prev

WWW: Smoke In Mirrors. Buy The Event

Takeaway: WWW will annihilate 3Q, and guide down 4Q. Not bc it has to but bc it wants to. Our thesis is on track regardless of the print. We're buyers

Conclusion: We think that two things are a near certainty when WWW reports 3Q numbers on Tuesday morning. 1) First, the company will annihilate 3Q earnings expectations. 2) Immediately following, it will guide down for 4Q. We think that it will guide as such because it wants to, not because it needs to. We’d use any weakness around a sloppy guide to add to an existing position, or better yet, use as an opportunity to build a position if you’ve otherwise been waiting on the sidelines regretting not being involved while watching it go from $40 to $58 over the past year. Our thesis hinges around WWW earning $5.65 in three years, which compares to the consensus at $4.25 (we’re 33% ahead of the Street).  All of our research suggests that this thesis is on track – regardless of what the company says tomorrow on its call. We’re buyers on the event.

 

A beat is already priced in. After all, WWW has beat 19 of the past 20 quarters – and the one quarter it missed was by a penny (less than 2%). But we think that we'll see both a top line and Gross Margin beat -- and upside by as much as $0.20 to the Street’s $1.01.  If we see any less, it’s likely be to be due to higher SG&A spending to facilitate growth in WWW’s PLG brands outside the US. We’re ok with that.

 

WWW: Smoke In Mirrors. Buy The Event - WWW chart1

 

Let’s bring on the accountability check.

It’s time for some basic math and an accountability check on WWW.  At the start of the year, the company said the following about the recent ‘PLG’ acquisition (Sperry, Saucony, Keds, Stride Rite) and its impact on earnings.  ‘Included in the fiscal 2013 guidance is GAAP accretion from the PLG acquisition in the range of $0.40 to $0.50 per share. Given the seasonality of the PLG brands, we expect modest accretion in the first fiscal quarter, slight dilution in the second fiscal quarter, strong accretion in the third fiscal quarter, and modest accretion in the fourth fiscal quarter.’  This means the first and second quarter roughly wash each other out and most accretion comes in 2H, which makes sense because a) the seasonality of the business lends itself to higher profitability in the second half, and b) the deals that WWW is striking with international distributors are cumulative in nature, and pick up over time as it relates to impact on the P&L.

 

Now, with the first half of the year already put to bed, WWW has realized $0.58 per share in accretion from the acquisition – which is huge. But the company managed to convince Wall Street that 2H would now be dilutive to earnings.  Huh?  How could that logically and mathematically be possible?

 

The way we look at it, this is a whole lot of smoke and mirrors.  WWW is saying that it pulled forward some demand from 3Q into 1Q, and that it pushed some costs from 2Q into 3Q – and as such, what was the most accretive period of the year becomes dilutive. It’s ironic that the company does not identify what those shipments are, or quantify how much they are impacting its financials.

 

This is another example of the company artfully managing the Street’s expectations. When all is said and done, we think it’s not unrealistic for WWW to print anywhere between $0.20-$0.40 per share in upside in 2H.

 

 

OUR THESIS

The Street is grossly underestimating the revenue growth opportunity as the legacy WWW scales its recently acquired brands over its global infrastructure.  We think WWW can and will add $1bn in sales to its $2.7bn base over 3-years. Under its former owner, Sperry, Keds, Saucony and Stride-Rite only generated 5% of its sales outside of the US, and most of that was in Mexico and Canada. Legacy WWW, on the other hand, is the most global footwear company in the world (yes, even more so than NKE and AdiBok), with 65% of units sold outside the US through an elaborate network of seamlessly-integrated third-party distributors. Given that the infrastructure is already in place, the incremental sales should be brought on close to a 20% incremental margin, versus 8% margin today. Similarly, minimal capital is needed on the balance sheet to grow these brands, making the growth trajectory over the next 3-5 years very ROIC accretive. As a result of the excess cash, the company will have the resources to systematically pay down the $1.2bn in debt it took on to do the PLG deal. Our math suggests an incremental 5-6% earnings growth from delivering alone. The stock might look expensive at 20x earnings and 12x cash flow, but the street’s numbers are low by an incremental 10% per year. We're at $5.65 to the Street's $4.25 three years out.  We’d buy aggressively on a pullback, but are not so sure that will happen. We think WWW is a $100+ stock over 2-years.

