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Russian Banking Woes

OAO Sberbank reported today that first-half net income fell 92% to 5.3 Billion Rubles or $170 Million from a year earlier. In our post “Ripples In Russia” from 7/17 we highlighted the underlying fundamentals that may pose intermediate to TAIL term risk to the performance of the Russian stock market (RTSI). Sberbank’s 1H ’09 numbers today underline the precarious situation of Russian banks, struggling with low capital levels due to the rise in bad loans, the depreciation of asset values and non ruble debt -while the Kremlin continues to provide assurances that banks will continue to lend. Can the center hold?

Prime Minister Putin, who has increasingly taken on responsibility for leading the economy, was on the tape today saying that Sberbank, the country’s largest bank, should keep lending and not close branches, calling 14% an acceptable interest rate for banks to charge. (In context, 14% represents a 300bp premium over the central bank’s current refinancing rate.) 

Transparency and accountable remain major issues when talking about the Russian economy. That said, it’s painfully obvious that the undercapitalized banking sector is in a precarious position and something has gotta give. At this point a bank bailout would be a tall order that would certainly blow out the government’s debt ratings, and further delay the country’s longer-term recovery process.

We’ll have our Eye on Russian banks, while respecting the high correlation between RTSI energy/commodity prices.

Matthew Hedrick
Analyst


Gold: Consensus Isn't Bullish Enough

On February 19th I wrote an Early Look titled “Long America, Short Gold”. For those of you that are new readers, I point that out for accountability purposes as I recall taking plenty of heat from the momentum chasing community for shorting gold.

Having already laid claim to people being “too bullish” on gold then (citing Einhorn making it his largest position at the time!), I beg for your attention to hear me know – I think consensus on gold is no longer bullish enough.

Most of you know that I want to be long what The Client (China) needs, and short what American bankers want them to need (US Treasuries, US Dollars, etc…). Gold is one of those things that China needs a lot more of. China recently reported holding 34M/oz of gold (1054 tons), but that makes them only the 5th largest holder of gold, globally, despite having the most open currency to buy more with.

There are 2 numbers that really matter here:

  1. $1.4 Trillion – that’s $1.4T out of a total $2T in Chinese reserves are in US Dollars/Treasuries
  2. 1.6% of Chinese reserves are in Gold

The average central bank holds at least 10% of their country’s reserves in gold. The Chinese are not interested in gaining exposure to any more US Dollars. Therefore the demand equation here is very straightforward. China needs more gold.

To get to 10% of reserves in gold China would actually need to buy another 5,000 tons. So next time someone tells you “the IMF” is selling 100 tons, send them the math in reply.

Gold, contrary to Mr. Bernanke missing it (inflation coming in Q4), is now breaking out to the upside. Andrew Barber and I have outlined all 3 durations for the price of gold in the chart below. Long term TAIL support remains $871/oz, and the immediate term breakout TRADE line = $931/oz.

Keith R. McCullough
Chief Executive Officer

Gold: Consensus Isn't Bullish Enough - gold

 


Sports Apparel Weekly Data Update

The latest weekly sports apparel data highlights a marked deceleration in the industry across all channels, with the exception of Family Retail (Meyer, JC Penny, Sears, Stage Stores).  The largest sequential delta in the data comes from the sporting goods channel, which posted a decline of 1.5% for the week vs. a  4.5% gain in the week prior.  Underlying this trend was a large 18.5% decline in the New England region, followed by a 8.7% drop in the Mid-Atlantic.  Additionally, when looking at the distribution channels, there was a positive result of 2% for the full line stores offset by large declines in urban/athletic and internet/catalog.  Average selling prices remained positive for the week as has been the trend for the month so far.  While one week does not make a trend, it is worth nothing that we are now beginning to compare against the beginning of back-to-school 2008.  With most, if not all, retailers citing a later back to school selling season this year vs. last, we would not be surprised to see near-term weakness until the current back to school period picks up later in August.

Sports Apparel Weekly Data Update - Sports Apparel Table

Sports Apparel Weekly Data Update - Sports Apparel   chart

Sports Apparel Weekly Data Update - Sports Apparel ASP chart


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HST: CONF CALL HIGHLIGHTS

Here is our summary from the conf call that just ended. The key takeaway is HST is operating well in a challenging environment.  While there are signs on the margin that lodging fundamentals aren’t getting worse, we’re still far from a recovery.  2010 Street numbers need to come down.

