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FL | Eroding on the Margin

Takeaway: As good as 4Q was, most metrics look sequentially worse to us. This is a fat-tailed short call, and we think it’s starting to play out.

FL numbers looked fine, good actually. But our point on the stock all along is that there’s asymmetric risk to the downside in a) the rate of change in fundamentals, and even more so b) the stock. FL beat by $0.04 ($1.16 vs the Street at $1.12) and put up a very respectable 7.9% comp. But…

  1. FL has beat every single quarter this economic cycle save one, and by an average amount well above what we saw today. This company is EXPECTED to beat.
  2. The flow through in profitability is less than half of where it trended 3 and 4 quarters ago. Compares are starting to get tough.
  3. Comp trends are disappointing in Feb, at a low-single digit rate month-to-date EVEN THOUGH a) there was a sequential uptick in Nike/Jordan launches this month versus last, and b) Feb 2015 was disappointing – so it faced an easy comp. i.e. there’s an increasing bifurcation between Nike’s solid release schedule and FL results. That’s bad.
  4. The steady sequential decline in e-commerce is unsettling, to say the least.
  5. Management sounded very confident in 1Q and the year – but this team only knows how to be confident. They’re reign started in the middle of the biggest multi-year surge in Volume and ASP-boosting Nike product since the early 1980s. Now that ends.

 

On Wednesday we said a whole mouthful on FL when we presented out 65-page Black Book – here’s the link to our report (CLICK HERE). This quarter was in line with our thinking.

 

Additional Details:

 

Comp Trends: Solid 4Q number at 7.9% showing an acceleration on a 2 and 3 year basis.  That was mostly generated outside the US, as the FL banner domestically put up a MSD comp for the first time since 3Q13. Quarter to date trends at LSD for the month of February are not encouraging.

FL  |  Eroding on the Margin - 2 26 2016 FL chart1

 

Monthly Comps: Below are our estimates of the monthly comps based on management commentary. i.e. MSD = 5%, LDD=11%, etc. We’ve now seen two consecutive months of LSD comp growth. Commentary around the February trend doesn’t add up. Per Nike’s website the basketball launches accelerated sequentially into the All-Star game and it is the easiest comp of the year for the company. From here, everything gets more difficult for FL.

FL  |  Eroding on the Margin - 2 26 2016 FL chart2

 

e-Commerce Erosion: Another bad indicator on the margin for FL who now competes directly with Nike online for dollars. Yes, FL has the stores that Nike does not, and there is still a place in this space for that experience. But, with more of the growth headed online we think a disproportionate amount of those dollars go directly to the brands – Nike in particular.  Nike hosted its analyst day back in October of 2015, where it laid out its $7bil e-commerce plan by 2020. A number that we think is low by $4bn. No surprise that the sales trends have followed the traffic trends at FL we’ve called out over the past few months at the same time Nike took its intentions public. Banner dot.com growth was just 20%, a big deceleration from the 50% we saw early in the year.

FL  |  Eroding on the Margin - 2 26 2016 FL chart4

 

Profitability: Incremental margin is down to 36% from the mid-70s in 1H15.  Now working against tough compares as comps moderate and spending accelerates. The leverage in this model is all but tapped, as noted by management on the call when talking about the need for MSD comps to leverage fixed expenses vs. the prior LSD.

FL  |  Eroding on the Margin - 2 26 2016 FL chart3


Central Planners' Futile Fight Against Economic Gravity

Takeaway: What happens when the edifice of omnipotent central planning comes crashing down?

Central Planners' Futile Fight Against Economic Gravity - central banker cartoon 02.02.2016

 

As the reality of global #Deflation and #GrowthSlowing continues to sink in, investors across the world are slowly awakening to the stark conclusion that central planners cannot fight economic gravity.

 

The latest case in point? Germany's CPI numbers this morning. Here's an update from our Macro team in a note sent to subscribers:

 

"German February Preliminary CPI fell to -0.2% year-over-year vs Expectation of 0.0% and 0.4% Prior. This is yet another data point that is going to force the ECB’s hand to act at its next policy meeting (March 10th) as inflation is tanking."

