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Do You Get It?

“A lie gets halfway around the world before the truth has a chance to put its pants on.”

                -Winston Churchill

 

In hedge fund circles, a common question to ask about someone is:  Does he or she get it?  During my ten plus year career in the hedge fund industry, I can honestly say I evolved from someone who definitely didn’t “get it”, to someone who clearly “got it”, and finally to someone who didn’t care if they “had it”.

 

While this morning I am writing the Early Look, I usually have the pleasure of editing the Early Look after Keith drafts it.  That’s what we stay at home defenseman do, we get up early, “put our pants on”, and block shots, or proofread as the case may be.  Yesterday, I was pretty sure that the Early Look would resonate with those who “got it”.  And based on the responses we received from our exclusive network, it did.

 

As Keith wrote yesterday, a key part of “getting it” is recognizing that people lie.  CEOs lie, Prime Ministers lie, Presidents lie, Investor Relations people lie, and, yes, even the media lies.  That’s it.  Start with that premise when analyzing what certain people say, and you are well on the path to the enlightened place of “getting it”.

 

Luckily, science actually helps in some degree when trying to determine whether someone is lying.  But since a person produces around 75 – 100 verbal and nonverbal cues per second and the average person is only capable of processing 7 – 10, the process of determining whether a person is lying is far from easy. We’ve reviewed literature on lying and come up with a few recommendations to help determine who is lying, which are as follows:

  1. Establish a baseline – Ask a person the person or view the person in situations where they clearly aren’t lying.  Specifically, ask questions like: what is your favorite restaurant? What was your favorite vacation? Etc. A person will have a baseline of behavior for non-lies, and when the person tells a lie their behavior, voice or body mannerisms, should change noticeably.
  2.  Behavior and body language – When someone is unduly hostile or anxious towards your question, it is likely a red flag.  Lying, even for the best of liars, is an uncomfortable action that is difficult to hide.  Most commonly, aggressively defending the lie and accusing the counterparty of deceiving is natural way to combat this discomfort.  Certain body signals will also give away discomfort, such as: objects or body parts put in front to create a barrier, posture changes, not facing you, rubbing the forehead, and using fewer hand movements than usual.
  3. Verbal cues – The manner in which a respondent answers a question can often be a sign of deception.  The respondent may take longer to answer, may answer quickly before a question is completed, may be overly polite, and may repeat the question.  The primary issue with watching verbal responses, is these can be rehearsed so the tell tale signs can be hidden easily.

Yesterday, we also highlighted another way to tell whether someone is lying.  That is, compare what they do to what they say.  Sounds pretty simple, and as we look around the global macro world this morning it is quite clear - some people are lying and some people are not.

  1. The Chinese aren’t lying – Premier Wen Jiabao of China last week stated that, “latent risks in the banking and public finance sector are increasing” and that slowing loan growth would be important tool to combat this emerging issue.  This morning Chinese lending for February was reported and it was down 49% sequentially and 37% year-over-year.  The Chinese are saying they will tighten, and they are doing it.  That’s the truth.
  2. American officials lie – The CPI is the determinant of the income for more than 80MM people as result of statutory action: 48MM people on social security, 22MM food stamp recipients, and 4MM civil service retirements.  Do you think, perhaps, the U.S. government has a small interest in understating CPI despite what they say?  There may be a reason that the CPI calculation is changed every four or five years . . .to the extent that the U.S. officials are setting policy based on an inflation number that they alter to understate inflation, I would consider that a lie. But of course, maybe I just don’t get it . . .
  3. The Greeks will continue to lie – As outlined above, a key sign that someone is lying is an undue aggressiveness towards innocent parties.  According to Greek Prime Minister Papandreou, speculators are “now threatening not only Greece, but the entire global economy.”  While this might be politically convenient, it is an aberration of the truth intended to remove focus from Greek fiscal policy.  The fact that the policy of the Greek government has led to a debt-to-GDP ratio of north of 110% and deficit-to-GDP ratio north of 14% has, amazingly, nothing to do with speculators. 

So . . . do you get it?

