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WMT: Our Tone is Changing

WMT: Our Tone is Changing


Yeah, WMT is likely to beat tomorrow, but revenue visibility is likely to come up short. Mgmt is failing to execute on a plan to offset its self-deflationary model, and time is running out. If WMT can’t perform in a cyclical bounce, how can they do so in a double dip? Tack on overlap with Obama’s Housing Finance Conference tomorrow, and the headlines don’t look good.


In February (2/11) we wrote a post entitled “The Rut of Consistency” which outlined the reasons why Wal-Mart shares were likely to stay in a trading range.  In this post, we explained that even with a flurry of organizational changes and strategic initiatives underway for 2010, the ultimate reward to both earnings and share price was simply driven by the potential for increased customer traffic and pricing power resulting from merchandising improvements.  We believe both of these areas are unlikely to show any signs of improvement with tomorrow’s 2Q report. 


We went on to write:


As a result, in the near-term there is little to suggest that the company’s fundamentals and share price are anything more than still stuck in a narrow range.  To meaningfully break this cycle of monotony, we would have to see a few key things: 1) merchandising efforts actually work and drive a mix shift back towards discretionary goods, which in turn drives average ticket and margins higher, 2) a meaningful pick up in contribution from international at higher EBIT margins (unlikely as the non-U.S units collectively remain in growth mode) and 3) an acceleration in traffic (share) growth as a result of all of the above-mentioned efforts combined.  In theory, achieving this short list is what management needs to do to get out of the rut of consistency.  In reality, the hope of inflation as a savior and reliance on merchandising changes to drive margins higher are likely to be disappointing to those looking at 2010 as a breakout year for the largest company on the planet.


That brings us to today, exactly sixth months later and our thesis is very much unchanged.  Tomorrow Wal-Mart will report earnings that on the surface will be very close to the Street’s expectations.  Maybe a penny or two of upside, but all eyes will again be focused on the top line.  We have no special insight or “channel check” that tells us where exactly domestic comps will shake out, but our best guess tells us it’s slightly negative again.  After all, sales momentum slowed across the board for all types of retailers in Q2 and we don’t expect anything different from WMT.


Revenue gains remain a challenge based both on the law of large numbers that keep traffic under pressure and the fact that Wal-Mart’s pricing prowess continues to self-deflate the sales line.  We also believe recent management changes in the U.S offer the clearest signal that sales remain under pressure.  If it ain’t broke, why fix it? The bottom line here is that Wal-Mart is struggling to give the consumer a reason to shop its stores beyond price alone.  A scenario we see no signs of abating anytime soon and one which will again be made clear with tomorrow’s report.  So long as the consumer remains challenged to find higher wages and overall employment, Wal-Mart is unlikely to convince Americans that that they should be buying more “want” and less “need”.  As a result, tomorrow’s scripted call will likely be more about “opportunities” in merchandising,  maintaining price leadership, and importantly how the Wal-Mart customer remains challenged.  All of these items will come to light on a day that shares headlines with the Obama Administration Conference on the Future of Housing Finance and will likely rekindle a day of focus on the weak consumer. 


If anything has changed, it may be our bias that the shares will stay in a range.  We believe that while expectations are low enough and any rational investor knows it takes time to move a ship as big as Wal-Mart, patience is running out.  The efforts to improve the company’s apparel program have fallen short (again), as has a Sam’s Club revitalization.  There is little to grasp onto from the “story” side of things here, and the results themselves are just not good enough to keep investors interested indefinitely.  We believe the rut of consistency may be nearing an end and the “safety” factor that has kept so many investors waiting patiently for margin expansion driven by the topline is being pushed out into the future once again.  From a risk perspective, the size and complexity of the organization alone gives us comfort that we’ll have plenty of time to change our minds if some day the latest team of merchants finally gives the consumer a reason to spend more within Wal-Mart’s price-driven box.  For now, we’re looking elsewhere for investment opportunities both long and short where we can identify more meaningful catalysts.


- Eric Levine


WMT: Our Tone is Changing - WMT SIGMA


I know, we all have bigger fish to fry than to keep tabs on labor unrest in Bangladesh. But it is getting to a point where it could further crimp apparel margins in the supply chain’s of US retailers and brands.


Though not a whole lot of people care, Bangladesh carries the distinction as being the fourth largest source of finished apparel goods for US retailers – garnering about 7% of the market.  Furthermore, so far in 2010, Bangladesh has had the sharpest upward trajectory of any sourcing nation – arguably taking share from China, the 800lb gorilla (35% share).


But in response to rampant local cost inflation (nevermind $0.80/lb.+ cotton) workers in Bangladesh went on strike on June 23rd, demanding $75/month versus the prior rate of $23. The government’s National Wage Board stepped in and mandated $43 (a 72% increase), but that’s not been enough for the entire workforce to resume production.


