Under 60 Seconds: MCD’s Earnings Report


Hedgeye highlights the three key points from McDonald's strong quarter courtesy of our veteran Hedgeye Restaurants analyst Howard Penney in under one minute.

Stock Report: Foot Locker (FL)

Takeaway: We added FL to Investing Ideas on the short side on 1/13.

Stock Report: Foot Locker (FL) - HE FL table 1 22 16


We are confident Foot Locker will prove to be one of the best multi-year shorts in retail. The bulls on Foot Locker are missing a huge negative fundamental turning point, while the bears are bearish for the wrong reasons. This is going to get far worse than anyone thinks. To be clear, this is not the typical ‘Internet is taking over, so short  legacy retailers!’ call and the catalyst has been in the works for a while now.


This change starts with Nike. Nearly a decade ago, Nike decided to shift incremental capital to build a Direct-To-Consumer (DTC) platform, and fund that with excess growth in the wholesale channel in the US. Now, with the building part largely done and the wholesale channel very full of Swooshes, the tides are turning. None of this bodes well for Foot Locker.


In other words, the old industry paradigm is breaking down. This change is great if you own content that consumers want — like Nike, UnderArmour and Adidas. But if you’re stuck between the all mighty Consumer and those Jordan 23s, Nike FlyKnit AirMax 180s, Yeezys or Curry 1s, then you (i.e. Foot Locker (FL), Finish Line (FINL), Hibbett Sports (HIBB) and most other traditional “brick & mortar” distributors) are in deep trouble. 




In the upcoming Fiscal Year 2016, FL will be working against 2 consecutive years of around 8% comparable sales growth with the economy weakening, and an SG&A rate at an all-time low of 19% (the lowest we’ve seen in a mall-based retailer). That’s how the company can comp 5%, and leverage that into a 30%+ EPS growth rate. But unfortunately, leverage works both ways.


We think that emerging competition from Foot Locker’s top vendor, Nike (=80% of sales), will stifle growth, and leave the company with an earnings annuity somewhere around $3.50-$3.75 per share. Is that worth $66? Not a chance. Not for a company that is Nike’s best off-balance sheet asset. And definitely not when the street is in the stratosphere approaching $6.00 in EPS (#NoWay). The company is likely to earn about $4.20 this year, which we think will prove to be the high water mark in this economic cycle. 




It’s no secret that Nike announced last year it would grow e-commerce to $7bn by 2020, which is a huge jump from its current $1.4bn (only 4% of sales). We think Nike is sandbagging, by the way, and that it will build its e-commerce operation to about $11bn – adding $10bn in e-comm sales in the next 4-years. Now, let’s say 60% of that is in North America…we’re talking $6bn in incremental revenue to Nike. To put this into context, the entire Athletic Footwear industry is likely to add about $6bn in retail over that time period alone.


Our estimates for Foot Locker three years out are 30% below the street, as we think it’s at peak earnings today. Importantly, this is not the kind of story that will play out with a simple press release.


This is a 40-year paradigm that is unwinding over a 5-year period. We think that three out of four earnings announcements will be negative – over and over again – at least based on current expectations. Along the way, we should see significant multiple compression, and margin erosion that will cut cash flow and torpedo that argument that we hear over and over about ‘FL throwing off so much cash.” It does until it doesn’t.


Stock Report: Foot Locker (FL) - HE FL chart 1 22 16

5 Hilarious Central Planning Cartoons

Takeaway: Sad and funny at the same time.

We love central planners here at Hedgeye... if only because they provide such amazing fodder for our cartoonist Bob Rich to lampoon. Heading into tomorrow's FOMC meeting, we've highlighted five of our favorite central planning cartoons below. If you like what you see, click here to sign up for our free Cartoon of the Day.




1. ahhh, easy money. 

5 Hilarious Central Planning Cartoons - central bankers cartoon 09.08.2015


2. The bulls loved it...

5 Hilarious Central Planning Cartoons - Central planning cartoon 03.20.2015


3. Currency markets? not so much...

5 Hilarious Central Planning Cartoons - currency wars


4. It's just a matter of time before it all comes crashing down...

5 Hilarious Central Planning Cartoons - central banker house of cards


5. then again, maybe it's already happening...

5 Hilarious Central Planning Cartoons - Monetary policy cartoon 11.07.2014

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Commodity-leveraged credit, which moved on a lag to top-down commodity deflation, is now FAST on the move.


With large impairment charges and write-downs foreshadowed by many large producers, credit markets are front-running balance sheet contraction to reflect lower short and long-term commodity price assumptions:

  • BHP made a pre-earnings announcement of a $7.2 Bn pre-tax impairment charge on U.S. shale assets.
  • Australia’s Woodside Petroleum said it expects to take an ~$1 Bn pre-tax impairment hit due to lower long-term oil price assumptions when it announces its full-year 2015 results in mid-February.

