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Diffusive Thoughts

This note was originally published at 8am on August 06, 2014 for Hedgeye subscribers.

Opportunity is missed by most people because it is dressed in overalls and looks like work.

-Thomas Edison


I recently picked up a new book called, “A Mind for Numbers”.  The book is written by Dr. Barbara Oakley, a professor of engineering at Oakland University, who, like many people, struggled with math and sciences while in high school.  Unlike most people with these struggles, she went on to become a very prominent professor in a very math oriented field.


The essence of the book is really about how to make a break through while studying any subject.  In doing so, the book proposes on relying on the two modes that our brains naturally work in: focused and diffused.  In focused thinking your brain logically works through problems in a careful and attentive manner. Meanwhile, diffused thinking occurs more in the background, your brain processes while you are doing other things like jogging, driving, playing sports, and so on.


Some of the most productive thinkers of our time actually systematically shifted theirs brains between the two modes.  In particular, Thomas Edison had a unique trick for shifting how his brain was operating.  Edison was known for his focus and work ethic, but he would also often take “cat naps” during the day.


During these small naps while sitting in a chair in his laboratory, Edison would hold a steel ball in his hands. As he would nod off into a deeper and deeper sleep, Edison would drop the ball and it would fall to the floor and naturally wake him. Thus Edison was able to switch into diffusive thinking, without getting into a much deeper sleep that would potentially make him groggy and slow his efforts.

Now for many of us stock market operators, a mid-day nap on the trading floor is probably not practical, but as Oakley writes in her book:


“The key is to do something else until your brain is consciously free of any thought of the problem.”


In effect, you need to distract your brain, so you can shift into diffusive thinking, so that the big picture part of your brain can kick into gear and help you solve the problem at hand. 


Diffusive Thoughts - EL chart 2


Back to the Global Macro Grind . . .


Like many of you, we tend to get in early and grind away at Hedgeye, but lately we have also been doing some diffusive thinking. On this front yesterday, my colleague Darius Dale prepared a 50 page presentation yesterday (after some long walks around our office park) that is titled, “Are You Prepared for Quad #4?”


As most of you know already, we look at economies based on our propriety GIP model (growth, inflation and policy).  In our view, as supported by historical studies, asset price returns are driven by shifts in growth, inflation and policy within an economy.  In the Chart of the Day, we highlight this graphically with a definition of the four quadrants.  Quad 4 occurs when growth slows and inflation decelerates, which typically elicits a dovish policy response.


If you’d like to see the full length presentation, please email your institutional sales contact or simply email sales@hedgeye.com.  Also CLICK HERE for a short video that Darius did on HedgeyeTV going through the key points.

A key catalyst for a shift in our thinking, aside from long walks or baths, has been the break out in the U.S. dollar. As Darius notes in the presentation, the investment conclusions from a shift into Q4 for the domestic economy are as follows:

  • Bonds over stocks;
  • Defensive equities over cyclical equities;
  • Late cycle investments over early cycle investments;
  • Buy U.S. dollar and short commodities.

As it relates to translating this directly into what we would recommend selling and owning under this scenario, we’d focus on the following:

  • Long – Long term treasuries (TLT), Muni Bonds (MUB), Healthcare (XLV), and Old China (FXI)
  • Shorts (or Underweights / Sells) – Russell 2000 (IWM), High-yield credit (JNK), Homebuilders (ITB), Regional Banks (KRE), Retailers (XRT), and Eurozone (EZU)

On the last point of selling the Eurozone, over the last month European equities have been getting crushed.  Every major European equity index is down over the last month ranging from the U.K. down -4% to Russia down -14%.  Germany is also clearly in the midst of a World Cup hangover as German benchmark equities are down -9.5% and now down over 5% for 2014.


Speaking of Germany, German factory orders were an unmitigated disaster for June.  Consensus expectations were for an increase of 0.9% from May and the actual number came in at -3.2%.  On a year-over-year basis, the numbers were just as abysmal as factory orders that declined -2.4%.  This marked the largest decline since September 2011.  For those long of Germany, hopefully Oktoberfest is a positive catalyst!