Let’s assume that only a quarter of this capacity is still on hold. That still suggests that 1.5-2% of the global capacity for apparel is taken out temporarily (until the cost structure is fixed).


One could argue that China could step in and regain share. Perhaps they will. But let’s face facts…China outwardly stated that it wants to shift focus away from exports and towards more local consumption. The only way it will pick up slack capacity is if it will be at a meaningful price hike.


It’s all the same thing to us. It spells apparel inflation. The assumptions we need to make on the demand side of the ledger are tough enough. But on the cost side too?


And the Street STILL has the industry blowing through peak margins next year.


C’mon…It’s time for a reality check.



Bangla-who? - Appl Export Bangladesh 8 10



EARLY LOOK: Capital Chases Yield

This note was originally published at 8am this morning. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK in real-time, published by 8am every trading day.





“Now I know that I can win and that I can beat the best players in the world.”
-Martin Kaymer               

Martin Kaymer persevered at Whistling Straits in Kohler, Wisconsin yesterday to capture the 92nd US PGA Championship. The 25 year-old German is only the second player from Germany to win one of professional golf’s 4 majors. With 5 foreign born players finishing in the top 10 this weekend, I couldn’t help but notice that this world continues to become more interconnected and competitive by the day.
In the end, the best players in the world will get the most attention, capital, and respect. When it comes to capital markets, this is a critical point for long-time US-centric stock market investors to acknowledge. Capital changes hands every day. Capital seeks winners. Capital chases yield.
On the stock market side of the scorecard, Kaymer’s Germany scores better than the US does at this stage of the 2010 game. For the YTD the German DAX is +2.6%, whereas the US (SP500) is down -3.2%. That’s a 580 basis point performance spread.
Our top-flight analyst on European strategy, Matt Hedrick, has written extensively on Germany this year (email sales@hedgeye.com <mailto:sales@hedgeye.com> if you’d like to see his most recent research), but here are some summary points distinguishing Germany versus the US that are important to consider:
1.      German y/y GDP growth is currently stronger than in the US

2.      German unemployment is lower than in the US (7.6% vs. 9.5%)

3.      German fiscal policy is more conservative than in the US (85 BILLION Euro austerity package vs. no austerity).

As a result, global capital is realizing higher rates of return whether invested in German Bunds or German Equities relative to US Treasury yields (hitting all time lows) and US equities (down in 11 of the last 14 days). In hindsight, this probably makes as much sense as most things do in the rear-view mirror.
What doesn’t make any sense is an expectation that the Fiat Republic in Washington will win market share for global capital fund flows by marking America’s “risk free” rate of return at ZERO percent. This is going to chase capital out of this country for an “extended and exceptional” period of time.
Notwithstanding the fact that Japan has seen more net funds flow into Japanese Government Bonds than the US has seen from China into US Treasuries in the last 6 months, the Japanese have already taught the world that it’s very possible to chase capital out of a large economy for decades. Enough fear mongering about the “great depression” here folks, we need to wake up, smell the coffee, and get America back to winning again.
Japan’s GDP growth continues to be hammered down by elevated levels of debt. Last night the Japanese reported another awful GDP number for Q2 of 2010. In a global demand environment where China and its South East Asian neighbors were growing double digit GDP growth rates, Japan grew 0.1% sequentially to 0.4% year-over-year. QE-Japan – nice…
Japan didn’t have a player make the cut this weekend at the PGA Championship either (Yuta Ikeda was 2-OVER and No-mora by Saturday). Japan’s population growth is negative and there isn’t a lot to smile about in the island nation once expected to see real-estate prices grow like tulips to a 16th century sky. As China overtakes them this morning as the world’s 2nd largest economy, Japan’s losing streak continues with the Nikkei down -12.8% YTD.
But have no fear, Paul Krugman and the Fiat Fools are here… telling you (like Krugman did in 1997 with his “PRINT LOTS OF MONEY” advice to the Bank of Japan), that it’s time for QE2, 3 and 4. No wonder why Kaymer and China’s Wen-chong Liang (tied for 8th at the PGA this weekend) think they can beat the best players in the world. America’s ball is in the water – and we’re trying to fight oncoming water with more “liquidity.”
Last week was not a good week for the US on the stock market scorecard. With the SP500 broken across all 3 of our core investment durations (TRADE, TREND, and TAIL), here’s the updated immediate term TRADE ranges for US indices:
1.      SP500 = 1072-1098

2.      Dow = 10,2380-10,554

3.      Nasdaq = 2160-2244

4.      Russell2000 = 603-639

While the perma-bulls were begging Bernanke to take on more QE water, the market’s reaction to QE Light was:
1.      Stocks DOWN (-3.7% wk/wk)

