Bottom line - Inventories Are Rising & Better Than Expected Sales Are the Calm Before the Storm

June existing home sales were better than expected due to the continued effect of the April 30 tax credit expiration pull-forward. June sales came in at 5.37 million (seasonally adjusted annualized rate) down 5.1% from 5.66 million in May, as compared with consensus expectations for a decline of 7.7%. Remember that this June print is a lagging indicator as it reflects deals closed two to three months ago (Apr/May) because of the 30-60 day lag between signing and closing. We would expect the next 3 months of data to get very steadily worse.  Moreover, the Administration may be moving in a direction away from supporting homeownership. This was profiled in a Washington Post article yesterday which we summarize and provide a link to at the end of this note.



Inventories of homes for sale rose this month on both a units and months basis. Inventory rose to 3.99mn units from 3.89mn units in May, a 2.6% increase. We think inventory levels are particularly important as these are the unknown in the price equation. In other words, these sales numbers are lagging - we already know what they'll be based on purchase applications that come out almost in real time, but the inventory numbers are new and there is no market proxy for this, so the uptick in inventory in June is very significant and sows the seeds for an 11-12 month supply figure in the next two months, which should be a wake-up call to the market that the housing market is poised for further decline.


Another way of putting the current environment in context is comparing it to the comparable period following the first tax credit stimulus. In other words, how does it compare with the average of the November & December 2009 prints of 5.96mn. Against that measure, sales are down a considerable 10% (5.37). Remember, the original tax credit expired in November, 2009. The current credit (for closing) expires September 30 (April 30 for signing), which means the average of November/December 2009 should be comparable to June 2010 (which reflects April/May activity).


It's clear that tax credit round two is having a less substantive effect on sales than round one did back in late 2009.






Inventory, on a units basis, rose 2.6% to 3.99 million units from 3.89 million units in May.


Inventory, on a months supply basis, rose to 8.9 months from 8.3 months last month. While inventory is up this month, it is well below where inventory is headed because its keying off a still artificially high June 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 4-4.25mn a few months from now. Meanwhile, inventory is at 3.99mn units. In other words, inventory should rise to 11-12 months or higher in the next few months.






THE FOREST OR THE TREES: EXISTING HOME SALES & NEW HOME SALES - inventory long term months supply 


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 on this topic. Contact or reply to this email for further information.


Washington Post Reports Obama Will Back Away From Support of Housing Market

On another note, there was an article in yesterday's Washington Post entitled "Obama's next focus of reform: Housing Finance" (link provided below), in which author Zachary Goldfarb reports that the Obama Administration will do an about-face on housing in the not-too-distant future following the passage of FinReg. According to Goldfarb, the Administration will back away from the oft-touted Clinton and Bush Administration maxims that homeownership for the sake of homeownership is good, and will implement new policies that would favor low-cost renting as opposed to owning, such as winding down government support for home loans. The author cites Raphael Bostic, a senior HUD official, as saying "In previous eras, we haven't seen people question whether homeownership was the right decision. It was just assumed that's where you want to go. You're not going to hear us say that." That said, Goldfarb quotes another Administration official - Andrew Williams, Deputy Assistant Secretary for Public Affairs - saying "You are overreading some kind of hard pivot here."


We would encourage investors to read the article directly rather than our summary above:


New Home Sales Rise Vs. the Lowest Reading Ever Recorded - Is This Really a Catalyst?

Yes, new homes sold in June rose to a seasonally-adjusted annualized rate of 330k, up 23.6% from a downwardly revised May print of 267k (revised from 300k). Should we get excited? Relative to bearish sentiment, perhaps this is good news, but we think it's temporary and doesn't change the bigger picture. As the following chart shows, new home sales of 330k are the fifth lowest reading ever recorded and squarely in the bottom of the range this data series has seen. While it's true that less bad is good, the relevant question is duration. Investors should ask themselves, if new home sales remain in a ~300k range +/- 30k for the next several years, as we think they will, will that be good enough for the stocks to work on any duration longer than the short term?