 

Central Planners' Futile Fight Against Economic Gravity - mario draghi

 

Bearing this in mind, it's worth reflecting on the almost frantic capitulation among serially overoptimistic global policymakers:

 

  • The IMF is now calling for "bold multilateral actions to boost growth and contain risk," while warning that a global growth downgrade from its current 3.4% is "likely."
  • The BOJ has called for greater G7 cooperation to "soothe" market jitters.
  • The ECB "is ready to do its part."
  • Meanwhile, Fed officials hold conflicting views about whether March is a "live" meeting or not for rate hikes.

 

In a recent Early Look, Hedgeye CEO Keith McCullough put forth a new theory about what happens when macro markets no longer believe the whims of audacious central bankers:

 

"... My Big Bang Theory for the #CurrencyWar (one of the Top 3 Themes in our Macro deck right now) is as follows:

  1. Japan is no longer able to convince markets that it can burn its currency at the stake on command
  2. Japan’s Yen starts to rise, and Japanese stocks start to crash
  3. Europe then fails to convince consensus of the same
  4. Euro goes up (instead of down) on Draghi’s next central-market-planning day (March 10)
  5. European and US stocks resume their current crashes and go straight down"

 

It's a troubling scenario...

 

One thing we're crystal clear on ... when the edifice of omnipotent central planning comes crashing down, it won't be pretty. Don't say we didn't warn you.

 

Central Planners' Futile Fight Against Economic Gravity - Card house cartoon 12.03.2014


REALITY CHECK: Inside Today's GDP Report

Takeaway: The modest upward revision to Q4 GDP was mostly due to a build in inventories.

REALITY CHECK: Inside Today's GDP Report - GDP cartoon 05.29.2015 large

 

Sorry. Today's updwardly revised Q4 GDP report from 0.7% to 1.0% is not the auspicious economic harbinger many are purporting it to be.

 

"Hold on a second," Hedgeye Senior Macro analyst Darius Dale wrote following this morning's revision. "Inventories rip because consumers bought less stuff than was initially estimated and this is POSITIVE for GDP?" 

 

Take a look at the table below from Hedgeye U.S. Macro analyst Christian Drake. As you will see, the modest upward revision to 4th quarter GDP was mostly due to a build in inventories. Also note that consumer spending was revised down.

 

Not good.

 

Click image to enlarge. 

REALITY CHECK: Inside Today's GDP Report - gdp today

 

 

We're sticking with our U.S. #GrowthSlowing call.

REALITY CHECK: Inside Today's GDP Report - GDP cartoon 10.29.2015


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Germany, HPI and CHINESE YUAN

Client Talking Points

GERMANY

German February Preliminary CPI fell to -0.2% year-over-year vs Expectation of 0.0% and 0.4% Prior. This is yet another data point that is going to force the ECB’s hand to act at its next policy meeting (March 10th) as inflation is tanking.

HPI

Part of our bearish thesis on housing centers on our expectation for home price growth to slow. Home prices follow the slope of housing demand on a 9-12 month lag and we are in month 8 of deceleration in Pending Home Sales in the existing market. The Case-Shiller 20-City HPI index released Monday was flat after 5-months of acceleration and yesterday’s HPI series from FHFA reflected a 2nd straight month of deceleration. We weren’t expecting the negative inflection in price growth quite this soon but the fledgling slowdown is worth noting. Recall, from a sequencing perspective: Demand leads price and the equities tend to follow the 2nd derivative trend in price.  

CHINESE YUAN

The multi-month trending increase in implied volatility on the Chinese yuan appears to have petered out, and the nascent series of lower-highs throughout the YTD is in line with our views on the currency: there won’t be a material, one-off devaluation over the intermediate-term. Rather, policymakers will look to continue to guide the currency lower, at the margins, in line with the recent trend of minor reference rate revisions. Today’s -3bps devaluation in in line with the recent slow-bleed we’ve been seeing since the large -51bps revision in early January. PBoC Governor Xhou Xiaochuan’s early comments at the Shanghai G20 Summit reiterated his previous guidance that “there is no basis for continuous yuan devaluation”. We disagree with that statement in that there is certainly a basis for the yuan to fall much further from here, but there’s also a myriad of reasons why they don’t want to pursue such a strategy, which we’ve discussed in recent notes.

