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JAPAN STRATEGY UPDATE: IS THE ABENOMICS TRADE OVER?

Takeaway: Trading Abenomics from here depends primarily on your specific investment duration.

SUMMARY BULLETS:

 

  • All in, the BOJ’s opting to stand pat as the currency market demands additional easing measures is the primary reason for the recent bout of yen strength (up +9% vs. the USD since its 5/17 YTD low).
  • More importantly, the USD/JPY cross has broken our intermediate-term TREND line of support at 95.95.
  • To the extent you have been short the yen or playing the Abenomics Trade in ancillary vehicles, it may prove prudent to sell/reduce your exposure upon confirmation (i.e. give it time to breathe) of a breakdown through the TREND line.
  • The long-term TAIL line of support is down at 88.67; that would be a good level to put the position back on/increase your exposure (as would a breakout back above the TREND line).
  • As one of our core research views, we remain the bears on the Japanese yen with respect to the long-term TAIL. We’re merely attempting to manage the immediate-to-potentially-intermediate-term risk of the position.

 

The minute-by-minute week-to-date chart of the dollar-yen tells us all we need to know about the Abenomics trade. Unlike last week’s sharp decline, the stair-step function exhibited in the week-to-date suggests that investors are slowly losing faith in the collective ability of Abe, Aso and Kuroda to deliver on the LDP’s contextually aggressive +3% nominal GDP and +2% inflation targets.

 

JAPAN STRATEGY UPDATE: IS THE ABENOMICS TRADE OVER? - 1

 

This is primarily due to the trifecta of headwinds that we outlined last Friday in a research note. Perhaps the most critical of those headwinds is the fact that the BOJ appears increasingly content to “play chicken” with market participants, meaning that they continue to stand pat on their previously outlined policies and guidance.

 

Essentially, they are asking the market to patiently trust that they’ll deliver the results that the Abe administration seeks with regards to not just ending structural deflation expectations, but instituting inflation and the broad-based expectation that inflation will be sustained. As we pointed out in a 3/15 research note titled, “JAPAN’S “INVERSE VOLCKER” MOMENT IS UPON US”, Japan’s monetary policy phase change is not unlike what the US experienced with the transition from Arthur Burns to Paul Volcker in the late 70s/early 80s.

 

Just today, BOJ policy board member Sayuri Shira warned that: A) it will take considerable time to achieve +2% inflation target given that the economy has been in a deflationary slump for 15 years and B) there needs to be more focus on the downside risks. She also affirmed previous guidance by BOJ Governor Haruhiko Kuroda that the board is not planning to implement additional programs to calm JGB market volatility, stating that “sufficient tools” already exist.

 

All in, the BOJ’s opting to stand pat as the currency market demands additional easing measures is the primary reason for the recent bout of yen strength (up +9% vs. the USD since its 5/17 YTD low). More importantly, the USD/JPY cross has broken our intermediate-term TREND line of support at 95.95.

 

To the extent you have been short the yen or playing the Abenomics Trade in ancillary vehicles, it may prove prudent to sell/reduce your exposure upon confirmation (i.e. give it time to breathe) of a breakdown through the TREND line. The long-term TAIL line of support is down at 88.67; that would be a good level to put the position back on/increase your exposure (as would a breakout back above the TREND line).

 

As one of our core research views, we remain the bears on the Japanese yen with respect to the long-term TAIL. We’re merely attempting to manage the immediate-to-potentially-intermediate-term risk of the position.

 

Darius Dale

Senior Analyst

 

JAPAN STRATEGY UPDATE: IS THE ABENOMICS TRADE OVER? - 2


EVEP – Where do we Stand?

EV Energy Partners (EVEP) remains a short on our Best Ideas list.  We added it on 4/26/13 at $47/unit and have a 26% “unrealized gain” (not the LINN Energy kind) as of yesterday’s close.  Our thesis is largely playing out as expected, and with EVEP $12 lower in short order, it is time to reevaluate.

