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CHART OF THE DAY: Online Retail Crushing Brick & Mortar

Editor's Note: This is an excerpt and chart from today's Early Look written by Hedgeye Retail analyst Brian McGough. Click here to learn more.  

 

Here’s the kicker – of the 263 basis points in share gain for e-commerce, 177bps of it came over the past 12 months. That sentence might be worth rereading. It’s huge, and I can assure you that no self-respecting brick & mortar CEO is taking about that. Those that are probably are on their way our [case in point – HBI’s CEO has 16 days left on the job. Macy’s has 108]. Those guys know the drill.

 

CHART OF THE DAY: Online Retail Crushing Brick & Mortar - mcgough Online Carrying Retail Sales


Circular Cesspool of Despair

"Success is not linear. Process, focus and effort all are." -- Me

 

It’s conference season – especially in Retail (back to school, Holiday approaching, etc…). That’s when CEOs of the biggest and baddest (literally) US retailers strut to Downtown NYC, Boston, or Nantucket. They flash their pearly whites in front of hundreds of people, then retreat to the "secret meeting" rooms most of you are not invited to share their real, uncandid thoughts about business. This is so bad, in so many ways, and has been core to how so many money managers have generated Alpha in the past.

 

But let’s be clear about something. You should be glad not to be invited to what I think is an egregiously clubby hot mess. Why? The information is simply wrong. It's maybe 75% accurate on the upcoming quarter (TRADE duration). 50% accurate on the year ahead (TREND). And it’s at best 25% right over one to three years (TAIL). Many investors we respect are increasingly not even showing up at these things anymore. The groupthink is pervasive, and the groupthink is often wrong.

 

Circular Cesspool of Despair - z tag

 

Why, you ask, can these vaunted CEOs be wrong? The management teams give the impression that they have a crystal ball. They don’t. The same could be said about the Fed. The irony here is that the Fed is increasingly using Wall Street as a source of information. Wall Street looks to companies (and the Fed) for information. Companies look to what the government is selling this week, and what they hear from the competition (through Wall Street). It's a circular cesspool of despair.

 

The end result, I think, is the best opportunity in nearly two decades to make money. We keep hearing, “it’s such a tough environment. Hard to make money in this tape.” That is true, if you aren’t looking through the groupthink, or you don’t have a process to game it over the near term. Don’t get me wrong. I’ve had some lousy calls in 2016. But I’ve had more good ones, and will have even more by year end. #process always wins.

 

It’s time for some @HedgeyeRetail Macro Grind

 

Here’s one of the biggest opportunities to make money in Consumer Discretionary today. Let’s start with Retail Sales – in the context of what really matters.

 

  • We have an $18 trillion economy.
  • $13.8 trillion in disposable income.
  • $12.7 trillion in consumption capacity (72% of GDP -- which is almost always maxed out).
  • ‘Only’ $5.5 trillion of that makes its way to Retail Sales.
  • Further, the GAFO category (General Merchandise, Clothing, Electronics, Home, etc…) is only $1.3 trillion.

 

It’s the GAFO category that’s represented by the sales and earnings reports of companies like Target, Home Depot, and Gap. There’s a perception that Retail Sales compares vs 2H15 are easy this year, and that’s actually true. Retail Sales growth slowed by 20-30bps in each of the last three quarters of last year. But that’s the $5.5 trillion number. The GAFO category, the one that’s representative of companies that report earnings, actually strengthened by 20-30bps over that same period. In other words, the Retail Sales comparisons for the data set that actually matters  get tougher from now through year end. Ignore the groupthink. Short the MVR.

 

But here’s the real trend that’s being obfuscated by those pearly whites – and that’s the impact e-commerce is having on the economics of the retail supply chain. “Yeah, thanks McGough, people are shifting spending online…thanks for that #newsflash.”  Got that.

 

What people don’t know is that e-commerce is accelerating off of a larger base. Consider this… online stores/marketplaces (like Amazon, Wayfair, etsy and even eBay) gained 263 basis points in share of retail sales over the past three years. That’s pretty huge given that it came off a base of only 7.6%. Keep in mind that the 180bps lost by a category like GAFO actually includes its own e-commerce sales. In other words, the share loss to online on the part of Kohl’s and Target came despite all their talk of growth opportunity in e-commerce when they are working the one-on-one circuit.

 

Here’s the kicker – of the 263 basis points in share gain for e-commerce, 177bps of it came over the past 12 months. That sentence might be worth rereading. It’s huge, and I can assure you that no self-respecting brick & mortar CEO is taking about that. Those that are probably are on their way our [case in point – HBI’s CEO has 16 days left on the job. Macy’s has 108]. Those guys know the drill.