Switching gears for a second, our Restaurant and Consumer Staples Sector Head Howard Penney has had a very successful alpha generating year within the restaurant sector and after rolling up his sleeves, focusing, and then taking a break (yoga?) to diffuse the thoughts, he has a healthy pipeline of Best Ideas in the Consumer Staples Sector.


The next idea he is rolling out will be a short call on Hain Celestial Group (HAIN).  We added the idea to our Best Ideas list as a short on Monday and the deep dive call on the name will occur on Thursday August 14th at 1pm eastern.  If you’d like the materials for the call, please email sales at Hedgeye (this call won’t be pro bono though, alpha doesn’t come cheap!).


Keep your head up and stick on the ice,

Daryl G. Jones

Director of Research


Diffusive Thoughts - Chart of the Day

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Changing Up Our Retail Idea List

Takeaway: We made 10 changes to our Idea List – 7 Shorts/3 Long – and outlined duration for each. NKE, FL, M, DDS, COH, DKS, AMZN, DG, HBI, URBN.

This week, we made several changes to our Retail Ideas list. We also changed the format to address how we see each of these names playing out by duration. In case you’re unfamiliar with how we approach duration…

A) TRADE = 3-weeks or less. This is largely near-term catalyst-driven. Not where we spend the bulk of our time, but need to be aware of what’s coming down the pike nonetheless.

B) TREND = 3 months or more. This is primarily driven by quarterly modeling assumptions 2-3 quarters out.

C) TAIL = 3 years or less. This is the long-term call about market share, margins, and the capital needed to get there. For all names we recommend, we actually go out 5 years.


Changing Up Our Retail Idea List - Retail IDeas



1) We added Foot Locker to the Short Bench. Trends look fine for FL today, especially in Europe, which is about 25% of sales. Nike and UA are fueling its momentum in the US as well. But the company is putting up a 10%+ EBIT margin on productivity of over $500/ft – 25% higher than historical peak. On top of that we’ve got a 15x p/e (close to peak), and are staring at sentiment scores that are among the highest in retail.

2) We added Macy’s to our Bench, and put it right alongside Nordstrom as names we’ll opportunistically look to get louder on as the research becomes more conclusive, or the price heads higher.

3) We removed Dillard’s from our bench. We originally were cautious on the name as we thought (and still think) that the $100+ real estate values being thrown around the Street were overstated by 3x. What we did not appreciate is the free cash flow story behind DDS. We won’t buy that FCF story here, but we definitely won’t short it.

4) We removed COH from our Top Three shorts. The punchline is that we think that there is at best $5 downside for this name, which is not enough for us given the risk to the upside. As much as we think that this Brand and Financial model are broken, we think COH makes a lousy short here. Here’s the link to our note on the name. (Link: CLICK HERE)

5) We moved DKS in place of COH on the top three. It’ll stay there unless the price corrects or estimates post-quarter come out to be too conservative.

6) We pulled Nike out of the Short side of the ledger and put it on the Long Bench. The name remains ridiculously expensive, but the fact of the matter is that in recent weeks Nike has made some moves that are incredibly rational on the cost side – like passing on Kevin Durant (to UA) and letting Manchester United go to Adidas. Both of those alone save Nike about $100mm/year. Combine that with easier SG&A comps in another 2-3 quarters, and Nike will likely have consensus numbers in the bag – and then some.

7) We added Amazon to the Short Bench. We’re long term believers in the model, but every incredible story has a price. We can’t believe that 300x earnings and 35x EBITDA is the right one for AMZN.

8) We removed DG from the Bench. But then about 30 seconds later we put it back on. We get the excitement around synergies of a deal with FDO. But we think that this bidding war is far from over. It’s already rich at 11.6x EBITDA, but we think it ultimately will have to pay somewhere in the mid-$80s for FDO – or about 13x EBITDA. When it is looking to pay that much for such a poor quality asset, we need to really ask ourselves about the prospects management sees in its core.



