Macro Analyst Ben Ryan discusses why Hedgeye remains bullish on gold despite recent news that Goldman Sachs has reiterated its bearish call. He speaks with Director of Research Daryl Jones.
Takeaway: Recent data supports our expectation that inflation will quash US consumption growth, while developing quant signals challenge that view.
Each day one of our summer interns, Kevin Brooke – the offspring of Yale Hockey legend Bob Brooke – compiles a blog run for our team. The purpose of the blog is find insightful macroeconomic or financial market analyses that challenge (or support) our existing macro themes, as well as those thought pieces that are generally informative.
Today Kevin hit a home run with two of the better pieces I’ve seen in recent weeks:
- Commodities Reverse Their Gains!: CLICK HERE to access the article
- Here’s Why Americans Are Having a Lot Less Fun This Summer: CLICK HERE to access the article
In discussing the latter data point first, we are most welcoming of this incremental evidence of our #ConsumerSlowing theme, as it shows a net percentage of Americans are spending more on Groceries (49%), Gas/Fuel (46%) and Utilities (35%). Per the cited Gallup Survey, those expenditure categories were the three largest in terms of the net percentage of Americans feeling the effects of cost-push inflation.
Interestingly enough, those three expenditure categories just so happen to be the three inputs to our Hedgeye Macro Consumer Squeeze Index, which continues to show #InflationAccelerating eroding domestic purchasing power.
On a prospective basis, we obviously need to see incremental commodity price appreciation in order for cost-push inflation to threaten the outlook for consumer spending in a material way (a la 2008 or 2011).
One key driver of our forecast for said price appreciation is #DollarDevaluation. Specifically, we think the Fed is gearing up to surprise investors by introducing directionally-dovish monetary policy, at the margins, as we progress through the back half of the year. Refer to the following pieces to review that thesis in full:
- US GROWTH: WHEN DOVES CRY (6/25/14): http://app.hedgeye.com/feed_items/36348
- 3Q14 MACRO THEMES CALL (7/11/14): http://youtu.be/AMJQLMk3od0
Today in the Federal Reserve’s Semiannual Monetary Policy Report to the Congress, FOMC Chairwoman Janet Yellen continued to “connect the dots” on an outlook for easier monetary policy:
- “The housing sector, however, has shown little recent progress. While this sector has recovered notably from its earlier trough, housing activity leveled off in the wake of last year's increase in mortgage rates, and readings this year have, overall, continued to be disappointing.”
- “Although the economy continues to improve, the recovery is not yet complete. Even with the recent declines, the unemployment rate remains above Federal Open Market Committee (FOMC) participants' estimates of its longer-run normal level. Labor force participation appears weaker than one would expect based on the aging of the population and the level of unemployment. These and other indications that significant slack remains in labor markets are corroborated by the continued slow pace of growth in most measures of hourly compensation.”
- “Although the decline in GDP in the first quarter led to some downgrading of our growth projections for this year, I and other FOMC participants continue to anticipate that economic activity will expand at a moderate pace over the next several years, supported by accommodative monetary policy, a waning drag from fiscal policy, the lagged effects of higher home prices and equity values, and strengthening foreign growth… As always, considerable uncertainty surrounds our projections for economic growth, unemployment, and inflation. FOMC participants currently judge these risks to be nearly balanced but to warrant monitoring in the months ahead.”
- “Of course, the outlook for the economy and financial markets is never certain, and now is no exception. Therefore, the Committee's decisions about the path of the federal funds rate remain dependent on our assessment of incoming information and the implications for the economic outlook. If the labor market continues to improve more quickly than anticipated by the Committee, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target likely would occur sooner and be more rapid than currently envisioned. Conversely, if economic performance is disappointing, then the future path of interest rates likely would be more accommodative than currently anticipated.”
- “In sum, since the February Monetary Policy Report, further important progress has been made in restoring the economy to health and in strengthening the financial system. Yet too many Americans remain unemployed, inflation remains below our longer-run objective, and not all of the necessary financial reform initiatives have been completed. The Federal Reserve remains committed to employing all of its resources and tools to achieve its macroeconomic objectives and to foster a stronger and more resilient financial system.”
If you’ve subscribed to our research for longer than one day, you’ll no doubt have realized that quantitative, market-based signals tend to front-run our interpretation of or expectations for underlying fundamentals, while our those same underlying fundamentals help instruct our outlook for market prices. It’s a dynamic, reflexive process that tends to generate “Circular Reference Warnings” among the linear, Consensus Macro forecasting community.
