R3: UK Comp/Austerity Duration Mismatch


July 7, 2010


There is a lot of head-scratching out there on the part of investors and managements alike about why austerity in the UK is not hitting consumers yet. We think that there is a meaningful duration mismatch brewing.





Marks & Spencer Group put up decent enough sales numbers (+4.4%) in its first quarter, but a tepid outlook wasn’t what the market had in mind. Sales were up 4.4% in the first quarter ended July 3, however, the retailer is cautious about the remainder of the 2010-11 fiscal year. Clothing (+7.4%) and General Merchandise (+7%) drove the sales gains. Per the company, customers responded well to improved styling, stronger fashions and great value.  I call that a fluff statement – but hey, numbers don’t lie. M&S’s discretionary business definitely remains healthy.  


This is most interesting because we’re hearing from Ralph Lauren, Nike, Calvin Klein/Tommy Hilfiger (WRC/PVH), Next, Burberry and others that sales in Europe remain healthy – at least in constant currency.


That dovetails interestingly with a question I’ve been hit with more than a few times over the past week. The crux of it is “when will austerity measure really begin to negatively impact consumer spending in the UK.”


Investors in the US have that attitude where they are shrugging their shoulders and saying ‘wow, I started to brace for a slowdown 2-3 months ago in UK, and have not yet seen it. Maybe I was wrong in my conservatism. Ironically, CFOs are saying the same thing. Now the companies are starting to think that they are bullet-proof, and are therefore conveying that cockiness to shareholders. Ultimately, investors are getting complacent with complacent management teams.


That, of course, is when the volatility – and the fun – begins. When does this come to light? I’m not sure. Will it be at the Goldman conference in September? Or when the companies give their 2011 plans w 4Q10 results in Jan?  Too much longer and the currency hedges will unveil holes in the model. Take your pick. Either way, complacency is gonna hurt those components of the global retail supply chain that don’t have a Macro process and have not been planning for this for 2-years.


Maybe the simplest way to put it is how Keith highlighted recently “Austerity hasn’t actually been implemented yet. When it does, there will be a lag as to when it ultimately touches the consumer. But old spending habits will die hard when they do… and duration mismatch between the actual austerity and it hitting people where it matters will become increasingly obvious.




  • We continue to keep an eye on Amazon’s apparel and footwear efforts as the site continues to grow the business in a post Zappos world.  This time the company is offering a set number of fall footwear SKU’s for pre-sale, with delivery beginning in mid August.  While this is something we don’t often see from a physical shoe store, we can’t ignore the positive benefits to Amazon’s cash flow and inventory management from gauging demand  for fashion styles in advance.
  • According to a Harris Interactive poll, 7 in 10 Adults see the economy staying the same or getting worse over the next twelve months.  The survey also highlights a more dire look in the next six months, in which only 21% of American’s believe their financial condition will improve over the next 6 months (down from 25% in May).
  • In an effort to begin monetizing Twitter, the company launched @earlybird, a Tweet that announces limited time deals, special events, and exclusive offers.  Similar to Gilt or RueLaLa, the Tweet stream aims to feed consumers find limited but compelling deals offered by retail partners.  Twitter will take a percentage of each sale generated by the service. 



Hot Temperature Drove East Coast to Shopping - Consumers throughout the Eastern U.S. sought relief from record-breaking temperatures Tuesday any way they could — including going shopping. As the thermometer topped 100 degrees in Manhattan and elsewhere, retail executives said traffic to their air-conditioned stores and malls was heavier than normal. The searing heat followed the warmest July 4th weekend since 2007 and the third-warmest June in 50 years. And the heat wave was forecast to continue through at least Friday, when temperatures are expected to dip to the more-normal mid-80s. Over the weekend, businesses in the eastern two-thirds of the U.S. experienced double-digit increases of seasonal purchases compared to the coldest 2009 period in a decade, according to Planalytics. West Coast consumers are still waiting for summer to start and holding off on seasonal purchases. <>

enhanced search functionality and increased customer service. <>

Hedgeye Retail’s Take: Let’s get the heat out of the way. It’s good for biz now, but cool weather in Aug will set back-to-school off on the right foot.


