The Obstinate One

“Nothing is more obstinate than a fashionable consensus.”
-Margaret Thatcher
Per our friends at being obstinate is “characterized by inflexible persistence or an unyielding attitude.”
I am no longer going to call him Heli-Ben. The cartoons and the free moneys… I’m done with those. This isn’t funny anymore. I am going to call him The Obstinate One. Shame on you Ben Bernanke. Shame on you.
Bernanke pandered to the political wind again yesterday. Never mind the original justification for going to this “emergency rate” of ZERO percent on your hard earned savings accounts. It’s time for The Obstinate One to make up new narratives that support the political position. He didn’t change anything in his “exceptional” and “extended” language. He made it clear that he won’t raise rates until both inflation and employment rise.
Let’s consider both:
1.      US Employment - He’s more of a 1930’s Great Depression guy, so he obviously doesn’t remember the 1970’s. Most Keynesians would rather not remember those STAGFLATION days either. They were professionally embarrassing for “economists.” Yes, Obstinate One, you can have a jobless recovery in inflation.

2.      Inflation - Newsflash: reported deflation already bottomed at -2.1% in the July of 2009 CPI report. Sequentially, Consumer prices will continue to rise (or REFLATE); particularly in the next 3-6 months. Yes, Obstinate One – that’s what we call an accurate Research Edge Macro forecast.

Yes, Obstinate One, we understand that the government has changed the way inflation is calculated 9 times since 1996. Yes, we understand that, as a result of the calculus, its now almost mathematically impossible to have core CPI reported north of 3%. Yes, we understand that Washington will never have to worry about inflation because they don’t use prices at the pump.
Americans should just stop whining, and take a cab. Enough already. The Obstinate One has successfully arrested the depressions and deflations in Wall Street bonuses. He’s been hired for another term. There is a strong case here for the willfully blind to have Washington fear-mongering consensus stay the course.
Into and out of the FOMC announcement, here’s what marked-to-market leading indicators of price inflation have done:
1.      The US Dollar broke my critical immediate term TRADE line of support ($76.20), trading down to $75.74

2.      The SP500 closed up for the 3rd day in a row, taking its REFLATION from March 9th back up to +55%

3.      The CRB Commodities Index closed at 276, taking it’s week-to-date price gain up another +2.2%

Here’s The Obstinate One’s Christmas present to the citizenry who should just take his word for it on inflation:
1.      Oil in a Bullish Formation (positive TRADE, TREND, and TAIL): immediate term support/resistance = $75.81/$81.41

2.      Dr. Copper in a Bullish Formation: immediate term support/resistance = $2.88/$3.05

3.      Gold in a Bullish Formation: immediate term support/resistance = $1054/$1095

How about “Great Depressions” in prices of International Equity markets that are now using our Burning Buck to carry trade?
1.      China closes up for the 5th consecutive day taking the YTD gain on the Shanghai Composite to +71%

2.      Brazil took a sniff of The Obstinate One’s free moneys and raced +2% higher into the close yesterday at +70% YTD

3.      Russian stocks are up again early this morning taking their YTD gain to +109%

Ah, who cares about the Russians, Brazilians, and the Chinese building economic power in this day in age. America has a lot of that to give, no? Are there any unintended consequences associated with Putin gaining political power again via petrodollars? How about Chinese military aspirations?
Who cares about all this when the American citizenry can fund it via a Piggy Banker yield curve (the spread between 10-year Treasury yields and 2-year yields has shot up to +263 basis points overnight as The Obstinate One politicized the short end of the curve)? Who needs to talk about these marked-to-market realities like a 3-month US Treasury rate of return of 0.05% (ZERO)?
If this weren’t so pathetic it would upset me. Instead, I’ll just sell American (I’m still short the US Dollar), and move on. Global capital flows to rates of return. Let’s not get patriotic about this – Japan already tried. The Australians get it. The Norwegians get it. The Indians get it. They want The Client’s (China) savings, and they’ll put a rate of return on it.
I have dropped my Asset Allocation to US Equities down to 3%. I have immediate term TRADE resistance for the SP500 at 1064. Intermediate term TREND support is now inching closer to the future that the perceived wisdom of The Obstinate One is signing off on – that line is 1027 – watch it, real-time.
Best of luck out there today,


EWZ – iShares Brazil President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt –leading to an investment grade credit rating. Brazil has managed its interest rate to promote stimulus. Brazil is a major producer of commodities. We believe the country’s profile matches up well with our reflation call.

