Editor's note: This unlocked edition of Daily Trading Ranges note was originally published February 21, 2014 at 7:55am. For more information on how you can receive these levels every morning in your inbox click here.
Takeaway: The Burning Buck arrested its decline for all of 24 hours off its year-to-date lows.
Takeaway: If UA's equipment really kept the U.S. off the Olympic podium, we can't imagine that they'd stay married to UA.
- "US Speedskating and Under Armour Inc. will announce that they have renewed their partnership through the 2022 Olympic Games, the company confirmed, a deal that comes on the heels of a public flap over new Under Armour skinsuits that divided the team in Sochi."
- "Under Armour Chief Executive Kevin Plank 'is a proud American and they will not retreat from supporting USS despite the challenges we've gone through together,' US Speedskating executive director Ted Morris said in an email to athletes, reviewed by The Wall Street Journal."
- "A spokeswoman for Under Armour confirmed the deal, but the terms of the deal weren't immediately known Friday."
Takeaway from Hedgeye's Brian McGough
Everyone has an opinion on this issue. So here's ours. Simply put, this whole thing is ridiculous.
If you were going to 'go for gold' in the Olympics, do you think that just maybe you'd have tested out your suit before the games? We have to think that these athletes did (in fact, they did at the Olympic trials -- and did not complain when they were beating athletes wearing Nike suits).
A few of the classier athletes -- like Shani Davis -- stood up and said something like "I'm not blaming the suit. I went out there and gave it my all, and other skaters were simply faster". #respect, Shani. We give the US credit for sticking to its guns with UnderArmour despite this PR mess. If they really thought that it was the equipment that kept us off the podium, we can't imagine that they'd stay married to UA.
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Takeaway: With ~90% of companies having reported, 2 trends have been clear: The Neg. divergence for Consumer & the return of forecasting fundamentals
CONSUMER COMEDOWN: As we’ve highlighted for a couple weeks now, consumer companies have turned in the notable, negative divergence in 4q13 earnings with just 30% of Consumer Staples companies besting revenue estimates.
Consumer Discretionary sits just ahead of Energy to round out the bottom third in sector level topline BEAT percentage.
Operating trends are diverging negatively as well with consumer facing companies reporting the worst momentum in operating performance with just 26% and 42% of companies registering sequential acceleration in sales and earnings growth, respectively, according to bloomberg data.
That negative divergence continues to get discounted by investors as Consumer Staples now sits as the worst performing sector YTD despite relative outperformance in slow growth/yield chase equities and the balance of the defense trio in Utilities/Healthcare sitting at the top of sector performance.
*Prices as of close 2/20/14
THE PRINT: The mini-resurgence in the import of forecasting fundamentals has been notable this earnings season as companies missing earnings continue to be sold aggressively. Of the minority of companies that have missed bottom line estimates, 71% have gone on to materially underperform (-5.1% on ave.) the market over the subsequent 3 trading days.
BEAT-MISS: No real change in trend WoW. With ~90% of SPX constituent companies having reported, the Sales Beat percentage stands 63% - well above both the 53% in 3Q13 and the 54% TTM average. At 73%, the EPS beat percentage is basically inline with the 3Q13 and TTM average of 74% and 73%, respectively.
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MINIMUM WAGE PROPOSAL ANALYSIS:
- Its largely a lose-lose proposition for employers as a cost pass-through ultimately drags on aggregate demand while a statutory increase in wage expenses serves as a de-facto income transfer from owners of capital to labor
- Ironically, rising demand for higher-skilled workers driven by legislated increases in the minimum wage may perpetuate a recurrent, self-defeating cycle for policy makers
- On net, a legislated federal minimum wage increase would benefit low income families, primarily via an income shift from business owners and higher income families and would work to support consumption in the short-term while reducing per-capita GDP over the longer-term.
WAGES & LABOR’s BAD BANK:
- There’s a credible case to be made for a Good Bank/Bad Bank view of the current domestic labor market and a lower level of labor slack than appears superficially.
- The current employment base and new workers with relevant skills (collectively “the good bank”) are in relatively good shape as initial claims base near frictional resistance and the economic stabilization matures while the long-term unemployed (“the bad bank”) remain unattached and in a terminal run-off of sorts.
- Initial Jobless Claims continue to move along near their historical, frictional lower bound at ~300K, the NFIB “Job Openings Hard to fill” Index continues to advance, Business Hiring Plans continue to make higher highs as does the Job Openings and Quits rate data in the JOLTS survey.
- There’s compelling evidence that the cyclical impacts of the recession on the LFPR have largely faded, and the secular drivers of the decline in labor force participation - which began in 2000 – are again reemergent.
