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Exporting Away

Position: Bullish Bias on German Equities (EWG)

 

As an update to our bullish bias on German equities, we got two pieces of data over the last days, both of which are lagging indicators but nevertheless bullish.  Germany’s trade balance showed a surplus of €14.1 Billion in June, with a 3.8% gain in exports month-over-month and an increase in imports of 1.9% versus the previous month. Certainly the weakness in the EUR-USD in June (see chart below) is helping to support gains in exports. On Q2 earnings calls we heard again and again of strong demand from China. While China will increasingly become a larger export market for Germany, in the near term its exporting picturing will make its largest gains alongside economic improvement from its largest trading partner, the EU. However, here we caution that we expect to see slower growth throughout Europe in the back half of 2010 as austerity measures choke off growth. We do see stability in the EUR, unlike the Euro parity camp, and currently our support and resistance TRADE lines for the EUR-USD are $1.30- $1.33.

 

Exporting Away - mh1

 

Secondly, July’s final reading of German CPI was in line with the initial estimate of 1.2%, a level we believe should roughly remain stable throughout the end of the year, and looks favorable compared to UK levels (see chart below). Notable changes month-over-month in German CPI were: clothing and footwear -3.5%; diesel oil -2.0%; and restaurants and hotels +2.6%.

 

Exporting Away - mh2

 

Matthew Hedrick

Analyst


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 21 points or 1.3% (1,113) downside and 0.9% (1,138) upside.

 

Equity futures are trading below fair value with today's FOMC meeting the key focus. The FOMC plans to release a statement at 2:15 p.m. today and, in my view, it’s unlikely that Chairman Bernanke will be able to string together the right words to satisfy the market. 

 

ADVANCE/DECLINE LINE: -1366 (+1599)

  • VOLUME: NYSE - 790.073 (-16.5%)
  • SECTOR PERFORMANCE: Every sector positive yesterday - XLY, XLK and XLB leading the way
  • MARKET LEADING/LOOSING STOCKS: CARMAX +4.95, King Pharma +4.44 and Hewlett-Packard (7.99%) and Tyson Foods (4.9%)

EQUITY SENTIMENT:

  • VIX 22.14 1.84%- The VIX is broken on TRADE, but bearish for equities.
  • SPX PUT/CALL RATIO - 2.01 up from 1.74 (low on 07/15/10 of 0.87)

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD - 25.99 -0.759 (-2.837%)
  •  3-MONTH T-BILL YIELD .14%, unchanged
  • YIELD CURVE - 2.3088 to 2.2974

COMMODITY/GROWTH EXPECTATION:

  • CRB: 274.59 -0.04%
  • Oil: 81.48 0.97% (first up day in 3)
  • COPPER: 335.30 0.33% (currently trading at 328 below 332 - BEARISH for growth expectations
  • GOLD: 1,200 -0.37% (trading down for 2 days)

CURRENCIES:

  • EURO: 1.3228 -0.39%  - (trading down for 2 days)
  • DOLLAR: 80.711 +0.38%) - (trading up for two days)

OVERSEAS MARKETS:

  • ASIA - Major indices closed weaker in response to a sharp fall seen in China in response to bearish economic data. Banking stocks were among the leading decliners, while energy stocks were also weighing on markets.  
  • EUROPE - European markets are range bound at lower levels with investors largely sidelined ahead of today's FOMC meeting. Mining, Financials and export orientated names are weighing on the indices.
  • EASTERN EUROPE - Trading lower - Russia down 1.86% and Hungary down 1.76%.
  • LATIN AMERICA - Mixed Peru and Chilie trading higher
  • MIDDLE EAST/AFRICA - Mostly lower with Nigeria leading the way…

Howard Penney

Managing Director

 

THE DAILY OUTLOOK - levels and trends

 

THE DAILY OUTLOOK - S P

 

THE DAILY OUTLOOK - VIX

 

THE DAILY OUTLOOK - DOLLAR

 

THE DAILY OUTLOOK - OIL

 

THE DAILY OUTLOOK - GOLD

 

THE DAILY OUTLOOK - COPPER


R3: Geared Up for M&A

R3: REQUIRED RETAIL READING

August 10, 2010

 