EWT – iShares Taiwan
With the introduction of “Panda Diplomacy” Taiwan has found itself growing closer to mainland China. Although the politics remain awkward, the business opportunities are massive and the private sector, now almost fully emerged from state dominance, has rushed to both service “the client” and to make capital investments there.  With an export industry base heavily weighted towards technology and communications equipment, Taiwanese companies are in the right place at the right time to catch the wave of increased consumer spending spurred by Beijing’s massive stimulus package.

XLU – SPDR Utilities We bought low beta Utilities on discount on 10/20. TRADE and TREND bearish.

EWG – iShares Germany Chancellor Angela Merkel won reelection with her pro-business coalition partners the Free Democrats. We expect to see continued leadership from her team with a focus on economic growth, including tax cuts. We believe that Germany’s powerful manufacturing capacity remains a primary structural advantage; with fundamentals improving in a low CPI/interest rate environment, we expect slow but steady economic improvement from Europe’s largest economy.

GLD – SPDR Gold We bought back our long standing bullish position on gold on a down day on 9/14 with the threat of US centric stagflation heightening.   

CYB – WisdomTree Dreyfus Chinese Yuan
The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP – iShares TIPS The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

XLI – SPDR Industrials
Industrials shot up +1.1% on 11/3 because of a monster Berkshire bid. That’s now in the price of XLI. We’ll short expectations for V-shaped recovery. TRADE bearish, TREND bullish.

EWU – iShares UK Despite areas of improvement, broader fundamentals remain shaky in the UK: government debt continues to expand, leadership in critical positions lacks, and the country’s leverage to the banking sector remains glaringly negative.  Q3 saw its GDP contract by -0.4%. The announcement of further bank stimulus and talk of the BOE increasing its bond purchasing program suggest that this will not end well.

XLY – SPDR Consumer Discretionary We shorted Howard Penney’s view on Consumer Discretionary stocks on 10/30. The sector is broken from an immediate term TRADE perspective.

EWJ – iShares Japan While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

UUP – PowerShares US Dollar We re-shorted the US Dollar on strength on 10/20. There continues to be no government plan to support it.

FXB – CurrencyShares British Pound Sterling The Pound is the only major currency that looks remotely as precarious as the US Dollar. We shorted the Pound into strength on 10/16.

SHY – iShares 1-3 Year Treasury Bonds
 If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.


Do I smell a converts deal and/or equity deal?


Yesterday, MGM announced that it entered into the 7th amendment to its credit agreement.  We wouldn't be surprised if MGM were to issue converts and/or equity on the back of a strong quarter and bullish conference call.


This most recent amendment allows MGM to issue new debt as long as that debt doesn't have seniority over the bank debt or debt that is being refinanced with the issuance proceeds and extends MGM's maturities.  It also allows for an equities issuance that doesn't result in a change in control.  The only give back from MGM is to permanently reduce the bank debt commitment upon any issuances that aren't going towards reducing existing maturing bonds. Below is a summary of Amendment #7.

  • Allow MGM to incur an additional $1BN of debt, provided that the debt is unsecured and covenants are no more restrictive than those contained in MGM's current "Qualified Unsecured Debt"
  • Other than the first $250MM, 50% of the proceeds from any issuance are required to pay down "Qualified Unsecured Debt", specifically proceeds will go towards permanently reducing MGM's term loan and revolving credit facility on a pro-rata basis
  • MGM may also issue "Refinancing Indebtedness" so long as the Refinancing Indebtedness:
    • Has a maturity that dates six months post the maturity of the Credit Agreement and is longer dated than the debt it is meant to take out
    • Is not senior to the Refinanced Indebtedness
    • Amount is not more than 125% of the Refinanced Indebtedness
    • Covenants are no more restrictive than those contained in the company's existing senior secured indentures
  • Company may issue additional equity so long as such issuance does not result in a change of control
    • Other than the first $500MM, MGM must apply 50% of the net proceeds from any issuance towards the permanent reduction of MGM's term loan and revolving credit facility on a pro-rata basis

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WRC: Getting By

In-line Q for a company that ‘everyone knows will beat’ is never good – especially when the driver was outsized SG&A reduction. We’re negatively predisposed here, but there’s no catalyst on the downside near-term. We’ll be patient.


Judging by the massive run up in Warnaco’s shares into the close on Tuesday afternoon, one might have thought this was about to be a blowout to the upside.  After all, it wouldn’t e the first time for WRC –which artfully manages expectations.  Yes, Warnaco managed to print an inline quarter, but it did so with a massive 17% y/y decline in SG&A.   As a result, in an environment where expectations are high, inventories are tight, and even the junkiest of companies are beating – this is hardly an impressive result from WRC. 


