growth in the housing sector.  He believes they are wrong.  His work indicates the issue in the housing sector will not be weak demand, but shortage of supply. 

 

New construction slacked off in recent years over fears of a slowdown.  This led to reduced capacity in the building industry, which will now hold back an acceleration of new construction.  Tuesday’s housing starts number for February was strong (see chart below), but Steiner says the industry remains below capacity to build new homes to meet current demand.  This will be something of a headwind for overall growth, but should drive prices substantially higher in the near term, as there will simply not be enough homes to meet demand.

 

A recent look at a major Harvard study shows immigration tracking above the high end of the estimates range.  New immigrant statistics are a significant component of standard models of growth in new household formation. 

 

This provides one more metric on top of earlier Hedgeye work that saw an increase in live births and pet buying, for example – key components of the housing equation – that should keep housing demand extremely robust. 

 

Finally, Steiner characterizes housing as a “Giffen Good,” an economic term meaning an item where demand increases as prices go up – a seeming inversion of the Law of Supply and Demand.  The coming shortage in new homes should drive a surge in price – which should continue to drive demand beyond current linear projections. 

 

Welcome to the Housing Parabola.

Housing's Parabola - SF Starts  2


FedEx: Clock Starts Now

Takeaway: While a disappointing quarter, the April 1 capacity reductions suggests the inflection point in Express margins should be here.

FedEx:  Clock Starts Now

 

  • Specific Timing Positive:  Excess FedEx Express capacity, particularly in Asia, has been a problem for a many quarters.  While a smooth transition with intact service levels is obviously critical, the April 1 specific date for Asia capacity reductions is a positive.   On the FY2Q earnings call, management commented that we should see margin improvement in FY4Q and the April 1 date seems consistent with that outlook.  In short, we should see a FY4Q performance that is significantly better than FY3Q. 
  • Probably a Lower Bar:  Since 2016 FedEx Express cost reductions of $1.6 billion are measured against 2013 results, the Express restructuring may now be against a slightly lower bar.  While that is incrementally negative, the overall opportunity remains enormous relative to FDX's market value.  We also suspect that the company can exceed its cost reduction goals.  The company commented that the cost cuts are on track and that much of those benefits should be achieved by FY 2015.
  • It’s Always a Competitive Issue:   International Express is a cost leadership industry, in our view.  Operating with excess capacity, misallocated network capacity and old aircraft is a recipe for weak margins, since competitors can price based on their lower cost structures.  Retiring 727’s “early” would have meant retiring them some years ago, in our view.  Retiring them ASAP seems like a fantastic plan and an easy way to expand margins, as does removing excess capacity.

FedEx:  Clock Starts Now - 1t

 

 

  • Not Really Volumes:  While Express volumes are not exploding higher, most of FedEx Express’s FY3Q pain seems self-inflicted.  While painful for investors today, it should be fixable.  International Express volume has been shifting toward slower, cheaper channels for a while and the company is finally responding.
  • Ground Fine:  FedEx ground continued to take share.  Margins faced a tough comp on a one-timer last year.  Growth in SmartPost is likely to limit margins, but is a result of a market expansion and not a market problem, in our view.
  • Domestic Express Improved: Domestic Express apparently improved, with International Express the key laggard....
  • International Delay Could Possibly Mean TNT Deal:  That FDX did not take stronger actions in the quarter to rationalize International Express capacity may mean that it is waiting on a TNT integration.  FDX management discussed network imbalances on the call.   That is speculation on our part, but a TNT transaction would more effectively balance the international network, in our view. 

FedEx:  Clock Starts Now - 2t

 

  • If DHL Can Do It…:  We have confidence that FedEx Express can dramatically improve its margins toward peer levels for a number of reasons.  First, the industry is well structured with two competitors domestically and basically three and a half internationally.  FedEx has strong market positions in the Americas and Asia.  Another indication that FedEx Express can restructure successfully is that Deutsche Post’s DHL Express Division did so from a much worse operating position.  

FedEx:  Clock Starts Now - 3t

 

 

  • A Long-term Long Story:  Since our FDX black book, we have expected that FY4Q 2013 (next quarter) should be the inflection point for Express margins. We obviously did not expect the sequential margin drop this quarter, but do not see it as a meaningful risk to our thesis.  If FedEx Express can match competitor margins by FY2016, FDX should find itself with two businesses that are each worth roughly what the company currently trades for.  To the extent that margins start to expand next quarter, the market may start to price that outlook in ahead of its actual achievement.  We continue to think that FDX is one of the best long opportunities in the sector and would use weakness in coming days to add positions at what we expect to be the Express margin inflection point.

 

 

 


Today: Expert Call with William W. Keep on Pyramid Schemes and the Multi-Level Marketing Industry

The Hedgeye Consumer Staples team, led by Rob Campagnino, will be hosting an expert call featuring William W. Keep TODAY at 1:00pm EST entitled "Pyramid Schemes and Multi-Level Marketing."

 

CALL DETAILS

  • Date: Monday, March 25th at 1:00pm EST
  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 587456#
  • Additional reading materials: CLICK HERE

 

TOPICS WILL INCLUDE 

  • What is Multi-Level Marketing (MLM) and where does it come from?
  • What are the key factors that determine a pyramid scheme versus a legitimate MLM company?
  • Framing the industry's learnings from such pyramid schemes as Equinox, Burn Lounge and Fortune Hi-Tech Marketing
  • Discussion of the FTC's role in the industry
  • Contextualizing Herbalife moving forward

 

ABOUT WILLIAM W. KEEP   

 

Keep is a professor of marketing at The College of New Jersey and currently serves as Dean of the school. His research and writings -- published in the Journal of Marketing, the Journal of Public Policy and Marketing, the Journal of Business Ethics, and The Chronicle of Higher Education, among others -- focus on long-term business relationships, business ethics, public policy and higher education. As a consultant he worked with a variety of firms and served as an expert witness in the prosecution of pyramid schemes, including Security Exchange Commission (SEC) v. International Heritage Inc., at the time the largest pyramid scheme ever prosecuted by the SEC. Keep has appeared on CNBC to discuss the topic of pyramid schemes, the MLM industry, and Herbalife and published articles on the subjects for CNBC and Seeking Alpha.

 

Professor Keep holds a PhD in Marketing from the Eli Broad College of Business at Michigan State University (MSU) and a B.A. from James Madison College at MSU in social science and economics.

 

 

CONTACT

Please email to obtain the dial-in information for this call and a copy of the presentation, or to learn more about our research.

 

 

ABOUT ROB CAMPAGNINO

Rob has nearly 20 years experience in the industry and within the last 5 years on the buy side at some of the top hedge funds in the business, including Pioneerpath, Diamondback Capital, and Searock Capital. Prior, he was a senior equity analyst at Prudential Securities where he was consistently Institutional Investor ranked. Before Prudential he was at Sanford Bernstein as an equity research associate covering food, beverage, and retail. He began his career as a strategic consultant with PricewaterhouseCoopers. Rob has a MBA from Columbia and BA in Economics from Duke.

 

ABOUT HEDGEYE

Hedgeye Risk Management is a leading independent provider of real-time investment research. Focused exclusively on generating and delivering actionable investment ideas, the firm combines quantitative, bottom-up and macro analysis with an emphasis on timing. The Hedgeye team features some of the world's most regarded research analysts - united around a vision of independent, uncompromised real-time investment research as a service.


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