 

TODAY’S CALL OUT

 

It’s been relatively quiet on the M&A front in retail of late, but Hanesbrands is breaking the silence this morning with the acquisition of Gear for Sports, a leading seller of licensed apparel in collegiate bookstores. While modest in size at $225mm, our view is that this is a net positive event for the company – here are a few things to consider:

 

Positives:

  • Clean – low integration risk given existing relationship between the two companies.
  • Opportunity for scale – with only three brands in its portfolio (GEAR FOR SPORTS, Champion, and Under Armour), HBI can provide product with favorable cost dynamics.  Plus eliminating the middle man (i.e the wholesale/distributor process) margins will be inherently higher on HBI brands.
  • Higher margin –11%+ EBIT margins at Gear for Sports. HBI hasn’t posted double-digit margins since 2003 and the company is buying the company for 7.5x, a multiple below where HBI trades currently ( 8.8x EV/EBITDA).

 

Negatives:

  • Balance Sheet – leverage now moving in the opposite direction.  After increasing debt for the first time since the spinout when the company reported Q2 results in July, this deal continues the trend adding $170mm in debt ($55mm in cash).  The company still expects to end 2010 with a debt-to-EBITDA ratio of ~3.5x on a pro forma basis.
  • Low Growth Business – While an average growth rate of 2% over the last two years isn’t shabby on a relative basis, this is not likely to be a true growth business once dust settles. 
  • Opportunity Cost – hitting the bid on a ‘distribution acquisition’ likely takes HBI out of the running for the opportunity to add a better known brand to the portfolio (at least in the near term).

The company will be hosting a call on the acquisition at 9am this morning (; code: 93137436). Among the items I’m more interested in clarifying is the proposed accretion related to the deal ~$0.20 in the first 12-months. On an absolute basis ($25mm in EBIT) that may be the case, but taking into account the opportunity cost in interest expense we are coming out closer to $0.08-$0.10. Either way, we view this morning’s acquisition which is both margin and earnings accretive as a positive near-term.

 

Details of the deal from the press release:

 

Financials:

(FY10 ended in June)

  • Sales ~$225mm
  • EBIT $25mm+
  • OM 11%+
    • (implied D&A of ~$5mm)

 

  • Expected to close in Q4 and be immediately accretive
    • ~$0.20 in 1st 12 months
    • ~$0.30 in 2nd 12 months
  • No write-offs or restructurings needed, not dilutive to 4Q or 2010 earnings guidance of $2.25-$2.35

 

Terms:

  • Total cost of $225mm
  • $55mm in cash
  • $~$170mm in debt
  • = ~7.5x EBITDA

 

  • To pay for acq. Instead of debt
  • Still projects 2010 debt-to-EBITDA ratio of ~3.5x on a pro forma basis

 

Casey Flavin
Director
 

 

LEVINE’S LOW DOWN 

 

- For those following the Jersey Shore, add Mike “The Situation” to the list of reality TV stars turned fashion mogul.  The Situation is launching a casual sportswear line in conjunction with an existing brand known as DILLIGAF (it’s acronym that requires Googling).  Retail partners have yet to be announced.

 

- In one of the more innovative uses of the iPhone app, The North Face launched Trailhead.  The app lists trails and maps around the US, as well as allows users to track their movements via GPS.  However, the most innovative feature comes with the weather forecasts.  The app actually suggests which North Face clothing you should wear based on expected weather conditions over the users specified route.

 

- Add H&M to the list of retailers finally launching e-commerce.  Similar to Zara, the retailer will launch in Europe first, on September 26.  No word on timing for the US launch.

 

 

MORNING NEWS 

 

Li & Fung Ltd. Plans to Privatize a Hong Kong-listed Transport Affiliate - Li & Fung has been acquiring rivals and entering into supply agreements to help meet a sales target of $20 bn this year. Last month Li & Fung increased its funds for acquisitions to about $1.15 bn. Privatization will help cut operational costs for Li & Fung as IDS provides logistics and distribution. <bloomberg.com/news>

Hedgeye Retail’s Take:  While not an acquisition of a “brand”, Li & Fung continues to invest in the tools needed to facilitate growth.  Expect more content related deals to take place as the company diversifies its revenue and profit model away from the traditional “middle man” operation. 