 

WWW: Smoke In Mirrors. Buy The Event - WWW chart2

 

WWW: Smoke In Mirrors. Buy The Event - WWW chart3


MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW

Takeaway: US sovereign swaps continue to spike, rising another 10 bps last week. Meanwhile, EU sovereign swaps & EU bank swaps continue to tighten.

Key Takeaways:

We're watching for interbank risk measures to rise as an indicator that the markets are becoming genuinely nervous. TED Spread, Euribor-OIS and Shifon are the three we watch actively. As of Friday's close, none of them were showing any signs of a breakdown.

 

* Sovereign CDS – The real trade here remains shorting the US and being long the PIIGS. US Swaps widened 10 bps (+31%) again last week bringing the level to 41 bps. The M/M change has risen to +19 bps (+85%). For reference, US swaps peaked at 64 bps in late-July 2011, the last time the US Govt budget process was in total dysfunction. Meanwhile, Italian, Spanish, Portguese and Irish swaps were all notably tighter on the week. 

 

* European Financial CDS - EU bank swaps tightened further on the week. Spanish, Italian and French banks all came in notably. On average, swaps tightened by 10 bps last week and are lower by 27 bps, on average, vs the prior month. One of the few EU Financials that posted deterioration was Sberbank of Russia, which saw swaps widen by 14 bps WoW.

 

 

Financial Risk Monitor Summary

 • Short-term(WoW): Positive / 4 of 13 improved / 1 out of 13 worsened / 8 of 13 unchanged

 • Intermediate-term(WoW): Positive / 8 of 13 improved / 3 out of 13 worsened / 2 of 13 unchanged

 • Long-term(WoW): Negative / 1 of 13 improved / 4 out of 13 worsened / 8 of 13 unchanged

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 15

 

1. U.S. Financial CDS -  The biggest mover on the week was GS with swaps widening by +8 bps. On the other end of the spectrum, MGIC saw its swaps tighten by 11 bps. Surprisingly, swaps overall were largely unfazed by the US Govt shutdown. Overall, swaps widened for 15 out of 27 domestic financial institutions.

 

Tightened the most WoW: AXP, CB, MTG

Widened the most WoW: TRV, GS, LNC

Tightened the most WoW: AXP, ALL, COF

Widened the most MoM: MBI, AGO, RDN

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 1

 

2. European Financial CDS - EU bank swaps tightened further on the week. Spanish, Italian and French banks all came in notably. On average, swaps tightened by 10 bps last week and are lower by 27 bps, on average, vs the prior month. One of the few EU Financials that posted deterioration was Sberbank of Russia, which saw swaps widen by 14 bps WoW.

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 2

 

3. Asian Financial CDS - Asian Financials were largely uneventful last week. Chinese banks were nominally tighter, dropping an average 2 bps W/W. Japanese financials were mostly unchanged with the biggest movers at +5 bps (Mizuho) and -3 bps (Nomura). Indian banks were also mixed. Two out of three widened, but IDB Bank of India tightened 9 bps to 340 bps.

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 17

 

4. Sovereign CDS – The real trade here remains shorting the US and being long the PIIGS. US Swaps widened 10 bps (+31%) again last week bringing the level to 41 bps. The M/M change has risen to +19 bps (+85%). For reference, US swaps peaked at 64 bps in late-July 2011, the last time the US Govt budget process was in total dysfunction. Meanwhile, Italian, Spanish, Portguese and Irish swaps were all notably tighter on the week.

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 18

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 3

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 4

 

5. High Yield (YTM) Monitor – High Yield rates were almost unchanged, falling a modest 0.2 bps last week, ending the week at 6.29% versus 6.30% the prior week.

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 5

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 1.0 points last week, ending at 1807.

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 6

 

7. TED Spread Monitor – The TED spread fell 1.3 basis points last week, ending the week at 22 bps this week versus last week’s print of 23.34 bps.

