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“I’ve had a perfectly wonderful evening. But this wasn’t it.”

-Groucho Marx


I’ve never had a headache.  Not one. 


It’s probably some recessive trait resulting in reduced gene expression and enzymatic/receptor activity along the CNS pain conduction pathway.  Or, perhaps I’ll prove to be an X-Man progenitor …. that seems cooler.


Headaches - z ty


The #MacroFates, however, have endowed Global Central Bankers with less luck as the growth and inflation headache remains both persistent and acute. Japan’s economic maladies continue to get chronic-er, China begrudgingly upgraded to prescription strength, EM & Commodity markets remain in strong-dollar hospice, and Europe is trying to change the locks while Draghi is away on holiday. 


Back to the Global Macro Grind...


Welcome to (what are supposed to be) the dog days of domestic macro.  Mid-August, Post-Jobs Friday hangover, a relative scarcity of macro data releases and a soft FOMC speech calendar – perhaps the slowest, non-holiday week of the year.      


Despite the dearth in high frequency domestic data, there’s always some macro hay to bale.  Here’s a quad-fecta of choice highlights: 


China Syndrome:  With China devaluing and choosing to support export growth at the risk of capital flight and IMF indignation, they were, in effect, explicitly acknowledging the growth problem.  Canada, New Zealand and Australia – the canonical “commodity currencies”  – got tagged on the news and capital flowed into treasuries, taking 10Y yields down -9 bps to 2.14% with the yield curve flattening toward 52-wk lows. 


The growth data (china housing starts down -21% YoY, Industrial production down to +6.0% YoY from +6.8% prior) and allocation rotation is seeing follow through this morning with the German 2Y trading back down to -0.29% (2015 lows)  and the U.S. 10Y down another -8 bps and flirting with a 3-month low at 2.05%. 


We’ve been strumming the slower (growth) and lower (rates) for longer tune for a while now and view these high-entropy events as crescendo’s in the larger, secular Macro symphony.   


Who Likes lower rates – mostly stemming from OUS turmoil? 


Homebuilders for one.  Global tumult is insidious, but usually manifests on a lag domestically so, in the nearer term, ↓rates =  ↑ affordability = ↑ room for prices to rise = ↑ housing.  Housing was actually green on the day yesterday along with Utes, Reits, bonds and all things low-beta, defensive yield.   


Sticking with housing, the Starts and Permits data set for release next Tuesday may prove interesting. 


Housing Starts:   The +295% YoY growth in MF permits in the Northeast ahead of the impending NYC tax exemption expiry helped augment the Total Starts figures for a second month in June and drove MF share of total up to a 42-year high.  Indeed, after rising a resounding +385% YoY in May, permits in NY state went vertical to +632% YoY in June.   A reversal of that pull forward sets the stage for a potential retreat in the reported July data.  For context, a decline back to the TTM average in permits in the Northeast implies a -12-13% sequential decline, taking the total back below 1.2 MM from the post-crisis high of 1.34 MM recorded last month.     


2Q Earnings Scorecard:    With ~91% of SPX constituent companies having reported earnings for 2Q, the results have been less than inspiring – particularly for a private sector economy purportedly  in position for an escape-velocity handoff from the Fed.   

  • Sales/EPS:  In the aggregate, Sales growth is running -4.3% while Earnings growth is tracking at -2.73%.  Granted, the weakness is centered on energy and the industrials complex but those sectors represent large swaths of economic activity and they don’t operate in a vacuum – and commodity price deflation remains a real and ticking risk and the hedge protection that supported 2014/2015 is a lot thinner in the coming year.
  • Beat/Miss:  Just 48% of companies have beaten topline estimates while 74% (in-line with recent qtr averages) have beaten on EPS.  Of course, as has been the case for the last 5 years, the progressive deflation of expectations ahead of the quarter remains the best means to manufacturing a “beat”.  This quarter has not been an exception as consensus estimates for 2Q15 have drifted steadily lower for SPX constituents into and through 1H15.    
  • Operating Performance:  As can be seen in the Chart of the Day below, lackluster beat-miss trends have not been buttressed by positive operating performance which has, once again, been underwhelming with just 38% and 43% of companies registering sequential acceleration in sales and earnings growth, respectively. 


U.S. Budget:  The Treasury will release the July Budget data this afternoon.  The CBO, however, releases a monthly budget review ahead of the official treasury release which is typically dead nuts.  The CBO estimates the budget deficit for July at $149B, putting the fiscal YTD total (10-months) at $463B.