 

UK Clothing Sales in July Led by Menswear and Womenswear - Clothing sales picked up slightly in July, helped by summer Sales and promotions but . Retail like-for-like sales across all sectors increased by just 0.5% in July as shoppers’ fear of looming public spending cuts took hold while total retail sales were up 2.6%. Menswear and womenswear clothing led the improvement in clothing sales while growth in kidswear was steady but weaker than earlier in the year. Clearance and promotions helped boost sales but often at the expense of margins, the BRC said. Dresses, tops and skirts, lightweight knits and swimwear sold well during the month. Bags, jewelery and hair accessories were popular, particularly in clearance Sales. <drapersonline.com>

Hedgeye Retail’s Take: Kidswear/juniors apparel weakness is a common theme out of the UK and the US in July.  Interesting to note how UK retailers boosted sales through promotions at the expense of margins while many US retailers hurt top-line due to fewer days of discounting.

 

UK Footwear Sales in July Slowed to Record Weakness Since August 2009 - Sales of men’s and kid’s shoes were down on last year for the first time since August 2009. Women’s footwear sales also slowed but continued to show a slight gain. Footwear sales were often discount-driven, with heavy mark-downs in clearance events to attract cautious shoppers. Sales of casual shoes and sandals were boosted by the warm weather but formal styles struggled. Autumn ranges which had already been brought into store had seen good early interest in new styles. <drapersonline.com>

Hedgeye Retail’s Take: Footwear weakness out of the UK in July marks a notable divergence from the commentary out of the US. 

 

Not All Back-to-School Shopping Occurs in August - A new study finds that consumer interest in computer purchases peaks in July, while interest in the office and school supplies and apparel categories remains strong well into September. Shoppers start thinking about school supplies and apparel much earlier and stay engaged with ads later than what is generally understood to be the crunch month of August. The PointRoll survey tracked interactions with online advertisements from 2006 to 2009. The study suggests marketers in the office and school supplies and apparel categories may want to rethink their practice of cutting advertising spend sharply in late August. According to PointRoll, companies currently reduce their back-to-school advertising by 75% at the end of August before Labor Day. <internetretailer.com>

Hedgeye Retail’s Take: Retailers, for the most part, already know this.  One thing to consider is that if computers sell the best in July but were noted as a category of weakness by COST and TGT, then be weary of over exposed electronics retailers like BBY.

 

Innovation is the New Buzz Word in M&A - There is a rush of companies searching for businesses that have the pulse of new consumers. New players are also entering the mix, making for some pretty interesting bedfellows. Take Wal-Mart Stores Inc., which bought video download site Vudu. Denim brand J Brand sold a majority interest, said to be worth more than $50 million, to Star Avenue Capital, a partnership between talent agency Creative Artists Agency and Irving Place Capital. And the Estée Lauder Cos Inc. acquired Smashbox, picking up expertise in digital, social media and television distribution, as well as a photo studio to boot. Looking beyond the traditional boundaries of fashion can lead to a big payoff. This emerging M&A model is a distinct departure from the traditional one, where retailer A buys retailer B, reaching new customers while realizing synergies. <wwd.com/business-news>

Hedgeye Retail’s Take:  Or, the glass half empty view would be that companies have run out of synergistic opportunities and are now increasing their risk tolerance in an effort to potentially acquire “the next big thing”.

 

Men’s Wearhouse Acquires 2 Leading Providers of Corporate Uniforms and Workwear in the UK - Dimensions Clothing Limited and certain assets of Alexandra plc, two leading providers of corporate uniforms and workwear in the United Kingdom, were acquired for $97.5 mm. The companies will be organized into a U.K.-based holding company, of which Men’s Wearhouse will control 86% and certain existing shareholders of Dimensions will control 14%. The acquisition is expected to be accretive to earnings in fiscal 2010 and projected annual sales for the business are expected to be approximately $207.8 mm, in fiscal 2011.

