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Ambition and Avarice

“Sir, there are two passions which have a powerful influence on the affairs of men.”

-Benjamin Franklin

 

And, in case you wondered whether or not your central planning overlords in Washington have yet to eliminate those two passions, they have only amplified them: “These ambitions are ambition and avarice; the love of power and the love of money.”

 

Franklin went on to add that, “separately each of these has great force in prompting men to action; but when united in view of the same object, they have in many minds the most violent effects. Place before the eyes of such men, a post of honour that shall be at the same time a place of profit, and they will move heaven and earth to obtain it.” (The Liberty Amendments, pg 23)

 

That’s why we all have no choice other than to Embrace Uncertainty in macro markets. There is nothing normal about a man from an un-elected US post moving your entire risk exposures with a whisper to the Wall Street Journal. Therefore you should not invest “normally.” Either #GetActive and do real-time macro or, as Dan Och recently said, “macro will do you.”

 

Back to the Global Macro Grind

 

BREAKING: Budget Deficit In US Narrows To 5 Year Low on Record Revenues –Bloomberg News

 

Not to be confused with the fear-mongering headlines Bloomberg/CNBC were running about how a US debt “default” could spell the 6th #EOW (end of the world) event of 2013, the fine folks in NYC’s groupthink tank finally nailed it.

 

Eleven months ago, we got ragingly bullish on the US Dollar because the only 2 factors in the (P) part of (POLICY) in our GIP (Growth, Inflation, Policy) Model @Hedgeye were Dollar Bullish:

 

1. FISCAL FACTOR: US Deficit/GDP was going to get cut in half to 4% (it was just reported at -4.1%, so we were off by a bit) because A) sequestration is good (spending down) and B) US #GrowthAccelerating would drive the denominator (GDP) up


2. MONETARY FACTOR: US #GrowthAccelerating would surprise those anchoring on last year’s Q412 GDP report of 0.14%, the Fed would fall behind the curve, #RatesRising would surprise to the upside, and tapering expectations would take hold

 

So easy a hockey head can do it. Then, sadly, the Fed gave into the mega Bond Bull Lobby on September 18th, 2013, smoked the Dollar, took rates back down, and the MONETARY FACTOR for USD Bulls was lost (again).

 

But the FISCAL FACTOR (which can only be obfuscated by the Fed as opposed to arrested like Bernanke did with USD and Bond Yields) continued along its path of least resistance and US Government Revenues were +15.2% year-over-year in September (not a typo)!

 

Oh, and the SP500 ripped the front-teeth out of all those #OldMedia mouth-pieces who shorted the October 2013 fear-mongered low about a US default when the US credit position was in its best position in half a decade. #NewAllTimeSPYHighs

 

And so it begins, after all-time SP500 and Russell2000 highs in October (SPY = +4.5% OCT 2013), it’s November. What in god’s good name are we supposed to do next?

 

To answer the question in any country, I always go back to the playbook:

 

  1. USA: FISCAL = hawkish (bullish USD); MONETARY = dovish (bearish USD)
  2. EUROPE: FISCAL = hawkish (bullish Euro); MONETARY = hawkish (bullish Euro)
  3. UK: FISCAL = hawkish (bullish Pound); MONETARY = hawkish (bullish Pound)

 

And to be clear, when I say hawkish or dovish, I mean what’s happening from a 2nd derivative perspective (i.e. what’s happening on the margin relative to the last 3-6 months).

 

This is why we’re #EuroBulls (see our Q413 Global Macro Theme deck) relative to being as bullish as we were, literally up until September 18th (shame on you Bernanke), on US growth. Same playbook; different relative pick.

 

Everything in macro is relative. Every asset allocator has a choice. And when push comes to shove in the coming 3-6 months, what will it be, German stocks or US stocks?

 

While the Russell2000 dropped -1.9% from its all-time performance chasing high in the last 2-days, German stocks hit a fresh all-time high. Fortunately, Mr. Market keeps score; not you or me. He gets it.

 

Since I’ve been bearish on Commodities and Fixed Income relative to Equities for the better part of a year now, I consider this shift to European Equities vs US Equities within an asset class that I like. If the Fed leans on the long-end of the curve, you can still be long US Equities, just not the Equities that worked best in 2013. The Growth Style Factor gets repressed by Bernanke’s intervention.

 

Having had an asset allocation to Commodities of 0% all year (CRB Commodities Index is 19 Commodities and it’s -6.1% YTD, on its YTD lows), getting long Gold for the 1st time in a long time gets interesting here too. I haven’t pulled the trigger yet, but front-running the next Hilsenrath article is a compelling catalyst.

 

How would that work? On a Friday, Bernanke’s boys float a headline to the WSJ that there won’t be a December taper, the Dollar gets slammed, Rates fall, and Gold rips. Oh yes, ambition and avarice matters in the land of the conflicted and compromised. And we aren’t yet dumb enough to not front-run proactively predictable behavior.

 

Our immediate-term Risk Ranges are now:

 

UST 10yr Yield 2.48-2.60%

SPX 1

DAX 8

USD 79.21-80.35

Euro 1.35-1.37

Gold 1

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Ambition and Avarice - Chart of the Day

 

Ambition and Avarice - Virtual Portfolio


What's New Today in Retail (11/1)

Takeaway: RonJon breaks his silence. WMT's US mftgring initiative is smoke and mirrors. NFL jersey stats are in. TGT kicks off holiday price war.

