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NKE – Consider the World Cup Biorhythm

Takeaway: 23x p/e is a tough risk/reward for a company that can barely grow EPS when the brand is hotter than ever.

We’re no more or less excited about owning Nike into the 4Q print to be reported after the close on Thursday. A few thoughts…

  1. Revenue Looks Good: We could see a slight beat on the top line. The company guided towards a high single digit rate. The brand still has solid momentum in the US and Western Europe. In ‘Nike Speak’ high-single digit sales guidance equals 11-12%. The Street is at 9.6%.
  2. Gross Margin Expectations Appropriately High: The Street is already looking for a 44.7% Gross Margin, which is 75bps ahead of last year and represents a meaningful sequential pick-up in the 2-year trend. We’re seeing a shift toward higher GM jurisdictions (which could also help tax rate), so this is a reasonable expectation. But we’d be surprised by much more – especially given that inventories ended the last quarter +15%.
  3. Need SG&A to Shine – and It Won’t: So with a likely slight sales beat, and in-line GM, that leaves it all up to SG&A to save the day.  The problem is that in all our years covering Nike, we have never seen the company spend money at the clip (even relative to size) that we’re seeing today. Nike is one of the best steward’s of capital in this industry, so it’s earned the benefit of the doubt as it relates to its capital allocation process which will ultimately result in increased cash flow at some point down the road. But with the company spending an estimated $100mm-$150mm on World Cup, we can’t exactly bank on this being the quarter for an SG&A beat. Let’s consider that number for a minute. This coming quarter, UnderArmour will spend about $55mm in marketing on EVERYTHING. Nike will spend 3x that on one sporting event.
  4. The World Cup Factor: A few people have told us “there’s no way Nike misses during World Cup”. That’s probably true. There’s no way it will allow itself to be in the financial press as disappointing while the biggest sporting match in the world is being played out . But mind you that Nike has not beaten by more than a penny in each of the past three World Cups.
  5. Nike’s biorhythm; The problem is that the Cup is always played in conjunction with Nike reporting its fourth fiscal quarter. Aside from Nike spending huge sums of capital on this event, you need to take into account Nike’s own internal financial biorhythm.  The same factors that lead to conservative goal setting between regional GMs and the C-Suite (and subsequent EPS smoking in quarters 1 through 3 also lead to muted upside in Q4). Why? If you are a business unit head at Nike, you have to fight for a given SG&A budget in a given year. If you don’t spend every last penny, then the chance of getting a similar (or larger) budget next year is slim to none. We’ve all heard the stories about what most people would consider excessive spending at Nike (ie. hiring rock bands to play at happy hour for your department). Most of those stories are true, and almost all happen in the fourth quarter.  The point is, if there is a quarter where you’re looking for NKE to beat on the SG&A line, 4Q probably won’t be the one – especially one where World Cup is being played in the back yard of Nike’s highest-profile National Team – Brazil.
  6. Guidance Not Headed Higher: The company already issued preliminary guidance for the May ’15 year “at or above our high-single-digit target range.“  It won’t come out and take guidance higher when the year is only four weeks old. They won’t take guidance down, either. But there’s an 80% chance it sticks with its previous comment, 15% chance it backs away, and 5% it guides higher.  

 

We’re not averse to owning Nike for someone who has an extremely long duration. But there’s no way we can justify putting money to work here for a company that is barely growing earnings when the brand is hotter than ever.  With the stock at 23x next year’s earnings, we simply think that there’s much better risk/reward elsewhere.  

 

NKE – Consider the World Cup Biorhythm  - nke financials


Poll of the Day Recap: 58% Voted Yes and say Fed Easing is Back on the Table

Takeaway: 58% voted YES, 42% voted NO

The US economy contracted a steep 2.9% in the first quarter, the government reported this morning, a decline that took many by surprise, but not Keith McCullough and the Macro team here at Hedgeye. They have been making the #GrowthSlowing call for months.

