The Economic Data calendar for the week of the 22nd of August through the 26th of August is full of critical releases and events. Here is a snapshot of some of the headline numbers that we will be focused on.
In this excerpt from The Macro Show on Friday, Hedgeye Retail analyst Alec Richards explains why Target shares have significant downside from today’s levels.
Our cartoonist Bob Rich captures the tenor on Wall Street every weekday in Hedgeye's widely-acclaimed Cartoon of the Day. Below are his five latest cartoons. We hope you enjoy his humor and wit as filtered through Hedgeye's market insights. (Click here to receive our daily cartoon for free.)
Fed projections are all rainbows, puppy dogs and ... bunnies.
Did you buy the all-time highs in U.S. equity markets?
In the past year, other than the U.K.'s FTSE, European equity market drawdowns range from the German DAX's -3% to -29% for Italy's FTSE MIB.
The pound has lost -12.6% of it's value (against the U.S. dollar) year-to-date as U.K. growth has slowed.
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Takeaway: Current Investing Ideas: HOLX, HBI, LAZ, FL, TIF, WAB, UUP, LMT, GLD, TLT
Below are our analysts’ new updates on our ten current high conviction long and short ideas. As a reminder, if nothing material has changed in the past week which would affect a particular idea, our analyst has noted this.
Please note that we removed Zimmer Biomet (ZBH) from the short side of Investing Ideas this week. We will send Hedgeye CEO Keith McCullough's refreshed levels for our high-conviction Investing Ideas in a seperate email.
We often get the pushback that "investors are bearish on the broader equity markets" and "the long-bond is now a crowded trade with little valuation upside." As Keith we wrote in our top-3 macro themes on Thursday morning, “long-term yields continue to track the rate of change in long-term GROWTH – get growth right, and I think you’ll get the UST 10-30yr right; from here to 1.63% is a good spot to be buying long-term bonds and their safe-yield proxies.”
Industrial production and capacity utilization data realized early in the week points to a continued deceleration in those respective growth rates. We haven’t been shy to call this an industrial recession.
The YoY growth rate in industrial production ticked up +20bps sequentially to -0.5%, holding in contraction territory for the 11th consecutive month. The growth rate is still slowing on a trending basis off the late-2014 peak, while commensurately accelerating on a trending basis off the late-2015 trough.
Capacity Utilization ticked up +50bps m/m to 75.9% in JUL, but the trending deceleration remains intact.
And as for the commentary that everyone is bearish on the S&P which is why it can’t move lower, well, everyone is not bearish on the S&P. It’s much more important to study how investors are actually positioned over listening to qualitative opinion.
Total U.S. market short-interest has been cut by 13% from the February lows and S&P net futures and options positioning (index+e-minis), while it’s been cut the last few weeks, is still +1.7x extended on a TTM z-score basis – this as we’re testing record low 2014 levels across various volatility metrics. Again, we’re much more comfortable with our #GrowthSlowing call over capitulating to market beta at all-time highs.
To view our analyst's original report on Hanesbrands click here.
Cotton prices have fallen over the last couple weeks from the YTD highs at the beginning of August. We should reiterate that our short call on Hanesbrands (HBI) is not based on higher cotton prices, but rather we think it's a company that is facing negative organic growth, at peak utilization, with peak margins, which is being forced to find additional growth via increasingly risky businesses at higher and higher multiples.
At HBI, cotton makes up 7% of COGS. The company hedges cotton out 6-9 months with the goal of providing time to adjust selling prices as much as possible to accommodate the input cost change. Including hedging and production process it takes about 4-5 quarters for price fluctuations to flow through to the P&L.
For HBI a 10% move in cotton price is about a 50bps impact to gross margin, or a 4% EPS impact. At a minimum we do not think cotton will head materially lower, which means the tailwind the industry has had for the past 3 years is gone.
To view our analyst's original report on Lazard click here.
No update on Lazard (LAZ) this week but Hedgeye Financials analyst Jonathan Casteleyn reiterates his short call.
To view our analyst's original report on Tiffany click here.
