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Turkey ... Much Ado About Nothing?

Takeaway: Turkish protests are creating a lot of headlines, but we think they will have little impact on long term fundamentals.

This note was originally published June 12, 2013 at 15:10 in Macro

Turkey ... Much Ado About Nothing? - turkey protests

 

"Turkey is not a second-class democracy.”

 

-Turkish Foreign Minister to Secretary of State John Kerry

 

To say Turkish equity markets have been volatile over the last two weeks would be an understatement.  In fact, on June 3rd the main Turkish equity index was down more than 10% as emphasized in the chart below.  While Turkey was largely immune to the so called Arab Spring, the current series of protests that have  been grabbing media headlines around the world appear to be a Turkish version of sorts, at least at first blush. 

 

Turkey ... Much Ado About Nothing? - yowsa

 

Turkey ... Much Ado About Nothing? - Turkey XU100 During Protest

 

Stepping back, the Turkish economy has been the fastest-growing economy in Europe since the early 2000s. In 2002, current Prime Minister Recep Tayyip Erdogan won his first general election and since then the XU100 index is up almost 9x, which can be seen on the graphs presented. Turkey is now the 15th largest world economy on purchasing parity basis.  The key components of the highly diverse Turkish economy include: agriculture which is 30% of employment (Turkey is food independent), the fourth largest ship building sector in the world, the 10th largest producer of minerals, and a very active tourism industry (with 11 of the top hotels in the world located there).

 

Turkey has also been much less affected by the financial crisis of 2008/2009 than many of its European peers.  In fact, Turkish GDP grew 9.2% in 2010 and 8.5% in 2011 (long term growth rates are highlighted in the chart below), which were some of the highest growth rates in the industrialized world.  The derivative impact of this economic growth is that the country level fiscal situation level is very healthy.   In fact, Turkey has met the 60% debt-to-EBITDA criteria of the Maastricht Treaty every year since 2004. As a result of the healthy economy, the Turkish Lira has been stable over the past few years with inflation under control.

 

Turkey ... Much Ado About Nothing? - Turkey GDP

 

Much of the economic success over the past decade can be attributed to Prime Minister Erdogan, who has been in power for most of that period.  Erdogan inherited an economy that was deep in recession in 2002 and with the help of Finance Minister Ali Babacan, Erdogan implemented a series of reforms. One key reform included dramatically reducing government regulations, which subsequently altered the path and outlook for the Turkish economy.  Perhaps most telling on this front is the fact that inflation was at 35% when Erdogan gained power and CPI is now running sub-5%.  

 

Given the economic backdrop and improving economic situation of the average Turk over the last decade, the protests against the government are somewhat counterintuitive.  Regardless, they are occurring with increasing scale.  The map and timeline below highlights this fact showing the spread of protests across Turkey. To date, these protests have led to 3 fatalities and 5,000 injuries.  

 

Turkey ... Much Ado About Nothing? - Turkey Map

 

Turkey ... Much Ado About Nothing? - Turkey Events

 

The protests in Turkey, though similar to the protests against local governments that erupted in the Arab Spring revolutions seen in northern Africa with Tunisia, Egypt, and Libya, also hold some specific differences. The unrest shown against Erdogan and his government is different because in the Arab Spring countries the protests were directed to the dictatorships that ascended to power, rather than democratically voted into office. On the other hand Erdogan has won every important democratic election.   As well, the Arab Spring was initially catalyzed by the poor economic situation of the broad populace.

 

To be fair, the AKP and Erdogan have lost some of their popular appeal and are being accused of infringing on personal freedoms in Turkey.  Recently the government implemented a restriction on alcohol sales and has also been allegedly imposing conservative Islamic views in legislation. The protesters have stood up, and have fought against police brutality and restrictions on labor unions.

 

There are a few options to what will happen next in Turkey. A scenario similar to the Arab Spring does not seem plausible, where protests fueled by the dissatisfaction of government led to complete regime changes in Tunisia, Egypt, and Libya. It is unlikely because the Erdogan has had such a positive impact on Turkey’s economy and the violence in the Turkish protests are not to scale of the Arab Spring.  In essence, there is no military or armed support to the protests.

 

Another option is for the protesters to eventually give in with no major changes being enacted or seen in the government. Erdogan has been visiting cities to gain more supporters so that he and the AK party will again win the popular vote in the Presidential elections in 2014.  

 

Ultimately, we do not think these protests will trump the strong track record of Erdogan and will eventually pass, although he may have to acquiesce on the civil liberties front.  The biggest tell to us on this front is a chart of credit default swaps on Turkish government debt.  While they are elevated, they are still largely in normal territory and are not signaling imminent economic or fiscal stress, which would come from a broad popular uprising akin to what occurred across the Middle East during the Arab Spring.

 

We aren’t ready to advise buying Turkish equities just yet, but our Hedgeyes are watching and waiting.

 

Daryl G. Jones

Director of Research

 

Turkey ... Much Ado About Nothing? - Turkey CDS


Retail: Japan Not Helping Margin Equation

Takeaway: Developments in Japan are not a welcomed change to the retail margin equation. Here's who has the greatest exposure.

Our Macro team is bearish on Japan from a long-term TAIL perspective (see the latest of Darius Dale's notes below). And yes, it matters for US retailers. Here's a list of brands that have direct exposure to Japan. We've already heard some of the companies (like Ralph Lauren) talk about taking up prices in Japan to help mitigate currency fluctuations, but those actions are not enough to cover the whole deficit. That's when secondary exposure comes into play, as the primary brands look to extract value from other supply chain partners to maintain their margins. We wouldn't consider this as 'critical' for US Retail right now, but with raw material tailwinds coming to an end, and labor costs accelerating to the upside, it is not a welcomed change -- particularly with margins at peak. At a minimum, let's be aware of it.

 

Retail: Japan Not Helping Margin Equation - one

 

 

06/13/13 02:05 PM EDT

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.

 

Retail: Japan Not Helping Margin Equation - 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.

 

 

Retail: Japan Not Helping Margin Equation - 2

 

Darius Dale

Senior Analyst

 

 

 


Retail (Pop)

Takeaway: This print synchs with our overall (decidedly non-consensus) bullish view on US consumption.

Witness the nice pop in May US Retail Sales popping 0.6% and past head-scratching Wall Street consensus.

 

Retail (Pop) - reb

 

This print synchs with our overall (decidedly non-consensus) bullish view on US consumption. Yes, we remain bullish on #GrowthAccelerating.

 

In particular, check out Restoration Hardware (RH) seeing a tidy uptick jumping around 3% today ahead of its earnings report.

 

That said, weather may be a factor in June for apparel and footwear retailers. #GotRain?

 

Retail (Pop) - bri


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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.    

 

---

 

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.      

 

---

 

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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