Bear Market Macro: SP500 Levels, Refreshed...

It’s kind of getting fun to watch this market trade between its TRADE (1085) and TREND lines (1144). Fun enough to be sitting here at 3PM on a Friday afternoon in July. Provided that 1144 remains overhead, I’ll call the US stock market a bear with refreshed immediate term TRADE resistance at 1109.


It was also fun watching American and European professional politicians make things up all week. I wrote two Early Look notes this week with one name in common, Fiat – the Fiat Guns and the Fiat Republic – but it’s really all one and the same. There is a very serious group of conflicted and compromised politicians in the Western world who genuinely believe that government is the answer to economic problems.


Next week’s big catalyst on the American Austerity front will be the National Commission on Fiscal Responsibility and Reform meeting in DC on Wednesday. Don’t forget that Clinton’s ex-Chief of Staff, Erskin Bowles, has already served up the opening volley on the deficit spending front by calling America’s debt and deficit balances “a cancer that can destroy the country from within.”


It’s the weekend – at least our long positions are safe until Monday.


Have a great weekend with your families,



Keith R. McCullough
Chief Executive Officer


Bear Market Macro: SP500 Levels, Refreshed...  - S P

R3: RL… Another Move People Will Underestimate


July 23, 2010


Korea gives yet another leg of growth to one of the most consistent growth stories in retail. Will RL sandbag integration costs, etc…1Q print? Yeah…probably. But there’s enough gas in the tank in this model that it shouldn’t matter. Consensus numbers are too low. 





RL’s announcement to repo its South Korea license from Doosan Corp is a slam dunk.  The price seems fair, and the integration costs are likely to be relatively small in light of RL’s ability to leverage recent structural investments in China.  Consider the following…

1)      This is spot on with the company’s strategy to control all of its brands, at all price points, in all channels of distribution, in all regions of the world. Have you ever visited a RL store in Korea? Not pretty…

2)      Korea is one of the more attractive ‘accessible luxury’ markets in the world. For comparison, Korea’s per capita spending is #30 in the world at $27,978, China is #95 at $6,567.

3)      Doosan has 5 freestanding locations and 175 shop in shops through S. Korea. By way of comparison, the Chinese license got RL 40 stores and 100 shop in shops.

4)      Interestingly enough, the risk profile in Korea is meaningfully less than in China – largely due to a more established and sophisticated consumer.

5)      Not only is the Korean consumer base more stable, but as of January 1 2010 RL has a major DC open in China. This allows them the luxury of materially ramping utilization of a new expensive asset.

6)      If you’re living in Europe or Asia, try going online and buying RL product. Good luck… is not yet ‘turned on’ there. They’ve only got the US humming. International in begins later this year. As it relates to Asia, try selling a 60% margin business when there is an unconsolidated partner who has full control over retailing similar product in a given region. 

7)      The price tag here seems reasonable. Keep in mind that most of these license acquisitions seem very expensive at the time as RL is buying an underloved asset who’s real growth potential has not been realized due to lack of integration with the rest of the company. The license cost $47mm (including $22mm of variable inventory and assets) compared to $18mm for China, and $26mm (10 years ago) for Japan.

8)      Two geographical licenses remain. One controlling Oceania, and the other controlling the Virgin Islands and parts of Latin America. The LatAm license makes sense next (tourist shopping markets), but Oceania is likely a rounding error.


The punchline here is that this gives yet another leg of growth to one of the most consistent growth stories in retail. Will the company start sandbagging integration costs, etc…when they print their upcoming quarter? Yeah…probably. But there’s enough gas in the tank in this model that it shouldn’t matter. Consensus numbers are too low. 





Adidas Preannounces Postive Earnings From World Cup - World Cup success isn't limited to Spain. Releasing preliminary results on Thursday, Adidas AG, the world's second-largest sporting goods company, said second-quarter profit jumped to 126 mm euros , from 9 mm euros during the same period a year ago, boosted by sales of soccer gear. Sales increased 19% and first half of 2010, profit reached 295 mm euros. Adidas outfitted 12 of the national teams competing in the FIFA World Cup in South Africa, including Spain.  <>

Hedgeye Retail’s Take: Lets not forget the impact of Easy Tones boosting Reebok sales, either.  World Cup goes away next year. Let’s hope for Adidas’ sake that the ‘toning’ category accelerates.


