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Bad, Bad Risk

“And the giant beside him about to fall, they will try to make you crawl.”

-Sly Stone

 

There all kinds of risk.  Good risk, medium risk, and bad risk. (Some investment bankers even say no risk.) Bad risk is also the name of a song by the U.S. funk band Sly and the Family Stone.  Growing up in the era of psychedelic drugs and music, it is likely that Sly Stone knew a few things about bad risk.

 

As Risk Master Brother McCullough is discussing on Bloomberg this morning, we are waking up to some funky news. Suffice it to say, in the world of global investing , potential sovereign debt defaults be some Bad, Bad Risk

 

Greek credit default swaps have been blowing out for the last few weeks and yesterday the culmination was a downgrade of Greek and Portuguese sovereign debt, the former to junk bond status.  That be bad.

 

As is often the case in global macro risk management, geopolitics matter.  In 1998, the United States and a few other nations came to the rescue of Mexico in her inability to roll over short term loans.  Sho’nuff, the United States actually made a profit of some $500MM on this bailout.  Ironically, the architect of this bailout was Treasury Secretary Robert Rubin.

 

Even the most eminent of Perceived Experts, like Brother Rubin, make funk predictions.   As it relates to sovereign debt defaults, we’ve quoted former Secretary Treasury Robert Rubin from a presentation he gave at Yale Law School last year in which he said, “he did not forsee any sovereign debt defaults.”  Now to be fair to Brother Rubin, in the same lecture he indicated that a Greek Philosophy class he took in his freshman year at Haw-havd was the underpinning of his risk management philosophy.  No math, brother?

 

(We’d just be piling on Goldman if we mentioned that Brother Rubin was also the former CEO of Goldman Sachs and that Goldman had a very substantial long position in Mexican bonds, and thanks to his bailout they got out whole.  But no need to kick a firm when it’s down!)

 

The simple math associated with Greece suggests that risk is accelerating. This morning the spread between Greek bonds and their German counterparts is 800 basis points (8%!). That be wide!  In addition, and we’ve highlighted this in the chart below, Greek credit default swaps continue to blow out.  By our last measure, they were at 842 basis points.  That would be funky, if it weren’t dang expensive insurance. 

 

Yesterday, S&P downgraded our Greek Brothers to junk status.  The implications of this go far beyond one country.  This is the first time any nation in the Eurozone has been downgraded to junk since the introduction of the Euro in 1999.  Incidentally, Greek debt is now on par with the economic stalwarts of Azerbajian and Egypt.  According to S&P, in a restructuring Greek debt could be worth as little a 30 percent of face value. Dang!

 

The question is: When is Germany going to get down with it? It is time to put some stank on it in the Eurozone!

 

This morning Sister Merkel, also known as the Chancellor of Germany, is going to be giving a statement regarding Greece at 10:45 a.m. eastern.  Mark that one in your Outlook calendar.  This will be a catalyst for the market.  And while it is earnings season . . . at the moment Macro Matters more than the EPS miss of Buffalo Wild Wings. Ain’t that the truth?

 

While it was an easy decision for the United States to bail out Mexico in 1998 (setting Goldman’s long exposure aside), it is a much more nuanced decision for Sister Merkel in regards to Greece.  As our European Analyst Matt Hedrick wrote yesterday:

 

“ While we believe Germany’s “contribution” is inevitable, what we’re currently seeing from Merkel is political posturing. On May 9th, Germany’s largest state by population and the industrial heartland, North Rhine-Westphalia (NRW), holds a state election.  Merkel’s Christian Democratic Party (CDU) along with her coalition partners the Free Democrats (FDP) need a win to retain the majority in the Bundesrat (upper house of parliament), which is critical for her party to carry out scheduled reforms, including tax cuts and health care reform. 

 

Recent polls suggest that Merkel’s opposition, the alliance of the Social Democrats-Greens, has a slight advantage. With government spending a hot topic in the election, Merkel must show that she’s not writing a blank check to the Greeks, and will continue to drive a hard line.”

