The REAL CIT Investment Theme

The REAL CIT Investment Theme

People are asking all the wrong questions about CIT - it's not about direct exposure to CIT - but rather derivative exposure to a) the small, non-public companies that will be hurt, and 2) the private equity portfolios that will be pushed to brink.

With CIT on the ropes, we're getting barraged with speculation related to which companies have exposure to CIT financed receivables.  In addition to the work we're recently published, there are a couple of facts to consider before making broad generalizations...

  1. According to the American Apparel and Footwear Association, 60% of the factoring volume in apparel/footwear is exposed to CIT. Yes, this is a scary number at face value.
  2. But it's smaller than one might think when put into context. CIT disclosed that in 2007 its factor exposure to the footwear industry was $2bn. We also know that this is a $60bn industry at retail, or which about $35-$40bn is wholesale (here the exposure lies).
  3. Stronger companies with exposure to CIT have been shifting away from CIT over the past 3 months as they played offense given what was coming down the pike.
  4. These 'exposure' numbers thrown around are annual. Yet we should be thinking of them as a snapshot in time - and a snapshot in time taken at the beginning of summer, when working capital needs in this area of the supply chain are low.

One of the most important points we can't forget is that CIT operates BOTH a factoring business and a commercial lending business.  Some larger companies, including GIII, have revolving credit agreements that include CIT as part of their lending consortium.  However, this is quite different than having CIT as a "factor".  Factoring is a transactional based process which is conducted on an invoice by invoice basis.  In general, it is not cost effective for a larger company to use CIT for this service.  With that in mind, CIT has 300,000 small and medium sized customers of which the majority are producing annual revenues of $10m or less.

What does all this add up to? There's no company-specific call as it relates to individual exposure to CIT. But where the juice lies is related to 1) the rate of bankruptcies of small, non-public companies, and 2) the private equity hangover.  The first point is pretty simple. The second is more complex.

What do I mean by pe hangover? Take a look back over 4 years at all the LBO transactions in retail. These were done when cost of capital was falling, and halfway decent ideas made millions for Average Joe Private Equity Guy. Now private equity firms are saddled with many weak businesses that are barely profitable - and that's before paying interest expense in a rising cost of capital environment.  So what does this all add up to? We need to drill down on the portfolio of each major private equity player to assess the domino effect.  For example, Leonard Greene owns Sports Authority, PetCo and part of Whole Foods. If PetCo goes punk, then there's less of an appetite to invest in TSA, which ultimately raises the prospect of filing for protection. The derivative play would be a positive one for Dick's in the case of TSA, and PetSmart in the case of PetCo.  These are just illustrative examples, but I think you get the point.

We have done meaningful analysis on the historical transactions. Please contact us for more detailed info.  We'll be using this as a source for new investment ideas in weeks and months to come.



Some Notable Call Outs

- The first day of business for ANF's flagship Hollister store in NY was reported to have been crowded and well received. However, upon more careful inspection of the clientele roaming the store, it became apparent that ANF hired customers (models) to mill about and fill the store. I remember the unveiling of Reuhl to the analyst community which included a mysteriously good looking staff, but this is a whole new approach to experiential marketing. Or better yet, a new way to create the appearance of demand on day one of this very costly, high profile Manhattan location.

- In a conversation with Charming Shoppes, we learned that the company is becoming more bullish and committed to its ecommerce opportunities. Earlier this week the company hired new leadership for each of the company's three brands. With ecommerce at only 4% of total sales and fulfillment infrastructure already in place, we expect to see this business grow measurably as the core retail chain is right-sized. And because we had to ask, the company does not have any direct relationship with CIT but does have a few small vendors that do.