Fashion World To Experience Inflation - Life is getting more expensive in the fashion world, and consumers could get stuck with some of the bill. “The era of apparel deflation is now over,” said Richard Noll, chairman and chief executive officer of Hanesbrands Inc. Cotton prices are up more than 50% from a year ago, labor and transportation expenses are rising and factories that closed during the recession remain dark, keeping a cap on supply as demand perks up. To top it off, Chinese officials have become more willing to allow the yuan to appreciate against the dollar, which could make goods made in the country even more expensive. “You’re starting to see price increases come through the entire supply chain, not just from commodity costs, but also from a supply and demand imbalance,” Noll said. “There is no question that costs are working their way through the supply chain and you will see a broad-based increase, I think, in retail prices for apparel in 2011.”


Hedgeye Retail’s Take: If ‘The era of apparel deflation is now over’ is not the quote of the year, then I don’t know what is. Now someone answer me this… If cost deflation is history, then it means that to purchase the same number of units, consumers to stomach a price increase for apparel. Anyone want to check the record books and see when the last time was that consumers took an apparel price increase?


New Balance Concept Store Opens in Dedham - New Balance opened its new concept store in Dedham, MA. The Dedham store will showcase a new design concept that highlights New BalanceÂ’s strong performance and technology brand story. <>

Hedgeye Retail’s Take: Too bad New Balance still can’t make money.


Supply-Side Limitations in Asia Hit the Top and Bottom Lines at LaCrosse Footwear - BOOT reported a second-quarter net profit of $0.1 million, or 2 cents a share, which is down 94% from $1.7 million, or 26 cents, in the same period a year ago. Net sales were down 11% with both the work and outdoor categories suffering declines in the quarter. Sales in the work market were down 15% due primarily to the timing of U.S. government orders. Sales in the outdoor market declined 2% from constraints on the supply of finished goods caused by capacity limitations at the firm’s manufacturing partners in China. <>

Hedgeye Retail’s Take: Capacity limitations = harbinger of higher prices.


Skechers Hires The Licensing Company To Oversee European Expansion - The Licensing Company has been appointed to oversee a European-focused merchandise program for Skechers. As agent, TLC will seek partners for the brand in apparel, fashion accessories, hosiery, bags, outerwear, sporting goods and luggage for men, women and kids. Skechers joins TLC's other clients, including Airwick, Bic, Jim Beam, Umbro, Cosmopolitan, Lysol, Jelly Belly, Perrier, Jeep, Michelin and Welch's. In the U.S., Skechers licensees include children's apparel, bags, eyewear, legwear, medical scrubs and leather accessories.  <>

Hedgeye Retail’s Take: SKX smells really bad to me here. A) They’re riding a massive unsustainable wave, b) They’ve underinvested in the base (ie they’re overearning), and c) are now outsourcing the job of finding ways to license out content in foreign markets.


Gilt Groupe Continues App Success With a Droid App - The limited-time sale retailer is building on its iPhone app’s success with a new Droid app. “We are starting to see downloads of the Android app and sales through it already this morning,” Shan Lyn Ma, senior director of product development at New York-based Gilt Groupe Inc., said earlier today. “The main insight we’re seeing so far is that the orders have been primarily from men.” That wasn’t surprising because men are known to be strong users of smartphones that run the Android operating system. And they’ve been an important part of the early growth in mobile activity on Gilt’s iPhone and iPad apps, which the retailer launched in August 2009 and April 2010, respectively.  <>

Hedgeye Retail’s Take: These retailers continue to fascinate me. They’re definitely doing the right things to navigate the fact that their models are not scalable.


Sluggish top line is well known but margin upside is likely going forward.



As we pointed out in our “PNK: MOVING INTO OVERSOLD TERRITORY” post on 7/7/10, the Street is likely underestimating PNK’s margin potential and the magnitude of the properties’ marketing underperformance.  PNK’s properties have generally underperformed the important metrics of revenue per slot and profit margins.  We believe the new management is a vast improvement to the empire builders of the past.  While progress will be gradual – only some margin improvement will be evident in the Q – PNK is an intermediate term secular margin story.  In other words, PNK has margin expansion potential that its competitors do not.


For the quarter, we are at $49.6 million in adjusted EBITDA, slightly below the Street.  Given the regional top line trends, we believe whisper expectations are low.  The driver for the stock will be margin expectations for the future which we believe will be ratcheted northward.  Cost cutting should be a two year story, consistent with other gaming operators.  The difference is that the other operators began cutting in 2008.  We expect cost cutting to fuel margin improvement through the end of 2011, even if top line trends remain sluggish.  We cannot say that for the other gaming operators.


