The Case Against Consumer Staples

Takeaway: It’s been a tough Q1 (and then some) for many staples investors that have to make a living generating alpha on the short side.

This note was originally published May 23, 2013 at 12:24 in Consumer Staples

It’s been a tough Q1 (and then some) for many staples investors that have to make a living generating alpha on the short side, or at least have to try and have their shorts go up less than their longs.  As with most market moves, there are multiple factors to which we can point as contributing causes to the run up in consumer staples:

  1. Investors chasing yield
  2. Inflows into low volatility ETFs
  3. M&A speculation in the wake of the HNZ acquisition
  4. Declining commodity prices and the associated expectation for improvement in gross margins
  5. Investors skeptical of the broader market rally and playing staples as a “safe” way to be long

Conspicuous by its absence is any case for the valuation of the consumer staples sector, broadly.  Valuation is always a tough one – it doesn’t matter until it matters, then when a stock heads lower (or higher, as the case may be), people point to valuation.

The Case Against Consumer Staples - Sector PE 5.23.13


Generally speaking, we like to see stocks heading higher as estimates head higher - that has not been the case.  Through Q1 earnings season, the "average" staples company missed revenue expectations by 0.4% and beat EPS by a meager 3.3%.


The Case Against Consumer Staples - Q1 EPS Summary


We have long made the case that investors have been using the staples sector (and utilities) as bond proxies.


The Case Against Consumer Staples - Yield Spread 5.23.13


The Case Against Consumer Staples - XLP vs. 10 yr. 5.23.13


With interest rates starting to creep higher, we may start to see money flow out of the consumer staples sector that was chasing yield and not invested for (or with, quite frankly) any fundamental view of the sector or the companies.


We also believe that certain stocks have benefitted from the inclusion in low volatility ETFs and associated money flows into those ETFs. 


The Case Against Consumer Staples - CPB and CLX 5.23.13


The Case Against Consumer Staples - GIS and KMB 5.23.13


In recent weeks, inflows into these ETFs have become decidedly less one directional.


The Case Against Consumer Staples - Low Vol Inflows


M&A speculation is more difficult to argue against.  We think some names continue to make sense over longer durations as potential targets of either activists (MDLZ - known) or strategic investors (BEAM, HSH, POST, DF).  We have always viewed the possibility of some sort of transaction as another reason to own a stock, but not the primary reason (unless you happen to work on a special situations desk, then have at it).  Therefore, names such as CPB or even TAP, that have benefitted in part from low-quality speculation remain squarely on our least preferred list.


As to commodity prices, we believe that the companies in our universe will see a benefit, but on a lag (3-12 months, depending on the hedging programs).  However, current multiples appear to be baking in a whole lot of good margin news, that may be fleeting in terms of duration given the competitive environment.  Most staples companies can't stand prosperity, and are likely, in our view, to deal back margin in an effort to support top line momentum, which is still faltering.


Where does this leave us?


Quite frankly, it leaves us with a long list of names where we have a hard time seeing how the marginal investing dollar makes money at current levels.  Our least preferred list is long and not so distinguished:


  1. KMB
  2. TAP
  3. CPB
  4. PM (more of an issue with the strength of the dollar)
  5. CLX
  6. CL
  7. GIS
  8. MKC

What we like remains largely unchanged:


  1. ADM
  2. CAG
  3. NWL
  4. BUD
  5. DF
  6. SPB

Call with questions,




Robert Campagnino


Managing Director






P: 203.562.6500




Matt Hedrick


Senior Analyst


Listening to each of these companies’ respective presentations today at the Sanford Bernstein conference, it was not difficult to understand why we like SBUX and are bearish on MCD.


Takeaways from the presentations:




We remain bearish on MCD as the stock has underperformed the S&P 500 by 550 basis points since we added it to our Best Ideas list on 4/25. On an absolute basis, the stock has declined -1.09%. We believe the Street’s expectations are still too aggressive, from a sales and earnings growth perspective, and the company needs to make structural changes to its U.S. business as the store has become too complex. Please click here for the materials for our presentation on McDonald’s from 4/25.

  • MCD CEO Don Thompson was cautious in his tone, citing soft economic environment and stagnant IEO industry
  • Comps have outperformed QSR sandwich operators in 16 of 19 weeks this year (we are wary of this statistic as sandwich concepts compete against everyone in food service)
  • Overall tone seemed to convey a message of near-term struggle with bright long-term ahead
  • Mgmt stating, first, that guest counts are important for franchisees was interesting – franchisees want higher margin items on the menu, there is a conflict between corporate and franchisees here in terms of priority
  • Unconvincing response as to what mgmt will do to revive U.S. business in ’13 – the menu is back and marketing is stronger and “more direct” – does not inspire confidence
  • Europe remains a significant problem for McDonald’s


SBUX – MCD DIVERGENCE CLEAR - best ideas mcd





Starbucks’ presentation represented a stark contrast to McDonald’s as the company offered a clear, positive and energized outlook for shareholders. The company’s data-anchored strategy is tailored for specific regions of the world, unlike the more general and now-outdated MCD strategy (three global growth priorities). We continue to view Starbucks as one of the best ways to play the strengthening U.S. economy and consumer.

