“Small, nimble, fast changing.”
That’s how Julia Lovell described early 19th century England (relative to China) in The Opium War. “While China’s slavish people had been homogenized into speaking one language … and sympathizing in the same manners.” (pg 79)
As a company or a country, you do not want to become 17-19th century China. You don’t want to be what Europe morphed into during the 20th century either. As a Canadian capitalist who came to this country in the 1990s, I often wonder what America’s 21st century will look like. It’s not what it used to be.
Sadly, the path of least resistance is one of a slower-growth bureaucracy. That’s not my opinion. That’s the history of countries who age. So don’t do that. Do what you can to put two-feet on the floor every morning and earn your keep; fight the tyranny of government groupthink; be nimble and changing.
Back to the Global Macro Grind…
If only because I finally took a vacation, watching the US equity market melt-up to lower-highs on no volume was interesting to watch, intermittently. But one week does not an intermediate-term TREND make. As a friendly reminder, it’s late April and most major US stock market indices are down year-to-date.
Inclusive of the Dow (which we are short in Real-Time Alerts via the DIA) and US Consumer Discretionary stocks (XLY) rising +2.4-2.5% last week, they are both still -1.0% and -4.6% for 2014. If you are long America thinking this is the 1990s #StrongDollar growth cycle again, that is not good.
Two of our most outside of consensus Global Macro Themes are:
- US #InflationAccelerating
- US #ConsumerSlowing
Both have continued to play out in April. While they are bearish from a cyclical and secular US consumption growth perspective (see our Q2 Global Macro Themes deck for details), there are obvious ways to play this from the LONG side:
- Long Inflation, explicitly, via Commodities (DBA, UNG, CAFE, etc.)
- Long Inflation, protection, via Treasury Inflation (stagflation) Protection (TIPs)
- Long #GrowthSlowing via Bonds (TLT) and any slow-growth Equity (XLU) that looks like a bond
Those speaking the Fed’s language (“there is no inflation”) and/or #OldWall consensus (“Wall Street Bond Dealers Whipsawed on Bearish Treasury Bets” –Bloomberg this morning) don’t get this, yet. But markets do.
Speaking of YTD market scores, how about those commodity markets!
- CRB Food Index up another +2.7% last week to +21.6% YTD
- Coffee and Soybean prices up again last week to +77% and +19% YTD, respectively
- Natural Gas +2.6% last week to +15.8% YTD
I know, I know. As long as you don’t eat and/or plan on running the air conditioning in your house this summer, those food and utility bills (according to those speaking one language in Washington) are “non-core” to what you really need to be spending on – a $600-700 iPhone 6 upgrade!
While I was in the pool with my kids Thursday, our long Natural Gas (UNG) and Coffee (CAFE) buy-signals in Real-Time Alerts ripped. But don’t tell the Fed that. They’re still saying what US consumers had to pay (front-month) to heat their homes this winter was “transient.”
Sure, almost every “fundamental” analyst in the Federal League can tell you that there is an “over-supply of Natural Gas” in America. But most of them won’t tell you there is an over-supply of people who were long the Dow and social media stocks on January 1st.
The YTD score doesn’t lie though; those saying there is no inflation do.
Into the belly of US “earnings season” (and away from the aforementioned asset allocations to commodities and bonds), how does all of this look from a Hedgeye Style Factoring perspective (in US Equities) in the last month?
- Top 25% Sales Growth Companies (Top Quartile of SP500 Companies) are -2.2% (vs. the bottom 25% being +2.2%)
- Top 25% EPS Growth Companies are -1.3% versus the bottom quartile being +2.6%
- High Beta Equities are -0.2% versus Low Beta +1.8%
Since it’s also NHL Playoff season, as Herb Brooks said in Miracle, “Again!”
Again, and again, and again… for centuries, big, fat, centrally planned countries who have devalued the purchasing power of their people in exchange for political safety have lost this war. It ends with inflation. And inflation slows both growth, and the multiples markets pay for them.
