In less than a year and half, President Obama has governed through a roller coaster of both Presidential experiences and Presidential approval. As we have often mentioned, he entered the Presidency with one of the highest approval ratings of any incoming President. This was based on incredibly high approval from his base, but also very strong support from the independents, who embraced his “change” mantra after tiring of Republican leadership for eight years. Over the past year and a half, Obama’s approval ratings have tumbled dramatically and his healthcare bill is being viewed in similar fashion.
A recent poll from Rasmussen highlighted current thoughts on the healthcare bill. Specifically, 54% of those polled favor a repeal of the healthcare bill. In addition, 50% now believe passage of the healthcare was bad for the country. Obviously, these numbers aren’t incredibly positive for this bill, or for President Obama’s approval as it relates to his healthcare initiative.
Unlike President Obama, President Reagan was hardly given a mandate when he was elected. At the convention in 1980, Reagan was very close to striking a deal with the moderate ex-President Gerald Ford to make him Vice President, which would have ceded some power over his agenda to moderate Republicans. Instead, he selected George H.W. Bush, and was elected to his first term as President with the narrowest of popular vote margins, less than 51% in fact.
The most significant move that President Reagan made in the first year of his Presidency was related to the Air Controllers Strike. Under law, the nation’s air controllers were not allowed to strike, along with a number of government unions. Rather than negotiate with the union, as most thought he would do, President Reagan announced from the White Rose Garden that if the air traffic controllers “do not report for work within 48 hours, they have forfeited their jobs and will be terminated.”
Despite the threat of serious political backlash, President Reagan fired 11,345 striking air traffic controllers and broke the union. While the nation’s air traffic control system would take years to recover, President Reagan had made his point and solidified his agenda. He was on the side of private business and against big labor. While this move wasn’t politically popular, it was important to President Reagan’s agenda.
The healthcare bill passage has parallels to the air traffic debate. Despite risk of political back lash and to his approval ratings, both President Reagan and President Obama, pushed forward agenda items that directly reflected their ideologies, and not political appeasement. On some levels, whether you agree with the politics or not, these decisions by both Presidents may be emblematic of their strong leadership.
In recent weeks, President Obama has made a number of decisions and taken a number of actions that seem to reinforce that he has had his Air Traffic Controller moment and is coming into his own as a political leader. He hammered on healthcare and was successful in passing it. He was strong on missile defense with the Russians, and was able to pass a successful arms control pact, even if delayed. In a recent meeting with Prime Minister Netanyahu of Israel, President Obama continued to press for a halt a construction freeze in east Jerusalem. Finally, President Obama recently made 15 recess appointments, including the contentions choice of Craig Becker to National Labor Relations Board.
So, what, if anything, will President Obama finding his leadership footing do for his approval and the Democratic party? As of yet, the results appear decidedly mixed. As of today, Obama’s approval rating on the Real Clear Politics poll average is 47.6%, which is basically at the lows of his Presidency. On the Rasmussen Daily Tracking Poll, he has seen a slight positive move. While those that Strongly Disapprove have held in at 44% over the last few days, which is his lowest reading since being elected, the Strongly Approve is now registering 30%, which is well off the March 9th trough of 22%.
As our Healthcare Sector Head Tom Tobin mentioned in his morning note, the midterm is widely anticipated to be a disaster for the Democrats. But with some of President Obama’s recent moves, which do represent a leadership of sorts, perhaps consensus had become too bearish on the midterms for the Democrats.
Even if consensus is correct, perhaps it is less relevant for President Obama than many pundits currently believe. Continuing with the comparison to Ronald Reagan, remember that President Reagan was first elected with just under 51% of the popular vote. In his first midterm election, the Republicans lost 26 seats. In his second Presidential election, President Reagan came back two years later and won an astounding 59% of the popular vote. If this indeed is an Air Traffic Controller Moment for President Obama, perhaps we shouldn’t write him off just yet.
On the theme of countries piling debt upon debt upon debt, which Keith “affectionately” refers to as “kicking the can further down the road”, today Greece issued its first debt offering since the EU and IMF agreed on 3/25 to “safeguard financial stability” in Greece. The €5 Billion 7-year Greek bond yielded 6%, or 334bps above 7-year German bunds, the proceeds of which will be used to meet (or roll over) nearing debt payments, including €12 Billion in April and €8.5 Billion in May.