COMPANY NEWS

 

JCP - Ron Johnson Speaks, Calls Reports On His J.C. Penney Tenure 'Largely Inaccurate And Surprisingly Uninformed'

(http://www.forbes.com/sites/barbarathau/2013/10/29/an-open-letter-to-ex-j-c-penney-ceo-ron-johnson-who-calls-reports-on-his-tenure-surprisingly-uninformed-when-youre-ready-can-we-talk/)

 

  • "Johnson told me via email that although it’s premature to discuss his tenure at J.C. Penney, he did say that much of the analysis of his stint at the chain has been 'lacking in depth, largely inaccurate, and surprisingly uninformed.'"

 

Takeaway: Maybe he's looking for a job.

 

WMT - Wal-Mart Boosts Made in U.S.A. Initiative

(http://www.wwd.com/retail-news/retail-features/wal-mart-boosts-made-in-usa-initiative-7259348?module=hp-retail)

 

  • "Bill Simon, Wal-Mart’s U.S. president and chief executive officer, revealed at an investment summit here Thursday that three of its suppliers have committed to moving production back to the U.S., or expanding existing capacity, as part of the retail giant’s longer-term commitment to buy $50 billion worth of American-made products over the next 10 years."

 

Takeaway: While we're all about boosting US production, let's put this into context. $50bn over 10-years is likely $1bn in year 1, and $10bn in year 10. But even if we want to be generous and call it $5bn per year, it's only 1% of the half a trillion worth of product WMT will sell next year. This is hardly WMT going all-out. It's a PR campaign more than anything.

 

MW, JOSB - Jos. A. Bank Prepared to Boost Men's Wearhouse Bid

(http://www.wwd.com/menswear-news/retail-business/jos-a-bank-would-boost-mens-wearhouse-bid-7259345?module=hp-topstories)

 

  • "The retailer said it would consider raising the original offer of $48 a share if 'given the opportunity to conduct limited due diligence in order to determine that such an increase would be justified.'”
  • "In a letter to Men’s Wearhouse chief executive officer Douglas Ewert made public Thursday, Wildrick said that the $48 offer 'was necessarily based solely on publicly available information. We believe that if we were provided with access to a limited amount of non-public information, we could promptly determine whether we could increase our proposed acquisition price. We are, of course, prepared to execute a mutually acceptable non-disclosure agreement to provide Men’s Wearhouse with the assurance that any information provided will be kept confidential.'"

 

Takeaway: JOSB simply doesn't get it. MW wants to go solo as it builds a house of brands, instead of being a standard, run-of-the-mill mid-tier men's apparel retailer like JOSB. If the deal does happen, it's going to be at a price well above here. The simple fact that JOSB is so aggressive in wanting this transaction casts serious doubt in its ability to grow profitably through its existing model. 

 

HBC - Hudson's Bay Begins a Beauty Metamorphosis

(http://www.wwd.com/beauty-industry-news/retailing/hudsons-bay-renovates-beauty-floors-7259968?module=hp-topstories)

 

  • "Hudson’s Bay is putting the finishing touches on an expansion and upgrade of the beauty selling departments of six of its 90 stores, four of them flagships."
  • "It is the first major renovation of those floors in Toronto, Montreal and Vancouver in 15 years, according to Shelley Rozenwald, chief beauty adventurer and senior vice of cosmetics for Hudson’s Bay and Lord & Taylor."
  • "The size of total departments also have significantly expanded. In the Yorkdale store, the beauty department has been doubled from 16,000 square feet to a total of 32,000 square feet. The entire store measures 200,000 square feet. The other stores, particularly Vancouver, picked up an additional 30 to 40 percent of space in their beauty departments."

 

What's New Today in Retail (11/1) - chart2 11 1

 

Takeaway: Big investment in an area that is among the most profitable for Macy's, Bloomingdales, and Nordstrom. But renovating 6 of 90 stores isn't going to move the needle.

 

DKS - Broncos and Seahawks Top NFL Jersey Sales 

(http://www.sportsonesource.com/news/article_home.asp?Prod=1&section=9&id=48573)

 

  • "Through the midway point of the NFL season, Dick's Sporting Goods Jersey Report is showing that Denver Broncos or Seattle Seahawks are by far the two most popular teams. In seven markets across the country (New York, Boston, Indy, Washington, Chicago, Dallas, and Atlanta), the Broncos and Seahawks are second (or third) in sales behind the local team(s)."

 

  • Team Sales Top 10 through Week 8 (The number in parenthesis indicates the team’s ranking in Week 1)
  1. Denver Broncos (2)
  2. Baltimore Ravens (3)
  3. Indianapolis Colts (5)
  4. Chicago Bears (4)
  5. Washington Redskins (1)
  6. New York Giants (6)
  7. Pittsburgh Steelers (7)
  8. New England Patriots (9)
  9. Seattle Seahawks (15)
  10. Philadelphia Eagles (16)

 

  • Player Sales Top 10 through Week 8 (The number in parenthesis indicates the player’s ranking in Week 1)
  1. Peyton Manning (2)
  2. Andrew Luck (3)
  3. Robert Griffin III (1)
  4. Russell Wilson (16)
  5. Tom Brady (9)
  6. Ray Rice (5)
  7. Eli Manning (6)
  8. Joe Flacco (7)
  9. LeSean McCoy (21)
  10. Colin Kaepernick (11)

 

Takeaway: Not a surprise to see either of those teams at the top. The player jerseys are more interesting. The fact that Peyton and Andrew Luck are 1 and 2 is borderline hysterical. As for the other Manning, it's good to see that he still ranks number 7 despite the year he's having. He's got some loyal fans.

