“During the past five difficult years, we’ve attempted to make the decisions and take the actions that would keep Caterpillar competitive in a global economy, no matter how difficult those decisions might be. Early in the 1980s, we recognized that our industry was faced with substantial overcapacity and that there would be tremendous price pressure on our products.”
-1986 Caterpillar Letter to Shareholders
On a list of the Worst CEOs of 2013 yesterday, CAT’s Oberhelman and UAL’s Smisek joined John Chambers and Michael Jeffries on the, let’s say, “laggard” list*. Both UAL and CAT have been Hedgeye Industrials ‘shorts’ since we launched in mid-2012, paired against ‘longs’ PCAR (later TEX) and lower cost airlines, respectively. While we are not surprised to see CAT and UAL on the list, is it fair to blame the CEOs? Was it really management?
As a long-time buysider, I worry about having my views immortalized in print. Intellectual flexibility is central to survival in markets; published opinions serve as an anchor. In October of 2012, we penned our previous Early Look "Steady-As-She-Goes?" outlining the short case for CAT. Luckily, there is little to change 14 months later. A differentiator in our Industrials work is a keen focus on industry specific cycles. I often hear cyclicals discussed in the context of the business cycle – particularly in reference to early/mid/late cycle. We take a different and, we think, more robust approach.
Back to the Global Macro Grind...
Most capital equipment cycles are simply driven by the fact that “stuff” gets old. Typically, regulation, tax changes or the like drive a period of abnormal demand, such as a pre-buy ahead of costly new emissions regulations. Clumps of capital equipment purchased at the same time tend to wear out at the same time, creating ups and downs in demand, capacity utilization and margins independent of trend growth. Central planners tend not to consider these long-tailed distortions when slamming policies into place, but our P&L is grateful for their neglect.
The cycles in airlines and mining equipment are a bit different, however.
In airlines, the cycle has historically been driven by a dance we call the ‘bankruptcy shuffle’. When the least competitive airline lowers costs in bankruptcy, it pushes the next airline down the cost curve into the top cost spot. As we see it, AMR’s bankruptcy last year thrust UAL into that uncomfortable seat, conceptually in the back near the bathroom. Given heavily unionized labor and little control over other costs, it has been very difficult for airlines to address uncompetitive costs outside of Chapter 11. While the airline industry appears to be benefiting from an accelerated replacement cycle in commercial aircraft driven by significant fuel cost increases, and probably consolidation and other factors, we do not think the industry has improved enough to allow the high cost player to make a reasonable profit. After all, AMR went bankrupt fairly recently. As we see it, this dynamic will continue to plague UAL.
In resources-related capital equipment, rising commodity prices drive growth in commodity capital spending. In mining, for example, higher metals prices allow profitable development of new mining projects. The staggering increase in metals prices in the past decade drove a ‘bubble’ in mining capital investment. Unfortunately, once metals prices stopped increasing, the stream of new projects started to run dry. And dry is normal. Assuming commodities remain flat to down, we suspect that CAT, JOY, Komatsu and friends will enter a period much like the early 1980s described in the quote above.
But what about management?
Hindsight is 20/20 and we usually prefer to give people – yes, management teams are made of people – the benefit of the doubt. But in the case of CAT and UAL, management actions should shake investors. For example, UAL’s 2011 non-GAAP income metrics include $600 million in profit from an accounting change (adoption of ASU 2009-13). Usually, the whole point of a non-GAAP presentation is to remove non-operating items. UAL stopped providing estimates for this benefit in 2012, despite some dicey S.E.C. correspondences on the issue. UAL also laid out a brand new cost cutting plan at its recent analyst day, while having failed to deliver on its current profit improvement plan. And don’t get us started on UAL’s special items. At CAT, management made spectacularly poor acquisition choices in Bucyrus and ERA, paying far too much and buying into a bubble, as we see it. Worse, CAT management seems to be in denial about the severity of the resources-related capital equipment downturn, with industry overcapacity a serious looming problem, by our estimates.
Management teams at cyclical companies often get too much credit or grief for factors well beyond their control. But when management teams make efforts to avoid, deny or hide what is really going on, a challenging period can quickly spiral into a disastrous one. CAT suffered mightily in the early 1980s, but that existential threat forced a clear-eyed appraisal of what was needed to survive and, many years later, thrive. In our view, these two management teams have yet to “make the decisions and take the actions” necessary, possibly out of a desire to avoid potentially humiliating accountability. They are people. Fortunately for shorts, we expect these management teams to focus on investor perception instead of business reality for a while longer.
Our immediate-term Global Macro Risk Ranges are now:
Good Luck Out There Today.
Jay Van Sciver, CFA
Takeaway: M opening round the clock. Why??? China retail unmistakably weak. Carrefour/WMT taking the wrong approach to India. JNY finally going away.
