Takeaway: Is Portugal the proverbial canary in the global market coal mine?
“And a young prince must be prudent like that,
giving freely while his father lives
so that afterwards in age when fighting starts,
steadfast companions will stand by him and hold the line.”
As many of you know, I recently joined the ranks of fatherhood after a solid run as a bachelor. Fatherhood is great on so many levels, but also very intriguing intellectually. As my daughter emerges on her 6th week, her mother and I have started talking a lot about sleep training, or lack thereof.
It seems there are many different (and really divergent) views on how to encourage a baby to fall asleep on a timely basis and, also, how to to ensure she gets the right amount of sleep. On one extreme, there is the "cry-it-out method," in which the infant figures out how to sleep on their own. On the other extreme is "attachment parenting" in which the infant is basically brought into the familial bed.
After doing a survey of my friends, one suggestion that was most unique was to read Beowulf just before bedtime. I’m not sure if we will employ the so called “Beowulf Method,” but admittedly if it didn’t put our little Emmy to sleep, it would certainly work with her parents.
Speaking of sleep training, global asset markets continue to be in deep REM sleep. In our Q3 themes deck, we emphasized this with our theme: Volatility Asymmetry. A few highlights from that theme include:
- U.S. equity volatility is literally at an all-time low and well below the 20-year mean of 20.05;
- Fixed income volatility is also literally at an all-time low and the current reading is 54.03, which is in the 1.5% percentile versus the long run mean of 99.7; and
- Finally, the JPM Global foreign exchange volatility index is at 5.45 versus the long run mean of 10.6.
Yes, it is official -- the world’s central banks have lulled the markets to sleep, for now at least.
Back to the Global Macro Grind...
The interesting thing about global markets of course is that global risk can happen all at once. Any of you that have invested and thrived over the last decade know this fact only too well. As of late, so do those investors that have parked capital in Portugal.
No doubt most of you have been following the woes of Espirito Santo family of financial institutions in Portugal over the last month. This morning the news actually got incrementally worse. Specifically, Riforte Investments SA, a holding company in the Espirito Santo family, missed a $1.2Bn payment of commercial paper yesterday.
The Portuguese Central Bank Governor was quick to put on his super central banker cape and fly to the rescue. In prepared comments, Carlos Costa indicated that shareholders of the parent were standing ready to inject more capital if needed. In the short run, this has actually helped as Banco Espiritu Santo’s bonds and stocks have recovered a portion of their losses.
Nonetheless, as we’ve highlighted in the Chart of the Day below, Portugal has disconnected with Europe rather quickly in the last month or so. Over the month, Portuguese equities are down more than 12% and are now down on the year just over 4.2%. Of the major markets in Europe, only Russia is down more (for some obvious reason related to the Ukraine).
No surprise, Portuguese sovereign debt has seen a comparable spike in yields. While the 10-year yield of Portugal is still at a reasonable 3.73%, the fact remains that this yield has widened dramatically versus its peripheral peers Italy and Spain. We have also seen Portugal’s sovereign debt auctions have a much tighter bid-to-cover as of late.
The big question remains whether this is a canary in the proverbial global market coal mine, or, conversely, whether the bad news is priced in. Our Financials Sector Head Josh Steiner likely put it best in his weekly Risk Monitor note when he wrote the following (emphasis mine):
“Portugal's Espirito Santo Group continues to dominate news flow on the banking front. Both EU and US global bank swaps are widening sharply, and TED Spread is beginning to widen as well. For now, there appears to be no reason to assume that Espirito Santo's problems are widespread, but there is a rising level of uneasiness as investors ask how could this bank, which was under so much scrutiny for the last few years, suddenly be now having such problems?”
His point is an astute one and time will tell whether this is the awakening of risk that seems to be broadly not priced into global asset classes.
Unfortunately for Europe, which remains under the strains of too much debt, the economic data coming out of Europe as of late, with the exception of the United Kingdom, has been less than robust. Most telling this week was the reading from the German ZEW economic expectations index.
