This note was originally published at 8am on February 04, 2015 for Hedgeye subscribers.
“The two most powerful warriors are patience and time.”
I love that quote. When I think about risk managing my firm, the Global Macro tape, and what I need to improve upon – as I get older, I usually come back to patience and time.
Can I maintain opposing thoughts, across multiple durations, and still operate objectively? Can I help both my team and yours understand the difference between an immediate-term TRADE risk and an intermediate-term TREND?
To me, the words patience and time don’t have to imply “long-term investor.” To be a long-term active risk manager (someone please market their fund as doing so!) you have to be patient so that, sometimes, you can act quickly.
Back to the Global Macro Grind…
Since centrally planned markets move quickly, why wouldn’t you, sometimes, risk manage quickly? As I’ve been sitting here this morning the S&P futures have gone from down 2 to down 9, to down 2 (on a Chinese rate cut), to down 6 twenty minutes later.
Yeah, that’s about as free-market as the Nikkei being jammed +2% into the bell on a “rumor that the BOJ is going to add another dovish member.” Lol! Seriously, like Japan hasn’t been dovish for 2 decades – they are printing 90 TRILLION Yens a year!
To be a warrior of this actively managed tape, in addition to patience and time, you have to have a lot of weapons at your disposal. One of the biggest ones is historical context. Another is keeping yourself together, mentally.
If you have neither context nor emotional control, you will get wrecked.
To review this most recent 3-day counter-TREND move in macro markets:
Yeah, Oil ramped. I get it. If you knew what a Down Dollar move would do to both Oil and the Commodities complex, you should have absolutely got that right too. To remind you where the trending probabilities were heading into this 3-day move:
Sure, it should have been harder to convince yourself that the SP500 could have a big up move on a Down Dollar move – but it really wasn’t that big – certainly not on an absolute or relative basis to the move in Commodities and their linked stock sectors:
I know, as long as you bought Greek stocks alongside everything that has been crashing in Commodities and their linked US equity sectors for the last 6 months, you absolutely crushed it yesterday.
I am not saying this is easy. I am simply reminding you how the next crisis looks – because you are already in it. It’s called a market volatility crisis perpetuated by central planners who move into panic mode in a final effort to “smooth” the tape.
Yes, do you know what Oil Volatility (OVX index) did in the midst of crude going from $43 to $53? It went up! And the implied volatility for the SP500 on my intermediate-term TREND duration did not change.
No, I do not profess to know how to call this, play by play, with everyone of these countries randomly coming out with made for Bloomberg ad rev headlines on what they are going to try to do to markets next…
But my longest term risk management conviction remains that this epic central planning experiment of markets will not end well. It will end the way that it is already ending – with confusion and volatility. Have patience with that.
Our immediate-term Global Macro Risk Ranges are now (12 macro ranges with TREND signal in brackets like this are in our Daily Trading Range product):
UST 10yr Yield 1.61-1.82% (bearish)
SPX 1987-2066 (neutral)
Nikkei 17292-17889 (bullish)
Greece (Athens Index) 674-849 (bearish)
VIX 16.06-21.87 (bullish)
USD 93.45-94.84 (bullish)
EUR/USD 1.11-1.14 (bearish)
YEN 116.03-118.34 (bearish)
WTI Oil 42.35-52.79 (bearish)
Natural Gas 2.60-2.81 (bearish)
Gold 1255-1291 (bullish)
Copper 2.42-2.59 (bearish)
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: This announcement out of KATE that it is transitioning its watch business to FOSL is bigger than the headline otherwise suggests.
This announcement out of KATE that it is transitioning its watch business to FOSL is bigger than the headline otherwise suggests. We get to a dime accretion by year three for a company that will end up earning $0.30 in 2014, with an even greater impact on cash flow. Here are some key considerations.
1) As it stands today, KATE has about an $80-$100mm watch business, which is about 7% of KATE’s total business at retail ($1.35bn footprint – grossing up the value of wholesale and licenses). But by our estimate, the business is only marginally profitable, with EBIT of around $5mm, or around 3% of total. Accessories like watches should be 2-3x the margin rate of things like apparel, shoes and other core categories.
2) KATE was determined to develop its watch/jewelry business in house. That might work for a sub-$100mm brand, but without the scale of a larger design and sourcing operation it would likely stay a $100mm business forever. There is a reason why KORS, Tory Burch, Marc Jacobs, etc. all have deals in place with FOSL. If KATE wants to take the watch business closer to $500mm over time (no pun intended), which it does, then the deal with FOSL makes perfect sense.
