This note was originally published at 8am on December 17, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“A question that sometimes drives me hazy: am I or are the others crazy?”
Per our friends at Wikipedia, “haze is traditionally an atmospheric phenomenon where dust, smoke, and other dry particles obscure the clarity of the sky.” That just about summarizes what I think about the US stock market right here and now.
When I say now, I mean yesterday’s closing price. The SP500 inched up another point above its YTD closing high, taking its YTD gain to +11.4%. If you’re looking at this market price through The Golden Haze of ‘everything is going to be ok’ from here, you must be saying that higher-highs in a market price are bullish. They are, until they aren’t.
Up until 2 weeks ago, The Golden Haze was quite tranquilizing in another asset class market price – Gold. Then the music of bullish price momentum started to fade away. It didn’t stop suddenly. It didn’t stop hastily. It just started to stop…
The price of gold is now hitting a 2-week low this morning and is officially broken on my immediate-term TRADE duration. What were bullish higher-highs before December the 6th can now be considered bearish lower-highs. Again, until they aren’t.
Since I sold our entire gold position on December 6th (+3.4% higher at $138.55 GLD), I suppose I have some credibility in attempting to make another “call” on gold from here. So let’s take a shot at this and consider the why and where from here:
Why is Gold down?
- CORRELATION RISK: Over the long term, Gold tends to underperform when real interest rates are positive.
- RELATIVE STRENGTH: Real-interest rates (domestic and global bond yields) have been blasting to the upside since November.
- CURRENCY COMPETITION: Don’t look now, but the US Dollar is up in 6 of the last 7 weeks as Fed Fighting becomes fashionable.
Where does Gold go from here?
- Immediate term TRADE: as of this morning my immediate term TRADE lines of support and resistance are $1362 and $1391, respectively. Trade the range.
- Intermediate term TREND: I introduced this line to investors in Calgary and Vancouver in a slide presentation on December 5th and 6th and the TREND line hasn’t changed. There’s intermediate term mean-reversion risk in the price of gold down to $1313.
- Long-term TAIL: there is a world full of support down in the $1210-1230 range and I’d love to buy back my gold there.
Now anyone who knows me well knows that I probably won’t have the patience to wait for $1230 gold on my buyback program. Heck, I may not have the patience to wait for $1313 either. But, provided that I remain bullish on the US Dollar (long UUP) and US Treasury Yields (short SHY), I’ll have a very hard time explaining why I’d buy back gold anytime soon. Being short gold on the next rally to lower-highs may be the better bet. We’ll see.
Back to The Golden Haze that is being long US Equities here… I think it’s instructive to think through the same CORRELATION RISK, RELATIVE STRENGTH, and CURRENCY COMPETITION scenario analysis that I went through for gold.
- CORRELATION RISK: using an intermediate-term TREND duration (6 months), the SP500 has an inverse correlation to the US Dollar Index of -0.77 and an r-square of 0.60. In other words, sustained USD strength should be bearish for US equities.
- RELATIVE STRENGTH: since March of 2009, the SP500 has outperformed gold by a lot (SP500 is +83.7% from its March lows, whereas gold is up 53%). So if Gold can go down in the face of Fed Fighting (competing with higher real interest rates), US stocks can.
- CURRENCY COMPETITION: seasonal spikes in the US Dollar Index have happened in both of the last 2 years (2009 and 2010). It wasn’t cool to be levered-long US Equities in either of those January-February periods.
Never mind the obscurity of making the “valuation” case for stocks here; valuation isn’t a catalyst. Never mind the atmospheric phenomenon of short-term politicking and its effect on stoking “growth” hopes in the US economy either. That’s now consensus.
Take the “call” to sell US stocks here from a man who is already -3.37% too early in his short position (that would be me), as every Big Broker’s “strategist” is now officially calling for the US stock market to be up next year.
My immediate term support and resistance levels for the SP500 are now 1234 and 1248, respectively. If the SP500 makes another higher-high in the coming weeks, look for me to short it again. Yesterday I moved to a 70% position in Cash in the Hedgeye Asset Allocation Model.
Enjoy your weekend and best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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Position: Long corn in our portfolio via the ETF CORN
Conclusion: The global corn supply and demand imbalance looks to persist into 2011 as we are seeing limited demand degradation due to increasing prices.
This has been a tough year for those short of corn. In 2010, world corn production is only up ~2%, while world stocks are down ~2% after declining almost 6% last year. More noteworthy, is that this has been the third year in a row in which consumption has outpaced supply. This shortage has been reflected in the rapid price move in last six months and in the year-to-date on a $ per bushel basis.
In fact, as outlined in the table above, corn has had the most rapid price movement of any of the major grains in 2010. The primary reason for this relates to two factors: weak crop yields in the United States and an inflection point in demand out of China.