 <wwd.com/business-news>

Hedgeye Retail’s Take:  How long before the “corporate uniforms” are replaced with suits in the UK?

 

Independent Retailers Feel Soft Sales and Credit Crunch - Retailers shopping the Cobb Show late last month at the Cobb Galleria here saw a slight uptick in business in the spring, but sales have been very sluggish this summer. The lack of availability of credit to small businesses is hurting retailers and vendors. Exhibitors said more manufacturers are requiring their retail customers to pay by cash on delivery, money order, company check or a credit card. Buyers were at the Cobb Show shopping for new trends for fall and looking for bargains. They wanted slimmer jeans, as well as other lifestyle looks, specifically board sports.  <wwd.com/retail-news>

Hedgeye Retail’s Take:  Sounds like the gradual (and profitable) shift in market share towards the better capitalized, larger chains is still underway.  Having a balance sheet has become a key asset even in an environment that is stable.

 

July's Import Cargo Volume Expected to Increase 15% - The large double-digit increases in June and July appear to be the result of backlogs built up due to the lack of shipping capacity earlier in the year after ship owners took vessels out of service during the recession and were slow to return them as the economy began to pick up. With many retailers appearing to bring merchandise in early to avoid any further bottlenecks, July is likely to be the peak shipping month for 2010 rather than the traditional rush of holiday season merchandise in October. There are indications that the shipping season may have peaked earlier than normal as the rush to re-stock inventories earlier in the year intersects with a combination of increased shipping capacity, consumer confidence levels not seen since August 2009 and the slowing growth of consumer spending,” Hackett Associates founder Ben Hackett said.  <sportsonesource.com>

Hedgeye Retail’s Take:  Keep an eye out for building inventories earlier than expected as this suggests holiday build is coming early.

 

Nike Opens New Store in Santa Monica Place, CA - The new two-story, 20,000-square-foot location unveils Nike’s newest store concept, including the introduction of Nike+ Run Club and team customization services. The store is the first multi-category concept in the U.S. since the company opened its last NIKETOWN in 1999. <sportsonesource.com>

Hedgeye Retail’s Take:  Putting the Nike store aside, this mall is supposedly one of the premier shopping venues to open in the last few years.  In fact, it may be one of the only malls to open in the last few years!

 

 Mizuno Corp Q1 Sales Strength Led by Europe and Americas - The Japanese athletic company cited athletic footwear as the largest contributor to growth. Revenue in Europe grew 14% and the Americas 15%, thanks to increased sales of footwear and baseball goods in those regions. <wwd.com/footwear-news>

Hedgeye Retail’s Take:  Another sign that performance footwear remains strong.

 


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THE M3: UNUSED PLOTS; WYNN COTAI; PROPERTY PRICES; STATS; ENTERTAINMENT CITY

The Macau Metro Monitor, August 10th, 2010

 

OVER 20 UNUSED PLOTS COULD BE TAKEN BACK Macau Daily Times, Intelligence Macau

The Land, Public Works and Transport Bureau's (DSSOPT) director Jaime Carion said, "[After a] recent and detailed analysis of over a hundred cases related to unused plots, it's a priority to find a solution for more than two dozen."  The cases include the expiration of the concession contracts, late premiums, and lack of development progress.  Carion added that authorities will also review whether or not the construction of a logistic centre at a Cotai plot granted in 2006 still “fits” the overall urban plan for the area.

 

According to IM, the Cotai plot that SJM is trying to obtain is going to be a third-party casino developed under the SJM license.  Despite all the hoopla lately on Cotai land parcels, IM thinks the land reshuffle has not begun yet.

 

WYNN MACAU TO PAY MOP 400 MILLION TO THIRD PARTY FOR LAND IN COTAI macaubusiness.com

In its quarterly report, Wynn Macau stated, “On August 1, 2008, subsidiaries of Wynn Resorts, Limited entered into an agreement with an unrelated third party to make a one-time payment in the amount of US$50 million in consideration of the unrelated third party’s relinquishment of certain rights in and to any future development on the 52 acres of land in the Cotai area of Macau....The payment will be made within 15 days after the government of the SAR publishes the company’s rights to the land in the government’s official gazette."  Wynn Macau is waiting for final government approval on the concession.

