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TACRM SAYS, “STAY LONG OF BRAZIL” (BRL, EWZ, PBR)… WHY?

Takeaway: Both the domestic macroeconomic outlook and globally interconnected risks favor remaining long of Brazil w/ respect to the TREND duration.

Yesterday, I had a call with one of our more astute long-term customers and he asked me a version of a question that we have been receiving a lot in recent months:

 

“Nice call on [INSERT INTEREST RATE-SENSITIVE ASSET CLASS HERE]. But how much more upside do you see from these levels?”

 

I specifically say “version”, because as a true believer in our repeatable and unbiased approached to front-running asset class rotations, he understood our calls from the beginning of the year while also getting involved on the long side of some of the more bombed-out macro markets where we saw opportunity – including Brazil.

 

Contrast this with what has clearly become consensus across the investment community in the YTD: chalking up the domestic growth slowdown to “weather” and sticking with the outcrop of 2013’s #StrongDollar + #RatesRising = #GrowthAccelerating trade.

 

Indeed, Brazil has had a nice run since our FEB 27th Best Ideas conference call and we continue to anticipate further upside from here. Specifically, the iShares MSCI Brazil Index Fund (EWZ) has appreciated +19.3% since then; that compares to a +1.7% gain for the SPY and to a sample mean of +5.7% for the 24 country-level ETFs we track across the EM space. Moreover, the EWZ’s +19.3% delta ranks third in the aforementioned sample, trailing only India (EPI) at +22.1% and Turkey (TUR) at +31%; we were fortunate to have been in print liking both throughout this time frame – India as a core long idea and Turkey as a beneficiary of our EM “junk” relief rally theme.

 

TACRM SAYS, “STAY LONG OF BRAZIL” (BRL, EWZ, PBR)… WHY? - EM Divergence Monitor

 

Going back to Brazil specifically, one of the reasons we’ve liked Brazilian equities – Petrobras (PBR) in particular – is because of our anticipation of a continued rally in the Brazilian real (BRL). Specifically, that would have a number of positive effects for Brazilian capital markets, including, but not limited to:

 

  • Easing operating margin pressure on domestic importers – most notably PBR; refer to our 72-slide presentation for more details;
  • Reducing pressure on net income margins as USD debt service costs are deflated; and
  • Attracting marginal financing for the current account deficit, which tends to be accretive to broad economic growth.

 

The BRL has indeed appreciated a fair amount since FEB 27th (+5.9%, which ranks second among the 21 currencies we track across Asia and Latin America and compares to a sample mean of +1.9%). Importantly, our proprietary FX valuation models see at least +10% upside from here on both a REER and carry basis.

 

TACRM SAYS, “STAY LONG OF BRAZIL” (BRL, EWZ, PBR)… WHY? - FX

 

TACRM SAYS, “STAY LONG OF BRAZIL” (BRL, EWZ, PBR)… WHY? - FX REER VALUATION

 

TACRM SAYS, “STAY LONG OF BRAZIL” (BRL, EWZ, PBR)… WHY? - FX CARRY VALUATION

 

Valuation is not a catalyst, however. What is a catalyst is continued poor performance by Dilma Rousseff and her Workers Party (PT) in the polls leading up to OCT’s general election; her support among voters dropped again to 37% from 38% in the latest Datafolha poll, which was published MAY 9th. Both consumer and business confidence trends – each at the lows of her administration – support a continuation of the aforementioned polling trends.

 

TACRM SAYS, “STAY LONG OF BRAZIL” (BRL, EWZ, PBR)… WHY? - CONSUMER CONFIDENCE

 

TACRM SAYS, “STAY LONG OF BRAZIL” (BRL, EWZ, PBR)… WHY? - BUSINESS CONFIDENCE

 

She’s clearly received little boost from the backing of former Brazilian president Lula da Silva and he’s already ruled out running in this election, effectively mitigating any upside surprise to credible promises for additional Big Government Intervention that investors have now come to associate with the PT – as most recently highlighted by PT president and Dilma’s campaign coordinator Rui Falcao who suggested this week that Brazil should consider capital controls to ward off speculative capital inflows and reiterated his opposition to an independent central bank.

 

Newsflash Falcao: global investors are responding to opinion polls and using their capital to vote you and Rousseff “off the island” for a reason. Your economic policy flat-out sucks…

 

Another catalyst for staying long of Brazil is improving GIP fundamentals. Our math shows World Cup host teams tend to receive a ~190bps sequential boost to real GDP growth and a ~100bps increase in the current account/GDP balance.