 

HST HOTELS 2Q09 EARNINGS CALL TRANSCRIPT WITH SYNTHESIS:

 

General Commentary on 2Q09:

Seeing a few subtle signs that trends are stabilizing

 

Excluding the $0.15 of charges, FFO would have beat consensus

 

Occupancy was slightly better, and ADR decline was worse.  Cost control was better than expected

 

Segment commentary:

  • Group attrition and cancellations continue to drive down rates as business was replaced by lower rated business
  • Corporate, special corporate also continued to deteriorate
  • Transient rates declined 20%
  • Group nights fell 21% but average group rates were only down 6% because of business booked in prior quarters
  • While the group cancellation rate was still above average, it got less bad and looks like its continuing to get less bad
  • Group booking pace also improved throughout the quarter

 

Weakness in rate will not abate until economy begins to recovery

  • Although rate deterioration also got less bad throughout the quarter and looks like it has bottomed out

On the investment side, expect that there will be more hotels on the market for sale later this year, HST expects to be opportunistic

 

The asset sold were non-core and required some material capex, expect to complete another 25MM in sales for the balance of the year

 

Commentary on outlook:

Visibility is very limited; there is a short booking cycle

 

The reduction in the RevPAR guidance is tied to the weaker-than-expected ADR in the 2Q09 and the assumption that the environment remains static (sounds like they are sandbagging)

 

Taking advantage of the IRS ruling allowing them to pay 90% of their dividend in stock

 

Supply environment is favorable going forward and will likely remain anemic for the next few year

  •  I guess we would argue that supply isn’t really the problem right now… it’s really a demand issue

 

RevPAR commentary:

Government business continued to benefit them in the quarter, expect the DC region to remain stronger than most through the year.

 

Also expect San Antonio and New Orleans to continue to outperform given the strong booking pace

 

Hawaii still impacted from flight reductions, but expect the portfolio to outperform for the balance of the year given easier comps

 

New York, had strong transient, weak group, and international demand was still solid. Expect it to continue to underperform for the year

 

San Fran continues to be challenging

 

Philly should continue to outperform in the third Quarter

 

New England is suffering from difficult comps from strong Boston performance last year, but also from rooms under renovation.  Expect performance to improve in back-half ‘09

 

Expect Florida region to struggle in the 3rd quarter

 

International declined 20.2% on a constant dollar basis- relatively well despite the hit to Mexico property.

 

Euro-JV underperformed

 

Operating margins:

Wages decreased 13.9% and unallocated expenses decreased over 14%

 

Going forward, mix will negatively impact margins

 

Expect insurance rates to increases

 

Wages to increase

 

Balance sheet/Liquidity:

Raised $1.1BN in 1H09

 

May not be able to close the renegotiated loan on the San Diego Marriott

 

Will continue to keep a lot of cash on hand until markets improved

Wrote down the asset held for sale, since it will sell below the book value

 

Q&A:

Are there more costs to continue to cut in the back half of this year?

  • Cost cuts started in earnest around this time this year and the effort has continued through the first half of this year
  • They still think they can continue to cut costs, through the back half of the year, they will be more modest
  • In 2010, they may be able to decrease costs a little bit – more so if the declines are occupancy driven
  • Will be difficult to achieve the same margin results as this year

Urban performance – thought it would be weaker in the quarter, why?

  • Their portfolio benefitted from concentrations in DC, New Orleans and Philadelphia

 

Group activity for 2010

  • Hard to find a clear theme
  • Booking pace is down significantly, but doesn’t reflect all the cancellations that have occurred this year and 4Q08… so if you adjust for that then its still down but not as much
  • Groups are definitely rate sensitive
  • Finding that a lot of groups are looking to get an all-in meeting price (F&B and other services) – ie looking for package deal
  • Have seen some pick up in booking activity but still behind where they were last year
  • In 3Q expect pace to be about down 20%, pace is about the same though but doesn’t capture cancelations – so adjusted about down 15%

M&A environment

  • Difficult to characterize
  • No more buyers than there were in the beginning of the year
  • Mortgage market is still difficult
  • Buyers are still all cash for the first few years of the investment
  • Cap rate side – no consistent themes right now. Cap rates are definitely falling, as you would naturally expect.  Discounts to replacement cost.  However, given the dearth of transactions, this is more anecdotal
  • Lenders are more likely to take a stronger stance as they get the keys handed back more often, but don’t expect the transaction environment to really pick up until next year (default driven that is)

How deep are the current cuts (floors shut down/ restaurants shut down)?