As we noted in our post from Friday titled “Politics vs. Pragmatism”, while Greece may have received the red-cross jersey late last week, sovereign debt issues among the other PIIGS remain at large. With some €53 Billion of Greek debt coming due this year and no clear policy from the Europeans to address bailout/default issues of its member states, we’d expect markets to continue to shake. Stay tuned.
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The movie The Blind Side finally brought some well-earned respect to what is arguably the second most important position on the football field – The Offensive Tackle. At Hedgeye, we have one of the finest OTs to play at Yale in recent years – a fine young man by the name of Darius Dale (otherwise known as Sunny D). Darius worked alongside me for the past 8 months, and is now shifting over to our Macro team. I’m both proud and nervous. Proud because Darius continues to grind hard every day and absorb every little nugget of knowledge he can, and he does it with a smile that lights up the room. I’m nervous because during those 8 months, Darius (6’ 4” 325lbs) ensured that I was not sacked once. Now he’s got Keith’s back, which is fine by me.
What’s my point here? The offensive tackle is a position that allows the quarterback extra time and protection to put points on the board when it matters. If you saw The Blind Side (amazing movie, but the book was even better), you couldn’t help but notice that Under Armour was all over it. Uniforms, gloves, shoes…the whole shebang. Is that because that’s the traditional garb at Ole’ Miss? Nope. Check out the Training update from Ole Miss below. No UAs to be found – only Swooshes.
Let’s be real about something. If Nike wanted this exposure, it would have had it. So let’s not turn this into a petty ‘UA is better than Nike’ campaign. Nike’s SG&A dollars are 10x greater than UA’s revenue. If Nike wanted to be highlighted in the 2000 Keanu Reeves flick “The Replacements” about scab players getting a second chance at the Pros during a Pro strike, then it would have had it. Instead, it threw a bone to Reebok.
Reebok was masterful at spending too much in endorsement dollars and then not following up with the right infrastructure investment. Nike plays it right, and I’m convinced that Under Armour does too. In fact, we know more about the depth and behavior of these arrangements than many might think – simply by pouring through financial statements.
All the brands are required to disclose meaningful off-balance sheet liabilities grouped by duration. Whether we’re talking a store that is locked into a 5-year lease, or an athlete with a 5-year contract, it’s the same thing from my perspective. There’s a major accounting lever that the company could use to impact its reported earnings. The same way that there are some retailers (i.e. DKS, WFMI) will take an 8-year asset and model it over 15-years which artificially inflates near-term earnings, we can see the same with an athlete endorsement.
Nike’s deals are spread rather consistently over the next 5-years. Interestingly, UA has 86% of its obligations due in 3 years or less. I like that. Will that number shrink? Yes, it likely will when we see the 2009 numbers which will include the likes of Michael Phelps and other higher-profile signings (announced and not). This simply tells me that UA has initially had a conservative accounting approach to how it has gone about building these deals – that compares to others (aka Reebok and others that are defunct) that have wagered too much on a pipe dream.
Yet another reason why I like how they are building this business for the long-term.
Finish Line provided another set of positive data points for the athletic footwear space with the reporting of its much better than expected results. The good news here is, we believe the industry hasn’t really hit its stride yet from a product and marketing perspective. The benign promotional environment, tight inventories, and category strength in running and toning are the primary reasons why we’re seeing an accelerating trend at retail across much of the space. However, we have yet to see much from Nike in terms of its product and marketing push- all of which are key to our longer-term thesis that the company is setting up for a three year period of above-trend growth and earnings acceleration. Along the way (i.e. back to school), we’re likely to see continued strength as product driven demand continues to build. As a retailer, be it Finish Line or Foot Locker, there is no better way to capitalize on what we believe is a sea change in the space over the next couple of years.
Importantly, Finish Line’s conference call confirmed that at the moment, this is a sector where we can see more than one player post solid sales and margins without it being at the expense of a competitor. In our view, the single biggest factor in this equation is inventory. Coming out of 4Q, both Finish Line and Foot Locker reported substantial inventory declines against accelerating (and positive) top line momentum. FINL reported inventories down 20% against an 8.1% sales increase while FL reported inventories down 7.4% against a 0.6% increase in sales. As such, we are in scenario that we haven’t seen in quite some time across the athletic space. Tight inventory, low levels of aged inventory, and consequently less promotional activity. As we are seeing first hand, this the key driver of ASP increases and quite a healthy scenario for both mall-based chains.
