Takeaway: On the margin, key initiatives in the Shanghai FTZ reform package are positive for China’s structural economic outlook.

TAKEAWAY: On the margin, key initiatives in the Shanghai FTZ reform package are positive for China’s structural economic outlook.


Today, China announced general guidelines for economic and financial market reform within the Shanghai FTZ. On balance, the outline was met with mixed-to-slightly-disappointed reviews from the analyst and financial media community.


While regrettably and conspicuously devoid of specific rates, quotas and other metrics that would allow analysts to quantitatively extrapolate the zone’s impact upon the broader Chinese economy, the guidelines were indeed full of key initiatives that we continue to think are positive for China’s TAIL-duration growth outlook via an infusion of capital and liquidity into the nation’s increasingly cash-strapped financial sector.


  • Key positives:
    • 18 service sectors will be granted access to private and foreign capital, with financial services being the most important as it relates to Chinese economic growth.
    • “On the condition of effective oversight”, China will allow Chinese banks in the zone to conduct offshore business – essentially allowing them to provide banking services to foreign depositors.
    • “China will push for a full-scale opening of the financial services sector to eligible private capital and foreign financial institutions.” Essentially, this will allow foreign-funded financial institutions to set up banks and team up with private Chinese banks to form joint ventures. Both initiatives will undoubtedly be supportive of increasing the supply of credit to China’s SMEs, which tend to be significantly more productive than their SOE counterparts.
    • Foreign-funded mutual funds will be granted access to operate in China via the Shanghai FTZ. With the securitization of financial assets also being promoted, the presence of foreign-funded mutual funds helps address the elephant in the room surrounding China’s still-developing ABS market (i.e. “who’s going to hit the bid on the bulk of China’s pending ABS sales?”), given that Chinese banks themselves will inevitably find it difficult to broadly offload assets unto one another.
    • While not specific to banking, another pro-growth reform initiative is the implementation of favorable tax policies that seek to boost investment and trade. An example of this is the Chinese government’s plan to make imported capital equipment exempt from taxes within the FTZ.
  • Key negatives:
    • Aside from the fact that it was light on specifics, the fact that the zone “aims to get up to international standards of convenient investment and trade, as well as full capital account conversion in 2-3 years” is disappointing. Why such a long delay? It’s not like this is China’s first rodeo with special economic zones (think: Deng Xiaoping’s Shenzhen success story).
    • Moreover, “creating conditions” to “test” capital account conversion, interest rate liberalization and cross-border use of the CNY is not the same as “proceeding with” any/all of those reforms right off the bat.


All told, while not necessarily a game-changer for the broader Chinese economy, we stand counter to the consensus interpretation that today’s announcement of the specific reforms earmarked for the Shanghai FTZ amounts to little more than a policy non-event.


Rather, we continue to believe Chinese officials are embarking  on a grand-strategy to [methodically] import foreign capital to offset the structural liquidity headwinds weighing on the country’s financial sector and its economic growth potential.


That, on the margin, is positive for China’s structural economic outlook (CLICK HERE for more details).


Have a great weekend,


Darius Dale

Senior Analyst



JCP Flash Call Invite. Today at 1pm EDT.

Takeaway: Please join us for a flash call on JCP today at 1:00pm. We'll take an in-depth look at why we'd play the other side of the JCP = zero call.

Please join us for a flash call on J.C. Penney (JCP) today, September 27th at 1:00pm EDT. The call will take an in-depth look at JCP and why we would play the other side of the 'going to zero' trade.




  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 798797#
  • Materials: CLICK HERE (slides will download one hour prior to the start of the call)



We'll Take The Other Side of The 'Going To Zero'  Trade

This is not for the faint of heart, as earnings are non-existent, there's a lame duck CEO, no square footage growth, and the average American probably could care less if JCP exists or not.  But everything has a price - even JCP. 