Expectations coming into the number were for a notable deceleration, but the actual number was much worse than expected. Specifically, July printed 27.1 versus expectations of 28.2 (29.8 prior). In reviewing the leading indicators for May, industrial production fell for a third consecutive month, missing expectations, and factory orders also missed. The ZEW Current situation survey also fell sharply from June while consensus expected a slight deceleration. That gauge printed 61.8 versus expectations for 67.4 (67.7 prior).
Growth slowing and banks imploding . . . perhaps our call that the U.S. Federal Reserve will be more dovish than consensus (read Jan Hatzius) believes will happen sooner than expected. But, hey, China just beat GDP by 0.1%, so there is that...
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.49-2.58%
BSE Sensex 249
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Takeaway: Join us for a call to debate the key issue today facing RH – real estate. Our deep dive will show why we think this story is far from over.
Please join us on Thursday, July 17th at 11:00 am ET for a call titled RH: Real Estate Deep Dive. We’ll be releasing our 2nd Black Book on Restoration Hardware, specifically outlining the key issues that we think are critical to the investment thesis and the stock at this point in the company’s growth trajectory. The reality is that some of the key factors to this story deserve greater scrutiny today than they did just $30 ago.
We’ll hit on several topics, but the key focus on Thursday will be real estate. The crux of our commentary will focus on the likelihood of success in RH’s build-out of its large format Full Line Design Galleries. We’ll outline the biggest opportunities, potential risks, and whether or not the company is set up to execute on this opportunity. Ultimately, we’re going to flush out the real estate profile and potential store growth in the same way and using the same tools many retailers use to analyze their own store growth opportunity.
KEY TOPICS WILL INCLUDE:
1) What does RH’s addressable market look like, and how will that evolve over the next 5 years?
2) How many markets in the US can support a Full Line Design Gallery at the sales productivity standards that RH is setting for its’ new stores?
- We’ll drill down on specific markets that have been announced, but will also analyze in great detail other markets that we think are likely candidates that the company has not yet announced.
- We’ll look quantitatively at the underlying economics of each FLDG market.
- We’ll break out ‘fill in’ markets versus new markets.
- The costs of the properties is evolving. How this is impacting RH’s ROIC?
3) A look at trends we’re seeing in anchor tenant space, and why we’re seeing more premium space available than most people might think.
4) Category expansion, and which categories present the biggest opportunities (and potential risks) at retail.
5) How much of a risk is a housing downturn to the RH story?
Participant Dialing Instructions
Toll Free Number:
Direct Dial Number:
Conference Code: 275779#
Materials: CLICK HERE
Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.
This note was originally published at 8am on July 02, 2014 for Hedgeye subscribers.
“Dreams of castles in the air, of getting rich quick, do play a role – at times a dominant one – in determining actual stock prices.”
-Burton G. Malkiel
For the past several days, I’ve been reading a gem of a book recommended by my colleague, Howard Penney. Malkiel’s “A Random Walk Down Wall Street” is a timeless, thought provoking piece that most curious investors would enjoy reading poolside on a beautiful summer day. I certainly did. After all, restaurant research isn’t limited to cheeseburgers and fries. In fact, a large part of our job pertains to understanding both human and market psychology. The castle-in-the-air theory, which concentrates on the psychic values of investors, serves as a constant reminder of this fact.
For those unfamiliar with its origin, the castle-in-the-air theory was popularized by John Maynard Keynes in 1936. While we tend to disagree with Keynes’ and his disciples on a number of economic issues, the notion that stocks trade off of mass psychology is widely appealing. Accordingly, some investors attempt to front run this onslaught of groupthink, not by identifying mispriced stocks, but rather by identifying stocks that are likely to become Wall Street’s next darling. All told, this can be a profitable strategy – until it’s not.
Back to the Global Macro Grind...
We believe we’ve identified one of Wall Street’s current darlings and recently added it to the Hedgeye Best Ideas list as a short. Del Frisco’s Restaurant Group (DFRG) owns and operates three distinctly different high-end steak chains. After coming public in July 2012, the stock has gained over 114%; quite impressive, by any measure. More importantly, however, we believe cheerleading analysts and the subsequent madness of the crowd have propelled the stock during this time. Is it reasonable to call a company whose adjusted EPS declined 7% in 2013 one of the greatest growth stories in the restaurant industry? We think not.
