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Rigorously Frugal

“I am for a government rigorously frugal and simple, applying all the possible savings of the public revenue to the discharge of the national debt; and not for a multiplication of officers and salaries merely to make partisans."

-Thomas Jefferson

 

In the spirit of searching for historical answers to the current problems in my head, I have started reading “Founding Brothers: The Revolutionary Generation” by Joseph J. Ellis. Suffice it to say, some of these common men rose up in the most American of ways – in a meritocracy.

 

American political history, like Washington and Wall Street storytelling, can be romantic. After all, for many, it’s all about twisting facts to fit a certain fiction that consensus can consume as believable. The reality of life seems to be that we never quite realize we are making history in the moment.

 

If Jefferson wasn’t partisan in his politics, John Adams wouldn’t have lost his marbles as many times as he did going off on Jefferson’s duplicity. Watch what people do, not what they say – we all have some form of partisanship in our lives. We are human. With that understood, it’s easier to consume the quotes of great leaders and storytellers at face value. The aforementioned Jefferson quote is brilliant when I consider it in the context of today’s conflicted professional politicians.

 

George Washington, John Adams, and Thomas Jefferson certainly had their political differences. Most men with a point of view do. One thing these “Founding Brothers” had in common, however, was their concept of frugality.

 

Per our friends at Wikipedia, frugality “is the practice of acquiring goods and services in a restrained manner, and resourcefully using already owned economic goods and services to achieve a longer term goal.”

 

You can tell stories about how frugal you may be but, within the context of our fore-fathers definition of the word, as an American society we have veered far from it. Being Rigorously Frugal is a solution that I’d like to put forth to this colossal American balance sheet mess. Everything starts with respecting the cost of capital and savings.

 

In the chart of the day, we’re showing the long term TAIL of the US Savings Rate going back to 1971 (when America was endowed with the world’s reserve currency). Today, US Savings are only 3.6% of GDP and, never mind “applying all the possible savings of the public to discharge the national debt”, our professional politicians get overly paid to perpetuate a levering up of our diminished savings!

 

As a reference point, Brazilian and Chinese savings as a percentage of GDP are approximately 4x and 10x America’s, respectively. Throughout the global economic downturn of 2008, neither of these countries fear-mongered their citizenry into believing that we were experiencing a “great depression.” Throughout the global economic upturn of 2009, both of these countries had the political spine to tighten monetary policy in the face of inflating prices.

 

Hopefully, you are already murmuring that China and Brazil are different than the US. From a growth perspective, they are – we get that. There is a huge difference between unlevered organic growth and levered deficit Spend-And-Hope growth.

 

Chinese savings (including corporate and household) have amassed to 49.5 TRILLION Yuan. Yes, that’s a lot of Yuan ($7.3 TRILLION US Dollars) – and guess what the wealth effect is for anyone bearing that Chinese Yuan is when China allows their currency to appreciate?

 

A large number of Americans living in the modern day Roman Empire of Fiat Fools don’t win here. If they aren’t Rigorously Frugal, that is. Gluttons of government sponsored over-consumption get taxed on anything we import from China or Brazil as the value of their respective economies and currencies appreciate. It doesn’t have to be this way, but until we change ourselves, the world will likely change us.

 

America is not alone in its addiction to cheap fiat moneys and over-consumption. The difference between America and the UK as of the past few months however is that the British are making the hard decisions that the “multiplication of officers and salaries” in the Officialdom of Washington aren’t willing to make.

 

Both Adams and Jefferson were more than half a decade dead by 1886 (they actually both died within 5 hours of one another), but that was the last time Britain had a Chancellor of The Exchequer as young as recently appointed George Osborne.

 

Osborne is my age and apparently agrees with my solution to this mess. This is what he had to say last night after he made cuts to healthcare spending, public salaries, housing subsidies, etc:

 

“I’m not going to hide hard choices from the British people… This is an emergency budget, so let me speak plainly about the emergency that we face.”