Almost All of Its Problems Are Fixable

Apparel retail might not be the best business in the world, but it is one that allows you to shake the etch-a-sketch clean every 13 weeks.  Our work shows that JCP's problems have been largely due to pricing, lack of promotions, and the omission of product that the consumer had otherwise grown to rely upon.


There's a Steep Gross Margin Opportunity

Johnson took away $2.5bn in revenue at a 48% GM, and substituted with less than $1bn of 33% GM product. There's over 500bp in GM recovery right there.


This Equity Offering Solved More Problems Than It Caused

As tight as cash seemed to be, JCP did not need this deal now. It was poorly managed/telegraphed. But the reality is that liquidity is no longer a near-term risk.  This makes the 'going to zero' call really tough to play for. It also takes risk of factoring companies limiting goods  out of the equation.  Lastly, it accelerates the quality and quantity  of CEO candidates.


Another Way To Play the JCP Recovery is to Short KSS

Our work suggests that KSS stole $800mm from JCP, and there's nothing permanent about that share shift. JCP is gunning for the business, and whether it succeeds or not, it will hurt KSS while it tries.




Please email for further details (please note that email will be the best way contact the team).

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NKE: Adidas Hates These Guys

Takeaway: Nike is making ailing US retailers as well as its global competitors (aka Adidas) look downright silly.

This note was originally published September 26, 2013 at 20:28 in Retail

What’s there to say about Nike’s quarter? We’re surrounded left and right by weakness in US retail, and yet Nike comes out and prints a quarter of Champions.


NKE: Adidas Hates These Guys - nike


NKE printed top line growth of 8%, and an acceleration in futures to +10%, with a nice balance of 7% growth in units, and 3% increase in price. We saw +120bp improvement in gross margins, which was far ahead of our above-consensus estimate – as pricing initiatives are being met with very little resistance, and raw materials costs are coming in below plan. SG&A was flat for the quarter, which is largely due to comparisons against event spending vs last year. But still, the growth algorithm is inarguable…sales +8%, gross profit +11%, and EBIT +40%. EPS came in at $0.86, well ahead of our estimate of $0.82 and the Street at $0.78. Inventory looked great as well, growing 6% -- below the rate of sales for the 5th quarter in a row.


You might say that Nike naturally sidesteps the US retail malaise due to the fact that it is a global company. But then why did Adidas – its closest global competitor that has a nearly identical scope, reach and mix outside of the United States – put out an announcement on September 20 taking down expectations for the quarter and the year due to weak sales globally, particularly Russia (which Nike highlighted as a strength this quarter), and golf (this was also weak for Nike, to be fair). This juxtaposition simply highlights how well Nike is managed relative to its peers.


We’re taking up our estimate to $3.25 for the year (20% EPS growth). We think that Nike is being conservative with its expectation for only 50bps of improvement in gross margins for the year, and although we’ll start to see more normalized levels of SG&A spending, the reality is that a high-single-digit growth rate in sales with 100bp+ in gross margin improvement is nothing to shake a stick at. Mid-high teens EPS growth on top of 25% ROIC makes Nike every bit worthy of its 20 forward multiple (and then some). Nike’s still a core holding any way we cut it.


We’ll return with a more thorough deep dive after Nike’s analyst meeting in two weeks. 

A Close Eye on Oil & Bonds

Client Talking Points


Brent is down -0.5% this morning and testing our long-term TAIL risk line of $108.57 support for the secondtime this week. There’s potential for a big breakdown here if the US Dollar can find a way to fight off Ben Bernanke. Down Oil is obviously a good thing for US consumers and economic growth.


Make no mistake: Vladimir Putin does not like the Petro Dollar being under pressure. Neither does the Russian stock market. It is down -1.4% this morning leading the losers. It is down at -2.8% year-to-date for the RTSI. You can bet your ruble that I’d like to see more of that.


The 10-year Treasury yield is still hanging out there in no man’s land at 2.62%. Our TREND support is the line that matters most at 2.55%. The immediate-term TRADE resistance is 2.74% now. Next week's U.S. employment report should be a rather decisive factor in determining where it goes next. We are watching bonds and Ben Bernanke very closely.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

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.