Asset Allocation

CASH 63% US EQUITIES 0%
INTL EQUITIES 0% COMMODITIES 4%
FIXED INCOME 25% INTL CURRENCIES 8%

Top Long Ideas

Company Ticker Sector Duration
XLU

Long-Term Treasuries (TLT) and Utilities (XLU) remain our two best fixed income and equity vehicles to play #Lower-For-Longer on growth and interest rates as the market gets more and more skeptical about the central bank dogma.

 

With market turmoil, the Junk Bond ETF (JNK) is down -4.5% vs. the defensive, growth slowing equity sector Utilities (XLU) which is up 6.7%, outperforming the S&P 500 by 12.9% on a relative basis. That’s yet more confirmation of our dour economic outlook economy (spreads widen in tumultuous market environments and Utilities are a defensive sector that outperforms when growth is slowing).

GIS

General Mills (GIS) is a large player in the Yogurt category with their Yoplait brand. Their competitors, Dannon, Chobani and Fage have been aggressive on merchandising and consumer spending, making it difficult to compete while maintaining internal margin objectives. GIS is turning on innovation with the growth of Annie’s yogurt and that should help the trajectory of the business. Yogurt being a roughly $1.4 billion business, turning it around is a top priority for management.

 

On the broader GIS long thesis, it's unlikely that the stock is going to go up 20% in the next year, but we do believe it will fare better than most in the consumer staples sector, especially as we head into an economic slowdown.

TLT

With the market losing faith in the central planning policy backstop, investors continue to yield to top-down market signals and the direction of the data. To be clear, the data continues to deteriorate and volatility continues to break-out.

 

The yield spread (10-year Treasury yield minus 2-year Treasury yield) has compressed 24 basis points this year, and TLT is up 8.6% vs. the S&P 500 which is down -5.2%. The December Federal Funds Futures contract has declined in a straight line since December’s rate hike.  

Three for the Road

TWEET OF THE DAY

The key takeaways on #Wayfair:

VIDEO | Under 60 Sec: Wayfair's Earnings Report | $W https://app.hedgeye.com/insights/49408-under-60-seconds-wayfair-s-earnings-report-w?type=video

@Hedgeye

QUOTE OF THE DAY

There is no royal road to anything. One thing at a time, all things in succession. That which grows fast, withers as rapidly. That which grows slowly, endures.

Josiah Gilbert Holland

STAT OF THE DAY

According to its annual report, FIFA with just 474 employees spent $115 million on personnel expenses in 2014.


CHART OF THE DAY: China's Economy Continues To Slow

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Director of Research Daryl Jones. Click here to learn more.

 

"... In the world of global macro data points, one to note this morning is that a survey of Chinese economists indicated that the Purchasing Managers Index is expected to decline in March. As emphasized by the Chart of the Day, this would be the seventh straight monthly decline in Chinese PMI and just another in the litany slowing economic data points globally. But don’t worry, PBOC Governor Xiaochuan was speaking at the G-20 yesterday conference and indicated the Chinese central bank still has room to ease..."

 

CHART OF THE DAY: China's Economy Continues To Slow - 02.26.16 Chart


The Revolution

“Every revolution evaporates and leaves behind only the slime of a new bureaucracy.”

-Franz Kafka

 

Many people in the pundit class are calling this the most important election of our lifetime. To be fair, that line seems to be trotted out every four years. Who knows? Maybe this time they’re right? Certainly, the extreme options that Americans are being faced with as an electorate suggest something is askew...

 

On the left, the extreme option that is very realistic is socialism, while on the right (and I’m sure this will offend some) there are options that appear akin to fascism, of sorts. Perhaps the next American Revolution is on its way? Regardless, the next 8 months will be entertaining as it becomes increasingly likely that Hillary Clinton and The Donald may be going toe to toe. As voters, we can be fairly certain we will get “the slime of a new bureaucracy.”

 

Speaking of revolutions, the Iranian Revolution occurred some 37 years ago this month. Over that period, America’s relations with Iran have been rocky to say the least. More recently, with the signing of the Joint Comprehensive Plan of Action between Iran and P5 + 1 (the five permanent members of the UN Security Council and Germany), relations have seemingly thawed and most importantly the oil spigot is coming back on.

