Got Growth Divergence?

Client Talking Points


Swiss and German stocks rising +1% and leading the follow-through charge this morning (in spite of continued weakness across major Asian Equity indices ... see the KOSPI down another -0.4% overnight). Take some time today or over the weekend to review our Q1 Global Macro Themes Deck from yesterday on the why that could continue.


Whack! The Shanghai Composite fell down another -0.7% last night to -4.9% year-to-date (compare that to Austria which is up +5% year-to-date). We have no interest in being long China’s major equity index here on the red start to the year. Incidentally, New Zealand up +2.7% year-to-date looks good!


What a start for the short-end of the yield curve with fresh 3-month highs of 0.43% for the 2-year. We will see if the reaction to the jobs report is enough to blast through the September highs again for the 10-year yield today. There's no resistance to 3.05%, then 3.09% after that on the 10s.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Hedgeye's detailed and constructive view on the improving fundamentals in the M&A market with a longer term perspective is a contrarian idea at odds with the rest of the Street which is overly focused on short-term results. From an intermediate term perspective, M&A is poised to break out in 2014. We are witnessing record amounts of cash on corporate balance sheets, continued low borrowing costs and the first positive fund raising round for Private Equity in four years. Moreover, a VIX in secular decline (this has historically benefited M&A), recent incrementally positive data points from leading M&A firms that dialogue has improved, and an improving deal tally from Greenhill & Company (GHL) themselves coming out of the summer all bode favorably for GHL. So is a budding European economic recovery that would assist a global M&A market that has been range bound over the past three years. GHL stands out as a leading beneficiary of these developments.


We remain bullish on the British Pound versus the US Dollar, a position supported over the intermediate term TREND by prudent management of interest rate policy from Mark Carney at the BOE (oriented towards hiking rather than cutting as conditions improve) and the Bank maintaining its existing asset purchase program (QE). UK high frequency data continues to offer evidence of emergent strength in the economy, and in many cases the data is outperforming that of its western European peers, which should provide further strength to the currency. In short, we believe a strengthening UK economy coupled with the comparative hawkishness of the BOE (vs. Yellen et al.) will further perpetuate #StrongPound over the intermediate term.


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.

Three for the Road


CNBC's coverage of the jobs report has devolved into a lotto contest for anyone dumb enough to guess @KeithMcCullough


"Talent wins games. But teamwork and intelligence win championships."

-Michael Jordan


The data breach at Target was significantly broader than originally reported: The company said Friday that 70 million customers had information such as their name, addresses, phone numbers and e-mail addresses hacked in the breach. The company had previously said 40 million shoppers had their credit and debit card information stolen in the weeks following Thanksgiving.

The Rivalry

“One friend in a lifetime is much; two are many; three are hardly possible.  Friendship needs a certain parallelism of life, a community of thought, a rivalry.”

-Brooks Adams


As many of you may have noticed already, my colleagues and I have a bit of a fascination with the sport of hockey.  In particular, Ivy League hockey, since many of us played at Yale (and our firebrand energy analyst Kevin Kaiser played at Princeton).  So, if you will, please tolerate my enthusiasm for just a minute here as this weekend is effectively our Super Bowl.


Specifically, this Saturday at 8pm Yale will be playing Harvard at Madison Square Garden.  In as much as I would like to wish my friends at Harvard good luck this weekend, I would, honestly, not really mean it.  But I sincerely do hope the Crimson don’t totally embarrass themselves, or next year we will have to invite Cornell to play us on the world’s biggest hockey stage. 


Now admittedly Harvard did once win a NCAA championship, albeit it was more than three decades ago.  On the other hand, Yale is the defending NCAA champion and over the last five years has amassed a record of 111 – 53 – 12.  Over the same period, Harvard hockey is 53 – 87 – 24.  As if having Larry Summers on their team wasn’t bad enough... ;)


In Malcolm Gladwell’s new book, “David and Goliath”, he digs into the idea that underdogs do disproportionately well in competition.  He cites a study from political scientists Ivan Arreguin-Toft that looked at all wars between small countries and much larger countries over the past two hundred years.  He found that the much larger country only win 71.5% of the time.  Further as Gladwell writes:


“What happens in wars between the strong and the weak when the weak side does as David did and refuses to fight the way the bigger side wants to fight, and instead uses unconventional or guerilla tactics.  The answer: in those cases the weaker party’s winning percentage climbs from 28.5% to 63.6%.  To put that in perspective, the United States population is ten times the size of Canada’s.  If the two countries went to war and Canada chose to fight unconventionally, history would suggest you ought to put your money on Canada.”


