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SKX: Overearning

Note to SKX management: C’mon guys…don’t get lost patting yourself on a job well done with Shape-ups (and it was, in fact, a job well done). But switch gears and deploy capital in a way that will prevent another blow up. The Street’s over $4.00 in ’11. I can get closer to $2.50.

 

Yes, it was a love fest on the SKX conference call. Shape-ups, product mo, blow-out quarter, etc… I get it, and so does the consensus. But there are some bigger questions to be asking here – and the answers don’t give me one iota of confidence in the sustainability of this business model or growth trajectory. Consider the following…

 

1) Shape-ups now account for ~25% of total sales according to our estimates, and accounted for 75%+ of growth vs. last year. Excluding Shape-ups, sales were likely up +10-15%. I will never take anything away from a company that is printing revenue based on hitting – and even creating – a trend. But we also cannot straight line this performance in perpetuity.

2) Industry-wide, ‘toning’ went from ~2.5mm pairs, at an average price point of ~$95 in 2009 to a current annual run rate closer to $1.2-$1.5Bn, 15-18mm pair at $80-$85, respectively.  SKX’ share is roughy 60% and has trended down recently as Reebok sales ramped up. Let’s face it folks, with fashion, nothing attracts a crowd like a crowd. Now Payless is selling them for $29.99 with a BOGO (buy one get one half off) and it is 1% of sales today moving towards 6% by year end. That alone would represent ~8% of the industry’s unit share in this category.

3) Why does all this matter? SKX cannot afford either a slowdown in unit demand or ASP compression in this category. Period.

4) Why? Because SKX deploys capital throughout its organization when it can, not when it should. Even today the company is deferring new DC and related equipment spend into next year.  Since launching Shape-Ups in early 2009, better than 55% of incremental revenue has landed on the bottom line as outlined in the chart below. After COGS and incremental store build costs alone, this should result in flow through less than 50%. Then add on capacity expansion (DC and equipment, but more importantly, people to crank on R&D and Sales/Marketing to play offense against potential pressure in toning). No one knows the exact flow through needed, but my math suggests that it's closer to 30%. 

5) The bottom line with margins is that this company should realize about a 600bp boost in margins this year. If we’re going to give the model any shot at sustainability, then they should be investing more, and printing margin improvement that is half what we see today.

6) In addition, despite higher product costs due to labor, commodities, transportation, yuan, etc… SKX is guiding to higher Gross Margins – which is anomalous and raises a red flag with me as to the sustainability.

7) Longer term, lets not forget that SKX is massively net short Yuan. With 90% of its product sourced in China and less than 5% of its revenue generated in China, this is a pretty steep delta against a freight train of a long-term Macro backdrop for the Yuan.  Nike, on the flip side (and even Adidas) only makes 26% of product in China. So it has $10bn in COGS, and $2.6bn in rmb exposure. But it has a growing and profitable China revenue engine, that stands at about $1.8bn today. I could make a strong case that Nike is net long the Yuan within a 2-year time period. That puts it near the top of any other consumer-related multinational that has such favorable exposure.  Skechers? Not quite.

8) The punchline? We’re going to see the sales delta slow within 2-quarters, which is the same time that prices in the toning category will be more competitive. Then higher product costs will matter, as will deferred infrastructure investment. Add that all together and it’s not unrealistic to get to 2011 being a down year. The point is that estimates are likely to come in over $4 in 2011 after this quarter. But $2.50 is perfectly within reach – and more likely. When SKX misses, it will get a 10x pe at best. That’s a $25 stock, or 33% down from here.

9) Timing: Will this deck of cards come crashing down next week? I dunno. I doubt it, actually. But I don’t think we have to wait a year, either. Looking at the quarters ahead, and synching with product flow, and competitive climate, I place a 60% chance it happens before Dec 31, and 80% before the end of 1Q11.  I’ll work closely with Keith and let him make the call as to what to do in the interim from a TRADE and TREND perspective. But if I owned this name today, I’d be punting it.

 

 

SKX: Overearning - SKX Incr EBIT Flowthr 3 7 10

 

 


Industrials (XLI) Sentiment

While we have been a little early, we are currently SHORT Industrials (XLI) in the Hedgeye virtual portfolio.  Our short thesis is grounded on the belief that a weakening labor market, softening consumer confidence, softening housing activity and retail sales, and an intensifying trade deficit are early signs of a renewed economic downturn.

