US STRATEGY - From Greece to China

Ahead of the long weekend the S&P 500 declined 0.27%, on a 35% increase in volume.  The global MACRO issues that are focused on Greece and China continue to drive sentiment.  On Friday, it was China’s turn to take center stage.  Seven of the nine sectors we track outperformed the S&P 500, but we only have two sectors positive on TREND - Healthcare (XLV) and Consumer Discretionary (XLY).  The Industrials (XLI) broke TREND on Friday. 


With the XLI breaking TREND on Friday it was the worst performing sector.  Some of the underperformance can be tied to tightening in China and worse than expected GDP numbers in Europe, which is weighting on the global RECOVERY trade.


Last week China hiked the Reserve Requirement Ratio for banks by 50 basis points; this follows a 50 basis point hike in January.  Concerns regarding Greece will not go away, as there does not seem to be real commitment buy the EU on how it will help out Greece.  The EU also has a lack luster economy to deal with.  The 16 country Euro area reported Q4 GDP of +0.1% sequentially vs. consensus +0.3% and prior +0.4%; dragged down by Germany reporting flat Q4 preliminary GDP vs. consensus +0.2% and prior +0.7%.


All of this was good news for our “Buck Breakout” theme. The Dollar index up 0.40% last Friday; the Hedgeye Risk Management models have levels for DXY at – buy Trade (79.60) and sell Trade (80.80). 


In the US, the January retail sales +0.5% vs. consensus 0.3% and prior of -0.3%.  As we wrote about on Friday the February University of Michigan Confidence preliminary number was 73.7 vs. consensus 75.0 and final January 74.4.


Consumer Discretionary (XLY) and Consumer Staples (XLP) outperformed the S&P 500 on the better than expected January Retail sales report and despite a disappointing preliminary February University of Michigan Confidence came in lower than expected and below last month. There were a number of earnings among the Restaurant industry; CAKE, CMG and PNRA were significant outperformers, while BWLD was the biggest loser.


On Friday, Technology was the best performing sector rising 0.2%.  MOT and the semiconductors were a source of strength.


Last week the VIX declined by 12.95% and closed at 22.73.  The Hedgeye Risk Management models have the following levels for VIX – buy Trade (22.05) and Sell Trade (28.27).  As we look at today’s set up the range for the S&P 500 is 53 points or 2.6% (1,046) downside and 2.2% (1,099) upside. 


At the time of writing, equity futures are trading above fair value as investors return from the Presidents’ Day extended weekend.  European markets were broadly higher with Financials outperforming following the earnings from Barclays. 


In early trading, copper rose for a second day as the dollar weakened.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.99) and Sell Trade (3.21).


In early trading gold is trading at a two-week high.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,046) and Sell Trade (1,121).


Crude oil rose as much as $1.33, or 1.8%, to $75.46 a barrel in New York.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (70.38) and Sell Trade (77.17).


Howard Penney

Managing Director


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The Week Ahead

The Economic Data calendar for the shortened week of the 15th of February through the 19th is full of critical releases and events. This Sunday marks the beginning of the Chinese New Year; additionally many markets globally are closed Monday for holiday. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


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Brazil's Developing Dirt

As a proactive global risk management exercise, we have recently focused our Hedgeyes on Brazil’s domestic newspapers (reading them in Portuguese).


Here are a few interesting takeaways that we have translated for you from this week’s domestic news. Ultimately, the US media focuses very little on the macro issues in Brazil, and we think there is an opportunity to be your risk manager calling out macro risks as they develop.


Political Corruption

11 – 12 February 2010 – O Globo (Brazil)


Jose Roberto Arruda, Governor of Brasilia, the nation’s capital city, has surrendered to Police in a corruption probe. 

Arruda is charged with accepting bribes in connection with awarding government contracts.  He was videotaped last year accepting bags of money and the video was YouTubed around the country.  His explanation at the time was that he was accepting donations to help him launch a program to distribute free panettone cakes for the city’s poor.  I kid you not.


One of the key witnesses in the government’s case claims he was offered a half million dollar bribe to reverse his testimony.


Five alleged co-conspirators have also been named.  Arruda was part of an opposition that had hoped to campaign against Dilma Rousseff, Lula’s hand-picked successor, partly by dredging up corruption charges that had been raised during Lula’s earlier presidential campaign.  It didn’t work against Lula then, and it doesn’t look like they will be able to use it now.  NB: Lula is leaving after two terms with something like an 81% approval rating.  This is amazing for a head of state who is not a dictator.


Lula expressed his concern about the implications of the arrest for the integrity of the political system – this is the first time in Brazil’s history as a democracy – post military dictatorship – that a high level official has been charged with corruption.