 

Like any astute geo-political, analyst Brother Hedrick has ascertained an important point, even in the face of a spiraling economic crisis in the Eurozone, politics still matter. To summarize this in the wise words of Sly Stone: “And the giant him about to fall, they will try to make you crawl.”  Now that’s a groovy realization.

 

Last month we did an in-depth presentation of sovereign debt and the risks associated with potential defaults.  The conclusions of this historical analysis was simply that defaults or restructurings are rarely one-off issues, and certain nations, not surprisingly Greece, tend to be leading indicators.

 

Rumors yesterday out of Europe suggested that Europe would convene a “Greek Aid” summit on May 10th.  By that time, Sister Merkel’s elections will be one day behind her.  If that date don’t speak the truth . . .

 

Keep groovin’

 

Daryl G. Jones

Managing Director

 

Bad, Bad Risk - merk

 


US STRATEGTY - ON GOLDMAN TIME

Last I checked, making money is not a sin and yesterday’s political grandstanding proved that most politicians in Washington’s are economically illiterate.  If you are a market participant you now know that Senators don’t know what they don’t know.  This is a disgrace to Washington and the best trade coming out of yesterday’s hearings is to be short treasuries. 

 

The S&P 500 came under pressure on Tuesday, suffering their biggest one-day pullbacks since February 4th. The RISK AVERSION trade was in full force and a big negative on the market as the VIX shot up 31.7% on the day.

 

The biggest MACRO driver was the focus on European sovereign credit concerns after S&P downgraded its ratings on both Greece and Portugal. We’re seeing confirmation of our 2Q10 theme of Sovereign Debt Dichotomy via rising CDS spreads, higher yield spreads, and weakness in equity markets from the PIIGS.

 

Treasuries rallied sharply yesterday on the back of European sovereign credit concerns. In addition, the dollar index was up 0.82%.

 

Despite another largely upbeat day for corporate earnings and events, regulatory fears also remained on the front-burner today, leading to another outsized selloff in the financials.  After falling more than 3% on Monday, the banking group remained for sale yesterday with BKX down another 3.1%.  The money-center names were among the laggards with C (down 5.9%), JPM (down 3.4%) and BAC (down 3.2%) showing weakness.  Ironically, GS was up 0.7%.  The stock managed to bounce as executives testified before the Senate's Permanent Subcommittee on Investigations.  The mortgage insurers were among the worst performers in the sector, while AIG (16%) sold off on a downgrade at KBW.

 

Some of the trades done in the Hedgeye virtual portfolio;

 

COVERING XLY - We shorted Consumer Discretionary when it was overbought. The Sector ETF is down -2.4% here and no longer overbought - covering red. KM

 

COVERING GIL - Stock is down more than the market here but holding an immediate term TRADE line of support at $28.61. Covering here and will revisit at a different time/price. KM

 

COVERING SPY - Apparently this market can go down, indeed. Covering our short position in the SP500 here as it is immediate term oversold. KM

 

SELLING CIT - Josh Steiner made the right call being long ahead of this morning's EPS report. We'll book the gain here on the news. We remain bullish on the intermediate term TREND, from a price. KM

 

On the MACRO front, The Conference Board consumer confidence index jumped to 57.9 in April from 52.3 in March, the highest level since September of 2008.  However, Consumer Discretionary XLY declined 2.9% and failed to garner support from the better-than-expected data.  Housing-related names were among some of the worst performers today with the XHB (4.2%) on the day. Yesterday, the S&P Case-Shiller 20-city composite home price index fell 0.1% m/m in February, snapping a string of eight consecutive monthly increases.

 

The Materials sector (XLB) was the worst performing sector yesterday, weighed down by the RECOVERY trade and the accompanying rally in the dollar. The industrial metals stocks were among the notable laggards in the sector, with the NYSE Arca Steel Index down 5.3%.  Gold stocks held up better on the day, with some support from the flight-to-quality gains in the underlying commodity.