 

We want to be short the stocks that are most levered to global industrial growth slowing.  As a reminder, we remain below consensus for US GDP growth in the coming quarters and years.

 

The following charts show investor sentiment of the components of the Industrials index (XLI).  Specifically, we are looking at “sell-side bullishness” versus “short interest days to cover.”

 

(1)    High Sentiment & Low Short Interest = Consensus Longs/Potential Shorts (upper left)

(2)    Low Sentiment & High Short Interest = Consensus Shorts/Potential Longs (lower right)

 

The Industrial sectors with the most bullish sentiment are Industrial Conglomerates, Machinery, Aerospace & Defense, Road and Rail and Air Freight.

 

Howard Penney

 

Industrials (XLI) Sentiment - h1

 

Industrials (XLI) Sentiment - h2

 

Industrials (XLI) Sentiment - h3

 

Industrials (XLI) Sentiment - h4


What is Hedgeye Thinking On Oil?

Conclusion: While we are bearish on the fundamentals for oil, the downward pressure on the U.S. dollar is supporting the price of oil -- so it remains in no man’s land from an investment perspective.

 

We’ve been noticeably quiet lately on oil, which is atypical for us on any topic.

 

All joking aside, we’ve been quiet on oil because we don’t have a conviction view at the moment, though fundamentally we are negative for three primary reasons: supply, lack of U.S. dollar correlation, and slowing U.S. growth.

  • Supply – As we’ve outlined in the chart below, U.S. stocks of crude oil are well above their five year range.  In fact, there are currently 360.8 million barrels of crude in storage in the United States, which is 23.4 days of supply.  This is an increase of 4% over 2009 supply numbers from the same period.  In addition, supply has been increasing steadily since the start of July.  Despite this, the price of oil is actually up almost 18% on a year-over-year basis for the same period.  (As a side note, oil production domestically is up almost 8% year-over-year to 5.4 million barrels, which is not a fact commonly bandied about.) 
  • U.S. dollar correlation - In 2009, the key macro factor driving the reflation trade was U.S. dollar down, and everything priced in U.S. dollars up.  Simply, the decline in value of the U.S. dollar versus other currencies increased the inherent value of those global commodities that were priced in U.S. dollars.  Oil was a primary beneficiary as its price increased by almost 80%.  The correlation, or at least the strength of it, is no longer intact.  In fact, since late June we have seen a dramatic decline in the U.S. dollar versus other major currencies, north of 7%, but have not seen a similar move in oil.  In 2009, oil moved inversely to the dollar with a factor of more than 4:1.  As noted, recently that correlation has gone away, so despite being bearish on the dollar, we are not seeing a corresponding correlation that makes us bullish on oil. 
  • Sequentially slowing U.S. growth – Early next week, during our August theme call, we will get into this in greater detail, but we believe that growth next year in the U.S. will be half that of consensus expectations.  This will be driven by the likely need for austerity measures and continued Housing Headwinds. The United States consumes ~24% of the world’s oil, so any change in the direction of U.S. economic growth will have an impact on global demand, and thus pricing.  This is further emphasized by the fact that the U.S. imports ~61% of its oil so is an even larger percentage of the export market with a commensurate impact on market prices.

Yesterday, the EIA reported supply information that was touched on above, that highlighted the anemic demand environment.  Specifically, consensus estimates were for an increase in supply of 2.3 million barrels, while the actual number came in at an increase of 7.3 million barrels week-over-week.

 

The wild card to the bearish scenario outlined above will be Chinese demand.  We have been quite vocal in our Chinese Ox in a Box thesis on China this year as we have seen the government take steps to slow down economic growth to head off inflation.  As of June, China was consuming 8.99 million barrels per day, which is up 10% from a year ago levels.  Any acceleration in Chinese economic growth, would offset some or all of the decline in U.S. demand due to sequentially slowing economic growth.

 

Longer term, the potential thirst for oil from China is substantial.  According to recent analysis from Platt’s:

 

“In any event, without delving deeper, we might expect China's steady state demand for oil could prove not less than that of more advanced Asian nations. Based on the experience of Korea and Japan, China's current population would be expected to consume approximately 55 million barrels per day at steady state (when per capita consumption plateaus), or nearly 2/3 of current global oil production, were the supply available.”