- Bangladesh and the apparel manufacturing industry - The apparel manufacturing industry has started to heal after labor unrest, arson attacks and vandalism last month that left two workers dead and hundreds of people injured. A major apparel factory, Ha-Meem, was destroyed by fire in the suburb of Ashulia. Ha-Meem's customer portfolio includes major U.S. firms such as American Eagle Outfitters Inc., Gap Inc., J.C. Penney Co. Inc., Kohl's Corp., Sears Holdings Corp., VF Asia, Target Corp., Charming Shoppes Inc. and Wal-Mart Stores Inc. Bangladesh still bears the impact of layoffs, wage cuts and the resulting violence, but production has resumed and exports are getting back to normal, manufacturers said. "We are trying to keep supplies to our buyers abroad unaffected in spite of destruction of 90% of our production facilities that was burned down," said Nazrul Islam, executive director of Ha-Meem Group. <>

- Poor countries to experience economic slowdown - The world's 49 poorest countries have been hit hard by the global economic downturn, including the export-dependent apparel sectors in some nations, a United Nations report said Thursday. The study forecasts the 49 nations will grow this year by only 2.7%, down from the 7.4% growth they averaged between 2003 and 2008. The slowdown forecast is 2.1% if Bangladesh, which accounts for about 25% of the total gross domestic product of the group of Least Developed Countries, is excluded. The report, compiled by the U.N. Conference on Trade & Development, concludes that poor African nations are likely to be "more severely affected" than Asian counterparts such as Bangladesh, which have more diversified economies. <>

- Mauritius plans to send back Bangladesh migrant workers - In face of acute financial crisis, the Mauritius government is planning to send back thousands of Bangladeshi migrant workers, a majority of whom work in garment factories in the country.  By taking this action of repatriating migrant workers, the government is attempting to save jobs for local people. There are great concerns over whether the repatriated workers are able to get jobs back home of which the clothing industry has also been hit due to the global slowdown. <>

- Obama administration and trade - The Obama administration will seek to lower trade barriers U.S. companies face abroad and increase pressure on countries to correct labor violations as it puts enforcement center stage in trade policy, U.S. Trade Representative Ron Kirk said Thursday. <>

- Kellwood Co. has bought itself a few more days of breathing room - The apparel firm has reached an agreement to extend the maturity date of $140 million in notes until Friday at midnight. A deadline of midnight on Wednesday passed without a resolution. In addition, the company reached a forbearance agreement with its lender. The agreement allows for the financing to stay in place so that a default on the notes wouldn't trigger any covenants and jeopardize a shutdown of the loan facility. <>

- Nordstrom at the top of a luxury report - The Luxury Institute reported Thursday that Nordstrom department stores ranked first in its annual report of top-rated high-end retailers. According to the results of its annual Luxury Customer Experience Index, Neiman Marcus was rated second and Brooks Brothers rated third among wealthy consumers who were polled online about such areas as satisfaction, personnel and store environment.  <>

- ASPs for outdoor footwear increased in June - Average selling prices for outdoor footwear inched up ever so slightly in the month of June, led by strong increases in the sport specialty retail channel, according to retail point-of-sale data compiled by SportScanINFO. The slight increase for the month of June versus the year-ago period was negatively impacted by a 4.2% decrease in average selling prices in the full-line sporting goods channel as promotions took their toll. <>

- UK disposable income decline slows down - UK Households' disposable income declined at a slower rate in July than previous months, but spending remained broadly unchanged. <>

- Extra rainfall will boost Australian cotton production 10% in 2010 - Australia is expected to raise its cotton production by 10% in 2010, according to an industry executive, because of strong gains in this year that came after heavy rainfall boosted the crop. Gordon Cherry, chief executive of Australia of Dunavant Enterprises Inc, said this year's crop increased to 1.45 million bales which is the best for four years and double last year's drought-affected amount of 700,000 bales. "Prospects for next year are quite good and if we get spring rain they will be even better. There may be 10% more harvested next year than this year," said Cherry. <>

- South Korea's Department Store Sales Climb 3.6% in Fourth Monthly Increase - Sales at South Korea's major department stores rose for a fourth month in June as consumers bought home appliances and accessories amid signs the economy is recovering from the global recession.  <>