 

WMT - Green Dot and Walmart Expand Walmart MoneyCard Portfolio with a Suite of Prepaid Debit Cards

(http://ir.greendot.com/phoenix.zhtml?c=235286&p=irol-newsArticle&ID=1871046&highlight=)

 

  • "Green Dot Corporation and Walmart today announced they have expanded the line of Walmart MoneyCard® reloadable prepaid debit cards to include six new card types designed to meet the needs of their growing customer base. Issued by Green Dot, the Walmart prepaid debit card portfolio now includes nine cards, and is available in more than 4,100 Walmart stores nationwide."

 

Takeaway: Timed perfectly with the expiration of food stamp stimulus.

 

TIF - Tiffany Scores $2.2M Judgment Against Cyber Counterfeiters

(http://www.wwd.com/business-news/legal/tiffany-scores-22m-judgment-against-cyber-counterfeiters-7259794?module=hp-accessories)

 

  • "Filed in the southern district of Florida, the lawsuit named 78 defendants operating Web sites such as salestiffany.net, shoptiffanyco.com, tiffanyandcomall.com, tiffanycooutlet.co.uk, which sold counterfeit Tiffany jewelry."
  • "As part of the judgment, the court required that the Web site operators’ infringing domain names be transferred to Tiffany. It also requested that $2.2 million be paid to Tiffany, but tracking down Internet counterfeiters to collect damages is extremely difficult, making the likelihood of collecting very slim."

 

Takeaway: Gotta hand it to TIF. This is yet another win for its counterfeiting police. These guys are not only resilient, but they're hugely successful.

 

Triumph - Triumph Launches Line With Helena Christensen

(http://www.wwd.com/markets-news/intimates-activewear/triumph-launches-line-with-helena-christensen-7260315?module=hp-markets)

 

  • "Triumph International, the world’s largest lingerie company, will launch its first e-commerce site for the U.S. market today."
  • "The Web launch is part of an aggressive initiative of the $2.1 billion intimate apparel and underwear firm to enter the U.S. innerwear market, which generates annual retail sales of $14.5 billion."
  • "The company, whose brands include Triumph, Sloggi, Valisère and Hom, opened its first Triumph stores in the U.S. at the Walt Whitman Shops and Roosevelt Field mall in Huntington Station and Garden City, N.Y., respectively, in August. A third store is slated to open in New Jersey in early 2014."

 

Takeaway: WWD is getting a little loose with its facts and figures here. Triumph is not the world's largest lingerie company. Victoria's Secret is almost 20x larger.

 

TGT - Target Guests Should Expect to 'Pay Less' This Christmas

(http://www.retailwire.com/discussion/17123/target-guests-should-expect-to-pay-less-this-christmas)

 

  • "Aside from everyday low prices and special promotional deals, Target offers: Five percent off all purchases to REDcard Rewards members; Additional discounts to guests using its Cartwheel app; Price matching. Target will match the price of qualifying items between Nov. 1 and Dec. 21 if a guest finds the same item for less in a local competitor's ad or at select online retailers."

 

Takeaway: Amazon and Wal-Mart might have something to say about this.

 

TCS - The Container Store Group, Inc. Announces Pricing of Its Initial Public Offering of Common Stock

(http://www.businesswire.com/news/home/20131031006627/en/Container-Store-Group-Announces-Pricing-Initial-Public)

 

  • "The Container Store Group, Inc. announced today the pricing of its initial public offering of 12,500,000 shares of its common stock at a price to the public of $18.00 per share. The shares will be listed on the New York Stock Exchange and will trade under the ticker symbol “TCS” beginning on November 1, 2013. The Container Store Group, Inc. is offering all 12,500,000 shares of common stock. The underwriters also have a 30-day option to purchase up to an additional 1,875,000 shares from the Company."

 

Takeaway: First they raised the range, then priced at the high-end. Not a surprise. This is a strong concept with ample unit growth (not to mention that the offering is only 12.5mm shares). Economics 101.

 

PERY, ELY - Perry Ellis International Expands Callaway Apparel Licensing Rights to Include Europe, Middle East and Africa

(http://investor.pery.com/releasedetail.cfm?ReleaseID=803104)

 

  • " Perry Ellis International, Callaway Golf's apparel licensee, today confirmed an agreement to expand its current partnership...to design, manufacture and sell golf apparel across Europe, the Middle East and Africa."
  • "Currently, the principal apparel distribution in the region is operated directly by Callaway Golf. Perry Ellis International will assume responsibility for distribution channels for golf apparel product across Europe, the Middle East, and Africa, transitioning on January 1st, 2014. The men's and women's European Callaway Fall 2013 line is currently available at retail at leading golf specialty stores and resorts in the UK, Ireland, Germany, Sweden, Norway, Spain, Portugal, Austria, Switzerland, Finland, Czech Republic, Turkey and the Middle East. The addition of South Africa as well as a full European roll-out of the brand is expected by Spring 2014."