M -Macy's to Open Around the Clock on Christmas Weekend
- "Macy's has become the latest retailer to offer extended hours in an effort to squeeze out the last little bit of the holiday shopping season. A total of 37 Macy's store locations around the country will be open around the clock from 7 a.m. Friday Dec. 20 straight through 6 p.m. on Christmas Eve."
- "For the stores that won't be pulling all-nighters, Macy's said it would offer extended hours at almost all of its stores from 7 a.m. to 2 a.m. starting Friday Dec. 20 through Dec. 23."
Takeaway: We'd love to see the numbers at the end of the holiday season (which we won't unfortunately) to see if staying open later/perennially actually has a positive impact on sales. We'd be floored if it turns out that staying open round the clock or to the wee hours of the morning does anything other than raise labor costs.
JNY - The Jones Group Announces Agreement To Be Acquired By Sycamore Partners For $15.00 Per Share In Cash
- "The Jones Group Inc. and Sycamore Partners today announced that they have entered into a definitive agreement pursuant to which affiliates of Sycamore Partners will acquire The Jones Group for $15.00 per share in cash, or a total of approximately $1.2 billion. The transaction is valued at approximately $2.2 billion, including net debt. Upon completion of the transaction, The Jones Group will become a privately held company."
- "Under the terms of the agreement, The Jones Group's shareholders will receive $15.00 in cash for each share of The Jones Group's common stock. This represents a premium of approximately 19% to The Jones Group's 30-day volume weighted average stock price for the period ended April 11, 2013, the last trading day prior to when media speculation began regarding the Company's plans to sell all or parts of its portfolio. The agreement was unanimously approved by The Jones Group's Board of Directors."
Takeaway: The worst kept secret in retail. We get an early holiday present -- that JNY finally goes away.
CDI - Christian Dior's Prospects in China Remain Bright
- "Christian Dior chief executive officer Sidney Toledano said the brand’s prospects in Mainland China remain bright, despite fresh evidence that a government crackdown on corruption and ostentation is sharply denting demand for luxury goods in the world’s second-largest economy."
- “'Our position in China is strong both in terms of image and market share gain, so I remain very confident regarding China, as far as Christian Dior Couture is concerned,' Toledano told WWD on the sidelines of the meeting. 'We have not been affected by the [crackdown on] gifting.'”
Takeaway: Dior is coming off a small base, and therefore can still grow in light of the lack of broad-based growth in the sector in China. But its comments overall support the problems in China that are echoed below.
CA - Carrefour might apply if Tesco passes muster
- "French group Carrefour, second largest retailer in the world after Walmart, is getting ready to open stores in India, it is learnt."
- "The company is engaged in talks with potential partners, including Kishore Biyani's Future group, with which it was close to inking a deal a little more than two years earlier, a source said."
- "Carrefour is likely to move forward with an application to invest in multi-brand retail stores in India, depending on how the government responds to the application of UK-based Tesco. Earlier this week, Tesco sent a proposal to the government to invest $110 million in Tata Group's Trent and run multi-brand stores in Karnataka and Maharashtra. The Foreign Investment Promotion Board might take up the Tesco-Trent proposal by the end of this month."
Takeaway: We're increasingly bearish on the concept of a supercenter in India. The current 'mom and pop' retail landscape would be devastated. Will people have more income if they work at Wal-Mart or Carrefour? Probably. But that argument doesn’t hold up too well in light of all the local merchants that would be out of a job -- and would revolt accordingly. The best path to success for Carrefour or Wal-Mart is to somehow embrace the small merchants and make them a part of the shopping experience. Yes, that sounds wacky, and we don't know how it could be done. But that's the answer from where we sit.
COST - Costco settles promotion lawsuit for $8M, vows reforms
- "Costco Wholesale has tentatively agreed to pay $8 million and change its promotion procedures to settle a long-running lawsuit alleging it failed to give female employees an equal shot at management jobs."
- "Costco Wholesale has tentatively agreed to pay $8 million and change its promotion procedures to settle a long-running lawsuit that alleges it failed to give female employees an equal shot at management jobs."
Takeaway: Not a big news item, but it's a precedent-setter. The biggest name to be impacted? Wal-Mart.
Report Cites Slowdown in China's Luxury Spending
- "According to a report released this week by the consulting firm, luxury spending in China has slowed significantly. Bain estimates that luxury sales in Mainland China grew by just 2 percent in 2013, compared with 7 percent growth a year earlier. The consultancy said men’s wear and watches were particularly hard hit, with sales of luxury timepieces falling 11 percent."
- "Bain expects the trend to continue through 2014, which is unsurprising given the high profile President Xi Jinping’s regime has put on anticorruption efforts. Thus far, however, the clampdown does not appear to include China’s top leadership and its own ties to family fortunes gained through political connections."
Takeaway: We rarely highlight studies by consulting firms, but this one draws some powerful conclusions. Nike sneakers might not be considered a luxury item, but with price points often breaching $200, we think it's a fair barometer. NKE's 1% constant currency futures growth supports the premise that things have yet to pick up in China.