R3: UK Comp/Austerity Duration Mismatch - Weather 7 10 


Mobile Commerce to Jump from 160 Retailers to 770 - Today there are 160 retailers active in mobile commerce, according to Internet Retailer research. By month’s end, if all goes as planned, there will be 770. E-commerce platform and online marketing provider Shopatron Inc. is in the final weeks of testing m-commerce site-building functionality that it will add to its platform offering at no additional cost to its more than 800 clients. <>

Hedgeye Retail’s Take: Kind of surprising that we still refer to this as ‘e-commerce.’ It’s getting to a point where it is just ‘commerce.’ Anyone that’s just catching on now is way behind the curve.


China's Shandong Ruyi to Complete Acquisition With Japanese Fabric Maker Renown - Shandong Ruyi Group, one of the largest Chinese textile manufacturers, has expected to complete its purchase of 41.18% stake in Japanese Renown Inc, a 108-year-old fabric maker, by the end of the month.  <>

Hedgeye Retail’s Take: A culturally odd deal that we see so few of. Nonetheless, it makes sense – especially with import/export duties eliminated intra-Asia as of 1/1/10.


BEBE To Shutter PH8 Concept - Bebe Stores Inc. said Tuesday it will end its failed PH8 experiment and either close the format’s 48 stores or convert them to the more promising 2b bebe concept. Closures and conversions are expected to begin shortly, with all stores either closed or converted by the end of Bebe’s 2011 fiscal year next July. Bebe said comparable-store sales for the fourth quarter would come in at the low end of earlier guidance of a midsingle-digit decrease to a midsingle-digit increase.  <>

Hedgeye Retail’s Take: It’s about time…


Pier 1 Plans to Slowly Re-enter E-commerce - Pier 1 is hatching plans to make all of its inventory available for purchase online by September, but for in store pick up and payment only. After a three year absence, Pier 1 Imports Inc. is making a very limited return to online retailing. The multichannel retailer of various home furnishings is hatching plans to make all of its inventory available online by September. But purchases will be limited to making a reservation online, but paying for the merchandise and picking up the items must be done in a Pier 1 store, the retailer says enhanced search functionality and increased customer service. <>

Hedgeye Retail’s Take: Very late to the party, but with 5 consecutive quarters of improved sales growth vs. inventories, PIR needs another trick. Maybe this is a temporary fix.


Indian Apparel Manufacturers Seek Business in Vietnam - Indian garment companies are seeking new business opportunities by planning to offer high-quality material as well as technology assistance to Vietnamese companies. <>

Hedgeye Retail’s Take: This is still a function of a focus on higher consumption intra-Asia vs. relying so heavily on the West. Not good long-term for us.


ANF Still Investigating Bedbug Problem in Manhattan - Abercrombie & Fitch Co. is still investigating its bedbug problem in Manhattan, but hoping to reopen the Abercrombie & Fitch unit in the South Street Seaport on Thursday. The company’s Hollister flagship on Broadway and Houston Street in SoHo reopened Saturday after the infestation was exterminated, and on Tuesday saw good traffic despite the scorching heat (and being temporarily tainted), with Broadway busy midday. <>

Hedgeye Retail’s Take: Tough to manage risk around something like this. More of a PR mess than anything else, but it definitely will have a lingering effect on that store.




The Macau Metro Monitor, July 7th, 2010


Paper maker Long Success, which also operates a VIP room in the Venetian Macao, is considering selling its gaming business, CEO Hu Dongguang said this week.  The group wants to focus less on gaming and more on environmental protection.

Although Long Success moved the Jun Ying VIP Club from Grand Waldo to the Venetian Macao in May 2009, the number of visitors stood below the group’s expectations during the year.  “Obviously, the keen competition arising from continuous openings of new casinos in Macau has made the operating environment more difficult,” the company wrote in its annual report.



Taiwanese Premier Wu Den-yih said, "Individual Chinese tourists may be allowed to come early next year if preparatory measures have been completed by the two sides."  So far, Chinese can only travel in groups to Taiwan. 


Up to 500 individual tourists will be permitted to travel to the island each day after the ban is lifted, probably in early 2011, said Wu who was quoted by the Economic Daily News.



Data from Uwin Real Estate Information Corp showed a total of 3.57 million square meters was sold in Shanghai's primary market, compared with 5.41 million sq meters a year earlier.  The average price of new flats fell 14.2% YoY in June.  Despite the property market cooling down, a number of mainland newspapers speculated yesterday that the government could release new cooling measures in the coming months.


While there is precedent for a lower multiple, we think the Street is too low on margins. The next year should validate the Board’s decision to replace Dan Lee.