So what’s next? After going through our model and recognizing management’s guidance of $2.70-$2.80 for the year, we are shaking out at $2.77.  If there’s upside it’s likely to be driven by a massive swing in F/X, which goes from being a 4% drag in revenues in 3Q to a 6.1% benefit in 4Q.  Overall, we remain negatively biased on this one as it is our belief that that the company has been starving itself of investment spend (in the brands) while predominantly focusing on its higher margin, non-US retail expansion (CK stores are still carrying 20% four wall margins).  We can’t argue that this strategy should and will continue to work in the near-term as the company maintains a 20+% square footage growth rate for CK retail expansion (even though backing into new store productivity gets us to abysmal incremental profit metrics).  Over the longer the run, we worry about what will happen when the rate of growth slows and mix-driven margin expansion reverses.  Admittedly, being short WRC as F/X turns into a substantial tailwind, inventories are cleaner than they have been in a year, and same-store sales are showing signs of acceleration, doesn’t make a ton of sense to us.   We’re still skeptical, but realize the factors line up for what is a classic case of “getting by”.


3Q Results

Overall topline came in slightly below our forecast, driven by weaker than expected intimate apparel revenues.  Offsetting this was weakness was a slightly improved retail segment comp, which increased by 2% in the quarter.  Same store sales now appear to have bottomed, after a substantial deceleration over the past year.  In fact, management pointed out that comps for October were up 10%, reflecting a major rebound across both Europe and Asia.  For those of us primarily focused on domestic trends, the interesting takeaway here is that both “weather” and easy comparisons were key drivers of recent strength no matter what region across the globe.


WRC: Getting By - 11 4 2009 9 16 22 PM


For the first time since 2Q08, Warnaco’s sales/inventory spread turned positive, with revenues down 5% and inventories tightly managed, down 11%.  Despite this favorable dynamic, gross margins were still down 260 bps year over year (clearance wasn’t a major theme on the call but it may have played some part here).  The negative impact of foreign exchange, promotional activity and a slight mix shift to lower margin products were to blame.  Offsetting the margin decline was a massive 550bps reduction in SG&A as a percentage of sales.  The decline in expenses of 17% y/y was the largest quarterly decrease we’ve seen since the company announced its plans to eliminate $70 million in annual costs in 2009.  Aside from cost savings initiatives, F/X was a substantial y/y benefit, as last year’s 3Q included $15mm of F/X related expense that reversed this year.  All told, the quarter was inline at $0.75 per share.



WRC: Getting By - 11 4 2009 9 16 57 PM


Eric Levine

Director, Retail Vertical

FL/FINL/HIBB: Timing is Everything

The trend in higher priced sneakers remains abysmal. 4Q is gonna be tough. But the setup into 2010 is something else entirely.



When sifting through sales results tomorrow, you should keep an eye on any anecdotes around athletic footwear – and specifically, why consumers are avoiding the category on the margin in the midst of an otherwise solid overall retail comp trajectory. Is it because of the strong boot cycle (ie dollars shift to dept stores)? Nah… Not much overlap as it relates to customer/purchase intent. My sense is that it remains the downshift we’re seeing. I’m not referring to a simple shift to lower price point product within like-for-like retailers, but rather the complete downshift into different channels – most notably the Family Channel (one of the reasons why we’ve liked PSS so much).


Maybe Mickey Newsome said it best on Hibbett’s Q2 09 Call: “Our most difficult business was footwear, off mid to high teens with all genders off. I really don’t remember [a quarter] being down this low.  We have gone through some down cycles in footwear but not to the extent that this one is.”


Allow me to inject my opinion… This is a space that is almost entirely product-driven. If the consumer is trading down, it is because there is no reason for them to pay up for something pricey. There are some unique products in the market right now – like Nike’s Lunar Glide. But aside from that, there’s not a whole lot. Something to consider is that come Spring/Summer I think Nike’s pipeline will open up (i.e. things that will be ordered over the next few months and show up at retail six months later), and this is the same time that UA’s new footwear org under new leadership will start humming. 


While that’s good for the whole industry, the particularly levered play is FL, FINL, and to a lesser extent HIBB.  Timing is key, as we still have an ugly quarter ahead. We particularly like FL, as all of this will coincide with the start of Hicks’ (new CEO) plan to turn around this perennial dog.


