Editor's Note: Below is a chart and brief excerpt from today's Early Look written by Hedgeye U.S. Macro Analyst Christian Drake. Click here for more information on how to subscribe.
Retail growth expectations are overly bullish. The Chart of the Day says it all…it shows the consensus EPS growth rate for a basket of bellwether names in the retail sector. After bottoming in FY15 (WMT FY16) consensus has numbers accelerating to 10% and 12% in FY16 and FY17 respectively. Compare that to WMT guiding to -10% in its FY16 (calendar ‘15), -9% at the midpoint of the guide in FY17 (calendar ’16), and flat in FY 18 (calendar ’17). Bottom line…either WMT sandbagged, or growth for others will come down. Such a significant gap has not sustained itself for any more than a few quarters.
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"Being unemployed has really helped to lower my carbon footprint."
- Comedic tree-hugging enthusiast
I couldn’t remember the meaning of the word ‘spendthrift’ until I was probably 21 yrs. old. It’s one of those anti-onomatopoeia words that means the exact opposite of what it sounds like.
How about its venerable cousin of the same ilk, #gainsay … any convicted guesses on that bad boy?
And since it’s Friday, let’s up the investment irrelevancy another notch:
Write this word down, show it to the person next to you and tell them to pronounce it: Quinoa
(for reference, it’s: keen-wah)
If it’s the 1st time they’ve seen it = 99.9% chance they get it wrong.
Co-worker bike to the office this morning wearing a hemp jumpsuit and leaving early for an Earth Day planning committee meeting? …. No worries, still 50/50 chance they get it wrong.
Take some of those TLT gains and see if anyone is willing to take the other side of a virgin Quinoa pronunciation bet.
Drinks on you tonight!
Back to the Global Macro Grind ….
If it’s the 1st time your favorite policy maker has seen a global balance sheet recession characterized by global overleverage, oversupply and negative global consumption demographic trends = 99% chance they don’t get the sustainable real growth Rx correct.
Granted, and as our visual macro distillation jedi Bob Rich illustrates above, when the available tool set is limited, sometimes it doesn’t matter what the question is. If all you have is a hammer, everything looks like a nail and all that ….
Fed policy doctrine says that the outside lag on policy is something on the order of 6-18 months. In other words, because a variable lag exists between the time policy is implemented and the time its impact flows through the real economy, the Fed’s forecast for growth and inflation 2-6 quarters out should dictate policy action today.
Here there are two (major) problems:
1. Data Dependence: For a self-described Data Dependent Fed, this represents a fundamental conflict. Policy action can’t be simultaneously dependent on reported data (which, itself, is 1-3 months old) and also on a variant forward projection of how the data will have evolved 0.5-1.5 years from now.
2. Serial Over-optimism: Forecast risk has been real and serially biased towards overestimation alongside a persistent expectation for a return to “trend-line” growth. On average, Fed forecasts have overestimated growth by ~100bps every year over the last half-decade. With GDP averaging just 2% over the same period, that magnitude of over-optimism is not insignificant.
Now, with the Fed again grazing blissfully in the panglossian forecasting fields in 2015, the domestic data train continues to onboard negative second derivative trends.
As review, from a rate-of-change perspective, we are past peak across the following:
· Payroll Growth: Peaked in Feb at +2.34% YoY. While past peak employment growth doesn’t herald an imminent recession, it does consistently typify an expansion in its twilight.
· Consumption Growth: Household Spending growth peaked in 1Q15. Consumption Comps get more difficult from here and, while reported growth will again be “good” on an absolute basis in 3Q, the slope of the line will be negative. With credit growth still muted, consumption growth is all about income trends and the accelerating growth in aggregate personal and salary and wage income over the last two years has supported an improving capacity for household spending. With lower growth in aggregate hours and flat earnings growth (remember: aggregate income is simply a function of # of people working * hours worked per week * earnings per hour) in August and September, income growth is flirting with a negative inflection as well.
· Confidence: Consumer Confidence (University of Michigan) peaked in 1H15. Unsurprisingly, confidence and real per capita income move concurrently. If income trends flag, a recovery to new highs in confidence becomes increasingly improbable.
· Profitability: Corporate profitability across both the S&P500 and the national aggregate has crested and moved past peak.
Indeed, as the market cap collapse in WMT signaled earlier this week, the profitability cratering observed across the energy and industrial complex is conspicuously creeping its way into the retail space.
