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"Hope is not the conviction that something will turn out well but the certainty that something makes sense, regardless of how it turns out”

-Vaclav Havel


HOPE is not an investment process, but I HOPE the EU and Ben Bernanke get it right.  As Keith McCullough posted yesterday he thought the prepared statement was “refreshingly objective” in saying the Federal Reserve will raise the discount rate “before long.”  This is an explicit change in the Fed’s language; a change we thought should have come in January. 


The two dominant MACRO factors at work yesterday were the fiscal challenges in Europe and Ben Bernanke testimony that wasn’t.  On the lack of conviction on how this is going to end, the S&P 500 finished lower by 0.22% on very light volume.   Although, the light volume is likely more a function of the East Coast snowstorm.


In our multi-factor model, the VIX was the only factor that suggested a continued benefit from the RISK AVERSION trade.  The VIX closed down 2.3% to 25.40, but is still bullish on TRADE and TREND. The Hedgeye Risk Management models have the following levels for VIX – buy Trade (22.40) and Sell Trade (28.34). 


The favorable risk implications are emanating from increased expectations for some kind of Euro/German rescue package for Greece and other troubled European nations.  Greek Prime Minister George Papandreou is on the tape saying he does not need help, but has apparently hammered out an aid package.  The Dollar index (DXY) gained some strength yesterday finishing up 0.21%.    The Hedgeye Risk Management models have levels for DXY at – buy Trade (79.69) and sell Trade (80.67). 


Yesterday, the Consumer Discretionary (XLY) underperformed the S&P 500 and broke TREND, leaving Healthcare as the only sector positive on TREND.  Although it should be noted that the XLV was the second worst performing sector yesterday, declining 0.6% 


The only sector up on the day was Financials (XLF).  The money center banks bounced yesterday from the benefited of the RISK AVERSION trade; the two standouts were BAC and JPM.  Outside of the banks, the asset managers outperformed too.


The strength in the DXY and earnings miss put pressure on the Materials (XLB), the worst performing sector yesterday.  The XLB declined 0.7% yesterday, with the weakness focused on the steel sector. ArcelorMittal announced below consensus Q1 EBITDA guidance, as higher shipments will be offset by lower ASPs and increased costs.  Ah yes inflation!


As we look at today’s set up, the range for the S&P 500 is 31 points or 2.1% (1,045) downside and 0.74% (1,076) upside.  Equity futures are currently trading above fair value in a follow through to yesterday's late day bounce and the EU support of Greece. 


Copper climbed the most in almost three months in London as lending increased in China and employers added jobs in Australia, improving the demand outlook.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.82) and Sell Trade (3.14).


The correlation for gold continues - gold is trading lower on the back of a stronger dollar.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,044) and Sell Trade (1,111).


The International Energy Agency raised its forecast for global oil demand this year as developing countries need more crude to fuel their economies.  Oil has traded higher for the last three day and looks to be up again today.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (70.11) and Sell Trade (77.26).


Howard Penney

Managing Director














Li Ning: Lighting a Match in a Dry Forest

When we hosted our call in early January discussing our Top 10 ‘Predictable Unpredictables’ (events that we assign a better than 60% chance of happening, but the consensus is not focused on) for the global softlines supply chain for 2010, we discussed the Chinese Import factor.  We’re not even through February and we’re already getting confirmation.


What kind of risk? (for those of you that did not participate in our call).  No, it’s not COGS. The consensus finally caught up to that one. Yes, we did discuss changes in the free trade environment in Asia, and the dollar falling out of favor with Asian factories. That’s definitely a concern. But the risk I’m referring to here is Chinese content/brands transplanting themselves onto US soil. Yes, Reebok has all but gone away, and Adidas is weakening. But a brand like Li Ning or Anta could come along and gain a couple of points of share of the $20bn athletic footwear market at the drop of a hat.


Well folks, Li Ning has just opened its first US showroom in Sneaker Valley – otherwise known as Portland, OR – where just about every viable player in the US athletic market has established a presence to attempt to raid Nike’s talent.


Li Ning is launching a press event on Monday focused around the launch of the ‘BD Doom’ game shoe, which is designed for LA Clippers’ star Baron Davis.  As a point of reference, other Li Ning NBA athletes include Shaq, Jose Calderon (Raptors) and Hasheem Thabeet (Grizzlies).


As a sidenote, this is either really good timing, or really bad timing for Li Ning. Nike is going on offense again, and the BD launch surrounds an athlete who is at a critical and questionable tipping point.


No one would accuse Davis of being in good form these days. And with Mike Dunleavy stepping down as the Clippers’ coach last week, Davis lost his last ‘loser’ excuse on a coach who is a control freak.