3) Bye bye Adelington. We’ve been wondering for a while now why Adelington (its in-house private label jewelry design company for department stores) still exists as a part of Kate Spade. The brand itself is losing licenses left and right and is now margin dilutive. We can only think that it served some support function for Kate’s Jewelry/Watch design effort, but now that it’s moving over to FOSL we don’t see the need to keep it around. We have it coming off the P&L in our model by the end of 2016.
4) Over the past 3 years KORS watch/jewelry business has grown over 140% to $730mm as of the end of FY13. That’s huge. Let’s say KATE can grow 3x in 3 years. That means we take away about $100mm in consolidated revenue at about a 5% margin, or $5mm. Then in year 1 we take the business to $150mm at a 10% royalty – that’s $15mm at about a 60%margin (could be as high as 80%). That’s $9mm, which is about 80% growth in watch-related EBIT in year 1 – and that’s not to mention the fact that it takes working capital off the balance sheet. The net is $4mm, or about $0.02-$0.03 per share. That might not seem like a lot, but it’s actually about 10% earnings accretion in year 1.
5) In year 2, the math works out to be something like $225mm x 10% x 60% = $14mm, or $9mm net of lost consolidated sales. There’s an extra nickel in earnings. We’ll likely build closer to a dime by year 3.
6) Not only is KATE signing up for FOSL expertise and sourcing power, it will now be able to tap into the brands global supply network. In the past KATE had been signing distribution agreements ad-hoc region by region. This helps simplify that.
7) The only real issue we can think of would be KORS ties with FOSL. The brand currently accounts for about 25% of FOSL’s revenue. That’s the equivalent of UnderArmour starting up a line at a new shoe factory in Asia only to find out that the entire building is otherwise dominated by Nike. That said, KORS and FOSL just signed a 10yr deal which locks in the license through 2024. If KORS were going to have bargaining power it would have been a few months back. In addition, this is not FOSL’s first rodeo. It’s dealt with competition like this before. If it mismanages either of the two brands (KATE, most notably) it will shoot itself in the foot as it relates to reputational risk. FOSL management won’t let that happen.
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Q & A
Tomorrow (Wednesday, February 18th at 11:00 a.m. EST) Hedgeye’s Macro and Energy teams will host a guest speaker call on US natural gas fundamentals with Keith Barnett, Head of Fundamental Analysis at Asset Risk Management (ARM), which is an independent producer services company that provides solutions for more than ninety clients through financial hedging advisory, physical marketing, and midstream solutions.
Topics for Discussion:
US Toll Free:
Conference number: 39017544
*A visual presentation will be available an hour prior to the call.
About Keith Barnett……Keith Barnett is Senior Vice President and Head of Fundamental Analysis at Asset Risk Management. He has over 30 years of experience in the energy industry with leading companies like Chevron, Columbia Gas Transmission, American Electric Power, and Merrill Lynch Commodities. Keith held engineering, managerial and executive positions with those companies in the areas of production, drilling, offshore platform design, natural gas marketing, fuel procurement, trading and structuring analytics, corporate strategy and fundamental analysis of energy markets. He had significant participation in two National Petroleum Council studies; including leading the power demand team in the 2003 natural gas study and serving on the steering and report-writing committees. Keith was also the Natural Gas Task Force lead for the Edison Electric Institute for several years. He has testified before the Federal Energy Regulatory Commission and the Senate Sub-committee on Energy on natural gas and power matters. He is a frequent speaker on natural gas, power, and global energy markets.
Prior to joining Asset Risk Management, Keith served as Director of Strategic Analysis for Merrill Lynch Commodities where he led the effort to create an integrated global point of view for energy commodities that could serve short term trading and longer-term investment horizons. He also worked most recently with Spring Rock Production, which is producing a state of the art natural gas and oil production forecast for the USA and Canada. Keith has an engineering degree from Texas A&M University.
About Asset Risk Management……Headquartered in Houston (with offices in Chicago, Denver and Pittsburgh), Asset Risk Management (ARM) has been helping oil and gas producers make better hedging decisions since 2004. ARM represents more than 85 public and private companies and interacts with all major energy commodity counterparties. ARM’s value is realized not only in the development and implementation of dynamic strategies, but in the ongoing optimization of those strategies as warranted by market volatility, execution efficiencies, reporting and continual monitoring of technical and fundamental factors in the market with the client's best interests and specific objectives in mind. Learn more: http://asset-risk.com/.
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