Why is PNK getting demolished?  Potential exposure to the Gulf oil spill, an economic wall of worry, high leverage, Baton Rouge concerns, a lousy May in the regional markets;  the list goes on and on.  The stock is down almost 40% in two months with no real announcements from the company.  That brings the valuation multiple down to 6x our 2011 EV/EBITDA.  One could take it a few steps further and point out that multiple includes $50 million in capex related to the construction of Baton Rouge (almost $1 per share) and doesn’t include non-EBITDA producing assets such as BR, Reno, and AC land that we value at $200 million or over $3 per share of equity value.


So the stock is cheap.  Blah, blah, blah.  After the market nose dive, a lot of stocks are cheap.  Besides, we’ve seen these regionals trade into the 5xs.  There has to be catalysts to buy a cheap stock these days.  We think better margins will be the main catalyst this year and next, although a completely revamped marketing program could boost top line as well.


Earlier this year, the PNK Board replaced the developer/empire builder Dan Lee with the operator Anthony Sanfilippo as CEO.  Mr. Sanfilippo, who has been buying stock recently, cut his teeth in the Harrah’s organization so he knows a little about database marketing.  He also seems to know a little about cost cutting.  We detailed the cost cutting plan first back in April in our Q4 earnings preview note so we don’t want to rehash the components here.  We did see evidence of the plan in Q1 where PNK surprised on the upside due to margins.


In looking at the following charts the potential for margin improvement is obvious.  We’ve compared PNK to the other pure regional gaming operators in terms of overall EBITDA margin and a more apples to apples comparison of EBITDA margin less gaming taxes.  PNK under Dan Lee clearly trailed the industry in this very important metric.  The other companies began to cut costs in 2008 when the industry turned, so their margin comparisons are much more difficult than PNK.  ISLE probably has more room to cut, although there are structural issues with some of their properties.  We believe PNK will still be comping against a higher cost structure through 2011.




As we mentioned, cost cutting shouldn’t be the only area of significant improvement.  Marketing is Mr. Sanfilippo’s specialty.  The chart below shows that PNK has trailed the industry on the operating side as well.  It compares PNK’s revenue per position in each of its major markets to the competition.  With the exception of PNK’s L’Auberge, PNK trails the market badly in win per position per day, presenting significant room for improvement for a good operating team.  L’Auberge, of course, is a much newer and better product than the weak Lake Charles competition.




We understand the market’s concern surrounding consumer spending in general and very discretionary gaming spend in particular.  Meaningful leverage only adds to the risk.  At least PNK has a few major levers left to pull vis-à-vis the rest of the industry.  Of course, if the economy double dips, no casino operator will emerge unscathed.

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This morning's data makes it 8 of the last nine weeks that the MBA Mortgage Purchase Applications index fell sequentially. The index dropped another 2% this morning falling to its lowest level since 1996 in spite of record low mortgage rates. The Purchase Applications Index is a good proxy for overall demand as it captures at least 50% of all mortgage purchase application volume.


Home prices are a simple function of supply and demand, but housing assets are sticky assets and reprice with a lag. We've found the lag to be one year. As such, record low demand today will manifest in materially lower home prices a year from now. We are now two months removed from the stimulus expiration and are still hitting new lows in demand. We'll keep a close eye on the remaining summer months to see whether demand rebounds as we get further removed from the stimulus expiration.




As a reminder, housing demand is positively correlated with affordability, meaning that demand wanes as prices go down. Similar to retail investors chasing performance, the math suggests that as home prices increase either as a result of high mortgage rates or appreciation of home values, more buyers come to the table. This is in stark contrast to the consensus belief that high affordability will stimulate housing demand and help clear burgeoning inventory.