Tiffany (TIF) reports earnings on Thursday August 25th. Yes, expectations are low, as is current sentiment in the market, but we think before the year is out we will see another reset to earnings expectations. This is what we know for certain headed into Thursday’s print.
As the core fundamentals continue to deteriorate, and we haven’t seen a clear plan from management in order to change the course of current trends. Not to mention we sit at the tail end of the economic cycle with luxury spending going negative for the first time in 5 years. At 19x unhittable earnings expectations, we’re still riding this on the short side.
To view our analyst's original report on Lockheed Martin click here.
Lockheed Martin (LMT) was down a hefty 4% this week ($254 per share from $265) primarily because of disappointment with Tuesday’s finalization of the numbers from the Reverse Morris Trust spinoff of its lower margin IT division to Leidos: Lockheed will end up repurchasing only 9.4M shares of stock versus projected 10M.
Investors should note that Friday’s price puts the stock back where it was exactly one month ago (+17% YTD) meaning that last month’s run up owed a lot to street expectations of the spinoff. Fundamentally, the main drivers of Lockheed’s revenue remain in place, if not improved. The F35 continues on its development track with the Navy version completing its final at sea development period.
The government released another $1B towards the Lot 9 production of 57 aircraft (now well over 50% complete) reducing LMT’s cash exposure used to keep suppliers going, pending conclusion of the now one-year-old negotiations for a final contract. Final contract terms are critical since the deal is to cover both Lot 9 and 10 and will become a basis for the approaching longer term block and multiyear contracts.
To view our analyst's original report on Foot Locker click here.
Foot Locker (FL) reported earnings this week and ultimately delivered a great quarter, beating on the top and bottom lines. The near term results do not change our long term view on FL which is predicated upon an unsustainable financial model, and a mismatch between how much FL needs to spend on both the P&L (SG&A) and on PP&E to drive the business now that the retail distribution paradigm is changing for the first time in 40yrs. Specifically, Nike has been spending on building up a world-class e-commerce model for the better part of 8-years – basically this whole economic cycle – and we’re now starting to see the fruits of Nike’s investment, while FL must now compete with a partner who accounts for 70%+ of its business.
On the quarter itself, the revenue outperformance was particularly impressive for FL with the comp accelerating 180bps against a tougher compare. With the comp rate running negative as of the May call, this made for the biggest intra quarter comp acceleration during this economic cycle. The acceleration in the business in 2Q makes the Double Digits Full Year EPS guidance much more hittable, though we think the current Street numbers are a bit of a stretch.
On the negative side, we would note that the leverage in this model is looking less and less attractive. Meaning even when beating expectations like the company did on Friday, the margin upside has all but dried up, demonstrated by SG&A deleverage on a 5% comp. FL leveraged the 4.7% comp into 5% revenue growth and 6% EBIT growth. EPS was up 11% aided by the 4% y/y share count reduction.
To view our analyst's original report on Wabtec click here.
While the bull story continues to pin its hopes on an acquisition of a French manufacturing company (which we still think the deal will not go through in its current form) Wabtec's (WAB) high-margin aftermarket business is continuing to deteriorate as equipment continues to be pulled into storage. Add in weak rail volumes, poor railcar and locomotive orders and we continue to expect 2016 EPS ex-Faiveley below $4/share as the company’s core freight market enters a multi-year downturn.
To view our analyst's original report on Hologic click here.
No update on Hologic (HOLX) this week but Hedgeye Healthcare analyst Tom Tobin reiterates his short call.
Takeaway: The credit card industry faces an uncertain future—will it be able to weather the storm?
Here's a preview of the next issue of "About Everything." You're welcome to join a Hedgeye Q and A on credit cards next week, date and time soon to be announced.
What's the outlook for the credit card industry? When you look at the central players up close--focusing, say, on the latest revenue and earnings numbers for the key network providers (V and MA)--the outlook appears pretty bright.
But when you step back and take a broader view, several large warning lights appear. Let's start upstream, where growing price competition for consumers and retailers is forcing acquiring banks to cut back on fees, thereby pinching margins. Tellingly, the most "premium" brand of all (AXP) is now in real trouble: Hip hop and HBO stars are no longer bragging about their titanium black card. Then let's focus on today's frozen credit cycle, which is depriving the acquirers of the "revolver" interest income they usually enjoy as the recovery matures. Finally, let's look ahead to the seemingly unstoppable growth in debit cards, prepaid cards, and ACH as a share of all noncash payments. Or further ahead to the even faster growth in mobile payments.
