Putin’s Silver Spoon

Takeaway: Russian President Vladimir Putin pulls the Ukraine back under his wing.

This note was originally published December 18, 2013 at 13:55 in Macro

Yesterday Russian President Vladimir Putin announced an agreement to loan the Ukraine $15 Billion and reduce the cost of natural gas exports by one-third. Will this quell the weeks of protests against Ukrainian President Viktor Yanukovych’s government?


While publically there was no talk of the Ukraine joining Putin’s custom union (for trade) – which already includes Kazakhstan and Belarus and is a contentious issue for the “Western” protesters – make no mistake that with this agreement Russia has reconfirmed its dominance over the Ukraine, and with it won a key geopolitical victory. For the Ukraine, it spells years, if not decades, before real reform (political and economic) may be realized.


Putin’s Silver Spoon - poot


Our Position: Despite heavy foot power (protests) against President Yanukovych over the last four weeks, we do not expect dissent to topple government leadership that is orientated to the East (Russia). This view is built on several factors, including the unwillingness of the EU to fully commit to bringing the Ukraine into the EU, or conversely meet the sway of Putin to fold the Ukraine under its geographic empire.


What Russia can provide in funds (both directly and through gas subsidies) we don’t foresee the EU attempting to match, and this balance of payments should reinforce existing strong levels of political corruption (beyond just the President), supported by a sizable proportion of the populous that identifies with the East. Further, unlike during the Orange Revolution, there is no clear organized opposition (merely disparate dissenters), all of which suggests to us that while protests may continue, there’s low probability that Yanukovych’s rule is toppled (especially following the deal with Russia) and a high probability that the Ukraine maintains its alliance with the Kremlin for the foreseeable future.


Below we note historical background, critical developments, and analysis aided by sources in the region to contextualize the protests:

  • Protests Beyond Just A Trade Agreement. While Yanukovych’s decision last month (21 NOV) to reject a trade deal with the EU (that had been in the works for a number of years) sparked the largest protest since the Orange Revolution in 2004, the dissent is rooted in opposition to years of crony capitalism, centered around a small group of oligarchs and government heads profiting from the state at the hands of the population.
  • The Orange Revolution Failed. The 2004 Orange Revolution ushered in great hope for the ideals of the West: democracy and reform in the spirit of the EU institution, but the Revolution failed.  Yulia Tymoshenko, with her camera-friendly crown of blond locks, and Viktor Yushchenko, with his discolored and uneven face after being poisoned by the opposition in 2004, were strong faces and voices of the Orange Revolution. The protests led to the defeat of Yanukovych in a forced second run-off election that ushered in Yushchenko as President and Tymoshenko as his Prime Minister in early 2005. While their leadership brought great “hope” that the country could have its Berlin Wall or Solidarity moment, their stars faded quickly (along with hope of real reform) under the weight of a corrupt state.  
  • Tables Turned. By 2010, Yanukovych won back the Presidency. By this time, Tymoshenko was surrounded by controversy and suspicion over gas contracts that she arranged with Russia in 2009: allegedly she agreed to inflated gas prices (which hurt the nation and led to shutdowns) in return for political favors and personal profit. Even Yushchenko testified against her in 2011 and Yanukovych sentenced her to a 7 year term in 2011 – a position the EU decries as “unjust” without substantiating with refuting evidence. Yanukovych’s rule since his reelection has been marked by the further consolidation of power and wealth, going so far as to take out certain leading businessmen (and oligarchs), redistributing assets and leadership positions to an inner circle of family members and a close cadre of “extended” family.
  • Economic Plight. The economy has unraveled under Yanukovych. GDP has gone from its last high of +5% at the end of 2011 to -1.3% as of Q3 2013. Pressing is an underfunded government (deficit around -8.5% of GDP) with plunging foreign reserves.  The country is estimated to have $17 Billion of debt payments due in the next two years, hence the importance of a bridge loan from Russia/EU. The government’s mismanagement of the economy has also included a lack of infrastructure spending and investment, equating to the erosion of living standards, while chasing away foreign investment on fears of sovereign default.   
  • No Opposition Leadership over Divided Kiev. Recent demonstrations illustrate that unlike the Orange Revolution, there’s no united leadership in the opposition parties. The contenders are made up of: Arseny Yatseniuk (leads the party formerly headed by Tymoshenko), Vitaly Klitschko (a boxing champion that heads the Udar “punch” party), and Oleh Tyagnibok (a right-wing nationalist).  All of them claim to have not seen the protests coming.
  • Ukraine and Kiev Remain Divided. A country with a population of 46 million, the western half of the country aligns itself politically with the West (Europe) and has the highest concentration of native Ukrainian speakers, whereas the eastern half aligns itself with the East (Russia) and primarily speaks Russian as a first language.  Kiev, the capital and largest city, is located centrally to the north, and is itself a very divided city both politically and linguistically. The recent demonstrations suggest that protesters have numbered anywhere between 100K to 600K, but the city remains divided. Reports suggest the protests have a grass roots organization “feel” that lack strong polarizing leadership and have been mostly met by non violence from the government/police, with no recorded deaths.  While the protests have been taking place, as recently as December 3rd, Yanukovych’s government survived a no-confidence vote.
  • Russian Interests. Russia is looking out for its national security interests first and foremost and using its stranglehold on natural gas as a bargaining chip. If Ukraine is under the influence of the EU, Russia is vulnerable to the south. Ukraine also represents an important natural gas transit country for flows to Europe, and a Ukraine under Russian influence helps to solidify Putin’s desires for a trading union. Given that Putin has done nothing to diversify his own economy in the last 12 years, he’s left with few options to exert his political clout beyond straight arming former Soviet satellite countries into his sphere of influence.
  • EU Interests. For the EU, the Ukraine is of less importance from a security perspective, unless it is looking to invade Russia (unlikely). Like Turkey, the Ukraine is geographically at the fringe of Europe. Given the experiences of the Eurozone ‘crisis’ and tail of slow growth alongside political indecision (there are now 28 separate parliaments and 18 Eurozone countries), we do not envisage the EU yearning to add a historically highly corrupt government to its roster.  
  • Russia Terms. To plug the country’s balance of payments deficit (for an estimated 18-24 months) Ukraine will issue $15 billion of Eurobonds which Russia will purchase from its National Wellbeing Fund containing $88.1 billion – the first tranche of $3 billion is expected as soon as year-end. In addition, the discount given to the Ukraine on natural gas, from current prices of around $400 per thousand cubic meters (tcm) to $268.50 tcm, is worth another $3 billion in subsidy. While Yanukovych did not sign off on entering Putin’s custom union (which Kazakhstan and Belarus have joined and which reeks of attempts to get the old Soviet gang back together), expect that this deal didn’t come without terms. Besides the national security piece that Russia receives, our guess is Putin will run the Ukraine’s PR campaign – he will decide if and when the Ukraine should enter his custom’s union.

Conclusion - Tipping East. The Ukraine remains a state uncomfortable with addressing its own sovereignty, preferring to be aligned. In our analysis, the Kremlin remains Yanukovych’s preferable partner over the EU given 1) Putin’s ability to quickly write a check (to cover the government’s liabilities), 2) his reelection aspirations for 2015 and ability to “win” cheaper, uninterrupted heat for the nation, 3) the cultural affinity to the East, including a significant percentage of the population that identifies with Russian rule and to some extent nostalgically yearns for a return to the Soviet days, 4) the likely harsher terms the EU and international organization could offer in exchange for loan packages, and 5) the lukewarm reception of the EU to fold the Ukraine into the EU.


If we look to the market for its risk assessment, as expected following yesterday’s deal Ukrainian CDS and sovereign credit yields dropped in a hurry. What’s interesting, however, comes from the second chart below that shows Ukraine’s 5YR Sovereign CDS pulled back on a historical basis (to its maximum based on Bloomberg data). Here it’s clear that while risk was being priced up into the event (1st chart), the absolute level is a moon shot from all-time highs in March 2009, a period when Western European nations had to negotiate with Russia over gas shut-down to their countries that was being pumped through the Ukraine. What this signals to us is that the EU community will only get its hands dirty in the interests of Ukraine when it stands to clearly and personally receive benefit. The “failures” of these protests for change and the muted response from the EU suggest to us that the Ukraine is far from what could be tipping point levels. Russia will remain its puppet master.


Putin’s Silver Spoon - hed1


Putin’s Silver Spoon - 2. ukraine


Matthew Hedrick



We’re not quite there for FY2014 but we’re getting close.