 

In the short term we remain bearish on oil supply and demand, but in the longer term China’s thirst will trump all else.

 

Daryl G. Jones
Managing Director

 

What is Hedgeye Thinking On Oil? - 2

 

What is Hedgeye Thinking On Oil? - 1


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PNK 2Q2010 CONF CALL NOTES

Solid quarter and secular margin thesis remains intact. Management says all the right things on the conference call. Here are our notes.

 

 

"Year-over-year improvements in second quarter total revenues and Consolidated Adjusted EBITDA reflect a full quarter's contribution from River City and initial benefits of a strategy focused on achieving company-wide operating excellence and best-in-market guest experiences. Our teams are already achieving success with multiple initiatives, which helped drive higher Adjusted EBITDA margins in five of our six markets."

- Anthony Sanfilippo, president and chief executive officer

 

 

CONF CALL NOTES

  • Less interested in masses and more interested in "profitable customers."
  • The margin improvement that they saw this quarter is just the beginning of their efficiency efforts. Want to get to a level where they balance great guest service and efficiency.
  • Removing non-value added assets
  • Focused on maximizing free cash flow
  • They are exploring future potential growth opportunities
  • They have not seen any impact from the oil spill in the Gulf
  • They are refining their design in Baton Rouge. Will have a very high quality casino in that location.  Believes that a lot of customers in the Baton Rouge area don't game there because there are no "attractive" facilities there. Even if TX legalizes gaming they don't believe that Baton Rouge would be impacted.
  • Look at Texas as a potential gaming market - if it does develop, they would want to be there.
  • Food and beverage is margins are going to improve going forward and will be more consistent with higher volume.
  • They overstaffed in River City and had a worker's comp claim there too. Will be fixed over the next quarter or 2. 
  • Have over $500MM of liquidity at the company today
  • Maintenance capex was $10MM in the quarter and $22MM for the first 6 months
  • Atlantic City - engaged a broker to sell the site.  Pleased to see that some land traded in AC (MGM land). Hopeful that they will be able to sell the land within a quarter or two.
  • Ramp up in St. Louis will take them 2-3 quarters. They aren't interested in unprofitable revenues
  • They are taking a close look at their properties to see if they have the right mix of products on their floor
    • This should be good for new slot orders

Q&A

  • Which properties have the most margin upside?
    • All of them have room for improvement
    • Belterra: they continue to have new and expanded competition all around them. Trying to figure out who the right customer for that facility is. 
    • New Orleans: Have a new GM there. Very focused on the West Bank. Struggle with the second floor of that facility which customers don't want to access - so they are trying to improve the first floor.
    • Reno: finally turned a profit
    • Looking at taking cost out of corporate that get allocated to the properties
    • Thinks that the largest opportunity is at L'Auberge
  • How overstaffed was River City (RC) and what was unusual in the quarter?
    • They are down a few hundred people from when they first opened
    • They haven't been aggressively marketing, although their competitors have been
    • They are putting the parking garage on hold. They are looking to added a covered parking valet area before winter hits.
    • They are focused on putting together a focused marketing strategy
  • They are rebuilding their IT database; they are looking at all of the systems/ processes/ reward process.  They are at very early stages. Do think that the new systems will allow them to make better marketing decisions. They currently don't have a CRM system.
  • Any other AC land transactions recently, aside from MGM?
    • No. They recognize that they there will be a material discount to what they purchased the land for.
    • They will be taking a capital loss to use for later 
  • Tax rate going forward? maybe 10% or less
  • Corporate expense going forward - should roughly be inline with 1Q2010

LOTS OF VOLATILITY IN THE INITIAL CLAIMS SERIES, BUT SIDEWAYS REMAINS THE TREND

Initial claims fell by 11k last week (7k net of the revision). This comes on the heels of the prior week’s increase of 37k.  At 457k, the number reported today is right in line with the 450-470k range the series has occupied for all of 2010.  On a rolling basis, the improvement was 4.5k bringing the rolling total to 452k. Ultimately, initial claims need to be in the 375-400k range before unemployment meaningfully improves.

