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Argentina: Teaching Us A Lesson

Argentina has one of the best performing equity markets in the world. Over the last twelve months, their Merval Index (Argentina’s equivalent of the S&P 500) has put up +67.9% in gains as the value of the Argentine Peso (we are bearish on the currency) plunges against the value of the US dollar.


Argentina: Teaching Us A Lesson - Equities YoY


While the country’s stock market is on fire compared to America, the country’s underlying economic situation leaves much to be desired. In fact, much of the equity market strength is being driven by strict capital controls and fear of eventual public confiscation of household deposits. Last week, Argentina turned to the International Monetary Fund (IMF) for a $400 million cash deposit in order to increase their allocation to an emergency line of credit of sorts. Though the country had $39.8 billion in reserves, Argentina is drawing on those funds for bond repayments ($30 billion since 2010) and it just hit a six-year low. Essentially, the country is fiscally under the gun and will remain in a tough spot as long as Cristina Fernandez is president.


Argentina: Teaching Us A Lesson - FX YoY


Buffalo Wild Wings reported a disappointing quarter last night with EPS coming in at $0.87 versus consensus of $0.99.




We believe this stock is a short here ($90.20/share) as the company is expanding its new wings-per-portion serving practice. Despite the sequential comp acceleration from 1Q to April, we believe there are several overriding factors that will drag on the stock’s performance over the next 3-6 months:

  • The new service initiative (wings by weight) has been tested in only 40 stores and produced flat-to-down comps vs +1.4% co-op comps but is being rolled out to all co-op stores by end of June
  • Traffic was negative in 1Q (-290 bps), April (-130 bps excl Easter)
  • Flex pricing will likely materially impact guest experience (5 wings vs. 6, 10 vs. 12, etc.)
  • Consensus is expecting +1.2% and +1.6% traffic in 3Q and 4Q, respectively
  • Labor costs increasing due to training costs related to “guest experience model” (wings by weight)
  • Margins are likely going to deteriorate further from here
  • Wing prices declining will mitigate some margin pressure but labor pressure seems significant and if
  • Mgmt has no credibility when it comes to guidance after 2012
  • FY13 EPS growth guidance of +17% (unch’d from prior) is a Hail Mary after an 11% decline in 1Q13


Notable Earnings Call Quotes:




“Well, I think we're just being cautionary.  We did see 80 basis points in the first quarter. We definitely have full attention to how we're rolling out this guest experience business model. And so we do believe that there is improvement to have on that as we go through the year. We're just not confident at this point in the second quarter on whether or not we'll see all of that. So we do think that for at least the near term an increase similar to Q1 is the most appropriate guidance.”


HEDGEYE: In response to an earlier question on guidance provided in February, management said, “We wouldn't have had a full view of our labor at the time that we did our February earnings call.” We would echo those sentiments with regard to labor for the balance of 2013. We believe the likelihood of management underestimating the impact of different initiatives on labor is high.  Examples include training staff to handle the flex pricing initiative, training an additional staff member as “guest experience captain”, etc. In 2012, management underestimated cost headwinds and we think labor is the 2013 iteration of that same mistake.





“Initially, same-store sales are flat to just slightly down. What the most important thing to the guest is to really understand how many wings they're getting... Well, we do plan to roll it with our July menu rollout and if wing sizes stay at the same place they are today, people would see a 5, 10, 15, 20 count as compared to the 6, 12, 18, 24. But if wing prices are different when we get to July, that could change – sizes, yes.”


HEDGEYE: What if the rollout across the system has a similar comp impact, in terms of the underlying trend? We expect that co-op comps in the back half of the year would be 2.5% and 2.9% for 3Q and 4Q, respectively. Consensus is modeling 3.3% and 3.6% for 3Q and 4Q co-op comp sales growth. Judging by the estimate of the serving portion size changes, outlined in the quote above, we expect this change to have a material impact on brand perception.



Earnings Recap


The table, below, provides an overview of the quarter’s key results versus what consensus was expecting.  Revenues came in ahead of expectations thanks to better-than-expected comps and April comparable sales growth is tracking at 5.2% versus the Street at 3.8%. An important caveat is that the Easter shift helped by 150 bps and price is running at 5% so traffic is down 130 bps.




Howard Penney

Managing Director


Rory Green

Senior Analyst




China: Handle With Care

Takeaway: China: can the Forbidden Economy be rescued? One expert says Yes – but there’s work to be done.

