prev

EYE ON AGRICULTURE - CORN

RISK REMAINS! Corn plant roots are shallow due to flood conditions earlier in the year and are currently more vulnerable to dry weather conditions. This year's crop is pollinating later than normal which puts it in harm’s way for hotter/dryer August conditions. The lateness of the growth could potentially expose the roots to frost. The same situation holds true for Soy.
  • Texas: EPA Administrator Stephen Johnson and Texas Governor Rick Perry agreed to delay the renewable fuels waiver decision - if prices continue to drop during the delay period it becomes more likely that the EPA will deny the waiver (7/24 was original deadline.) Cattle lobbyists maintain that current RFS mandate, coupled with any unforeseen weather issues, could drive corn to $8 for 2009 season when mandatory blending goes into effect. To put it in context: There are 162 operating ethanol plants with 41 under construction or expansion In the US, with almost all running at significantly less than total capacity. Total US ethanol capacity is estimated at 9.4B gallons currently.
  • Canada: C.D. Howe Institute (economic think tank) sponsored study by University of Guelph (top agricultural sciences school in Canada) has stirred protest from bio-fuels industry groups. Study contends that there are no demonstrable environmental benefits of current bio-fuel process. Canadian media have linked study to World Bank report earlier this year which contended that bio-fuels were responsible for 75% of global food inflation.
  • South Korea: Increasing use of black sea barley for stock feed -Ukraine/Russia harvest expected to be good. This potentially has a negative pressure on Barley buyers in NA as Canadian farmers were more focused on Corn & Wheat due to pricing.
This chart shows pricing levels for the most recent closing price next to the prior closing price for CBOT corn futures contracts maturing between September 08 and December 10.
This chart shows pricing levels for the most recent closing price next to the prior closing price for CBOT wheat futures contracts maturing between September 08 and December 10.

Jobless Claims Ramp - The "Trend" Moves Higher

US weekly jobless claims came in at 406,000 this week, up from last week's revised print of 372,000. Both the absolute level of claims and the 4 week average re-assert the concerning "Trend" of a deteriorating US employment picture.

Inflation is dampening, but so is US economic growth. That dynamic needs to be understood.
KM

MCD - MICKEY D’S DILEMMA!

In the second quarter, MCD’s same-store sales increased 3.8% - that’s the good news. The bad news is that 75% of MCD’s same-store sales gain was traffic. With MCD having raised prices by 4%, the average check is declining significantly. Can you imagine what the franchise community is thinking! Inflation is everywhere and people are spending less in our restaurants. But we have more of them!

So what is driving the check lower?

First, the average check at breakfast is lower than the rest of the day. Second, the focus on beverages is putting downward pressure on the check as not every purchase is with a full meal. Third, the push to advertise the dollar menu at the expense of full priced items is putting pressure on the check.

Senior management at MCD believes this is “healthy.” Healthy for whom? To help stabilize margins MCD is dependent on raising menu prices. So the trend is for customers to buy lower priced items and at the same time the company is raising prices.

  • Something has to give!

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

IN CASE YOU FORGOT!

The federal minimum wage will rise to $6.55 an hour on July 24th, the second of three annual 70-cent increases passed by Congress last May. With housing markets collapsing, financial markets in disarray and the economy looking at a consumption recession, the increase in minimum wages could complicate a challenging environment.

Raising the minimum wage over the next two years regardless of changes in economic conditions could accelerate inflationary pressures. In addition to increased labor inflation, restaurants and retailers are among the sectors impacted the most by rising commodity prices and slower consumers spending. If companies try to raise prices to offset minimum wage hikes, on top of current pricing trends, they run the risk of lower guest counts.

This Bull Isn't Spanish

This bull is Asian. This bull is Small Cap. This Bull is Short Interest – This bull is a stock picker!

This is a bull shark ripping the underbelly of everything complacent and consensus. The last thing you want to be short out there in these trading waters this morning is a high short interest Chinese internet company like say, Baidu.com (BIDU -trading +13%). Realizing that you’re smarter than everyone else didn’t pay you staying short the US Financials this past week, nor is it going to pay your “fundamental” short Amazon (AMZN) or Qualcomm (QCOM) bets this morning (they’re trading +8% and +10% respectively). If you’re short a trifecta ticket with Chipotle (CMG), Sketchers (SKX), and Ryland (RYL) – you’re a winner!

CMG and SKX are trading down -12% and -13% pre-open, respectively, and yes they have high short interest – but that factor gets wiped aside on alpha day, so be careful out there – some of these bulls are not like the others. I have to give some Obama knuckles to my partners, Brian McGough and Howard Penney, for nailing these two shorts in their portals. Great job, Gentlemen.

I know this has to be a frustrating month for some, if not for many. I’ve been bearish on the market’s “Trend” for 9 months, but I’m having another good month riding this bull “Trade”; lucky me, I guess. Understanding where we go next continues to weigh to the bullish side of an extended “Trade” higher, and as depressing as my notes may have been in months past, it is only too ironic that I am depressing the shorts with these key strokes. This is a complex market system of interconnected factors. They change daily, and they must be respected.