Our immediate-term Global Macro Risk Ranges are now:
Brent Oil 108.21-110.62
Natural Gas 4.46-4.78
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
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TODAY’S S&P 500 SET-UP – April 21, 2014
As we look at today's setup for the S&P 500, the range is 47 points or 1.71% downside to 1833 and 0.81% upside to 1880.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.32 from 2.33
- VIX closed at 13.36 1 day percent change of -5.78%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: Chicago Fed, March, est. 0.20 (prior 0.14)
- 10am: Leading indicators index, March, est. 0.7% (prior 0.5%)
- 11am: Fed to purchase $3.25b-$4b in 2019 sector
- 11am: U.S. to announce plans for auction of 4W bills
- 11:30am: U.S. to sell $25b 3M, $23b 6M bills
- Vice President Joe Biden to Ukraine, meets w/govt officials
- Congressional Delegation led by House Foreign Affairs Cmte Chairman Ed Royce travels to Ukraine
- 8:30am: Outgoing NTSB Chairman Deborah Hersman speaks about her tenure at National Press Club
- 9:30am: Supreme Court issues list of cases it may consider
- 10am: Supreme Court hears arguments in Argentinian bond case
- 11am: Supreme Court hears arguments in Coca-Cola false-advertising cases
- House, Senate out of session on recess
- WASHINGTON RECESS: Nationals Park Eats, Shakespeare’s Birthday
- U.S. ELECTION WRAP: New Koch Attack; NRCC Sees More Contenders
WHAT TO WATCH:
- Pfizer said to have held now-dormant talks to buy AstraZeneca
- Barrick-Newmont deal talks said to hit snag on spinoff plans
- Keystone review delay angers pipeline backers
- SEC said to weigh shining light on how brokers route stocks
- Square Inc. discussed possible sale to Google: WSJ
- Japan’s trade deficit widens as export growth weakens
- Ukraine says Russia prepares grounds to invade after deaths
- Tesla poised to start delivery of Model S to Chinese drivers
- China Auto Show coverage
- Teva rejected by Justice Roberts on generic copaxone delay
- BofA, NYSE sued by Providence, RI, on high-frequency trading
- VW signals outselling GM in China; carmakers gather in Beijing
- Pacific-trade talks proceed as agreement eludes U.S., Japan
- Express Scripts awarded 7-yr Tricare Pharmacy pact
- ’Captain America’ takes N.A. box office for third week
- Barclays to exit some commodities trading: FT
- 2014 Boston Marathon takes place amid heightened security
- Halliburton Co (HAL) 7am, $0.71 - Preview
- Hasbro (HAS) 6:30am, $0.10 - Preview
- Kimberly-Clark (KMB) 7:30am, $1.47 - Preview
- SunTrust Banks (STI) 6am, $0.66
- BancorpSouth (BXS) 4:01pm, $0.30
- Brookfield Canada Office (BOX-U CN) 5pm, C$0.43
- Brown & Brown (BRO) 4:15pm, $0.42
- Cadence Design Systems (CDNS) 4:05pm, $0.20
- Celanese (CE) 4:35pm, $1.21
- CYS Investments (CYS) 4:01pm, $0.36
- Hexcel (HXL) 4:06pm, $0.49
- Netflix (NFLX) 4:05pm, $0.81
- Rambus (RMBS) 4:05pm, $0.12
- Rent-A-Center (RCII) 4:15pm, $0.55
- Rogers Communications (RCI/B CN) 4pm, C$0.71 - Preview
- Umpqua Holdings (UMPQ) 4:05pm, $0.23
- Waste Connections (WCN) 4:05pm, $0.41
- Zions Bancorporation (ZION) 4:10pm, $0.42
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Gold Drops to Two-Week Low as Technical Indicator Signals Losses
- India’s Top Court Ends Ban on Iron Ore Mining in State of Goa
- Hedge Funds Cut Gold Bets in Longest Slide of 2014: Commodities
- India Said to Forecast Normal Monsoon Rainfall as El Nino Looms
- Brent Falls Amid Speculation Price Gains Excessive; WTI Steady
- Barclays to Exit Some Commodities Trading on Revenue Decline: FT
- China Spot Copper Premium Surges as Supply Cut: Chart of the Day
- Wheat Declines to One-Week Low as Rains Seen Helping U.S. Crops
- China Nickel Concentrate Imports Hit 19-Month High on Prices
- Strike-Hit Platinum Companies Increase Pay Offer Amid Strike
- Korea Agro-Fisheries Buys 19,521 Tons of Rice in Tenders
- Rebar in Shanghai Drops Near 1-Month Low on Signs of Weak Demand
- Libya Currently Pumping 235,000 Bbl/Day of Crude: NOC Spokesman
- Indonesia’s Kharisma Sells 6,000 Tons of Crude Palm Oil (Table)
The Hedgeye Macro Team
Takeaway: This might have been the meeting LULU wanted, but certainly not what we expected. LULU could have crystallized its growth plan, but whiffed