  • Goals of the company remain as lofty as ever – no constraints being placed on Schultz’ ambition
  • SBUX foundation for growth is solid, primed for accelerated growth over the next 5, 10 years
  • Challenges in Europe are persisting and will persist for “quite some time”
  • Growth being supported by Via, K-Cups, home brewer systems, tea and other categories such as juice
  • Expanding the loyalty card into the grocery aisle and following the rise of mobile internet closely




If you wanted to own a global company with strong growth prospects, sound fundamentals, high exposure to the U.S. recovery and low exposure to Europe’s travails, you would own SBUX and not MCD. We remain positive on SBUX and negative on MCD.


SBUX – MCD DIVERGENCE CLEAR - mcd operating income



Howard Penney

Managing Director


Rory Green

Senior Analyst


Takeaway: Our ongoing trade remains #shortfear. People have been too bearish.

(Excerpt from this morning's Hedgeye conference call)


Our ongoing trade remains #shortfear.


People have been too bearish. Check out the latest “Bull/Bear Survey.” The nominal level of people who will admit they are bullish is extraordinarily low for the market move we are in. Only 52% admit they are bullish. And yet, the market continues plowing ahead despite the pessimism.


The negativity doesn’t reconcile with recent economic data, notably yesterday’s consumer confidence number which not only surprised people short equities, but those long bonds. Look, the same problem that people have being long bonds, is the same problem people have being short equities: They are too bearish on growth. We’ll say that until we’re blue in the face.


It’s also worth mentioning that there our Macro Team assumed a lot of risk sticking our neck out and going long the #GrowthAccelerating theme earlier this year well ahead of consensus. But we nailed it. Bond yields certainly agree with our call, stocks agree, and the USD agrees.


Bottom line: We continue to buy the dips. 

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What’s Up With the Swissy?

Takeaway: The CHF remains overvalued versus the USD and EUR over the immediate term.

This note was originally published May 28, 2013 at 13:54 in Macro

TRADE Call (3 weeks or less): The CHF remains overvalued versus the USD and EUR; expectations that the SNB could shift the floor in the EUR/CHF or cut rates to negative may burn the CHF lower. (etf: FXF)


TREND Call (3 months or more): We’re bullish on the USD versus the CHF as our #StrongDollar remains intact. However, the CHF could strengthen against major currencies if it moves back to “safe-haven” status, especially should we experience another round of sovereign or banking risk scares out of the Eurozone, and/or if the SNB does not cut below 0%.


The Swiss Nation Bank (SNB) meets next on June 20th to discuss its interest rate policy. There’s speculation based on comments from the SNB’s head Thomas Jordan last week that it could implement negative interest rates and shift the floor in the EUR/CHF. [Last Wednesday the EUR/CHF hit 1.2614, the weakest level for the franc since May 2011].  We believe over the immediate term TRADE there’s more weakness in the EUR/CHF and USD/CHF. Beyond the potential policy moves by the SNB, we’ve seen investors pulling assets from the “safe-haven” trade and we remain grounded in our #StrongDollar call.


As we show in the first chart below, beginning in September 2011 (following the CHF appreciating to an all-time high in August) the SNB bought foreign reserves to maintain a floor in the EUR/CHF at 1.20 francs. Since September 2011 the SNB has increased its FX reserves by +125%, and we have reason to believe that the SNB wants to get involved in the global currency war. Both a cut to the 3M target interest rate (currently at 0%) into negative territory, and continued FX buying and/or an adjustment in the EUR/CHF higher could burn the CHF lower versus the EUR and USD, at least over the near term.  


What’s Up With the Swissy? - YY. FX RESERVES large


What’s Up With the Swissy? - YY. CHF LT



Policy Challenges

In many ways the SNB is in a tough spot to manage the economy. These challenges include:

  • Swings in the currency to and from safe-haven status
  • Steady deflation
  • Low interest rates

The amount of FX buying from the SNB shows just how terrified it is of a strong currency. The worry here is two-fold -- that a strong currency 1.) will cripple export demand and 2.) force domestic companies to lower prices to ward off cheaper imports.


With about 60% of exports destined for the EU, it’s interesting to note that there’s a relatively weak relationship between the overall price of the currency and export demand. Below we show that the correlation between the CHF/EUR and Swiss Exports is +0.41. We think some of the weakness in this correlation can be explained by its basket of export goods, with a heavy mix of pharmaceutical and luxury exports, which command pricing power.


So while rhetorically there might be great emphasis placed on the threat of a strong CHF on exports, we do not think it holds up. 


What’s Up With the Swissy? - YY. EXPORTS


On deflation, Switzerland has been hit by a steady level of deflation since late 2011, with CPI falling for 19th straight months (currently at 0.40% Y/Y). We believe that while Switzerland has benefitted from falling energy prices from a stronger USD, the Bank wrestles with its policy to promote inflation. It fears that under an environment of steady deflation consumers will put off purchasing, assuming prices will go lower in the future.