Will China Break?

Hedgeye hosted a conference call on Monday with Dr. Carl Walter, author of Red Capitalism: The Fragile Foundation of China’s Extraordinary Rise.  Dr. Walter received his PhD in political science from Stanford University, where he has now returned as a visiting scholar.  Dr. Walter spent two decades in Beijing in the investment banking sector, including a decade as chief executive officer of JPMorgan’s China banking subsidiary.  


Dr. Walter led off with his conclusion: in his opinion, China will not break.  But it may bend quite significantly.


Who’s In Charge?

While many in the West view China as a centralized one-party dictatorship, Dr. Walter says this is simplistic and wrong.  China’s consolidated power structure is made up of a complex web of interconnected entities, each with their own interest, and each with their own levers of power.  Dr. Walter compares the China of today to Europe.  Even though the nation is run by a central Party, much of the actual power is de-centralized across geographic and economic mini-centers.  


And Power is what it is all about.  The challenge every political official faces is, How to stay in power?  The answer in every case is, Create economic growth and do it in a way that reinforces social stability.  The average Western observer may not appreciate how delicate China’s social fabric feels.  If the head that wears a crown lies uneasy, imagine being one of a small cluster of crowned heads – all with competing interests – with 1.3 billion potentially dissatisfied subjects.  Clearly, it’s not all dumplings and wine at Central Party HQ.


Banking On It

The big banks are the pillar of China’s economic system, providing the funding that drives economic programs.  Individual Chinese do not deposit their money in small local banks, because they know local institutions are essentially powerless.  China’s five biggest banks hold over 60% of the nation’s deposits, with a more than equivalent share of influence.  


Policy makers pushed for greater corporate capital raising in recent years, in their efforts to stimulate growth.  The banks dominated the marketplace, but without a developed capital market, “capital expansion” was really expansion further into the banks’ balance sheets.  New bank loans accounted for over 85% of capital raised in 2009 – the peak year for corporate capital expansion, with over 11 billion reminbi (RMB) raised.  The balance was corporate bonds – zero equity capital was raised that year – and most of the bonds are, in turn, bought by the large banks.  Where does the money go?  


Seventy-five percent of corporate bonds are issued by State-Owned Enterprises (SOEs), while 20% go to the financial platforms of a host of joint ventures and other private financial vehicles, much of it in connection with local economic programs.  Financing from private deposits is already used up, and there is little or no equity financing, making China’s economy look like the serpent that swallows its own tail.     


The drain on bank balance sheets is exacerbated by China’s rating agencies, which rate all corporate bond issues and corporate loans as investment grade.  These means the banks have to make only minimal loss provisions – or none at all – as they continue to expand outstanding credit to an ever-larger percentage of their asset base.


There is no liquid trading market for corporate bonds, which means the prices don’t fluctuate.  “Marking to market” can only happen if the market actually exists.  With no trading in the bonds, the prices don’t change, so banks don’t have to reflect lower asset values on their balance sheets.


Like any enclosed economic construct, this system functions perfectly well, until it doesn’t.


Bulls – And  Bears – In China’s Shop

The banks over-lent in the 1980s and were reined in during the 1990s, giving way to a brief inflationary period in the early 2000s, all while China’s central planners were trying to figure out how to best grow their economy to keep the largest numbers of citizens content.


Now the banks are lending but not generating economic growth.  The central authorities recognize that banking may no longer be the economic solution for China and the discussion now is about changing business models.


But to what?


Any business model requires fundamental underpinnings.  With the banks so dominant in China’s economy, Dr. Walter says corporate governance is a glaring weak point.


Even though the major banks are listed on the Hong Kong exchange, and even though they are subject to public company audits, Dr. Walter says the real management of the banks is not their boards of directors, but the Party committee.  In fact, until recently it was not even Beijing, but regional party committees who directed bank operations, as so much lending was tied to regional projects.  


In the past, local officials or Party cadres who wanted to advance their careers would lean on banks to over-lend locally to drive economic growth in their region.  In the 1980s, when the banks prepared to list on the Hong Kong exchange, control was centralized to Beijing.  In 2008, when the central Party announced their intention to lend in order to stimulate the economy, provincial party officials went into a feeding frenzy.  Local projects were proposed and approved left and right and, says Dr. Walter, “the banks lent like crazy.”  In this scenario, Beijing lost a significant amount of influence over the banking system even while nominally retaining control.