Conclusion: This LULU analyst meeting had all the potential to be a world class Analyst Event to catapult the Company beyond the PR gaffes and product blunders of 2013. Unfortunately, the company blew it. We liked new CEO Laurent Potevin, but think that he got some really lousy guidance and support from his Finance organization as it relates to how to speak to the investment community (something he’s never done). What management said was fine, but it could have been so much bigger, better, and far more strategic. Overall, the messages came across as very tactical, and had a lack of focus and cohesiveness. We understand that sounds punitive on our part, but we don’t see how anyone with a 2-3 year investment horizon (where our best Retail ideas live) could have exited that meeting thinking otherwise. That said, over an intermediate-term duration (2-3 quarters), we think that LULU is still probably headed higher as it is one of the few Retailers that will have an accelerating EPS growth rate (reasons outlined below). No changes to our model, which already calls for meaningful acceleration in the top line, but with EBIT margins slipping from 24.5% to about 19% over our modeling horizon. We left the meeting with greater confidence that the current margin level is not sustainable if this company is to grow like we think it should. With the stock at $52, we think that top line growth trumps any margin degradation. We won’t get concerned about the margin risk until the stock is well into the $60s.
We’re not going to make any friends in Vancouver with this one. Then again, making friends is not our job. Here goes…
Let’s cut right to the chase. This LULU analyst meeting was one of the most underwhelming investor events we’ve attended in many years. To be clear -- it wasn’t what the company said, as it said a lot of good things – but rather the problem was in what it didn’t say. After a year that Lululemon would like to forget, plus new blood in the executive suite, this was a layup opportunity for LULU to showcase a big fat-tailed growth strategy, and solidify a crisp message to the investment community. But the layup missed.
After being short the stock since the Fall, we turned bullish before the fourth quarter print (LULU: PULLING THE PLUG ON THE BEAR) after our research showed that consumer sentiment on the Lululemon brand was getting better on the margin. But that was just a near-term tactical change in opinion. We were really looking forward to this meeting to get a good sense of the strategic vision of the company under the leadership of new CEO Laurent Potdevin.
Unfortunately, we couldn’t find it.
If we had to sum up Potdevin’s strategy in our own words, it would sound something like this “We have a great company, and a great brand. Nothing is broken. We made some missteps last year and those need to be undone. But overall, it’s business as usual.”
That’s a pretty disappointing thing for us to hear. We wonder if a) he simply was not ready for this event – in fairness, he’s only been on the job for three months and has never spoken to a group of analysts before (a daunting task for even the most capable executive), or b) his mandate by Chip (who still owns half a billion worth of stock) and the Board is to make tweaks rather than institute major change at the company. Of course, a less desirable option is that he has the mandate to make change, but does not have the experience to recognize that it is necessary. We don’t think that’s the case here.
We’re going to give Potdevin a pass on this one. We think he’s a better executive than the sum of his messages suggested.
The biggest problem, we think, was the absence of the Finance organization at the Analyst event. No formal presentation by CFO John Currie? No long-term financial goals? Potdevin should be leaning heavily on his CFO for guidance around how to communicate with Wall Street – a crowd he’s never interacted with before. This was Currie’s shot to step up and show his new boss how valuable he can be. But he missed – in a very big way. This showed us how weak the Finance organization is inside Lululemon relative to the power of the Brand and market opportunity. Maybe that was acceptable when the Brand was growing up. But now with the Brand in adolescence and experiencing severe growing pains, it’s at a point where it needs superior leadership from the Finance organization. The fact that the Board is OK with its absence is disappointing to us on many levels.