 

Brazil has yet to see these likely tailwinds roll through the system and, as a result, we remain well above both the street and the BCB on 2014E growth and [marginally] below both on 2014E inflation. If we’re right, Brazil’s woeful fiscal situation will show optical improvement and monetary policy will remain tight (not that it wouldn’t have anyway – the BCB just sold and rolled over a cumulative ~$450M of FX swaps yesterday, signaling a renewed commitment to supporting the currency).

 

TACRM SAYS, “STAY LONG OF BRAZIL” (BRL, EWZ, PBR)… WHY? - BRAZIL

 

One last catalyst that remains non-consensus is a continuation of recent global macro asset class flow trends. We’ve spent much of the past 12-18M designing and backtesting a quantitative model that can help investors front-run said flows at both the primary and secondary asset class levels. At a bare minimum, our TACRM™ All-Weather System consistently provides investors with a real-time “look-see” on rotation-based asset class flows.

 

There are four primary tools our All-Weather System employs to accomplish its stated goals (please email us if you’re interested in having an in-depth discussion regarding the rigorous quantitative methods employed in each tool):

 

  1. TACRM™ Global Macro Thermodynamic Monitor: We first take the “temperature” of nearly 200 global macro ETFs that represent individual markets or specific plays within each market. From there, we can track the current temperature of any market and compare it to both other markets and its own recent trends. Brazil is still exhibiting signs of a classic bearish-to-bullish reversal on this measure.
  2. TACRM™ Global Macro Weathervane: By taking the temperatures of all the individual markets that comprise a particular primary asset class, we can then calculate a measure of relative momentum by first calculating intra-asset class dispersion and then normalizing said dispersion. The result is a generalized dynamic asset allocation reading for each primary asset class on a 0-100% scale. From there we can track the current reading (i.e. the “weather”) of any asset class and compare it to both other asset classes and its own recent trends. Both Fixed Income & Yield Chasing and EM Equities continue to take share – supportive of our call on Brazil. Specifically, that gives us a green light for carry trading strategies, as well as portending positive EM equity beta.
  3. TACRM™ Global Macro Barometer: By taking each asset class’ current reading from the aforementioned weathervane system and normalizing it as a percentile of its respective TTM and trailing 5Y peaks, we can get a generalized sense of how much “pressure” is developing in any given asset class. The pressure is on to the upside both in Fixed Income & Yield Chasing and EM Equities, forcing investors to divest their DM Equity, FX and Commodity holdings to keep pace. This setup is also supportive of our call on Brazil.
  4. TACRM™ 40/40 Club Thermodynamic Monitor: By plotting a similar thermodynamic analysis with the “hottest” 20 and “coldest” 20 markets, we can get a sense of what secondary asset classes are really in or out of favor. The growth style factor remains for sale domestically – supportive of Brazil via a continuation of #DownDollar and #RatesFalling.

 

TACRM SAYS, “STAY LONG OF BRAZIL” (BRL, EWZ, PBR)… WHY? - 1

 

TACRM SAYS, “STAY LONG OF BRAZIL” (BRL, EWZ, PBR)… WHY? - 3

 

TACRM SAYS, “STAY LONG OF BRAZIL” (BRL, EWZ, PBR)… WHY? - 2

 

TACRM SAYS, “STAY LONG OF BRAZIL” (BRL, EWZ, PBR)… WHY? - 4

 

All told, both the fundamentals and TACRM™ support remaining long of Brazil, so we will – for now at least. When it is appropriate to deviate from this strategy, I promise we’ll/you’ll be among the first to know. Marrying top-down quantitative signals with bottom-up fundamentals analysis is one of the reasons we continue to add value to our institutional customer base – effectively differentiating ourselves from most other sell-side macro research providers.

 

Have a great night and/or wonderful Thursday morning,

 

DD

 

Darius Dale

Associate: Macro Team


M - SETTING UP TO BE A GREAT SHORT AFTER 2Q

Takeaway: 2Q will be good, then there's risk. Street's numbers ignore the economic cycle. We're well below starting in '15. A deal might save Macy's.