We have increased our 2014 FY EPS from $1.65 to a likely Street high $1.90 on the back of significant cost cutting.  Not surprisingly, our net yield (constant-currency) projection declines from +1.4% to +0.3%, due to continued Caribbean uncertainty and adverse FX impact.


Lower yield guidance was expected but the cost outlook was indeed a pleasant and major surprise.  The management reorganization paid dividends much sooner than expected.  Already, new management is driving cost synergies and efficiencies in the fuel, operations, and procurement areas under new CEO Arnold Donald. 


With 2014 net cruise costs ex fuel now expected to be only ‘slightly higher’ vs +3-4% earlier and 2014 fuel metric per ton guidance of $650 (fuel efficiency: +4%), we believe EPS was boosted by 15-20 cents in each category. 


While the cost side of the business is heading in the right direction, yield expectations came in slightly below already lowered Street numbers.  We mentioned in our preview ‘THOUGHTS AHEAD OF CCL F4Q’ that mgmt may give conservative flat net yield (constant-currency) guidance.  The demand environment (pricing and bookings) in the Caribbean has been weak while Europe is mixed ahead of Wave.  But that does not matter much right now as Wave will dictate how 2014 will shape out.


Here are other takeaways from the earnings release/call:


1)  Onboard and other yield outperformed in F4Q - Will onboard begin to drive yields in 2014 with ticket yields under pressure?  Onboard guidance for FY 2014 (‘little higher than +1%’) was roughly in-line with us.


CCL: $2 ON THE HORIZON? - ccc1


2)  Lower fuel price per ALBD - The divergence in brent oil vs bunker in recent times and a favorable hedging strategy may have played a role.


CCL: $2 ON THE HORIZON? - ccc2


3)  Europe is mixed

  • Costa strength offsetting other brands
  • Northern Europe behind booking curve, trying to catch up

4)  Watch out for FQ2/FQ3 capacity growth in the Caribbean (CCL, RCL, NCLH, MSC)

  • 1Q: 3%
  • 2Q: 19%
  • 3Q: 22%
  • 4Q: 13%

GDP Goes Boom!

Client Talking Points

United States

Boom! 4.1% US GDP growth for Q313. Just unbelievable. Remember the call consensus US stock market bears (and Gold Bond bulls) completely missed in 2013? Exactly. #RatesRising mapped US #GrowthAccelerating from 0.14% to 4.1% like a Hedgeye glove. US GDP at this time last year (Q412) was 0.14% - this acceleration was epic. Of course, beware of growth slowing from here.

S&P 500

This is the first up week for US Dollar in six. That matters, big time, to how Global Macro trades. Right now 8 of 9 sectors in our Hedgeye S&P Sector Model are bullish on both our TRADE and TREND durations. What's the market story of 2013? Buy-the-Damn-Bubble #BTDB on red! Just an epic year to be long growth, as an investment Style Factor. Our Hedgeye SPX range is 1792 - 1821.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Our bullish call on the British Pound was borne out of our Q4 Macro themes call. We believe the health of a nation’s economy is reflected in its currency. We remain bullish on the regime change at the BOE, replacing Governor Mervyn King with Mark Carney. In its October meeting, the Bank of England voted unanimously (9-0) to keep rates on hold and the asset purchase program unchanged.  If we look at the GBP/USD cross, we believe the UK’s hawkish monetary and fiscal policy should appreciate the GBP, as Bernanke/Yellen continue to burn the USD via delaying the call to taper.


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.


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


Another upward revision to UK GDP growth this morning for Q313 #StrongPound working @KeithMcCullough


"The greatest danger for most of us is not that we aim too high and we miss it, but we aim too low and reach it." - Michelangelo


The S&P 500 has rallied 27 percent so far in 2013, on course for its best performance since 1997. Three rounds of central-bank bond purchases have helped propel the equity benchmark 167 percent higher from a 12-year low in 2009. (Bloomberg)

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Avoid, Deny, or Hide

“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:


UST10yr 2.86-2.95%


VIX 12.91-14.91 

USD 80.15-81.14  

Gold 1191-1232 


Good Luck Out There Today.


Jay Van Sciver, CFA

Managing Director


Avoid, Deny, or Hide - jvs


Avoid, Deny, or Hide - yup7


What's New Today in Retail (12/20)

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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