 

INDUSTRY NEWS

 

Bangladesh: Garment Workers Refuse Third Wage Hike Offer

(https://www.sourcingjournalonline.com/bangladesh-garment-workers-refuse-third-wage-hike-offer-td/)

 

  • "The government-formed Minimum Wage Board met today to settle the wage structure with an offer of Tk 4,250 ($55) per month, but the ready made garment (RMG) workers and their labor representatives were not having it."
  • "The RMG industry has been embattled for weeks seeking a wage increase from the current Tk 3,000 ($39) per month—the lowest worldwide wage rate in the industry—to Tk 8,114 ($105), a number considered to be a more reasonable living wage for the sector’s four million workers."
  • "Fearful factory owners came up from the previous offer in September to raise wages by 20 percent to Tk 3,600 ($47) after workers staged violent demonstrations and skipped work forcing factory closures in some cases. Just yesterday, more than 20 factories in Gazipur closed when workers demonstrated damaging production units so demands might be met."

 

 

 

 


Show Some Spine

Client Talking Points

INDIA

One of the best performing stock markets in the world this week was India’s Sensex. It closed up another +0.3% while markets like Japan were down -0.9% and Indonesia was down -1.7%. India is being rewarded for having a spine on their currency monetary policy – raising rates.

#EUROBULLS

While the Russell 2000 corrected -1.9% from its all-time high into month end, EuroStoxx powered to close the month at new highs. I still like European stocks more than U.S. stocks because I like the Euro here more than the U.S. Dollar. Incidentally, the USD is immediate-term overbought within a bearish TREND.

GOLD

Gold is holding flattish at $1322 this morning. I’m still waiting on buying Gold for the first time in a year. Research and risk signals are two entirely different things, and I tend to go with the signal over the research because I’m not smarter than the market. Our asset allocation to Commodities has been 0% for almost a year now (the CRB Index hit a new year-to-date low yesterday of -6.1%). So, buying gold would take me off 0%, if and when I do.

Asset Allocation

CASH 52% US EQUITIES 6%
INTL EQUITIES 20% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 22%

Top Long Ideas

Company Ticker Sector Duration
DAX

In line with our #EuroBulls Q4 theme, we’re long the German DAX via the etf EWG. With European fundamentals showing improvement off low levels, we expect outperformance from Germany, and in turn for the region’s largest economy to pull the rest of the region higher. ECB policy remains highly accommodative and prepared to aid any of its sovereign members to preserve the Union. Inflation remains moderate and fundamentals are positive: confidence readings and PMIs are up since June, with factory orders trending higher and retail sales inflecting to push the trade balance higher. Finally, the unemployment rate has held steady at the low level of 6.9%, all of which signals to us that Germany’s economic climate is ramping up.

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.

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

What a joke that default fear mongering was by #OldMedia - drove all-time highs in $SPY though @KeithMcCullough

QUOTE OF THE DAY

I'm getting sick and tired of doing anything half-way. -Knute Rockne 

STAT OF THE DAY

58%: For marijuana advocates, the last 12 months have been a period of unprecedented success as Washington and Colorado became the first states to legalize recreational use of marijuana. And now for the first time, a clear majority of Americans (58%) say the drug should be legalized. This is in sharp contrast to the time Gallup first asked the question in 1969, when only 12% favored legalization.


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November 1, 2013

November 1, 2013 - Slide1

 

BULLISH TRENDS

November 1, 2013 - Slide2

November 1, 2013 - Slide3

November 1, 2013 - Slide4

November 1, 2013 - Slide5

November 1, 2013 - Slide6

 

BEARISH TRENDS

November 1, 2013 - Slide7

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November 1, 2013 - Slide10

November 1, 2013 - Slide11

 

 


THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – November 1, 2013


As we look at today's setup for the S&P 500, the range is 31 points or 0.94% downside to 1740 and 0.82% upside to 1771.                        

                                                                                                       

SECTOR PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

EQUITY SENTIMENT:

 

THE HEDGEYE DAILY OUTLOOK - 10                                                                                                                                                                  

 

CREDIT/ECONOMIC MARKET LOOK:

  • YIELD CURVE: 2.27 from 2.25
  • VIX closed at 13.75 1 day percent change of 0.73%

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:58am: Markit U.S. PMI Final, Oct., est. 51.1
  • 9:10am: Fed’s Bullard speaks on monetary policy in St. Louis
  • 10am: ISM Manufacturing, Oct., est. 55 (prior 56.2)
  • 11:15am: Fed’s Kocherlakota speaks on health care in Minn.
  • 12pm: Fed’s Lacker speaks in Philadelphia
  • 1pm: Baker Hughes rig count
  • 5pm: Total Vehicle Sales, Oct., est. 15.43m (prior 15.21m)

GOVERNMENT:

    • Commerce Dept holds Day 2 of SelectUSA Summit with speakers incl. Commerce Sec. Penny Pritzker, Sec. of State John Kerry, Caterpillar CEO Doug Oberhelman; Ludwig Willisch, CEO of BMW North America
    • President Obama meets with Iraq’s Nouri al-Maliki at White House to discuss defense, security issues

WHAT TO WATCH:

  • FAA to let airlines apply for broader use of electronics
  • Dutch govt selling $8.7b of ING’s U.S. mortgage bonds
  • U.S. rule change allows $500 carryover in flex spending acct
  • China manufacturing gauge tops ests. in recovery boost
  • Nortel patent owner Rockstar sues Google, Huawei: Reuters
  • U.S. tech leaders calling for data use laws: Washington Post
  • Google, Red Hat, Oracle engineers deployed for Obamacare fix
  • MasterCard momentum may build vs Visa as Europe rebounds
  • Barrick may raise $3.45b in share sale to reduce debt
  • RBS suspends 2 forex traders; would be first suspensions: FT
  • Pemex may list some assets on exchange as early as 2014
  • Oct. U.S. auto sales may disappoint; SAAR may hit 15.4m
  • Macau casino revenue surged to record $4.6b in Oct.