Right now, those quantitative signals aren’t as supportive as they were even 2-3 weeks ago. Looking to our Tactical Asset Class Rotation Model (TACRM for short), we’re seeing a SELL signal in FX for the first time since late APR and the third-consecutive week with a SELL signal in Commodities, after having been squarely in BUY territory since mid-FEB.
Refer to the following presentation for more insight into TACRM’s quantitative signaling capabilities: http://docs.hedgeye.com/HE_TACRM_2014.pdf.
It’s worth noting that TACRM’s BUY and SELL signals aren’t necessarily meant to generate absolute returns (although the backtest data on slides 15-20 of the aforementioned presentation suggests TACRM is quite good at doing just that); rather, these signals are relative to the other asset classes (e.g. BUY Fixed Income & Yield Chasing in lieu of XYZ asset class, which would have a commensurate SELL signal).
Additionally, it’s also worth noting that within our hierarchy of quantitative risk management signals, TACRM sits squarely below Keith’s multi-factor, multi-duration model that is core to each of our fundamental views. Regarding those signals, the key levels to watch are:
- WTI Crude Oil: we need to see it hold sustainably below these levels in the coming weeks for us to consider materially altering our economic outlook
- Threatening Bearish TREND = 101.89
- Threatening Bearish TAIL = 100.27
- CRB Index: we need to see a sustained breakdown below the TREND line for us to consider materially altering our economic outlook
- Threatening Bearish TREND = 297
- Squarely Bullish TAIL = 291
- Gold: we need to see a sustained breakdown below the TREND line for us to consider materially altering our economic outlook
- Squarely Bullish TREND = 1281
- Squarely Bearish TAIL = 1324
- USD Index: we need to see a sustained breakout above these levels line for us to consider materially altering our economic outlook
- Squarely Bearish TREND = 80.71
- Squarely Bearish TAIL = 81.19
Our process is dynamic and, if nothing else, mentally flexible. We aren’t wed to any thesis, so if the facts change (i.e. commodity inflation reverses and the Fed is supportive of a stronger USD), we’ll change with them.
Hope this is helpful and thanks for the questions,
Associate: Macro Team
Takeaway: We are removing Lorillard (LO) from Hedgeye's high-conviction stock idea list.
We are removing long Lorillard (LO) from Investing Ideas today.
After Consumer Stables analyst Matt Hedrick added LO on 3/6/14 and months of rumors that it would be taken out, this morning Reynolds American (RAI) announced its intention to buy LO in a cash-and-stock transaction currently valued at $68.88, or a total of $27.4B (including debt).
The price is significantly below our share target of $80, and it’s worth noting that there is significant runway before the deal is expected to close in 1H 2015. That said, this has been a fantastic position for us.
We want to underline that beyond RAI we do not see another competitive bidder for LO. Further, given that we expect a lengthy regulatory approval process on anti-trust considerations this deal is still a long way from closed and may present a further investment opportunity.
Shares are up over 15% from where we added it to Investing Ideas.
Rigorous statistical analysis suggests that Singapore’s weakening macro environment could impact casino revenues.
THE CALL TO ACTION
We’ve found several macroeconomic metrics to be correlated with Singapore gaming revenues. Given the few number of data points – Singapore is still a young but mature gaming market – it is too early to quantify each metric’s significance. Considering the discretionary and cyclical nature of mature gaming markets worldwide, LVS and Genting Singapore investors should be worried about Singapore's deteriorating macro environment.
THE MACRO SETUP
The Singapore government recently released a slew of macroeconomic data for Q2 and it’s difficult to find any ray of positivity. Q2 GDP contracted (QoQ) for the 1st time in 7 quarters. Retail sales (ex motor vehicles) are trending -2% YoY (April-May period). Watches/jewelry sales (seasonally adjusted) fell 8% (April-May period). On the housing side, Singapore private residential prices fell again in Q2 following the Q1 decline. The results are even more extreme for Singapore new private home sales which fell 68% in the month of June. CPI also ticked up in Q2 relative to Q1.
The Singapore Dollar remains higher versus a majority of its cross currencies in Q2. As Genting mentioned several times on its conference call, a stronger Singapore dollar is a headwind for the mass business due to a lower bet per trip.