 

The Healthcare (XLV) was the best relative performer yesterday with a renewed focus on some of the more defensive sectors.  The XLV underperformed as of late on concerns about the larger-than-expected impact on guidance from healthcare reform.  

 

Yesterday, copper traded down 4.6% to a one-month low on recovery concerns. 

 

In early trading, equity futures are trading below fair value in a continuation of yesterday's broad based declines sparked by S&P's rating downgrade for Portugal and Greece.  

 

Today’s MACRO events: 

  • MBA Mortgage Applications
  • DOE Crude Oil Inventories
  • FOMC Rate Decision

Howard Penney
Managing Director


WYNN "YOUTUBE"

In preparation for WYNN's Q1 earnings, we've aggregated some forward looking commentary from the company's Q4 release and conference call.

 

 

Q1 should be a strong quarter for WYNN, but given the run in the stock it may not matter.  We're above the Street in revenues but in-line for EBITDA this quarter due to a low hold percentage - and the associated margin impact - despite record VIP volumes.  While we think that Wynn Encore will have solid performance, we think that perhaps the Street is ahead of themselves in modeling margins for the backhalf of 2010.  Below is a "YouTube" from last quarter's call and some our thoughts.

 

FORWARD LOOKING COMMENTARY & TRENDS

  • "Although I don't make forward-looking statements as a rule, we're tracking substantially ahead of that the first two months of the year....and incidentally, we're not holding high, we're holding low..at 2.8"
    • The market was indeed on fire in 1Q2010 and Wynn did perform well...although they did suffer from weak hold - we estimate 2.6% on VIP since March hold was a pathetic 2.3%
    • Our Macau 1Q2010 estimates are as follows:
      • RC of $20.6BN, VIP win % of 2.6%, and VIP win of $536MM
      • Mass win of $117MM, Slot win of $50MM
      • Net revenue of $555MM and EBITDA of $144MM
  • Vegas: "I don't see any major change in the future. I don't see it getting worse per se"
  • "We're about to refurbish our rooms in Wynn because they're five years old. It puts more pressure on our competition because our service levels and the targeted attractiveness of our facilities gets more and more effective. Nothing left to do but the basics better."
  • "The danger that you described is real. I mean, rates stay down in Las Vegas, how long do rates stay down in Las Vegas before they become the norm? You asked me that question, and I say to you, I don't know. But what should I do? Have empty rooms?"
  • "We had a very big Baccarat year last year in Las Vegas in spite of everything else."
  • "If you're talking about strictly convention booking, you can say that '10 is better than '09, and you can say you see a trend of increased bookings. It is totally irresponsible and naive for anybody to say based upon this slight trend we project this infinitely into the future and give you some rosy baloney story about what's going to happen in '11."
  • "How about for the Southeast Asia customer percentage?" [of total customers to WYNN Macau]
    • "It's less than 5%."

OTHER NOTABLE COMMENTS

  • "The workforce in Macau is totally delicious."
  • "We're more of a Chinese company than American company today as we're having this call. I love it. Thank God for being outside the United States today."
  • "I love the idea that they're going to start five and six because it's a Sheraton, they're lower-end products.  And that's lots of folks.  And then they, Sheldon, built all those ferry boats.  I think that's good too.  And he was subsidizing everybody else on Cotai by those ferry boats and it's also worked out well for him.  That's all great stuff, it all happened and what I'm looking forward to is opening the nicest place in that neighborhood and skimming off the top end of the business just like we did downtown in Las Vegas on the Strip, in Atlantic City and we're doing it now in Macau. That's our stick, we do that. We love overdeveloped markets, it's where we thrive."
  • "Would I build Encore if I had to do it today, no, I'd keep my money."


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BWLD – ON THE PRECIPICE OF A DEEP HOLE

Our first look at the BWLD Q1 earnings just released.

 

Our proactive approach to restaurant sustainability trends led us to write a short thesis Black Book on BWLD In October 2009.  While holding on to a short bias in a raging bull market is painful, the thesis continues to play out as penned late last year. 