Before moving specifically into these factors, in the chart below we wanted to highlight the history of corn imbalance for the past decade. As the chart shows – while the consumption of corn globally has been growing driven by demographic growth, increased consumption, and the use of corn as an alternative fuel – production shows a slightly different story. In fact, in the last decade we’ve had three shortages of corn, which are driven by the inability of production to keep up with consumption.
In terms of world production share, the United States currently leads the pack. In fiscal 2009, the U.S. grew almost 40% of the world’s corn, and was by far the largest grower, at over 300 metric tonnes. In terms of exporters of corn, the U.S. exports the most corn, with just over 50% of the export market; Argentina is the second largest exporter at about 14% of the export market.
Collectively, the United States and Argentina dominate corn exports. The recent growing seasons in these regions has been weak, which is the critical factor as it relates to global supply and demand, and therefore price. Specifically, Argentina is experiencing very dry weather, which will likely hurt yields for Argentine corn crops as December and January are the key pollination periods. A similar weak growing season in the United States has led to the projection that U.S. corn stocks could drop to the 832 million bushel levels.
As it related to demand from China, the Shanghai JC Intelligence recently increased its estimates for Chinese corn imports to 7.5MM metric tonnes, which was an increase of 22.7% from the groups’ last estimate. This is an important inflection point, since up until last year China was a net exporter of corn and is now potentially poised to become one of the largest importers of the commodity. Chinese corn demand will likely continue to increase despite the threat of monetary tightening, as the government is focused on curbing food inflation domestically and needs to import food stuffs to do this.
Speaking toward global grain demand, the Canadian Wheat Board recently announced that, “domestic demand remains solid, and it remains to be seen how much the price has rationed offshore demand.” This was also verified by the USDA who articulated in their December 10th report that global demand remains strong despite accelerating prices.
Collectively, the combination of resilient grain demand (irrespective of rising prices), difficult growing environments in Argentina and the U.S., and low stock levels in the United States appear poised to continue to drive corn prices higher. In fact, corn stocks have not been this tight since 1, when the current stocks-to-use ratio was also in the 6% range. Put more bluntly, absent demand destruction, we could run out of corn!
It seems the corn bears might be setting themselves up to be corn cobbed…
BWLD is not loved and many of our screens are flashing bearish for the stock. A deeper look at the model yields some rather different conclusions.
Over the past month BWLD is down 6.4% versus the average full service casual dining stock up 7.1% and the company has caught two upgrades from the sell side. Short interest is on the high side at 14% as a percentage of shares out, but declining steadily over the past two months. At 6.5X EV/EBITDA, expectations are low for BWLD and a one multiple improvement in valuation implies $6.37 of upside, or 15%, from current prices.
We have been monitoring our screens lately and BWLD was flashing bearish on this name. Insider selling, for instance, has been on the high side and Keith’s levels also confirmed a bearish outlook so we decided to dig into the model a little further.
I understand the bearish longer-term thesis on BWLD. It has grown too fast. I have expressed this view myself at length over the course of the past twelve months or so but the fundamental story over the next couple of quarters looks solid. Also, pertaining to the pace of growth issue, my ROIIC outlook for BWLD is strong. In the past two quarters, AUV’s have outpaced comparable restaurant sales partly due to the closure of 8 older underperforming stores and strong performance from store openings.
On a less positive note, management did mention that franchise comparable restaurant sales were softer in 3Q due to the higher incidence of store openings in existing markets. They did not refer to this as cannibalization, of course, but it certainly sounded like it to me!
This stock has not been performing strongly of late, relative to its peers, but our model seems to be telling a different story heading into the first half of 2011. As with any model, the takeaways are only as useful as the assumptions my projections are based on but I am comfortable stating that the company’s 4Q and FY11 guidance may be slightly modest. Management actually said that they were being conservative with 18% EPS FY11 guidance. Currently, our conclusions arrive at 4Q EPS of $0.55 versus the street at $0.53 and we are estimating FY11 EPS of $2.55, a 21% year-over-year increase, versus the street at $2.47 and management’s guidance of an 18% year-over-year increase.
My assumptions assume relatively flat-to-slightly improved comp growth on a two-year basis. For 4Q10, I am at +1% relative to the company’s guidance of at least flat comp growth. Company guidance here is, in my view, conservative seen as flat comp growth implies a slowdown in two-year average trends of 40 basis points. Given that October two-year average trends accelerated by 90 basis points, I am at ease with my comp assumption of +1%. Management commentary around comparable store sales performance in October indicated that October comps were -0.7% but lapped a strong comparison of +5.9% for the same month of 2009.
Remodels are also buoying comparable restaurant sales, lifting comparable restaurant sales by 5% and the company is looking to carry out 20 remodels in 2011.