With revenue’s growing at a 3% premium to outlays this year, and after adjusting for payment timing issues, this represents a -$41B decline relative to the same 10-month period last year and the lowest total in the post-crisis period.  The deficit-to-GDP ratio has improved to just 2.4% (from peak of 10.3% in 2010) alongside those favorable fiscal flows and in spite of uneven and middling growth. 


An improved and improving fiscal balance is $USD supportive although that remains a 2nd order consideration as monetary policy continues to control the speculative FX flow.  Relatedly, given the pervasive dollar strength and expectation for a divergent policy path for the U.S., it’s interesting to note that $USD performance in the peri-liftoff period across the last five cycles has been fairly distinct.   The market tends to discount the policy action with the currency  strengthening ahead of the move and subsequently weakening once rate hikes actually commence.  Whether the extraordinary conditions currently prevailing globally represent a unique dynamic will be an interesting one to risk manage. 


One for the road:   If you missed it, last week the SEC approved a rule requiring public companies to disclose the pay ratio of the CEO to that of the company’s median worker.   The disclosure is unlikely to affect material change, but the baby-stepping towards transparency is positive on the margin and, at the least, will provide headlines and fodder for the inequality debate.  


Yesterday (& today) proved to be a massive headache for global policy makers, EM and commodity markets and “reflation” portfolio’s.  The timing of high-entropy macro events can be surprising, but their manifestation is not.  If you’ve been following the Macro Playbook of the last month with growth/inflation slowing (TLT) and defensive yield (bond proxies, XLU) anchoring your starting line-up,  you’ve had a perfectly wonderful evening.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.11-2.24%

SPX 2064-2098 

VIX 11.88-15.18
USD 96.35-98.46
Oil (WTI) 41.82-46.09

Gold 1079-1121


Christian B. Drake

U.S. Macro Analyst


Headaches - z CoD 2


Takeaway: Down across the board. SJM Palace on track for 2017 opening.


  • GGR down 40.3% YoY in 1H of 2015
  • EBITDA down 49.1% YoY 
  • Profit down 54.1% YoY
  • EBITDA margin down 8.5% YoY 
  • cost of labor increasing
  • Mass GGR down 26.8% YoY
  • VIP down 48.7% YoY
  • Slots down 12.3% YoY
  • Share of Macau GGR stood at 22.3% YoY 
    • 25.5% of Mass Mkt share 
    • 21.2% of VIP
  • Grand Lisboa 
    • GGR down 43.5% YoY 
    • EBITDA down 49.6% YoY
    • Profit down 53.3% YoY
    • OCC down 15.2% YoY
    • ADR up 2.3% YoY
  • Dividend of HK10 cents p/s was declared 
  • Challenging conditions in the market place and regulation to blame for the slow down in GGR. Tough to pin point where the bottom is. 
  • They remain optimistic on the Chinese economy, which will continue to drive GGR in the future. 
  • Junket closure and downsizing common theme, and could continue. 
  • OCC down due to VIP business decline 
  • New system has been deployed to sell rooms which has driven OCC in July. focus shift to mass and premium mass player has aided the uptick in OCC. 
  • Confidence remains very strong. Lisboa Palace is well underway. Foundation work is nearly fully complete. 
  • Cost control initiatives have already started. 
  • CapEX HK5.9billion in 2015, due to the opening of Palace. 
  • Major focus to still return capital to shareholders despite the challenging market.
  • Always looking to shift tables, feel that they have some opportunity to shift around more tables in 2H. 
  • Adding 11-14 tables for mass segment in Q4. 

Q & a 


Quantify the cost savings going forward?

  • Annualized savings are roughly HK50 million. Mostly due to labor attrition and decrease in headcount.

OCC up in July? To what levels? 

  • Targeting close to the high 80's low 90's 
  • Infrastructure is in place to accommodate the mass customers

CapEx tied to construction of SJM Palace? Plan with Adjacent properties?

  • Not a focus right now. Simply focused on finishing the SJM Palace.

Hold adjusted EBITDA for the Q?

  • No, do not have it calculated. 

Cost cutting measures? Potential in the future for more cost cutting vs. the competitors that are opening sooner than you? 

  • SJM pure gaming company, do not have a lot of non gaming initiatives that they can cut. 
  • Not replacing some of the labor they lost to attrition has been the opportunity to reduce costs. Might see more potential for this in the future, but it is not a focus.