 - Despite bigger discounts, France's summer sales have flopped - L'Institut Français de la Mode (IFM) - the French Fashion Institute in English - reported business over the first two weeks of sales, which began on June 24, was down between 3% and  5%. Hypermarkets suffered the biggest decline, with sales down at least 10%. Only department stores managed to maintain 2008's levels. Traffic appeared to be in strong decline at a majority of the retailers surveyed, and the average shopping basket was also less than last year's. The FEH said when sales kicked off the discounts were noticeably higher than last year, which weighed on retailers' business. The FEH said its members had anticipated a decline in consumption and adjusted their buying patterns and inventory levels. Sales continue across France until July 28. <>

- Redcats management changes - Redcats, the home-shopping unit of French retail-to-luxury group PPR, has reshuffled the top management of fashion and home furnishings catalogue La Redoute in a bid to improve its competitiveness. Nathalie Balla has been named managing director of La Redoute, effective Aug. 31, and Redcats' chief executive officer, Jean-Michel Noir, will become chairman of the unit. Balla and Noir will replace Nicolas Bernard, who is leaving the helm of La Redoute because of "diverging views" with management, Redcats said. Bernard, a Redcats veteran since 1982, had been ceo of La Redoute since May 2008. <>

- Eddie Bauer auction in progress - The bankruptcy court auction for bankrupt Eddie Bauer Holdings Inc. started late Thursday and, at press time, was expected to continue into today.  According to sources at the auction, VF Corp., which expressed interest earlier in the week, is looking only at the intellectual property assets of Bauer. Other bidders are understood to be stalking-horse bidder CCMP Capital Advisors LLC, an affiliate of Rainier Holdings; private equity firm Golden Gate Capital; Iconix Brand Group Inc., working in tandem with an unidentified strategic retail partner, and liquidation firms Gordon Brothers and Hilco Consumer Capital, which are said to be planning a joint bid.  A hearing is set for July 22 to approve the buyer selected at auction.  <>

- Tiffany and eBay lawsuit in appeal court - The five-year legal battle between Tiffany & Co. and eBay Inc. moved to a federal appeals court on Thursday. The two sides agree on at least one thing: there are counterfeits for sale at the online auction house. But they differ on whose duty it is to prevent those knockoffs from being sold, which formed the crux of legal arguments before the U.S. Second Circuit Court of Appeals.  <>

- Bloomingdale's has new brand with new fiber - Bloomingdale's will devote some of its floor space this fall to showcase not just a new brand, but a specific fiber. The high-end retailer has agreed to introduce an in-store shop concept exclusively featuring a collection of apparel made from Supima, the brand of extra-long staple cotton grown in the U.S. The fiber is generically known as pima cotton. The Bloomingdale's flagship here on 59th Street will launch the concept in September near its men's department with a collection of T-shirts, henleys, hoodies and other luxury basics. Following the launch at the flagship, Supima in-store shops will open in Bloomingdale's SoHo location here and then on to 16 stores across the country.  The goal will be to expand the Supima apparel brand into from knits into more categories, including underwear and slacks. <>

- Carrefour SA reports sales declines - Carrefour SA, the world's second-largest retailer behind Wal-Mart Stores Inc., reported a 1.2% decline in second-quarter sales Thursday. Sales from established stores dropped 2.2% in the quarter. Carrefour said it saw some encouraging results during the second quarter, including market share gains in France; the testing of new store concepts such as discount brand Dia and convenience supermarket Carrefour City; the turnaround of its troubled operations in Belgium and Italy, and faster growth in Brazil and China. <>

- Callaway Golf lowers full year estimates - Callaway Golf Co. poor Q2 results prompted the company to lower its guidance for the rest of the year. Changes in FX rates adversely affected net sales by approximately $19 million. <>

- Spyder Active Sports, Inc. named Thomas McGann as its new CEO - McGann was formerly president of Burton and CEO of Motorsport Aftermarket Group. He replaces Jake Jacobs. <>

- VF promotion for its Outdoor & Action Sports EMEA group - VF International promoted Patrik Frisk to president - Outdoor & Action Sports EMEA, responsible for the JanSport, The North Face, Reef and Vans brands in the EMEA (Europe, Middle East and Africa) region. <>