 

We contended that BWLD aggressive growth position is causing unit level performance to deteriorate, which was not fully reflected by the market.  Today, the most telling proof to our thesis is from CEO Sally Smith saying “we are addressing specific unit performance.”  Same-store sales growth has outperformed AWS growth for the last 3 quarters, which is another indication that new unit volumes are declining.

 

Company same-store sales came in relatively flat (vs. the street’s +1.4% estimate) during the quarter, implying a 30 bp sequential slowdown in 2-year average trends from the prior quarter.  This is the third consecutive quarter that comps have come in light relative to street expectations.

 

Management’s remarks from the press release include:

“We are experiencing softness in April same-store sales of (3.7%) at company-owned and (2.4%) at franchised locations.  We are addressing unit performance as well as implementing system-wide strategies to drive sales.”

 

“While we expect that our previously-announced net earnings growth goal for 2010 of 20% may be achievable, improvement in same-store sales and moderate wing costs are key to meeting this goal.”

 

BWLD – ON THE PRECIPICE OF A DEEP HOLE - bwld sm

 

BWLD – ON THE PRECIPICE OF A DEEP HOLE - BLWD SSS

 

Howard Penney

Managing Director

 



Merkel’s Struggle with Greek Junk

Position: Long Germany (EWG)

 

While Goldman claims the spotlight today, European sovereign debt concerns remain at large; in fact risk has heightened for the PIIGS in recent days (particularly Greece) despite a European and IMF guaranteed loan of €45 billion to fund Greece’s debt. We’re seeing confirmation of our 2Q10 theme of Sovereign Debt Dichotomy via rising CDS spreads, higher yield spreads, and weakness in equity markets from the PIIGS (see charts below). What is Germany’s role in this risk equation?

 

In the near term, the PIIGS continue to shake as conservative German Chancellor Angela Merkel reiterates her position that Greece must do more, i.e. increasing austerity measures, before funds are certain. [Note that Germany is on hook to contribute some €8.4 Billion Euros to Greece, the largest contribution of all Euro member states].

 

While we believe Germany’s “contribution” is inevitable, what we’re currently seeing from Merkel is political posturing. On May 9th, Germany’s largest state by population and the industrial heartland, North Rhine-Westphalia (NRW), holds a state election.  Merkel’s Christian Democratic Party (CDU) along with her coalition partners the Free Democrats (FDP) need a win to retain the majority in the Bundesrat (upper house of parliament), which is critical for her party to carry out scheduled reforms, including tax cuts and health care reform. 

 

Recent polls suggest that Merkel’s opposition, the alliance of the Social Democrats-Greens, has a slight advantage. With government spending a hot topic in the election, Merkel must show that she’s not writing a blank check to the Greeks, and will continue to drive a hard line.

 

In the longer term, we believe that the deeper debt-laden countries, globally, will underperform more fiscally conservative countries, like Germany. Please see our post titled “Q2 2010 Themes: Sovereign Debt Dichotomy” on our portal that lays out one play: long Germany, short Spain.  Currently, the DAX is outperforming Spain’s IBEX 35 by a spread of 1,560 bps YTD. It may not be long before we see equity and credit charts from the likes of Spain or Portugal that resemble Greece. That said, we also believe the selloff in Greek equities and bonds is overdone given Germany’s ability to support Greece when it is politically expedient.  Stay tuned.