 

Maybe Osborne and newly elected PM, David Cameron, aren’t as Rigorously Frugal as implied by the 79% asset allocation to cash I moved us to on June 9th, 2010; certainly not as Rigorously Frugal as the 96% cash position I moved to on September 18th, 2008; but, directionally at least, frugality is as frugality does.

 

The beauty of having cash savings is that you can invest those hard earned moneys opportunistically. Since June 9th, the SP500 is +3.6% higher. I have been investing opportunistically. I have been picking my spots. This morning the cash allocation in the Hedgeye Asset Allocation Model is down to 61%.

 

I’ve always been conservative in my finances. I’ve never used leverage in running a fund. This doesn’t make me the Street’s favorite hedge fund manager, but it certainly keeps me alive. That’s all this Rigorously Frugal believer of what I think I will call a “Revolutionary Generation” 30 years from now has to say about that.

 

My immediate term support and resistance lines in the SP500 are now 1087 and 1129, respectively. Yesterday, on market weakness, we raised our asset allocation to International Equities from zero percent to 3% by buying a country that has a very respectful savings rate - Singapore (EWS).

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Rigorously Frugal - hilt


DRI – GLIMPSE AT MAY INDUSTRY TRENDS

Darden is scheduled to report fiscal 4Q10 earnings after the close tomorrow.  Casual dining names, in general, have traded lower in response to CPKI’s revised calendar 2Q10 guidance issued yesterday.  CPKI provided the first real glimpse of May trends and it was not good.  CPKI announced that May same-store sales declined 7.9%, following a 2.7% decline in April.  For reference, CPKI was facing its easiest monthly comparison of the quarter in May so 2-year average trends decelerated rather significantly for the concept as well.   We have yet to hear how the industry as a whole fared in May as Malcolm Knapp will likely report industry data soon after Darden reports its quarterly numbers, but judging from CPKI’s May numbers, the Knapp May whisper-number of -1%, which implies flat 2-year average trends, seems aggressive. 

 

Darden widened its gap to Knapp performance during its fiscal 3Q10 and I would expect the company’s outperformance to continue in the fourth quarter.  Through April, the industry on average, as measured by Malcolm Knapp, improved about 100 bps sequentially on 2-year average basis from Darden’s fiscal 3Q10 timeframe.  May is obviously the big question mark for both Darden and the industry but my same-store sales estimates for Darden assume that 2-year average trends during 4Q10 held steady to improved slightly sequentially from 3Q10, excluding the estimated holiday and weather impacts, across all of the company’s concepts.  My -0.1% blended same-store sales estimate is slightly better than the street’s -0.4% estimate, reflecting my expectation for a stronger LongHorn performance (+2.0%) and slightly weaker Red Lobster number (-3.0%) relative to the street's estimates.  For reference, DRI guided to a -2.5% blended same-store sales number for the full year, implying -1% in the fourth quarter. 

 

Based largely on my slightly better than expected same-store sales estimate, I think the company’s earnings will come in at $0.90 per share, better than the street’s $0.88 per share estimate.  That being said, I expect both restaurant level and EBIT margins to decline about 40 bps YOY during the quarter as a result of sequentially more difficult comparisons; though EBIT margin should remain above 10% in the quarter.  It is important to remember that DRI reported a 10.8% EBIT margin in 3Q10 (excluding the $0.04 charge related to the company’s decision to adjust gift card redemption assumptions), a near peak margin, but management commented that it has “new targets for peaks at this point.”

 

Outside of May trends, investors will be most focused on what management has to say about FY11 guidance.  Darden provided its long-term EPS guidance of up 10% to 15% and said it was comfortable with this range on its last earnings call, but did not give a specific range for FY11.  It will be important to hear what the company says about its outlook for same-store sales growth and commodity costs.  The company’s long-term earnings guidance assumes +2% to +4% same-store sales growth which, depending on how the company fared in May and into June, could be a stretch as it assumes a continued improvement in 2-year average trends.