Here are some factors that are impacting same-store sales in 4Q10:
- Christmas falling on a Saturday - management said could be slightly negative but could not quantify and was not even sure if it would be a negative
- BWLD increased media spend significantly in November and December (not reflected in the October numbers, which would suggest trends should accelerate from October, not decelerate)
- Slightly lower pricing impact in 4Q of +1.6% vs. +1.9% in 3Q
- The bigger picture issue are the trends in CD since October - good not great!
Restaurant margin should continue to increase in 4Q and 1Q as favorable year-over-year wing prices help. Through the first two months of 4Q, wing prices were down 15% year-over-year (in line with the year-over-year decline in 3Q). The company should experience the biggest year-over-year favorability in 1Q11 as prices peaked in 1Q10. The comparison clearly gets more difficult from there and management did state that there is not much visibility on traditional wing prices. However, given the peak levels reached in 2010, they would still expect slightly favorable prices in 2011. Traditional wings account for 21% of sales. Boneless wing prices should be flat year-over-year in 2011 as the company is contracted through March 2012. Boneless wings account for approximately 19% of sales.
The company is expecting to pay higher prices for alcohol in 4Q10 and FY11 than it paid in 3Q10 and this increase was highlighted by management as being part of the reason for the upcoming price increase in January. Together with a new menu rollout in April, the price increase in January will account for a cumulative 2% increase in price for 1H11. Largely due to that increase in the price of alcohol, there could be additional pressure on COGS in 4Q relative to 3Q, given that the price increase won’t take effect until 1Q11. Overall, though, I would stress that COGS will remain quite favorable given the year-over-year declines of wing prices in 4Q.
Management is expecting some labor pressure as it expands its Happy Hour test in 4Q and then rolls it out in 1Q11 to all locations. The company is also investing in labor training to improve speed of service at lunch.
BWLD also guided to some pressure in 4Q on the operating expense line. Media spend is expected to be up about 25% year-over-year in 4Q10. The company is expanding their radio presence in November and December (supporting Happy Hour among other things), and this expected to drive the high year-over-year increase in media spend. 2Q and 3Q saw more moderate year-over-year increases for this line item.
In terms of overall casual dining trends, Knapp Track sales trends for the category were disappointing in November, declining 55 bps on a two-year average basis. BWLD is one of a rare breed in casual dining at the moment as it is looking at COGS favorability over the next couple of quarters. For competitors depending on sales leverage to drive the bottom line, this latest Knapp data point is certainly bearish. The risk to our +1% 4Q comp estimate is obviously that the industry may slow from a top line perspective but the COGS favorability means that BWLD is relatively less at risk from this impacting its bottom line.
I would also refer to the Sanderson Farms 4Q Earnings Call commentary which indicated that demand for prepared foods was strong through the first week of November and then evaporated. Demand for chicken in general also turned weak and this should benefit BWLD from a COGS perspective.
All in all, it seems that sentiment around this name is decidedly negative. Insider selling is at an elevated level relative to most of its peers and short interest, while coming down over the past few weeks, remains high at 14% of shares out. I think there is a strong chance that earnings could surprise to the upside for 4Q and FY11.
Athletic apparel and footwear sales were solid again this past week during what is typically the slow(er) period between Thanksgiving weekend and holiday sales leading up to Christmas. Underlying trends remain strong in both athletic footwear and apparel despite even more challenging comps suggesting last week’s positive results were not anomalous, but in fact evidence of continued strength in consumer spending – particularly in the athletic channel. Here are a few callouts from the week:
- Sales improved across all three channels with athletic specialty retailers continuing to outperform both the family and discount/mass channels with the later decelerating on a sequential basis while sales at family retailers improved on the margin.
- Footwear sales are exhibiting high price elasticity in the face of increased ASPs though broadly speaking pricing has firmed curbing what appeared to be heightened promotional activity in the first week following Thanksgiving weekend. Meanwhile pricing at athletic specialty retailers continues to register up MSD suggesting more full-priced selling, less discounting, or most likely some combination thereof relative to other channels.
- New England significantly outperformed other regions up +23% for the third time in the last four weeks. The negative callout on the week was the Pacific region registering the most anemic growth yet still positive. These results were in stark contrast with four straight weeks of significantly improved sales on a relative basis.
- Unseasonably colder weather, particularly in the southeast last week (good for HIBB) have clearly been a positive driver of apparel demand month-to-date and does not seem to be abating near-term. This has been evident in the outperformance of outdoor outerwear and VF’s The North Face, which has been crushing it of late.
- Despite recent narrowing between the performance and non-performance footwear growth spread, it’s widening once again on a trailing 3-week basis driven by diverging yy trends over the past 2-weeks stressing the importance of merchandise mix at the retail level – more favorable for FL & FINL.
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