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Holy Nikkei!

Takeaway: Get the Yen right, you’re getting Japanese stocks right.

Ka-Boom!

Holy Nikkei! - drake1 

The Nikkei closes its year up +0.7% at the year-to-date high of 16,291 up +59.3% as the Yen goes out on its year-to-date lows south of $105 (down -18% vs US Dollar).

 

Bottom line: Get the Yen right, you’re (still) getting Japanese stocks right.

 

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KMP/KMI: Shipping is the New "Toll Road"?

SUMMARY: KMP’s latest acquisition is supportive of our negative view on the Kinder Morgan complex……Kinder Morgan enters Jones Act shipping – a new industry for KMP, purchased from private equity, at a time of record dayrates.  Shipping is highly-cyclical, it’s likely that KMP overpaid.  Even with IDR forgiveness, we believe that the deal is dilutive to KMP in every year after properly accounting for replacement CapEx (which KMP will not do).  Deal is modestly accretive to KMI in 2017, but at the expense of KMP dilution.  Is this the best KMP can do with a $1 billion of capital?   

 

KMP enters Jones Act shipping trade with latest acquisition……On 12/23, Kinder Morgan Energy Partners (KMP) announced that it will acquire two shipping companies from Blackstone and Cerberus – American Petroleum Tankers (APT) and State Class Tankers (SCT) – for $962MM in cash plus an assumed capital expenditure obligation of $214MM, a total investment of $1,176MM.  The acquired assets include five 330,000 bbl (50,000 dwt) Jones Act oil/product tankers that are currently operating, and an additional 4 tankers of the same size under construction/order.  The 5 operating tankers are all new, with the oldest put into service in 2009.  KMP estimates that the acquired assets will generate $55MM in EBITDA in 2014 and $140MM in EBITDA in the first full-year that all 9 ships are operating, 2017.  We estimate that each new tanker costs ~$130MM, so Blackstone/Cerberus has already sunk ~$306MM into the four CST tankers under construction.  Backing that unemployed capital out from the cash purchase price, we estimate simple deal economics of 11.9x 2014 EBITDA, 8.4x 2017 EBITDA, and 1.0x replacement cost.  This is KMP’s first venture into shipping; the businesses will be housed in KMP’s “Terminals” segment, which is becoming somewhat of a misnomer now that KMP is sliding shipping and coal royalty businesses into the segment, similar to how KMP’s +40,000 bbl/d oil production operation is considered “CO2.”    

 

History of APT/SCT……APT and SCT were born out of an 2006 joint venture between U.S. Shipping Partners L.P. (40%) and Blackstone/Cerberus (60%).  The JV was to construct 9 new Jones Act product carriers at General Dynamic’s (GD) NASSCO shipyard for an estimated cost of $1.2 billion ($133MM/tanker), and then sell them to U.S. Shipping (100%) at specified prices.  First delivery was scheduled for 2009.  At the time, U.S. Shipping’s Jones Act fleet was aging and in need of replacement – the JV acted as a warehousing/financing vehicle to get this done.  But the Jones Act market rolled over with the 2008 credit crisis and ensuing recession, and U.S. Shipping was unable to meet ongoing obligations, monetize assets, and finance the purchase of the new JV tankers; U.S. Shipping filed for bankruptcy protection in April 2009.  U.S. Shipping released its stake in the JV in a July 2009 bankruptcy settlement, and Blackstone/Cerberus took 100% ownership of the newly-named American Petroleum Tankers (first five tankers) and State Class Tankers (next four tankers).  Blackstone promptly employed Crowley Maritime Corp. (private) to manage the vessels (Crowley will continue to manage the vessels for KMP).  In October 2013, after a stunning increase in Jones Act tanker rates and a red-hot MLP IPO market, Blackstone/Cerberus had an ideal exit opportunity and filed an S-1 for American Petroleum Tankers Partners L.P.  Two months later, the IPO was pulled, and KMP acquired the companies.

 

Questionable timing for entrance into highly-cyclical biz……On 12/17/2013 Reuters reported that Exxon contracted a 337,000 bbl Jones Act tanker for a 6-month charter at a record $110,000/day.  A week later, Kinder Morgan announced its entrance into Jones Act shipping with the purchase of APT and SCT.  In our view, Kinder Morgan is entering a highly-cyclical industry in which it has no experience via a purchase from private equity just as popular media channels report on record-breaking profits.  That strikes us as a risky investment – it’s likely that KMP overpaid. 