 

I am expecting there to be a lot of investor questions about the company’s food cost outlook in response to all of the media focus on the expected increase in seafood costs as a result of the oil spill in the Gulf of Mexico.  Just yesterday, it was reported that as a result of the oil spill, Red Lobster was removing oysters from its menu in a few weeks when the current supply runs out.  Although oysters only make up a small percentage of Red Lobster’s menu, potentially higher shrimp costs would have a greater impact on the concept’s margins.  This is not a concern for 4Q10 as the company is 100% locked in on all of its seafood costs for the quarter and guided to a mid-single digit decrease YOY.   As of February, however, the company was only locked in on 23% of its seafood costs through December 2010 or about halfway through fiscal 2011.  Seafood costs represent DRI’s largest ticket food item, accounting for 30% of total food costs. 

 

We will have to hear what Darden says on its earnings call on Thursday morning but, for now, I am comfortable with the company’s ability to grow EPS by at least 10% in FY11, within its long-term guided range of +10% to +15%.  The street is currently estimating 12% EPS growth.  I would not be surprised, however, if same-store sales fall slightly short of the 2% to 4% range. 

 

I continue to believe that DRI is one of the best positioned restaurant companies going forward and that return on incremental invested capital is moving higher in FY11.

 

DRI – GLIMPSE AT MAY INDUSTRY TRENDS - DRI 3Q10 RL SSS

 

DRI – GLIMPSE AT MAY INDUSTRY TRENDS - DRI 3Q10 OG SSS

 

 

Howard Penney

Managing Director

 


Bear Market: SP500 Risk Management Levels, Refreshed

After an unconvincing, low volume, 2-week rally in US Equities, the intermediate term TREND remains bearish.

 

The intermediate term TREND line of resistance was not tested to the upside and now we are seeing short term (immediate term) TRADE lines of resistance develop inside of 1144. In the chart below we outline an important updated line of resistance at 1130. The one-factor 200-day moving monkeys are obviously grappling with a breakdown through that line today as well.

 

There is an important immediate term TRADE line of support at 1093 that needs to hold. Our go forward outlook on a double dip in both US growth and US Housing remains.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Bear Market: SP500 Risk Management Levels, Refreshed - 1


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JUNKET CREDIT BUBBLE?

Junkets are getting liquidity from many sources.

 

 

With monthly VIP revenues up an average of 85% this year, Macau may indeed be benefiting from a credit bubble. However, we found no visible signs of that abating as we turned over every rock and looked in every nook and cranny on our recent trip to the SAR.  It’s not all credit related – Mass revenue was up 39% over the same period – but the junkets have bountiful access to capital.

 

The consensus commentary from almost everyone we met with in Macau was that business is good and there doesn’t seem to be a whole lot of risk on the horizon for the balance of 2010.  By all accounts, the junkets are flush with cash and, barring a crackdown from Beijing, will continue to keep the credit flowing to players, who in turn will keep trying their luck in Macau.  So where are the junkets getting the capital?

  • Public equity – Some of the junkets are public
  • Private equity – Junkets are paying 10% annualized interest for 30-day money.  Wealthy Chinese individuals and Chinese private equity firms are the primary lenders.
  • Operators – Most operators provide the junkets with some level of rolling working capital, usually over 30 days.  We’ve heard recently that City of Dreams, MGM (upcoming IPO), and Wynn have ramped up the lending, while LVS has been more aggressive on direct play credit.
  • “Other” sources

Apparently, the lack of good investment opportunities around the world has made the ballpark 10% annual return that many junkets offer on private placements an attractive option for wealthy Chinese to park some of their cash.  Since default on credit obligations to a junket rarely occurs (for obvious reasons), the high yield offered by junkets is viewed as safe and therefore quite attractive.