What about opportunities abroad? Sorry, that window is closing as well. Indeed, there is growing worry about threats from abroad. If there is one specter that wakes up credit card executives in the middle of the night, it is the image of millions of 30-year-old Americans tapping on WeChat (the English-language version of "Weixin," the single most used mobile app in China). Looking ahead, some analysts already prefer to talk not of the credit card industry but rather of the "payments" industry.
Pushing all of these challenges is a strong and adverse generational tide. Quite simply, as you go younger than the 1970 birthyear, you will increasingly find Americans who don't like credit cards, don't like banks, and in fact don't really care for much of the financial services industry. A revolution is brewing.
Credit card companies are on edge. In June, Synchrony Financial (SYF) warned of higher-than-expected defaults—prompting JPMorgan Chase (JPM), Wells Fargo (WFC), Capital One (COF), and Discover (DFS) to bolster their reserves for credit losses.
To be sure, these firms tell just a portion of the overall story. The credit card industry encompasses a wide range of players who assume various roles in the transaction. There are the “issuing banks”—like Citigroup (C), JPMorgan, Bank of America (BAC), and Capital One—that receive 1% to 3% of every transaction plus a base rate (often $0.05 or $0.10) depending on the type of card, what network was used, and where the item was purchased.
Then there are the “acquiring banks” (overlapping with the issuing banks) that process payments on behalf of the merchant. These companies earn a “merchant discount rate” worth between 1% and 3% of the transaction value.
Finally, there are the “networks”—Visa (V), MasterCard (MA), American Express (AXP), and Discover—that act as middleman skimmers between the issuing and acquiring banks. Though they make just a sliver of a percentage from each transaction (0.11% to 0.14%), these fees generate $30 billion annually for Visa and MasterCard, or a whopping 30 percent of their revenues.
On the surface, the industry should be thriving. General purpose credit card spending grew from 10% of GDP in 2000 to 15% in 2014. In 2014 alone, the number of processed transactions increased 10% YoY for Visa and 13% for MasterCard.
However, a closer look at the major players reveals some stark divides. While stock prices are up for most of the major networks (Visa, MasterCard, and Discover), they are down for American Express, a “premium” network whose business model may not survive in today’s newly price-pressured environment. They are also down for most of big issuing banks (like JPMorgan Chase, Bank of America, and Citigroup). To be sure, big banks globally have had plenty of bad news unrelated to credit cards. But look at Capital One, an issuing bank that makes most of its money from its credit card business—and whose stock has unperformed the S&P 500 since the Great Recession.
The credit cycle is stuck in a rut. After economic downturns, the industry only extends credit to individuals with excellent FICO scores. As time passes, companies gradually take on higher-risk customers with lower scores. These customers are more likely to carry revolving balances and pay higher interest rates—bolstering industry revenues. When these borrowers ultimately default on their debts, the customer base shrinks and the cycle repeats.
Or at least, that’s how it’s supposed to work.
Today, as we might expect late in the economic cycle, credit card transaction volume by type of card continues to rise. Balances held by issuing banks are nearing their pre-recession peak, while charge-off and delinquency rates—though still at historic lows—are beginning to rise. Credit card default rates are on the rise as well, which is an indication that we’re nearing our peak number of credit card holders.
Historically, the compensating advantage for reaching full credit card capacity has always been a growth in interest payments from borrowers who don’t pay off their debts (so-called “revolvers”). But that isn’t happening during this cycle. In fact, the number of revolvers is actually falling, while the number of people who immediately pay off their debts (“transactors”) is rising.
In other words, credit cards are experiencing all of the costs of a late-cycle economy with none of the benefits.
Alternative payment methods are gaining ground. Sure, credit card transactions as a share of all noncash payments have remained relatively stable in recent years. But this situation likely won’t last.
Why? Credit card payments have held steady only by cannibalizing check payments, which have dropped off from 46% of all noncash transactions in 2003 to just 15% in 2012. There’s simply no more room for credit cards to grow.