1) Added Nike, as noted above.

2) Added URBN. This is a name we want to be bullish on, but have been wading in slowly. We think the management team is exceptional, we like the unit growth and e-commerce platform, and the problems at the core UO concept are definitely not terminal. The only thing holding us back is that having such highly productive concepts like Urban and Anthropologie that are doing $700/ft and $1,000, respectively are a double edged sword. They’re highly profitable, and very defendable. But turns in the business – both on the upside and downside – take an extremely long time to play out. Our point is that we could be sitting here in a year and people might still be complaining about weakness at UO.  At some point it won’t matter, and that time might be now. But we need to do more research to get the answer.

3) Added HBI. Let’s be clear…we don’t like this company or the business. This is a classic example of a company with a growth-challenged base business that is obfuscating its core by acquiring other companies. It’s track record is amazing…just as one acquisition approaches its 12th month, it goes ahead and buys something else. But whether we like it or not, HBI has a great 12-months ahead. It has year 2 synergies of Maidenform plus a full year of DB Apparel. Growth will look solid, HBI will beat conservative expectations, and investors will get paid with stock repo and dividends in the interim. As a kicker, lower cotton prices start to accrue to HBI in about another two quarters. We think this stock works from here.

investing ideas

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Hedgeye Macro is hosting an expert call this Thursday, August 21st at 11:00 a.m. EDT to better understand the developing risks to Brazilian coffee production capacity next year and beyond. Brazil accounts for more than 1/3rd of global coffee production, and the damage from an unprecedented drought in the first three months of 2014 may have caused irreparable damage to a much larger portion of the 2015-16 crop than believed by consensus.

Our expert speaker will be Judith Ganes-Chase, founder and president of Ganes Consulting, an independent agricultural softs commodities research and consultancy firm. Judy worked on the sell-side for 20 years before founding J. Ganes Consulting in 2001.

Call Objective:

  •  With irreparable damage from last winter’s ---(BRAZIL SUMMER) drought already manifest, consensus opinion is much too optimistic on Brazil’s production capacity into next year and 2016
  • Lifecycle of the Tree: The idea that above average rainfall can restore soil moisture and rehydrate the trees allowing the lack of vegetative growth to be offset is simply not true. Production estimates for a 2015-16 crop based on the coffee from trees that have not yet flowered are PREMATURE
  • End users may be able to hedge OTC through financial intermediaries, but the assumption that the crop paid for in the future is locked-in and available is an issue. Scarcity may be a problem à ESPECIALLY OF BETTER GRADES OF COFFEE.
  • Relevant Tickers: CAFE, JO, SBUX, DNKN, MCD, MDLZ, GMCR, THI  

Call Participant Instructions:

Participant Dialing Instructions

Toll Free Number:

Direct Dial Number:

Conference Code: 998836#

Materials: CLICK HERE


About Judith-Ganes Chase:

Judy has over 25 years of experience covering the agricultural softs space. Prior to founding Ganes Consulting in 2001, she spent most of her career as a senior softs analyst at Merrill Lynch and Shearson Lehman. Her most recent post was as the Director of News and Research at InterCommercial Markets.


 Ms. Ganes-Chase is a contributing member to Elliott Associates, Gerson-Lehrman Groups Council, and Coleman Research Group. She is also a participant in the ICE (Intercontinental Exchange) research program and makes regular contributions to several industry-specific publications: Specialty Coffee Association of America, National Coffee Association, and the International Women’s Coffee Alliance (IWCA).    


Hedgeye Macro Team


Cartoon of the Day: 'Crazy'

Takeaway: It's different this time. Right.

Cartoon of the Day: 'Crazy' - Crazy bull cartoon 08.19.2014

DKS - Uninvestable

Takeaway: There're puts/takes w the qtr…but bigger picture, there’s more bad news to come. We think 5-6% margins are more likely than recent 9% peak.