 

Matthew Hedrick

Analyst

 

Merkel’s Struggle with Greek Junk - g1

 

Merkel’s Struggle with Greek Junk - g2


PFCB – Earnings Preview

PFCB reports 1Q10 earnings tomorrow morning.  To recall, PFCB management said that from an earnings standpoint 1Q10 would be the low point of the year.  The company guided to FY10 EPS of $2.00, stating that 2H10 should be stronger than 1H10 and 2Q10 better than 1Q10, which implies 1Q10 earnings of below $0.50 per share.  Management also said that although top-line trends continued to improve on a sequential basis early in 1Q10 when you exclude the weather impact, weather had been a factor.  Specifically, CEO Bert Vivian commented, “ We’ve had starts and stops with respect to Mother Nature, so it’s tough. I would just caution everyone that as we look at our first quarter, we are off to a little bit slower start than perhaps we would have liked due to the weather. We’ll see how the back half of the quarter turns out.”  The shift in PFCB’s reporting calendar around the 53rd week in 2009, which was the week between Christmas and New Year’s Eve, will also negatively impact reported 1Q10 top-line trends.  The week between Christmas and New Year’s Eve was a high volume week for the company and produced average weekly sales of roughly $119,000 at the Bistro relative to the average of about $90,000 for all of 4Q09.  The benefit of this critical week in 4Q09 will be offset in 1Q10. 

 

Based on this less-than-favorable outlook, investors may not be expecting too much tomorrow.  I think PFCB management tends to be conservative.  To that end, I would expect earnings to come in a penny better than the street’s $0.49 per share estimate and above management’s implied quarterly guidance. 

 

The company did not give any specific same-store sales guidance for the first quarter but full-year comps are expected to be negative at the Bistro (negative in 1H and positive in 2H) and positive at Pei Wei.  Relative to industry trends as reported by Malcolm Knapp during the first quarter, PFCB’s aforementioned comments set low expectations, particularly regarding the Bistro.  The street is estimating that comparable sales at the Bistro come in -4.1%.  Although a -4.1% number would imply a sequential improvement from 4Q09 of 110 bps on a 1-year basis, it only points to an 80 bp improvement on a 2-year average basis.  Malcolm Knapp reported last night that the industry as a whole improved about 220 bps during the first quarter on a 2-year average basis from 4Q09.  That being said, if PFCB only manages to meet street expectations at the Bistro during 1Q10, I don’t think investors will be too excited because weather was an issue for all industry players. 

 

My comp estimate of -3% at the Bistro still implies that the concept is lagging its competitors as it would highlight a sequentially wider gap-to-Knapp on both a 1-year and 2-year basis, but it would indicate that trends are improving materially.  For Pei Wei, I am modeling +2% comparable sales growth (in line with the street’s +1.8% estimate).  PFCB has really turned the corner with Pei Wei and a +2% comp would mark the concept’s second quarter of positive same-store sales growth, which would be impressive in this environment.  Margin comparisons are tough in the first half of the year, particularly at the Bistro, as the company began to benefit from its operational initiatives in early 2009. 

 

It will be interesting to see if management provides any additional details around its agreement with Unilever and its new frozen food venture.  The company has not commented too much on the new agreement, except to say that it does not require any capital investment on the part of PFCB.  On the last earnings call, management said the product would be introduced in 2010 and PF Chang’s Home Menu was since launched in April.  If this agreement turns out to be anything like the one CPKI first developed with Kraft, then it has the potential to add a high margin royalty stream to PFCB’s earnings. 

 

PFCB – Earnings Preview - PFCB Home Menu

 

Current FY10 Guidance:


EPS: $2.00 (2H better than 1H and 2Q better than 1Q)

 

Revenues: roughly flat (slightly negative comps at Bistro, slightly positive at Pei Wei and reflects the impact of a 52 week fiscal year in 2010 vs. 53 weeks in 2009)

 

New units: 3-5 Bistro restaurants and 3-5 Pei Wei restaurants

 

Restaurant level margin: flat YOY (favorable cost of sales offsetting the anticipated impact of deleverage of certain fixed operating costs and higher planned marketing spend)

 

Depreciation: up a little bit vs. 2009

 

Pretax margin: better YOY (YOY favorability in preopen, interest and G&A expense)

 

FCF: $90M+ ended FY09 with cash balance of $63M above the typical $40-$50M range (expect to pay down $40M credit facility, $40M in share repurchase and about $20M in dividends based on 45% payout ratio)

 

Capex: $40M

 

 

Howard Penney

Managing Director


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