EARNINGS:

    • Allete (ALE) 8:30am, $0.73
    • American Axle & Manufacturing (AXL) 8am, $0.56
    • Buckeye Partners (BPL) 7am, $0.83
    • CBOE Holdings (CBOE) 7:30am, $0.45
    • Chevron (CVX) 8:30am, $2.70 - Preview
    • Church & Dwight (CHD) 7am, $0.73
    • Emera (EMA CN) 7:10am, $0.35
    • Exelis (XLS) 7am, $0.41
    • Fortis (FTS CN) 7am, $0.26
    • Genesee & Wyoming (GWR) 6am, $1.22
    • Madison Square Garden (MSG) 7:30am, $0.22
    • Newcastle Investment (NCT) 6:30am, $0.12
    • NextEra Energy (NEE) 7:30am, $1.39
    • NorthStar Realty Finance (NRF) 7:30am, $0.24
    • NV Energy (NVE) 6:31am, $0.89
    • Oaktree Capital (OAK) 8:30am, $1.00
    • Pembina Pipeline (PPL CN) Aft-mkt, $0.26
    • SNC-Lavalin (SNC CN) 8:27am, $(0.47)
    • Spirit Aerosystems (SPR) 7:30am, $0.61
    • Telephone & Data Systems (TDS) 7:58am, $(0.10)
    • Ultra Petroleum (UPL) 8am, $0.35
    • United States Cellular (USM) 7:59am, $0.09
    • Washington Post (WPO) 8:30am, est. N/A

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

  • Palm Oil Enters Bull Market on Best Weekly Gain in Three Years
  • Wheat Analysts Most Bearish in Year on Record Crop: Commodities
  • Gold Heading for First Drop in Three Weeks on Fed Speculation
  • Palm Oil Supplies in Indonesia Seen Disrupted by Prolonged Rains
  • WTI Crude Heads for Longest Run of Weekly Declines Since 2012
  • Copper Rises as China Manufacturing Expands More Than Estimated
  • Wheat Poised for Worst Week Since June as India to Boost Supply
  • China Refined Lead Market Seen by Antaike in Deficit in 2014
  • India Iron Ore Exports to Remain Subdued, Morgan Stanley Says
  • OPEC October Crude Production Climbs in Survey on Iraqi Gain
  • U.S. Gulf Crude Sinks to Lowest Against Imports: Energy Markets
  • Wal-Mart to Widows Will Feel U.S. Food Stamp Cuts Starting Today
  • Founder of Top India Commodity Exchange Resigns Amid Probe
  • China Gold Imports From Hong Kong Fall on Premium, Slow Demand

THE HEDGEYE DAILY OUTLOOK - 5

 

CURRENCIES

 

THE HEDGEYE DAILY OUTLOOK - 6

 

GLOBAL PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 3

 

THE HEDGEYE DAILY OUTLOOK - 4

 

EUROPEAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 7

 

ASIAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 8

 

MIDDLE EAST

 

THE HEDGEYE DAILY OUTLOOK - 9

 

 

The Hedgeye Macro Team

 

 

 

 

 

 

 

 

 

 

 

 

 


NJOY Conference Call Summary And Key Takeaways

Yesterday we hosted a conference call on electronic cigarettes with Craig Weiss, CEO of NJOY, a closely-held manufacturer and marketer of electronic cigarettes.  This is part of a series of talks we’ve held with industry experts to better understand the growing e-cigarette category (click for replay podcast and presentation). We came away from the call with a number of insights on NJOY and the new and growing e-cig category, which we provide below under Presentation Highlights and Key Takeaways. Further below we’ve also reproduced what we thought was a very engaging and insightful Q&A session from Craig.

 

As it relates to our investment outlook, we remain very bullish on e-cigs, with category sales estimated at ~ $1.5B to $2B this year and poised to double in the coming years.  While the category only represents a minor (around 1-2%) portion of the overall sales portfolio of Big Tobacco and pending FDA legislation (more below) could stand to shake up the industry, we believe the interest and “buzz” from management and investors on the category is playing into U.S. tobacco stock prices, as both parties recognize the need for the industry to replace declining traditional cigarette volumes, albeit without cannibalizing existing business.

 

Our preferred tobacco stock on this front remains Lorillard (LO). Unlike Altria and Reynolds, who in the quarter joined the category with their own e-cig offerings, MarkTen and Vuse, respectively – LO bought Blu in April 2012 – we prefer LO, a company that is well aware that the FDA is considering restricting menthol.  We believe the company, highly levered to menthols (~85%), has less cannibalization risk pursuing e-cigs (especially should an FDA ban or some form of tighter restrictions be imposed down the road) vs MO or RAI due to its portfolio mix.  We think Blu is enjoying first-to-market advantage and in Q3 results, Blu saw strong sales growth of 11% quarter-over-quarter (+350% year-over-year) to $63MM. LO CEO Murray Kessler’s e-cig strategy appears to be to forgo short-term profits for long term gains: he sold e-cigs for break-even in the quarter and was able to boost Blu’s market share to 49% versus 40% last quarter. Over time, we do think that e-cigs can be margin-enhancing to the combined cigarette category.  For more see our note titled “What’s Big Tobacco Saying About E-Cigs in 3Q13?