  • There are some hotel where they have shut down the entire tower
  • They have been shutting down floors
  • F&B outlets have reduced hours across the board
    • Trying to serve dinner from the bar/ lobby or just room service in certain cases as well
  • Success in cutting managers by 25%, postponing & cutting bonuses

Are they teeing themselves to acquire hotels in the 2010 & 2011?

  • Best time to be a buyer is earlier in the cycle, to buy at good cash flows and below replacement costs
  • While they are aware that they are not through the downturn, they think the time to be a buyer is when they think they have hit bottom and things are going to begin to improve
  • Don’t expect them to be super aggressive
  • But expect them to add selectively through 2010 & 2011

Do they need to raise more money to become net acquirers?

  • Have some dry powder now
  • But will look to follow the 2003-2005 model, which was additional equity issuances
  • Would consider buying debt/ paper to get at the assets, although it’s challenging because most of the loans are in pools.  But would be very interested, where it is possible, to get asset through debt acquisition

Size limits in the mortgage market

  • Big change once you go over a $100MM – need 2 lenders or more usually
  • San Diego loan is complex.  Lenders want a say in the renovations.  If they can, they will do a new mortgage; otherwise will just repay the loan.

See themselves reducing market diversity over time and increase concentration that they like (DC/ San Fran) and worried about some southern markets with supply issues.

 

Could see that their brand profile to widen – like getting more Hilton and Intercontinental. 

 

Not inconceivable that they would be smaller over next few years, but do expect to be net acquirer. 

 

Want to be in larger hotels, sell some smaller ones… less hotels more rooms.

 

Full year guidance at the low end of their guidance, doesn’t necessarily reflect the “less bad” thesis.

 

General sense is that 3Q09 is that it will match up with 2Q… could be a little better.  Still expect 4Q09 to be better solely due to easier comp, but will be the weakest on a 2 year trailing basis. 

 

RevPAR range 17-23% of RevPAR declines in the back half.  Low end assumes things do not get any better.

 

Asset sales that were consummated, cap rate was in the mid 7’s.  Capex plan another of 15-20k per key over next few years… so including that it’s a low 6 cap rate. 

  • Basically cash flow was awful and they’re suburban and smallish… and thought the outlook would not be good… cap rate is irrelevant in our opinion.

 

Don’t think that they can keep costs flat in 2010.  Some of that depends on what happens with inflation next year.  Unless occupancy stays flat and utility costs decline, it will be extremely hard not to have modest cost increases.  Wage increases at the hourly level, if not the more senior level. 

 

Dividend reduction

  • Mostly because of the equity issuance (same dollar amount over more shares = less per share)
  • Operating and liquidity environments are still challenging so think saving $100MM in cash is most prudent

VFC: Same Guidance, Different Mix

VFC reported solid results last night, ahead of the Street by $0.10 and well-ahead of our estimate.  Admittedly, the areas of risk that we had been focused on heading into the quarter were not fully realized.  However, we’re not going to try and poke holes in earnings quality or point out the inconsistencies in the results in effort to try and justify our cautionary tone.  Instead, the reality is that VFC put up a sizeable headline beat and did not lower guidance.  Did they massage the components of guidance and adjust them accordingly to maintain the $4.70-$5.00 outlook?  Absolutely they did.  But, the reality is manufactured results are exactly what they are – a reality.  In this case, with numbers coming in close to, or perhaps even above consensus for the back half, it is unrealistic to believe VFC shares are heading meaningfully lower in the near term.  Consider the following:

Including the $0.10 beat, management reaffirmed its full year guidance of $4.70-$5.00; however, it’s important to note this guidance is now predicated on a few new factors:

1)      Foreign currency: Baked into 2H earnings is a Eurodollar exchange rate of 1.37 compared to the previous assumption of 1.30 lessening the Fx impact on revenues by ~$60mm or roughly 1%. Depending on the margin at which incremental Fx related money flows through the P&L, VF would realize a $0.07 benefit assuming corporate margins, but the reality is that it is likely to be higher so let’s call it a $0.10 benefit on a 20% incremental margin in the 2H.

2)      Tax rate: While the 25% tax rate posted in Q2 was noted as “in-line,” it was outside of the expected range between 28%-30%. As a result, the full-year rate was adjusted from 29% to 27% equating to another $0.10 tailwind in the 2H.

3)      The Q2 beat: The full-year range now includes better than expected results in Q2 that take up year-end earnings by yet another $0.10.