Our Retail Sector Head, Brian McGough, aptly contextualized the Walmart release and the broader readthrough to retail in an institutional note on Wednesday. Since I remain perma-bearish on wheel re-creation, here’s an unedited reprint of the highlights:
1) WMT set the bar so low with its guidance today that we have to wonder how the rest of retail is not quaking in its boots. The mid-point of the guide implies that earnings will be off 10% this year and another 6-12% in FY 17 AND we won’t see 2015 earnings levels again until at least FY19. If anyone is questioning what end of the economic cycle we’re in, it’s not the end you give a kiss at bedtime. While a struggling WMT is a terrible barometer for all of retail, it’s even more troubling when you consider what WMT is investing in. Wages and Price. That will be a significant headwind on the gross margin and cost side. Any peers (ranging from TGT to CVS to COST to KSS to Albertson’s [winner of “most poorly timed IPO of the decade”]) who think they can sidestep this reality are delusional.
2) Wages – by the end of FY17 WMT will have invested $2.7bn or $5,400 per each of its 500,000 eligible US employees. It will account for -4.5% to -9% of EPS change in FY17 or 75% of the aggregate earnings decrease. That type of deleverage for a company like WMT who in the US employs 1.4mm workers and accounts for 16.5% of workers in the Food & Beverage, Health/Personal Care, Clothing, and General Merch categories that’s a game changer. Anyone who has not proactively managed their expense line will have a tough time. It’s a good thing for KSS that it does not have to pay higher wages because it’s employees love to come to work (that statement will come back to haunt CEO Mansell).
3) Retail growth expectations are overly bullish. The Chart of the Day below says it all…it shows the consensus EPS growth rate for a basket of bellwether names in the retail sector. After bottoming in FY15 (WMT FY16) consensus has numbers accelerating to 10% and 12% in FY16 and FY17 respectively. Compare that to WMT guiding to -10% in its FY16 (calendar ‘15), -9% at the midpoint of the guide in FY17 (calendar ’16), and flat in FY 18 (calendar ’17). Bottom line…either WMT sandbagged, or growth for others will come down. Such a significant gap has not sustained itself for any more than a few quarters.
Dost thou gainsay the acceleration in retail spendthriftery?
Reality, Rates & Rhetorical Questions: How many times has the Fed raised rates into a slowdown and with headline inflation at +0.0%? … what’s that quinoa pronunciation success rate, again?
Could inflation percolate as we lap the energy collapse comps and a weaker dollar drive price inflation in things priced in dollars?
Sure, but the internals driving that reflation are delusory (remember why the dollar is weaker). It’s akin to a drop in the labor force driving the unemployment rate lower. The positive headline is simply an antithetical symptom of the underlying reality.
Keith has been harping on this point but it bears harping as it’s about as unambiguous a Macro market signal as it gets: Down Dollar + Down Rates ≠ Growth Accelerating.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.96-2.06%
Prepare. Perform. Prevail.
Christian B. Drake
U.S. Macro Analyst
Yesterday we spoke with James Robb a Director at the Livestock Marketing Information Center (LMIC) regarding the looming crash in beef prices. Below please find the materials and associated audio from our conversation:
AUDIO: CLICK HERE
MATERIALS: CLICK HERE
A 50% decline in beef prices back to historical averages is well within the realm of possibilities. Below is a 30 year look at Feeder Cattle CME $/lb., current levels are greater than two standard deviations above the average. The information that James Robb provided supports the potential decline down to historical levels.
Corn, a core component of feed has been volatile, and is projected to stay that way when looking short-term. When looking longer term prices have leveled off and are projected by LMIC to remain stagnant to slightly down.
Heifers can either go to feed lots to be slaughtered or to breeding herds for beef cow replacement. In the chart below you see that heifers being held for beef cow replacement ticked up +6.5% in 2015. In simple terms that means for the time being the herd is growing and less cows are being slaughtered.
The decrease in slaughtered cattle is because you simple don’t need as many cows, because they weigh more than ever.
Cattle cycles typically run anywhere from seven to ten years. We are at about the two year mark and LMIC predicts that we are still 2-3 years away from the peak. This means declining prices for longer, providing a tailwind for restaurant companies until 2018. Cattle inventory is projected to rise sharply as shown by the brown line in the chart below.
What event(s) could lead to significantly lower prices?
- Macroeconomic factors, if the U.S. economy goes into a recession in 2017, prices will fall.
- Mother nature, if we get another drought in the southern plains, we will have a herd liquidation that will have a short term impact on supply.
Will the lower for longer corn market lead to lower beef prices?