 

FDA regulation remains one large wild card for the category.  The agency was expected to announce regulation this month—it’s anyone’s guess now just when that may happen. It’s our opinion that the FDA wants to protect the consumer, while not stifle e-cig innovation that can ultimately lead people away from the harmful combustible cigarettes. A few of the larger regulations expected to be addressed are online sales, flavors, and marketing, however regulations could go much further. It appears the science on e-cigs remains incomplete, which would suggest to us that the agency may err on the side of less regulation versus more regulation until the science is (more) conclusive.  [As a side note, the City Council of NYC decided yesterday to raise the minimum age to purchase cigarettes (and explicitly included e-cigs in the bill), which is expected to be signed off by Mayor Bloomberg and go into effect in 6 months.]

 

 

NJOY Presentation Highlights:

 

Founded in 2006 and ramping up distribution in 2009, NJOY is one of a handful of private companies that we believe can be competitive with Big Tobacco in the e-cig category.

 

NJOY is now in some 80,000 retail stores across channels nationwide with its traditional and menthol flavored disposable e-cigs and Craig says the opportunity for e-cigs is analogous to the impact that filtered cigarettes had in changing the industry, quoting Mark Twain: “History doesn’t repeat itself, but it does rhyme”.  Craig says that with its product offerings at the front counter of stores, including its countertop spinners, consumers can have closer proximity (touch and feel) to NJOY’s products versus tobacco products that by law (Master Settlement Agreement) must be relegated to the back counter.

 

One clear differentiating factor for NJOY versus such brands as Blu, Mistic (product of Ballantyne Brands), and Vuse, is that NJOY’s product packaging aims to make the product as close as possible to a traditional cigarette in terms of look, feel, and size. Craig says the reason for the product packaging strategy is that, while there will always be a market for someone that does not want to look like they’re smoking, he believes you need to make the bridge of familiarity between the very ingrained habit of smoking and choosing an alternative like an e-cig short enough so it’s easy to cross.  This is why NJOY has made its product as familiar as possible to smokers: every smoker carries a pack and lighter, so these form factors have also been integrated into the packaging as a bridge to familiarity and to improve the product’s overall experience. 

 

Another point of differentiation is NJOY’s conviction that the industry is trending towards disposables and away from rechargables. This goes against the discussions we’ve had with other e-cig companies such as Ballantyne Brands and a general tone from Big Tobacco, all of which are in support of the margin enhancing opportunities with the razor, razor-blade model of a rechargeable unit.

 

Craig comments that much of the e-cig share is determined by retail presence: LO’s Blu is in 50% more outlets than NJOY and he believes that while current consumer preference is based on availability, ultimately consumers will gravitate towards those with the best consumer experience.

 

 

Key Takeaways

  • UK and EU Parliamentary decision to not regulate e-cigs as medicinal products may have little impact on the FDA, given the differences across markets: estimated that menthol tobacco market in the EU is maybe 3% of total sales (tiny compared to ~ 30% in the U.S.) and adoption trends and sales are behind the U.S., ~ 2years
  • LO’s acquisition of SKYCIG (1. OCT 2013), while the first push by Big Tobacco internationally, there still remains a very large and fragmented market in the EU (and the slightly more established UK market)
  • Despite great strides in a very short period of time, next generation e-cigs will be/need to be even closer to traditional cigarettes in terms of feel and experience to maintain adoption. The relative health benefits remain an obvious advantage, but also the lack of smoke odor and social stigma, and increased convenience
  • MN remains the only state to tax e-cigs like traditional cigs. Three states more recently tried to pass taxes on e-cigs, all three of them failed – Utah, Oklahoma, and Hawaii
  • Any online or advertising bans would stand to benefit those manufacturers that already have widely penetrated retail outlets
  • Any push by Big Tobacco to sell their e-cigs at break-even for extended periods may push smaller players out of business

 

The following is a complete transcript of the Q&A from Craig Weiss:


Q:  Any guess how the FDA will treat online sales, flavors, and indoor vaping?  How would you guess deeming regulation from the FDA will impact NJOY and the industry?  Do you think the rulings from the UK and EU Parliaments on e-cigs will impact the FDA’s decision?


A:  On the first question there’s a lot of speculation on what the FDA will do. I don’t know that I have any more insight than anyone else does. My guess is that electronic cigarettes will continue to be available and it’s hard for me to see any scenario whereby the FDA sends 3-4 million people back to tobacco cigarettes and back to their death. I see good manufacturing practices requirements and ingredients disclosures, age verification requirements. As for the big ones, which would be online sales, flavors and advertising, my guess is that they’ll punt those further down the road until they gather more information on the impact that e-cigs are having on the population, and I know for a fact that the FDA is engaging on that research right now to do population based studies on the impact of e-cigs, and it will take some time to gather the data.