So, who knows, if Harvard hockey were to do something totally unconventional, like say put their football team on skates, maybe they will have a chance this weekend!


Back to the Global Macro Grind...


Yesterday, Keith presented our top three global macro themes for Q1 2014.  Like clockwork, we’ve been doing these themes for the last five years.  Those three themes are as follows:

  • #InflationAccelerating – CPI comparisons globally are easy and commodities are basing, as a result we are expecting a re-acceleration in reported inflation.  From a sector perspective, the three sectors we like in this scenario are technology, healthcare and energy;
  • #GrowthDivergences – This could be the year in which global growth divergences increasingly matter for stocks, especially as rates begin to normalize, and Europe looks set up to see accelerating economic growth.  Conversely, we are starting to question whether Japan’s recovery is losing steam; and
  • #FlowShow – In a world in which 75% of the global financing stock outstanding is in debt, there is a lot money that can flow out of bonds and into equities.  In the Chart of the Day below, we again emphasize that the ratio of debt-to-equity was 50/50% in 1999.

One key supporting point for the idea that Europe could well be the global growth leader, at least on a percentage change basis, is the fact the European sovereign debt markets have all but recovered.   Remember that sovereign debt crisis from a few years ago? Well, the European credit markets barely do.


This morning the Spanish 10-year yield is trading at 3.70%.  This is a mere 74 basis points wider than the U.S. 10-year yield.   In fact, last night Spain kicked off its funding program and raised $7.2 billion in five year debt, overshooting its target.  Further, this debt was sold at 2.411%, which was the lowest funding rated of the Euro era for Spain.


Now in the long run, the Spanish economy still has excesses built up from the parabolic housing bubble it experienced.  Nonetheless, in the short run as the likes of Spain, Italy, France and Portugal are able to sell debt at reasonable rates, this is both a real positive for their governments and their governments’ ability to spend, but more importantly for banks.  As broad borrowing rates go down, this will eventually filter back to corporations who can then borrow at low rates to more aggressively fund capital expenditures and expand. 


Since we are on the topic of housing, I should flag that the U.S. housing market is at the top of our list for worries as it relates to the U.S. economy.   In fact, mortgage applications are down 22% from their 2014 peak reading.


Even if it’s not clear yet that housing headwinds will derail the U.S. economy, it is setting up for some interesting short ideas.  In particular, our Financials team just added Nationstar Mortgage (NSM) to our Best Ideas list this week.  Previously, this had been a top long idea for us, which played out well as our earnings estimates were higher than the consensus.


Conversely, our view is now that the consensus earnings estimate of north of $5 for 2014 could come in as low as $1. 


Now, how’s that for a downside surprise? 


We are doing a deep dive on the name and will outline the thesis this Monday at 11am EST. (Email to subscribe for access.)  NSM trades more than $30 million in volume per day, so there’s lots of stock out there to short, especially if you believe our Financials team that the best case scenario is that the stock will get cut in half.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


The Rivalry - Chart of the Day


The Rivalry - Virtual Portfolio



In light of yesterday’s downgrade, we’d like to reiterate our LONG call on YUM.


It is our belief that the vast underperformance of its China Division in 2013 was largely driven by circumstantial issues (food supplier incident and Avian Flu) rather than structural issues.  In fact, we believe YUM continues to have a material opportunity to capitalize on a growing consumer class in China that is expected to double from 300mm+ in 2012 to 600mm+ by 2020.  While China same-store sales could remain volatile in 2014, we believe they will accelerate meaningfully over the prior year. 


