This note was originally published at 8am on October 21, 2014 for Hedgeye subscribers.
“There is something in the New York air that makes sleep useless.”
-Simone De Beauvoir
I’m not known as a big sleeper. I’ve been krolled (not to be confused with being trolled on Twitter) a few times during the due diligence process for different ownership/partnership stakes and positions, and “irregular hours” always comes up as a “flag.”
Back when we started the firm in 2008, that’s why I called this morning rant the Early Look. And so my amateur writing career began… with the promise of only one repeatable competitive differentiator: getting up early and writing to you at the top of the risk management morning.
Last night we hosted a small group dinner in NYC to talk about how everything has “bottomed.” While the feedback (and fear) is that most don’t want to “miss” the next move up, I couldn’t sleep last night thinking that fear itself might just be the biggest #Bubble of them all.
Back to the Global Macro Grind…
When someone uses the word “fear”, it tends to have negative connotations. And, to be clear, I am thinking very negative things could happen if I am correct in calibrating that many got longer of #bubble exposures on the equity and junk bond market’s most recent bounce.
Sure, they may have sold short indices and overpaid for volatility, protection, etc. in the heat of last week’s melt-down, but they A) didn’t sell all of their crashing small/mid cap equity exposures and/or B) their junkie “high-yield” positions either.
In risk management speak, in bear markets we call this cardinal sin “selling what you can, not what you should”… and while my calibration might be wrong, I can’t see that in the market’s futures/options positioning (which is getting longer of beta, not shorter).
To review where some of the hardest core #Bubbles are in this interconnected world:
To me, a lot of this is one and the same thing. And it really starts with the 1st #Bubble (Central Planning) because that’s what drove macro markets to inheriting the mother of all interconnected risks (see exhibit 52 in the Q4 Macro Themes Deck) – the #Bubble in Spread Risk (see Chart of The Day):
What’s fascinating about this 3D risk picture is that almost every equity only PM we meet with agrees with it much more adamantly than any of my US stock market centric #bubble charts (like the one that has Russell 2000 at 55x earnings with low liquidity).
There’s obviously confirmation bias in that, but reality is that unless you think it’s different this time (almost every “the bottom is in” thesis has something to do with markets not being able to go down anymore), this is how The Waterfall of Spread Risk works:
You see, the core differentiator in our call this year has always been fundamental – that growth slows and starts to get priced into expectations.
“So”, instead of living in fear of your own performance and/or what the “other funds” did last week when the Russell was -15% from its July #bubble high, why don’t I hear most people focusing on what was causal to the gap down in bond yields and equity markets to begin with?
You can lose sleep over what everyone else is doing, or you can focus on what you need to do to get the fundamental research right. And this early riser humbly submits that if you get the rate of change in growth and inflation right, you’re going to get both bond yields and your exposures right.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.09-2.25%
WTI Oil 79.97-83.95
Best of luck out there,
Takeaway: Moving FL up to our Core Short list. Key issue “what he no longer sees that is making him go”. Similarities to Murphy/GPS are startling.
Conclusion: We’re moving FL up from our Short Bench to our Core Shorts. The announcement of Ken Hicks retiring as CEO is the icing on a cake that was already baking. To be clear, we don’t think that FL is in trouble because Ken Hicks is leaving. We think that Ken Hicks is leaving because Foot Locker is in trouble. The juxtaposition here with Glenn Murphy leaving GPS last month is striking. Both of them; a) are seasoned executives, b) joined their respective companies within a year of the last recession (and trough margins), c) have hit home runs with zero square footage growth retailers, and d) are leaving for no apparent reason. How can this be anything other than a negative signal for where we are in the retail margin cycle? We’ve been harping over and over again about how we are in year six of a six year cycle. We can’t help but think that these two gentlemen are validating that premise.
Another point…one thing that kept us on the sidelines about pushing the FL short case was all the talk of an LBO. Even though we thought it was ridiculous, the reality is that the math works for someone gullible enough to straightline current margins into perpetuity. But would Hicks be walking out the door if the company was being shopped to buyers? Probably not.
As background, we added Foot Locker to our Idea Bench in August as a short. Trends look fine today, as better product from Nike and UA on top of more efficient store formats are pushing productivity past old limits. But sometimes limits push back. Today FL is operating in excess of $500/ft, which is about 25% higher than historical peak, margins are setting new peak levels at 11% this year, and the stock is trading at 15x forward earnings (close to peak).
Since August, three things have happened, all of them negative.
1) Europe has started to soften for many retailers on the margin, including footwear and apparel.
2) Nike and UnderArmour both put up stellar consumer-direct comps, with e-commerce readings literally off the charts. We’ve never seen the athletic brands so blatantly aggressive in growing outside of the traditional wholesale channel.
3) Ken Hicks stepped down. This is the icing on the cake. The guy was money for FL, and for shareholders. The stock has been a 4-bagger since he was appointed in Aug 2009. He has beat two sets of long-range objectives in half the time intended. We know that he has groomed Johnson and other top talent to take his role in as seamless a manner as possible. But it’s just not enough.
We’ll be back with more detailed analysis on our short thesis.
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Takeaway: Hedgeye's Brian McGough thinks Victoria Secret's "free shipping" offer is a continuation of a trend that will plague the rest of retail.
Victoria's Secret (LB) has used the Free Shipping offer as an offensive weapon in the past (they were one of the first to do so, actually), but this is a continuation of a trend that we think will ultimately plague the rest of retail.
While LB is a high-end brand with a very loyal customer base, we would note that even a powerhouse like Victoria's Secret can't easily absorb free shipping costs due to a relatively low average basket size.
Takeaway: RHP should report a solid Q3 and clarification of diluted share count will be welcome
Consensus estimates, management guidance and commentary, and questions for management in preparation for the earnings release tomorrow
Please see our note: http://docs.hedgeye.com/HE_RHP_EarningsPrep_11.3.14.pdf
Takeaway: KATE: Best Idea Flash Call Wednesday, 11/5 at 11:00am ET.
We’re hosting a Flash Call on Wednesday, November 5th at 11:00am ET to outline why we added KATE to our Best Ideas list as a long. We’ll review, in detail, our thesis across durations (Trade, Trend and Tail) and will explore where the stock should go as well as where we could be wrong ahead of the company’s print (on Thursday the 6th).
Key Topics Will Include:
1) Bottom-up category growth model. Penetration and growth potential in handbags, apparel, footwear, accessories, etc…
2) Where KATE is in its store maturation curve, and the implied impact on comp.
3) A look at earnings and profitability under a real reporting structure – one that we think it will adopt within 2-years – as opposed to the opacity that exists in the model today.
4) Property strategy relative to other brands, and cost implications.
5) Process by which KATE could jettison Jack Saturday.
6) Scenario analysis for updated guidance to long-term model – both the risk and the upside.
7) Where we could be wrong in having KATE as one of our Best Ideas on the long side.
Participant Dialing Instructions
Toll Free Number:
Direct Dial Number:
Conference Code: 213986#
Materials: CLICK HERE
Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.