- Short-term unemployed likely have a significantly greater impact on the direction of wage inflation than the long-term unemployed.
- The broader TREND in wage growth remains positive.
- Passivity doesn’t sell advertising and generally doesn’t drive AUM, but a little more patience and a little less manic punditry is probably the right prescription
Earlier this week the CBO released its analysis of the employment and growth impacts likely to occur should the federal minimum wage – as has been proposed by lawmakers - be raised over the course of the next three years.
Below we review the prevailing, conventional view of wage controls on labor economics, summarize the CBO’s main conclusions, and offer some additional commentary on the current state of the labor market and prospects for the slope of wage inflation.
THE IMPACT OF WAGE CONTROLS: THE TEXTBOOK
The scope of effects stemming from legislated wage controls are ranging but conventional economic analysis suggests a few primary, and non-mutually exclusive, impacts on employment and aggregate demand.
- THE SITUATION: Facing a direct drag on profitability from higher wage costs, employers are faced with a selection of tradeoffs and a few operational options. Broadly, and in the shorter-term, they can eat the full impact of higher human capital expenses, pass on all or some of the cost increase to consumers, or attempt to mitigate margin contraction via implementation of some combination of the two. Alternatively, if they judge they have excess capacity, employers can simply fire workers to help buttress profitability.
- THE IMPACT: A pass through of costs raises the price of goods /services for consumers and, all else equal, results in lower demand. In reflexive fashion, lower end-demand leads to lower production and, subsequently, lower demand for labor. This negative scale effect is somewhat constrained given the percentage of the total labor force impacted by the wage controls but, in effect, represents the canonical self-reinforcing cycle that characterizes larger contractionary cycles.
- Note that its largely a lose-lose proposition for employers as a cost pass-through ultimately drags on aggregate demand while a statutory increase in wage expenses serves as a de-facto income transfer from owners of capital to labor.
- SUBSTITUTION & SKILL SHIFT: Beyond the more immediate term, the rise in labor costs relative to other inputs of production (ie. technology) incentivize a shift towards increased use of technology at the expense of low-wage human capital. Further, employment of higher-wage workers may increase given generally higher productivity rates and the need for higher skill/specialization to operate/manage that new technology.
Ironically, rising demand for higher-skilled workers may perpetuate a recurrent, self-defeating cycle for policy makers as decreased/increased demand for low/high wage workers can serve to drive further wage disparity, ensuring a re-emergence of the same wage disparity dynamics lawmakers were targeting in the first place.
CBO’s CONCLUSION: On net, real income would increase by ~$2B.
- Employment: CBO estimates that an increase in the minimum wage to $10.10/hr by July 2016 would result in ~500K fewer jobs than would otherwise be created.
- Real Incomes: CBO estimates that aggregate real income would increase by $5B for low-income families and lift ~900K people above the poverty line. Further, real income for families between 3X and 6X the poverty line would increase by $2B on net and real income for families above 6X the poverty line would decrease by $17B on net.
GROWTH: Positive in the shorter-term, negative longer-term
The marginal propensity to consume is generally higher for low-income individuals. Thus, a legislated rise in income for low-wage employees is likely to flow through to consumption rather immediately.
However, over the longer-term, in which aggregate output is determined by the size of the labor force, the capital stock, and factor productivity, the CBO estimates a smaller workforce would lead to lower national output than would otherwise be the case.
So, on net, a legislated federal minimum wage increase would benefit low income families, primarily via an income shift from business owners and higher income families and would work to support consumption in the short-term while reducing per-capita GDP over the longer-term.
Source: CBO - HERE
LABOR’s BAD BANK: IS THE LABOR MARKET TIGHTER THAN IT APPEARS?
There’s a credible case to be made for a Good Bank/Bad Bank view of the current domestic labor market.
The current employment base and new workers with relevant skills (collectively “the good bank”) are in relatively good shape as initial claims base near frictional resistance and the economic stabilization matures while the long-term unemployed (“the bad bank”) remain unattached and in a terminal run-off of sorts.
SUPPORTING EVIDENCE: Initial Jobless Claims continue to move along near their historical, frictional lower bound at ~300K, the NFIB “Job Openings Hard to fill” Index continues to advance, Business Hiring Plans continue to make higher highs as does the Job Openings and Quits rate data in the JOLTS survey (Job Opening & Labor Turnover Report).
Further, recent research out of the Philadelphia Fed (HERE), which analyses worker flow and non-participation data from the BLS’s Current Population Survey (CPS), offers compelling evidence that nearly 80% of the decline in the labor force participation rate (LFPR) since the beginning of 2012 is accounted for by the increase in non-participation due to retirement (which, in turn, is driven by domestic age demographic trends).