Despite a weakening overall top-line, dismal revenues from the company’s core cash-cow (Jeanswear), and a meaningful slowdown in the North Face, the company was able to report a substantial gross margin performance. The mix shift towards owned retail driven by robust store growth will continue to benefit gross margins (especially in international markets), but we maintain that decelerating top-line trends will have to improve to sustain operating margins. Based on 80 new stores over the last twelve months and the average store contribution, we calculate that retail contributed roughly $120mm in revenues this quarter. Taking into account management’s comment that retail accounted for a 40bps improvement in gross margin, we estimate that retail stores are operating just shy of 50% compared to a low 40% core margin. As a result, the incremental 70 stores should contribute approximately 75bps to gross margins in 2009. With management committed to a 10% inventory reduction by year-end, it will be a challenge for VF to expand margins beyond recently adjusted expectations.

Additionally, while late to the expense control party vs. other apparel manufacturers, VFC seems to have found upside from their cost cutting efforts.  After all, the company spends $400m on advertising alone, which is a huge source of funds when trying to make the numbers.  

The timing here is no longer imminent as evidenced by the 2Q results, but the reality is cutting costs and opening stores can only go so far.  With jeanswear, imagewear, and sportswear all showing meaningful declines we suspect the ability to manufacture decent results will eventually come to an end.  But for now, we’ll watch the fundamentals closely and monitor key organic growth drivers to determine when the next opportunity arises to become cautious again.

 

VFC: Same Guidance, Different Mix - VFC S 7 09


Obama’s Approval Broken

On June 22nd, 2009, we wrote a note titled, “Approval Breaking Down For Obama”, which outlined the following:

“Most interestingly, the independents that moved to Obama in hoards during the presidential election last fall, now seem to be seriously wavering.  While on the other hand, Obama's support among his own party is as strong as ever.  So what is happening among the independents?  The best place to find that answer may come from New Hampshire.  In the New Hampshire Union Leader this morning, which is the largest paper in New Hampshire, there was an editorial sharply critical of Obama's health care plan, and specifically the disconnect between Obama saying there will be no additional spending for his plan and the Congressional Budget Office suggesting that current proposals would dramatically increase spending.”

According to the New Hampshire Union Leader:

"For health care reform to "not add to the federal deficit over the next decade," every penny of new taxpayer spending on health care reform would have to be paid for by either a tax increase or a spending cut somewhere else. We're talking about roughly $1 trillion in spending -- all paid for. But remember, we already have a $1.8 trillion deficit this year. Every penny spent on health care reform is a penny not spent to pay down the existing deficit. So in reality, health care reform will at the very least perpetuate existing deficits even if it doesn't expand them.

While having solidarity among his party is powerful, in a country where only ~ 40% of adults identify themselves as Democrats, Obama has to continue to appeal to independents and if the New Hampshire Union Leader is any proxy, he is losing them.”

It is fair to say that Obama’s approval rating is now broken, and the independents are slipping away. Since June 30th, the Rasmussen daily tracking poll has measured a negative rating for Obama and since July 9th has registered a rating of between – 5 and – 8.  This is a major divergence from the first couple months of his Presidency in which he was rated in the +15 to +20 range.  This poll measures the delta between strongly approve and strongly disapprove. 

Not surprisingly, the underlying data shows the tale of the tape.  According to Rasmussen, almost 83% of Democrats approve of President Obama, while 81% of Republicans disapprove, and approval among those voters without party affiliation is basically split.  This leads to broad approval rating for Obama, according to the Rasmussen polls, which is still positive with 51% of voters approving.  Despite the still positive approval rating, as we’ve noted before, the Rasmussen Daily Tracking poll is often a leading indicator for broader approval as it measures what is happening on the extremes.  Shifts in strongly approve and strongly disapprove reflect these extremes and sustainable changes on the extremes will lead to a sustainable change in overall approval ratings.

Obviously highlighting President Obama’s approval rating is not a political comment by us, but an observation of fact.  The reality is, President Obama has been spending substantial political capital in the first few months of his Presidency.  Unlike his predecessor who asserted that he had earned political capital going into his second term and was going to spend it, President Obama did have real political capital to spend.  That said, President Obama’s political bank account now has substantially less capital in it as he has spent it on healthcare, foreign policy, and the stimulus package.  As of yet, he has seen only a negative return on this capital, and if he cares at all about his approval rating he will be much more prudent in spending political capital on a go forward basis.

Daryl G. Jones

Managing Director

Obama’s Approval Broken - rasmussen

 


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