So, while the Bank is hardly worried about stoking inflation with a rate cut, it’s aware of the policy risks around cutting from 0%:

  • further taxing savers
  • stoking a mortgage and housing bubble
  • chasing away safe-haven assets
  • no ability to guarantee that negative rates will incentivize banks to increase lending

While we’ve yet to see signs of a dangerous expansion in the mortgage and housing market (the SNB cut to 0% in August 2011), this threat remains on the minds of policy makers. We’re also seeing investors park less of their assets in Francs or Franc-denominated assets as the risk climate in the Eurozone improves.


One big question mark that remains is the extent to which banks, especially if the SNB cuts to negative rates, increases their lending to seeks a better return on money.  


What’s Up With the Swissy? - YY. CPI



Broader Fundamentals Appear Strong, Relatively

Below is a snapshot of Swiss GDP. Our call-out here is that with GDP low to depressed across much of the region, we think Switzerland’s relative outperformance will continue to anchor a market of strong investment despite low interest rates.  A weaker CHF versus its trading partners on the margin will also remain a positive.


Swiss GDP is forecast to rise +1.3% this year versus -0.50% in the Eurozone. With a Swiss budget surplus of +0.3% of GDP in 2012 and debt of 53% of GDP last year, its fiscal house remains in order and could quickly transition back to its safe-haven status should we get another round of sovereign or banking risk scares out of the Eurozone.


What’s Up With the Swissy? - YY. GDP


Below is a graphic illustrating our levels on USD/CHF via the etf FXF. We outline the intermediate term TREND line that the FXF violated. We view this as a bearish signal and expect weakness into the SNB’s June 20th meeting. Should the bank act, either in cutting rates, and/or adjusting the floor, or setting future expectations for either, we’d expect further weakness. 


What’s Up With the Swissy? - XX. FXF


The Swiss Market Index (SMI) is up 20.5% YTD, leading the pack as the best performing European index YTD. The SMI is up 4.6% MTD and as we outline in the chart below (via the etf EWL), is in a bullish formation. 


What’s Up With the Swissy? - XX. EWL



Matthew Hedrick

Senior Analyst





Morning Reads From Our Sector Heads

Takeaway: Here's a quick look at articles Hedgeye Sector Heads are reading this morning.

Keith McCullough - CEO

Volcker's Aim: Responsive Government (via New York Times)

South China Sea Tension Mounts Near Filipino Shipwreck (via Reuters)

Pakistan: Deadly 'US Drone Strike' in Waziristan (via BBC)


Howard Penney - Restaurants

Wendy's Last Among Big Burger Chains With Hispanics: Survey (via AdAge)


Felix Wang - Gaming, Lodging & Leisure

Universal Says Robinsons Talks on Casino Put on Hold (via Bloomberg)

Easier Taiwan Visa In August (via Macau Business Daily)

Poor Norwegian Breakaway Design Claim Divided (via CruiseShipNews)


Rob Campagnino - Consumer Staples

Smithfield to Be Sold to Chinese Meat Processor (via New York Times)


Daryl Jones - Macro

Upside of Low Employment Is Longer Life (via Bloomberg)

Death By Carry (via Zero Hedge)


Josh Steiner - Financials

Fannie, Freddie Regulator Reaches Settlement With Citigroup (via WSJ)

Morgan Stanley Gears Up for Property Fund (via WSJ)


Kevin Kaiser – Energy

Peyto Drilling in Natural Gas Downturn Rewards Investors (via Bloomberg)


Don't Fight the Data!

Client Talking Points


We've got a nice yield rip alongside very bullish US consumer confidence, jobless claims, and housing data as of late. Consensus says don’t fight the Fed; I say don’t fight the data. Bernanke is way behind the curve now. +187bps wide and widening on the 10s/2s spread makes the Financials a happy hunting ground to buy on red. We bought NSM back yesterday; 2.17% 10yr Yield, overbought up here.


Russia remains one of our top macro short ideas next to Yens and JGBs right now, so this was a position we didn’t cover on red last week. RTSI -2.2% this morning leads losers in a weak European Equity session. Russia is back down double digits (-10.3% YTD) and should continue to weaken, provided that the PetroDollar trade of the last decade remains under #StrongDollar attack.


It's been a while since Hong Kong flashed the negative divergence of the Asian session, but here it is. Despite China holding its gains, Hang Seng down -1.6%, breaking my immediate-term TRADE line of 22,796 support (that’s new, so we’ll watch that). Meanwhile, Philippines +1.6% (we’re long) led gainers in Asia; KOSPI +0.4%, back to bullish TRADE and TREND.

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


"consensus says don’t fight the Fed; I say don’t fight the data – Bernanke way behind the curve now" @KeithMcCullough


“Somewhere in the world someone is training when you are not. When you race him, he will win.” -Tom Fleming


According to Gallup, three-quarters of U.S. adult workers say they will continue working past retirement age, with 40% saying they will do so because they want to, and 35% because they will have to.


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