What Didn't Work?

“I have not failed. I’ve just found 10,000 ways that don’t work.”

-Thomas Edison


If you analyze every line item of what I like and don’t like right now, there are plenty of things that aren’t working. Unless you’re raging Long Chinese stocks and Commodities vs. Short US/European Stocks (and Bonds), you probably have some issues too.


In the last week the US Dollar has completely dislocated from what was a consistent and correlated moved with US interest rates. What was the #StrongDollar Deflation (one of the biggest macro moves in a decade) has morphed into Down Dollar, Up Rates.


But is the US Dollar down ahead of another weak US jobs report? Or are Rates Up ahead of a good one? I can’t give you 10,000 different ways to ask me those two very basic questions – but in the last week, I’ve fielded hundreds of them!

What Didn't Work? - z d4


Back to the Global Macro Grind


Some people say that part of the value I provide is my unique perspective. Unlike many macro economists, strategists, and chartists, I am a former hedge fund guy who has made almost every mistake you can make, using live ammo.


Setting aside all of my human flaws, I think most of you (buy-siders) can empathize with getting things wrong. It’s only on the sell-side where the pace of improvement in Macro Strategy has been stalled by not accepting mistakes and learning from them.


As one of the bigger buy-siders (Ray Dalio) wrote in Principles: “At Bridgewater, we created a culture in which it is ok to make mistakes, but unacceptable not to identify, analyze, and learn from them.”


Roger that, Ray.


One of the mistakes I made recently was underestimating how our fundamental research call (#LateCycle Growth Slowing) would impact the USD/Oil trade.


From an intermediate-term TREND perspective, I thought Oil (WTI) would settle into a range of $36-57/barrel. This morning, on another Down Dollar move, Oil is up another +2.5% to $61.91.


You can apply creative writing skills from your no-buy-side-P&L-experience all you want, but from where I was born/raised in this business, this is commonly called being wrong (until you have the mental humility to change your mind).


So here’s my mind-changing this morning:


  1. Intermediate-term TREND price deck for Oil now = $42.06-$69.03
  2. Intermediate-term TREND risk range for the US Dollar Index = $90.29-100.03
  3. Intermediate-term TREND risk range for 10yr US Bond Yield = 1.73-2.39%


My mind changes every day actually. As price, volatility, and economic data changes, what do you do, Sir or Madame?


The first thing you’ll probably notice about my intermediate-term view is that:


A)     It’s more in line with the Global Macro reality of the last 6-12 months than the last 6-12 weeks

B)      And that the intermediate-term risk ranges are wacky wide


#WackyWide risk ranges are leading indicators for rising volatility. And rising volatility perpetuates mistakes.


To be clear, my mistake wasn’t being short Oil for this entire move up (we covered commodity shorts ahead of an easier Fed and #LateCycle Labor reports, for a trade). It wasn’t being long it at $100 either. It was in not being long it from $45 to $62.


My main mistake there was that I didn’t think Oil’s Volatility was going to compress almost as fast as it exploded to the upside. To put the volatility of volatility (in Oil) in context:


  1. From SEP 2014 to FEB 2015, Oil Volatility (OVX) went from 17 to 63 = +270%
  2. From FEB 2015 to now, OVX dropped from 63 to 36 = -42%


Every buy-sider who survived the 2007-2009 gets that unless you were on the right side of the decline, it was hard to run out and buy something with historical volatility of 20-30, never mind 63. This #behavorial reality leads me to more of a question (from here) than an answer as to whether or not I should buy Oil with upside to $69.03, when the downside is still $42.06.


Did the guys/gals who bought Oil and its cyclically related inflation expectations exposures (E&P MLP stocks, Energy Junk Bonds, Levered Long Oil Futures, etc.) down at $45 own it from $90 to $45? Or are we talking about a whole new investor class who nailed it both ways? While I’m not certain about anything in this profession, I’m pretty sure long-term Oil bulls averaged in.


Of all the mistakes I’ve made, averaging into losers is by far the most punishing. Especially when I’d have our funds in smaller cap exposures, doubling and tripling down on mistakes could make them all the more severe. Sure, I could tell my partners that I wasn’t wrong. I could say I hadn’t really failed (yet). But the #truth happens on the next decline, when you can’t get out.


When my Global Macro model says lower-for-longer on both US and Global Growth Rates… and every central planner on the planet is trying to “ease” the confusion implied in the volatility of the aforementioned risk ranges, what works for me isn’t adding to my mistakes; raising Cash does. And I’ll do that again this morning in the Hedgeye Asset Allocation Model.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.85-2.21%

SPX 2084-2106
VIX 13.03-14.79
USD 94.08-96.01
EUR/USD 1.06-1.13
Oil (WTI) 53.99-62.30


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


What Didn't Work? - z chart day

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WTW: Don’t Care Until 2016 (1Q15)

Takeaway: This story doesn’t get interesting again till we get closer to 2016. But the bigger question now is whether mgmt can stave off Chapter 11.