China still has far to go before it develops credible capital markets.  Dr. Walter calls China’s stock market an economic “afterthought.”  The stock markets were primarily a policy tool to permit China’s SOEs to incorporate and establish a presence and a valuation for their securities.  Out of tens of millions of trading accounts on China’s exchanges, only about 7% actually execute transactions.  


Where To Next?

China’s big banks are the economy.  This goes beyond Too Big To Fail.  The Chinese will not allow their big banks to fail.  When Lehman was put into bankruptcy, says Dr. Walter, the Chinese were flabbergasted.  They simply could not understand how the US government could allow a “flagship name” institution to fail.  Could it be, they wondered, the US was actually too weak to rescue a major investment bank?  


China will have a difficult time creating a financial marketplace.  Until it does, there will be no market discipline to accurately price its securities, bonds and loans, to attract serious inflows of foreign capital, or to drive growth.


Government policy has distorted the pricing of bank portfolios.  Currently, there is a 3% differential in yields between corporate loans and bonds.  Since the same entities that issue bonds also take out bank loans, there is no incentive to create a bond trading market.  The banks continue to dominate – or to be stuck with – the lion’s share of Chinese debt.  Chinese households own less than 5% of the nation’s bonds, while foreigners own less than 2%.  Despite noises from such potential buyers as Australia, there is no significant outside market to create accurate pricing or provide liquidity for China’s banks.

Without liquid markets, how do the banks stay afloat?  Remember that the bonds don’t trade – which means no liquidity for the banks (bad) – but it also means the price of the bonds in their portfolios never changes (good!)  Far better[easier] than issuing new bonds to pay off the old ones, China’s banks simply extend maturities – extend and pretend.


This is simply [at worst] unsustainable [and at best economically unhealthy].  All the more so as Chinese local governments and the SOEs turn out to be bad credit risks.  In the 1990s, says Dr. Walter, banks loans rose as high as 75% of GDP – and up to 25% of loans went bad.  Now, the level of problem loans has declined slightly – around 20% in 2010 – but total loans have soared to over 130% of GDP.


In the past decade, the more banks have loaned, the slower China’s economy has grown.  Lending has continued to flow to massive projects driven more by concerns over social stability than by economic justification.  Local debt continues to pile up – by some estimates it could be up to RMB 16 trillion today – a RMB 6 trillion increase over 2011 – on a current GDP of about RMB 45 trillion.  China has borrowed itself into a quagmire, by borrowing from itself for dubious projects.  It has perhaps not been more profligate in its misuse of debt than the West – indeed, Dr. Walter says a global economic recovery will [would] play a significant role in revitalizing China’s economy.  



China’s Party officials remain deeply concerned over potential civil unrest and will continue to focus on local economic programs.  But the country is already significantly overbuilt.  At the same time, economic inequality continues to grow. 


Some 300 million people have been brought up out of poverty in China in the last 20 years – but that leaves one billion people who have not.  Central Party officials and their hangers-on will continue to grow richer, as will those living and working in the prosperous coastal regions.  Dr. Walter expects the rest of the society to decline economically, leading to ever-greater inequality.  China’s aging population does not have Medicare or 401(K) accounts – they have only their savings – and less of a younger generation to rely on, thanks to years of the one child per family policy.  


The difficulty of establishing a consumer-based economy under these circumstances could pale next to a very real possibility of severe social problems, and possible social unrest, in the coming 3-5 years.  This has Party officials constantly looking over their shoulders.


Dr. Walter says China’s banks are not headed for collapse.  There are plenty of assets available to fill the gap left by an unreliable financial system.  But China does not have a good record on financial reform.  Its most significant players – the SOEs, the banks, and the local party organizations – are opposed to it, as each sees the current dysfunction as working to their advantage.  It will take ingenuity and cooperation and the forceful exercise of political authority to bring meaningful change, and the key to how well and how quickly the Chinese ship can be righted lies with the personalities at the center.  

Walter says Xi Jinping, the new General Secretary, is an excellent man for the job: he is outgoing, relaxed and confident in public, and has the support of the military.  But one man is not sufficient to change the course of the gargantuan ship of the Chinese state.  


Finally, China is a major piece of the global financial puzzle.  It will not recover on its own.  Its own recovery will be both a result of, and an influence on global economic trends.