 

But here’s what really matters. Most of these companies, HBI, TGT, KSS, LULU, FL, JWN, BBBY, BBY, TIF, JCP, WSM (I could go on) are all woefully underinvested in dot.com. Their current throughput in their D.C.s is near peak, and yet the e-commerce business simply can’t grow at a sustainable and profitable clip. That means they continue to suffer top-line misses, or meaningfully up investment spending and take earnings lower.

 

This is not to say all companies are doing it wrong. In fact, many of them, like RH, are perceived to be screwing up – and while they have had some painful self-inflicted wounds, the reality is that are leaning when others withdraw. That’s how you win a joust. Who else is doing that? WMT, NKE, and even DKS.

 

We’re about to enter a period (2017) where earnings/margin bifurcation should blow out between quality management teams and the junk. We’re modeling more companies than ever putting up 20%, 40% and even 60% earnings misses. Others will beat by the same magnitude. This is one of the biggest opportunities to make money in Retail equities since the dot.com bubble burst a decade and a half ago. Remember? 80% of the ‘new economy’ ended up being a really bad idea and subsequently crashed and burned. The other 20% blew out expectations and became the next Amazon.

 

Welcome to Retail 2017.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.49-1.73%

SPX 2106-2163

VIX 14.01-19.96
USD 94.50-96.29
Oil (WTI) 42.64-45.45

Gold 1

 

Have a great weekend.

 

Brian McGough

Retail Sector Head

 

Circular Cesspool of Despair - mcgough Online Carrying Retail Sales


JT TAYLOR: Capital Brief

 JT TAYLOR: Capital Brief - JT   Potomac banner 2

“I like the noise of democracy.”

- James Buchanan

 

CLINTON TURNS THE PAGE: It’s no secret Hillary Clinton has struggled recently, but her three day rest break may serve as the reset she needed. With 52 days until Election Day, she’ll need to turn the page and focus on the issues. If she continues to hammer Donald Trump, her impolitic comments stay on the front page, but with the race statistically tied, it's more important that she moves on. Moving past her missteps shows her in a positive light - something she currently lacks with voters. Her campaign hopes American voters are ready to shift back to the real issues at hand - immigration, national security, and the economy - areas where Clinton should shine.

 

TRUMP TAX CUT: Trump unveiled parts of his new economic plan, claiming it would create 25 million jobs in a decade and grow the economy by 3.5% per year - strong numbers for a man who continues to criticize economic statistics. His plan would remove millions of low-income Americans from tax rolls and cut no spending from Social Security, Medicare and Medicaid. The benefits sound great and Trump is moving in the right direction with his presentation, but the overall plan lacks detail, and warrants questions on unclear costs.

 

BENEFITTING FROM THE BUMP?: We get it, Trump is in excellent physical health to serve - but that’s not the only thing that is showing healthy signs as of late - his poll numbers have taken a strong jump over the past week. And like we’ve mentioned before, the way the state votes in the presidential election has a direct correlation to the way it votes for the Senate - take for instance OH and NV - both are considered battleground states for the presidential and Senate elections. Earlier this summer, both races tightened up, but are now leaning Republican. If the correlation stays true, and his momentum continues, Republicans could ultimately hold the Senate…and quite possibly take the White House.

 

PROGRESSIVE PAY BACK: The progressive wing of the Democratic party is still feeling the burn from President Barack Obama, and is becoming ill at ease that Clinton isn't one of them - because she’s really not. Progressives have taken steps they feel are necessary, and created a blacklist of individuals they know will not represent them in the Clinton Administration. The list includes many of Clinton’s closest associates, and depicts them as the kind of establishment figures that progressives fear. Clinton knows she has to compensate her allies for their support in her campaign, but it remains to be seen how far she is willing to go to.

 

SUPREME COURT SHOWDOWN: Chatter has quieted down in the corridors of the Senate over Supreme Court nominee Merrick Garland, but the prospects of a Clinton presidency continue. We’ve pointed out that just a few months from now the alternative could be much different - especially if Democrats are able to take the Senate and narrow the gap in the House - and we still feel that way. Clinton has even gone on to mention that she wouldn’t be bound by President Obama’s nomination of Garland and would look elsewhere if she takes office in January with the seat still unfilled - and that indication is enough for us. Republicans need to come around to the notion that Garland may be their best option going forward.

 

FIGHT FOR FINANCIAL REFORM: The tug-of-war over financial services reform continues as the House approved a bill to ease regulatory requirements on private-equity managers, and the House Financial Services Committee moved their long-awaited bill to repeal and replace parts of Dodd-Frank out of committee. The bills, which do not have a companions on the other side of the Capitol, face long odds of ever becoming law and are already facing veto threats from the White House. Financial reform has been on the House Republican agenda for some time now, and even though their efforts continuously fall short, they’re putting down strong placeholders in the event a Republican takes over the White House.


