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I'm Sorry America

This note was originally published at 8am on December 17, 2013 for Hedgeye subscribers.

“I can only say: I’m sorry America.”

-Andrew Huszar


In the opening sentence to his recent WSJ op-Ed (which the NY Times wouldn’t publish), “Confessions of a Quantitative Easer”, that’s what Andrew Huszar wrote. Since he ran the biggest Fed bond buying program in US history, that was a big apology.


I had the pleasure of hosting Andy at our new Hedgeye headquarters in Stamford, CT yesterday for our 1st segment of a series @HedgeyeTV that we’re calling Real Conversations.


The short-term headline of our conversation is that Andy doesn’t think the Fed tapers tomorrow. The longer-term implication of our conversation is that Andy thinks the Fed has been politicized, allowing “QE to become Wall Street’s new Too Big To Fail policy.” So don’t look for an actual “taper” of consequence, any time soon.


Back to the Global Macro Grind


Not to be confused with Ben Bernanke’s take on the whole thing, Huszar left “Fed-up” because he didn’t believe in how “the central bank continues to spin QE as a tool for helping Main Street.”


Yesterday at the Federal Reserve’s 100 year birthday party (the one that no one in America cared to celebrate), Bernanke went on and on saying that the “Fed’s willingness, during its finest hours” … was to “stand up to political pressure.” Got-it.


Moving along… the entire global currency market, which has picked up some volatility as of late (JPM’s FX Volatility Index was +3.7% last wk to +8.1% YTD), awaits our central planning overlord’s decision tomorrow.


We’re short the US Dollar in our Q413 Global Macro Themes deck and we re-shorted the US Dollar (UUP) on its bounce to lower-highs last week in #RealTimeAlerts. Huszar’s take on it all simply confirmed what we were thinking.


From a risk signaling perspective, where do we stand on the FX War’s Big 3?

  1. US Dollar (Index) = Bearish Formation (bearish on all 3 of our core risk mgt durations – TRADE, TREND, and TAIL)
  2. The Euro (EUR/USD) = Bullish Formation (bullish on all 3 of our core risk management durations)
  3. Japanese Yen (USD/JPY) = Bearish Formation

The bearish intermediate-term TRENDs in both the US Dollar and Yen make sense as (relative to the ECB, whose balance sheet has shrunk) the Fed and BOJ have been the marginal debaucherers of their currencies as of late.


Japan has been doing this for over a year now, while the Fed re-engaged in Buck Burning with the no-taper decision in September. So that makes getting long the Yen versus the US Dollar here interesting. Warning: it’s early.


Looking at the leans in Global Macro consensus (net long or short positions in CFTC futures and options contracts), here’s where the game is currently at:

  1. USD = +6,730 net long contracts (versus +7,725 three months ago)
  2. EUR = +15,115 net long contracts (versus +39,803 three months ago)
  3. JPY = -129,614 net SHORT contracts (versus -90,060 three months ago)

In other words, consensus A) in US Dollar bulls isn’t as sure as it was 1yr ago (when the net long position in USD was +19,471), B) is more worried about another ECB rate cut (even though the European economic data continues to accelerate) and C) is wacky net short the Yen (now that it’s down -16% vs USD for 2013 YTD!).


So what do you do with that? Start yelling to the heavens that “it’s a bloody currency war and a race to burn everything; buy bitcoin!” Or do you buy Yen in early 2014 as consensus marks the bottom?


I’ll tell you how I used to think about stuff like this – dogmatically. I was certain that my research view was going to be right (until it would be very wrong) and had a complete disrespect for market timing.


Note to self (sponsored by Dan Och at OZM): if you disrespect Mr. Macro Market’s timing signals, he’s going to “do you” some humbling P&L exercises.


Our track record risk managing currencies is better than a moving monkey’s, primarily because we use risk controls:

  1. Buying a currency, I wait for an immediate-term TRADE oversold signal within a bullish TREND
  2. Shorting a currency, I wait for an immediate-term TRADE overbought signal within a bearish TREND

Those are the easiest calls to make. The toughest are the ones that eventually have the biggest TRENDING reversals (bearish to bullish reversals or vice versa). Buying the Yen versus the USD would be a potential example of that in early 2014. But, for me, I need to take my time and score the bottoming process (they are processes, not points).


In parallel to the quantitative signaling, what we do as a research team is try to play out scenarios and catalysts (preferably with tangible macro calendar catalysts). What if Huszar is right and the Fed’s Policy is To Big To Fail? What if the Fed doesn’t taper in DEC, then the US economic data continues to slow in JAN? What if you’re looking at no taper in 2014 and a Yellen Qe6?


If that were to play out, I’ll be really sorry for America too.


Our Financials team will be hosting a call on “Mortgage Mayhem” at 1pm today to discuss the coming January upheaval in the mortgage market from the new QM regulations. The speaker will be industry authority, Larry Platt, an attorney with the law firm of K&L Gates. If you’re an Institutional investor and would like access to the call, email sales@hedgeye.com.


Our immediate-term Global Macro Risk Ranges are now:


SPX 1765-1815

VIX 14.26-16.84

USD 79.79-80.44

EUR/USD 1.37-1.38

USD/JPY 101.72-103.84

Gold 1216-1255


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


I'm Sorry America - Chart of the Day


I'm Sorry America - Virtual Portfolio






Macau Public Security Police say 920,872 tourists visited between December 20 and December 26, up 16.08% YoY. 



According to Singapore PM Lee, 2013 GDP rose 3.7%.  This implies 4Q GDP grew between 4.1%-4.5% (Bloomberg survey: 4.8%).  Lee reiterated a forecast for the economy to grow 2%-4% in 2014.  



Holy Nikkei!

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


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


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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