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

BUD – Q1 Results More Bad than Good

BUD reported Q1 EPS this morning and ABI BB is currently down about 3% in European trading – volume was weak across the board and volume guidance was soft relative to expectations.

What we liked:

  • Beat on EPS ($1.16 versus $0.98 consensus), but entirely due to below the line items (tax rate, lower interest expense year on year)
  • Pricing remained robust leading to constant currency organic revenue growth of +1.5% against a reasonably difficult comparison (Q2 comps ease, Q3 and Q4 stiffen) despite a decline in volume

What we didn’t like:

  • Volume softness across multiple regions save for Asia Pacific with organic volume declining 4.1% against the most difficult comparison of the year
  • Market share decline in the U.S. (50 bps)
  • Lack of operating leverage (unsurprising, given volume declines) as constant currency EBIT grew only 0.2% on constant currency revenue growth of +1.5%
  • Gross margin declined 133 bps against the most difficult comparison of the year
  • Cautious volume commentary on Brazil (industry flat to down low-single versus prior view of low to mid-single digit growth)

Stepping back for a moment and looking at BUD within the context of the broader consumer staples group, we continue to struggle to find names that we are comfortable with over almost any duration given what we see as the currently stretched state of valuations.  With BUD, we have good visibility on double digit EPS growth driven by continued strong pricing, merger synergies (eventually) and below the line items - even factoring in continued volume weakness.  The company’s FCF yield (7%) remains attractive relative to the group.  Based on that context, we are going to keep BUD on our preferred list.  We expect a couple of European sell-side downgrades, just because that is how those analysts generally roll, but we think BUD continues to make sense once the impact of this quarter shakes out.


Call with questions,




Robert  Campagnino

Managing Director





Matt Hedrick

Senior Analyst

Morning Reads From Our Sector Heads

Keith McCullough (CEO):


Corn Erases Gain as Supplies May Be Ample Amid Planting Delay (via Bloomberg)

Todd Jordan (GLL):


Online poker is back: Legal website launches in NV (via Yahoo! News)


Norwegian says sales uplift vindicates 10% commission move (via Travel Weekly)

Rob Campagnino (Consumer Staples):


Anheuser-Busch InBev Sales Miss Street Expectations (via Fox Business News)


Josh Steiner (Financials):


Most Banks Could Still Profit Under Tough New Overhaul Proposal (via NYT Dealbook)


MBIA Loses Bid for Ruling on Countrywide Loan Repurchase (via Bloomberg)


BofA Asks Judge to Throw Out Mortgage Suit (via WSJ)


Kevin Kaiser (Energy):


Boom Times for a Tiny Texas Town (via WSJ)


Brian McGough (Retail):


Demands for Action as Bangladesh Death Toll Mounts (via WWD)


Under Armour, On Setup Shop In Rose City (via SGI News)


Euro Trip

Client Talking Points

Talk About It

Everyone is talking about Europe, the ECB and Mario Draghi. Will he institute a rate cute this week? If not, will investors be sorely disappointed or can they swallow the reality that rates could stay the same? Regardless of the actual outcome, the Euro is taking a hit this morning against the US Dollar and has dropped below out TAIL risk line of $1.316

Step By Step

The Asian markets are following the lead of the US and are rallying hard with Korea's KOSPI index putting up +1.2% to the upside overnight. That puts the index back above our TREND line of resistance of 1943. It has the ability to continue to rally if US tech doesn't get clobbered and if the Yen can stop its bleeding. That remains to be seen for now.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Decent earnings visibility, stabilized market share, and aggressive share repurchases should keep a floor on the stock.  Near-term earnings, potentially big orders from Oregon and South Dakota, and news of proliferating gaming domestically could provide near term catalysts for a stock that trades at only 11x EPS.  We believe that multiple is unsustainably low – and management likely agrees given the buyback – for a company with the balance sheet and strong cash flow as IGT.  Given private equity’s interest in WMS (they lost out to SGMS) – a company similar to IGT that unlike IGT generates little free cash – we wouldn’t rule out a privatizing transaction to realize the inherent value in this company. 


WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow 


With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view.

Three for the Road


"Last day of the month...always interesting ~ #BuckleUp" -@TheKillir


"When a thing ceases to be a subject of controversy, it ceases to be a subject of interest." -William Hazlitt


Employment cost index rises 0.3% in first quarter of 2013.

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