The trend in both sales and margins in China suggest that the company has made significant progress restructuring the business, setting the stage for improved profitability in 2014.  We believe there is enough pessimism around a potential recovery in China (as evidenced by yesterday’s downgrade) that there is upside to estimates in 2014.



YUM is currently our favorite LONG in the big cap QSR landscape fueled by a substantial long-term growth opportunity, including a strong and growing presence in China as the country transitions from a producer to a consumer economy.  We believe China same-store sales will not only benefit from easy comparisons, but will also be driven by incremental sales from menu innovation and daypart expansion in the region.  In addition to China, YUM has positioned itself well for the future through considerable penetration in other developing markets. 


YUM has been strong in the U.S. for the past couple of years, led primarily by an innovative Taco Bell business.  We believe the company has the correct drivers in place to capture additional market share and drive incremental sales at this concept.  The breakfast daypart is a huge opportunity for Taco Bell and, if successful, could drive incremental gains.



YUM: CHINA WILL BE KEY IN 2014 - 1 9 2014 4 38 00 PM


YUM: CHINA WILL BE KEY IN 2014 - 1 10 2014 7 16 26 AM




Easy same-store sales comparisons in China, improving margins across the major divisions, and a potential acceleration in domestic consumer spending could all lead to multiple expansion in 2014.  Investors punished the stock on bad news for the majority of 2013 and, as such, we expect them to reward the stock on good news throughout 2014.  As it stands, we see approximately 16-30% upside in the stock (depending on the trajectory of profitability in China), implying a stock price between $87 to $100 per share.



YUM: CHINA WILL BE KEY IN 2014 - 1 9 2014 4 54 38 PM



In the series of annotated charts below, we run through our bull case from a fundamental perspective.  It quickly becomes clear that operating margins are set to accelerate and that a turnaround in China would have a considerable impact on the profitability and earnings of the company.



YUM: CHINA WILL BE KEY IN 2014 - 1 10 2014 7 43 08 AM

YUM: CHINA WILL BE KEY IN 2014 - 1 10 2014 7 43 45 AM

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YUM: CHINA WILL BE KEY IN 2014 - 1 10 2014 7 44 54 AM

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YUM: CHINA WILL BE KEY IN 2014 - yum cost of sales

YUM: CHINA WILL BE KEY IN 2014 - laborrrr china

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YUM: CHINA WILL BE KEY IN 2014 - us rlmnsjpg

YUM: CHINA WILL BE KEY IN 2014 - intl rlmns

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YUM: CHINA WILL BE KEY IN 2014 - gagagaga

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YUM: CHINA WILL BE KEY IN 2014 - 1 9 2014 3 21 37 PM

YUM: CHINA WILL BE KEY IN 2014 - yum intl op margins

YUM: CHINA WILL BE KEY IN 2014 - chinappp



Feel free to call with questions.



Howard Penney

Managing Director


January 10, 2014

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International Entertainment, the company controlled by the family of Asia’s fourth-richest man, Cheng Yu-tung, agreed to pay as much as HK$7.35 billion ($948 million) for a 70% stake in Sun City Gaming Promotion Co, a junket operator. Cheng owns a 10% stake in closely held Sociedade de Turismo & Diversoes de Macau SA (STDM) - the 10% stake in STDM gives him control of 293 million shares of SJM.


Sun City expects its credit facilities offers to customers will be no less than HK$12 billion during 2014 and 2015 while the rolling turnover at its VIP rooms across Macau will be no less than HK$1.68 trillion, it said in the statement.



According to multiple industry sources on Thursday, the Korean government plans to announce its new tourism strategy later this month, which, among other things, would relax financial rules for foreign bidders to earn casino licenses in the nation’s economic zones.  “We are considering easing the bidding standards after receiving complaints that it is too difficult to meet the criteria of BBB credit ratings,” said a government official. “But we have yet to decide on detailed plans.”  Caesars and Universal are potential bidders. 


Korea’s casino operator Paradise Group, together with Japan’s Sega Sammy Holdings, has already launched an 11,190-square-meter resort project, with its construction planned to start in April for completion by 2017. 

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