As we flagged in a recent note PRODUCER LEVERAGE , much of the spread risk lies with what are current IG credits.


Two important points we would make with respect to the more recent moves in credit markets:


1) Both high-yield AND investment grade have historically moved together when spreads widen (all corporate credit is at risk), and there is a large amount of IG credit that could move high-yield in 2016 in the current price environment.


2) A good chunk of low-notch IG commodity credit trades like it’s going high yield, but there is also a large chunk that is 1-2 notches off lowest IG-Notch that has just started moving in the last couple of months – These issues are worth a look if you are behind our pending recession call. 


NOTCH RISK - Energy and Materials IG Yield




NOTCH RISK - Energy and Materials Spreads


NOTCH RISK - Energy   Materials HY Index


To consolidate concerning commentary from S&P & Moody’s on the shift in credit quality at the end of last week:

  • S&P: More companies were at risk of having their credit ratings cut at the end of December than at the close of any other year since 2009
  • S&P: The number of potential downgrades was at 655, compared with 824 reported by the finish of 2009
  • S&P: The year-end total for 2015 was "exceptionally" higher than a yearly average of 613
  • S&P: Oil-exporting countries face fresh downgrades as crude prices fall further. The agency currently has Azerbaijan, Bahrain, Kazakhstan, Oman, Russia, Saudi Arabia, Brazil, and Venezuela on negative watch.
  • Moody’s: Friday morning, Moody's disclosed it was putting the ratings of 120 Oil & Gas companies and 55 mining companies on watch.
  • S&P: Revised 2016 and 2017 metals price assumptions late Friday night, following on its recent reduction in 2017 oil price forecasts from $US65 a barrel to $US45. (expected but meaningful):

-        Iron Ore: Cut to $65/MT for 2015-16 vs. $85/MT back in October

-        Copper: $2.70/lb. for 2015 through 2017, down from its previous forecast of $3.10/lb. for 2015-2016

-        Gold: Forecasts remain flat at $1,200 per ounce for the period from 2015-2017.

-        Nickel: Lowered from $8.00/lb. in 2015-2016 to $6.50/lb. this year and $7.25/lb. in 2016

-        Zinc: Lowered from $1/lb. this year to $0.95, but maintained its $1/lb. forecast for 2016


In the table below, we have pegged a significant amount of investment grade credit from commodity producers that could get downgraded to high-yield ($227Bn) -- some credits much more at risk near-term than others.


A move to HY from IG should perpetuate spread risk with forced selling from institutional money.  As mentioned above and with regards to our short JNK position, the insurance on low-IG credit in the commodities space that hasn’t moved as much (YET) is worth a look into a potential recession as a way to play our short JNK view outlined in the Q1 Themes deck.   


NOTCH RISK - chart1 IG to HY


NOTCH RISK - chart3 credit outstanding vs. HY YTM


One of the bubbliest charts we’ve put together alongside the above slide as it relates to commodity producer balance sheet leverage is one that shows interest expense skyrocketing despite unprecedented lows in financing expense. We continue to think the deleveraging here is in the early innings.


NOTCH RISK - Interest Expense





COH | When ‘Horrible’ is ‘Awesome’

Takeaway: We think that ‘The Space Stinks’ argument is drying up. The biggest winner here might be KATE.

Let’s face facts…these Coach numbers stunk something awful. Sales were +4%, but down 3% excluding the addition of Stuart Wietzman. Even including the deal, gross profit was down 2%, EBIT was down 5%, and EPS down 7% -- and this was on top of a 31% EPS decline last year, and 14% decline the year before. Terrible numbers for any company that actually cares about driving a basic financial model.


But we’re not talking about one of those companies. We’re talking about Coach – a company that has not grown sales organically since the debut of the iPhone 5. When we added Coach to our Long bench (after being short for over 2-years) in December all we were looking for was incremental lack of weakness on the margin. We definitely got that.


So what would make us get full-on bullish? It would be confidence that this company can actually grow it’s top-line sustainably. From a modeling perspective, we can move the 69% gross margin or the 50% SG&A ratio around by a few points here or there. But the only thing that makes this clock tick is revenue growth. Our confidence on that one still needs some work.


But until then, there are a few metrics that keep us in the game with a positive bias.

1. The first is the raw earnings algorithm. For two years it’s been terrible, and for two quarters it’s been…well, better. The chart below suggests that earnings are hitting a trough – and we’d point out that that this is the same time other companies will see increased downward revisions as the economy weakens.