 

CHINA PROPERTY PRICES UNCHANGED ON MONTH WSJ, Xinhua News Agency

Chinese property prices in July rose 10.3% YoY, slower than June's 11.4% YoY growth. On a month-to-month comparison, July is flat with June.  New home prices rose 12.9% YoY in July, 1.2% points lower from June.  Prices of 2nd hand homes gained 6.7 % last month, compared with an increase of 7.7% in June.

 

The National Bureau of Statistics also said investment in real-estate development, one of the main forms of private investment in China, rose 37.2% to 2.39 trillion yuan (US$353 billion) in the January-July period from a year earlier, slowing from a 38.1% rise in the January-June period.

 

DEMOGRAPHIC STATISTICS FOR THE 2ND QUARTER 2010 DSEC

Total non-resident workers fell 701 in 2Q to 72,142. Also, 847 individuals were authorized to reside in Macau, down by 1,101 QoQ.

 

MACAU SEES RISE IN PERSONAL HOUSING LOANS macaubusiness.com, Macau Daily News

For money supply in June, M1 grew 2.5% compared to May and M2 grew 2.8% MoM to MOP 222 billion.  Loans to gaming and restaurants, hotels and similar establishments dropped 12.5% and 12.4%, respectively, in June relative to May.  In June, total deposits with the banking sector grew 1.7% MoM in June.  The loan-to-deposit ratio stood at 73.8%, up 0.7% points. 


SINGAPORE'S Q2 ECONOMY EXPANDS BY 18.8% YOY Channel News Asia

The final estimate of Singapore's 2Q GDP showed 18.8% growth, slower than the initial estimate of 19.3% growth.

 

RP AIMING TO STRIKE GAMBLING GOLD INQUIRER

PAGCOR chairman Naguiat believes an 'Entertainment City' in Manila by 2014 can compete with Macau and Singapore. Naguiat said the government was looking to eventually build integrated casino and entertainment resorts in other parts of the Philippines, including picturesque Palawan island and Cebu, the nation's second biggest city.


Spinning a Yarn

“A lie has speed, but the truth has endurance.”

-Josh Billings

 

When someone spins you a yarn, they are trying to deceive you by lying.  While it is strong language to use, it is increasingly obvious to Americans that Washington is spinning yarns in the run up to November mid-term elections almost as frantically as the Fed is printing dollars. 

 

The seeds are sown by the “Fiat Fools” and other political leaders in Washington for this country to be in for some bad times ahead.  The question is when, not if.

 

Ben Bernanke might be able to plug a temporary hole in the dam, but he will only be making things worse for the longer term.  The definition of quantitative easing says it all: ‘A central bank does this by first crediting its own account with money it has created “ex nihilo” (out of nothing)’.  Creating something out of nothing – that’s a good policy! You can’t make this stuff up… 

 

As Keith said in our MACRO call for clients last week, “Pleading for another round of quantitative easing is like the Romans pleading for Caesar to go into his final Senatorial meeting.”  Needless to say that ended badly for Caesar and it’s going to end badly for the USA too.  The death of the Fiat Republic!   

 

Ahead of the FOMC meeting today, the VIX rose 1.8% yesterday and volume on the NYSE was anemic and declined 16.5% day-over-day.  The 0.5% move in the S&P was the sign of pleading for Chairman Bernanke to come to the rescue.   The FOMC plans to release a statement at 2:15 p.m. today and, in my view, it’s unlikely that Chairman Bernanke will be able to string together the right words to satisfy the market. 

 

On July 21st he said, “the central bank wasn’t ready to take any action in the near term.” Although, at the same time, his assessment that the “economic outlook remains unusually uncertain.”  The lack of conviction in this market suggests that investors are looking for more clarity from the FOMC today.  KKR backing away from its planned $500 million U.S. offering is just one example of the anxiety evident in the marketplace.

 

The two key areas we are focused on are housing and employment.  Neither area is showing improvement.  The politicians can spin last week’s labor market report to fit the narrative, but as suggested by the deterioration and downward revisions in the data, the recent economic “recovery” has all but evaporated.