This analysis, which sits in general agreement with our prior analysis (see: EARLY LOOK: PARTICIPATE), suggests the cyclical impacts of the recession on the LFPR have largely faded, and the secular drivers of the decline in labor force participation - which began in 2000 – are again reemergent.
Source: Shigeru Fujita, Federal Reserve Bank of Philadelphia (study link above)
So, there exists a fairly steady drumbeat of improvement across a range of labor market metrics.
DOES A TIGHTER (than it appears) LABOR MARKET AUGUR RISING WAGE INFLATION?
Recent research from the NY Fed (Here) examining the impact of unemployment duration on compensation growth suggests that long-duration unemployed exert less of an influence on wages than short-duration unemployed.
In the context of a good bank/bad bank labor market model, evidence that short-duration unemployment exerts a disproportionate influence on compensation growth argues that labor market slack may be less than total unemployment figures suggest and inflationary wage pressures greater.
CHICKEN OR EGG? Inflation, however, is generally a lagging indicator and wage inflation vs. broad price inflation presents as a chicken or egg problem. Specifically, can you get wage inflation without rising prices or accelerating demand?
On balance, evidence supporting wage pull inflation – rising wages sparking broader price inflation via a wage-price spiral - isn’t particularly convincing. Most arguments for higher wages causing higher prices pre-suppose higher demand or fail to address the initial reason wages increased to begin with.
Indeed, wage and unit labor cost growth moves largely in tandem with broader measures of price inflation and discerning the direction of causality isn’t clear.
Overall, it’s hard to argue for any material/sustainable wage inflation in the absence of a broader rise in prices or without rising demand or an acceleration in credit expansion and/or corporate investment.
Source: Linder, Peach, and Rich (study link above)
SURVEYING WAGE TRENDS
Despite near universal lamentation about the lack of wage inflation, the Trend in salary and hourly earnings growth has been positive. Below we profile a number of the primary measures of wage growth. Generally, on both a 1Y and 2Y basis the slope of improvement remains positive across each of the metrics.
Pulling the charts back, however, reveals the chief source of economist discontent. While we’ve experienced consistent, ongoing (albeit slow) improvement in wage growth, we remain well below historical averages. For example, nominal earnings growth for production and nonsupervisory employees currently sits just above 2% vs. a long-term historical average of ~3.1%.
- Real Wage Growth for Non-Supervisory Employees: The plight of middle and low income earners has been well advertised and the chart below has been well circulated. As can be seen, while the trend in growth has been positive over the NTM, real wages for production and nonsupervisory workers haven’t advanced in over four decades.
- Private Sector Wages: On both a 1Y and 2Y basis, real hourly earnings of private sector workers continues to improve.
- Aggregate Private Sector Salary & Wage Income: The combination of employment gains and wage growth continues to support growth in aggregate private sector salaries and wages with growth currently running +5% on a 2Y basis. Notably, State & local gov’t employment growth has been positive for 5 straight months now and December’s budget deal which modified sequestration was spending friendly on the margin – so there’s some positive momentum for wage & salary income.
PATIENCE OR PROTRACTED PENURY?
The frustration and impatience on the pace of the recovery that pervades media reports and pundit commentary offers an interesting juxtaposition against the almost universal acknowledgement that balance sheet crises and the back end of long-term credit cycles invariably augur protracted periods of sub-trend growth.
We’ve purposefully offered a one-sided take highlighting the evidence that the labor market may be tighter than it appears superficially and there are certainly credible arguments supporting the case for secular stagnation. There’s little argument that the pace of the recovery remains stubbornly slow, but broader labor market trends remain positive.
Passivity doesn’t sell advertising and generally doesn’t drive AUM, but a little more patience and little less manic punditry is probably the right prescription
Christian B. Drake
Takeaway: Quiksilver is one of our top long-term ideas. We think that consensus has it all wrong.
Editor's note: This unlocked research note was originally published February 06, 2014 at 14:53 by Retail Sector Head Brian McGough. For more information on how you can subscribe to Hedgeye click here. Institutions please ping email@example.com.
Note: Our goal today is not to present a complete bullet-proof bull case on ZQK, but rather to share some of the building blocks of our call, and set the stage for a more comprehensive research product that we expect to present in the coming weeks.
ZQK is one of our top long-term ideas. We think that the consensus view has it all wrong.