 

For background information, see our prior work on EVEP:

 

4/26/13: Short EVEP: New "Best Idea"

5/2/13: EVEP: Beyond the Yield

5/10/13: EVEP is Still a Short

 

Conclusion: We are not “covering” the short here, but we would “lighten up.”  Risk/reward is not what it once was, but we remain negative for two key reasons:

  1. Leverage/liquidity situation is dire; we believe that EVEP will raise equity in 2H13, and that is not yet a consensus view.
  2. There is no legitimate valuation support anywhere close to the current price, in our opinion.  EVEP is overvalued relative to the intrinsic value of its own assets, as well as its E&P peers.

As of 3/31/13, EVEP had $944MM of long-term debt, $19MM of cash, $925MM of net debt, and a net derivative asset of $48MM (adjusted EV of $2.37B at $35/unit).  Net debt increased $74MM sequentially in 1Q13, and assuming no A&D activity and no change in the distribution, net debt will increase ~$77MM every quarter for the next three quarters.  If we draw the cash balance down to $0, that gets us to total long-term debt of $1,160MM at YE13.  At that level the credit facility would be at $660MM, near its borrowing base limit of $710MM (EVEP has $500MM of senior notes (8.0%, 2019)).

 

In 2013, we estimate that EVEP will generate $159MM of open EBITDA and $33MM of hedge gains, for EBITDA of $191MM (note: we do not exclude unit-based compensation from EBITDA as EVEP does – that just doesn’t make sense to us).  Current adjusted net debt/2013 open EBITDA is at 5.5x (($925MM - $48MM)/$159MM); current net debt/2013 EBITDA is at 4.8x ($944MM/$191MM).  Using our YE13 net debt estimate at $1,160MM, leverage ratios will be at 7.1x adjusted net debt/open EBITDA and 6.0x net debt/EBITDA at year end.  It’s also worth noting that net debt exceeds the value of the proved reserves (SEC PV-10 of $874MM at YE12).  The point is that EVEP is dangerously over-levered – which we do not think is really appreciated – and needs to raise capital.

 

The levers that EVEP can pull are 1) asset sales and 2) equity raises.  We think that we get both this year.

 

In our view, EVEP can sell down its Utica Ohio wet gas acreage for ~$200MM (45,000 net acres at $4,444/acre) – but it will be in a number of different transactions, and the timing is uncertain.  Acreage prices in the Utica are still fluid, but we feel like we’ve given the benefit of the doubt to EVEP in our assumptions below:

 

EVEP – Where do we Stand? - evep acreage

 

We assume that the rest of the Utica acreage (volatile oil window, other OH, and all of PA Utica) does not get monetized (though a JV carry arrangement is possible).

 

Those proceeds are not enough.  If EVEP manages to realize the full $200MM in proceeds in 2013 (unlikely), net debt will down to $960MM at YE13 – still over-levered by any measure – but it would not be long until EVEP is again bumping up against the borrowing base ceiling as in 2014 and 2015 EVEP needs to raise another $100MM and $60MM of capital, respectively, assuming the distribution is not cut.

         

If EVEP wants to maintain the current distribution – we think they do as cutting it is a death sentence – we think that it raises equity in 2H13 (perverse, but it is what it is).  EVEP hasn’t done an equity deal since February 2012 when they sold 4MM shares at $67.95/unit (brilliantly done) for proceeds of $268MM.  Suppose that this time around they raise $200MM at $34/unit – that would be 5.8MM new units, diluting exiting unitholders by 14%.  That's what we're playing for.    

 

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As we have written previously, we believe that fair value for EVEP is in the low $20’s.  We use traditional E&P valuation approaches (NAV and multiples of cash flow), not a yield target.  We do not believe that EVEP’s current distribution is sustainable without consistently funding it with capital raises, so we think that method is inappropriate, and overvalues the enterprise.  At the current price – $35/unit – EVEP trades at 2.7x EV/PV-10, 15.0x EV/2013 open EBITDA, and 12.0x EV/2014 open EBITDA.  Compare those metrics with E&Ps that have better assets and better growth prospects and trade at 1.5x PV-10 and 5x EBITDA – and most E&Ps have acreage for sale and midstream businesses just as EVEP does.      