 

They also expect the Fed to react, writing today, “With respect to 2014, the Fed will continue to surprise investors by incrementally easing as the year progresses. An example of this is last week’s rhetorical easing via extending rate hike guidance. A cessation of tapering at the September 16-17 FOMC meeting is not out of the question (then the Fed will likely have to cut their 2014 growth forecasts – again).”

 

That leads us to today’s poll question.

 

Does today's GDP stink bomb put Fed easing (more cowbell!) back on the table?

 

Poll of the Day Recap: 58% Voted Yes and say Fed Easing is Back on the Table - Dovish Hawkish

 

At the time of this post, 58% voted YES, 42% voted NO.

 

Voters who believe YES the GDP print put Fed easing back on the table reasoned:

  • The Fed will continue the easing beyond original plans, but not in the form of buying T-Bills, mortgages, etc. Fed will continue to taper down to zero and then ease through some backdoor method not so visible to the markets, i.e., the EU buys T-Bills and in turn Fed buys ECB debt somewhat behind the scenes. All IMHO.
  • The Fed can't help itself. At the first sign (in their minds) of any problem, they'll revert to more easing. Plus, I thought Janet Yellen was very dovish when she spoke last week.
  • We've built a habit out of easing, and weaning off of that will be nearly impossible since it's produced results in terms of stabilizing the markets.

Those who voted NO Fed easing is not back on the table has this to say:

  • No a change in the monetary policy will only confuse the markets. By the way the GDP number is backward looking, in theory the FED is looking forward and they are seeing a better economy in the future (of course they could be wrong as they have been so many times in the past). So no, IMO they will stay put.
  • Yellen has a clear runway to stay the course. Any bumps in the road can be attributed to the prior Fed (OK, so she was co-chair, but that's only "co") and both the political will - and more important stock prices - seem to want her to continue to taper and beyond.
  • Although very bad, the data is incredibly skewed by the drop in healthcare spending. A cynic would say this is to help flatten the 2Q final print when we'll see a big healthcare spend reversion just a few weeks before mid-term elections.
  • GDP is looking in the rear-view mirror. The Fed will focus on what's happening this quarter and next. By all accounts, we're seeing some level of recovery, albeit choppy. As such, I think the Fed stays the course and keeps tapering.


Expert Call: Geopolitical Outlook in The Energy Space

Expert Call: Geopolitical Outlook in The Energy Space - 06.25.14 Expert Call Logo

 

We will be hosting an expert call featuring Dr. Meghan O'Sullivan, Kirkpatrick Professor of the Practice of International Affairs and Director of the Geopolitics of Energy Project at Harvard University's Kennedy School. The call will be on Friday, June 27th at 1:00pm EDT.

 

CALL OBJECTIVE

To highlight the interconnectedness and progressive implications of recent geopolitical tension in the global energy space.

 

KEY WILL TOPICS INCLUDE:

  • Regional consequences of an ISIS advance in Iraq
  • Russian energy influence and its geopolitical undercurrent 
  • High level overview on the implications for the U.S. oil and gas boom

 

CALL DETAILS

  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 923285#
  • Materials: CLICK HERE (slides will download approximately one hour prior to the start of the call)

Ping for more information.

 

 

ABOUT PROFESSOR MEGHAN O'SULLIVAN

Meghan served as special assistant to George W. Bush and National Security Advisor for Iraq and Afghanistan from 2004-2007. She has spent two years in Iraq, most recently in the fall of 2008 at the conclusion of the security agreement and strategic framework agreement between Washington and the government of Iraq. Prior to her current post, Meghan was a senior director for strategic planning and southwest Asia in the NSC as well as political advisor to the coalition provisional authority administrator and deputy director for governance in Baghdad.

 

She is currently an adjunct senior fellow at the Council on Foreign Relations, a consultant to the National Intelligence Council, and a strategic advisor to John Hess, the Chairman and CEO of Hess Corporation. She is also a foreign affairs columnist for Bloomberg View as well as a member of the Council of Foreign Relations, the Trilateral Commission, and the Aspen Strategy Group. O'Sullivan has published several books and articles on American Foreign Policy and has been awarded the Defense Department's highest honor for civilians, the Distinguished Public Service Medal. Esquire Magazine named her one of the most influential people of the century. 