In the last 72 hours we’ve been issued macro facts that are outright bullish. Most of these factors center around deflating an inflation bubble. You can find these facts littered all over the world. They’re fairly straightforward too. So let’s go through a list of 9 bullish factors, for starters:

1. Oil broke my support level of 126.16
2. CRB Commodities Index broke my support level of $428
3. US Dollar recovered from crisis zone, through my resistance level of 72.61
4. US Treasury 10 year yields rallied through my resistance level of 4.05%
5. Brazil raises interest rates overnight to 13%, and remains hawkish
6. US Federal Reserve rhetoric changes to explicitly hawkish after Plosser and Bernanke comments
7. Canadian and Brazilian stock markets continue to break down (Food and Oil inflation proxies)
8. Russian, Norwegian, and Middle Eastern equities (Energy inflation proxies) continue to break down
9. Asian currencies and stock markets strengthen in tandem

The facts have changed, and unless these levels reverse in unison, there is no reason to be short this bull shark. That does not mean I want to buy everything. That certainly does not mean I want to run out and buy US Financials after they have ripped the shorts for a +30% 6 day move. It means, I don’t want to be long commodities (including Gold); and it means I want to be picking stocks, assets, and country’s that fit the macro short squeeze profile. Vietnam reported the 1st of global inflation numbers we will see for July, and it was the 1st sequential deceleration since guess when – October 2007. I am looking for CPI and PPI July inflation reports to decelerate, globally.

China traded up +2.6% overnight to 3053 on the Shanghai Index. As I said yesterday, that’s a contrarian macro “Trade” that I think works. Conversely, a country that’s levered to the Euro pinned up at 1.57, and hostage to their own balance sheet malaise like Spain is, should be avoided like the bubonic plague. Spain reported a whopper of an unemployment number this morning at +10.4% year over year, and Spain’s stock market is trading down -1.1% as a result, taking its cumulative losses from October 2007 to -26%.

This bull is a “Trade” that can run for longer than some “wanna be” short sellers can remain solvent. This bull isn’t Spanish. This bull needs to be understood.

*Full Disclosure: I am long FXI.
KM



SKX: Management Needs to be Schooled

This quarter is a great example as to why SKX has been on my ‘avoid like the plague’ list. I’ve been getting a lot of pushback on this one because it looks so dang cheap. But appearances can be deceiving – especially when a 4-year positive fashion cycle and an 8-year ‘easy-money’ supply chain collided to lift margins near peak levels of 8-9%. Now we’re seeing SKX invest in the wrong initiatives at the wrong part of the cycle. People get hung up on the conference call about the impact of American Idol endorsements, and Cali Gear sales (Crocs knock-off). At the same time SKX is pushing hard to grow when the market for its product is changing for the worse and margins are taking a hit. Quite frankly, I could care less about the David Cook endorsement right now. Skechers is trying really hard to grow, and the real question for me is whether it should simply change its colors -- pull back on capex and working capital, boost margins, and flat-line sales. Ordinarily that’s really bad for a small cap growth company’s multiple. But at 6.5x EBITDA, the risk of multiple contraction would be pretty slim. In fact, I’d argue for multiple expansion given the ensuing cash flow stability. Instead, SKX is taking the aggressive path and is trying to grow when it shouldn’t, and is therefore likely to take margins another 3+ points lower over 2 years. That means that the stock looks cheap today at $23.74, and will look expensive in 12 months at $15.

I always pause and consider the contrarian case when I have so many reasons to be negative on a name. But there really were not many positive factors coming from this quarter. Here’s a couple worth pointing out.

1. The quality of earnings was abysmal. Sales +1%, EBIT -8%. The way I am doing the math, FX helped the top line by about 3.8-4% (management danced around the question and did not provide an answer on the call). Assuming a 25% flow-through rate, this helped EPS by about $0.04, pegging real EPS decline of about 15%.

2. While I’m on the topic of International, I still do not understand why this company should grow internationally!! It is a knock off company. Real aspirational brands work overseas. When brands don’t matter, then it’s speed to market, local consumer expertise, and low cost production that does matter. Perhaps with the exception of speed to market, I don’t think that Skechers excels at any of those things. The real challenge is that SKX falls squarely into the bucket of a company that has not managed through an unfavorable FX cycle. I challenge anyone to find me a company in retail that came out of its first negative FX swing with flying colors. I’ll dare not ask the question as to whether this management team is conservatively assuming that Big Ben will play some offense, take rates higher, and get the dollar to reverse course.

3. It’s clear from my sources as well management’s comments that the ‘low profile’ shoes that drove SKX’s business are seeing impact from what I think is a sustainable long-term downtrend (my 6/4 SKX post).

4. Bad debt exposure heading higher. With disproportionate exposure to troubled mid-tier retailers vis/vis its share of the total market, I think that the hits we’re seeing from Goody’s and Shoe Pavilion will only be the beginning. I guess a bigger question is why SKX is increasingly showing up as a large creditor (with Goody’s being the best example). That probably points back to the fashion shift and the need for SKX to find non-traditional channels for its wares.

5. I love watching the progression of how a management handles their respective business in different market environments. SKX is a textbook example of an organization that simply does not learn from its mistakes – specifically as it relates to inventory/margin trade-off. Check out my little Sales/GM/Inventory analysis. The vertical axis measures sales growth less inventory growth (i.e. a higher number is better) and the X axis measures the yy change in Gross Margin. Plotting SKX’s path over 2+ years is simply classic.

The narrative sounds something like this…
a. 1Q06-2Q06: “Business is solid. We’re on trend and margins are up. Life is good. Let’s order more stuff.”
b. 3Q-6-1Q07: Ok margins are still decent, but inventory is building. We’re gonna hang on under the assumption that we can sell this built-up inventory at a respectable margin.”
c. 2Q07: “We were wrong. Inventories are still too high, and now margins are down Ouch!”
d. 3Q07: “Ok, we messed up. Let’s clear the inventory – even if at an undesirable margin.”
e. 4Q07-1Q08: “We’re geniuses. Problem solved, and now we’re back on trend. Let’s up our growth plans again.”
f. 2Q08: “Uh oh. Inventory building and we’re back to where we started.”
A classic example of how not to trade off the income statement and balance sheet in retail -- courtesy of SKX execution. See color above.

the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

next