- Zumiez settles class action lawsuit - Zumiez reached a tentative agreement to settle a class-action lawsuit in California for about $1.3 million. A former employee accused Zumiez in the lawsuit of not paying all the overtime it owed him, not providing meal breaks as required by California law, and not properly itemizing pay stubs, among other things.  <>

- Wal-Mart, Best Buy Are Sued by Chinese Company Seeking to Block Knockoffs - Best Buy Co., Wal-Mart Stores Inc. and other companies were sued over dashboard mounts for navigation devices in a rare case of a Chinese company seeking to enforce patent rights in a U.S. court. <>

- Negative article on Crocs - Many people were ready for the Crocs trend to be over even before the shoes hit stores in 2002. Blogs were launched that attacked the shoe company for its colorful $30 foam footwear. Maxim even named Crocs one of the "10 Worst Things to Happen to Men in 2007." Now, the company has until September to pay back its losses. But as people continue to throw their Crocs in the back of the closet, the company is left with a surplus of shoes and little consumer interest.

- Nine West is looking for the voice of its Vintage America Collection - The fashion retailer tapped singer/songwriter Miranda Lee Richards to help conduct an online talent search at The winner of the "Vintage America Voices Contest," which began July 14, will receive the opportunity to record and release a single through Sony/ATV Music Publishing's in-house label, Hickory Records. Judges include Richards, Nine West Creative Director Fred Allard, Lucky Merchandising Director Rebecca Babcock and Co-President of Sony/ATV Music Publishing Danny Strick. The winner will be announced Sept. 16.  In addition to landing a single record release through Sony/ATV, the winner will be featured in the December issue of Lucky, receive Vintage America product, and the opportunity to meet Miranda Lee Richards. Lucky partnered with Nine West to promote the campaign.  Richards is promoted extensively at where fans can download her new single, "Early November." <>



RL: Ralph Lauren, CEO & Chairman, sold 127,600shs ($6.8mm) less than 1% of common holdings as part of 10b5-1 plan.

HIBB: Michael Newsome, CEO & Chairman, gifted 5,000shs ($90k) less than 2% of common holdings.

TJX: Carol Meyrowitz, President & CEO, sold 46,568shs ($1.6mm) less than 10% of common holdings.

ROST: Gary Cribb, Executive VP & COO, sold 99,057shs ($4mm) roughly 60% of common holdings.

NKE: Trevor Edwards, VP, sold 16,000shs ($830k) after exercising the right to buy 16,000shs as part of 10b5-1 plan.

RBI: Richard Ellman, Director, purchased 2,304shs ($20k) increasing common holdings by ~50%.

RBI: Jeff Davidowitz, Director, purchased 2,304shs ($20k) increasing common holdings by ~30%.

RBI: Williams Watkins, Director, purchased 2,304shs ($20k) increasing common holdings by ~15%.



