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DKS: Still Bearish; ROIC Going Lower

Takeaway: DKS’ 2Q print validated our bear case that it is trading greater investments from lower cash margin, and ultimately, a lower multiple.

DKS’ 2Q print validated our bear case that the company is putting up a greater proportion of incremental capital on both the P&L and the balance sheet for disproportionately less cash flow in return.  Our view is that this trend (which also applies to Macy’s and Gap) will mitigate any kind of valuation support, as multiples have no business being near their tops when returns are rolling over like we see today.

 

Like many retailers quarter-to-date, sales trends were soft, and the company did not have a firm grasp as to why. It comped down for the second quarter in a row, and though gross margins held steady, inventories were up 12.4% on 6.6% sales growth. That’s not a good setup by any stretch for gross margins heading into the back half.

 

If there’s any bullish angle, it’s that earnings expectations might finally be down to more doable levels. But the reality is that this stock is still trading at over 18x current year earnings, which is downright expensive.  Based on our model, it will never have over a 9% operating margin again (see our assumptions below). We’d need to see consensus estimates come down by about 25% in the outer years for us to back off of our bearish stance on DKS. That’s unlikely to happen.

 

Avoid the temptation to support it here. Let it cook.

 

DKS: Still Bearish; ROIC Going Lower - 8 20 2013 12 14 32 PM

 


Morning Reads on Our Radar Screen

Takeaway: A quick look at some stories on Hedgeye's radar screen.

Keith McCullough – CEO

Rupiah Forwards Plunge to Lowest Since 2009 as Bond Risk Surges (via Bloomberg)

Asia stocks hit by fears about emerging markets (via MarketWatch)

Fukushima Plant Has 300-Ton Water Leak (via New York Times)

 

Morning Reads on Our Radar Screen - duut

 

Brian McGough – Retail

J.C. Penney Posts Slower Sales Decline on Ullman Plan (via Bloomberg)

Retailer Dick's Sporting Goods misses estimates, shares fall (via Reuters)

 

Jonathan CasteleynFinancials

Capital Flows Back to U.S. as Markets Slump Across Asia (via Bloomberg)

1997 Asian financial crisis (JC note: If someone blows up in China this is your analog. via Wikipedia)

 

Kevin Kaiser – Energy

E&P Investors Fear the Oil Party Hangover (via Wall Street Journal)

BHP delays $14 billion Canada potash push as profit drops (via Reuters)

Go Your Own Way – Offloading Heavy Canadian Crude On The Gulf Coast (via RBN Energy)


GALAXY 2Q 2013 CONFERENCE CALL NOTES

Galaxy beat our 2Q EBITDA estimate and we were high on the Street.  High mass hold and controlled corporate costs were the driving factors. 

 

 

"We are very pleased to report improving financial results across the business and that Phase 2 of Galaxy Macau remains on schedule. The Group also expanded its existing Cotai landbank with the strategic purchase of the Grand Waldo Complex.  We also strengthened our balance sheet by prepaying a significant portion of our bank borrowings. I am particularly delighted that the half year culminated in the Group being included as a constituent of the Hang Seng Index. Looking into the future, Macau's prospects for the remainder of 2013 and beyond continue to be bright. We believe that our development pipeline for Phases 2, 3 and 4 plus the Grand Waldo Complex on Cotai position us well for continued growth." 

 

- Dr. Lui Che-woo, Chairman of GEG 

 

CONF CALL 

  • Galaxy Macau:  opened new premium mass Pavilion club, will open new VIP room in late Q3
  • Starworld:  all-time record in mass; opened new premium mass room, made some shifting in VIP rooms 

 

Q & A

  • Sands Cotai Central competition:  all operators have benefited from SCC opening, including Galaxy Macau
  • Galaxy Macau revenue growth:  visitation has grown especially in mass segment
  • Galaxy Macau Phase 2 capex:  YTD over a billion dollars; have spent $2.8 BN of $19.6BN budget; significant ramp-up in capital outflow at the end of this year and 2014.
  • Henquin Island:  Galaxy looking at it
  • 2Q Hold adjusted EBITDA:  refused to give it given 'no standardized definition'; wants analysts to focus on the volume growth
  • GM Phase 3/4:  combined capex HK$60-80BN -start the project out with the arena and construction could start at end of year/ early 2014.
  • Net cash $5 billion before Waldo acquisition
  • Took Waldo tables and employed them at other properties
  • Table mix:  1/3 VIP, 2/3 MASS; 3Q 2013 will have a little more VIP tables
  • GM Phase 2 table count:  working closely with govt 
  • GM Phase 3/4: some gaming
  • Starworld:  VIP RC - tables yielding better, redesigned new VIP room, more rewards, 16 VIP operators down from 17; Q3TD is very positive
  • Non-gaming revenue decline:  accounting adjustment - reclassification of travel-related revenue; Starworld disruption at L16
  • No fees with prepayment of loan

Early Look

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Macro Tricks

“We were forever inventing new tricks.”

-Hans Bethe

 

From a strategy and teamwork perspective, one of the most fascinating aspects of reading American Prometheus (The Triumph and Tragedy of Robert Oppenheimer) has been how well these to-be-famous scientists collaborated with one another.