 

The feeling in Macau now is that although Chinese monetary tightening would lessen availability of capital, the impact on Macau would be delayed and not huge.  The bigger perceived risk is a China crackdown. If Macau gets "out of line," Beijing will use its power to pressure the junkets.  So far the new Macau Chief Executive, most of the operators (Sheldon’s behavior is much improved but not exactly perfect), and most of the junkets (there may be another shoe to drop here) have behaved.


R3: ADIDAS’ WISHFUL MATH

R3: REQUIRED RETAIL READING

June 22, 2010

 

Don’t you love when CEOs tout ‘record’ growth rates vs. levels from 2008 and 2006?. Hey Adidas, there’s this thing called a CAGR. You may want to give it a whirl.

 

 

TODAY’S CALL OUT

 

Am I the only one who thought it was hilarious when Adidas issued a press release yesterday noting that it would post a record year in football sales following the World Cup. Adidas claimed that soccer sales are expected to be at least 1.5Bbn Euro for the year, which is 15% more than its previous record in 2008 and 25% from 2006.

 

Herbert Hainer (CEO) noted "After the first 10 days it is already clear that this World Cup will be a great success for Adidas. We will not only achieve our ambitious goals in football, we will over achieve them.”

 

First off…EVERY company that claims to be a growth company (and have a growth multiple) should set record results EVERY YEAR. Second, it’s been a while since I’ve heard a CEO state how good its growth numbers are vs. 2-years ago and 4-yrs ago!  Hey Herbert, there’s this thing called a CAGR. Try giving that one a shot on your next press release! Sure, 15% since ‘08 and 25% since ’06 sounds great, but we’re talking less impressive CAGRs of around 7%. Again, that’s great, but it is about the rate of growth in football apparel/footwear globally.  Winners take share, and they take it profitably.

 

 

LEVINE’S LOW DOWN 

 

- In an effort to flex its creative muscles, Urban Outfitters is bringing an interesting approach to its latest Manhattan location slated to open later this year. The outside of the store is designed to look like a series of local mom and pop stores. Whether this is an attempt to appease local opposition to development or purely creative genius is unclear. Either way, Urban continues to show its flexibility in choosing sites and adapting them appropriately.

 

- Keep an eye on Polyvore, the internet’s largest fashion community. Think Facebook crossed with e-commerce. The site allows users to create custom “sets” of fashion items, almost as if they were creating a spread for a fashion magazine. However, all the images are actually linked back to online stores in which other social networkers can actually purchase the goods. Putting the sales aspect aside, this may be one of the fastest ways to see a trend unfold, ever.

 

- Mark your calendar for July 17th, the official return date of Abercrombie’s Quartlery (magalog). Maybe reverting back to old strategies will help to boost the company’s sales, which have been struggling pretty much since the last magalog printed several years ago. In all seriousness, wouldn’t have made sense to re-release the publication in iPad or iPhone form in an effort to keep up with the times? While the rest of the world is going all digital, ANF is heading back to paper…

 

 

MORNING NEWS 

 

Chinese Footwear Companies Focus on Domestic Rural Markets - As national policies intensify consumption in rural areas and competition is getting more intense in urban areas, an increasing number of Chinese footwear companies have been shifting their business focus onto the rural markets, according to the China Leather Industry Association.  <fashionnetasia.com>

Hedgeye Retail’s Take: This call is gaining momentum – we hit on this theme again last week after Yue Yuen results reflected significant outperformance in sales out of Asia. A stronger Yuan only bolsters the case.

  

WMT Works With City of Chicago to Build Stores, Jobs - Wal-Mart Stores Inc. said Monday it is working with the city of Chicago on a plan to build “several dozen” stores and create about 10,000 jobs in the process.As part of a long-term initiative, dubbed the Chicago Community Investment Partnership, Wal-Mart said within five years it would seek to open stores that, in addition to positions within the stores and organization, would create about 2,000 unionized construction jobs to help ease the city’s 11.4% unemployment rate. <wwd.com/business-news>

Hedgeye Retail’s Take: WMT taking advantage of the rare opportunity to score one with local communities while it still can..