 

With respect to how things are shaping up internationally, I don’t know if [the UK and EU regulation] has such an impact on the U.S. It’s a different regulatory structure here. E-cigs cannot be regulated as medicinal products per a ruling in 2010 – so the real question is how the FDA will exercise its tobacco jurisdiction over the products (but not as medicinal products).  It’s clearly a struggle between the Center for Tobacco Products and the FDA because they can’t take cigarettes off the shelves, and I think they know based on the scientific data that e-cigs are better for a smoker than a cigarette. So they have to figure out how they can restrict a product while leaving unrestricted a cigarette which they know to be toxic.

 

So we’ll see how this shakes out. My guess is this is the beginning of a very long process. Even the publication of rules will follow a commentary period before they’re proposed rules, before they go to become final rules—there’s a very good chance there will be litigation, and then they’ll have to go through a more formal process once they have enough scientific data.

 

So I think you’re likely to see something in the next couple of months, certainly by the end of this year, with the FDA asserting jurisdiction and maybe laying down ground rules, but I think the longer process is going to play itself out over the course of the next several years.

 

 

Q:   On the international piece, we saw LO buy SKYCIG earlier this month, do you have any plans to move internationally?


A:  We have already moved internationally. We sell in the U.K. right now and are on the cusp of rolling out to market in Europe and around the rest of the world. IF you look at the LO acquisition, it doesn’t have a lot of market share – it is maybe the fourth brand there – and what they really acquired was the infrastructure. There is no Newport brand outside of the U.S., in fact there is hardly any menthol  market outside of the U.S., and so they spent $50 to $100MM (depending on the terms) to buy the infrastructure of 30 people associated with the business. I have been able to build out a fairly serious infrastructure for a lot less money and I think I’m poised to expand far more rapidly. But what you’re seeing is the first indication of how costly it would be for big tobacco to buy infrastructure because they can’t pull the distribution levers they can domestically and of course tobacco companies are geographically landlocked.  In the U.S. you have the big three tobacco companies that are more or less [just doing business] in the U.S.  And then you have BAT, Imperial (in Europe), JTI (in Asia) – there’s a lot of isolation among the big companies. You have PMI, which is big and global, but not particular dominant in one particular area, so I think there’s a great opportunity to be a big global player in the e-cig space which his obviously something that NJOY is attempting to achieve.

 

 

Q:  Can you discuss capital needs associated with growth? What growth trajectory can be maintained with internally generated cash flow? How do the different sales channels and geographies place burdens on the growth capital account?


A:   We’ve raised over $100MM, we’re well capitalized for growth.  Fortunately our product is selling, so that helps to generate a lot of revenue to help the brand grow, so we feel pretty good about our ability to continue to scale whenever we bring on new countries, distributers, and retailers, those relationships typically start with a purchase order, and a load-in, since the stores have to load-in inventory, so that requires a large infusion of capital every time you do that. That’s part of what explains the LO numbers– their growth has all been distribution, their same-store-sales are declining but they’ve been adding enough stores to offset that and show growth but they had three flat quarters followed by a slight uptick, but that again goes to the stores that they’re adding.

 

 

Q:  What have you learned about demographic trends and consumer behavior of e-cig users?  Any gender or age trends?  What’s the defining aspect for conversion to e-cigs versus traditional? 


A:   Demographically I don’t think the numbers are too dissimilar to what you see from the general smoking population.  E-cigs skew a bit more female than the general smoking population, just because women tend to be a little more health conscious than men.  Because e-cigs have traditionally been a bit more expensive than traditional it also skews a little more higher income, but I see that changing as the price comes down. Four years ago an electronic cigarette could cost $150, and it was a pretty terrible product, today we’re selling  an e-cig for $5.99 (based on a 5-pack selling for $29.99) for a product that is far better than what was available back then. It’s a little too early to read too much into the demographics, but it typically tends to follow the smoking population.

 

 

Q:   Can you talk about NJOY’s suppliers? Do you worry about supply chain disruptions and quality control?


A:   We have a pretty good network of very high suppliers, with built in redundancy in the system. We manufacture the liquid in the U.S. in GMP facilities that we have oversight over.  Another aspect of doing manufacturing properly in Asia is that you get two things that are hard to replicate in an automated U.S. facility: the ability to rapidly innovate and scale rapidly. And so those two things are reasons why Apple continues to manufacture in China. No one has more money than Apple or ability to build facilities in the U.S., so why haven’t they?  The reason is because those key assets, the ability to rapidly innovate and scale rapidly, you can only achieve through the manufacturing prowess that China has to offer. And so we’ve availed ourselves of that. That’s reflected in the rapid innovation cycle that you’ve seen from our products as opposed to those from our competitors which for more or less have been selling the same commoditized offerings for the last several years.

 

 

Q:  From a timeline perspective, where do you think you guys are at versus where you want to be, with that ultimate throat hit and satisfying experience that the consumer is accustomed to with traditional cigarettes?