COH  |  When ‘Horrible’ is ‘Awesome’ - 1 25 2016 COH Algo



2. The SIGMA chart for COH looks outstanding. Coach has not been this clean with its inventory position since 4Q10 (iPhone 4…to stick with that metaphor). This is an extremely positive gross margin setup for COH. Stocks usually don’t (almost never) go down when the picture looks like what you see below.

COH  |  When ‘Horrible’ is ‘Awesome’ - 1 25 2016 COH SIGMA 


3. The last thing that keeps us positive is not a metric, but a group attribute. Since August 2014 ‘The Space’ has been a disaster. Not necessarily the business trends, but definitely the stocks. This hit KATE the hardest, as it continued to deliver but had its multiple cut in half while Kors and Coach put up horrific numbers. But now Coach is stabilizing. We’re pretty sure that KATE is performing well. That just leaves Kors as the lone brand hemorrhaging share. It’s tough to make the case that ‘The Space’ is broken when only one brand is on the decline. In this scenario, COH and KATE (which have a dramatically different customer, by the way – see graphic at the bottom of the note) help each other, allowing Kors to shoot itself in the foot – in the US, at least – all by its lonesome.

COH  |  When ‘Horrible’ is ‘Awesome’ - 1 25 2016 COH Customer 

#HOUSTON...We Have A Problem

Client Talking Points


We Have (an accelerating) Problem:  The 4th largest metro in the country is ground zero for energy deflation and the negative data flow keeps flowing.  Goods Producing jobs in Houston are -2.9% YoY, births are tracking -12% YoY, Existing Home inventory is up +28%, Housing demand is down -11% and prices are starting to roll.  Yesterday, the Dallas Fed manufacturing index printed at a remarkable -34.6 with production crashing 23 points (largest decline in 11 years) and the index dropping to the worst level since 2009.  Don’t try to catch the knife on #DeflationsDominoes or homebuilders with Houston leverage – it’s going to get worse.  


While data continues to slow across the region, expect the ‘issues’ around the refugee ‘crisis’ to remain a drag. Winter may limit movement across borders but there’s a long TAIL ahead to deal with large movements of people. The newest development on this front comes from The Times reporting that the EU is set to suspend its passport-free travel zone, Schengen. 


With large impairment charges and write-downs foreshadowed by many large producers, credit markets are front-running balance sheet contraction to reflect lower short and long-term commodity price assumptions. Moody's disclosed Friday morning it was putting the ratings of 120 Oil & Gas companies and 55 mining companies on watch.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Utilities (XLU) continue to be the bright spot in the equity markets for 2016. XLU is up 1% this year, having edged out all other S&P 500 subsectors by a wide margin. Last week, XLU was down marginally but was still second best among the subsectors, beating all but Healthcare (XLV). Essentially, it's paying off to own low-beta XLU in a crashing market.


General Mills (GIS) has turned on its advertising for no artificial colors and flavors in its cereal, as well as an increased effort for its gluten free campaign. Click here to view the 30 second spot TV commercial.


These steps taken on cereal, coupled with improved merchandise planning across their portfolio in the second half should bode well for the company’s future performance. Additionally, General Mills fits neatly into the style factors that we like from a macro point of view, large cap, low beta and liquidity.


Rating agency S&P disclosed on Thursday three concerning stats as it relates to the wellness of credit oustanding:

  • More companies were at risk of having their credit ratings cut at the end of December than at the close of any other year since 2009
  • The number of potential downgrades was at 655, compared with 824 reported by the finish of 2009
  • The year-end total for 2015 was "exceptionally" higher than a yearly average of 613


Then on Friday, S&P followed with additional action:

  • Disclosure that oil-exporting countries face fresh downgrades as crude prices fall further and that it could repeat last year's move when it made a big group of cuts all at once
  • S&P currently has Azerbaijan, Bahrain, Kazakhstan, Oman, Russia, and Saudi Arabia on negative outlook in its Europe, Middle East and Africa region, as well as Brazil and Venezuela in Latin America

Moody’s echoed the shaky state of credit markets by announcing it was putting the ratings of 120 oil and gas companies on watch Friday.


Strap on your seatbelts as we expect that credit spreads will continue to widen. If the Fed pivots on its “4 rate hikes” in 2016 as the data continues to slow, Treasury bond yields get pushed lower and high-yield spreads widen into a late cycle deleveraging. This should continue to generate alpha in a Short JNK, Long TLT trade.

Three for the Road


$MCD is taking share from $CMG!



Good is not good when better is expected.

Vin Scully                                


In Norway - oil has fallen so low and salmon risen so high that one standard, 4.5 kilogram fish costs more than a barrel of crude (measured in kroner).

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