As it pertains to Foot Locker, it’s important to remember that this is also a company in the very early stages of a major turnaround. The tailwinds impacting the entire space are gravy on top of what we believe is one of the more compelling opportunities on the long side. As such, we must be mindful of the separation between a rising tide that is currently lifting all boats and the efforts underway by Foot Locker management to permanently enhance the company’s sales productivity and operating margins. We still believe the biggest near-term milestone for Foot Locker will come with back-to-school. This will be our first opportunity to really understand and observe some of the key merchandising, marketing, and store segmentation efforts underway. Until then, expect the overall demand for athletic apparel and footwear to remain robust, providing substantial support to our thesis, but at the same time reminding us that FL’s heavy lifting is still ahead. With that said, there were still some notable call-outs from Finish Line’s conference call which we believe are pertinent to Foot Locker and the overall space:
- Post 4Q trends have dramatically accelerated, with quarter to date same store sales running up 15.5% against a 1.2% decrease in the same period last year. For reference, Foot Locker mentioned it was tracking up 6% through the very early part of March. This is the first data point we have gotten in the sector which suggests there is more to be positive about than just easy comparisons.
- Performance running was a key driver in 4Q and continues to be the leading sub-category within the store. This is consistent with commentary from FL and HIBB and is fully supportive of FL’s efforts to test and potentially roll-out its RUN concept store.
- Basketball beginning to show some signs of life. This is key for Foot Locker, which has a much bigger presence in the category vs. Finish Line. Basketball has been lagging (likely due to higher price points and lack of product intros), but positive commentary is encouraging. For Foot Locker, we believe this bodes well for the impending re-acceleration in House of Hoops growth.
- Finish Line is looking to cull its store base with 30% of the chain up for lease renewals but is not really looking to grow (at least near term) units on a net basis. Recognizing this is not a growth sector by any means, it’s good to see both major players no longer growing for the sake of growth. Making efficient use of existing real estate appears to be at the top of both FL and FINL priority lists- a factor which should not be ignored as we consider the potential for margin expansion for both players in the mall.
Full notes/details from FINL’s call:
Product and Category Review
- Product Assortment:
- Leadership position in running, happy with the performance of the running category, high comps and improved merchandise margins, picking the right product to have in doors
- Toning category is extremely successful and will continue to take full advantage of this trend, believe the category will strengthen throughout 2010 and beyond as brands invest in the shoe
- Carrying the Best Brands:
- Footwear: Nike and Puma in running
- Apparel: The North Face, Under Armour, Brand Jordan
- Footwear Comps: +10%
- Running leading way in men’s and woman’s, Toning made a big impact, ASP's for footwear up 7%, strong sell thru at full price for performance footwear. Customer is embracing performance footwear as fashion. Overall running was the key driver of comps in Q4, Nike continued to be the leader within running. Lightweight models such as Lunar and Free, as well as Air Max and retro-inspired silhouettes performed well.
- Puma Running came on stronger in Q4
- Running Comps up double digits
- Nike Puma and Asics will continue to deliver solid product in 2011
- Basketball: encouraged by improvement, comps up in mid singles driven by Brand Jordan as well as Nike’s Lebron signature products. Enthusiastic about basketball going forward.
- Toning: Women’s products dominated with Skechers and Reebok, sold through all the Reebok product quickly but are taking necessary steps to get product in stock. Expect to see toning continue to grow in fiscal 2011 as other vendors enter this category
- Athletic Casual Category: continues to be challenging with comps down mid-teens
- Men's performed better on a same-store basis compared to women's in Q4.
- A bright spot was men's Polo launch, which took place late in the third quarter, expect to see continued positive results as they work with Polo to expand and enhance assortment.
- Kids: comp store sales were up almost 7% for the fourth quarter and were up slightly for the year.
- Stronger in girls than in boys.
- Driven by running as Nike Air Max, Puma and exclusive products performed well.
- Brand Jordan and Skechers Twinkle Toes were also big hits.
- Softwoods’ comps +9%, apparel and accessories posted solid gains
- Apparel: worked hard to right size inventory, heavy lifting is behind them.