A:   We have a ways to go – by this I don’t mean in terms of time as we’ve moved very quickly—but I mean in terms of the offering that’s currently in the market. No matter how you slice e-cig growth, the category is currently 1-2% of the entire tobacco category. So why are we only 1-2% of the tobacco category and I think the answer is the products aren’t good enough yet (as a massive generalization). They’ve made great progress, and are building inroads, with good momentum, but the products need to get better – the good news is they are starting to get better very rapidly. NJOY will continue to lead the way to continue these innovations. There are not many people out there that have devoted the time, energy and resources that we have from a chemistry and science perspective and hardware perspective to build a product that we think will ultimately replicate the smoking experience.  We feel that the products we’re rolling out in Q4 and early next year are a quantum leap closer to achieving the holy grail – I mean how much would you pay for French fries that don’t make you fat?  At the end of the day when you can deliver on something, or get somewhere that is close enough – as an example Diet Coke and Coke Zero as a category are bigger in the U.S. than Coca-Cola, so you don’t have to deliver 100% of the sugar, calories and the taste of Coca-Cola if you can offer them other things, which of course Coke Zero and Diet Coke do and which electronic cigarettes do, which is other significant benefits. And it’s not just the health concerns, you also have the odor which is a huge issue – smokers hate the smell of smoke, what it does to their hair and clothes. The cost is a big issue. As the cost come down relative to smoking and the societal pressures to be alleviated, as is the emerging scientic data with regards to health – as that data becomes more prominent smokers will start to realize more and more what the opportunity is for them when they make the switch.

 

 

Q:   What’s your sales mix of disposables versus rechargables and how do you see that evolving across the industry?


A:   NJOY is entirely disposable and I would say for the category it is moving almost entirely towards disposables, and I see that trend continuing.  I would say from a unit perspective, even Blu’s rechargeable business is declining and disposable are increasing, so the category is overwhelmingly disposable according to Nielsen today. Blu’s disposables accounted for 81% of Blu’s unit volume, according to the latest Nielsen.

 

Is there are rechargable customer, absolutely.  There is a value consumer willing to compromise on product experience, to go through the hassle of recharging, plugging things in and screwing things together – it’s like comparing to Soda Stream which is more cost effective than buying Coca-Cola, but I don’t think people believe that is going to be a mainstream experience in the U.S. (at least) to offset soda.  There are lots of things that are better value propositions.  Re-chargeable AA batteries are a better value proposition than buying AAs. But how many people do you know that are exclusively using rechargeable batteries versus disposables.  We don’t do it because it’s not convenient. So at the end of the day there are people willing to sacrifice convenience for value but that is a small segment of the population. I mean 85% of smokers buy by the pack, only 15% buy by the carton, although it’s greater value –while there are other factors at play, the vast majority of the cigarette market is the premium market, a very  small percentage discount market. I think roll your own is maybe the appropriate analog and it is about 1% of the market in the U.S.

 

 

Q:  How are states regulating e-cigs? Which states are taxing e-cigs like a tobacco product?  Is there any legislation we should be aware of?


A:  Only one state has succeeded in taxing e-cigs, it’s Minnesota. MN did that early on before there was really galvanized support for e-cigs among the consumer population. Three states more recently tried to pass taxes on e-cigs, also all three of them failed – Utah, Oklahoma, and Hawaii. And so in all three cases, when the taxes were proposed, literally hundreds, in some cases thousands, of people descended on those capital to protest. I don’t see taxation as the same type of threat that I think people assume it is.  Even in Italy, there some consideration of taxation and people went on a hunger strike. When is the last time you saw people go on a hunger strike, for say Coca-Cola.  You didn’t see this when there was a proposed ban in NYC – people are passionate about their e-cigs.

 

 

Q:  How important is the ability to market the product?  Worried if marketing gets banned, will it stunt your future growth?


A:  The marketing is very important, it is critical that we’re able to communicate that smokers have an alternative. We’ve made this position clear publically, we’ve made this position clear privately to the FDA.  I don’t want there to be advertising restrictions. I want to tell smokers that they have an alternative and I want them to know that that alternative is my product. But even in some scenario in which there are advertising restrictions, at least for NJOY, it would likely benefit us because no one else would be able to advertise and we’re already in the vast majority of locations where tobacco is sold in the U.S., in leadership positions at retail.

 

 

Q:   Both Altria (Mark ten) and Reynolds (Vuse) are likely to begin their own distribution rollout similar to Lorillard with Blu, for how long will the rapid industry sales growth be relatively profitless given the heavy investment phase?


A:  Vuse and MarkTen will presumably roll out nationally sometime in 2014 although it is a much more complicated effort for them than it is for LO. Not all tobacco companies are created equally.  LO has a gun to its head on menthol – if menthol goes away, their entire company goes away. So they have to diversify, they have to get behind e-cigs and push the heck out of it. Their customer base is not likely to move to e-cigs, which is mostly a menthol/Newport customer base, so they have the least risk among the tobacco companies to be pushing an e-cig.  It’s much more complicated for Altria and Reynolds who would be directly cannibalizing the sale of their current products in a way that Lorillard is not. I don’t think you’ll see as aggressive a roll-out form Altria and Reynolds as we saw from Lorillard but at some point they are going to roll out and they’re going to leverage their distribution networks and will get in a couple hundred thousand stores, because that’s what they do. At the end of the day, that’s going to bring new users and smokers into the category and I believe those people will migrate to the best product, which I think will be our product. But even if LO showed that they were operating the Blu business break even, that’s because they are spending so exorbitantly on marketing and it’s not clear to me that the business has to be run in that way. It depends on you want to focus on: growth, or profitability, how you want to growth the business and what your aims are. At the end of the day there is GM and there is net income, people have to make a decision what matters to them most for each company. And each investor may make different decisions. 

 

 

Matthew Hedrick

Associate


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