  1. UNEVENTFUL PRINT: Mgmt already conceded 2015 was going to be a rough year when it disappointed on 2015 guidance.  While the print was relatively uneventful with a slight top-line miss on Fx, and reiterated guidance, the key takeaway from the print was that the 2015 winter selling season was in fact its worst winter selling season in its public history.
  2. DON’T CARE UNTIL 2016: Our tracker is showing decent improvement into 2Q15, but that doesn’t matter all that much.  The first quarter sets the tone for any given year given WTW’s seasonal attrition issues.  That said, no quarter in 2015 will change the tide from here, and 2015 is largely irrelevant outside of tracking seasonal attrition patterns, which at a minimum appear to be approving.  
  3. CHAPTER 11?  WTW is dangerously approaching the point where it costs more to acquire its members than the gross margin it earns from them.  If that ever happens, it’s basically game over.  WTW’s 2015 target of $290M in cash can only go so far with an annual debt service of roughly $120M.  For more detail, see the note below.


WTW: Chapter 11?

02/27/15 08:46 AM EST

[click here]


WTW: Don’t Care Until 2016 (1Q15) - WTW   1Q Selling Season 2015 4

WTW: Don’t Care Until 2016 (1Q15) - WTW   Tracker 4 15

WTW: Don’t Care Until 2016 (1Q15) - WTW   Per Member 1Q15



Let us know if you have any questions or would like to discuss in more detail. 


Hesham Shaaban, CFA



Thomas Tobin



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KATE – We Feel Good About The Print

Takeaway: We think that the long-term call is absolutely on track, and that KATE’s 1Q results should be another milestone on the way to $75

We think that the long-term call is absolutely on track, and that KATE’s 1Q results on Thursday should be another milestone on the way to $75. As the company doubles its sales base over the next three years while taking margins from 11% to 19%, generating $3+ in earnings power. Sales and margins trends look in-tact over the near term as the US e-comm trends looked solid even with the pullback in Flash events. And, margins stand to benefit from the elimination of stand-alone Jack/Saturday stores and the shift of the ‘Friends and Family’ from 1Q14 into 2Q this year.  


We’re Above Consensus. We think that management was being overly cautious with its targets for 2015. There are so many levers in this model, and our sense is that the company downplayed them. KATE guided to $185mm-$200mm in EBITDA for the year – assuming the top end of revenue guidance, that’s 15.7%, or about flat on a year/year basis (adjusting for the Jack/Saturday dilution). But we’re modeling $237mm, or about 110bp higher than last year. That’s about 65% EBITDA growth for the year, a number we expect to moderate only slightly to 50% the year after.


Quite frankly, we like the company’s conservatism, as it will keep expectations grounded, and mitigate the likelihood of an earnings day sell-off, which happens too often for KATE to call it a coincidence.


What’s It Worth? So that begs the question as to what we should pay for KATE. By the end of this year, we’ll be eyeing about $345mm in EBITDA and $1.30 in EPS.  When looking at the 50% and 100% growth rates in EBITDA and EPS, respectively, we could definitely argue a big multiple. On the flip side, this is a fashion business, and there will almost certainly be a time (like KORS is experiencing now) where it will see multiple compression as it matures.   But keep in mind that KORS has a brand footprint of $6.4bn and EBIT margins of 30%. KATE has a $1.4bn footprint (smaller that Tory Burch at $1.9bn) and margins of only 11%. It will be a long time before we have to ask the ‘is it over’ question. Until then, we think the multiple will continue to defy gravity in the eyes of anyone that’s not a growth investor.


For argument’s sake, let’s keep the forward multiples in place that KATE has today – 50x earnings and 19x EBITDA. We think that there’s upside this year as the company beats. But on 2016 numbers we’re looking at 50x $1.32 = $66, or 19x EBITDA in the mid-50s. Roll ‘em to ’17 and you get to over $2+ in earnings power, or around a $75 stock.


KATE – We Feel Good About The Print - kate financials 5 5





1) This is perhaps the most polarizing number we will see during the print on Thursday. While we usually don’t play the near-term comp game, let’s strap the accountability pants on for KATE management. It guided 1Q14 high-teens, 4Q at 8-14% and the full year at 10-13%, and printed 29%, 28% and 24% for each quarter and the year respectively. The company’s initial guidance for the year calls for HSD comps improving sequentially throughout the year. We should see a typical KATE print, sales coming in ahead of expectations followed by a guidance raise.