We’ve run the regressions and the only thing we’ve definitively concluded is that there is not enough revenue data points to formulate a working model. However, we can derive a very high R square using multiple macro variables even though the t-stats (measuring statistical significance) among individual variables are mostly fairly weak. Again the low t-stats are more of a function of a limited dataset.
Among the most statistically significant and positively correlated variables are private residential prices, visitation, and watch/jewelry sales. Negatively correlated variables include CPI and currency. Unfortunately, none of these variables are moving the right way to support casino revenue growth. Fortunately, all of these data points, with the exception of visitation, are released on a timely basis.
We will understand the statistical impact macro has on gaming revenues as more quarters pass. However, our view is that the deteriorating macro environment, as evidenced by variables that we believe will prove to be significant, is negatively impacting casino play at the Singapore casinos.
For LVS, we are projecting Q2 Marina Bay Sands (MBS) EBITDA of $378 million, which assumes a normal hold percentage, versus the Street at $390 million. Given the macro weakness, we feel less certain in our Q2 and 2014 MBS EBITDA estimates.
Takeaway: This is one of the most hated stocks in retail. It might be sleepy and boring, but we like this name in the mid-$20s.
Conclusion: This is one of the most hated stocks in retail. We understand the bear case, but think it’s foolish to be beared-up on a name when sentiment is at its worst, valuation is bordering on cheap, and growth is on the verge of reaccelerating.
This one is a head-scratcher. WWW beat the Street’s EPS expectation by 15% – putting up a better-than-expected top line, a positive reversal in Sperry (which is a lightning rod for this stock), and gave every indication that the productivity of international distribution agreements is improving (this was critical for us – see write up below). Yes, EPS was driven in large part by lower SG&A growth, but that was known heading into the quarter. The stock was up 8% pre-market, but then once the call got underway it cratered, and is down 2%. The primary culprit is that guidance was very ‘Wolverine-ish’, meaning that the company reaffirmed the year, but lowered the upcoming quarter – so it can beat it handily in another 13 weeks. In addition, we think that people will be concerned that the company will back away from its long term revenue target. We’re really not concerned about either of these things.
One thing that never ceases to amaze us is how much people love to hate this company. We’ve all seen companies that are perennially hated, but seriously, pull up a 20 year stock chart for WWW. It does not strike us a management team and business model that’s worth betting against for anything more than brief periods of time. Our Sentiment Monitor below, which combines Sell Side rankings with Buy Side short interest and assigns a quantitative score, shows just how hated WWW is today. When the Sentiment score gets below that dotted green line in the chart, it almost always signals a contrarian time to buy (the inverse holds true for stocks with sentiment above the red line).
Here’s something to think about from a timing perspective on WWW as it relates to its PLG acquisition.
1) Year 1: Even though the deal was consummated in 2012, it really only benefitted 2.5 months of the year. The real ‘Year 1’ was 2013. This was a breakout year for the stock as WWW blew away EPS estimates as it immediately realized revenue and cost synergies from the deal. The stock was up 66% for the year, more than double the market. It really served as the poster child as to why you want to own a stock in the first year after a transformational acquisition.
2) Year 2: Unfortunately, we’re in this year right now. We’re in the back half. But we’re still in it. In deal terms, we’ve anniversaried the Year 1 euphoria of synergies, and are still building the infrastructure to support organic top line growth and margin expansion. This begins in Year 3. Unfortunately, growth investors don’t want the stock at this point in its cycle, and it’s probably not cheap enough for value investors. GARP investors might look at it, but there’s not enough ‘G’ in the GARP equation here given a tough start to the year in US retail.
3) Year 3: 2015 – this is when we actually start to see a reacceleration in growth due to the investments that were made in years 1 and 2 of the acquisition. In WWW’s case, it will be an extension of the International growth that we’re starting to see in its numbers as Keds, Sperry, Saucony, & Stride Rite grow more aggressively overseas. That plus accelerated growth in e-commerce across all of its brands. In the end, we think that we’ll be looking at growth rates 2x what we see today.
The punchline is that today’s stock move definitely takes away what little wind WWW had in its sail, which we clearly don’t like. But when we step back, the reality (as we see it) is that the stock is bombed out, sentiment is simply abysmal, it is trading at 14x earnings and 10x EBITDA when earnings and cash flow have a long-term CAGR of 20% and 25%, respectively. That might be justified if it the business was decelerating. But we think we’ll see an inflection in 2H, and then a material acceleration in 2015. That should start to be discounted in the back half of this year -- to some degree. It might be sleepy and boring, but we like this name in the mid-$20s.