 

Dr. O'Sullivan received a B.A. from Georgetown University, a Masters of Science in Economics and Doctorate in Politics from Oxford University.


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Cartoon of the Day: A Real Stinker

Takeaway: The U.S. economy declined 2.9% in the first quarter. That didn’t smell good to anyone.

Cartoon of the Day: A Real Stinker - GDP skunk 6.25.2014


Restaurant Value Spread In Unfamiliar Territory

The BLS released CPI data for the month of May last Tuesday, June 17th, 2014 and we thought it’d be interesting to look at the impact it could have on the restaurant industry.  Most notably, the Restaurant Value Spread turned positive for the first time in 25 months as food at home inflation outpaced food away from home inflation in May; as such, the spread widened by 120 bps sequentially to +70 bps. 

 

This can be interpreted two different ways:

  1. Bullish data point for restaurants: consumers are more enticed to eat out
  2. Bearish data point for restaurants: consumers have less discretionary income to spend on eating out (which is often viewed as a luxury)

 

Restaurant Value Spread In Unfamiliar Territory - chart1

 

While we aren’t here to solve this debate, we’d be remiss not to highlight these two hotly contested beliefs.  We’d also be remiss, however, to ignore the recent trends we’ve seen in grocery and food service sales.  The data would suggest a favorable environment for restaurants is developing.  LTM grocery sales have been fairly flat to-date in 2014, while LTM food service sales have shown a slight acceleration.  Importantly, food at home inflation has  accelerated sequentially in each of the last four months.

 

Restaurant Value Spread In Unfamiliar Territory - chart8

 

Restaurant Value Spread In Unfamiliar Territory - chart9

 

 

The charts below highlight important sequential inflation trends:

  • Core CPI accelerated 10 bps sequentially to +1.9%
  • Food at home CPI accelerated 100 bps sequentially to +2.7%
  • Food away from home CPI decelerated 20 bps sequentially to 2.0%

 

Restaurant Value Spread In Unfamiliar Territory - chart2

 

Restaurant Value Spread In Unfamiliar Territory - chart3

 

 

The spread between food at home CPI and core CPI widened 90 bps sequentially to +0.8%.

 

Restaurant Value Spread In Unfamiliar Territory - 4

 

 

The spread between food away from home CPI and core CPI narrowed 30 bps sequentially to +0.1%.

 

Restaurant Value Spread In Unfamiliar Territory - 5

 

 

NSA Full-Service CPI accelerated 10 bps sequentially to 2.2%.

NSA Limited Service CPI decelerated 20 bps sequentially to 2.2%.

 

Restaurant Value Spread In Unfamiliar Territory - 6

 

 

Howard Penney

Managing Director

 

Fred Masotta

Analyst


US GROWTH: WHEN DOVES CRY

Takeaway: Our GDP estimates are coming down and consensus macro remains out to lunch with theirs. Stick w/ our YTD game plan RE: investment strategy.

UNLEASH YOUR INNER DOVE

The other day at lunch, I was describing the recent progression of my wardrobe to Hedgeye Health Care Sector Head Tom Tobin. In hearing this, Tom went on to compare my latest fashion exploits to that of Prince in the 80s. Having been born in the 80s, I don’t remember much, if anything, of Prince or his music. So I did what most fashion-forward millennials do when they don’t know something – I Googled it!

 

Needless to say, his music is legendary. “When Doves Cry” is a personal fav…

 

US GROWTH: WHEN DOVES CRY - Prince

Source: Google Image

 

As it relates to actual macroeconomic analysis, the doves are definitely starting to cry at the Fed. In a fantastic article today, Reuters journalist Howard Schneider walks though the current debate being held amongst members of the Federal Reserve and its regional banks. Specifically, the Yellen-led institution is openly debating pushing out their forecasts for labor market tightness, citing both new and old analyses in the process.

