THE HEDGEYE EDGE
Our bullish call on the British Pound was borne out of Hedgeye’s Q4 2013 Macro themes call. We continue to believe that the health of a nation’s economy is reflected in its currency. The Pound has benefitted from the UK’s fiscal discipline to embrace austerity before its regional peers during the global recession – a policy decision that is paying off in spades through accelerating growth above its European peers. Additionally, we expect a stronger currency to increase consumer spending power by deflating imported inflation.
Incidentally, our bullish call on the British Pound versus the US Dollar was further strengthened today with the European Central Bank unexpectedly cutting its main interest rate by 25 basis points to a record low of 0.25%. From our perch, it’s now anyone’s guess how the central bank currency wars between the USD and EUR will play out. However, anchored on our Q4 2013 Macro theme of #EuroBulls (presented on 10/11/13), we continue to like the British Sterling.
Finally, data out this week showed the UK Services PMI for October hit a 16-year high at 62.5 (above 50 = expansion), an outperformance over its peers. Our call for #GrowthAccelerating in the UK is now showing up in economic forecasts: the European Commission in its autumn report this week raised UK GDP expectations, to +1.3% in 2013 from +0.6% and to +2.2% in 2014 versus a previous estimate of +1.7%.
INTERMEDIATE TERM (TREND) (the next 3 months or more)
We remain bullish on the regime change at the BOE, replacing Governor Mervyn King with Mark Carney. In its October meeting, the Bank of England voted unanimously (9-0) to keep rates on hold and the asset purchase program unchanged. If we look at the GBP/USD cross, we believe the UK’s hawkish monetary and fiscal policy should appreciate the GBP, as Bernanke/Yellen continue to burn the USD via delaying the call to taper.
Additional bullish signals include the slope of UK economic growth, just clocking a 3-year high, and the British stock market (FTSE) is breaking out to new highs. The fundamental data, from business and consumer confidence to retail sales and manufacturing, continue to confirm the improving growth environment we’re forecasting.
Taken together, we expect a continuation of this positive data to propel the Pound higher.
ONE-YEAR TRAILING CHART
“Around the world, we are focused on providing the menu quality and choice, customer service and affordability that are the hallmarks of the McDonald’s experience.”
- McDonald’s October Press Release
Despite management’s aforementioned focus, there is something that is not resonating with McDonald’s customers. While MCD is a fundamentally strong company, we find it difficult to believe that it will be able to drive “initiatives that will deliver the greatest benefit” for McDonald’s customers, as promised.
The charts below show sales trends across MCD’s four main regions – and they are not pretty. October’s results prove that same-store sales continue to steadily decelerate on a two-year basis. That said, we are comfortable in reiterating our view that McDonald’s has legitimate, inherent issues that management must address.
Next week, McDonald’s will host its analyst day to address the initiatives management has lined up for 2014 in order to stem the decline in global sales. Our research tells us that the company will make an aggressive push to sell more coffee in attempt to capture incremental market share in the coffee category next year. We expect this to be a main topic at the analyst day on November 14, 2013.
Our goal is to understand the potential consequences, both good and bad, of this strategy. Delving more into this topic, we have conducted a proprietary Retail Coffee Consumer Survey, which features some of the top coffee retailers, including MCD, SBUX, DNKN, KKD, and Peet’s.
We will be holding a conference call on Tuesday, November 12th at 11: 00am EST in order to present our findings and analysis.
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Takeaway: LULU selling 2nd Chance Pants, PUM and ADDY must hate NKE, JNY loses another suitor, JCP puts up fantastic .com comp number
JCP - J. C. PENNEY COMPANY, INC. PROVIDES UPDATE ON CONTINUED PROGRESS OF TURNAROUND
JCP Q3 Update:
- Same store sales increased 0.9 % in October, marking a 490 basis point increase over September
- Sales on jcp.com increased 37.6 % versus last year, a continuation and acceleration of the positive trend in the Company's online business
- Conversion continues to improve in October compared to last year, reflecting favorable customer response to promotional events and improved inventory levels
- "The Company attributes its improved sales trends to the restoration of inventory levels in key private brands, including St. John's Bay®, Stafford®, and jcp Home(TM), and significant sales increases in Levi's®, Nike®, Carter's®, Dockers®, Alfred Dunner®, Vanity Fair® and IZOD®, some of the Company's largest national brands."