Those who are bullish are focused around the new management team, cost cutting, and optimization of a broken organization. While we agree with those points, the reality is that those initiatives will only get the stock into the high single digits. Which doesn't get us too excited given that the stock is already pretty much there. In order for us to build confidence in ZQK as a BIG call from here, we need revenue growth. We were skeptical at first – probably because the company hasn’t grown its top line in about 5 years. Yeah, we really like new management – and quite frankly are surprised that the Board attracted such high quality – but if you hand a bunch of broken and saturated brands to even the best management team, we’re pretty sure it will be a colossal failure. Fortunately, our research suggests that's not the case here.
We conducted an extensive analysis based on insight from a diverse group of Action Sports consumers, and walked away with confidence that the ZQK brands are far more relevant and authentic than we suspected. There’s very little that needs to be done to get these brands to a point where the new ZQK management team can kick-start growth.
While we’re only slightly ahead in 2014, our revenue estimate in the out years is 23% ahead of consensus. We also think that ZQK has well over $1.00 in earnings power, which is more than 50% ahead of consensus. A buck in earnings on top of a $7 stock certainly grabs our attention.
Accordingly, this is the first of a series of notes that outlines some key factors behind our thesis, with this report focusing specifically on brand desirability and authenticity. The data referenced is based on a statistically valid survey of 1,000 Action Sports consumers.
Later in this series, we’ll ultimately build up, in specific detail, how and why we are different than the Street as it relates to categories, brands, consumers, and geographies. If you’d like to listen to our original presentation on ZQK, click the following link (http://app.hedgeye.com/m/n_T/a'R(u6/zqk-survey-conference-call).
Question #1: Brand desirability remains high
It goes without saying that underinvestment in ZQK's core brands has hurt top line growth trajectory, but brands have bent - not broken. We asked consumers to rank the following brands in the order that they would purchase if price was taken out of the equation – which we translate as ‘desirability’. In charting out the results (see chart below), ZQK brands scored towards the higher end of the peer group. Vans, Nike S.B., etc. have stolen share over the past few years, but not to the extent that we had anticipated. Quite frankly, we expected ZQK’s brands to score near the bottom. This was clearly not the case.
Question #2: Core consumers still like the brand
One of our greatest concerns headed in to our study is that we’d find out that Action Sports Enthusiasts would consider Quik, Roxy and DC as being too mainstream. Unfortunately, once a brand becomes mainstream, there’s really no coming back. Again, we thought we’d learn that ZQK scored near the low end of its’ peer group. In reality that simply was not the case. Did it do as well as Nike, Vans and Converse? No. But it outscored well over a dozen other brands (some are not pictured here), and proved to be well above average. In a perfect world we’d like higher scores, but the bottom line here is that the survey tells us that ZQK's core consumers have not given up on the brand. Not by a long shot.
Question #3: Repurchase Intent
The worst thing a brand can do is fire its consumer. It’s abundantly clear to us that ZQK did not go there. A company can fix distribution, product, and brand messaging, but it’s nearly impossible to get consumers back when they've said they are gone for good (i.e. LULU).
So we asked questions to gauge people’s intent and willingness to purchase product in the future. The groupings to the right side of the chart show the percent of people that indicated they would ‘likely’ or ‘definitely’ shop these brands in the future. Any way we slice it, we think that the numbers are impressive. But the key area to look at is the cluster of three columns to the far left. This is where we ask people if they will ‘never shop this brand again’. We ask this in all the surveys we conduct, and by far and away ZQK’s reading ranked among the most favorable. Only 2.0%-2.5% of consumers say that they’ll never return – and we’d argue that Roxy’s high reading is a function of older teens having outgrown the core product.
Question 4: Power Rankings
One of the ways we rank brands is in what we call a ‘Power Ranking’. In effect, it takes into account two factors. 1) Where the brand ranks in consumers’ desirability and awareness, and then 2) the revenue base of the brands. Why does that matter? Everybody is aware of Converse and Vans. But not necessarily the case with much smaller brands like DC, Volcom, and Etnies. So we take the brand factors, and we adjust for the size of the revenue base it generates. It’s one of the best ways we can normalize stats across companies.
Surprisingly, in our Power Rankings, ZQK is beat by only one brand – Hurley (owned by Nike), which has a surprisingly strong awareness relative to its size. But DC and Roxy registered particularly strong results. Quiksilver came in at 0.9x, which is in-line with Converse, Vans and Volcom. Overall, a good showing.
The Bottom Line
Our goal here today is not to outline a complete bullet-proof bull case, but rather to share some of the building blocks that will lead to a research product that we expect to present in the coming weeks. This is only 4 of 52 slides we have in our deck, and our data files include much more information.
Please contact us if you want more info.
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