WWW: THOUGHTS INTO THE PRINT
This WWW quarter to be reported tomorrow is an important event for our confidence in our Long thesis. To be clear, we’re not too worried about the EPS number. We think that looks fine. We’re at $0.28, about a penny above the Street, which would represent a 22% growth rate in EPS compared to a 6% decline in 1Q. The consensus view is that the revenue is weak, and that the company will make up for it with lower pension expense. That’s mostly correct, but well-telegraphed. We shouldn’t see any downward revision to guidance for the year. If anything we think WWW will beat and keep FY guidance steady, implying that 2H will be lower (that’s what it always does). Keep in mind that the company was at the FFANNY trade show in early June where it held 1-on-1s, and then presented at a broker’s Consumer Conference. Both of those happened just 1-2 weeks before the quarter closed June 14th. In other words, WWW knew its numbers, and likely would have preannounced at that time if it thought the quarter or year was at risk.
The key thing we’re looking for, however, is a) the number of international distribution arrangements signed for Sperry, Keds, Saucony and Stride Rite, and b) the revenue generated by the deals that have already been signed. Why is this so important? The crux of the investment opportunity here is WWW scaling up the International distribution for the four PLG brands. It already has the most efficient international distribution network of any footwear company in the world, with better than 60% of its shoes sold outside the US across a network of 210 distributors over 11,000 points of distribution. All of them are on SAP, and all are exclusive to WWW. Conversely, the PLG brands generated only 5% of its sales outside of the US due to the inefficiencies of being under the umbrella of its former owner, Collective Brands (Payless). When we look at the timeline associated with this deal, organic international growth should be ramping up right now. Here’s the timeline…
PLG Acquisition Timeline
- 2012 was the year of the PLG deal (4Q12). It was big, and painful initially – no EBIT, just interest from $1.2bn in debt.
- 2013 was the year of integration. In 1H people moved around, brands were repositioned, and management realigned. Then in 2H the chessboard was largely set, but they had to seal the deal with an SAP implementation, which went without a hitch.
- Then comes 2014 – which should be all about revenue growth. The global salesforce, which is the most efficient footwear distribution operation on the planet, has four new major tools (brands) in its toolbox. WWW has been lining up international distribution arrangements over the past 18 months and is now sitting on about 55. Aside from each of those arrangements getting more productive, there’s still another 150 that could be added by our estimates.
Here’s what the company has said in its last seven public appearances about its cadence in signing new deals.
- Q2'13 CC (Jul ‘13): almost 20 distribution agreements in key growth markets and anticipate another 15 to 20 programs will come online in the back half of 2013
- Q3'13 CC (Oct ‘13): We continued to make progress on this front during the quarter by signing and executing distribution agreements covering 14 key growth markets, bringing the total number of new agreements since closing to nearly 35 covering 67 countries.
- Investor Day (Oct '13) : Since acquisition, we've signed 35 new agreements covering 67 countries, and we're very excited about certainly the most recently inked agreements with the Elan Corporation for the Sperry Top-Sider and Keds brand for the China market.
- ICR (Jan '14):
- Q4 '13 CC (Feb '14) : significant investments to build out the full Sperry Top-Sider lifestyle assortment. We have seven license agreements in place today for everything from swimsuits to sun glasses and our most exciting initiative, the introduction of a full range of Sperry apparel via license agreement with Li & Fung is scheduled to launch this coming fall... We've signed 15 to 20 new contracts for Sperry. We still only have Sperry in about 67 countries around the world, for example.
- Q1'14 CC (Apr '14): During the quarter, we signed agreements covering over 25 key growth markets, bringing the total number of new agreements since closing to nearly 55, covering nearly 85 countries.
- Baird Conference (May '12): And as we noted in our earnings call last week, since the acquisition closed, we've signed 55 new distribution agreements for the newly acquired brands covering 85 markets. And so those distribution agreements are in place.
So there are 55 agreements in place as of May, and probably close to 70 today. We’re ahead of the consensus this quarter due to revenue growth associated with these arrangements. If we’re wrong, then we’ve got to step back and question our logic, math and thesis. But based on what we know today, we’re comfortable owning this one.
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