- "The Company also continues to make strides in the remerchandising and reconfiguration of its Home department both in stores and online to better reflect how customers shop while highlighting its most compelling brands and price points. These changes are beginning to resonate, as Home saw the largest percentage sales increase among the Company's divisions in October."
- "The Company noted, however, that gross margin showed sequential improvement within the quarter, with October representing the highest margin levels of the quarter."
Takeaway: This is old hat to the market by now, but it's still worth highlighting. True, a 0.9% comp is hardly worth declaring victory over -- especially when you're going against a -26% comp last year. But the +38% dot.com growth number was absolutely fantastic. That's a respectable growth number for a REAL company, never mind JCP. We still think that this beast is fixable, and remain in the bull camp..
LULU - LULU is repurposing its see-through Luon pants. Maybe these ones will fit everybody or should we say every body?
Takeaway: The company can't be quoted in the press as suggesting that the product did not fit the consumer because the women are too fat. Seriously…that's the most ridiculous thing we've heard from a Chairman of a company. You don't blame the consumer for not fitting into your product, you blame yourself for not making product that fits the customer.
MW, JOSB - Activist Takes Stake in Men's Wearhouse
- "The Men's Wearhouse Inc. has a new large shareholder in the form of Eminence Capital…"
- "The New York-based hedge fund in a regulatory filing Thursday said it is now the single largest shareholder in MW, holding nearly 4.7 million shares, or a 9.8 percent stake."
- "Eminence’s chief executive officer Ricky C. Sandler said in a letter to MW’s board: 'We are writing to you to express our disappointment in the board’s response to the recent proposal put forth by Jos. A. Bank [to] acquire MW….In our view, the board’s actions to date with respect to this matter fail to fulfill that obligation.'"
- “'We agree with the board that the proposed $48 share price undervalues MW both for its stand-alone prospects and for its fair share of the merger synergies.'"
Takeaway: We remain of the view that MW should remain independent, unless JOSB gives it complete assurance that it move forward with its business plan on its own. The $48 price is still too low.
GIII, JNY - G-III Drops Out of Jones Pursuit
- "G-III Apparel Group Ltd., which had been looking to acquire Jones’ apparel business, has dropped out of the process, according to two sources."
- That leaves private equity firm Sycamore Partners, which has been pursuing the footwear side of Jones, in an uncertain position. It is unclear whether Sycamore is able to, or even wants to, make a play for all of Jones, or if there’s another investor who would step into G-III’s place and buy the other portion of the company."
- "One source said the Jones camp has recently reached out anew to other investors to see if they want to buy the whole firm."
Takeaway: Not a surprise. JNY's brands are not desirable to the general public (if 80% of the brands went away the consumer wouldn't care), the stock is not valuable to the public equity market, and it's no surprise that private capital is getting skittish as well.
PUM - PUMA SE amends full-year 2013 guidance
- "PUMA’s Management anticipates one-off charges, the majority of which will be non-cash effective, of approximately € 130 million to be booked in the fourth quarter of 2013. The majority of these special items will consist of impairments charges related to non-current assets. New initiatives include the closure of the product development centre in Vietnam and the intended transfer of our international product teams from London to Herzogenaurach."
- "Reflecting these new elements mentioned above, Management now expects 2013 full year net earnings to be positive, but significantly below those of 2012 (previously: increase in net earnings compared to 2012)."
Takeaway: First Adidas takes down numbers…now Puma. Not a good month for German sports apparel brands. At the same time, Nike is crushing it. Germany hates Nike.
BEBE, TUMI - BEBE & TUMI report quarterly results
Takeaway: Two polar opposite SIGMA results here. BEBE (surprisingly) takes a sharp about-face from the Danger Zone to positive sales/inventory territory. On the flip side, TUMI went from the Sweet Spot (sales up, inventories down and margins up) to the dungeon -- pretty much polar opposite to where it had been.
HBI - HanesBrands to prepay 8% senior notes due 2016
- "The company will prepay the remaining $250 million of 8 Percent Senior Notes on Dec. 16, 2013, completing its successful multiyear campaign to use cash flow to retire all of the company’s bond debt except for its $1 billion of 6.375 percent notes."