Joshua Steiner, CFA


Allison Kaptur




To Be or Not To Be Tax Free

As fiscal losses mount at the local level and the back to school season begins,  the discussion surrounding tax free holidays is building.   Some states view these holidays a stimulus to help local businesses and consumers while others are clearly seeing incremental sales tax as a source of revenue.  As we head into the critical back-to-school selling season, it’s important to understand what’s different this year vs. last from both a timing and magnitude perspective.   And, with June sales reported tomorrow,  we expect to hear the first indications of how tax free holidays may be expected to impact July and August results. In an effort to capture the various shifts in timing and program parameters versus last year, we present the following graphics below. Here are a few noteworthy observations:

  • There are typically 3 different types of sales tax holidays: hurricane preparedness, clothing and school supplies, and energy efficient appliances.  For the purposes of this post we are focused on the clothing and school supplies.
  • The top 5 states most exposed to teens in the 15-19 year-old demographic are CA, TX, NY, FL, IL, representing 37% of the entire domestic teen market.  However, only three offer a tax free holiday (TX, NY, & FL).
  • The two biggest teen states (CA & IL) that don’t offer the tax free holiday have some of the highest state sales taxes in the country.  CA and IL are also #1 and #4 respectively on a list for highest projected budget gaps as a percent of the state’s general fund budget.
  • So far, FL and MD are the only two states adding events vs. this time last year.  They are adding 3 and 7 day tax-free events respectively.
  • GA, Washington DC, and South Carolina have either repealed or suspended their respective tax free holidays.
  • NY just repealed it’s tax-free status on shoes and apparel under $110, however this will not take effect until October 1st.  The suspension will last until April 1st, 2011, at which point a $55 tax-free threshold will be established for a year.  Then, in 2012, the original exemption will be reinstated.

With municipalities struggling to meet budgets, we should expect continued contraction in this list of tax free events as well as growth in efforts to add or boost sales tax overall.  


To Be or Not To Be Tax Free - TeenStateExp 7 10


To Be or Not To Be Tax Free - taxfree


Continuing a trend from last week the MACRO calendar continues to provide us with disappointing news.  Yesterday, the ISM non-manufacturing index fell to a four-month low of 53.8 in June from 55.4 in May, as new orders fell for a third straight month, declining to 54.4 from 57.1 in May.  The biggest concern was the demand outlook as order backlogs slipped to 55.5 from 56 and the employment index edged back below 49.7 from 50.4 in May.


Despite this, the S&P 500 experienced a Bear Market Macro bounce, as the S&P 500 finished higher by 0.54%.  The upside was driven by the strength in global markets, especially China.  The euphoria faded as the Consumer Discretionary (XLY) names underperformed heading into same-store sales Thursday.  The XLY was the only sector to be flat on the day.


The biggest divergence yesterday was the decline in the Russell 2000 which declined 1.5%.  Within the small cap space the S&P 600 Restaurant Index declined 3.6% on the day.  Yesterday, the S&P Retail Index declined 0.5% on a flurry of June same-store sales previews which focused on the favorable impact from the calendar shift, but raised concerns over 2H10 expectations.


The RISK AVERSION trade was evident yesterday as Treasuries were stronger with some help from the weaker-than-expected non-manufacturing ISM data.  The dollar index closed lower, closing at $84.03 down 0.62%.  The Hedgeye Risk Management models have the following levels for the USD – Buy Trade (83.80) and Sell Trade (85.18).  The VIX moved lower by 1.5% - the Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (25.65) and Sell Trade (30.61).


With a sharp decline in the Dollar index, it’s worth noting a big spike in the euro - the euro traded up 10.87%, closing at 1.26.  The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade (1.22) and Sell Trade (1.28).


The three best performing sectors yesterday were Utilities (XLU up 1.2%), Energy (XLE up 1.0%) and Technology (XLK up 1.0%).  The oil services group finished higher for a fourth straight session with the OSX +0.5%.  Despite a reversal in natural gas, coal stocks still finished mostly higher with some help from M&A activity.


The XLK outperformed as the S&P Software index rose 1.8% on the day, with CTXS +2.5%, MSFT +2.4%, ORCL +2.2% and RHT +1.8%.   


The Materials (XLB) was a laggard, weighed down by the paper and forest products group, where falling pulp prices have gained some attention.   The S&P Steel Index also declined by 0.8% on the day. 


In early trading copper is trading down for the first time in four days as the dollar is rallying.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.83) and Sell Trade (2.98).


In early trading gold is trading at a six-week low.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,187) and Sell Trade (1,229). 


The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (70.79) and Sell Trade (75.29). A slowing global growth outlook and a cyclical build-up in U.S. stocks are exerting downward pressure on the price of oil. 


As we look at today’s set up for the S&P 500, the range is 50 points or 2.6% (1,001) downside and 2.2% (1,051) upside.   Equity futures are trading below fair value continuing the weakness from yesterday afternoon.  On the Macro Calendar today, we have MBA Mortgage Purchase Applications.


Howard Penney













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