Meanwhile, all other forms of noncash payments—prepaid cards, debit cards, and Automated Clearing House transactions—have become vastly more popular and their growth shows no signs of slowing. This is bad news for the industry, which takes a much larger cut from credit card transactions than any other type of transaction.
Mobile payment options are also giving credit cards a run for their money. Apple Pay currently takes a 0.15% cut of the 2% interchange fee, while other rivals like privately held LevelUp aim to get rid of fees altogether. Merchants like Starbucks (SBUX) and Walmart (WMT) have even developed their own systems that circumvent per-swipe fees.
While these “digital wallets” are working within the existing payment system for now—that is, cooperating with the networks—it’s the nature of technology to squeeze out the middleman in the long run.
Both the stagnating credit cycle and the rise of competing payment methods have been driven by generational change.
Many Generation Xers and most Millennials don’t like being in debt or being punished with interest rates and fees. That goes double for the “prestige” of showing off your AmEx card—which, in any case, is losing any meaning in the era of online payment.
While older generations are comfortable paying off purchases over time, risk-averse Millennials would rather pay off purchases immediately to avoid ruining their credit score. It doesn’t help that the gap between credit card interest rates and interest rates on any other form of consumer debt has never been wider.
Together, according to Fed data, Xers and Millennials account for the vast majority of the drop-off in credit card use since 2008. (Xer credit card use was soaring before plunging steeply during the Great Recession, while Millennials have been moving away from credit cards since 2001.) Indeed, the percentage of adults under 35 who hold credit card debt has fallen to its lowest level since 1989. Many Millennials who watched their parents struggle during the Great Recession have long since cut up their credit cards—if they ever had them to begin with.
In fact, Millennials don’t want to take on consumer debt of any kind: While student loan debt continues to rise rapidly for young adults, every other form of indebtedness (housing, autos, as well as credit cards) is falling. As Millennial Rebecca Liebman stated, “I don’t want to use a credit card irresponsibly, and because of that, it’s scarier to use. I grew up—I saw 2008—I saw my dad get laid off. I don’t trust the financial market.”
More fundamentally, many Xers and Millennials don’t much like the banks who issue credit cards. A rising share of households headed by these consumers are either “underbanked” (rely on alternative financial services in addition to banks) or “unbanked” entirely.
Xers see financial technology startups as an attractive alternative to the banks that cost them their net worth during the Great Recession. Millennials, meanwhile, see them as a convenient part of their lifestyle: Why risk late fees and interest charges when you could use PayPal, LevelUp, and WeChat, apps that offer everything from easy bill payment to social networking?
The possibility that such mobile services might someday soon become as popular in America as they now are in China is a specter that haunts the credit card industry.
Credit card companies are pulling out all the stops to win over consumers. Most are making image tweaks to mimic their cool Silicon Valley competitors. MasterCard, for example, unveiled a new logo with lower-case letters to deemphasize physical cards as it shifts gears to digital payments.
Plenty of issuing banks are even cutting down on the number of fees they charge. Fewer are charging annual fees, foreign transaction fees, and balance transfer fees.
But it will take more than a new logo and a discount for Millennials to change their habits and give credit cards a chance.
Don’t expect payment networks to find long-term success abroad. For decades, one steady source of revenue growth has been to expand credit card use abroad—especially in developing markets. But that avenue may be closing.
In 2014, EU courts forced MasterCard to cap its interchange fees. Now, U.K. consumers are preparing a $24.5 billion class-action lawsuit against the company over its cross-border processing fees. Walmart Canada has stopped accepting Visa in three stores over “unacceptably high” fees. China did open its markets in June to foreign payment card companies—but not without implementing strict capital requirements.
The underdeveloped world is hardly a sound bet, either. Many late-developing countries won’t even go through a credit card phase. Countries in sub-Saharan Africa and southeast Asia are already leading the world in mobile payments. In 2013, a massive 43% of Kenya’s GDP flowed through M-Pesa. In the Philippines, where more than a third of the country’s cities and municipalities are bankless, there were 217 million mobile-phone transactions in 2013.
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