In his own words “I got to go out and get back to being my old self now. [Interim] Coach Kim is going to allow me to be a little bit freer and play off instincts. So, I just got to get back to that mentality. From there, I think everything else will take care of itself.”


You better, BD. Li Ning is betting on you.


Regardless of Davis fate, this move by Li Ning won’t be the last. I actually think that this is very good for the industry. The ONLY time the US athletic footwear industry could be accused of being healthy is when there was someone stepping up to challenge Nike. Under Armour will do so in 2010, and some foreign content will keep Nike on edge. That’s when it performs the best. All these things add up to better product, and better comps for retail. It turns out to be less about market share and more about growing the market. As I’ve been saying, I have a high degree of confidence that we’ll finally return to growth in the footwear market in 2010.


Li Ning: Lighting a Match in a Dry Forest - shoe


Li Ning: Lighting a Match in a Dry Forest - shoe2


Chipotle is scheduled to report 4Q09 earnings after the close tomorrow, and based on the company’s recent track record (as shown in the chart below), it will likely beat street estimates.  I am modeling EPS of $0.84 versus the street at $0.81.  If my number is right, this outperformance would not come even close to the 26% earnings upside in 3Q09, but as the chart below also shows, this earnings beat was still not enough to get investors excited as the stock traded down 8% the following day.


CMG – WHERE TO FROM HERE? - CMG eps vs estimates


Investors have become accustomed to better-than-expected earnings, so what has mattered more is the trend in top-line numbers.  In 3Q09, the 150 bp sequential slowdown in 2-year average trends helps to explain why the stock performed so poorly.  To that end, we could see the stock trade higher on Friday as my estimates assume +2.3% same-store sales growth, better than the street’s +1.4% estimate.  Going forward, however, I would expect comparable store sales trends to get worse as we move through 2010, even if traffic trends on a 2-year average basis get less bad, which should influence CMG’s stock performance.


Throughout the third quarter, CMG’s EBIT margins have improved on a YOY basis in 2009, with the company operating at peak margins during 2Q09 and 3Q09 of 15.1% and 14.5%, respectively.  The company’s return on incremental invested capital has also moved higher in 2009.  These peak margins and returns are also reflected in CMG’s peak multiple.  The company is currently trading at nearly 11x on a NTM EV/EBITDA basis relative to the QSR average of 8x.


I have previously said that a restaurant company’s stock price performance is often highly correlated to the direction of returns and as the second chart below shows, this has been true for CMG.  The current direction of returns often impacts if a stock will move higher or lower and CMG’s trajectory of returns as of 3Q09 puts CMG in a seemingly favorable position.  So the most important question is whether the next leg is up or down and as I see it, CMG’s peak margins and returns are likely to roll over. 


CMG – WHERE TO FROM HERE? - CMG ebit margin 3Q09




In 4Q08, CMG rolled out a 6% incremental price increase, which helped to leverage the company’s P&L at a time when traffic was negative and deteriorating further on a 2-year average basis.  The 6% pricing impact from 3Q09 will come down in 4Q09 to +2.5% as we lap the 4Q08 price increase.  The company will have flat pricing as of January 1 and as of the last earnings call, did not expect to take any pricing in 2010 until management saw an uptick in consumer spending. 


My +2.3% same-store sales estimate for 4Q09 assumes some improvement in traffic trends on a 2-year basis (most likely the primary difference between my higher same-store sales estimate and that of the street’s) as we have seen sequentially better numbers in the fourth quarter from those restaurant concepts that attract higher income consumers.  Even so, EBIT margins should begin to roll over in 4Q09 from the peak levels earlier in the year.  I am expecting continued YOY margin growth but of a lesser magnitude than in the prior three quarters.  Some of this sequential decline in margins is explained by the fact that the fourth quarter typically results in lower margin and also the company is opening considerably more restaurants during the quarter, which implies higher preopening expenses and increased inefficiencies on the labor line.  The roll off in pricing also removes some of the leverage in the model and will have a bigger impact in 1Q10 when I would expect margins to begin to decline on a YOY basis.


Also impacting margins in 2010 is the fact that the company is forecasting low single digit food and labor cost inflation after getting significant leverage on both these expense lines in 2009.  In describing the gives and takes in its operating model, management stated on its last earnings call, “The way to think about it is in a perfect world if there was zero inflation and you had zero comps, our margins would hold up exactly as they are today. If you have a little bit of inflation - let's say it's 1% inflation across the board, across labor, across food, across everything - that would hit your margin for about 70 basis points; 2% inflation across everything would hit you for about 140 basis points.”  As I just said, management is not expecting zero inflation, but is expecting flat comps and the resulting impact on margins is obvious.  To be fair, management’s comp guidance assumes no improvement in consumer spending, so it might be somewhat conservative, and a lot will depend on whether management changes its stance on pricing in 2010. But, as I see it, operating margins are coming down in 2010.