 

The strategy of increasing the supply of money in an economy when short-term interest rates are near zero is not going to fix the housing or the employment picture. The only benefit from another round of quantitative easing is to provide the banks with even more excess reserves with which they can buy the treasuries that the Chinese are selling.  Coupled with the fact that the Chinese would rather buy Yen than dollars, the current situation is a real problem for the USA.

 

The global markets’ response to the policies of the Fiat “Wizards of Washington” is a move away from the dollar, which increases the risk for inflation (not deflation) in terms of consumer prices.  A segment on today’s “morning edition” program on NPR with the economics editor of The Wall Street Journal focused on the Fed “watching for signs of deflation”.  I bet they are looking very hard.  We’ve said it time and again: the calculation used for government data for inflation is compromised and does not give an accurate reflection of the reality consumers are facing.  Prices at the pump and at the grocery store are reflecting that.  The forty-one million Americans receiving support from the Supplemental Nutrition Assistance Program (food stamps) are aware of that reality too.

 

On the inflation front, the market will get a small whiff of things to come on Friday.  There is a very good chance that the July CPI could surprise to the upside versus consensus expectations.   Although gasoline prices were flat month-to-month for July (according to the Department of Energy), a swing in seasonal factors will take gasoline prices higher, which will make the CPI number look inflationary.  Complicating the storytelling on Friday is oil trading at $80 and prices at the pump approaching $3.00.  Numbers don’t lie; politicians do.   

     

Turning to some important global macro data, yesterday copper traded down 2.1% and could not hold the critical intermediate trade line of 3.32.  Stocks in China fell 2.9% last night; the most in six weeks after data released in China showed real estate sales falling, while prices are rising less than expected. 

 

Taken together with the sluggish import data, a deepening in the slowdown in China’s economy is a real possibility.  China and copper have been leading indicators for growth globally over the last 18 months and U.S. markets will feel the effects of these moves.

 

The immediate term TRADE lines of support and resistance for the S&P 500 are 1113 and 1138.

 

Function in disaster; finish in style,

 

Howard Penney

 

Spinning a Yarn - hpel


Structural Unemployment

Conclusion: Even though Hedgeye is hiring, unemployment in the United States is becoming an increasingly structural issue as evidenced by the percent of unemployed that have been out of work for 6-months or more.

 

We are going to keep this note short and tight even by Hedgeye standards.  I asked my teammates Darius Dale and Matt Hedrick to look at longer term unemployment as a percentage of total employment going back as long as the data would allow us.  The output of their work is the chart below.

 

The chart highlights the percentage of total unemployed that have been unemployed for more than 6-months.  As can be seen in the chart below, more than 45% of unemployed have been unemployed for more than 6-months.  This is the highest level we’ve seen for long term unemployed going back to 1948.

 

The conclusion is simply that the unemployment in this nation is becoming structural.  While the credit boom created employment in the housing and construction sector, that entire industry has gone away and been replaced by . . . well, not much at this point.

 

As the non-partisan Congressional Budget Office stated in a recent paper:

 

“As a result, gains in employment after this recession will probably rely more than usual on the creation of new jobs, possibly in new firms that are located in different places and require workers with different skills than those needed in the jobs that have disappeared. For workers who have lost jobs to which they cannot return, acquiring new skills can take time. (In contrast, it is easier for workers who have been laid off temporarily to return to their jobs because the employers already know the workers and the workers already have the right skills and are familiar with the work.) For workers who need to move to different regions to find new jobs, the sharp declines in home prices during this recession, combined with the high loan-to-value ratios on many mortgages before the downturn, will hinder relocation. With a significant share of homeowners now owing more on their mortgages than their homes are worth, many people may not be able to sell their house for enough money to enable them to buy one in a new area.”

 

Further, this trend of longer unemployment comes with major issues because the longer unemployment lasts, the more likely it becomes that complacency sets in and the unemployed person becomes less willing to pursue employment in a traditional sense.

 

Maybe it’s just me, but I’m not sure quantitative easing is going to get us out of this one.

 

Daryl G. Jones

Managing Director

 

Structural Unemployment - Unemployed 6mo


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