- Yes, cost of production eventually works through the system after a certain period of lag. If corn stays stable or trends lower that will be supportive of continued herd growth and lower prices.
Lower beef price will benefit many companies across the consumer staples space. We highlighted TSN, HRL and CAG as major beneficiaries, but many more companies will benefit on a smaller scale.
Please call or e-mail with any questions.
Takeaway: WYNN’s Q3 EBITDA was in line with our estimate, that is to say, below the Street. But Wynn’s commentary was decidedly negative.
CALL TO ACTION
The Q3 earnings call was decidedly negative, even to the point where Steve Wynn called out the Macau government for the first time, at least in our collective memories. The likelihood of continued, rapid deterioration in the junket business is increasing and Wynn did nothing to dispel that notion. We see the investor focus continuing to shift back to Mass and for that reason we continue to prefer LVS as the top pick in our long Macau trade call. Please see our presentation from last week:
Wynn’s Q3 was weaker than expected at the property level but in line with our corporate EBITDA estimate, due to lower corporate expenses. However, as outlined last week in our presentation, we were 7% below the Street. Wynn management provided no comfort regarding a turnaround in Macau fundamentals although Mass commentary was relatively positive. Indeed, Mass revenues at Wynn Macau exceeded our estimate and gives us comfort that investors will increasingly focus on that segment which finally faces easy comps in October. Look for near term LVS outperformance fundamentally and from a sentiment perspective.
Q3: LIKES AND DISLIKES
As can be seen by the table below, WYNN managed to eke out a slight beat, driven by the 2nd consecutive quarter of corporate expense reduction. However, at the property level, Wynn was a disappointment all around, even relative to our below the Street projections.
WHAT WE LIKED:
- Mass performance in Macau – Sure it was down 28% YoY but it was up sharply QoQ and both volumes and revenue exceeded our estimate. Mass may or not have stabilized, but with the first easy Mass comp in October for the market, stabilization will likely be the narrative for investors and that should be good for the stocks over the near term, particularly LVS.
- Corporate expense reductions – For the 2nd straight quarter, WYNN vastly improved (reduced) its corporate cost structure, pushing corporate expenses down 40% YoY. The company is tightening the belts where it can, because it can’t do much at the property level in Macau. WYNN has always been kind to the executive suite but we think investor pressure is having an impact.
- Core table drop in Las Vegas – I know, the high end is struggling on the Strip. But that is well known and Wynn Las Vegas actually beat our estimate despite a 50% YoY decline in their high end gaming volumes in Q3. Base Mass in Vegas actually looked good
WHAT WE DIDN’T LIKE:
- Steve Wynn’s tone toward the Macau government – Sure he’s spot on. The government’s obsession with table caps makes little sense. Worse, the “late in the game” table allocations makes it impossible to design the casino floor and do any sort of labor planning. However, we wonder whether these discussions are better had outside the public forum? Until now, Steve Wynn has been the model citizen, always speaking highly of the Macanese and Chinese governments.
- Non-gaming across the properties – Despite the sell side cheerleading, non-gaming didn’t look that great in Las Vegas nor Macau, at least not to us. Every non-gaming category at each property fell short of our estimate. We realize that non-gaming is outperforming gaming but that’s not much of a reference point. In fact, F&B in Las Vegas was the only segment posting a material YoY gain. Macau was a disaster.
- Property level margins – Property revenues were actually higher than we projected in both LV and Macau, driven by more casino activity than our dire prediction. However, margins missed at both, despite better Mass revenues.
- Promotional activity – Higher than expected at both properties and much higher as a % of revenues. It’s a competitive environment in both markets and that’s hurting margins.
- Management very negative on the junkets – Steve Wynn’s comments on the junkets are probably what’s spooking investors. Mr. Wynn intimated that more junkets may go out of business and that Wynn will be pulling some credit from the junkets. The junket business is still deteriorating and WYNN maintains a lot of exposure still.
- Slots in Las Vegas – The slot segment is very high margin and a good proxy for the overall health of the Strip. Slot handle was worse than expected and without that segment performing well, it’s difficult to corroborate the U shaped Las Vegas recovery thesis
Yet another weak quarter at the property level, but it’s Steve Wynn’s comments that may be the problem for the stock today. WYNN has had a nice recovery off the bottom but LVS looks like the better long play over the near term. Investor focus should shift to the Mass segment which is obviously performing much better. Importantly, Mass faces the first negative comp here in October and while we’ll hold off on proclaiming that the segment has stabilized, mass stabilization should be the investor narrative and that will be good for LVS’s stock. Buy LVS on weakenss.
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