FL/FINL/HIBB: Timing is Everything - 11 4 2009 8 37 59 PM


FL/FINL/HIBB: Timing is Everything - 11 4 2009 8 38 40 PM

SBUX – Continues to make progress

Starbucks is scheduled to report fiscal fourth quarter earnings after the close tomorrow.  The reported comparable sales number, primarily in the U.S., and any initial fiscal 2010 comp guidance will matter most relative to investor sentiment.


My $0.22 per share estimate is a penny higher than the street and is above the company’s $0.19-$0.20 per share guided range. 


Continued momentum from 3Q09:


Like last quarter, I am expecting continued sequential improvement in SBUX’s comparable sales growth.  My estimates assume a 3% decline in same-store sales growth in the U.S. (from -5% in 3Q09) and a -1% number in the company’s International segment (from -2%).  These assumptions imply that 2-year average growth remains even with last quarter, which could be conservative given the level of momentum in sales growth throughout the third quarter.


I would expect this sequentially better -3% results in the U.S. to be driven largely by continued improvement in traffic trends as check will continue to be pressured somewhat by the company’s recent focus on value offerings, such as its beverage and food pairings and discounts offered through its Starbucks loyalty card programs.


Margins should continue to look better on a YOY basis; though U.S. margins will most likely decline somewhat on a sequential basis from 3Q09’s reported 13.4% number.  This should not come as a surprise, however, as management set expectations lower for the fourth quarter, citing “normal seasonal variances in [its] U.S. business.”  Margin improvement will be driven largely by continued commodity cost favorability in the U.S. and the additional $180 million of costs savings that are expected to be implemented in the quarter. 


Looking at dairy costs, there has been some concerns out there over the recent increase in milk prices, which will no doubt have an impact on the business on a go forward basis, but milk prices on average were down 45% YOY during SBUX’s fiscal Q4 (even more than the average 41% decline during its fiscal 3Q09).  In October and November, some of this YOY favorability has diminished with prices down only about 20%.  But, this is more of a concern for the company come Q1. 


Starbucks recently addressed this concern in a press release after the Wall Street Journal published an article titled “Pricier Milk Could Curdle Profit Growth at Starbucks”, stating, “The Wall Street Journal article of October 11 omits an important aspect of Starbucks dairy cost management.  Approximately six month ago, Starbucks initiated a program to mitigate the price uncertainty of a portion of Starbucks future purchases of dairy products.”  I find it surprising that Starbucks even responded to this article, but I think it further highlights the fact that the company does not think the rising dairy prices pose a significant, immediate risk to earnings.  Management had stated on its 3Q earnings call that it expected dairy prices to be neutral to somewhat unfavorable to earnings on a YOY basis in fiscal 2010.  I am interested to learn more about this dairy cost management program because I don’t recall the company ever hedging its milk exposure in the past. 


Cost savings will play a major role in the quarter as the expected $180 million represents the peak in initiated savings year-to-date ($75M in Q1, $120M in Q2 and $175M in Q3).  That being said, the fourth quarter is also the last quarter before the company begins to lap these initiatives on a YOY basis.


Negative currency translation attributed to the 11% decline in International revenues in the third quarter as a result of the stronger U.S. dollar compared to the British Pound and the Canadian dollar.  In the fourth quarter, this trend continued but to a much lesser degree on a YOY basis.  Based on current exchange rates, this currency impact will likely turn positive in Q1.


Management already provided some fiscal 2010 guidance when it reported 3Q09 results.  Specifically, SBUX said it expects 13%-18% EPS growth (including the 53rd week), assuming 150-200 bps of margin improvement in the U.S. and 200-250 bps of margin growth from its international segment.  The company did not provide any comp guidance or unit growth targets, except to say that it expects to grow store counts year-over-year, driven primarily by international growth and some growth in the U.S.


I think any number better than -1% for U.S. comparable sales guidance would be both positive and reasonable.


Though not relevant to Q4 results, I would like to hear what management has to say about:


1.  the recently launched VIA product.  For reference, Starbucks put out a press release on October 12 stating that after only 2 weeks of national availability of Starbucks VIA, early indicators showed that the product was exceeding expectations. 


2.  how much it is planning to spend behind the brand (management already said it intends to spend significantly higher marketing dollars than any typical quarter to support the launch in Q1). 


3.  its recently announced plan to combine its two Starbucks Card programs in an effort to increase customer frequency.


4.  future plans for free cash flow usage.  As I have said before, I would like to see the company use its increased level of free cash flow in 2010 to establish a dividend.  I would also expect the company to begin to buy back stock again in 2010.



SBUX – Continues to make progress - sbux4q09

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