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THE MACAU METRO MONITOR, DECEMBER 20, 2013
SJM CASINO STARTS TRIALING SMOKING ROOMS Macau Daily Times
SJM Director, Angela Leong said that SJM has already set up a smoking room in the Casino Crystal Palace. “We are constantly looking to the future and have thus started trialing [a smoking room]. We will have to continue with the test over a longer period of time to see if it will help improve results of air quality tests in the main area.” She promised that they will continue to install smoking rooms in their other casinos.
Meanwhile, the Director has revealed that there will be a wide range of facilities in the future Jai Alai casino. “We will not focus on merely offering a casino. We will have a shopping mall, some art-related elements, as well as spaces to engage Macau’s food culture. We hope that some of Macau’s distinct culinary culture can be added to the venture and that some small and medium level businesses can move into Jai Alai to bring in some more characteristics of Macau…We will also include some traditional gambling elements”, said Leong. She hinted that since this project is not gaming oriented, it will not be that closely associated with the Casino Oceanus that is located next-door."
TODAY’S S&P 500 SET-UP – December 20, 2013
As we look at today's setup for the S&P 500, the range is 29 points or 0.97% downside to 1792 and 0.63% upside to 1821.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.56 from 2.57
- VIX closed at 14.15 1 day percent change of 2.54%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: GDP Annualized q/q, 3Q rev, est. 3.6% (pr. 3.6%)
- Pers. Consumption, 3Q revision, est. 1.4% (prior 1.4%)
- 11am: Kansas City Fed Manuf Activity, Dec., est. 6 (pr 7)
- 1pm: Baker Hughes rig count
- 9:30am: U.S. Chief Negotiator Dan Mullaney, EU Chief Negotiator Ignacio Garcia-Bercero hold press conference
- 10am: U.S. Treasurer Rosie Rios signs currency
- Senate adjournment will follow confirmation of nominations including John Koskinen to lead IRS
- President Barack Obama, family scheduled to depart for Hawaii for Christmas
- China’s Vice Premier Wang Yang, U.S. Commerce Secretary Penny Pritzker, U.S. Trade Representative Michael Froman chair mtg of U.S. and China Joint Commission on Commerce and Trade; Beijing,
WHAT TO WATCH:
- Senate pushes Yellen confirmatione to Jan. in nominee deal
- Passes defense authorization totaling $625.1b
- Obama kills health insurance mandate for canceled policies
- Bankers say agencies’ answer on Volcker CDO rule inadequate
- SEC internal clashes said to flare over CMBS cases, NYT says
- Banks said to snitch on FX competitors to avoid EU fines
- Sycamore to buy Jones Group fashion co. for $1.2b
- Jazz Pharma. buys rare disease drugmaker Gentium for $1b
- Banks said preparing for Sprint bid for T-Mobile: WSJ
- Axiall to tap cheap gas with $3b Louisiana ethylene plant
- Apple’s Oracle dispute split from patent-infringement suit
- Apple says demand for Mac Pro outstripping supply: Forbes
- AmEx merchant settlement allows different debit surcharges
- Cathay Pacific orders 21 Boeing planes valued at $7.5b
- Fisker won’t make cars at Delaware GM plant, Carper says
- TD Bank not focusing on large U.S. retail expansion: CEO
- Chinese accused of plotting to steal DuPont’s GMO corn
- BlackBerry (BB CN) 7am $(0.46) - Preview
- CarMax (KMX) 7:35am $0.48
- Finish Line (FINL) 7:05am $0.02
- Navistar International (NAV) 7am $(1.56) - Preview
- Walgreen (WAG) 7:30am $0.72 - Preview
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Wheat Reaches 19-Month Low as Argentine Crop Adds to Supplie
- Gold Climbs From Lowest Close Since 2010 as Goldman Sees Los
- Barrick Omen for Gold Miners With $44 Billion Debt: Commoditie
- Brent Heads for Weekly Gain on Growth Prospects After Fed Mov
- Copper Rises as Growth Outlook Fuels Closing of Bets on Declin
- Raw Sugar Rallies for 2nd Day as Robusta to Arabica Coffee Dro
- WTI-Brent Spread Narrowing as U.S. Exports Record Fuels: Energ
- Indonesia Must Consider Economic Impact From Ore Ban: Wacik
- Shanghai Gold Exchange Contract Volume Surges on Price Slump
- Commodity Funds Post First Outflow Since 2000: Chart of the Da
- Aluminum Surplus May Widen Through 2015 on Output, Marubeni
- Refiners Turn to Exports, With 4% Growth Expected: 2014 Outloo
- Wheat Traders Turn Bullish After Two Weeks of Betting on Decli
- Rebar Posts Worst Week in a Month on China Cash Crunch Concerns
The Hedgeye Macro Team
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