 

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We want to wait for our catalyst – equity raise – before “covering” our position.  We don’t think it’s priced in yet, but maybe it’s starting to be.  While EVEP is still very overpriced in our eyes, we understand that most investors and analysts do not look at EVEP the same way that we do, and we don’t expect them to “come our way.”  We want to keep the position on, but would “lighten up,” as risk/reward is not what it was when we initiated the short at $47, and there are two potential catalysts that could squeeze EVEP higher: an DCF/unit accretive acquisition; and/or EVEP monetizes a small amount of acreage in the Utica for a high price, and investors extrapolate that number across its entire position.    

 

Kevin Kaiser

Senior Analyst


Stories on Hedgeye's Radar Screen

Takeaway: A quick look at some stories we're reading (and watching) this morning.

Keith McCullough - CEO

Emerging Markets Act to Stem Capital Flight (via Bloomberg)

Turkey protests: Ruling AK party may hold vote on park (via BBC)

 

Stories on Hedgeye's Radar Screen - reading


Kevin Kaiser - Energy

Report: 33 injured in Louisiana plant explosion (via WAFB)

 

Daryl Jones – Macro

CIT's Thain: 2008-Style Crisis Can Still Happen (via Bloomberg)

 

Howard Penney - Restaurants

How to get fired from a fast food joint: Wendy's employee pictured eating ice cream direct from the Frosty machine (via Daily Mail)

Chipotle to open second ShopHouse unit in Los Angeles (via Nation’s Restaurant News)


Jonathan Casteleyn – Financials

After its first monthly outflows ever in May Pimco's Total Return ETF $BOND has lost another $119 MM MTD in June (via PIMCO)

 

Brian McGough - Retail

Retail sales, jobs data show underlying economic strength (via Reuters)

 

 

 

 


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Staples Valuation Remains Stretched

Valuation alone is never a catalyst in our investment process; however below we updated charts on forward P/Es of the consumer staples sector and its main sub sectors. Needless to say, while valuations have come in over recent weeks, they remain stretched. That said, our quantitative real-time set-up for consumer staples (etf: XLP) is bullish, trading above its intermediate term TREND line. We’ll let the charts do the talking:

 

Staples Valuation Remains Stretched - ww. 1

 

Staples Valuation Remains Stretched - ww. 2

 

Staples Valuation Remains Stretched - ww. 3

 

Staples Valuation Remains Stretched - ww. 4

 

Staples Valuation Remains Stretched - ww. 5

 

Staples Valuation Remains Stretched - ww. 6

 

Staples Valuation Remains Stretched - ww. 7

 

Staples Valuation Remains Stretched - ww. 8

 

Matthew Hedrick

Senior Analyst

 


CHART DU JOUR: IT'S NOT THE ECONOMY, STUPID

Regional gaming still disappointing

 

  • Despite an improving economy, May regional gaming revenues are disappointing – coming in below our projection of flat
  • June may look even worse – we are projecting down 5%
  • Q2 estimates look aggressive for regional companies – ASCA, PNK, PENN, BYD
  • Market saturation and bad demographics should continue to pressure this industry

CHART DU JOUR: IT'S NOT THE ECONOMY, STUPID - sss



Weimar Nikkei: We Called It

Takeaway: To be crystal clear on our conclusion on how we think this ends for the Japanese people: in tears.

(Editor's Note: This note was originally published on May 30, 2013. We have been pounding the table on Japan for quite some time here at Hedgeye. In other words, we called all this market mayhem well ahead of consensus. As CEO Keith McCullough is fond of saying, it is a "certified Gong Show" in Japan. For more information how you can sign up for our services, please click here.)

The big picture

“Economics is haunted by more fallacies than any other study known to man.”