As Malkiel goes on to say:
“Beware of very high multiple stocks in which future growth is already discounted, if growth doesn’t materialize, losses are doubly heavy – both the earnings and the multiples drop.”
The truth is, the company currently screens as one of the most expensive stocks on both a Price-to-Sales and EV-to-EBITDA basis in the casual dining industry. While we’re not insinuating DFRG is the beneficiary of a “get-rich quick speculative binge,” we are confident the stock is severely dislocated from its intrinsic value.
Part of the hype has been driven by the company’s positioning within the restaurant industry. Del Frisco’s caters to the high-end consumer; a cohort that the stock market would suggest is doing quite well. While this may be true, we believe the high-end consumer has been slowing on the margin as inflation in the things that matter (food, energy, rent, etc.) continues to accelerate. Contrary to popular belief, high-end consumers can feel the pinch too and two-year trends at the company’s hallmark concept, Del Frisco’s Double Eagle Steakhouse, would suggest the same.
Admittedly, the Double Eagle Steakhouse, though slowing, is a healthy concept. But it’s only 25% of the overall portfolio. The other 75% consists of a fundamentally broken concept (Sullivan’s) and an unproven growth concept (Grille). Naturally, the Street is discounting an immediate turnaround at Sullivan’s and a flawless rollout of the Grille, neither of which we see materializing. In fact, we continue to expect restaurant level and operating margin deterioration throughout 2014. This has less to do with all-time high beef prices (32.8% of Del Frisco’s 2013 cost of sales) and the recent wave of minimum wage increases (25% of Del Frisco’s restaurants have exposure), than it does with the fact that the company is systematically growing at lower margins and, consequently, returns.
More broadly, there are a number of red flags that the Street is unwilling to acknowledge right now including decelerating same-store sales and traffic trends, declining margins, declining returns, increasing cost pressures, expensive operating leases, peak valuation, positive sentiment and high expectations. We simply refuse to give the company credit for what it has not proven and while we can’t hit on all the minutiae of our thesis in this note, we do have a 67-page slide deck that does precisely that (email email@example.com for more info). In short, our sum-of-the-parts analysis suggests significant downside.
You can delay gravity, but you can’t deny it. Needless to say, we don’t expect this particular castle-in-the-air to stay there much longer.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.50-2.59%
Brent Oil 111.51-115.43
Join us today at 11am EST as we continue our Speaker Series on e-cigarettes and e-vapor with John J. Wiesehan, Jr., CEO of the Charlotte based company, Ballantyne Brands, LLC.
Ballantyne Brands is a leading private manufacturer with the third largest market share in the U.S. (in the xAOC channel) with such e-cig brands as Mistic and Neo and personal vaporizer Haus.
Is the consumer switching to an alternative vaping product, and why? Mr. Wiesehan, Jr. will offer his latest insights and expertise to Hedgeye's ongoing research on the e-cigarette/e-vapor category.
KEY CALL TOPICS WILL INCLUDE
- Industry developments and trends
- How the FDA's proposed regulations stands to impact the industry
- Ballantyne Brands product offering versus Big Tobacco's
- What does future technology look like
LO, MO, PM, RAI, ECIG, VPCO, BTI
ABOUT JOHN J. WIESEHAN, JR.
John J. Wiesehan, Jr. is currently the CEO of Ballantyne Brands, LLC. A graduate of Lindenwood University in Saint Charles, Missouri, John spent time at General Electric as the Worldwide Operations Manager. From General Electric, he moved to Woods Industries as Vice President in the Sales and Marketing sector. In October 2012, John joined Ballantyne Brands, LLC located in North Carolina and became CEO.
- Toll Free Number:
- Direct Dial Number:
- Conference Code: 544867#
- Materials: CLICK HERE (Slides will download one hour prior to the start of the call)
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