Conclusion: We think Macy’s is at a critical point in its decision tree. The company printed a 1Q growth algorithm that is typical with what we’d expect from a dinosaur department store – negative comps (-1.6%), lower gross profit dollars (-1.3%), but modest growth in EBIT (+1.8%) due to lower SG&A spending. All in, about 800bps of Macy’s 9.3% EPS growth came from financial engineering via share repo. The company is going to have a better 2Q due to the timing of a major promotion and what we agree will be a little snap-back in spending from depressed winter levels. We get the whole ‘best in breed’ thing (sort of), but past a good 2Q, we think that investors should be asking themselves what they’re really in this name for. Is this a breed you need to own?  Even Macy’s CFO, who we actually think is very good, used the word ‘hope’ on the conference call not once, not twice, but FIVE times when referring to recovery in different parts of Macy’s business in 2H. They’re allowed to hope. But in modeling out a cash flow trajectory, we’re not. Once 2Q earnings is past us, we’d look to short this one aggressively.

 

M - SETTING UP TO BE A GREAT SHORT AFTER 2Q - m financials

 

We’re coming in about 4.6% below consensus for this year – at $4.25. We think that M will beat 2Q, and then miss 2H. That’s something to keep in mind regarding near-term positioning. But it’s not the near-term that really worries us. We’re looking out across our five-year model, and we have EBIT down every single year, with stock repo and repayment of debt maturities making up the difference to keep EPS relatively flat. If we’re right, then we’re looking at an annuity of $4-$4.25 in EPS. Let’s capitalize that by a 10% cost of equity and it suggests a stock in the low $40s. If you want to use a 10x multiple instead, you get the same value (M has traded below 8x earnings in the past). This low $40s value comes out to about 5.7x EBITDA, which is hardly a trough level one might expect from a retailer with zero square footage growth.

 

We understand all the hype around company initiatives like My Macy’s, MAGIC, etc…these are all what makes Macy’s the leader in the space. But the reality is that we are officially in year six of an economic recovery, and the department store group has never gone more than five consecutive years of margin expansion without a material decline in margins.

 

M - SETTING UP TO BE A GREAT SHORT AFTER 2Q - margins   

 

The bigger concern is not a 5% EPS miss for this year, but a 50% miss in year 5. The Street’s numbers not only dismiss the potential for a near-term margin correction, but they assume we go ANOTHER five years with the business and retail cycle improving. If this actually happens, then yes, you will probably make a lot of money in Macy’s. But you’ll probably make more in high-quality growth names in the consumer space that have recently been annihilated.

 

M - SETTING UP TO BE A GREAT SHORT AFTER 2Q - M consensus

 

One thing that we wonder about Macy’s is what it does strategically if a) this year does not pan out as planned, and b) 2015 looks even more challenging. In years past, whenever Macy’s ran into a problem, it acquired another department store chain to eventually assimilate under the Macy’s banner. It’s a strategy that worked. But with a National footprint, coverage at the high end (Bloomingdales) and in the middle/upper-middle (Macy’s), it really has no other physical retailer to buy. That’s what makes us think about the potential for Macy’s to either do a transformational dot.com merger, or gobble up smaller e-commerce business that have earned the consumer’s respect in a different segment. We’re thinking of names along the lines of GILT, Bonobos, and others (some which trade publicly). It’s unlikely that any such deal would be accretive for Macy’s given the multiple disparity, but we wouldn’t put it past M to go this route. Something to chew on.


Poll of the Day Recap: 91% Feel Price Squeeze at Grocery Store

Takeaway: 91% YES; 9% NO.

Simply put, the PPI report today showed (shocker!) that inflation is soaring – thanks in large part to food prices.

 

So, we asked in today’s poll: Are you feeling the impact of higher food prices at the grocery store?

 

Poll of the Day Recap: 91% Feel Price Squeeze at Grocery Store   - 2


At the time of this post, a revealing 91% of voters said YES; just 9% said NO.


Of the many YES voters, people explained exactly what they're seeing at the store and how it has impacted them:

  • “I see sale prices higher than previous regular prices. I see package sizes/quantities reduced. I see quality declining.”
     
  • “Yes, particularly since I eat organic, unprocessed food. The prices are so shocking even on packaged food that I don’t eat that I don't understand how people are feeding their families and staying obese and still able to pay for anything else.“
     
  • “Seriously, who isn't agonizing over higher prices?  Yesterday, @Cub:  most varieties of apples $1.99/lb, Gallon of Land O Lakes Milk $3.99, T-bone Steak (save up to $4/lb) advertised as $6.99/lb, Pepsi 12-packs sale price of 4 for $12. Regarding Pepsi, I believe in the last 5 years, you could purchase 24-pack on sale for $3.99.  Anyone whose cost conscious is aware of price increase and/or size/amount of item/stuff decrease.  Regarding smaller package/amount size, when's the last time you were able to purchase a 5 quart pail of ice cream?  5 qt ice cream pails used to be commonplace…not anymore.”
     