The housing market has caught three positive datapoints in the last week. MBA mortgage purchase applications posted a 3% sequential rise last week. Existing homes sales data released on Friday came in better than expected, and this morning new homes sales data showed month-over-month improvement. We think this string of positives has managed to give a nice short-term lift to all housing-related sectors. By way of example, the XHB homebuilder ETF is up 12.2% off its July 2 low after falling 28.6% off its April high. This retracement is setting the stage for the Second Act.


The one positive we'll afford the new home market is that inventory is low. In fact, it's at an all-time low of 210k. Clearly this is positive. The question, however, is whether sales come back to anywhere near where analysts think they will in a  2-3 year timeframe. We don't think so. For further information, refer to our recent note examining the concept of cumulative displacement of new home sales in this cycle relative to prior cycles.









Joshua Steiner, CFA


Allison Kaptur


We estimate table revenue run rate for July is now around HK$15.7 billion which would put total gaming revenue, including slots, at HK$16.4 billion, up 76% YoY.



It looks like July has accelerated in Macau over the past 2 weeks based on the following numbers through July 25th.  We estimate table revenue run rate for July is now around HK$15.7 billion which would put total gaming revenue, including slots, at HK$16.4 billion, up 76% YoY.   We assume acceleration from the HK$499 daily run rate experienced over the first 25 days, since the World Cup slowed things down in the beginning of the month.  Our estimate mid-month was HK$15.2 billion.  Market shares shifted a bit since our last update on July 18th with MGM and MPEL gaining share and Wynn losing share.  We suspect the shifts were hold related.



WMT Apparel: Not Too Big To Succeed

WMT Apparel: Not Too Big To Succeed


While the resignation of Wal*Mart’s head of apparel falls squarely in the ‘who cares’ bucket at face value, there are some considerations worth noting. 1) Dottie Mattison was forced to share responsibilities 2 months ago, so this is no major surprise.  2) The images below are a pathetic, but a very real depiction as to how this category comes across in a typical Wal*Mart store. If I were CEO, I’d take responsibility and make some changes too. 3) This begs the question as to why WMT keeps hiring people who fail.  My sense is that the company can put a dozen people in this job, and they’ll be a dozen failures. Let’s not forget that WMT sells about $26bn in apparel, making it the largest apparel retailer in the US by a long shot.


But unfortunately they try really hard to apply typical Wal*Mart sourcing and design mojo to a category that needs to be treated completely different. The company needs to hire people and give them latitude to radically alter the content inside the stores – up to and including acquiring higher-end content that the market is making available at extremely attractive prices. Think Liz Claiborne at Wal*Wart…  We can think this all day, and financially model how many transactions would be so value-added. But, unfortunately, the powers that be in Bentonville won’t go there... yet.


WMT Apparel: Not Too Big To Succeed - 1


WMT Apparel: Not Too Big To Succeed - 2




Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.


The MCD conundrum is a common problem in this environment and the road ahead may have some potholes.


The second quarter results from McDonalds were strong on many fronts; U.S. comps remained resilient in June, traffic was up (check was down), and margins were up with a favorable outlook remaining in place for costs in the U.S. for 2010.  The earnings call provided some interesting commentary on the company’s strategy to continue to drive sales in a soft macroeconomic environment.  Although, some caution is merited going forward.


Looking back over the 2006-2008 time period the McDonald’s system rose prices 3-4% per year to drive top line sales.  In late 2008 and early 2009 the economic climate would not allow the system to continue the same strategy.  During that same 2006-2008 period, MCD saw a slowdown in transaction growth.  In many markets across the US sales would be up for a given month, let's say 3-4% and transactions would be flat or down.  Knowing that TC’s (transactions counts) are an integral part of the overall corporate strategy this made management nervous, but overlooked it as they were getting the sales increases they needed.