 

If not, a good way to start is to put your pants on early and catch the lies before they “get halfway around the world”.

Keep your head up and stick on the ice,

 

Daryl G. Jones

Managing Director

 

LONG ETFS

 

XLV – SPDR Healthcare — Healthcare was down again on 3/9/10 in the face of “Obamacare” inspired fear. While we fear we may be early here, it’s better than fearing fear itself.

 

UUP – PowerShares US Dollar Index Fund — We bought the USD Fund on 1/4/10 as an explicit way to represent our Q1 2010 Macro Theme that we have labeled Buck Breakout (we were bearish on the USD in ’09).

CYB - WisdomTree Dreyfus Chinese Yuan — The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP - iShares TIPS — The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are mispriced and that TIPS are a efficient way to own yield on an inflation protected basis.

 

SHORT ETFS

 

SPY – SPDR S&P500We moved to neutral (from bearish) on the S&P500 on the week of February 22. At 1139, for the immediate term TRADE, we’ll go back to bearish. This market is finally overbought. We shorted SPY on 3/5/10.

 

EWP – iShares SpainThe etf bounced on 3/3/10 in part from a strong day from Banco Santander, the fund’s largest holding in the Financials-heavy (43.8%) etf. We shorted Spain for a TRADE again on 3/5 as every sovereign debt risk has a time and price to be short of. We have a bearish bias on the country; massive unemployment, public and private debt leverage, and a failed housing market remain fundamental concerns.

 

IWM – iShares Russell 2000With the Russell 2000 finally overbought from an immediate term TRADE perspective on 3/1/10 and added to it on 3/2; we got the entry price that the risk manager makes a sale on strength.

 

GLD – SPDR Gold We re-shorted Gold on this dead cat bounce on 2/11/10. We remain bullish on a Buck Breakout and bearish on Gold for Q1 of 2010, as a result.

     

IEF – iShares 7-10 Year TreasuryOne of our Macro Themes for Q1 of 2010 is "Rate Run-up". Our bearish view on US Treasuries is implied.

 



DPZ – REAL TIME NOTES FROM PRESENTATION

DPZ’s comments were in line with what we heard from the company last week when it reported 4Q09 results.  The company maintained its optimistic tone and reiterated that current sales are up significantly following the late 4Q09 launch of its “new and inspired” pizza.  Relative to DPZ’s competitors, management made two interesting comments.  First, DPZ said that the pizza category is now growing and is up 5%, but the company does not know yet how much of the growth is driven by DPZ versus its competitors.   DPZ’s “significant” pickup in quarter to date sales trends most likely does not bode well for Pizza Hut from a market share perspective. 

 

Second, DPZ stated that it will be interested to see if it is stealing share from the frozen pizza category.  Management said that although the frozen pizza category is seeing growth in its average ticket, it is not experiencing growth in the number of people buying frozen pizza.  With DPZ now selling pizza at lower price points than some of its frozen pizza competitors, it could take share.  This is a potential negative for CPKI.

 

Notes from the presentation:

 

Pizza  - Great category rooted in family tradition:

  • 1 trillion in food industry
  • 33 billion is pizza

 

DPZ-specific:

  • Delivery and carry out
  • 45% of sales are international
  • In over 60 countries

Average check for party of four eating QSR pizza is $22.54 vs. $49.94 at FSR

“New and Inspired” Pizza product

  • Months of consumer trials have gone on
  • Very pleased with the launch of this product
  • Sales are up significantly but we have not quantified that as yet

 

#1 delivery company

  • Small chains and independents make up 55% of market share
  • DPZ 18%
  • Other 2 national competitors make up 27%
  • Great growth opportunity
    • 20% of sales comes from online ordering
    • Technology is a very important part of the delivery business’ future
  • Margins grew last year largely due to commodities and new efficiencies

 

Business Units

  • Domestic stores
    • 4,461 Franchised stores
    • 466 domestic stores
  • Domestic Supply chain (partnership with franchisees – 50%of profits)
    • 17 dough manufacturing facilities
    • One equipment and supply facility
  • International
    • 4,072 Franchised stores
    • No Company-owned stores
    • 6 dough manufacturing and supply chain facilities