 

Our view is that perhaps the single most important question determining the price of oil from a supply and demand perspective is how quickly Iranian production ramps back up. So far, Iran has surprised the experts with its ability to get production back online. The pace at which Iran goes from its current roughly 1.1 million barrels per day of production to its target of 4.5 million, will weigh heavily on the global oil market and the over-levered balance sheets of domestic producers for years to come.

 

The Revolution - oil iran saudi

 

Digging further into this topic, this coming Thursday, we will be hosting a small group dinner in New York with former U.S. Secretary of Energy Spencer Abraham, former Vice Chairman of the International Energy Association Joe McMonigle, and Guly Sabahi who is a partner in the internal energy practice at Dentons and a noted expert of the soon-to-be unveiled Iran Petroleum Contract. If you’d like to stay ahead of the proverbial curve and join the dinner, please email to reserve a spot.

 

Back to the Global Macro Grind …

 

In the world of global macro data points, one to note this morning is that a survey of Chinese economists indicated that the Purchasing Managers Index is expected to decline in March. As emphasized by the Chart of the Day, this would be the seventh straight monthly decline in Chinese PMI and just another in the litany slowing economic data points globally. But don’t worry, PBOC Governor Xiaochuan was speaking at the G-20 yesterday conference and indicated the Chinese central bank still has room to ease . . .

 

Japan has more significant headwinds than a monthly purchasing manager survey decline. According to the 2015 census, Japan’s population declined for the first time on record. Japan’s population shrank by about 0.7%, or almost a million people over the last five years. Most noteworthy is that population decline is really a broad based issue in Japan with 39 out of 47 prefectures and territories showing a decline. 

 

Given this backdrop, it should be no surprise when we report this morning that Japanese CPI came in at a blistering +0.0% this morning. When your population is in full on decline, it’s pretty hard to engineer inflation, no matter how many trillion Yen your central bankers throw at the problem.

 

In China, central bankers are telling us that they have room to do more. In Japan, they are telling us they aren’t worried about negative rates. And at the G-20, IMF Managing Director Lagarde was urging nations to implement more fiscal reforms and structural reforms. Clearly, whatever economic malaise we are currently experiencing and may experience through the course of the year, there is an appropriate government response. That said, with German CPI falling -0.2%, that response is not likely to be a fiscal one.

 

In the U.S., the major uncertainty still revolves around the Presidential election. According to our colleague JT Taylor at Potomac Research, Senator Rubio may have gained some much needed ground in last night’s debate. As JT wrote this morning in his morning bullets:

 

MARCO HITS HIS MARK: "Robo-Rubio" is officially gone. Marco Rubio needed a strong performance last night to show that he was capable of taking on Trump, and he delivered --whacking him with a phone book's worth of oppo research at the outset, and making much of the debate look like a one-on-one between himself and Trump. He also took a major step to solidify his standing in the establishment lane. He figured out that mocking Trump is far more effective than attacking him as a liberal. Cruz jumped into the fray, leveling additional attacks against Trump and his business dealings, but hewed closely to his stump speech and was argumentative and petulant for the second debate in a row. He did get some punches in, but because he split his time taking digs at Rubio and Trump, he was outshone by Rubio's sarcasm and agility. 

 

The big test for Rubio will come in the media cycle between now and Super Tuesday, and whether he can survive the certain counterpunch from Trump. The big test for the Republican party will be whether last night changes Trump supporters' feelings about the mogul -- if past is prologue, the answer is no. The big question for Rubio and Cruz -- where have you been for the past 10 debates?”

 

This may not be the most important election of our lifetime, but it will certainly have a direct impact on the economy and policy, so we will be reporting on it in real-time. If you’d like to be added to JT’s morning bullets, please email and let them know.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.65-1.82%

SPX 1

VIX 17.99-27.48
EUR/USD 1.09-1.13

YEN 111.30-114.95 

Gold 1178-1252 
Oil (WTI) 27.07-34.25

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research 

 

The Revolution - 02.26.16 Chart


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