 

US-Brazil Cotton Deal Shaded With Doubt - The U.S. and Brazil have reached an agreement in a long-standing dispute over cotton subsidies that could essentially forestall the imposition of sanctions on U.S. exports until 2012. Under the long-term framework agreement, the two sides will meet quarterly to discuss a resolution in the context of a new farm bill containing the cotton subsidy programs that Congress will begin negotiating in 2012.In April, the U.S. and Brazil reached an agreement that averted $800 million in sanctions for 60 days. Under the deal, the U.S. agreed to make some changes in its cotton export and credit guarantee program and to work with Brazil to establish a $147.3 mm fund to provide technical assistance and capacity building for the Brazilian cotton industry. The agreement affects raw cotton, woven fabric, men’s and boys’ cotton pants and shorts, women’s and girls’ cotton pants and shorts, and some jewelry and beauty products.  <wwd.com/business-news>

Hedgeye Retail’s Take: Consider this a band-aid approach to a broader issue for US cotton producers – less stability and support in the near-term future.

 

India’s Shopper's Stop Plans to Increase Stores by 50% - Shopper’s Stop Ltd. , India’s second- largest publicly traded retailer, plans to add 50% more stores in about 18 months as demand rises in the world’s second- most populous nation. <bloomberg.com/news/retail>

Hedgeye Retail’s Take: China, China, China... There’s another country out there that has around 2.4bn feet. India is definitely a tougher culture to crack, but seeing it’s second largest publicly traded retailer grow at this rate can’t be dismissed.

 

Hugo Boss to Open Up to 60 Stores This Year - Hugo Boss AG aims to open as many as 60 new shops per year, a third of which will be in China, to help raise sales, Handelsblatt reported, citing CEO Claus-Dietrich Lahrs. Hugo Boss wants to increase the share of sales stemming from shops and Web-based retail to about 50% by 2015 from 33% last year, the newspaper said. <bloomberg.com/news>

Hedgeye Retail’s Take: 15% growth isn’t exactly earth-shattering, but the shift towards controlling its own distribution is certainly noteworthy. A growth initiative in China on the day that the Yuan is revalued is not exactly great PR timing.

 

Alli Sports Acquires Standard Boardshop - Alli Sports, the NBC- and MTV-owned company behind the Dew Tour, has acquired Standardboardshop.com, the skate e-tailer. It also plans to launch a new e-commerce site called the Alli Shop. <sportsonesource.com/news>

Hedgeye Retail’s Take: This acquisition by Alli, a leading action sports multi-media site, makes a lot of sense. Standardboarshop.com provides Alli with an online retail presence – one of, if not the outperforming channel(s) in retail.

 

E-book Reader Price War Erupts - Barnes & Noble brought the price of a fully functional 3G e-reader under $200 today. Hours later, Amazon.com beat it by $10. The market for e-books has been heating up so much that it may have reached a tipping point where merchants can now subsidize device cost via e-book sales.  <internetretailer.com>

Hedgeye Retail’s Take: As with any razor – razorblade model, there’s little keeping prices of the device afloat with profits embedded in e-book sales. It’s only a matter of time before we see a $99 reader. Innovation in this category will be vital.

 

Father's Day Results Lift Retailers - Shoppers turned out for Father’s Day, lifting the spirits of retailers and affording them the opportunity to meet or exceed plan. Tailored clothing and dress shirts, along with knitwear, were among the bestsellers for most stores, stoking further confidence that the upcoming fall season will be healthy. Brooks Borthers, which ran some one-day specials to drive traffic, said business was strong the week leading up to Father's Day and better than anticipated. Barneys New York was also upbeat noting that shirts, ties, briefcases and watches did well. Saks Fifth Avenue reported that men's wear delivered on buy-now, wear-now and pre-fall with top categories in dress shirts, knit shirts and men’s accessories. Men’s wear for Lord & Taylor saw positive growth, but a slowdown from doubt digits to midsingled-digits. <wwd.com/business-news>

Hedgeye Retail’s Take: We can’t say this catches us by surprise given the dynamic of improved consumer confidence and pent up demand still for certain wardrobe items with men’s dress-wear near the top. For the first time in a long time, the customary Father’s Day shirt or tie was probably met with uncharacteristic appreciation this year.