 

Domestic Franchisees

  • Strong business partners with long term partnerships and high collection rate
  • Owner-operators with no outside business interests
  • No significant concentrations
    • 1,200 franchisees owning 3 or 4 stores on average

Unit economics

  • Low cost to open/operate – 150-200k for new store
  • Cash on cash returns in 30-40% range

 

Commodities

  • Cheese is the most significant aspect
  • Cheese prices anticipated to be in 1.50-1.70 range, as per earnings call, but prices going down (only 1.27 yesterday)
  • Rolling over low prices from 2009 but hopefully, we will be surprised

 

International profits are driven by franchise royalties

  • 91% of 2009 international operating income
  • International represented 34% of total DPZ operating income in ‘09
  • Significant international growth in 2009
    • Global Retail Sales CAGR of 12% from 2004 to 2009

 

Capital Structure

  • $1.5 billion of debt
    • 6% blended cash interest rate
    • Interest only with 2 one-year extensions on top of 5 years  -through April 2014
  • 6-7x leveraged now. Intend to be in the 3-4x range by refinancing time.

 

Positive EPS trends

  • In 4Q09 delivered 35 cents (30 cents normalized for extra week) vs. consensus of 25 cents

 

Long range outlook:

  • Domestic SSS: +1% to +3%
  • Int’l SSS: +3% to +5%
  • New Units: 200 to 500 globally
  • Global Retail Sales: +4% to +6%
  • Normalized Annual Cap-Ex: $20 to $30 million
  • Tax rate: Approximately 39%

 

Use of cash

  • Capex is being used to deleverage
  • Pay significant dividends
  • Repurchase shares

 

Important points from Q&A:

Q: Promotional environment? Franchisee financing? Small franchisees?

A: Promotional market is competitive between PZZA and DPZ. 80% of all pizza sold is on deals. The consumer has always been looking for deals when they decide where to get pizza.

Small franchisees have not been as forthcoming, still tight. Well capitalized franchisees still coming forward.

Q: 80% of menu is new…what’s next? Additional product?

A: Continuing to offer promotions but want to make sure that people try the new pizza product we just rolled out.

Q: Domestic franchise growth and why it has grown over past 5 years?

A: DPZ has 1,000 stores we could open domestically…not saturated market.  Harder to find growth opportunities than before.  We know growth is there. Once the credit market opens up that will help.  Franchisees were hurt badly in ’08 by commodities and prices had come down in ’09. So we need to make sure unit economics are right and we can attract the right franchisees.

Q: PZZA said that the pizza market had gone from 5% decline to 5% growth. Where is the share coming from?

A: Pleased to see pizza category up, we get the same data. We don’t know how much of the 5% of growth is ours vs our competitors.

Q: Growth in online business.  Logistically, what are the pluses and minuses of the online stuff?

A: Now 20% of sales, and expect it to continue to grow.  Corporate stores are leading  the way with this with higher ROI.

Gets a menu in front of the customer.  Tracking mechanism.  Good website. Less labor involved. Very efficient.

Q: Frozen pizza competition?

A: Frozen is growing but most recent data shows that the ticket is growing but the number of people that is buying the pizza is not…I’ll be interested to see if we are taking share from the frozen pizza companies because some of our pizzas are priced lower than some frozen pizzas options.

Q: Shift in TV advertising. Is this the highest level? What is driving it?

A: In 2008 we moved money to coops from national advertising and that was a mistake. Went back to franchisees and they agreed on 5% for 2009 for national advertising.

Now rolling up to 5.5% (with unanimous support from franchisees)

Q: What kind of pathway do you think we can expect from new pizza? What date will you give us data on? When will business tend to trend down?

A: It can taper off within days or it can taper off within a few weeks…end of December was very strong when the “new and inspired” pizza product was launched. Promotions typically taper off, but this is not a promotion.  We have completely revamped our core product and we have no history with revamping a core product to measure current performance and if can be sustained.  Reported trends will come with 1Q earnings on May 4th.