 

The key takeaway is that the FOMC is setting up to surprise both buy-side and sell-side consensus to the downside with respect to tightening monetary policy. A less-tight labor market in the interim means the Fed can remain “accommodative” for longer – which is exactly what is being priced into the interest rate markets. Expectations for a 2015 Fed Funds Rate hike are down -27% on average, across the curve, from when we correctly introduced this bold prediction back in JAN.

 

US GROWTH: WHEN DOVES CRY - Fed Funds Implied Rate

 

With respect to 2014, we still think the Fed will continue to surprise investors by incrementally easing as the year progresses. An example of this is last week’s rhetorical easing via extending rate hike guidance. A cessation of tapering at the SEP 16-17 FOMC meeting is not out of the question (then the Fed will likely have to cut their 2014 growth forecasts – again).

 

If there’s one thing we’ve learned in the post-crisis era, it’s that the Fed – which continues to use outdated, linear forecasting models – is always wrong on growth.

 

US GROWTH: WHEN DOVES CRY - FOMC Growth Forecasts

 

Preferring to opt for differential calculus and Bayesian modeling techniques, we remain the “bears” on 2014 growth and the “bulls” on 2014 inflation and both the Fed and the investment community will have to continue to chase our growth estimates lower. In doing so, we think the Fed’s marginal dovishness is likely to weigh on the USD and propel our inflation estimates higher – hurting household consumption (i.e. ~70% of GDP) in the process.

 

REFRESHING THE MODEL

With this morning’s bomb of a 1Q GDP print, our predictive tracking algorithm is now -41% below both the Street and the Fed for 2014 GDP growth; recall that we were at +2.2% to start the year:

 

US GROWTH: WHEN DOVES CRY - UNITED STATES

 

US GROWTH: WHEN DOVES CRY - GDP Summary 062514

 

US GROWTH: WHEN DOVES CRY - Consensus Macro Estimates

 

Both the Fed and the Street have been cutting their growth forecasts of late and we expect them to keep cutting:

 

US GROWTH: WHEN DOVES CRY - GROWTH

 

Tough comps paint a dour outlook for 2H14:

 

US GROWTH: WHEN DOVES CRY - GDP COMPS

 

After pushing back hard in 1Q, the investment community is finally starting to catch up to our hawkish inflation outlook:

 

US GROWTH: WHEN DOVES CRY - INFLATION

 

Easy comps are supportive of this view:

 

US GROWTH: WHEN DOVES CRY - CPI COMPS

 

As is annualized currency weakness – which should only accelerate if the Fed continues to get easier, at the margins:

 

US GROWTH: WHEN DOVES CRY - FX

 

BUT, BUT WASN’T IT ALL JUST THE WEATHER?

Notwithstanding the fact that both CapEx and employment growth are late-cycle in nature (we are 60 months into an economic expansion – the average length in the post-war era) AND the fact that a sustained boom in either has never occurred without concomitant structural appreciation of the dollar and higher interest rates, we do cede the view that the weather played a material role in crushing 1Q GDP.

 

US GROWTH: WHEN DOVES CRY - CapEx

 

That said, however, we think the bounce “off the lows” in domestic high-frequency economic data is both long in the tooth and poised to roll over starting in JUL.

 

US GROWTH: WHEN DOVES CRY - Eco Table 062514

 

US GROWTH: WHEN DOVES CRY - Bloomberg ECO Surprise Index

 

CONCLUSION

All told, we reiterate our still-active 2014 macro themes and their associated investment implications (i.e. LONG slow-growth yield-chasing, late-cycle industrial pricing power and M&A; SHORT early-cycle sectors like the consumer, housing and financials – especially regional banks):

 

  • #InflationAccelerating (1Q14)
  • #GrowthDivergences (1Q14)
  • #ConsumerSlowing (2Q14)
  • #StructuralInflation (2Q14)
  • #HousingSlowing (2Q14)

 

We will host our 3Q14 macro themes call on JUL 11 at 11am EDT; email if you need the details.

 

Keep an eye on those doves!

 

DD

 

Darius Dale

Associate: Macro Team


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