CALL INVITE: ELECTION UPDATE WITH CHARLIE COOK OF THE COOK POLITICAL REPORT: Please join us for a call on Tuesday, September 20th at 2:00 PM EDT with Charlie Cook of the Cook Political Report to discuss his outlook on the presidential race, the state of play for House and Senate elections, and a preview of the upcoming presidential debates later this month. Call details can be found here.


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Five Reasons Why a Freeze Isn't in the Cards

Takeaway: Iran cannot freeze & the IEA now says non-OPEC production will rise in 1H2017. This is anti-freeze to Saudi Arabia.

1. Most important: for Saudi Arabia, it's too soon for a production freeze. The market is still oversupplied with record huge crude inventories. Therefore, in the Saudi’s view, more cap-ex cuts and production declines are needed to bring the market into balance, otherwise the last two years of pain - costing the Saudi’s about $100 billion a year - were for naught.

 

In 2014 when the Saudi’s declined to intervene with production cuts to limit the price slide, the market share strategy was launched. Saudi Arabia realizes they are no longer the only actors affecting oil markets, especially in light of surging US shale production. If the Saudi’s cut production to stabilize prices, they lose market share.

 

The strategy called for a period of low prices that would force production declines in high cost production (shale & off-shore mega projects). After one year, the Saudi’s, and most everyone else for that matter, were surprised at the resiliency of US shale. So the Saudi’s were determined to ride out another year of low prices to starve non-OPEC production. What followed were cap-ex cuts two years in a row and a steady decline in US production. According to the IEA, global cap-ex cuts since 2015 are now at $330 billion, and Wood Mackenzie further estimates cap-ex cuts in global upstream of nearly $1 trillion out to 2020. Meanwhile, US production has steadily declined about one million b/d from a high of 9.5 million b/d n April 2015.

 

But crude stocks are still at record levels – a stark reality that is putting a damper on the market-is-balancing party. The most recent EIA data for the week ending September 9 reported crude stocks were at 510.8 million barrels - up 55 million barrels this year and 100 million barrels above the five-year average.

 

The Saudi strategy has worked. The IEA said this week that Saudi Arabia has ousted the US as the world’s top producer. However, price signals this summer near $50 have slowed declining production. The IEA changed its previous forecast that the market was balancing at year-end and now says non-OPEC production will rise in the first half of 2017. Rising non-OPEC production is anti-freeze to the Saudi’s.

 

So a freeze now would just throw a lifeline to US shale. In our view it is still too soon for any change in OPEC production policy. Saudi Arabia is more nervous about oil at $50 than $40 because they know it keeps US shale alive. The barometer for any new change in OPEC production policy is declining US production and Saudi Arabia wants to see more of it.

 

2. Iran is just nine months into ramping up exports and regaining market share, and simply can't agree to any limits on production now. Since nuclear sanctions were lifted in January, Iran has aggressively entered the market share game. As we forecasted in December 2015, Iran has quickly ramped up production and exports in excess of 700,000 b/d. Two separate independent assessments now peg Iranian exports at one million b/d of crude on the global market.

 

Iranian production has significant implications for oil markets for two reasons: 1) All that new Iranian crude has just replaced the one million b/d decline in US production; and 2) Surging Iranian exports has launched a market share proxy war with Saudi Arabia as both producers go after Asian and European customers. The Saudi’s say their record July production of 10.69 million b/d was needed because “customers asked for it.”

 

Some analysts say that Iranian production is plateauing, and therefore, the timing might be right for a freeze. We don’t necessary disagree that production may have peaked. We said back in December that we thought Iran could reach about one million b/d on their own but to get back to pre-sanctions levels they would need western capital and technology. Nevertheless, arguments that Iranian production is plateauing will fall on deaf ears in Tehran for purposes of the freeze. Iran intends to get back to pre-sanctions production levels at all costs.

 

For its part, Iran has said it cannot participate in a freeze until “it returns to the market share before the sanctions.”

 

3. Iran & Saudi Arabia geopolitical tensions are at sky high levels and don't bode well for a productive meeting in Algeria. Syria has always been a source of intense disagreement between Iran and Saudi Arabia and continues to be so. Iran supports the Assad regime while Saudi Arabia supports the rebels and wants Assad replaced. However, two other recent flashpoints make further cooperation on any front highly unlikely.

 

One is in Iraq, where an Iranian supported militia plotted to assassinate the Saudi Ambassador to Iraq. Media reports say that one of the plotters confessed that an Iranian official developed and oversaw execution of the plan. You may recall that in 2011 Iran was also tied to a failed plot to assassinate the Saudi Ambassador to Washington. The Ambassador at the time, Adel al-Jubeir, is now the Saudi Foreign Minister and the Kingdom’s “bad cop” when it comes to Iran.