 

LOTS OF VOLATILITY IN THE INITIAL CLAIMS SERIES, BUT SIDEWAYS REMAINS THE TREND - claims rolling

 

LOTS OF VOLATILITY IN THE INITIAL CLAIMS SERIES, BUT SIDEWAYS REMAINS THE TREND - claims raw

 

Below, we chart US equity correlations with Initial Claims, the Dollar Index, and US 10Y Treasury yields on a weekly basis going back 3 months, 1 year, and 3 years.Not surprisingly, Consumer Discretionary has the largest inverse correlation to Initial Claims (r-squared = 0.67) on a 1-year basis. On the flip side, it is a surprise to see that the Financials have the second lowest inverse correlation to Initial Claims (r-squared = 0.15) on a 1-year basis.

 

LOTS OF VOLATILITY IN THE INITIAL CLAIMS SERIES, BUT SIDEWAYS REMAINS THE TREND - 1

 

As a reminder, May was the peak month of Census hiring, and it will remain a headwind through the September data as the Census continues to wind down. 

 

LOTS OF VOLATILITY IN THE INITIAL CLAIMS SERIES, BUT SIDEWAYS REMAINS THE TREND - census chart

 

Joshua Steiner, CFA

 

Allison Kaptur


LOTS OF VOLATILITY IN THE INITIAL CLAIMS SERIES, BUT SIDEWAYS REMAINS THE TREND

Weekly Claims Volatility Has Become the Norm, But the Underlying Trend Remains Steadily Sideways

Initial claims fell by 11k last week (7k net of the revision). This comes on the heels of the prior week’s increase of 37k.  At 457k, the number reported today is right in line with the 450-470k range the series has occupied for all of 2010.  On a rolling basis, the improvement was 4.5k bringing the rolling total to 452k. Ultimately, initial claims need to be in the 375-400k range before unemployment meaningfully improves.

 

LOTS OF VOLATILITY IN THE INITIAL CLAIMS SERIES, BUT SIDEWAYS REMAINS THE TREND - claims rolling

 

LOTS OF VOLATILITY IN THE INITIAL CLAIMS SERIES, BUT SIDEWAYS REMAINS THE TREND - claims raw

 

The table below shows the price performance of each Financial subsector over four durations. 

 

LOTS OF VOLATILITY IN THE INITIAL CLAIMS SERIES, BUT SIDEWAYS REMAINS THE TREND - subsector perf chart

 

 

Below, we show the correlations between initial claims and each of the 30 Financial Subsectors. To reiterate, Credit Card and Payment Processing companies show the strongest correlations to initial claims, with R-squared values of .62 and .72 over the last year, respectively.  Surprisingly, some subsectors show a positive correlation coefficient to initial claims - i.e. Financials that go up as unemployment claims go up.  These names are concentrated in the Pacific Northwest Banks and Construction Banks, though these correlations are usually not very high.  

 

In the table below, we found the correlation and R-squared of each company with initial claims, then took the average for each subsector.  For composition of the subsectors, see Chart 5 below.

 

LOTS OF VOLATILITY IN THE INITIAL CLAIMS SERIES, BUT SIDEWAYS REMAINS THE TREND - init. claims subsector correlation analysis

 

The following table shows the most highly correlated stocks (both positively and negatively correlated) with initial claims. Note that the top 15 negatively correlated stocks have a much stronger correlation on average than the top 15 positively correlated stocks - as you would expect, given that most of the Financial space is pro-cyclical. 

 

LOTS OF VOLATILITY IN THE INITIAL CLAIMS SERIES, BUT SIDEWAYS REMAINS THE TREND - init. claims company correlation analysis

 

Astute investors will note that in some cases the R-squared doesn't seem to reconcile with the square of the correlation coefficient. This is a result of finding the correlation and then averaging. For example, Pacific Northwest Banks have an average correlation coefficient of .32 and an average R-squared of .52 (with CACB, CTBK, FTBK, and STSA strongly positively correlated and UMPQ strongly negatively correlated). The different directions have the effect of canceling out each other out when finding the average correlation coefficient, but do not cancel out when finding the average R-squared. 

 

As a reminder, May was the peak month of Census hiring, and it will remain a headwind through the September data as the Census continues to wind down.

 

LOTS OF VOLATILITY IN THE INITIAL CLAIMS SERIES, BUT SIDEWAYS REMAINS THE TREND - census chart

 

Joshua Steiner, CFA

 

Allison Kaptur


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.64%
  • SHORT SIGNALS 78.61%
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