 

Wide crude differentials (Brent – WTI, for example) in the US have created new arbitrage opportunities for moving crude oil from one US port to another, pulling capacity away from the traditional intra-US product routes like Gulf Coast-to-Florida and intra-West Coast.  This sudden increase in demand for Jones Act vessels coupled with relatively inelastic supply (mainly due to a lack of quality US shipyards and 1-2 year lead times) has caused a spike in rates.  Consequently, a tail risk that KMP is now exposed to, especially given the timing of the purchase, is a lift of the US crude oil export ban which would narrow US crude spreads; with new deliveries expected over the next few years, a narrowing of crude oil spreads would likely lead to excess capacity in the Jones Act trade.  According to APT’s S-1,

 

“Despite these recent declines [in the number of Jones Act qualified tankers], the number of product tankers in the Jones Act fleet could begin to increase in 2015. Crowley Maritime Corporation and Aker Philadelphia Shipyard recently announced a joint venture to build four new product tankers to be delivered in 2015 and 2016, with an option to build up to four additional tankers in the future, and NASSCO has contracted with State Class Tankers to deliver the four State Class newbuild vessels in 2015 and 2016 and with Seabulk Tankers, Inc., a wholly-owned subsidiary of SEACOR Holdings Inc., to design and construct three 50,000 dwt product tankers to be delivered in 2016 and 2017, plus an option for one additional vessel.”  

 

One shipbroker said recently that it’s the first time in 20 years that Jones Act shipping has been “clearly profitable.”  We expect the industry to respond to that incentive in the way that competitive, cyclical industries do – build capacity.  Interestingly, despite the current boom, Tom Crowley – Chairman, President, and CEO of Crowley Maritime Corp. (leading Jones Act shipper) – said this concerning returns on new Jones Act investment:

 

“The irony of this market is there are lots of people making the windfalls on investment in the energy itself. But as we look at the capital costs of building new tonnage, the investment isn’t being driven by a perceived windfall on the return. We are looking at modest returns on a three-to-five-year charter while essentially taking the risks on the long-term.  We will remain subject to the state of the market as well. There are some operators with older vessels that are getting good returns, but new investment needs to be tempered because it is fully loaded with capital costs and operational risk.”

 

Crowley may be alluding to the fact that a 50,000 dwt newbuild Jones Act tanker (made in the USA) cost ~$130MM.  But according to international shipbroker Simpson Spence & Young, a double-hull tanker of similar size (“Handymax”) constructed in Japan costs only ~$45MM!  One built in South Korea or China is likely even cheaper.

 

KMP's economics are largely locked-in through 2015/6, when its initial 5-year time charters are up for option or renewal.  But these tankers are long-lived assets (30 years), and whether or not this acquisition destroyed or created value for KMP unitholders will not be known for many years.  We note, though, that KMP did not leave much room for error buying into record rates.

 

Of course, no replacement CapEx……The “genius” (it’s really not that smart, and it’s another obvious example of an aggressive maintenance CapEx policy, much like in KMP’s E&P operation) of this deal for Kinder Morgan is in the financial engineering on the replacement/maintenance CapEx line.  A tanker requires large upfront construction CapEx but very little additional capital over a fairly-predictable useful life.  After 30 years of sitting in saltwater, the hull rusts out and the tanker is scrapped and replaced with a new ship.  Depreciation does a decent  job of accounting for this, though it will understate the nominal cost of replacing the ship unless we have 30 years of deflation.  It is common among shipping MLPs (and other MLPs with “depleting” assets) to reserve for “replacement CapEx” such that DCF is more indicative of terminal free cash flows, though KMP will not do this, as far as we understand it.  APT’s S-1 listed annual replacement CapEx for 5 tankers at $11.5MM, or $2.3MM/tanker.  This seems very aggressive given that it is depreciating $130MM tankers at ~$4.3MM/year (nominal salvage value of $1.5MM).  If we assume 2.0% annual inflation, a $130MM ship with $1.5MM of salvage value (today’s dollars) will cost $233MM to replace (net of the inflated salvage value) in 30 years.  Straight-lining that amount gives us annual replacement CapEx of $7.8MM/tanker.  In 2017 when KMP has 9 tankers in operation, that would equate to ~$70MM of annual replacement CapEx.  KMP will not include this reserve, which it can get away with for the next 25 – 30 years.  Regardless, it’s another example of how KMP’s “DCF” overstates its true profitability.

 

Deal math: dilutive to KMP, barely accretive to KMI……With the allocation of replacement CapEx as described above, the deal is dilutive to KMP in all years out to 2017, and is 0.8% accretive to KMI in 2017.  If we (inappropriately) set replacement CapEx to $0 (as KMP will do), the deal is only 0.6% accretive to KMP’s guided 2014 distribution of $5.58/unit and 2.8% accretive to KMI’s guided 2014 dividend of $1.72/share, in 2017.  