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.


Financials sector senior analyst Jonathan Casteleyn continues to carry T. Rowe Price as his highest-conviction long call, based on the long-range reallocation out of bonds with investors continuing to move into stocks.  T Rowe is one of the fastest growing equity asset managers and has consistently had the best performing stock funds over the past ten years.

Three for the Road


@KeithMcCullough So much hate against you! You must be doing something right!!! @1ens


He who lives by the crystal ball will eat shattered glass.
- Ray Dalio


A shutdown of the U.S. government would reduce Q4 economic growth by as much as 1.4 percentage points depending on its length, economists say, as government workers from park rangers to telephone receptionists are furloughed. (Bloomberg)

KMB – We’re Still Bearish

Kimberly Clark remains one of our favorite names on the short side as a difficult environment is pressuring volume growth, input costs are accelerating, and macroeconomic factors have rendered the stock far less attractive as a source of yield. In addition, the market is still demanding 17x forward earnings (which are likely too high) for the stock. We expect investors to pay up for organic sales-driven growth, not share repurchases and cost savings. The long-term opportunity for the company, particularly in emerging markets, is impressive, but we would wait for 3Q and possibly 4Q earnings to pass before getting behind the stock.



Ahead of 3Q EPS on 10/22: Ahead of earnings, we are highlighting the following factors as most important to us changing our fundamental view from negative to neutral or positive:

  • Organic sales growth accelerating
  • EBIT growth re-acceleration
  • FX impact easing into 4Q
  • FCF growth (following a -2.1% decline in 2Q)
  • Positive commentary or data points on innovation pipeline


Top-line Concerns: The Company’s growth profile is hampered by difficulties in developed markets such as Korea, Australia, and the U.S. In the U.S., the higher margin personal care business registered negative volume growth despite negative product mix in 2Q, which was a concern for investors. 



Cost Savings: The Company has driven a tremendous amount of cost savings - $1.9 billion - out of its business over the past nine years, largely driven by a focus on the supply chain. Two-thirds of the savings have been generated by “lean manufacturing practices” and the remainder has been driven by the company’s global procurement organization.  Management is guiding to a $300-350 million annual savings figure (from $250-300 million prior estimate).  


At the Barclays Back to School conference, CFO Mark Buthman stated, “the more savings we drive, the more that we find”, as an explanation for the increasing dollars being slashed from the company’s budget. While adding efficiency to a business is good news for shareholders, we do not view cost-cutting as a growth business in and of itself. The company’s organic sales growth is of much greater importance and evidence of an improvement on that front is necessary for us to get comfortable with owning the stock. As the chart below highlights, recent EBIT growth has increasingly been driven by cost savings.


KMB – We’re Still Bearish - kmb cost savings



Input Costs Likely Accelerated in 3Q:  The acceleration in oil and pulp prices from 2Q to 3Q implies that raw material inflation is likely to be a greater drag on operating income in 3Q than it was during 1H12.


KMB – We’re Still Bearish - KMB inflation



Rates Rising: We have belabored this point, but it is worth emphasizing again. A rise in interest rates from current levels, driven by strong employment data, Federal Reserve commentary, or other market factors, could drive capital further from the consumer staples sector. While correlation is not, nor does it imply, causation, it is interesting to note that during the 2009-2012 period, when quantitative easing measures from the Fed dared investors to chase yield, consumer staples traded at a strong inverse correlation to 10-year Treasury yields. The inverse correlation of KMB to the 10-year yield was, in fact, even stronger during the 2009-2012 period, which may indicate that KMB was even more “bid up” by fundamental-agnostic investors, in pursuit of yield, than the XLP.


KMB – We’re Still Bearish - kmb vs yield vs xlp vs yield



Quantitative Levels: KMB is in bearish formation with intermediate-term TREND resistance at $98.23.


KMB – We’re Still Bearish - KMB levels




Rory Green

Senior Analyst