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 7

 

8. CRB Commodity Price Index – The CRB index rose 0.2%, ending the week at 286 versus 286 the prior week. As compared with the prior month, commodity prices have decreased -1.5% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 8

 

9. Euribor-OIS Spread – The Euribor-OIS spread widened by 1 bp to 14 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. 

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 9

 

10. Chinese Interbank Rate (Shifon Index) –  The Shifon Index fell 2 basis points last week, ending the week at 3.13% versus last week’s print of 3.15%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 10

 

11. Markit MCDX Index Monitor – Last week spreads widened 3 bps ending the week at 89 bps versus 86 bps the prior week. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1.

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 11

 

12. Chinese Steel – Steel prices in China fell 0.2% last week, or 6 yuan/ton, to 3488 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 12

 

13. 2-10 Spread – Last week the 2-10 spread widened to 232 bps, 2 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 13

 

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.6% upside to TRADE resistance and 1.0% downside to TREND support.

 

MONDAY MORNING RISK MONITOR: US SOV SWAPS CONTINUE TO RIP / INTERBANK MEASURES STABLE FOR NOW - 14

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 

 


SAD STATE OF AFFAIRS

Client Talking Points

US DOLLAR

I guess if you have the head of the US Treasury in charge of fear-mongering recklessly about a US “debt default,” some people might actually believe him. It also drives ad dollars. Meanwhile, the bond market still doesn’t care. What's going on right now is that the credibility of the US Dollar continues to melt down. As it should. Shame on Lew. It's sad to watch.

UST 10YR YIELD

Bond market has moved 2 basis points this morning to 2.62% on the 10-year. In other words, the bond market still doesn’t believe Jack Lew. The line that matters most in our model is intermediate-term TREND support of 2.58%. We’ll soon see if it holds. Stocks do not like the slow-growth message implied by Down Dollar and #RatesFalling.

OIL

The only good economic news this morning? Brent Oil is down -0.9% and testing a $108.57 TAIL risk breakdown (again). It’s a little like watching a game of ping-pong. But with more than 360,000 net long contracts (futures/options) still out there, John Kerry isn’t the Oil bull’s best-friend-forever this morning with his niceties to Assad.

Asset Allocation

CASH 55% US EQUITIES 12%
INTL EQUITIES 18% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 15%

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.

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.

TROW

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

TWEET OF THE DAY

GOLD: you'd think Gold bulls would get paid by Congress - nope, -2.2% last wk and flat this morn @KeithMcCullough

QUOTE OF THE DAY

The person who says it cannot be done should not interrupt the person who is doing it. –Chinese Proverb

 

STAT OF THE DAY

The median estimate of more than 60 economists in a Bloomberg survey is for the 10-year yield to rise to 3.36% by the end of 2014; that would still leave it below the average over the past decade of 3.53%. (Bloomberg)


the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

October 7, 2013

October 7, 2013 - dtr

 

BULLISH TRENDS

October 7, 2013 - 10yr

October 7, 2013 - spx

October 7, 2013 - dax

October 7, 2013 - nik

October 7, 2013 - euro

 

BEARISH TRENDS

October 7, 2013 - VIX

October 7, 2013 - dxy

October 7, 2013 - natgas

October 7, 2013 - gold

October 7, 2013 - copper

 


Breaking Bad Rates

This note was originally published at 8am on September 23, 2013 for Hedgeye subscribers.

“If personality is an unbroken series of successful gestures, then there was something gorgeous about him, some heightened sensitivity to the promise of life, as if he were related to one of those intricate machines that register earthquakes ten thousand miles away.”

- F. Scott Fitzgerald, “The Great Gatsby”

 

Sunday is the day that many of us spend the evening relaxing in front of the T.V. and, if the advertisers are lucky, watching live sports.  If the advertisers are not so lucky, we are likely catching up on TIVOed or Netflixed T.V. shows (that lack live and targeted commercials).  A fan favorite around the Hedgeye office is Breaking Bad, which coincidentally was awarded the Emmy for Best Drama last night.