 

Another way to analyze the deal economics (irrespective of KMP's distribution)......The investment will generate $34MM of recurring FCF in 2017.  Given the 50/50 IDR split, we give $17MM to KMI and $17MM to KMP.  We estimate that the KMP equity investment will be $547MM (50% equity financing net of $41MM of aggregate IDR forgiveness), giving KMP a 3.1% ROE in 2017. 

 

KMP/KMI: Shipping is the New "Toll Road"? - km3

 

Kevin Kaiser

Managing Director

 



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McGough: Disaster @Target $TGT

Takeaway: Don't underestimate how much of a disaster this is for Target.

Editor's note: Hedgeye analyst Brian McGough provides his quick take on the debacle at Target

McGough: Disaster @Target $TGT - tar2

  • "Target on Friday confirmed that strongly encrypted PIN data was removed from its system during the security breach that took place between Black Friday and Dec. 15."
  • "'While we previously shared that encrypted data was obtained, this morning through additional forensics work we were able to confirm that strongly encrypted PIN data was removed,' Target said Friday. 'We remain confident that PIN numbers are safe and secure. The PIN information was fully encrypted at the keypad, remained encrypted within our system and remained encrypted when it was removed from our systems.'”

Takeaway: Don't underestimate how much of a disaster this is for Target. Yes, it's a breach of confidence on the part of the consumer -- and as we know from JCP, rattled confidence can take a long time to regain. But there is also financial pain -- partially in the form of lost sales, but also because TGT was not insured for this. That's the part of this whole mess that simply blows our mind. Some retailers simply use Paypal, as it transfers the liability. We know it's unrealistic to assume that all TGT shoppers use Paypal. But it is realistic to expect the company to but in place the appropriate risk management (i.e. insurance). 

 

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COMMODITY CHARTBOOK

Notable trends:

  • Coffee prices continue to rise, ticking up +0.9% over the past week.  Despite the recent upward trend, coffee prices remain down -28.7% on a year-over-year basis.  We expect coffee prices to remain low in 2014, but a continuation of the recent upward trend could, on the margin, negatively affect sentiment around SBUX, DNKN, GMCR, KKD, THI and other coffee retailers in 2014.
  • Cheese Block and Milk prices were up +0.8% and +0.1% over the past week and are up +14.9% and +2.3% on a year-over-year basis, respectively.  High dairy prices are, to varying degrees, a negative for TXRH, CAKE, DPZ, PZZA, and CMG.
  • Corn and Wheat prices are down -2.0% and -1.2% over the past week and are down -30.3% and -27.1% on a year-over-year basis, respectively.  Grain costs continue to provide retailers, restaurants and consumers with lower food costs than a year ago and should benefit 4Q margins for companies with large exposure to this group.
  • Beef prices have been trending up YTD and should continue to pressure margins for BLMN, TXRH, CMG, MCD, JACK, SONC, WEN and others with significant exposure.  We expect some restaurants, mostly fast food providers, to feature chicken products on their menus in 2014 if the rise in beef prices persists.
  • Gasoline prices ticked up 150 bps over the past week and are now up +0.6% on a year-over-year basis, despite being down for the majority of the 2013.  We will continue to monitor this trend, as any sustained increase or decrease in gas prices could have a significant impact on the direction of discretionary spending.  

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Howard Penney

Managing Director

 


What's New Today in Retail (12/30)

Takeaway: JCP rights another RonJon wrong. TGT’s reputation falling like lead. WMT/Sams crushing it in China. Labor unrest kicks up notably.

COMPANY NEWS

 

JCP, SQBG - JC Penney and Sequential Brands Group amend William Rast license agreement

(http://www.sec.gov/Archives/edgar/data/791770/000114420413069301/v364066_8k.htm)

 

  • "As previously disclosed, on November 17, 2011, William Rast Sourcing, LLC and William Rast Licensing, LLC, each a wholly-owned subsidiary of Sequential Brands Group, Inc., entered into an exclusive license agreement with J.C. Penney Corporation, Inc., pursuant to which the Company granted the Licensee a license to use its William Rast trademark in connection with the manufacture, sale and distribution of multiple product categories, including men’s and women’s apparel and accessories."
  • "Due to changes in circumstances with respect to the License Agreement, the Company and the Licensee entered into an amendment to the License Agreement on December 24, 2013, pursuant to which the term of the License Agreement will end on June 30, 2014 instead of January 30, 2016."
  • "In addition, under the terms of the License Amendment, the rights granted to the Licensee under the License Agreement were deemed non-exclusive (instead of exclusive) for the duration of the term and the Company will be permitted to enter into additional licenses with other parties to use the Trademark in connection with the manufacture, sale and distribution of the Products."