We do harbor some longer term concerns:  the consumer, particularly as it relates to domestic gaming spend, and the long-term impact of political pressure on Gulf drilling as the oil industry drives 16% of Louisiana’s economy.  However, the influx of relief workers related to the oil spill should have a net positive impact on near-term business.  


For all of 2010, we are projecting $207 million in adjusted EBITDA, $10m above the Street.  The differential grows in 2011, $245m versus the Street at $228m.  That puts the valuation at only 6.1x 2011 EV/EBITDA.  Excluding construction in progress associated with Baton Rouge, which won’t contribute any EBITDA in 2011, the valuation falls below 6x.


U.S. market saw weak volume on yesterday’s rally. 




As we look at today’s set up for the S&P 500, the range is 20 points or 1.0% (1,083) downside and 0.9% (1,103) upside.  Equity futures are trading mixed ahead of the European banking stress tests results due at noon.  Analysts expect between 5-10 banks to have failed and will need to raise additional capital.




Moody's Investors Service said it placed Hungary's credit rating on review for a possible downgrade after the government was unable to reach agreement with international donors on fiscal targets.


The U.K. economy grew almost twice as much as economists forecasted in 2Q10.  Gross domestic product rose 1.1% after increasing 0.3% last quarter.  Economists forecasted 0.6% growth, according to Bloomberg. 


German business confidence unexpectedly surged to a three-year high in July after exports boomed and economic growth accelerated. The IFO institute said its business climate index, based on a survey of 7,000 executives, jumped to 106.2, the highest since July 2007, from 101.8 in June.




Overnight the MSCI Asia Pacific Index end the week higher for the third straight week.  China closed up another 0.4% last night, bringing the weeklong rally to 6.1%; China was the best performing market in the world last week.  The improving sentiment in China is due in part to speculation about some relaxation of property tightening measures.  China is still broken on TREND.


Copper was up 2.3% yesterday to close at 3.18, 0.01 below the TRADE line of resistance.  Oil is trading near its intermediate TRADE line of resistance of 79.12.  Yesterday, we shorted copper (JJC).  


Treasuries were weaker yesterday with the strength in global equities.


Europe was another bright spot on the back of the upside surprises in the flash Euro zone manufacturing, services and composite PMIs for July.


Yesterday, the S&P rallied on decelerating volume, while the down days are on accelerating volume; a bearish sign.




The Industrials (XLI) sector provided a nice chunk of upside leadership in the S&P 500.  Strength was fairly broad-based, though Transports +3.9% were the standout after UPS +5.2% beat consensus EPS expectations for Q2 on margin upside, while the company also raised 2010 guidance above the Street.

The rail companies were another bright spot following a meaningful EPS beat from UNP +4.8% on a lower-than-expected operating ratio.


Housing-leveraged stocks were among the best performers today with the XHB +3.7%. Recall that the group rallied nearly 4% on Tuesday despite the weaker-than-expected June housing starts data.


The third best performing sector yesterday was the Financials (XLF).  Along with the asset managers, which rallied on the back of an unexpected improvement in Q2 flows at JNS +11.8%, the financials were underpinned by the strength in the banking group, with the BKX +3.9%. Regional’s provided the upside leadership. 


Howard Penney

Managing Director


US STRATEGY – UP MARKET, DOWN VOLUME - levels and trends 723














The Macau Metro Monitor, July 23rd, 2010



According to a company statement, Sands CEO Steve Jacobs has left LVS. COO Mike Leven will run Sands, helped by Director Irwin Siegel, until a successor is found.  Steven Weaver, who was previously Sands China's president of Asian development, will serve as an adviser.  Although no reason was given for his departure, there was speculation it was due to rifts between him and Adelson, particularly on Jacob's comments regarding casino development plans in Japan.



Total visitor arrivals surged by 30.6% YoY to 1,904,395 though comparisons were easy given the swine flu pandemic last year.  Visitors from Mainland China increased by 44.7% YoY to 985,127 (51.7% of total visitor arrivals), with 377,491 travelling to Macao under the Individual Visit Scheme, up notably by 62.6% from June 2009 (232,161).



According to IAG, Ng Fok, a Macau businessman with ties to Stanley Ho, is one of the people behind Macao Dragon.  Mr. Fok is currently chairman of Hotel Presidente Macau, a four-star SJM-licensed casino hotel opposite Wynn Macau on Avenida da Amizade.