Without the ability to raise prices, senior management saw the need to drive incremental TC’s in late 2008 and early 2009 with the slowdown in the economy.  As with every company I follow, MCD’s earnings call was punctuated with references to the softening macroeconomic environment.  Unemployment remains a pressing concern for MCD and, along with inflation in food-away-from-home and food-at-home; unemployment is one of the key metrics management monitors when considering pricing in the menu. 


As a result, for the past year it's been all about TC’s to buoy comps through the recession at the expense of check.  For the time being, declining commodity prices have mitigated the margin impact of the lower check.  Thus the McDonald’s CONUNDRUM - how do you balance the negative impact of lower menu prices on margins with the benefit of lower commodity prices going away in 4Q10 and 2011?    


In the United States, the Dollar Menu at breakfast continues to generate growth in guest counts and sales, but is putting significant pressure on the average check.  The decline in average check at breakfast is rumored to be as much as 10%.  Check is also being dragged down by an increase in one and two-item visits versus the normal four average items per visit in the U.S.  As a side note, a similar situation is found with CAKE – traffic is being driven by low cost items and there is evidence of check management on the part of consumers.  Both MCD and CAKE were down significantly following the reporting of 2Q10 earnings.


The recent rollout of smoothies has certainly provided plenty of buzz in the market and management stated that their expectations for smoothie’s sales have been exceeded and the margins have helped to offset some of the margin pressure.  


I would have liked more specificity around the McCafe strategy to ascertain the ROI the company is gaining from the venture.  Premium products may be raising the profile of the brand, or offering more variety, but these higher margin premium items have not been driving incremental customer visits.  As management stated on the 2Q10 earnings call, the entire boost in margins over the past three quarters was commodity driven.


McCafe and premium Angus snack wraps are not the way forward for MCD sales trends in this environment.  Should the commodity environment turn unfavorable over the next few quarters, MCD’s margins are highly vulnerable.  While commodity costs remain favorable, as the benefit to the MCD food basket reverses, margin erosion will surely ensue.


As you can see from our SIGMA chart on MCD, the company is operating in Nirvana (positive sales and positive margins).  In short order (1-2 quarters), the company will be headed down to the “trouble brewing” quadrant.  This will begin to limit the upside potential for EPS and also suggests that valuation will contract and not expand.  


One telling disclosure from management, on the slightly softer Europe comps in June versus May, was “our branded affordability proposition helps us tremendously across Europe.  We have also got some great premium products that we’ve implemented”.  Whatever the intention of this statement, it sums up the true dynamics behind MCD’s overall sales – value is still driving traffic, premium products are not.


Another CONUNDRUM for the company; franchisees keep complaining that when average check drops each customer becomes more expensive to service.  This is not a “high quality” problem. 










Howard Penney

Managing Director

R3: Running Now? Really?


July 26, 2010


The toning craze may be more about perception than reality but it still has blossomed into a meaningful business over the past year.  Next up is Skechers’ effort to tap into the men’s market by changing the product’s name from Shape-Ups to the Skechers Resistance Runner.  Is the male the customer ready for this?





Over the weekend we were struck by the frequency of Skechers’ latest television campaign featuring a men’s running shoe.  Clearly a major and costly effort is underway to try an build a men’s “toning” business, but this time it’s disguised as a “running” shoe.  The product dubbed the Skechers Resistance Runner or SRR is clearly aimed at the male consumer, who is not likely interested or just flat out embarrassed to wear a toning product.  With the toning market almost entirely focused on women, it was only a matter of time before a strategy emerged to take aim at men. Initial efforts to engage the male customer with identical take-downs of the female products have likely been slow to materialize.  As a result, we now have a $149.99 Skechers running/toning hybrid.


And while we never like to make a call on product or fashion alone, we’re going to go out on a limb here and suggest that the male consumer is not dumb.  Merely changing the name of a shoe from “toning” to “running” and dropping the brand name Shape-Ups is not likely to fool anyone.  Furthermore, combining the toning sole with a Nike-esque silhouette and then charging only $10 less than the comparable Nike marquee product seems even more ludicrous.  Take a look at the $150 Skechers shoe vs. Nike’s $159 Air Max+ 2009 below. 