  • “12 oz (no; not a lb); of Hormel bacon was $7.99 yesterday.”
     
  • “We now have a 'vegetarian' dinner in our house once/week because of the high beef prices."
     

Conversely, those who voted NO pointed out that “we had deflation in food prices for 7/12 months last year,” and that “professionals don't worry about the price of milk.” Another NO voted noted, “Ok, lime prices are higher -- but that's really about it. Food is still cheap in America compared to the rest of the world.”

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REGIONAL GAMING: TREND FRIEND

Regional gaming is back! Well that’s a little strong but we are seeing improvement and insiders are buying.

 

  • Anecdotally, we’re hearing May is showing improvement from April (which improved from March) which is consistent with our math as seen below.
  • June will be impeded by one less weekend day but still, the overall decline should only be modest.
  • Overall, Q2 is shaping up nicely relative to reduced guidance.  The release of May gaming revenues beginning in early June could be catalysts.
  • Insiders at both PENN and PNK have bought stock in the last week – obviously a positive signal.  BYD management, did you hear that?

 

REGIONAL GAMING: TREND FRIEND - sss


Hedgeye Retail: Our Heavyweight Candidates for Newly Vacant Kohl’s CEO | $KSS

Takeaway: There are now three potential top jobs open at mega-US retailers.

Hedgeye Retail: Our Heavyweight Candidates for Newly Vacant Kohl’s CEO | $KSS - kss

 

Kohl's CEO Planning Management Shuffle

• "Mr. Mansell is planning a management shuffle, according to a person familiar with the matter. And he is also scouting for a new chief merchant who would be a candidate to ultimately succeed him, people familiar with the matter said."

 

• "The CEO is seeking to boost growth when the retail industry is struggling with budget-conscious shoppers who are increasingly turning to the Internet for everyday purchases."

 

• "Kohl's board is looking for Mr. Mansell, 61 years old, to demonstrate progress on those fronts at a board meeting Wednesday, the day before Kohl's reports first-quarter earnings. At that session, he is expected to describe plans for a broader management reorganization, said a person familiar with the situation."

 

• "In April, Kohl's lost its chief merchandising officer, Donald Brennan, who joined the company in 2001 and was promoted to chief merchant in 2010 but had received a weak performance grade, according to regulatory filings. Mr. Mansell has been personally sounding out candidates for the chief merchant's job with an eye to having them eventually succeed him as CEO, several people familiar with the situation said."

 

• "Mr. Mansell has reached out to Brendan Hoffman, who earlier this year said he plans to leave his post as CEO of Bon-Ton Stores Inc. when his contract expires in February, these people said. Mr. Hoffman is unlikely to take the job since it wouldn't immediately place him in a CEO role, one of the people said."

Takeaway From Hedgeye’s Brian McGough:

This tells us that there's now three potential top jobs open at mega-US retailers: Target, JC Penney, and Kohl's. The pool of candidates is not huge, but there are some heavyweights. There's Roger Farah, who has only two weeks left at Ralph Lauren, Bill McComb, who is currently on vacation after turning the dog that was Liz Claiborne into the hyper-growth Kate Spade. And there’s Vanessa Castagna, who was the underappreciated architect of the Eckerd-era turnaround at JC Penney over a decade ago. Let's also not forget Glenn Murphy from Gap. The fact of the matter is that he is a far better CEO than a company like Gap probably deserves. He's done a great job fixing the company, and at age 51 -- has a much bigger and better job left in him.

 

*Watch Brian McGough on HedgeyeTV explain one key point in his bearish thesis on Kohl’s.

 

*     *     *     *     *     *

 

Editor's Note: This is a complimentary research excerpt from Hedgeye Retail Sector Head Brian McGough. Follow McGough on Twitter @HedgeyeRetail

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Howard Penney Has Done It Again, Ladies and Gentleman | $BLMN

Takeaway: Smart investors pay close attention to Howard Penney.

Hedgeye Restaurants sector head Howard Penney is simply on fire. Last week we highlighted his great call on Bloomin’ Brands (BLMN). And guess what? The stock has continued to fall – it’s now down -20% since he added it as a Best Ideas SHORT on November 27, 2013 at $26.71/share. Since this time, 2014 EPS estimates have been revised down from $1.33 to $1.22 and the share price has acted accordingly.

 

Howard Penney Has Done It Again, Ladies and Gentleman | $BLMN - 9

 

Howard also discussed BLMN as one of his favorite short ideas on HedgeyeTV back in April.

 

 

What have we learned here? Pay close attention to Howard Penney.

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