 

Howard Penney

Managing Director


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.

Fidgety: SP500 Levels, Refreshed...

A flat market can make any real-time risk manager fidgety because, in the end, a market won’t perpetually stay flat.

 

The week-to-date, and ever since we shorted the SP500 on Friday at the 1139 for that matter, has been virtually flat. Yes, we have had fits and starts of intraday strength and weakness; and, yes, the bullish side of this market continues to deserve the bullish benefit of the doubt; but on a closing price basis, it’s been basically flat. I do not expect this to continue beyond this 3-day period.

 

In the chart below I have outlined both levels that I think can be attained. While there is more immediate term downside here than there is upside, in the face of another horrendous consumer confidence report this morning (ABC/Washington Post report came in at down -49 versus -49 last week, despite the SP500 being up +3.1% last week) and President Obama’s approval rating hitting a new low this morning (The Rasmussen Reports daily Presidential Tracking Poll for Wednesday shows that 22% of the nation's voters Strongly Approve of the way that Barack Obama is performing his role as President. Forty-three percent (43%) Strongly Disapprove giving Obama a Presidential Approval Index rating of -21. That matches the lowest Approval Index rating yet recorded for this President), the SP500’s pain trade remains UP (1154).

 

In terms of down side support, the bullish intermediate term TREND line of support is now at a higher-low of 1108 (or a -4% correction level from 1154 if this market is actually able to make up its mind and close at that higher-high).

 

My immediate term strategy is to not try to be a hero on the short side, but wait and watch. If I see 1154, I’ll likely short more SPY up there. If I don’t, well that will make us right on our current short position and… I guess I’ll be less fidgety.

 

KM

 

Fidgety: SP500 Levels, Refreshed...  - spx


What Are You Reading?

What Are You Reading?

 

While we tend to incorporate a fair number of athletic references in our research notes, the Hedgeye Risk Management team is also a bit on the nerdy side and we quite enjoy reading.  In fact, our CEO actually reads a book every ten days.  (If he speeds it up a little, he may catch me some day!)

 

 For your enjoyment and interest, below we’ve listed some of our current favorite book recommendations.  These selections are from all members of our team, from research to technology, and all parts in between.  Each team member also wrote a brief note as to why they enjoyed the book and why they believe it is important to read.

 

We hope you will enjoy the list.  And please do forward us your recommendations.

 

Best,

 

Daryl G. Jones

Managing Director

 

 

1. “A Whole New Mind” - by Dan Pink
The book argues that the future of global business belongs to the right-brainers; it’s counter to what most companies accept as the “standard”.

 

2. “Extreme Programming Explained” – by Kent Beck
Brilliantly short approach to software development that addresses technical, managerial, and people issues.  Technical brilliance aside takes in to effect people at all parts of the process, as opposed the plug and play replaceable parts that most processes account for, better than the kinder, gentler 2nd edition in that his response is more extreme, and thus harder to maintain.

 

3. “Three Cups of Tea” – by Greg Mortensen

Really interesting glimpse into what's going on in remote parts of Pakistan and Afghanistan.  Book is uplifting and inspiring in what an organization is trying to do for education there. 

 

4. “The Moral Animal: Evolutionary Psychology and Everyday Life” – by Robert Wright

What’s not to love about a book that provides a scientific justification for cheating?  On a serious note, this is fascinating book that provides the genetic background to much of our instinctive behaviors.  Rooted in early Darwinian research, the book posits, and maybe rightly so, that perhaps we humans are nothing more than moral animals.

 

5. “The Education of a Speculator” – by Victor Niederhoffer

This is one of the few accounts from a global macro risk manager that actually tells you what it is that we men and women of the early morning macro shift actually do. Niederhoffer checks all of the boxes that resume chasers want to see (Harvard B.A. in stats/economics; Ph.d. from University of Chicago). At the same time he was a world class athlete (champion squash player) and someone the "he's smart" crowd can't deny (worked for Soros, managing all of fixed income and FX from 1). He's also blown up, which helps show what real experienced risk managers need to have learned firsthand. He's a renaissance man.