R3: Running Now? Really? - 1





 - According to the Compete Online Intelligence report, one in three consumers researches a purchase online before making it in a store. The primary drivers of the research online but purchase in-store include cost, convenience, and the need for a tactile experience. Interestingly, consumer electronics, kitchen products, home furnishings, home improvement, and movies/music/games are the categories consumers research most but then purchase in store. Over 40% of purchases in these categories are researched online and then bought in a store.


- Nordstrom isn’t the only retailer collaborating on a Twilight apparel and accessories line. This time UK retailer, Marks & Spencer, is launching a men’s underwear collection in conjunction with the movie’s star, Robert Pattinson. Called “R-Pants”, the new line of undergarments are meant to appeal to a younger demographic than the traditional M&S customer. Oh and by the way, 25% of all men’s underwear in the UK is purchased at the Marks % Spencer.


- Whether it’s the Walgreen’s influence or many years in the making, word has it that the latest iteration of Duane Reade remodels in Manhattan are generating some buzz. While some of the remodeled stores were an upgrade from prior, poorly laid out locations the new ones are being compared in some ways to Sephora and Target. Open-sell (and more upscale) cosmetics, a mini-fresh food/supermarket department, and a noticeably increased number of registers are all hallmark’s of the company’s latest prototype. It’s been a long time since NY consumers actually wanted a Duane Reade in their ‘hood and this may finally be a reason for New Yorkers to shed their negative views on the tired brand.





Body Central IPO - Body Central Acquisition Corp. filed a shelf registration statement with the SEC for an $86.3 mm initial public offering. Founded in 1973, the value-priced retailer operates 196 stores under the nameplates Body Central and Body Shop across 23 states. It sells apparel and accessories under the labels Body Central and Lipstick. The Jacksonville, Fla.-based specialty apparel retailer’s primary customers are women in their late teens and 20s. The symbol will be BODY and Piper Jaffray and Jefferies & Co. are the co-lead underwriters. <>

Hedgeye Retail’s Take:  Another value-focused fashion retailer going down the IPO route.  Unfortunately, the company’s fashion positioning and price points do little to differentiate from the numerous other mall concepts chasing the same customer demographic. 


Everyone's A Critic Online - In today’s era of online shopping, consumer reviews are taking the place of word-of-mouth buzz. Instead of friends telling friends about their shoe purchases, reviewers potentially have the ear of the entire Internet universe. That’s a risky proposition for brands. Less-than-favorable comments on issues from fit to flexibility can negatively impact comfort companies. Still, industry sources agree that honesty remains the best policy. Most retailing sites post all reviews in their entirety. A recent Nielsen Global Consumer Report on Internet shopping found that 42% of North American consumers said online product reviews were useful to them.  At Zappos, about 1,500 to 2,500 reviews are posted each day across all footwear categories, said Matt Burchand, senior director of content at the Henderson, Nev.-based website.  <>

Hedgeye Retail’s Take:  Nothing new here except that we suspect companies aren’t always honest with letting their customers post their free-flowing thoughts.  The recent iPhone 4 debacle is a case in point.  According to some tech blogs, negative consumer comments posted on apple’s forums were removed by the company during the initial wave of negativity.  Is censorship the next big issue for consumers? 


Volcom to Acquire Australian License - Volcom, Inc. signed an agreement to acquire the Volcom licensee in Australia. Terms of the transaction were not disclosed. The company anticipates the acquisition, which is expected to close in the third quarter, to be neutral to earnings in 2010. <>

Hedgeye Retail’s Take:  While none of the company’s recent activities is a game changer, it’s worth noting the Volcom has been one of the more active names in the M&A space lately.  Even after the bid for West 49 was dropped, Volcom managed to pick up a California lifestyle brand as well as its Australian licensee.