 

Asia Drove Swiss Watch Export Gains in May, Europe Slows Down - Swiss watch exports posted another double-digit gain in May, though the increase was driven mainly by Asian markets as key European economies recorded sluggish to negative sales. Foreign sales of Swiss watches were up 13%. Sales in Hong Kong, the largest market for Swiss timepieces, rose 30.2% while China practically doubled in May, with a 98.8%. However, sales in Italy crept up just 0.2% while France progressed by 3.4 %. Germany again saw sales slide, with a 24% drop that saw it slipping to the eighth position among leading markets. <wwd.com/business-news>

Hedgeye Retail’s Take: Given the pace of appreciation of both the Hong Kong Dollar and Chinese Yuan versus the Franc since May, we’d expect demand to remain strong through June as Swiss timepieces remain on ‘sale’ on a relative basis in the largest markets.


HOUSING FIZZLES EARLIER THAN EXPECTED SETTING STAGE FOR WORSE DOWNTURN

Bottom line

May existing home sales were much worse than expected in spite of the continued effect of the April 30 tax credit expiration pull-forward. May sales came in at 5.66 million (seasonally adjusted annualized rate) down from 5.79 million in April (revised a tad from 5.77 million). Expectations were for sales to rise north of 6.2 million units. Sales coming in 9% below expectations reflects a major incremental negative datapoint.

 

Summary

Remember that this May print is a lagging indicator as it reflects deals closed two to three months ago (Mar/Apr) because of the 30-60 day lag between signing and closing.

 

In our view, the relevant benchmark is how it compares with October 2009's print of 5.98mn. Against that measure, it's down considerably (5.66). The original tax credit expired in November, 2009, putting October 1 month ahead of that expiration. The current credit (for closing) expires June 30 (April 30 for signing), which means 1 month ahead equals May.

 

In other words, it's now clear that tax credit round two is having a less substantive effect on sales than round one did back in late-2009.

 

HOUSING FIZZLES EARLIER THAN EXPECTED SETTING STAGE FOR WORSE DOWNTURN - 1

 

HOUSING FIZZLES EARLIER THAN EXPECTED SETTING STAGE FOR WORSE DOWNTURN - 2

 

Inventory, on a units basis, fell a modest 3.4% to 3.89 million units from 4.04 million units in April.

 

HOUSING FIZZLES EARLIER THAN EXPECTED SETTING STAGE FOR WORSE DOWNTURN - 3

 

Inventory, on a months supply basis, fell slightly to 8.25 months from 8.4 months last month. While inventory is down nominally on a months supply basis, this is somewhat misleading because its keying off an artificially high May 2010 sales rate. If we assume that the same dropoff in sales occurs following this tax credit expiration as followed the last tax credit expiration we can expect to see a sales rate of 4.25-4.5mn a few months from now. Meanwhile, inventory is at 3.89mn units. In other words, inventory could rise to 10-11 months or higher very shortly.

 

HOUSING FIZZLES EARLIER THAN EXPECTED SETTING STAGE FOR WORSE DOWNTURN - 4

 

Our view is that this pull forward of activity is setting the stage for a much weaker-than-usual summer housing environment. Housing-sensitive stocks could be at risk heading into the 2H10 and 2011 time frame.

 

We have an extensive report coming out on this topic on Friday for subscribers and prospects of our Financials Vertical, which we will summarize on a conference call at 11am on Friday.

 

 

Joshua Steiner, CFA

 

Allison Kaptur


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