 

For those that haven’t watched this Emmy award winning T.V. show, it is about a high school science teacher who, after discovering he has cancer, turns to cooking methamphetamine to pay for his cancer treatments and provide a level of comfort for his family.  No surprise, the protagonist Walter White begins to struggle with returning back to the somewhat simple life of being a high school teacher and ultimately decides to create his own methamphetamine empire.

 

As Walt pursues broadening his drug empire, he becomes increasingly morally corrupt and as the title insinuates, truly begins to “break” bad and make decisions that benefit his short-term gain at the expense of almost all else.  While it would be a stretch to compare the FOMC to drug dealers, even if much of the country is addicted to low interest rates, in the Chart of the Day we’ve taken a look at the 10-year yield over the last three weeks and titled it, “Breaking Bad Rates.”

 

To be fair, lower interest rates aren’t all bad.  For those of us who want to refinance our mortgage or buy a new home, it is actually quite a good thing.  From a more macro perspective though, loose monetary policy leads to a weak dollar, which sustains high commodity costs.  Low interest rates also incentive more speculative type investing, which create amplified business cycles.

 

As the market showed us last week, even if Chairman Bernanke is not suffering from the same internal conflicts as Walter White, the world is definitely addicted to the cheap American dollars that his policy has propagated.   As Bernanke said in his press conference last week:

 

“We want to be sure that the economy has adequate support until we can be comfortable that it is, in fact, growing the way we want it to be growing.”

 

Rationally, if the Chairman of the Federal Reserve comes out and questions the underlying strength of the economy, one would expect more economically sensitive asset classes to sell off, or at least be weak.  That, though, is not the reality in our current centrally planned world in which addiction to low interest rates is spreading faster than Walter White’s blue meth across New Mexico.

 

Back to the global macro grind . . .

 

Speaking of breaking economic data, the news out of China this weekend is largely breaking to the positive.  Septembers HSBC flash purchasing managers index came in at a better than expected and expansionary 51.2.  This was also a sequential improvement from August of 50.1 and the highest reading since March.  As a result, the Shanghai Composite is up more than 1.3% this morning leading most of the major Asian indices.  Imagine that a stock market that actually trades on the underlying growth prospects of its economy!

 

Our quantitative model, actually front ran this positive data point, which my colleague Darius Dale published in a note on September 6th titled, “China Goes Bullish Trend the Only Positive Data Point That Actually Matters.”  At the time, we were struggling with the myriad of data points out of China, which were still more negative than positive, but the equity market, being the sneaking leading indicator it is, ultimately signaled to us more good news was to come.  And so it has.

 

The set up for China gets increasingly interesting if the HSBC survey is correct and Chinese GDP is set to accelerate sequentially and exceed current consensus estimates.  While we are not quite ready to get aggressive on the long side of China just yet, we do like those economies with accelerating growth and benign inflation.   In fact, we’d call that breaking good and at a minimum we would not short China.

 

To be fair, none of the structural headwinds that we’ve been researching and writing about have gone away, but on the margin things do appear to be getting less bad at a time when the majority remains overly cautious on China.  According to a Bloomberg poll from last week, which surveys Bloomberg Professional users, more than 32% cited a slowing China as the #1 risk to the global economy and only 17% indicated they believe that China’s economic outlook is improving.   Didn’t know the consensus view on China? Now you know.

 

Speaking of breaking good, the economic data out of Europe this morning is also largely positive.   While the Eurozone flash manufacturing PMI edged down to 51.1 in September from 51.4 in August, both the Services and Composite PMI hit 27-month highs.  Now this is just one data series, but the potential for a sustained European recovery is a theme that you will likely see us highlight more and more often heading into year-end.

 

Our immediate-term Macro Risk Ranges are now as follows:

 

UST 10yr 2.58-2.81%

SPX 1700-1730

DAX 8563-8741

USD 80.16-81.11

Euro 1.33-1.35

Gold 1291-1340

 

Good luck out there this week.

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Breaking Bad Rates - Chart of the Day

 

Breaking Bad Rates - Virtual Portfolio



Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

next