Declining margins never bode well for returns and in my opinion, nor will the company’s new real estate strategy.  In 2010, CMG currently plans to open 120-130 new restaurants, even with the expected level of openings in 2009.  However, due to the “recent pressure on developers and the corresponding reduction in number of new developments currently available for [CMG] to buy or lease” (as cited by the company), CMG is now pursuing a new real estate strategy.  In the past, the company only opened restaurants in what it deemed “tier 1” trade areas.  Going forward, management plans to still open about two-thirds of its new units in these “tier 1” areas, but due to the limited number of opportunities, it will also pursue what it is calling “A model sites,” which it says are “tier two trade areas which still have attractive demographics typically characterized by lower occupancy costs and develop for a substantially lower investment cost.”


This new strategy will put pressure on new unit AUVs as the A model sites are expected to generate about $1.1 million in sales volumes, which is below the company’s average opening range of $1.350 million to $1.4 million.  In the past, CMG has built two-thirds of its new sites in proven markets, which yields opening volumes above its average new unit volumes and one-third in new and developing markets, which come in below average at $1.1M.


For 2010, CMG is planning to build 25% of its new openings as A model locations.  Initially, CMG said it will build these A models in proven markets, which means these relatively lower AUV new builds will take away from the higher volumes typically generated in proven markets.


Tier 2 sites are still expected to achieve cash on cash returns in the mid 30% range because the lower development, occupancy and operating costs will offset the lower expected sales volumes.  These new “A model sites” will not pose a problem should they generate the expected returns, but it always concerns me when a restaurant operator appears to be compromising its real estate decisions in order to maintain growth.  The fact that the company said it will pursue as many tier 1 locations as it can implies that they are still the preferred sites.  To that end, the tier 2 locations signal less discipline on the part of the company for the sake of maintaining growth.  These types of compromised real estate decisions often lead to declining returns.  And, increasing penetration of proven markets could put the company at risk of cannibalizing sales going forward.  That would not be a new story for a restaurant company.


Howard Penney

Managing Director

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JNY: ‘They’re Baaaaack!’

JNY:  ‘They’re Baaaaack!’


JNY is morphing back to its old value destroying self again – both financially and behaviorally. JNY may have one quarter left of salvation, but then it’s gonna get ugly. The market is blissfully unaware of what lies ahead.



In case you weren’t counting, three of the seven analysts on the JNY call congratulated JNY on ‘a quarter well done.’  Am I the only one that hates when I hear someone being congratulated for doing their job – and a mediocre one at that? How’s that for a company that preannounced negatively a week ago, and put up a loss of $125mm thanks to yet another write down of its marginal assets.


I increasingly do not like this name. I’ve avoided being on the short side for the past three quarters as management simply had too many easy levers to pull to maintain momentum -- regardless of whether these levers should be pulled at all. Now we’re at a point where the incremental upside will be tougher to come by.  


Let’s consider the facts…


1. Wholesale Better Apparel (29% of Revenue and 55% of cash flow): Just printed an 11.2% margin – up 128bps from a year-ago. This margin absolutely HAS TO hold, which is a stretch. With so-called ‘bad business’ already having been pruned (i.e. lost), the natural mix shift to a better book is not going to recur. JNY will get about a 3% top line boost due to its Rodriguez acquisition and from jump ball business created by LIZ hopping in the sack with JCP. But on the same token, with LIZ no longer at Macy’s whim, JNY will see added pressure for markdown dollars at quarters’ end by the 900lb gorilla – even if it is not JNY product that is not selling through. This also holds true for Jeanswear and Footwear.


2. Wholesale Jeanswear (24% of revenue and 35% of cash flow): Let’s face an ugly reality. This business just printed a +3.5% top line, but a 385bp improvement in segment margins, and it just highlighted a major roll over this quarter in top line due to anniversarying a big push last year with l.e.i., and increased competitive pressure. This was also the source of JNY’s asset write down. Margins in ’10 are not looking good here.


3. Wholesale Footwear (26% of Revenue and 30% of cash flow): This business is the poster child for a wholesale business that benefitted from the boot cycle. Could it last another quarter? Maybe. Another year (of sequential improvement in trajectory of boot sales)? Not likely – by a long shot. The company is guiding for 4-9% top line growth for ’10. This looks like a stretch without meaningful margin erosion.