Zara Stores Open in India - Moving fast in the Indian market, Spanish retailer Zara opened three stores in the country within five weeks. The brand made its debut on the Indian market through a joint venture with Trent Ltd., the listed retail arm of the $70.8 bn Tata Group. Trent already has a presence in the retail industry with Westside stores and Star Bazaar hypermarkets. Inditex controls 51% of the joint venture, while Trent Ltd. owns 49%. Current regulations on foreign direct investment in India stipulate that foreign single-brand retailers must pass a 49 percent stake on to a local partner. According to a June report by McKinsey & Company, Indian apparel sales are forecast to reach $25 bn this year, having grown in excess of 10% over the past five years — a growth rate faster than that of the overall India retail market — and the trajectory is expected to continue over the next five years, doubling within that time period.  <>

Hedgeye Retail’s Take:  Keep an eye on the loosening of the foreign direct investment laws, which many now believe may soon be relaxed.  As such, we’d expect many brands and retailers to begin to dip their toes in the Indian market as they prepare for potential growth.  If McKinsey is even half correct on its apparel sales estimate, then there is a long, long road ahead for apparel growth in this market (provided the consumer is even remotely interested in foreign brands).


Bangladesh Ranks 4th Largest Garment Exporter - Bangladesh has been ranked the world’s fourth largest garment exporter, contributing around 3% of total exports, according to the World Trade Organization. The 30-year-old RMG industry of Bangladesh has transformed into a global sourcing destination. Bangladesh is the biggest exporter of cotton T-shirts and stands second in exporting cotton pullover and jeans to European countries. As also the country, in terms of volume is the second biggest exporter of cotton trousers to United States. Currently, Bangladesh in its more than 5,000 garment manufacturing units employs around 2 mm people, of whom 90% are women.  <>

Hedgeye Retail’s Take:   While Bangladesh’s importance in the world of apparel sourcing continues to grow, it’s worth noting how fragmented the sourcing base remains for the category.  As the 4th largest exporter, the country’s share of exports is just 3%.  This should serve as a reminder that at least for now, there are many, many options for which a brand or retailer can source garments in a cost effective manner across the globe.


Footwear Manufacturers Continue to Move to Indonesia - Six Taiwanese and South Korean shoe makers are relocating their factories from China and Vietnam to Indonesia, which will create an additional income of US$550 mm for the country, said the Indonesian Shoes Association (Aprisindo). Due to increasing labor costs and raw material issues in China and Vietnam, the six manufacturers, which have been outsourcing a significant amount of shoes and products for leading footwear brands like Nike, Adidas, Reebok and Geox, are expected to finish the relocation by this year-end mainly to East Java.  <>

Hedgeye Retail’s Take:  Indonesia continues to be the biggest beneficiary of rising costs in China, which at least for now should continue to benefit.  However, as wages and material costs rise in China and manufacturing leaves the country, we would not be surprised to eventually see some sort of duty or VAT rebate measures to help keep Chinese factories and workers employed.


Japanese Retailers Win In Summer Heat With Non-Smelling Underwear - Japanese retailers are headed for hot summer sales of cheap beer and non-smell underwear, driven by above-average temperatures and consumers with fatter wallets. Sales of the products are beating projections, said Hiroshi Katsuno, manager of Goldwin’s Maxifresh underwear group. “Data from our experiments show that one shirt can absorb smell coming from four liters of sweat,” he said. The Uniqlo chain, owned by Fast Retailing Co., has increased sales of sweat-absorbing, quick-drying underwear even as overall sales slowed in the three months through May.  <>

Hedgeye Retail’s Take:  If ever there was a time for Under Armour and its anti-cotton, moisture wicking products to gain acceptance now appears the time.  While we hope warmer temperatures aren’t here to stay permanently, the need for innovation in textiles is clearly heightened by global warming.