Are you more socially responsible than your competition?

  • Yes, they feel as though need to remain a paternalistic employer. Many 2nd generation employees and even 3rd generation employees. 

Premium mass and base mass are outperforming competition through the summer


CapEx to peak in 2H and into 2017, what does that do to the dividend?

  • Dividend policy still stands, regardless of additional CapEx. 

Transit visa loosening, a tailwind?

  • Yes, starting to see stronger trends in July and August, especially on the mass and premium mass segment. 

August 12, 2015

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KSS | Comfortable with Short Into Results

Takeaway: Headline may be benign, but a lot in this print should support our Short. We maintain our view that annual EPS likely to never grow again.

Conclusion. KSS remains our top short. Do we think that the wheels will completely fall off the story with this Thursday’s print? No. But we don’t think we’ll see any notable upside, and we expect to see key metrics erode in support of our bigger call on the name that annual earnings are likely to never grow again. To put that into context, we’ve got numbers between $3.50-$3.75 from 2016-18. That’s 40% below the consensus, which has earnings marching over $6.00. The stock may appear cheap to some at an 11% FCF Yield (the most common bull case we hear). But we’d argue two things…1) while numbers are coming down, department store yields have gone well above 20% (just ask Dillard’s), and 2) our model has a lot less margin and cash flow, and only a 6.5% FCF Yield at $3.75 in earnings. Lastly, unlike with Macy’s and Dillard’s, there is absolutely no real estate play with KSS. So when all is said and done, we’d be short KSS into this print, and if the company throws the bulls a bone – as it does from time to time – then we’d get heavier on it. This is as much of a ‘core short’ as we can find in this market.


Here’s a summary of the key things we’re looking for in this quarter…

  1. The only way we expect to see the recent positive trend in store traffic to continue is if KSS gives it all back in lower merchandise margins.
  2. The only comp we’re likely to see will come by way of e-commerce, which is GM% dilutive by 1,000bp.
  3. Combining those two factors, we can’t reconcile how the Street could be looking for a 20bp improvement in GM% y/y.
  4. We’re also looking for growth in credit income (25% of EBIT) to continue to slow due to cannibalization from its Y2Y Rewards program, which should lead to contraction in its biggest profit center by year-end (without having to make a call on the credit cycle).
  5. There’s no real guidance one way or another with KSS, so it will be interesting to see how management handles Revenue expectations for 2H. The consensus is looking for an implied underlying comp acceleration from -1% to +3% over just two more quarters. That’s BIG for a company like KSS.



Comps Get Tougher. The sales line should be the biggest ‘driver’ of this print on Thursday (with the caveat that earnings are really not growing). Expectations have come down considerably since 1Q where the buy side was looking for 4%+, and Consensus has walked numbers down from 2% (10bps lower then where it sat before the 1Q print) to 1.5% over the past month which helps explain the 5% sell off. The 1.5% seems achievable from where we sit, but assumes a positive 2yr comp -- something KSS has only printed once in the past 9 quarters (4Q14).


Then, comps get much tougher for the company with current consensus estimates assuming that the company accelerates sales sequentially on a 2yr run rate from the -0.9% number reported in the first quarter to 2.8% in the 4th quarter. We don’t believe that KSS’ current arsenal of sales drivers: personalization, loyalty, beauty, BOPIS is enough to reverse the 3yr trend of negative store comps.

KSS  |  Comfortable with Short Into Results - KSS sales trend


If KSS has anything going for it this quarter, it’s that e-comm comps were extremely easy in the months of May and June (at 15% vs 30% in July). But, the company lapped the same benefit in the first quarter where comps were 12.4% and failed to realize the benefit. Traffic rank numbers which take into account both unique visits and page visits per user ended the quarter up in the mid 40% range, a slight acceleration from what we saw in 1Q. But, what we think is more notable is a) the accelerated ramp of JCP which is a big deal considering our works suggests that KSS was the biggest beneficiary of the JCP market share hemorrhage, and b) the relative underperformance of M compared to the group.

 KSS  |  Comfortable with Short Into Results - KSS ecomm


Gross Margin

Management’s bull case for this year was predicated on improving merch margins due to tight inventory management. That was well and good when the company entered FY15 with a sales to inventory at a favorable 5% (the first positive spread in over 3 years), but the SIGMA trajectory inflected in a meaningful way to the downside headed out of 1Q against the easiest comp of the year. That almost never equates to a positive gross margin event. Management tried to downplay the margin headwind of 5% inventory growth by calling out the growth in National brands which carry a higher AUR (units per store were up 1% vs. last year), but that also comes with its own margin pressure.


