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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


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


Early Look

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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


THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP


As we look at today’s set up for the S&P 500, the range is 29 points or 1.4% (1,091) downside and 1.3% (1,120) upside.  Equity futures are trading above fair value more than making up for yesterday’s loss. 

Today will bring a slew of earnings releases and weekly jobless claims. 

  • Advance/Decline Line: -1086 (-726)
  • Volume: NYSE 1004 (-9.9%) - Volume is down DoD - yesterdays decline was on unconvincing volume.
  • Sector Performance: Every sector declined yesterday - 4 outperformed (RECOVERY/REFLATION trade underperforming - day 2)
  • Market Leading Stocks: Wyndham WW +8.0%, CB Richard Ell +7.5% and Eastman Kodak -15.2%, IGT -10.1%

Equity Sentiment:

  • VIX 24.25 (4.6%) - The VIX is broken on TRADE, but up for the last two days.
  • SPX Put/Call ratio - 1.99 up from 1.40 (low on 07/15/10 of 0.87)

Credit/Economic Market Look:

  • TED Spread - 32.3875 to 31.5519
  •  3-Month T-Bill Yield .14% to .15%
  • Yield Curve 2.3736 to 2.3843

Commodity/Growth Expectation:

  • CRB: 266.16 +0.64%
  • Oil: 76.99 -0.66% (down for 3 days)
  • Copper: 324.55 (1.22%) – looking to be up 8 of the last 9 days - trading above its TRADE line - BULLISH for growth expectations
  • Gold: 1,161 (0.09%) - Gold has decisively broken the Hedgeye intermediate term TREND line of support (1197); the long term TAIL of support -4.2% lower at 1115

Currencies:

  • EURO: 1.2997 (0.9%)  - Up 5 of the last 6 days - trading above the TRADE line
  • DOLLAR: 82.179 (-0.01%) - BEARISH formation

Overseas Markets:

  • ASIA - With the exception of China, most Asian markets declined today on soft economic figures from the US.
  • China on fire, closing up for the 8th out of the last 9 days, +0.55% on the Shanghai last night; still -19.1% YTD.
  • EUROPE - European markets are trading higher after a slow start as market participants digested a raft of corporate results and shook off mixed markets across Asia and disappointing US economic data. Pharmaceutical and telecom companies are amongst the leading gainers. Major indices trade just below session highs.
  • Eastern Europe surging - Russia up 1.7% and Ukraine up 1.2%.
  • Greece has finally traversed the Hedgeye TREND line of 1652; trading up +22% from the 6/7/10 bottom; monster squeeze.
  • LATIN AMERICA - Major indices are lower, with Venezuela and Brazil up 0.38% and 0.2%, respectively.
  • MIDDLE EAST - Mostly higher with the UAE trading down another 0.1% and Egypt up 1.4%. 

THE DAILY OUTLOOK - 1


CRI: This Smells Punk

CRI wins the award for the most disappointing EPS report yet. Really…there’s not much on the positive side to pull out at all. Yeah, the company missed and guided down. But it’s the speed of and derivation from which things changed is the bigger callout for me.

 

Consider this…

1) Every division experienced sequential erosion in underlying top line trends.

2) The most pronounced was in CRI’s mass business. Though Mass is CRI’s lowest margin business, it is the highest ROI by a moonshot.  Revenue rolled in this space by about 1500bp, and CRI noted that it was almost entirely driven by loss in shelf space at Wal*Mart. So let me get this straight, WMT’s apparel business is in disarray, they fire their head of apparel, and simultaneously cut space from CRI. Perhaps unrelated, but I certainly wouldn’t want to be the head of the Mass business at Carter’s now.

3) Carter’s posted the sharpest sequential erosion in its trajectory on our SIGMA chart out of any company to report this EPS season. See chart below. The punchline there is that inventories are building relative to sales at the same time the company is about to go up against its biggest gross margin gains in years.

4) CRI’s guidance suggests an acceleration in top line throughout the remainder of 2010, yet 2H earnings better than 20%. Yeah, I know that labor, commodity and import costs are up. No escaping that. But do you think that just maybe they can slow down their growth a bit and gain control of their business? Instead they’re budgeting costs up 10% in 1H (enough?), and are banking on raising prices in certain areas to offset these costs. Do you want to bank on that? I don’t. Hey CRI, stop adding stores, and get the product org in order. Note to management: even big retailers in disarray rarely cut great product.

5) No one should forget that this company is operating at peak margins of around 13%.  Even during the years where CRI struggled leading into and out of its well-deserved management shake-up, it never got below a 9% margin. Then it raced up from there printing what I’d consider an unrealistic revenue flow through rate from wholesale restocking and commodity cost relief.

6) Also, remember that it’s ills last go around were based on the fact this has traditionally been the ultimate ‘baby basics’ play. The brand is extraordinarily defendable in that segment, but unfortunately, growth has been coming from playwear (competing with the Old Navy’s of the world), mass channels, and company retail – all of which are inherently more volatile that CRI’s core. Unfortunately, the company has not yet invested in the infrastructure needed to sustain the top line in those businesses when faced with anything other than a bullish consumer tape.  

7) The company guided to down gross margins in 1H next year – without further clarification or quantification. That’s fine, and in fact I would not expect the company to know what Gross Margins will be given factors above. But a warning to those financial modelers out there…don’t think ‘down’ in terms of  40, 80, or even 100bp. This could be much more.  Just ask Li&Fung.

8) Bottom line: yes, 2011 should be a down year. If the consensus does not come out with such numbers after the conf call, then despite trading down today, this name is likely to have additional downside.

 

 

CRI: This Smells Punk - CRI 7 10 black

 

 


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