From SJM's perspective, motivation to strike a marketing deal with Macao Dragon to drive traffic to SJM-licensed Taipa casinos isn't very strong, given that SJM doesn't own the full economic benefit of the casinos.  However, IAG believes if they do team up, they could target mass market players who want privacy and more affordable hotel rooms on Cotai.  Taipa's SJM casinos could also be marketed to mid-level high rollers as distinctively Chinese-owned and managed properties. 


The Monetary Authority of Macau (AMCM) said,  “The growing pace of gaming receipts would slow in the second half, while the gradual increase in investment spending would add force to economic growth. As a result, the real GDP growth is expected to exceed 15.0 percent for the whole of 2010.” AMCM also forecasts a below 3.0% jobless rate, 3-4% CPI, and relatively stable local interest rates for 2010.


According to Mr Tam, the appreciation of the RMB and the supply of daily necessities from the Chinese mainland to Macau are the two major factors that will push up inflation in 2H 2010.  Once the inflation rate reaches 3% (based on average figures for a 12-month period), the government will adopt specific measures in a "timely" manner to ease the inflation pressure, added Tam.  For the 12 months ended June 2010, the average Composite CPI rose by 0.97% YoY.



Private home sales prices in Singapore slowed down to 5.3% growth in 2Q, compared with 5.6% growth in 1Q.  This was a tad higher than the 5.2% initial forecast reported earlier this month.


S'PORE CPI UP 2.7% IN JUNE Channel News Asia

The 2.7% CPI growth is less than the market forecast of 3.5% growth.



CBRC announced yesterday that the average NPL ratio for chinese banks was 1.30% at the end of June, 0.28% lower than at the end of 2009, indicating that the sector remains healthy despite concerns that a slowdown in the economy may damp loan quality in the longer term.


Jay Santiago, Pagcor's new spokesman, said  "We have four proponents which have made commitments to start off construction on the Entertainment City, which is connected to the Bagong Nayong Pilipino.  We are in the process of reviewing the contracts they've entered into, the business models that have been proposed, and we're looking at the lay-out of the project. Chairman Naguiat wants it to be more of a tourist attraction rather than a gambling destination."  The Entertainment City deal was brokered by former Pagcor chairman Efraim Genuino to ensure Aruze didn't pull out of the scheme for an Okada Resort, including casino.


Also, the Resorts World Manila casino and hotel project opposite the Manila International Airport  is under gaming policy review, ordered by President Aquino.


Important consumer commentary from management.


CAKE posted in interesting quarter.  Same store sales up 1.6%, traffic up 1.4% and price up 1.4%. The implication is that pricing was down1.2% for the quarter.  As management state the consumer is doing a little “check management” when they come to the Cheesecake factory.  This is a problem - especially with commodity prices increasing. 


The company has touted the success of the new section on the menu “Small Plates and Appetizers.”  Unlike some restaurant companies that count entrées to measure traffic trends, CAKE actually measure traffic in terms of actual guest counts, which the server inputs when inputting an order for the table.  While you can not directly draw this conclusion, it seems likely that the success of the small plates and lower price points are the driver of incremental traffic.


Despite this, the company wants to raise prices 1% with roll out of the summer menu.  The company is trying to balance an increase commodity pressures and other expenses, while at the same time trying to get back to peak margins.  With the incremental traffic being driven by lower price points, the risk to the business model increases.  In a cautious consumer environment, slowing traffic trends is real possibility.


As you can see from out CAKE sigma chart, the company is currently operating in “nirvana”, the quadrant where same-store sales and restaurant-level operating margins are increasing year-over-year.  Given the current trends the company will move down in the “trouble brewing” quadrant, where same-store sales are still positive but margins are contracting year-over-year.  And that is how I would describe the position the company is in.  There is trouble brewing when the incremental consumer is coming in for lower price points and you need to raise prices to maintain margins.  