Social Unrest

O Globo 11 February – One of the directors of the social activist group Nos do Morro was found murdered in Rio de Janeiro.  Jose Frederico Pinhiero was found with his throat cut after being reported missing by his family.


Nos do Morro is a major Rio de Janeiro not-for-profit cultural and social welfare group founded in 1986.   It combines cultural activities with social programs in the Morro de Vidigal neighborhood of Rio.  It has programs designed to keep kids in school and promotes local culture.  Group members have been featured in national and international venues, including appearing in such internationally known movies “City of God.”


A related cultural group, AfroReggae, was also victimized.  Its leader was attacked and robbed.  The assailants were caught on street cam video but have been released on their own recognizance, pending court proceedings. 


[COMMENT: It is not clear to me whether there is police, or other government support for attacks against successful grass roots social programs, but clearly there is no immunity for the Good Guys caught between those warring for control in the inner city.  If these high-visibility champions of the inner-city poor are also their victims, one has to wonder how successful the government will be in cleaning up crime and violence in advance of the World Cup and Olympic Games.  This could get extremely ugly.]


Moshe Silver and Keith McCullough


Early Look

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FL: Thinking and Doing

When we originally wrote our “wishlist” (see note from 12/17) for Foot Locker, one of our key points highlighted the company’s opportunity to both right-size and optimize its 3,700 store portfolio.  We’ve already gotten confirmation of some store closures, and now we’re “seeing”  some efforts to optimize.  It appears that Foot Locker is converting its Union Square store in Manhattan into a new concept called, RUN by Foot Locker.   While no formal announcement has been made regarding this prototype, it’s currently under construction and in plain view.  Clearly if management wanted to keep this a secret they wouldn’t have picked this location…


FL: Thinking and Doing - FL RunSign 2 10


With our retail detective hats on, we observed several individuals working inside the store yesterday, mostly testing different wall displays.  The inside of the store is still very much in a raw state, so it’s probably at least a few weeks before we actually see any signs of opening.  Nonetheless, we view the idea of a running concept as a step in the right direction and potentially integral to the segmentation efforts needed to differentiate the chain (both amongst competition and itself).  As a reminder, running is the largest sub-segment of the athletic footwear market with nearly $5 billion in sales at retail, and one that has been showing substantial growth for about a year.  Additionally, while none are publicly traded, there has been an increase in the growth of specialty running stores over the past few years with the likes of Fleet Feet, Road Runner Sports, and others.  


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Unique to any credible running effort is a wide selection of technical brands and most importantly customer service.  In running specialty stores there is very little price promotion or discounting.  Maybe a loyalty program to foster repeat business, but barely any POS promotions.  Wouldn’t that be a change for the historical champion of the BOGO strategy? While it’s too early to tell exactly what Foot Locker is planning for its price/value message here, there is no question that running shops make up for discounting with exceptional customer service.  Which from a runner’s perspective, typically includes personalized fitting, gait analysis, and other technological innovations aimed at matching the customer with the ideal shoe.  


Another key aspect of specialty running shops is community involvement, which often makes the stores a hub for marketing local events, classes, and outreach.  Yes, they’re very Lululemon-like when it comes to mixing commerce with true passion for the sport.  Clearly there is work to do here as the concept evolves, but building a service oriented culture could have substantial ramifications not just for a running concept, but for the entire chain.  After the store opens, we look forward to a field trip to test out this theory.


Another thought… is this a way to diversify away from Nike without changing Nike’s space allocation at existing Foot Locker stores? That would be a margin boost for FL – to the extent it can still drive traffic. In a category like running, that would probably not be a problem.  But on the flip side, our sense is that FL tests some Nike mono-brand stores, where FL will carry the real estate and fixtures, while Nike will sell in as a wholesale model.


Will these work? We don’t know, and for now we don’t care. Test or no test, the bottom-line here is Foot Locker’s new leadership is thinking and doing.   We’re on the cusp of hearing more details about the broader strategic plan, but again this is a step in the right direction.  It certainly seems like a better idea than long lost Footquarters.  We also suspect this isn’t the only idea to come from management.  Now if only all of these “labs” were in a 1 mile radius of company headquarters it will make the detective work much easier…


- Eric Levine


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As we previewed yesterday we thought consumer confidence in February would not live up to expectations….


The Reuters/University of Michigan preliminary consumer sentiment index dropped to 73.7 from January’s 74.4 reading and expectations of 75.0.  How can this be happening at a time when GDP is 5.7% in 4Q09 and the unemployment rate unexpectedly dropped in January?


Here is my list (feel free to add to it if I miss anything):


(1)    40% of American STRONGLY DISAPPROVE of the way President Obama is performing.