- TNF, Brand Jordan, and UA drove the apparel business
- Licensed products were positive with particular strength in NCAA fleece
- Expect apparel business to continue to perform well now that they have completed the rightsizing of the inventory and put a strong emphasis on leading brands. The larger gains we experienced upon taking these actions will now level off to a more sustainable growth trend.
- Accessories: Watches, Sunglasses, Socks
- Looking Forward:
- Emerging Channels: Mobile Commerce, evolving with the consumer
- Light weight running trend will continue to succeed driven by Nike and Puma
- Basketball’s improvement is encouraging and expect it to continue
- Month to Date: +15% comps
- Subtle shift in the mood of the consumer
- Although the customer is not visiting the malls as much as last year, they are willing to pay for the full price
- Running: Running success is not an overnight trend of the business, have been working on the category for 12 years. Have worked with NKE management to take the leadership in the running category. The product engine continues to flow from Nike, Puma, and all the technical brands.
- Expenses: Permanent reductions made in 2009, only new costs going forward will be variable. Still areas of opportunity to go after cost reductions. Shifting focus from cost savings in 2009 to driving top line in 2010. Will grow SG&A to support Sales. Will not need more labor. Efficiency program more than labor additions in SG&A.
- March Trends: Traffic trends behind the 15% comp is a little better, flat, clearly big drivers have been conversion. Inventory is the lowest in the 21 years they have seen. The mix ends up being the best product due to such tight inventories.
- Toning: a sustainable business, not seeing cannibalization of other categories (women’s running was strong in Q4). Still too early to tell if there are repeat customers.
- Growth: plenty of room to grow profit and sales. Internet is great. Looking to grow outside of the core of the business. Have learned from prior experiences and will use those to head in the correct direction instead of hesitate and be discouraged. Shareholders should be aware that FINL is working on other avenues outside of the core business to drive growth. Not prepared to discuss these avenues of growth but working on them currently.
- SG&A: leverage occurs around -3% to -4%, leverage position will come down a bit but still remains at a slightly negative comp. Absolute dollars SG&A growth will be up if sales are up, down if sales are flat.
- Long Term Size of Finish Line Store Base: size of the stores is more related to the size and the volume of the malls they operate in. “A” malls will have larger stores, lower level malls with less traffic will have smaller stores. Long Term store portfolio depends on the landlords. Will stay in those 20-30 stores planned to close if the real estate community offers better opportunities.
- Staying Liquid with Open to Buy: recipe for inventory cleanliness. Have worked hard on reducing aging inventory as a % of the mix. Inventory levels are up in running and toning and other successful categories.
- Regional Trends: Sales across the country are consistent right now. Not making up the difference of what they lost in the West, but trends have certainly stabilized.
- Management: Very Optimistic Group
- Real Estate: 30% of the store base is up for renewal in the coming year, hope to not close the 20-30 stores.
- Reaction to Foot Lockers Apparel Renovation: Will stay strong on strategic initiatives, competitors will help drive FINL into a better business.
- Apparel: real growth came from the men’s apparel
- Casual Footwear Business: relative to the inventory position, athletic casual segment is part of the strategic reduction. As they focus on the performance side, casual athletic shrinks. Still focused on the fashion elements of casual athletic. Much more focused category going forward. Polo is resonating well with customers in a pure fashion play. Nike, Adidas, Chuck Taylors (growth slowing down a bit) all offer solid casual athletic product.
- Sales, Inventory, Margins: Key focus has been growing sales faster than inventory. Margin expansion might slow but will continue to improve, but the sales-inventory rate is the key focus. Still not at the best historic level of inventory turns. At just over 2.7 inventory turns and have more to improve.
- ASP’s: selling more product at regular price. More runway for ASPs but too early to tell.
From Josh Steiner's update on housing (3/26):
In the last few days there have been at least three notable positive developments, on the margin, related to housing, and arguably one big negative.