The REAL CIT Investment Theme - SV 7 17 09



200-Moving Monkeys

"Monkeys are superior to men in this: when a monkey looks into a mirror, he sees a monkey."
-Malcolm de Chazal
Irrespective of the 200-day Moving Monkeys clanging for cover, you may have noticed that some actors in this circus continue to take themselves very seriously. And maybe they should. This is a serious game of storytelling. Particularly for those without a mirror.
I might write a children's story about them. Maybe a Curious George tale. Or better yet, how about a "best of" You Tube video? Are all Moving Monkeys the same? Or do they rotate cages on those 6 panel CNBC shouting matches when shown the green banana of an up market day? Who eats green bananas anyway?
At yesterday's bright green 940 close, the SP500 is 0.6% off her YTD high. No, these returns are not Chinese (+75.2% YTD). No, these are not the returns of a Great Depression either. These super special 2009 YTD returns for the SP500 (+4.1%) are especially for the monkeys.
They are for Merideth Whitney, who launched her firm as bearish as you could be before the most expedited short squeeze in modern history. They are for Nouriel and Garty. Never mind if one was hyper bearish at the March lows and the other last week - who cares about some silly accountability metric like a +39% rally from March 9th or a +7% one from July 9th? This is the CNBC zoo where professional monkeys rarely have to be called out on the instant replay.
Our Q3 Investment Theme call of Range Rover remains. Buy the SP500 at 871. Sell at 954. As the monkeys clang for crashes and bubbles just sit back, take your time, and manage risk around their noise.
Research Edge is an accountability mechanism. Every position, its timing and price - it all has a time stamp. Have I been early shorting things this week? Sure, but I was also early buying things too. On July 9th, with the SP500 closing at 982, I had my highest invested position of 2009. That's not me trying to get a helicopter ride to my next media event - that's just shot that I decided to take.
On May 27th, 2009 I agitated the consensus bears when I wrote an Early Look titled "Roubini The Revisionist" - suggesting that the former professor turned manic media rockstar was going to fly his helicopter of pessimism into a wall. This morning, his revisionist tales are next to impossible to comprehend. Are you bullish? Are you bearish? If the recession ends in 5 months, do you stay short that lagging economic indicator until that day? Martini or caviar?
The New Reality remains: as everyone is trying to call for crashes and bubbles AFTER they occurred, we're just going to trade in a proactively predictable range.
As we squeeze the temples of consensus to the high end of my range, I will be selling. When and if we revisit the low end of my range I will be buying. Monkey hockey player, yes I am. Monkey say as monkey do.
The Volatility Index is broken across all 3 of my durations (TAIL, TREND, TRADE), the yield curve (10 year US Treasury yields minus 2's) is 260 basis points steep, and the TED Spread (my best measure of counterparty risk) is as narrow as it gets - only 34 basis points wide.
These cross asset class risk management facts were not a whole heck of a lot different on July 9th. The only thing that's changed is Wall Street's narrative. We are seeing an unprecedented level of groupthink impact what used to be the world's finest financial system. While not as concerning as piling leverage on top of leverage, it's getting close. Larry Kudlow is not a fiscal fiduciary. He is a partisan perma bull with a TV contract.
The only way out of this is to take away the bananas and put the monkeys on mute. That will be most effectively achieved by raising the Fed funds rate. Don't forget that the steepest the US Treasury yield curve has EVER been is 270 basis points wide. All that means is that the short end of the curve is politically compromised and conflicted. When that happens, three constituencies get paid: Debtors, Bankers, and Politicians.
Every payout to Washington/Wall Street has a payer. As the Buck Burns, so do our Creditor's anxieties. Them Men and Women with the Yellow Hats be Chinese and American. If you want to earn a rate of return for being fiscally responsible (saving), this Fast Money trade aint for you.
Whether its weak demand for Chinese government bond sales last night or the government of Hungary issuing 5-year debt this morning at 6.8%, the long term cost of capital in this world is going higher, not lower. Capital in an interconnected global financial system has no religion. It's not political. Over time, savers seek rates of return on their moneys. Japan and the USA don't get that yet. Over time, I hope they do...
Hope, of course, is not an investment process. As cost of capital heightens... and the access to it tightens... the 200-Moving Monkeys at GE's financial entertainment division will go away. That's when I'll call this a bull market. For now, this is just a circus of clanging monkeys, and I am happy to trade the range of their predictable behavior.
Have a great weekend,


USO - Oil Fund-We bought USO on 7/6 and 7/8 on a pullback in oil. With the USD breaking down, oil should get a bid.  

EWZ - iShares Brazil-President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt -leading to an investment grade credit rating. Brazil has managed its interest rate to promote stimulus. Brazil is a major producer of commodities. We believe the country's profile matches up well with our re-flation theme.

CAF - Morgan Stanley China Fund - A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth.

CYB - WisdomTree Dreyfus Chinese Yuan - The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP- iShares TIPS - The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%. We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

XLV- SPDR Healthcare - We re-initiated our long position in healthcare on 6/29.  Our healthcare sector head, Tom Tobin, wants to fade the public plan, and he's been right on this one all year.

GLD - SPDR Gold - Buying back the GLD that we sold higher earlier in June on 6/30. In an equity market that is losing its bullish momentum, we expect the masses to rotate back to Gold.  We also think the glittery metal will benefit in the intermediate term as inflation concerns accelerate into Q4.