IMPLICATIONS FOR THE STOCK
All in, we don’t think our disappointment over the meeting means that the stock is a short. We want to be clear about that. Again, the company didn’t say anything bad. They just didn’t say anything that gives us confidence that they can navigate through the changing competitive landscape while making the right capital deployment decisions to regain market share and strengthen its financial returns. In fact, we think that over the next few quarters the stock is still likely to be a decent-enough long at current levels given a) near-term earnings recovery (one of the few retail names that will post an accelerating sales, margin and EPS trajectory for this year as it anniversaries Luon and Chip), and b) reasonably supportive valuation. As much as that might suffice for an intermediate-term call on the stock, it’s not enough for us to make the big multi-year double call. Not even close. What kills us is that this thing has all the nascent ammo to be a tremendous stock – but we didn’t hear enough for us to think that will come to fruition. We hope we’re wrong. But hope is not an investment process.
Here’s a few more takeaways from the meeting.
1. Management noted how the company is going to grow outside the core (into non-exercise categories where competition is fierce), while investing in innovation around its Yoga and Running business (which we applaud). But in doing so, the company thinks that current margin levels are sustainable over the long term. We don’t doubt the growth potential for LULU for a minute. But we question how it will come at a margin level equal to what we see today. It simply does not add up.
2. There was a genuine focus on product quality and innovation that we have not seen from LULU in the past. That was definitely a breath of fresh air. But again, we wonder how this can possibly enter the equation without any degradation to margins.
3. We’re still not sure if LULU has a strategic plan. We’re not saying that as a slight to the company. It has a strat planning department, so presumably it has a plan. But we did not hear a single part of that during this meeting.
4. Usually, I’ll ask a company if its deck is available so I can review all the stats and figures it gives out in meetings such as this. I didn’t have to ask LULU. There was no deck. That’s a first.
5. Another first… noted above but worth noting again -- no presentation by the CFO. I was beyond floored by this. I’ve been going to analyst meetings for 20 years, and never have I seen the CFO not give a presentation with long-term targets or other forms of quantitative context. To be clear, this is not only important to give Wall Street a framework with which to analyze the company, but more importantly, it shows Wall Street that the company actually has that context internally. If a company is consistently firing on all cylinders and creating value for shareholders, then maybe it can pull off omitting a financial plan. And I stress ‘maybe’. But LULU does not exactly have that luxury. It needs to provide more information, not less. At least Laurent has an excuse – he’s brand new -- but Currie does not.
6. It’s important to elaborate on the point above about Laurent making ‘tweaks’ as opposed to major change. Our biggest concern here is that LULU is a powerful and iconic brand that is – metaphorically speaking -- going through puberty. All brands go through these growth stages. It needs the right oversight and investment to ensure that it can double in size over 3-5 years. We didn’t get that. We heard someone who does not sound like he’ll be heavy handed with investment, and we don’t get the sense that CFO Currie is steering that ship either. It’s still early, so we won’t count Potdevin out. His tenure is still young. But he’s never seen a major brand through this part of a growth spurt before. Our biggest concern is that he is running the company as Chip Wilson otherwise would – simply because he has no one there to guide him through uncharted waters.
Of course, there were some positives to the day.
1. The people at Lululemon are truly passionate about what they do. This sounds like fluff, but the only other company I’ve ever seen where people are that passionate about coming to work every day like this is Nike. There’s something to be said about that. It’s part of what makes the Brand great.
2. As much as I was displeased with the messaging from the Finance team, Tara Posely (Chief Product Officer) absolutely crushed it. She has a lot of experience at a lot of different retailers – some good, some not so good – but there’s no doubt that she found her calling at LULU. She came across as extremely confident, competent, authoritative, and a clear leader within the company. And yes, she too has only been there four months.
3. The product/innovation lab was impressive. It seems like a mini-version of what Nike houses in the Mia Hamm building. But that should in no way diminish how important it is to LULU. Having only been open for two weeks, we should presumably see some of the benefit by year-end.
4. The building blocks for International expansion are slowing coming into place. The company opened its first store full line store in London two weeks ago and just finished the onboarding process for its head of Asia, Ken Lee. International showrooms now total 15 (8 in Asia and 7 in Europe).We agree with the company that there is significant opportunity in markets outside of North America and Australia, but the company failed to communicate exactly what investments need to be made in order to facilitate this rollout. We tie all this back to our optimism about where the top line will go, but the sacrifice they are likely to make on the margin line to get there.
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