 

Takeaway: Yet another example of JCP walking away from a mistake that Johnson rammed down its throat. The primary line for Rast was the JT line of (primarily) denim. Sounds appealing to me, as well as many people reading this note. But the average Joe consumer simply did not want it. They wanted Arizona. Timberlake announced back in the Spring that he was walking away from the deal. No surprise there. Nice to see JCP followed suit. The only things worse than making a mistake is a) not fixing it, and b) not being transparent about it.

 

TGT - PIN Numbers Stolen in Target Breach

(http://www.wwd.com/retail-news/department-stores/pin-numbers-stolen-in-target-breach-7326296?module=hp-topstories)

 

  • "Target on Friday confirmed that strongly encrypted PIN data was removed from its system during the security breach that took place between Black Friday and Dec. 15."
  • "'While we previously shared that encrypted data was obtained, this morning through additional forensics work we were able to confirm that strongly encrypted PIN data was removed,' Target said Friday. 'We remain confident that PIN numbers are safe and secure. The PIN information was fully encrypted at the keypad, remained encrypted within our system and remained encrypted when it was removed from our systems.'”

 

Takeaway: Don't underestimate how much of a disaster this is for Target. Yes, it's a breach of confidence on the part of the consumer -- and as we know from JCP, rattled confidence can take a long time to regain. But there is also financial pain -- partially in the form of lost sales, but also because TGT was not insured for this. That's the part of this whole mess that simply blows our mind. Some retailers simply use Paypal, as it transfers the liability. We know it's unrealistic to assume that all TGT shoppers use Paypal. But it is realistic to expect the company to but in place the appropriate risk management (i.e. insurance).

 

CROX - Crocs, Inc. Announces Financial Partnership with Blackstone, Expands Share Repurchase Plan, Announces CEO Retirement

(http://investors.crocs.com/phoenix.zhtml?c=193409&p=irol-newsArticle&ID=1887091&highlight=)

 

  • "Crocs, Inc. today announced that an investment fund affiliated with Blackstone has agreed to purchase $200 million of newly issued series A convertible preferred stock. In connection with the investment, Crocs intends to revise its capital structure to accommodate a $350 million stock repurchase program approved by its board of directors. This includes using the net proceeds of approximately $180 million from the Preferred Stock as well as excess cash to fund the repurchase plan."
  • "With its investment, Blackstone will be entitled to two seats on the Crocs board of directors."
  • "John McCarvel also announced his intention to retire as president, chief executive officer and board member on or about April 30, 2014."
  • "Crocs also updated its fourth quarter 2013 outlook and currently expects revenue to be at the low end of the previously provided guidance range of $220 million and $225 million, and diluted loss per share to be at the low end (meaning the higher loss) of the previously provided guidance range of ($0.20) and ($0.23)."

 

Takeaway: None of this -- not the CEO retirement, lower guidance, or greater involvement by a major investor -- comes as a surprise. We still think that CROX is ungrowable without severely impairing either its EBIT margins or asset turns.

 

UHR - Fire Destroys Swatch Workshop

(http://www.wwd.com/accessories-news/watches/fire-destroys-swatch-workshop-7326781)

 

  • "A fire has destroyed a workshop at the heart of the Swatch Group division that produces the movements used in the majority of Swiss watches, the world’s largest watchmaker said."
  • "The flames were brought under control by 9.30 a.m. and nobody was injured, but the workshop 'has been entirely destroyed,' Swatch Group said."

 

Takeaway: So unfortunate. The timing is a double cheek slap. 1) This time of year is never when you want to have something like this happen (but at least it was after most watches for holiday were already on the shelves -- if not on people's wrists). 2) Swatch is in the midst of integrating its Harry Winston acquisition. While this does not threaten smooth integration, it definitely diverts management's time and attention.

 

WMT - Walmart in drive to expand Sam’s Club chain in China

(http://www.ft.com/intl/cms/s/0/a3fff99c-6ec2-11e3-9ac9-00144feabdc0.html#axzz2oxWTN9NG)

 

  • "The expansion of Sam’s Club is also tapping into a trend that is transforming Chinese consumption habits: the rapid growth of China’s auto market."
  • “'About 90 per cent of the people who shop in our Sam’s Clubs drive to the club versus our Supercenters, where that number can be as low as 10 per cent,' says Greg Foran, head of Walmart’s China business, on a tour of one of Beijing’s two Sam’s Clubs. 'They’re coming to this particular location maybe once a month and they’re buying enough items to last them that month . . . The frequency of shopping is less but the value of [each customer’s] basket is a hell of a lot more.'”
  • "Walmart is concentrating the discount warehouses in the outskirts of “tier 1” and “tier 2” cities – primarily provincial capitals and independently administered conurbations such as Beijing and Shanghai – where incomes and car penetration rates are highest."