XLI - SPDR Industrials - We don't want to be long financial leverage, which is baked into Industrials.

EWI - iShares Italy - Italian Prime Minister Silvio Berlusconi has made headlines for his private escapades, and not for his leadership in turning around the struggling economy. Like its European peers, Italian unemployment is on the rise and despite improved confidence indices, industrial production is depressed and there are faint signs, at best, that the consumer is spending. From a quantitative set-up, the Italian ETF holds a substantial amount of Financials (43.10%), leverage we don't want to be long of.

DIA  - Diamonds Trust- We shorted the financial geared Dow on 7/10, which is breaking down across durations.

EWJ - iShares Japan -We're short the Japanese equity market via EWJ on 5/20. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

XLY - SPDR Consumer Discretionary - We shorted XLY on 7/9 on a rip as our team has turned negative on consumer.  

XLP - SPDR Consumer Staples - We shorted XLP on the bounce on 6/17.   Added to the position on 7/1, as our stance on the consumer is no longer bullish like it was in Q2, when gas prices and mortgage rates were dramatically lower.

SHY - iShares 1-3 Year Treasury Bonds - If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic


We won't see the words NO and VACANCY anywhere on the Strip in 2010. Hotel supply growth has been on a tear since late 2007 while demand has cracked. And we're not done yet.

The chart below shows that Las Vegas Strip visitation levels are back to 2004 levels, on a TTM basis.  Over the same period, room inventory increased 10%.  The supply/demand situation is about to get much worse.  With visitation still potentially falling, room inventory will jump another 9% by the end of 2010.  Is the CityCenter/Fontainebleau/Cosmopolitan triumvirate enough of a draw to drive a 9% increase in visitation?

PLENTY OF ROOMS AVAILABLE AT THE STRIP INN IN 2010 - strip vis vs room supply

While visitation to Las Vegas may have gotten "less bad", it will need to improve materially to offset the new supply that is on the way. CityCenter is opening in December 2009 with 5,900 rooms, followed by Fontainebleau and Cosmopolitan, both likely to open sometime in 2010, adding another 6,800 combined.  CityCenter is billed as being "destined to be one of the great urban places of the world", according to its website.  It will need to live up to that billing and more to attract the 1.1 million incremental visitors necessary (assuming two guests per room) to offset the new supply.  Unlike The Mirage and Bellagio before it, CityCenter is more of a residential product that may lack the "wow" factor to drive significant incremental visitation to Las Vegas.

High-end properties will be hit hardest by the new supply.  The cumulative supply additions represent a 57% increase in the current number of high-end rooms on the Strip. It is difficult to imagine that the market will be able to absorb this increase in the current economy with, at best, a "tepid" recovery on the way in 2010.  We believe that the incremental rooms will generate little new demand and will end up diluting the market for the existing Strip players particularly impacting WYNN, LVS, and MGM. 


As a reminder, RevPAR is already on a big time decline.  YTD RevPAR is down around 30%.  The only question now is whether 2010 or 2011 will be the RevPAR trough, because it doesn't look like it will be 2009.

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It seems that once a month someone spreads the rumor that Beijing is loosening the strings. We've said it before but Beijing is always tinkering but never fully opening or closing the spigot.

As can be seen in the following chart, it didn't take long for Beijing to stabilize the Mass Market.  Beijing began controlling the border in June of 2008 and by September Mass Market revenue growth was reduced to 5%.  From September to the present, growth was consistently in the range of +9% to -5%.  We don't have the data but our guess is the volume was even more stable.  I'd say the Beijing powers are quick learners.

VISA REFRESHER - macau mass market rev

It has been my belief that Beijing is interested in keeping Macau growth consistent with the growth in China GDP; that is, mid to high single digits.  The evidence certainly bears that out.  This is good and bad for the operators.  Certainly, over the long-term, this kind of stability warrants a high valuation in terms of cash flow multiples.  Unlike most gaming markets there is excess demand for Macau and Beijing is the stabilizer.  The downside is more near-term.  As Macau approaches a 6 month period of 25%+ Mass table supply growth beginning in December, same store revenue will plummet.  It is unlikely that Beijing is targeting mid to high single digit same store growth for Macau.