- "The company expects to incur costs of approximately $15 million in the fourth quarter of 2013 for bond prepayment expenses and acceleration of noncash unamortized debt costs. The expectation for these costs has been previously communicated and is incorporated in the company’s 2013 financial guidance."
Takeaway: More of the same from HBI. Financial engineering is creating value. Not our preferred way to drive the stock, but hey…it works. The accretion from the MFB acquisition is a bigger deal. The company continues to sandbag. Estimates are going higher.
Chinese Luxury Market Poised for Uptick
- "The luxury market in China is expected to regain momentum in 2014 as Mainland consumer tastes and spending habits continue to become more sophisticated, according to a new luxury forecast released by communications agency Ruder Finn in partnership with Ipsos Group, a market research firm."
- "Chinese consumers increasingly care less about brand names and more about the uniqueness of products, the study said. It also found that Mainland shoppers care more about customer service, with 92 percent of those surveyed expressing dissatisfaction with service offered by luxury brands within China, which is fueling more purchases overseas."
- "Nearly 40 percent of Chinese surveyed said they are turning to the Internet for luxury shopping, representing a 22 percent increase compared with 2012."
Client Talking Points
I didn’t think they would cut. But when they did, I sold everything Europe. I have no patience whatsoever for these people doing stupid things. Cutting rates while growth was accelerating? Just incredible. Euro Down = European Stocks Down, for now. Our EUR/USD TREND line of support ($1.34) is credibly and deservedly under attack.
Note to the Fed and ECB: All Asian growth markets have done nothing but go down since September's "No-Taper" decision in the U.S. and yesterday’s ECB rate cut decision. From the mid-September highs, Japan’s Nikkei is down -4.6%. The Shanghai Composite is down -6.7%. All of a sudden, the Yen is losing the currency war versus Fed and ECB!
In related news, the U.S. bond market took that ECB cut as another US #GrowthSlowing signal yesterday. (Incidentally, it is easy to slow from 2.84% GDP). Witness a nice move higher in bonds (not in the higher beta Gold trade). It's actually fascinating to watch this un-elected and un-precedented currency war play itself out. This morning's U.S. jobs report up next. 2.63% is the Hedgeye TREND line for the 10-year Treasury.
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Top Long Ideas
In line with our #EuroBulls Q4 theme, we’re long the German DAX via the etf EWG. With European fundamentals showing improvement off low levels, we expect outperformance from Germany, and in turn for the region’s largest economy to pull the rest of the region higher. ECB policy remains highly accommodative and prepared to aid any of its sovereign members to preserve the Union. Inflation remains moderate and fundamentals are positive: confidence readings and PMIs are up since June, with factory orders trending higher and retail sales inflecting to push the trade balance higher. Finally, the unemployment rate has held steady at the low level of 6.9%, all of which signals to us that Germany’s economic climate is ramping up.
WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.
Financials sector senior analyst Jonathan Casteleyn continues to carry T. Rowe Price as his highest-conviction long call, based on the long-range reallocation out of bonds with investors continuing to move into stocks. T Rowe is one of the fastest growing equity asset managers and has consistently had the best performing stock funds over the past ten years.
Three for the Road
TWEET OF THE DAY
U.S. Stocks Are Not ‘Bubbly,’ Says JPMorgan’s Lee. Funny - he said the same thing in mid 2008 @zerohedge
QUOTE OF THE DAY
“People generally see what they look for, and hear what they listen for.” -Harper Lee, To Kill a Mockingbird
STAT OF THE DAY
According to a recent Gallup poll, a whopping 70% of American workers have "checked out" at work, and 20% actively hate their jobs.
Takeaway: FNP gave us all the ammo we need to stick to our guns that this stock is on its way to $40, then $75, then higher.
Conclusion: FNP remains one of our top ideas, and as we stated Wednesday, we think that a $40 price tag next year will be a simple checkpoint on its way to $75. We've got to admit, we were half-hoping for a sell-off on the (usual sloppy) GAAP numbers, as this is a classic 'add on weakness' stock. We initially thought we'd get it, as the margin performance was less than inspiring, and the GAAP EPS number missed by $0.02. But clearly that sell-off did not happen. The market is finally at a point where it gives a free pass to (i.e. it doesn’t care about) anything that's not Kate Spade, and it lauds management's capital infusion into Kate -- even if it comes with margin degradation. Our take on the company and the stock is almost identical to what it was before the print -- except that we took our numbers (which were already the highest on the Street) up by about 10%. We remain extremely bullish on FNP, and though we'd ideally like to buy more on a pullback, we're increasingly doubtful -- at least from a fundamental vantage point -- that we'll get that chance.