 

Takeaway: An interesting read into the shopping habits for Chinese consumers in the consumables space. It makes obvious sense that people would need to drive more often to get to a Sam's -- as the real estate is usually located in the sticks.  But the ratios of 90% drive to Sam's vs. 10% drive to supercenters seems extreme to us. 

 

INDUSTRY NEWS

 

Retailers Reflect on Holiday Shoe Sales

(http://www.wwd.com/footwear-news/retail/retailers-reflect-on-holiday-footwear-sales-7326123)

 

Daniel Kahalaniowner, DNA Footwear, Brooklyn, N.Y.

  • Holiday sales strategy: "We did a Thanksgiving sale, and we did a one-week sale [before] Christmas. Now we are going into our end of the season sale that starts Jan. 6."
  • Top sellers: "Ugg is not dead. Everyone wants to say that it is, but there is still high demand. People also couldn't get enough Sorel."

Andrea Poukeyco-owner, Kick, La Crosse, Wis.

  • Holiday sales strategy: "We send out direct mailers to the top 20 percent of our customers for holiday with a coupon for $25 off of a $100 purchase or more. We do that every year and [it has] been working every year.
  • Top sellers: Sorel and Sam Edelman

Dan Ungarpresident, Mar-Lou Shoes, Cleveland

  • Holiday sales strategy: "[A promotion offering 30 percent off boots] worked very, very well. Additionally, we did a 15 percent off friends and family [sale]... but frankly consumers are not even responding if it's not somewhere between 40 and 70 percent off."
  • Top sellers: Ziera, Clarks, SAS and Ugg classic styles

Caroline Pricesales associate, Kicks Shoes, Columbia, S.C.

  • Holiday sales strategy: "Our owner is all about shopping local and giving back to the community. We always do something philanthropic at Thanksgiving and Christmas in exchange for giving our customers a discount... This year, at Christmas, our charity was Toys for Tots, which kicked off about two weeks before Christmas."
  • Top sellers: "We’ve sold a lot of Dolce Vita, Vince Camuto and Kate Spade. They’re always good brands for us, in particular the Dolce Vita line because it's very fashion forward but isn’t so pricy."

Dave Levyowner, Hawley Lane Shoes, Shelton, Conn.

  • Holiday sales strategy: "We did radio spots that branded us — [no] promotions or discounting this season." 
  • Top sellers: "No. 1 [was] Ugg. A lot of people thought it would be way down, but it was exceptionally strong, [especially] the standard styles. Additionally, New Balance, SAS, Merrell, Dansko and Minnetonka. We also had huge increases with Kamik."

 

Breaking News: Cambodia Overrun by Factory Worker Protests

(https://www.sourcingjournalonline.com/breaking-news-cambodia-overrun-factory-worker-protests/)

 

  • "Despite the announcement of an eagerly awaited rise in the minimum wage for factory workers, Cambodia’s manufacturing industry has been halted by tens of thousands of protesters, swarming the streets in a show of demonstration."
  • "The Labour Advisory Committee reported a $15 increase in monthly wages, effective April 1, 2014. Under the newly accepted plan, the minimum wage will rise incrementally over the next five years, lifting it from its current $80 per month to more than  $160 per month. In 2015, the monthly minimum wage is set to increase again by $15, then by $16 in 2016, $17 in 2017 and, finally, $17 in 2018. Unions have been demanding that the minimum wage increase to the target $160 immediately."

 

Political Chaos Hits Bangladesh Industry

(http://www.wwd.com/business-news/government-trade/political-chaos-hits-bangladesh-industry-7326519?module=hp-topstories)

 

  • "As Dhaka witnessed one of the highest days of political drama of the pre-election fervor on Sunday, businesses remained largely closed as ground transport was shut down. The opposition led parties continue to call for businesses and the city itself to remain closed on Monday to send a strong message of protest to the ruling Awami League."
  • "Officials of the Bangladesh Garment Manufacturers and Exporters Association told WWD that they were struggling to ensure that orders could be met although December has been a hard month and that garment factory owners were now paying major penalties because of the political situation. 'Cancellation of orders worth $3.77 million have happened in this month itself,' a BGMEA official said. This was in the first three and a half weeks of this month."

 

 

 

 

 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.64%
  • SHORT SIGNALS 78.57%
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