 

Hans Bethe, who eventually won the Nobel Prize in Physics in 1967, said “the intellectual experience was unforgettable.” (page 182). Since he was working alongside Oppenheimer, Feynman, and Bohr, I don’t doubt that for one second!

 

I’m not making a political statement on nuclear. I’m simply pointing out how a culture of trust and collaboration can incubate innovation. While the powers that be will likely never acknowledge the Global Macro models we are building here @Hedgeye, we are getting more and more respect from you, the practitioners, every day. On behalf of my team, thank you for this experience.

 

Back to the Global Macro Grind

 

One of the most interesting realities embedded in our independent research process is that we don’t know where we are going to end up next. Our Global Macro Themes are born out of intermediate-term market signals and then contextualized by long-cycle research. If it feels like we’re forever inventing new themes, that’s because the market’s ecosystem is forever reinventing itself.

 

Since #RatesRising and #DebtDeflation have been the two Q313 themes most of our clients want to talk about, that’s what I have focused my time ranting about. That, however, doesn’t mean that our 3rd major Macro Theme for Q3 doesn’t exist. In fact, today is as glaring an example as any in which #AsianContagion should be jumping off your screens.

 

Reviewing the risks of #AsianContagion:

  1. Some overvalued Asian currencies are breaking down from an intermediate-term TREND perspective
  2. Some Asian debt markets are getting increasingly nervous about the negative deficit impact of a weakening currency
  3. When both a country’s currency and debt deflate, you get local inflation and local #RatesRising – that’s bad

From a process perspective, our Senior Asia analyst, Darius Dale, called out the following equity divergences 24 hours ago:

  • Indonesia -5.6% DoD vs. a regional median delta of -0.2%
  • Thailand -3.3% DoD vs. a regional median delta of -0.2%
  • India -9.1% MoM vs. a regional median delta of -1.2%

Then, on Indonesia in particular, he called out yesterday’s key economic data point:

  • 2Q Current Account Balance - current account deficit widened to a record on both a nominal basis and as a % of GDP

And finally, we get this morning’s Bloomberg headlines (under Economy):

 

A)     “Rupiah Forwards Plunge To Lowest Since 2009 As Bond Risk Surges”

B)      “Rupee Drops To Record on Fed Tapering Concern”

 

These macro headlines (i.e. old news) come after Indian, Indonesian, and Thai markets move. The proactive risk management Macro Trick is to know they are moving (and why) before consensus realizes it. This macro theme is 1.5 months old.

 

Indonesian stocks are -11% in the last 3 days and India’s stock market continues to be one of the worst in the world for 2013 YTD – all for Hedgeye playbook reasoning (this kind of stuff confuses Keynesians who think weak FX is a good thing!).

 

Again, to review in the most simplest of complexity’s terms:

  1. Currency Burns, then local  
  2. Inflation Accelerates and Growth Slows; and finally          
  3. Deficit worries (and credit risk) rise; and bonds fall (#DebtDeflation)

If you want to be really worried about something other than the US Bond market crashing, we’d suggest Asia (ex-Japan). That’s not a new Hedgeye Jedi Macro mind trick as of this morning either. That’s what was already trending.

 

Our immediate-term Risk Ranges are now:

 

UST 10yr 2.70-2.91%

SPX 1

VIX 13.51-15.36

USD 80.91-81.96

Yen 97.11-98.26

Copper 3.25-3.39

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Macro Tricks - Chart of the Day

 

Macro Tricks - Virtual Portfolio


Asian Contagion? Exactly.

Client Talking Points

UST 10YR

Evidently #RatesRising too fast makes consensus very nervous; especially those poor souls who still remain levered long the slow-growth, yield-chasing asset allocation the Fed had them in. The 10-year Treasury yield is backing off its immediate-term TRADE overbought zone of 2.86-2.91%. So this morning should provide a de-stresser on that front; Utilities (XLU) are already down -5.2% already for the month!

INDONESIA

Boom! Indonesia is down -11% in just three days as the Rupiah hits a 4-year low and #DebtDeflation takes hold. This is how the ball bounces in our #AsianContagion Q3 Macro Theme. It is both interesting and sad to see it playing out in India (Rupee broke 64 vs US Dollar this morning... new lows) and Indonesia, but not at all surprising. We called this.

COPPER

Sneaky 1-month squeeze to watch as the net short position in Copper went away last week (CFTC futures/options contracts). The question now becomes whether copper will be able to overcome the @Hedgeye TREND line of $3.39/lb? Not today. This is an important commodity to watch as a proxy for the entire commodity complex which has reflated this month.

Asset Allocation

CASH 26% US EQUITIES 28%
INTL EQUITIES 24% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 22%

Top Long Ideas

Company Ticker Sector Duration
WWW

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. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.

MPEL

Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016.

HCA

Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward.  Near-term market mayhem should not hamper this  trend, even if it means slightly higher borrowing costs for hospitals down the road.

Three for the Road

TWEET OF THE DAY

Hedgeye's #AsianContagion Theme taking hold (when a country’s debt and currency values deflate at an accelerating rate) #Rupiah

@KeithMcCullough

QUOTE OF THE DAY

“I know from experience that nobody can give me a tip or a series of tips that will make more money for me than my own judgment.” -Jesse Livermore

STAT OF THE DAY

Hubris? Herbalife and J.C. Penney have cost Bill Ackman's Pershing Square an estimated $1 billion or so (The Economist)


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