Here's our key modeling assumptions that get us to $1.85 by 2018.
- In addition to Juicy being kicked out of the portfolio by mid-'14, we assume that both Lucky and Adelington are sold off by the end of '14. We assume $475mm in gross proceeds for the pair.
- Proceeds go to pay down debt, leaving FNP (net) debt free by 2015.
- We assume the Corporate comes down from its current $66mm run rate to $50mm by the end of next year. We're going against the grain with management's comment that corporate will be 4-5% of sales. You don't boot 58% of revenue without taking a commensurate whack out of overhead. We know management is hyper focused on this. Ultimately, a 24% cut in Overhead (to $50mm) with a 58% cut in revenue seems fair.
- We assume that Kate Spade goes from 196 stores today to 551 over our modeling time horizon.
- On top of that, we have sales productivity going from about $1,200/square foot today to $2,000. This is completely doable for Kate Spade and Jack Spade. We're on the fence with Kate Spade Saturday, as it targets a customer that does not have the same level of disposable income. Nonetheless, if Saturday becomes such a meaningful part of the mix and dilutes price point, our store addition numbers will prove conservative. Six of one, half dozen of another.
- We conservatively assume that new Kate stores open at 40% of the productivity level of existing stores.
- We've got Kate's EBITDA margins going from 16%-24%. There's about 4% of 'DA' in there, so we're really talking an EBIT margin of 20%. We're extremely comfortable with this given the 29% level at KORS and 31% at COH (even though COH should be closer to 20% in order to actually grow its revenue).
- We assume that streamlining charges (which we're getting tired of) go away at the end of 2014.
- We've got interest expense turning into interest income. Only $6mm per year…but hey, they're coming off of $48mm in annual debt service. It matters.
- While this won't be a share repo machine (it's all about growth) we have the share count beginning to come down in 2015 as FNP uses some cash to pluck away at its share count.
- Growth is expensive, so in our cash flow assumptions, we have capex going from 5.5% of sales today to 10% off a much higher sales base. That equates to around $200mm. We're all for that level of spend. The returns are clearly there.
HERE'S OUR NOTE FROM EARLIER THIS WEEK
FNP: 3-Bagger. Add on Weakness
Even after the big move we still think that FNP is a BIG idea, with 3x upside over a 3-4-year time period. That said, we’re neither here nor there on tomorrow’s print. Here’s our thinking into tomorrow…
- FNP remains one of our favorite TAIL ideas, as we think that 1-2 years out the stock starts with a 4 (versus $27.66 today).
- But we don’t feel strongly about it one way or another headed into tomorrow’s print.
- This company gives guidance based on what it thinks it can hit, not on what it can beat. Our point is that if we want to get sucked-in to the game of ‘beat by a penny/miss by a penny’, this can literally go either way.
- There’s not likely to be an announcement on the sale of Lucky or Adelington with the release, though we’ll likely get added color on terms surrounding the previously announced sale of Juicy. All in, don’t expect any thesis-shifting strategic announcements.
- Our bigger picture call is simple. Kate Spade (which accounts for all of FNP’s EBIT) is going from $700mm in revenue at a 12% EBIT margin (with leverage), to $3-4bn in revenue at a debt-free 20% margin. We think people have the revenue trajectory partially correct, but they’re still way too low on the margin. In the end, consolidated EBIT will go from break-even (currently hurt by divisions that are on the block) to $800mm. The stock is expensive on earnings today, but is trading at 3.4x its $900mm EBITDA number.
- The punchline on this name is that an 8x EBITDA multiple on our $900mm EBITDA number gets us to a stock of about $75 vs the current $27.66. It won’t happen overnight, as we all know stock moves aren’t linear, but will grind higher quarter after quarter, year after year.
- This has been and will continue to be the perennial ‘I missed it’ stock for investors, who subsequently watch it go up another 25% in their face.
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