4. Retail: (21% of revenue and -20% hit to cash flow): Here’s where I’m most concerned. JNY is in store closing mode, and 1Q alone should see a double digit revenue hit due to 50 fewer stores, and that should accelerate to 165 stores by end the of the year (it closed 96 in 2009). Also, retail has been a beneficiary of the boot cycle – something that’s not likely to recur in 2010. Management is on record as saying that it will break-even at retail this year. That might seem impressive in looking at the $41mm loss JNY just printed at retail. But read the fine print – that is ‘before corporate allocation.’  We estimate about $40mm in corporate expenses, or about $12mm at retail. So ‘breaking even’ actually equates to losing a double-digit number in what is reported to the Street. You can’t cut a business to profitability long-term. Ultimately you need to sell stuff that the consumer wants.


5. Balance Sheet: Lastly, let’s consider this thing called the balance sheet. On the plus side, JNY printed a commendable 18 point spread between sales growth and inventory growth. But how much longer is that sustainable for? Working capital should be helped by store closures, but keep in mind that in 2009 working capital was accretive to cash flow from operations to the tune of 29%. That’s the SAME year when capex as a percent of sales came down to 0.9%. Yes, boys and girls, that’s 0.9%. Can someone find me any company that touches this industry that can sustain a capex rate below 1%. Thanks in advance. In fact, JNY already guided that capex is going up to 1.5%, or about 55-60%.


6. Buy, Buy Buy. Another note on cash. JNY did not buy back stock this quarter, and in fact it issued a small amount. The company said flat-out that it is in full-on deal mode. No stock repo, no debt paydown. They’re gonna buy something. Let’s look back at JNY’s track record of acquisitions. Actually, let’s not. It’s too depressing. Just take a quick glimpse at long-term return on capital.


The bottom line here is that JNY is easing back into the ‘old Jones’ mindset. Cut when you should invest, and acquire when you can, not when you should.  Let’s not forget that this is a company that historically traded as low as 3-4x EBITDA and 9-10x EPS, and had up to 35% short interest. Today it is at 6x EBITDA, 14.5x earnings, and has a paltry 6% short interest. Some might argue that 6x EBITDA is not expensive. And overall, it’s probably not – IF they believe in the stability of cash flow. I’ll go to the mat with them on that one!


-Brian McGough


JNY:  ‘They’re Baaaaack!’ - jny


JNY:  ‘They’re Baaaaack!’ - jny2



Risk Management Time: SP500 Levels, Refreshed...

This tape definitely has the continued potential to frustrate people. I think we are going to continue to trade in a range with a bearish bias.


Chasing the snap-back intraday rallies is going to be a monkey’s game. Shorting/Selling the high end of the range and Buying/Covering the low end should really drive some alpha. I outline this range (1044-1076) in the chart below. Unless we can clear and close above the 1076 line (dotted red), I think we’re going to keep grinding between 1044 and 1076.


Because plenty of the monkeys have been distracted with European sovereign debt news doesn’t mean the rest of global macro ceases to exist. There are 2 big game changers out there that are mutually exclusive to where Greek CDS trades on a tick:


1.       The US Dollar

2.       China


On the US Dollar front, the Buck Breakout looks poised to continue, making a series of intermediate term higher-highs and higher-lows. Staying ahead of Bernanke’s changing rate rhetoric should lead you to water on your US Dollar positioning. What is good for the dollar is bad for reflation trades, commodities, etc.


On the Chinese front, tonight we are going to get another inflationary CPI report. While the precedent for one of those inflation scares is backward looking (last month), it really started China’s recent -10% correction. It deserves your risk management respect.


China was up +1.1% last night and could easily get rocked tonight. If that happens, I’d consider an SP500 test of 1044 probable in the next 3 trading days.



Keith R. McCullough
Chief Executive Officer


Risk Management Time: SP500 Levels, Refreshed...  - lsp


He Who Sees The Light?

If you didn’t know why everything “reflation” has been getting crushed for the last 3 weeks, now you know…


In a refreshingly objective prepared statement today, Ben Bernanke said the Federal Reserve will raise the discount rate “before long”…


Make no mistake folks – this is an explicit change in the Fed’s language. I have been saying for some time now that the current language of “exceptional and extended” was both unsustainable and unreasonable. Apparently the Greenspan Group-thinkers are starting to see the light.


My immediate term downside target in the SP500 is now 1044. I am not in the camp that a Fed hike (or implied hike due to the change in the language) is going to crush stocks to smithereens. I simply think they are going lower, for now.


Goldman Sachs has set unreasonable expectation that the Fed is going to maintain a zero percent rate policy in perpetuity (until 2012).


As Shakespeare said, “expectations are the root of all heartache.”



Keith R. McCullough
Chief Executive Officer


He Who Sees The Light? - bernspan


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