-Henry Hazlitt

 

 

That’s the opening sentence to one of the best introductory books on markets that you’ll ever read: Economics in One Lesson. Hazlitt wrote the book in 1962, then republished it again in 1979. The quote is timeless. It’s also cyclical.

 

Our everything Japan Jedi, Darius Dale, and I spent the day seeing clients in Boston yesterday and we had some colorful debates about what both the New York Times and The Economist are all of a sudden championing as “Abenomics.”

 

To be crystal clear on our conclusion on how we think this ends for the Japanese people: in tears. Never mind a country that starts doing it with a quadrillion in debt, there has never been a country in the history of humanity that has devalued their way to long-term economic prosperity. Championing Japan’s economics today is the equivalent of cheering on the Weimar Republic circa 1924.

Macro grind

The exciting thing about getting long the Weimar Republic’s stock market in the early 1920s is that you would have crushed it on the long side. The devastating thing was the other side of the trade – The People, their liberties, and purchasing power got crushed too.

 

Try some anti-gravity (economic or physical) exercises at home, and let me know how it ends. As a general rule, what goes up comes down, fast. The Yale Economics Department didn’t teach me that, btw. Incredibly, Keynesians believe they can “smooth” gravity.

 

The Weimar Nikkei was down another -5.2% last night. It’s down -13% from its Policy To Inflate high of May 22. That’ll leave a month-end mark. So will the implied volatility this kind of a move perpetuates throughout our interconnected global macro ecosystem.

 

What is a Policy To Inflate?

  1. A Policy To Inflate is an explicit (and implicit) strategy to debauch and devalue the currency of your people
  2. Bernanke is the “innovation/communication” dude who taught the Japanese to roll this out (without calling it what it is)

How do you devalue?

  1. As Bernanke’s boy, Paul Krugman, suggested to the Japanese in 1997, you need to “PRINT LOTS OF MONEY”
  2. And, ideally, have your conflicted/compromised politicians spend their brains out on borrowed moneys, at the same time

Then you have to overlay the almighty “communication tools” (i.e. central planners whispering inside info to “consultants” who then tell fund managers and/or bark about how much more you can print if/when you feel like the stock market needs more juice).  

 

This communication tool thing has the potential to be a lot more powerful today than it was for the Germans in the 1920s, primarily because the distribution pipe for our conflicted/compromised media is exponentially larger.

 

Remember, any lie can live for as long as people are dumb enough to believe it. I don’t think the media is as dumb as they are cornered. If they don’t broadcast this Fed, BOJ, and ECB propaganda, they lose access to the only meaningful content they have left.

 

BREAKING NEWS: central planner A says B to reporter C in the WSJ and/or English Major D @CNBC – markets react!

 

People who are paid to believe lies inspire us. So we are going to publish the Hedgeye Risk Management Top 10 things a hard core Bernankian is going to tell you in a meeting about the benefits of 0% interest rates and burning your currency.

 

At the top of the list will be things like “exports”, “competitiveness”, etc. These aren’t new arguments. But what’s fascinating about them is that they are the same fear-mongering and regressive arguments that central planners have been making since the 1920s.

 

Losers make excuses when their plans aren’t working. For Abenomics to work, we need to see sustained real (inflation-adjusted for local currency) economic growth.

 

In the short-term, they might get the illusion of that – it’s called inflation. In the long-run, what do they care about what they really get? On that score they’d agree with Keynes too; in the long-run they (and the Weimar Nikkei) will be dead.

  • CASH: 30
  • US EQUITIES: 22
  • INTL EQUITIES: 18
  • COMMODITIES: 0
  • FIXED INCOME: 0
  • INTL CURRENCIES: 30

Our levels

Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST10yr Yield, VIX, Nikkei225, and the SP500 are $1361-1424, $101.06-103.98, $83.31-84.61, 100.41-103.69, 2.01-2.18%, 12.35-15.11, 13506-14920, and 1641-1674, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Weimar Nikkei: We Called It - Chart of the Day large


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