First, California passed a plan yesterday to allow a $10,000 homebuyer tax credit, which would be effective May 1, 2010 and run through December 31, 2010. The timing of the plan is no coincidence - it's timed to begin the day after the planned expiration of the Federal Government's $8,000 homebuyer tax credit. The legislation calls for $100 million to be allocated for first time homebuyers, defined as anyone who hasn't owned a home in the last three years. There is a further $100 million allocated for any buyer of a new, unoccupied home. The initiative, at a total cost of $200mn, will be tacked onto the state's deficit of $20bn. There was only one state legislator who voted against the bill on the grounds that California couldn't afford it. We wouldn't argue there. Gov. Schwarzenegger signed it into law yesterday. A similar program to this one was in place last year, but was exhausted in just four months (March-June). A further positive may be in the cards as well. A separate bill that would have exempted state taxation on forgiven mortgage principal was supported in principle by Gov. Schwarzenegger, but was vetoed because of unrelated riders tacked onto the bill. It is expected that this issue will be taken back up in coming months. For reference, California passed such a law in 2008 that had a two-year shelf life, so this bill is simply aimed at extending a law already on the books, but set to expire.
Second, Bank of America rolled out a plan two days ago, on a very limited basis to facilitate a measure of principal forgiveness. The program intends to keep underwater borrowers in their homes to stem the tide and cost of foreclosure in coming years. Aimed squarely at high-risk Countrywide borrowers with subprime and Option ARM loans who are 60 days delinquent or are current but are likely to become delinquent, and who are significantly underwater (i.e. 20% or greater), the program would enable up to 30% principal forgiveness over five years. For instance, on a $400k loan where the home is now worth $300k, Bank of America would move $100k into a separate, interest-free account, and would forgive $20k/year for up to 5 years provided the borrower remained current. The catch is that Bank of America is only targeting 45k borrowers for principal forgiveness with this program. The program is expected to ultimately forgive $3bn in principal. For reference, the most recent First American Corelogic data shows $801bn in total negative equity represented by all underwater borrowers, so Bank of America's program would address roughly 37 bps of the problem. A step in the right direction, but clearly not enough to solve the challenge.
Third, the White House is set to unveil today a renewed effort to combat foreclosure. Using existing funds under the $75bn HAMP program, the Administration has rolled out 5 key, new initiatives that it thinks will, on the margin, help a significant number of additional homeowners keep their homes. The new programs will be implemented over the next six months. The final details of the program will be rolled out later today, but we provide below the preliminary details.
1. Unemployed homeowners would be given a reprieve of 3-6 months, during which their mortgage payments could not exceed 31% of their income.
2. The government will double incentive payments to lenders in exchange for modifying second liens. This is a small step in the right direction, as second liens have been a major roadblock to effectively modifying first lien mortgages.
3. The government will increase financial incentives for lenders to facilitate short sale transactions.
4. Similar to the Bank of America announcement detailed above, the government will provide financial incentive for lenders to forgive principal on loans with LTVs greater than 115%. As proposed, the plan would call for lenders to forgive this debt over a three year time period (vs. BAC's 5 year time period). It's unclear what the offsetting financial incentive from the government will be.
5. The government will role out an FHA refinance program, whereby borrowers can refinance their loans up to 100% LTV with the FHA provided that lenders forgive the balance above 100%. For loans where there is a second lien, the FHA will permit refinancing up to 115% on a CLTV basis.
On the flipside, the OCC and OTS released a joint report yesterday with updated performance reporting for loans modified under the HAMP program. The conclusion is that re-default rates remain quite high, though they do seem to be improving with more recent vintages. For instance, 61% of loans modified in 3Q08 had re-defaulted within 12 months. For comparison, loans modified in 4Q08 had a 58% re-default rate after 12 months. On a shorter-term duration, six months out from the quarter in which loans were modified, re-default rates have fallen from 48% for 3Q08 to 34% for 2Q09. This clearly represents progress, but that level of re-default rate suggests that there are ultimately a high proportion of borrowers that are still either willingly (strategic) or unwillingly (job loss) re-defaulting. Principal forgiveness initiatives, should they gain further momentum as we think they will, should help to further improve success on this front, as will generally improving economic conditions.
On the negative front, Bernanke's testimony yesterday raised the risk of the Fed potentially selling some of its Agency MBS paper. We've written in the past about the risks we think exist from the Fed exiting its $1.25 trillion Agency MBS purchase program at the end of this month (i.e. next week). Clearly the Fed would add insult to injury if, on top of removing their $1.25 trillion bid, they also added significant supply to the market.
Conclusion. On the margin, there have been several positive developments in short order for the housing market, with one potential negative. We are currently working on a larger piece looking at the upcoming challenges facing the housing market, and we will explore these themes in greater detail in that report.
Joshua Steiner, CFA