On the DTC front, e-comm caused 42bps of dilution in the first quarter, and assuming a 20%+ growth rate in the DTC channel (which the company no longer discloses) that amounts to 30bps of headwind for the year assuming of course that there is no further deterioration in e-comm gross margins. That’s a big hit for a company like KSS to handle especially when you consider that the company started this new rewards programs which equates to 5% cash back, National Brand penetration growing (a conservative 4bps to 7bps of headwind for every 100bps of mix shift), and the current inventory position of the company.

 KSS  |  Comfortable with Short Into Results - KSS Sigma


SG&A Comps


It’s tough to reconcile the company’s guidance of 3-4% growth for the quarter after management guided to 4%-5% growth in 1Q and printed 1.6%. But what we do know is that…

  1. Credit was a 13mm (70% of the dollar decrease) benefit in 2nd quarter of last year, that’s slowed over the past two quarters to 1mm and 2mm, respectively. We think that continues to march lower as the Yes2You rewards program continues to curb credit portfolio growth.
  2. 2Q14 was just the 2nd time in the past eight years that the company leveraged SG&A expense on a negative sales number.
  3. Employment costs are headed nowhere but higher. KSS management seems to be in denial about the added pressure from two of largest players in the retail space raising wages to $9, but the way we are doing the math by extrapolating the guided WMT cost pressure to the relevant number of KSS employees we get to 60bps of margin pressure and a $0.35 (8% hit) to earnings. That hasn’t manifested itself yet, and probably won’t until the retail hiring season kicks up in 3Q for BTS.

KSS  |  Comfortable with Short Into Results - KSS SGA Leverage


No Change To Guidance

No matter what the company prints on Thursday, it’s pretty clear that the company won’t make any material changes to its FY guidance. The company updated its guidance policy last year, and noted that it would only update its Fiscal year numbers once in the 3rd quarter.



There hasn’t been a lot to like on the Management front at KSS over the past few months.


First, KSS ended its 14 month search for a new Chief Merchant when it decided to add responsibility to the plate of Michele Gass current Chief Customer Officer. With the entire global retail industry  as a talent pool to source this position, Mansell picked the person who said very explicitly at the Analyst Day in October that 'love' would drive the business -- not once, or twice, but 19 times. Also, being a Chief Customer Officer (something that has no P&L responsibility or accountability) has nothing to do with being a Chief Merchant. This one will be hard for the bulls to defend.


And more recently, the company’s CIO, Janet Schalk, ended her 4 year tenure as CIO and jumped ship to Hudson's Bay citing a ‘great deal of uncertainty’ over the management transition taking place within the company centered around the hiring of a new yet to be named COO.


As noted in our Snyder’s-Lance (LNCE) earnings note this morning, we will be hosting a live Black Book presentation on August 19th at 11:00am ET.



We view LNCE as a high quality, small cap name in the Consumer Staples space.  The company’s brands are well positioned in the snacking category to allow for sustainable volume growth and margin expansion for the next 3-5 years.  


Their direct-store-delivery distribution network (DSD network) is vital to success. It allows LNCE to have feet on the street, being stewards of the brand, working with store management and making sure product is always on shelf. Think about the power Coca-Cola harnesses by having their own distribution network, this is the same thing but for snacks.


M&A opportunities are abundant for this company as they look across the landscape. Management has stated that when thinking about returning cash to shareholders the first thought is on M&A, share buybacks and dividends come second. Angie’s, KIND Snacks, Justin’s and thinkThin jump to mind as possible acquisition targets.


A lot more to come as we dig deeper over the next week. Right now we are seeing 25%+ upside to the name driven by robust organic volume growth and market share gains.


We will be speaking with the company this week to dive a little deeper into some of our questions. To the extent you have something you want answered, please email us by either responding to this note or to our email addresses included below.



Toll Free:


Confirmation Number: 13616471

Materials: to be made available later



Howard Penney

Managing Director


Shayne Laidlaw



MCD: Adding McDonald's to Investing Ideas (Long Side)

Please note we are adding McDonald's (MCD) to Investing Ideas today.


Our restaurants team led by Sector Head Howard Penney will send a full stock report detailing our fundamental view later this week.


MCD: Adding McDonald's to Investing Ideas (Long Side) - Mcdonalds 90s logo.svg

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