(2)    While the U.S. unemployment edged downward in January, consumers still appear a little wary about the labor pool.

(3)    Those with a job are worried about becoming laid off.

(4)    For most consumers paying down debt remains the priority.

(5)    Most consumers are focusing on needs over wants.

(6)    3, 4 and 5 suggest that most consumers are just not that comfortable with their financial standing.

(7)    The market’s decline at the end of January appears to have rattled investor confidence this month.

(8)    25-30% of consumers are underwater with their mortgages.

(9)    This winter sucks.


Ben Bernanke recently said the Federal Reserve will raise the discount rate “before long.”  With conventional mortgage rates around 5% and likely headed higher this could deflate very important assets on the consumer’s balance sheet.  It’s unlikely that current conditions are going to improve to a degree that we see any significant move to the upside in consumer confidence. 


Howard Penney
Managing Director








  • While the domestic new construction sales environment in NA will remain challenging, they will benefit from conversions when M&A activity picks up
  • See tremendous growth for their conversion brands
  • Returned 90% of their generated cash flow through dividends and buybacks in 2009
  • Grew membership in Choice Privileges (CP) by 2MM, and now CP members now deliver 25% of gross revenues. Hope to add 2.2MM CP members in 2010
  • New construction franchise sales are more impacted - declined 72%. Conversion sales decreased 32%
  • Repurchased an additional 200k shares through Feb 11, 2010
  • Had $65MM R/C availability as of Feb 11, 2010
  • It's clear that conversions are where the action will be for the next 18 months


  • Conversion demand outlook?
    • New construction demand will be challenged with the lending environment through 2011.  However, when it comes back it will come back first to limited service.
    • Conversions will accelerate when they feel more comfortable that trends have bottomed and when transaction volumes pick up.  Independent conversion is also an opportunity.
    • In the meantime, they have the ability to incentivize some deals by providing sliver capital
  • Why does upscale makes sense for them
    • Because they are unrepresented there... need to be in more urban locations, which tend to be more upscale and upper upscale opportunities. Will also give them the opportunity to grow more internationally
    • Hope that they will find the right opportunity this year
  • Why is Comfort Inn room down sequentially?
    • "pruning" hotels that aren't meeting brand standards and moving a significant number of those into Quality bands
  • Why are they confident that their limited service brands will see a steep RevPAR recovery throughout the year
    • They usually are a few quarters behind full service.  Believe that there will be an upturn in RevPAR mid year, and that they will have a more dramatic recovery in back half
    • RevPAR in Q2-Q3, down mid single digits and Q4 flat
    • Q1 gets less weighting 
    • Their busiest time is the summertime - since they are leisure oriented and looking for value
  • Have less RevPAR sensitivity and hence its easier for them to "make their numbers" by tweaking below the line items
  • What kind of brands are they interested?
    • It will include brands that own real estate but they are not interested in owning that real estate
    • Thinks that there should be some attractive acquisitions in the next 18 months, but they haven't shown themselves yet
  • SG&A for 2010?
    • Low single digit % increase.  To the extent the development is better or worse, commissions will impact that.
    • Believe that they have some more flexibility on the SG&A but that they are sized appropriately and would like scale their structure
  • Have they considered helping their franchisees access larger banks?
    • They are most likely not going to be able to help since the majority of loans are sub $7MM and don't have multiple franchises
  • Do they think that leisure travelers are taking advantage of trading up?
    • No - they gained share last year.  They did see some of their competitors "buying" share late last year. This is still a definite value orientation on a net net basis
    • Giving people what they want: Free breakfast, free parking, free internet
  • R/C refinancing?
    • Tenor is shorter now than what is was before. So they will consider terming out some debt.  Will need to address the R/C refinancing sometime in 2010- but not sure when. There is a possibility that they will put some fixed rate debt back in the structure at a 5-6.5% rate for a CHH like credit, depending on tenor.
    • Not counting on significant interest rate hikes in the near term, so that's why they are thinking about fixing some debt. Despite it being near term dilutive, its a good move in the longer term
    • Will not use FCF to delever, want to keep returning cash to shareholders
  • Would they need to see to accelerate the buyback
    • If they saw a significant gap btw share price and their perceived value of the company
  • They will stay with the franchise model when and if they go upscale.  When they go internationally they sometimes need to adjust their model.  If they buy a brand with significant management business they will figure out what to do with that.  Want to stick with just franchise
  • They are participating with EXPE at similar levels that they have done historically.  EXPE is not a significant distribution channel for them
  • SG&A decreased as a result of lower variable commissions and reduced headcount by low single digit
  • Ok this guy is a little slow... yes interest rates declined in 2009 and CHH has all variable debt

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