2) For the quarter we are at a 10% comp, and will be very surprised if we see anything in the single digits. More details on the math behind our assumption and the two controversial areas below…


a) E-Comm The company continued on its planned pull back on ‘Flash Sales’. Similar to 4Q14, the company hosted 2 ‘Flash Sales’ compared to 3 in the prior year’s quarter. In 4Q14 the company posted sales growth of ~45%-55% depending on the aggregate weight of the segment. In the quarter, e-comm alone would support 5% comp growth assuming it is a) 25% of the business in 1Q, b) grows at 20%, and c) Brick and Mortar comps are flat. If we ratchet e-comm comps up to 25% holding all other assumptions the same, it would get us to a 6.3% comp for the quarter.


b) Japan – Due to the 37% comp KATE Japan posted in 1Q14 ahead of the country’s consumption tax hike from 5%-8%, management cited this as one of the main reasons for the guided sequential slowdown in comp trends. But given the size of the business (12% - 15% of total revenue) we’re not overly concerned about the potential headwind. Let’s say that comps in quarter are flat, which would imply a 300bps deceleration on the 2yr trend line, and sales growth for the rest of the company was 20%. We are looking at 360bps of headwind to the company average. Or, bear case, Japan is down 10% we are looking at 540bps of dilution. Realistically, let’s assume that the 2-year run rate stays even with 4Q levels – even though it is actually trending higher. A 6% Japan comp would imply a 22% 2-year trend (flat sequentially). That suggests 250bps of sequential headwind on a consolidated basis.


c) Our algorithm consists of a few parts. Organic growth ex. Japan and Jack/Saturday of 13.5%. Japan down 3%. Which gets us to 10% comp growth. That’s broken into e-comm growth of 20% (~25% of the consolidated revenue base) and B&M comps of 6.7% down from the 21% we saw in 4Q14.


EBITDA Margin:

1) Gross Margins: The way we see it, the combination of Jack/Saturday caused 130bps of dilution in FY14 from inventory write off charges alone. The company will get all of that back in ’15. With the additional benefit of shedding free standing Jack/Saturday doors which were operating well below the company average.


a) For the quarter, the company is comping against a 150bps decrease in Gross Margin as the company moved its ‘Friends and Family event’ into 1Q14 to pull forward sales lost to a late-April Easter that fell in 2Q14 last year. The company did not repeat the sale in 1Q15 this year. That should more than offset any headwinds from Fx or occupancy related to the newly converted Juicy outlet doors.


2) In total we get to operating margin expansion of just over 300bps, with the majority driven by SG&A leverage with 100bps of Gross Margin expansion. Add on the $12mm in estimated D&A cost gets us to an adjusted EBITDA margin of 11.3%.


NDLS: Earnings Disaster

Key Takeaway

NDLS delivered a dreadful 1Q15 print and a similarly disappointing outlook for 2015.  Management did very little on the call to dissuade our thoughts that NDLS should not be growing – at all.  Until they realize this, and scale back growth, the stock will be a short.


NDLS: Earnings Disaster - 1


Painful performance.  NDLS reported system-wide SSS of +0.9%, well short of the consensus estimate of +1.4%.  This comp underperformance drove top and bottom line misses of $2.7 million and $0.02, respectively.  To put the severity of this comp underperformance into perspective, Black Box reported 1Q15 comp sales of +3.0%.  We’d typically expect and emerging fast casual concept to lead this benchmark.  To wit, Potbelly delivered +5.5% same-store sales growth in the first quarter!  We’d note that majority of the same-store sales disappointment stems from three problem markets: Colorado, the DC Metro Area, and Austin.  Excluding these three markets, same-store sales grew +3.2% for the quarter.  Management guided down full-year same-store sales guidance from 2.5-4% to low single digits and EPS growth guidance from 20% to 0%.


Established markets are a problem too.  In the past, we’ve harped on Noodles’ inability to effectively enter new markets.  Specifically, we question management’s restaurant expansion strategy that was more heavily weighted to newer markets than existing.  New markets, and the subsequent lack of brand awareness, have consistently been the culprit for poor same-store sales performance in the past.


NDLS: Earnings Disaster - 2


Now management is blaming the weakness on established markets, particularly Colorado and Austin, that are both comping negative year-to-date.  Remarkably, despite being in the Colorado market for more than 20 years, the team conceded that they must bring more top of mind awareness here.  With the addition of the DC Metro Area, these three markets (dubbed the problem markets) account for approximately 30% of all Noodles locations.  We were previously solely concerned about new markets as opposed to existing; now we have reason to worry about both.


NDLS: Earnings Disaster - 3


Initiatives underway to right the ship, but are they enough?  Management believes it has the initiatives in place, both on the operational front (throughput and deployment initiatives) and marketing front (branding, marketing, and promotional work), to reaccelerate comps in 2H15.  Marketing spend will ramp from 0.4% of sales in 1Q15 to 1% in the latter half of the year and should provide a little boost to sales, but this is far from a solution to the brand’s current struggles.  Quite frankly, these initiatives are not the panacea the Noodles needs.  If management doesn’t halt its unit growth strategy and hone in on operations, they will continue to destroy significant value.


NDLS: Earnings Disaster - 4

REPLAY | The Macro Show with Darius Dale

Here is the replay of Senior Macro Analyst Darius Dale on the Wednesday May 6 edition of The Macro Show.





The Macro Show is Hedgeye's dynamic pre-market rundown highlighting the most important global macro developments. The Macro Team shares 15 minutes or less of prepared market analysis and commentary and then answers your questions in a live Q&A session.

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