 

6. “The Next Asia” – by Stephen Roach

Roach is Chairman of Morgan Stanley Asia and a keen analyst of the world’s economic situation.  The book is a collection of columns, small essays, postings, research notes etc going back to 2007, when this all started breaking out, and Roach clearly explains the underlying mechanisms of the financial crisis.  The book was a disappointment to its publisher because the press didn’t get enthusiastic about something that was “just a collection of old columns.”  Consequently, the book did not sell really well, which is too bad.  It is a crystal clear analysis of a highly complex situation, presented in plain English and full of insights that should shape our view of what is going on in the world today.  The pieces are short – usually no more than 3 pages – so they make convenient reading.  It’s a great history book for the intelligent non-professional who wants to understand how this whole mess happened.  And it’s a useful antidote to the professionals’ propensity to solipsism.

 

7. “Market Wizards: Interviews with Top Traders” – by Jack Schwager

Crux: I've always thought the best way to learn anything is to learn from those who know it best. Who better to learn investing from than some of the most successful traders in history. This book is a compendium of interviews with legendary traders and investors. What I like best about the book is that the common denominator of the interviewees has nothing to do with their approach to trading or investing - they have wildly different durations and use different instruments and have completely different approaches. What they seem to share in common, however, is a very strong sense of risk management and a core set of investing or trading principles that they stick to throughout their career. This proves that there is no one right or wrong way to be successful at investing. Rather, you need to have a process that is consistent with your beliefs and a risk management approach that keeps losses to a minimum.

 

8. “Manchild in the Promised Land” – by Claude Brown

It’s very compelling story about a ghetto kid growing up in Harlem in the 50’s and making his way to college though a childhood of crime.

 

9. “The Places In Between” – by Rory Stewart

In 2002, immediately after the fall of the Taliban, Stewart set out to cross Afghanistan on foot.  The book can take its place on the shelf alongside the best of his British Adventurer forebears – TE Lawrence and Wilfred Theisiger (Lawrence: Seven Pillars of Wisdom, Thesiger: Arabian Sands.  These are must-read books if you want to know about the world we live in today.  Thesiger was the first European to document a crossing of the Empty Quarter – the Arabian desert – and he tells his tale quite well.  Lawrence is a brilliant stylist, possibly very heavily coached by GB Shaw, whom he credits with helping out with the MS.)  Unlike the news reports of the Afghan war, this is personal experience of the places and people of Afghanistan, coupled with striking insights into the history of the place, and of human nature in general.  It puts the Afghan war – and with it, our perceptions of humanity – in a whole new context.  As with the writings of Thesiger and Lawrence, once you read this book you will never look at this part of the world the same way again.

 

10. "A Short History of Nearly Everything" – by Bill Bryson

This ranks as the greatest book ever written. Over the course of 500 pages, Bryson explains in funny and laymen's terms what amounts to the entire scientific knowledge our species has acquired and how it came to acquire it. Required reading for any enlightened individual.

 

11. “Fooled by Randomness” – by Nassim Taleb 

It gives a great insight into misconceptions in business, investing, and life caused by people not recognizing randomness and the role it plays in those spheres. At present, with politicians piling debt upon debt, a trick that has been tried before, Taleb's passage on man's tendency to "denigrate history" (not learn from others' experiences) is particularly telling.

 

12. “About Grace” – by Anthony Doerr

Themes of long cycle natural phenomenon alongside a personal story of loss and renewal.

 

13. “You Are Not A Gadget: A Manifesto” – by Jason Lanier

Provides a less optimistic view point of new media.

 

14. “The Pragmatic Programmer: From Journeyman to Master ”  - by Andrew Hunt and David Thomas.

This book speaks to me about what software development is all about: all the categories of skills and tools needed.

 

15. “Guns, Germs and Steel” – by Jared Diamond

It is seldom that I find a book that starts from a simple premise and profoundly shifts my world views, and the record of how relative events across the world occurred in the same timeframe.  Although China was not well covered in his analysis, and can challenge some of the main points, the breadth of the work makes it stand in my opinion as one of the best recent books I have read.