  • Weary of macro environment
    • Fed revision
    • Consumer confidence
  • Still produced traffic +1.4%
  • Sales were solid
  • Comps and savings helped drive 22% of EPS growth
    • Anticipating more in savings this year than in 2009
  • Opening new model (final for year) next month
  • Seeing more availability of quality restaurant sites



  • 1.3% increase in operating weeks due to opening new restaurants
  • Sequential sales comparisons impacted by gift card redemptions and holidays
  • Traffic up 1.4%, pricing up 0.6%
  • Check management by customers – particularly with beverages
  • G&A were down 80 bps vs 2Q09
    • Lapping accrual related to CEO retirement plan
  • D&A was down 30 bps yoy
    • Lower depr reslting from impairment charge being recorded
    • Positive sales leverage
  • Operating margins in the second quarter of 2010 improved 180 bps to 8.9%
    • On track to surpass operating margins of 07 – 7.3%
  • No more interest rate collars in place on remaining debt outstanding
  • 670,090 shares bought back at 17.4m dollars
  • Cash balance of 86m despite using sme cash to pay debt and unwind interest rate collar
  • Generated about $58m million in free cash flow


3Q Guidance

  • EPS between $0.31 and $0.33
  • Assumes comps between flat and +1%
  • Expecting dairy pressure, preopening expenses yoy (no new restaurant in 3Q09), and additional marketing expense to impact EPS by $0.04 (combined)


Full year 2010

  • EPS between $1.32 and $1.38
  • Assumes comps between 1% and 1.5%
  • In 4Q CAKE hits hardest compares yoy
  • 60% commodities contracted for 2010 but food inflation of flat to +1%
  • Lower contracted proteins but higher dairy and fish




  • The worst market we have is down 1% - California




Q: Changed back half of year earnings guidance?


A: Earnings outlook changed by 4 cents and 3 cents was upside of 2H. we changed it by a penny



Q: How are trends looking now, consumer habits?


A: Not talking about month by month.  We continue in the quarter to track closely to forecast.  When we expected soft comps because of difficult yoy compares we got them. 



Q: Still going to grow at low single digit range?


A: We’re looking at many sites, more than we did for 2010.  We won’t have color on 2011 until lease negotiations are further along.



Q: Price? Average check – still incremental boost from small plates?

A: Comps are up 1.6%, 1.4% is traffic, price is 1.4%, negative mix shift negated price.  Guests managed checks by buying fewer beverages.


Definitely some trading down. 


Expecting cost of sales for year to be about flat.



Q: On negative menu mix, do you think you’ll start to lap trade down that consumers have been doing? Do you think summer menu price may stick more?

A: They might…(not too confident!)



Q: Looks like volumes are lower, is there any reason to believe that there is not a capacity to grow comps based on historical range?


A: There definitely is capacity to gain our comps back if we take guest counts back.  We lost traffic, not pricing.  We can get it if we can get customers not managing check as much.



Q: How confident are you that you can control check management more?


A: It’s an art not a science, have to find a balance. We’ve seen TC’s increase over the last two quarters. (not convincing here)…



Q: What are some of the plans for this quarter?  Do you see trends move when you ramp up spending on marketing?


A: We are spending more in 2Q than we did in 1Q? it’s timing.  2010 marketing as % of sales will be about flat on last year.  We see redemptions in weekly sales, certainly.  Marketing is focused on remaining on brand and not doing deep discounting.  Engaging customer.  And creating positivity. 



Q: You introduced small plates and snacks as economy slid…considering the economy is not doing what we might of though, what is your take now? Guest satisfaction?


A: Last year we increased satisfaction every quarter.  Our expectation for this year is to maintain or slightly raise the level.  We are maintaining the high level of guest satisfaction. 

Menu innovation is one of our advantages. We have a new menu in just a few weeks.  Recently we brought our new cheesecakes that are the best selling we’ve ever had.



Q: Grand Lux has a small base but obviously slowed slightly…commentary?


A: Negative holiday shift in 2Q impacted Vegas and Florida strongly and they are a big part of the pie.



Q: 10-12 openings maybe in 2011, are any of those small formats?


A: Right now the Annapolis size is now our favorite – 8,500 sq ft.  The answer is yes and we’re looking at 7,000 when we think we can do 7m.  Might earmark one 2011 site for 7,200.  8,500 is the favorite at the moment. 



Q: Impact from the gulf?


A: No exposure there…Miami was strong though.



Q: Labor turnover vs where it was at the peak?


A: Incremental savings coming primarily on the labor line.  Turnover remains strong, slightly higher than peak retention but far above peer average. 



Q: Guidance, bakery revenues? Outside accounts?


A: Primary role of the bakery is to provide high quality desserts for restaurant.  They also sell externally; there is not a large amount of outside customers.  Bakery revenues are difficult to predict.  One customer can move the needle. 


Q: G&A guidance?


A: In 2009 we held back on a lot of things (raises, infrastructure) that we are spending on in 2010.  Going forward I would expect that our growth in G&A will be less than revenue growth so some kind of G&A leverage as soon as 2011.


Howard Penney

Managing Director

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