 

The other flashpoint is the ongoing war in Yemen where Iran is equipping the Houthi rebels with weapons. An Iranian-supplied rocket was recently fired from Yemen into Saudi Arabia killing two young girls in the Saudi border town of Najran. About 500 Saudi civilians have been killed in border fighting with Yemen. Another rocket also recently hit near a Saudi Aramco facility in southwestern Saudi Arabia setting fire to a power relay station.

 

With the increased rocket attacks by Yemen into Saudi Arabia and the failed Iranian assassination plot in Iraq, we don't have the makings of a productive meeting in September.

 

4. No Iran exemption – a freeze is not a freeze without Iran. President Putin told Bloomberg recently that it would be “unfair” for Iran to be required to participate in a freeze so soon after nuclear sanctions were lifted. Putin’s comments, plus a newly formed Saudi-Russia energy working group, have led many observers to believe a freeze agreement can be reached in Algiers that exempts Iran from participation.

 

We see an Iran exemption has a non-starter for Saudi Arabia. The long-standing Saudi policy is that it will agree to a freeze as long as all producers, OPEC and major non-OPEC, participate as well. Setting aside the non-OPEC producers participation requirement, Saudi Arabia is intently focused on Iranian production. And the policy comes from the top. In April Deputy Crown Prince Mohammed bin Salman (MBS) said “without a doubt” Iran must participate in the freeze. In MBS’ own words: “If all countries including Iran, Russia, Venezuela, OPEC countries and all main producers decide to freeze production, we will be among them." He also added this warning: "If there is anyone that decides to raise their production, then we will not reject any opportunity that knocks on our door.” Fast forward to July, when the Saudi’s hit record production of 10.69 million b/d and August looking just as robust. We take MBS at his word: no freeze without Iran.

 

5. Saudi shift in tone should not be seen as a shift in policy. Public relations have been increasingly playing an important role in oil markets. At his first OPEC meeting in May, new Saudi Energy Minister Khalid al-Falih was the first to appear in Vienna. In contrast, the Iranian minister was the last to arrive walking into his Vienna hotel about midnight the night before the OPEC meeting.

 

Coming off the failed Doha freeze meeting in April that Saudi Arabia was blamed for scuttling and which Iran didn’t even attend, Saudi Arabia is trying to appear more cooperative in dealing with fellow OPEC members and in the process paint Iran as the bad uncooperative actor.

 

After oil markets took a pounding in July, Minister al-Falih made comments in early August about cooperating with other OPEC members "if necessary."

 

Iran has also said it would attend the International Energy Forum (IEF) in Algeria. We think one of the real drivers for Iran to attend is to meet potential crude customers attending the IEF but also to try to appear cooperative with the latest freeze talk.

 

September is historically a challenging month for oil prices with lower demand and refinery transitions. Therefore, we expect to see more “unnamed sources” in news articles talking up the prospects for a production freeze agreement at the end of the month in Algeria. The Saudi’s will play along since they want to be viewed constructively by other OPEC members. But it’s a shift in tone not in policy. Iran cannot participate in a production freeze, and therefore, Saudi Arabia emphatically will not agree.


The Macro Show with Keith McCullough and Ben Ryan Replay | September 16, 2016

CLICK HERE to access the associated slides.

 An audio-only replay of today's show is available here.

 


CERN: Adding Cerner to Investing Ideas (BEAR SIDE)

Takeaway: We are adding CERN to the short side today.

Editor's Note: Please note that Healthcare analyst Tom Tobin will send out a full report outlining our high-conviction short thesis. In the meantime, below is a brief summary written by Hedgeye CEO Keith McCullough this afternoon.

 

CERN: Adding Cerner to Investing Ideas (BEAR SIDE) - z cer

 

Our healthcare team (Tom Tobin and Andrew Freedman) just wrapped up an excellent Best Ideas call (on the bear side) on Cerner (CERN). With the stock bouncing alongside US Equity Beta (a bounce we were setting up for on more #GrowthSlowing data), I say you sell yourself some (insiders have been).

 

Summary: Cerner has secured its dominance as the #2 EHR vendor in the U.S. and #1 Healthcare IT vendor in the world.  While we don't believe this will change anytime soon, we also don't believe they are immune to the challenges of a saturated market with limited replacement opportunity. Using data from HIMSS Analytics, which is inclusive of 100% of hospitals and health systems in the United States, we have constructed a "virtual pipeline" for the entire Hospital EHR Industry.  

 

Based on our analysis, we expect Cerner's core market to slow and likely decline, driving the stock from the current price of $63 to the $50 level and below.

 


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