Conclusion: ‘Better than expected’ does not equate to a good quarter. Yes, we liked the 3.2% comp, 96% new store productivity, and $100mm repo – the second highest ever for DKS in a single quarter. It’s rare that DKS beats a quarter – we’ll give a golf clap when it’s due. But when all is said and done, depending on how you adjust for special charges, earnings were down between 5-10% on +10% sales growth. Not exactly a good quality number. On top of that, inventories remain elevated, margins are under pressure, and e-commerce grew at its lowest rate in 11 quarters. None of these factors get us particularly excited about owning this name – over any duration. Most importantly, to us at least, while people will obviously be talking about Golf due to the horrible trends and restructuring, we think there are bigger takeaways;  a) looked at over a longer time period, this Golf Galaxy deal was simply horrendous. DKS bought at the top of a golf cycle, and is downsizing at the bottom of one. Textbook example of how not to deploy capital. B) we think that there’s a bifurcation in the golf market that is making it structurally unable for DKS/Golf Galaxy  to compete. The company is taking its presence from 20% of sales to 15% and ultimately to 10%. Maybe the right answer is zero. The bigger question is whether or not this is an example that might apply to the rest of the Dick’s business as well.  We’re modeling mid-single digit EPS growth – 200-300bp below the rate of store growth – over the next 5 years. We think that this stock is flat-out expensive.



There are a few things that don’t sit right with us about the Golf business, and the downsizing effort that the company is taking. Clearly, the golf equipment business is under severe pressure. That’s nothing new. This started six quarters ago for Dick’s, and has manifested itself in financial results for virtually every other retailer and brand that participates heavily in the Golf business. But what we don’t understand is that Dick’s bought Golf Galaxy in 2006 – right at the top of a golf cycle -- as a way to strategically double down on a category that it viewed as a long-term value creator. Now we’re sitting here at what is arguably the bottom of the golf cycle, DKS is cutting costs from the model outright, and it’s even talking about how 63% of its Golf Galaxy leases come up within 3-years and will be candidates for closure. We’re not necessarily saying that golf is a good investment now. But with retailers under pressure and OEM’s cutting capital allocation to golf equipment, this strikes us as an opportunity to take share and reposition for the next upturn, if nothing else. Buying High, and Selling Low is rarely a winning strategy. Unless of course, the company has reason to think that it simply won’t be a part of any upturn in the market.


DKS - Uninvestable - dks1 


Based on the monthly sales trends for Amazon and eBay, we’re inclined to think that DKS is right in that it will simply not participate in any eventual upside in the golf space.  In other words, we can simply write this off as a deal gone bad.  Consider this. The time of year where most golf equipment is bought at full price is in April and May. Then discounts pick up in June, and accelerate meaningfully as the Summer progresses. Amazon’s numbers, in particular, show a simply staggering acceleration from -5% in April/May to 43% as we entered the key discounting period in July.


DKS - Uninvestable - dks2 


What we think is happening is that there’s an increasing bifurcation in the golf market.  Dick’s sells primarily to the ‘Occasional’ golfer, which accounts for about 44% of the golfing population. ‘Avid’ and ‘Core’ golfers are about 26% and 30%, respectively, and tend to shop in much higher-end golf specialty stores. One might think that this is not too bad, as it leaves 44% of the market for Dick’s. But that ‘Occasional’ player is also the lightest spender, and only accounts for about 19% of the market. That’s the same consumer that is more inclined to shop on Amazon or eBay for equipment at a heavy discount. An Avid golfer (45% of total spending) is not buying new gear on Amazon in August because it’s cheaper. They don’t care about price – and they have a favorite local store with high-end service where they buy equipment. Dick’s attempted to fill that void by hiring 400 Golf Pros to work in its Golf Galaxy stores. But they were all fired last month. Dick’s can’t compete with the golf specialty shops at the high end, and it’s proving that it can’t compete online with Amazon at the low-end.


DKS - Uninvestable - dks3 


DKS - Uninvestable - dks financials


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