Reebok To Blitz NFL Jersey Market - Tennessee Titans quarterback Vince Young celebrates the day his mother was born, wearing No. 10 for her June 10th birthday. And Jacksonville Jaguars running back Maurice Jones-Drew recalls the teams that turned him down to play pro football—that would be all 32 in the draft—with No. 32 emblazoned across his chest. There are some of the stories behind those NFL jerseys, according to a marketing campaign breaking next month via M&C Saatchi Sport & Entertainment. The print and retail ads are part of a collaboration among longtime NFL sponsor Reebok, the NFL Players Association and the Champs sporting goods chain that will try to energize sales of the apparel category dubbed names-and-numbers after years of focus on women, performance and lifestyle merchandise. The campaign, running through September, will have a dedicated Web site with video footage of players like New York Giants quarterback Eli Manning and safety Kenny Phillips, Kansas City Chiefs running back Thomas Jones, and other stars talking about the origins of the numbers they wear. More than 600 Champs stores will get extensive signage, crew T-shirts and POP for the seven-figure program under the tagline, “Every number has a story. What’s yours?” <>

Hedgeye Retail’s Take:   Another minor victory for Foot Locker and Champs, which should benefit from this collaboration with Reebok and the NFL.  Recall that Champs has also partnered with the NBA to create shop-in-shops focused on local teams depending on store’s location.  We continue to believe closer collaboration with the brands and in this case, the leagues, is one of the key components to the company’s turnaround efforts.


R3: Running Now? Really? - 2




Last week, 7 of our 8 risk measures registered positive (improved) readings on a week-over-week basis, while one was neutral. None were negative.


Our risk monitor looks at the following metrics weekly:

1. CDS for all available US Financials (29 companies)

2. CDS for large European Financials (39 companies)

3. High Yield

4. Leveraged Loans

5. TED Spread

6. Journal of Commerce Commodity Price Index

7. Greek Bond Spreads

8. Markit MCDX


1. US Financials CDS Monitor – Swaps were mostly positive last week.  26 of the 29 CDS reference entities tightened, while 3 widened.   

Conclusion: Positive.

Tightened the most vs last week: AXP, JPM, PMI

Widened the most vs last week: TRV, ALL, SLM

Tightened the most vs last month: MS, AXP, MBI

Widened the most vs last month: TRV, ALL, SLM




2. European CDS Monitor – We include a look at European swaps to gauge risk perception across the Atlantic, particularly following the release of the stress tests.  European financials CDS was largely unchanged day over day, demonstrating the relatively muted market reaction to the release of the stress tests.   

Conclusion: Positive. 

Tightened the most vs last week: EFG Eurobank Ergasias, Caja de Ahorros del Mediterraneo, UBS

Widened the most vs last week: Erste Group Bank, HSBC, RBS

Tightened the most vs last month: BBVA, Credit Suisse, UBS

Widened the most vs last month: Alpha Bank, National Bank of Greece, Investor AB




3. High Yield (YTM) Monitor – High Yield rates fell 14 bps last week. Rates closed the week at 8.60% down from 8.74% the week prior.  

Conclusion: Positive.




4. Leveraged Loan Index Monitor - Leveraged loans rose by 9 points last week, closing at 1475 versus 1466 the week prior.  

Conclusion: Positive.




5. TED Spread Monitor - Last week the TED Spread fell slightly, closing at 35 bps versus 38 bps last week.  

Conclusion: Positive.




6. Journal of Commerce Commodity Price Index – The  JOC smoothed commodity price index is a useful leading indicator.  A sharp sell-off in this index starting in July ’08 heralded further declines in the stock market.  This week, the index rose slightly, closing at 9.51, up just over 2 points versus last week’s close at 7.29. 

Conclusion: Positive. 




7. Greek Bond Yields Monitor – Greek bonds yields and CDS continued to plateau at a high level.  Last week yields rose 13 bps, ending the week at 1038 bps versus 1025 bps the prior week.  

Conclusion: Neutral.




8. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps.  We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on four 5-year tenor baskets including 50 reference entities each. Each basket include a diversified pool of revenue and GO bonds from a broad array of states. Our index is the average of their four indices.  A volatile week ended with spreads closing down 7 bps at 214 bps versus 221 bps a week ago. 

Conclusion: Positive.




Joshua Steiner, CFA


Allison Kaptur

real-time alerts

real edge in real-time

This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.