So don't believe the rumors that Beijing is somehow going to completely pull its big finger off the big hole in the dike to Macau.  Moderation is the likely goal here and to date, Beijing has succeeded.


Research Edge Portfolio Position: Long CAF

The NBSC Q2 GDP release registered at 7.9% year-over-year growth for a total of CNY 7.4 trillion (based on current price, production approach).

FULL STEAM - barber345

This headline growth data was accompanied by slew of other positive data points: Industrial Output increased by 10.7% Y/Y in June, Fixed Investment rose to 33.6% (cumulative) and Retail Sales register a 15% increase for the month.  On the heels of this data, the Shanghai composite rose by 1.4%, lifting the total capitalization of Chinese public equities above Japanese stocks to retake the status of second largest global equity marketplace.

On the heels of yesterday's blockbuster M2 and Reserve figures the rearview mirror for Q2 supports the bullish thesis we were espousing at the time: that the enormous amount of money being put to work by the central government would shock the system back into motion through sheer force while tax incentives and subsidies would encourage increased internal consumer demand.  Now that the stimulus is baked into the equation and our Q1/Q2 thesis has played out, we face a diverging path ahead.

As I commented yesterday, the massive infusion of credit has created real systemic risk and consumer demand -though resilient, will not be able to broaden to the extent necessary to offset the decline in external demand in the near future.  As we move forward, our focus will be on identifying specific sectors and industries in the Chinese market and we will be proactively managing risk as the likelihood of a short term correction has increased significantly in our opinion.

Andrew Barber


SBUX - Breaking Out of the Past

SBUX is scheduled to report fiscal 3Q09 numbers after the close next Tuesday, July 21 and I would expect the company to continue the trend of beating EPS expectations ($0.22E vs. consensus of $0.19) despite continued weakness in top-line numbers. Fiscal 3Q09 should mark a return to double digit operating margins, the first quarter of YOY operating margin improvement for SBUX since 4Q07 and the company's U.S. segment should post its first quarter of margin expansion following 12 quarters of declines. And, this is based on my expectation of a 5%-6% decline in U.S. same-store sales, which would signal a sequential improvement from the 8% decline in 2Q09.

The real benefit to margins in the quarter and going forward will stem from the company's goal to eliminate $500 million of costs in FY09, $345 million of which should be implemented by the end of 3Q09. Although SBUX will continue to feel some pressure on the cost of sales line as a result of the fixed cost nature of occupancy costs, lower dairy and coffee prices should minimize the deleveraging effect of continued same-store sale declines.

With the company having launched its first national advertising campaign in May (mid Q3), I am most interested in hearing about how the campaign is being received and the impact it is having on driving customer traffic. Specifically, was the company successful in continuing its trend from 2Q of reducing traffic losses on a sequential basis? My 5%-6% U.S. same-store sales decline estimate relies on a quarterly sequential improvement in traffic. Easier YOY comparisons, new advertising, the company's first limited time promotion of iced coffee for $1.95 (initiated in May through the end of the quarter) and the results from my May "Grass Roots Survey" all make me comfortable with this assumption.

SBUX management commented on last quarter's earnings call that the marketing campaign "will build over time" so I am not expecting that the marketing will have made a big impact on Q3 results, but increased communication to consumers can only help. The company did state that it is not significantly increasing its advertising spend and instead, it is making a long-term investment. As I have said before, I think SBUX needs to spend $300-$400 million in the U.S. to have a share of voice that will make it competitive with its peers. Although Starbucks will not get to this level of spending right away, I would like to hear more about the direction and magnitude of the new advertising campaign, which I think is essential to the long-term success of the brand.

From a cash flow perspective, SBUX should continue to demonstrate its ability to generate significant cash even in a tough environment. With an estimated 25% YOY decline in capital spending, SBUX should be able to pay down more debt in the quarter and further strengthen its balance sheet.

SBUX - Breaking Out of the Past - SBUX EBIT Margin 3Q09E


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 80.52%
  • SHORT SIGNALS 78.70%