 

16. “The Great Gatsby” – by F. Scott Fitzgerald

The range of human spirit.  However flawed; it’s colorful.  Glass houses being so alluring yet so fragile.  How prestige is a mirage and the people who hide behind society are sometimes the weakest characters.  The struggle to survive and succeed more interesting than the success in and of itself.  The curse of being a human being.  “Wanting” can destroy.

 

17. "Quasars, Redshifts, and Controversies" – by Halton Arp

In essence, astronomer Halton Arp identifies many irregular galaxies and forms a theory about their properties, but this theory accumulates more and more evidence against it.  Blindsided by selection effect, he battens down the hatches and concludes that the problem is with the scientific establishment, not with his research.  This is true for a handful of scientists/schools every hundred years - Copernicus, Galileo, Einstein, etc. - and the rest of the time the proponents are quacks.  Arp propels himself into the latter category, despite a hugely successful early career.

 

18. “Atlas Shrugged” – by Ayn Rand

The lessons of Atlas Shrugged are timeless.  Through a captivating fictional story, the destructive impact of government is exposed.  The book is more relevant now than when it was written in the 1950s. 

 

19. “Cod” - by Mark Kurlansky

Cod is a story of exploration and ambition around a topic near and dear to me: food.  Cod takes us on the multi-century journey of the dance between two species: man and cod. From 14th century Basque fisherman crossing the Atlantic in open boats to chase a prized commodity, to evolving markets and tastes over time, and through the complex interplay of global forces even today. A thoughtful, data-driven, and well-written case study on a dying industry, with crisp lessons on human nature, resource depletion and the market’s unstoppable force. 

 

20. "Salt" – by Mark Kurlansky

Reminds us that in a world so complex, when you look back at why or how we get to where we are today...the answer can be so simple.

 

21. "State of Fear"- by Micahel Crichton

For the prologue alone, I believe that Michael Crichton reveals the depths to which group think can betray society.

 

22. “Lone Survivor” – by Marcus Lutrell

Amazing story of pride, promise, and unbreakable will that provides invaluable perspective to any challenge.

 

23. “The Alchemist” – by Paulo Coelho 

Story of a young Spanish boy on a mission to fulfill his Personal Legend (Destiny) and find his Treasure (Fulfillment).  The book depicts the transformation of innocent and pure youthful dreaming into an optimistic reality of achievement.  The boy is led by the signs of the universe and the guidance of great kings and alchemists with some obstacles along the way but finds that in the end of his epic journey that the fulfillment of his dream was the journey itself.   

 

24. “The Accidental Billionaire” – by Ben Mezrich 

The story of two socially awkward Ivy leaguers, trying to increase their chances with the opposite sex, ended up creating FACEBOOK.  Harvard boys with a mathematic background and less-than-smooth approach with the female population.  They just wanted to meet some girls.  

 

25. “Hatchet” – by Gary Paulsen 

Hatchet is the story of a boy named Brian. On a trip to the Canadian oilfields to spend the summer with his dad, the pilot of the Cessna he is traveling in suffers a heart attack and dies. Brian must land the plane in the forest. Brian learns to exist in this wilderness. He faces many dangers including  hunger, animal attacks, and even a tornado. This book gives the reader a better understanding of what it is like to survive in an untamed land.


STRIP A LITTLE BETTER THAN WE PROJECTED

Gaming revs on the Strip fell 3%, better than our estimate of a 6% drop, owing to higher slot hold percentage. With CityCenter open and -15% comp, the Strip should be doing better.

 

 

Aside from a little higher than expected slot hold, there is not a lot unusual about the January Strip gaming revenues.  Due to the timing of Chinese New Year, Baccarat volume actually fell 6% y-o-y but a higher hold percentage drove Baccarat revenues up 13%.  Overall table hold percentage was normal at 11.8%.

 

January of 2009 was a horrible month with total gaming revenues down 15%.  The January 2010 2-year comp was down 17%.  The good news, at least for appearances, is that February faces the easiest comp of the year.  February 2009 Strip revenues fell 23%.


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