2.      Volatility UP (VIX +21% wk/wk)

3.      2-year yields UP (closing the week at 0.53% vs. 0.51% in the wk prior)

What was probably least expected was US short rates going up on the week. Then again what’s least expected by consensus is where winners in this part of the 21st century are going to find they can beat the former best players in the world. Capital will chase yield as score changes every day.
On Friday morning’s opening market strength we sold our long Singapore position (EWS) and raised our position in Cash from 55% to 61%. My immediate term TRADE lines of support and resistance this morning are 1072 and 1098, respectively.
Best of luck out there today,

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R3: LOW: Gradual Fade (Expected)


August 16, 2010


The results out of LOW this morning were slightly off the mark, but not beyond the realm of expectations.  For now the gradual fade is visible. But as 2011 brings with it a likely double-dip in housing – this story could look very different.





One of the more obvious conclusions coming out of our conference call and Black Book on housing’s impact on retail related to the headwinds the home improvement retailers should face in 2011. Yes, I know. You don’t need to be a rocket scientist to make that conclusion.  With Lowe’s reporting this morning, we get a glimpse into where the DIY/Home Improvement sector is heading, and for now, it’s not that surprising.  The stock might be up on the number relative to expectations. But let’s face some facts… comps decelerated on a 1 and 2 year basis for the first time in 6-quarters, and earnings were down 10% on 3.7% sales growth. At face value, can someone rationally tell me why this is acceptable?


The one area that LOW had in its favor was inventory management. While still growing faster than sales (in 7 of the past 8 quarters), the sales/inventory ratio (see SIGMA chart) sequentially ticked up this quarter, which explains away the little squeeze in the stock today.


But the only real catalyst to get this name higher will be cash flow momentum – which is not there (especially vis/vis Home Depot), and/or a true underlying rebound in the housing market. As we gain confidence along with our Macro and Financials/Housing team that a double dip in 2011 is increasingly likely, can someone explain to me why LOW can’t have a down year AGAIN, and then AGAIN? Note: The Street has 12% EPS growth baked-in to this model for the next 24 months.


- Eric Levine, Director


R3: LOW: Gradual Fade (Expected) - 1





- JC Penney noted the early customer response to the company’s Liz Claiborne launch has been “overwhelmingly positive”.  Interestingly, the brand has not been officially launched, as marketing efforts are slated to begin in mid-September.  Unfortunately, a couple of weeks worth of data, while positive, is too limited to draw a conclusion on the ultimate success of the launch.


- Fashion blogs are abuzz with Talbots latest marketing campaign.  As the company continues its transition towards a more youthful (not teen, but younger) image, the latest print ads featuring Linda Evangelista are out and gathering attention.  The next step is to see if the marketing shift will translate to a sustained pick up in fall sales as “tradition is transformed”.


- While e-commerce may still present one of the greatest opportunities for growth for the retail sector in general, it does not look like it will be driven by further broadband adoption.  After several years of uninterrupted growth, consumer use of high speed internet access at home appears to be hovering around 66% of American adults.  This represents a small (up 5%) increase from the prior year and the smallest increase in seven.


- If you thought holiday sales promotions came early last year, the “Christmas Creep” will be upon us even earlier in 2010 according to an annual benchmark report from Experian Marketing Services. While Target’s “Black Friday in July” sales appeared aggressive at the time, we can expect more of the same from other retailers looking to capitalize on early movers as consumer spending trends become increasingly less certain heading into the 2H.





Long Beach Port Cargo Traffic Increases in July - The monthly container cargo count at the Port of Long Beach increased for the eighth straight month in July 2010, rising 35.8%. Imports were up 32.5%, while exports rose 16.4%. Empty containers, which are mostly bound overseas for refilling, were up 63.1%. <polb.com/economics>

Hedgeye Retail’s Take: Despite concerns over consumer spending in the 2H, container traffic continues to suggest retailers are betting on stronger demand heading into the holiday sales season.

R3: LOW: Gradual Fade (Expected) - 2


Cotton Climbing Higher to 1995 Peak - Cotton may climb to the highest price since 1995 as rising demand in emerging markets for everything from shirts to bed sheets forces textile makers to restock inventories that are the tightest in 13 years. Export sales by the U.S., the largest shipper, are off to their fastest start since 1993 as apparel demand in China, the biggest consumer, increased 24%, government data show. Cotton may advance 13% to a 15-year high of 94.9 cents a pound before new supplies are harvested in October, according to 17 analysts surveyed by Bloomberg on Aug. 12 and Aug. 13. The commodity is projected to extend its gains because demand is growing in Asia’s developing nations, even as signs emerge that the U.S. economic recovery may slow. While the rally is enriching some cotton investors, it’s also boosting costs for Levi Strauss & Co. and Hanesbrands Inc. <bloomberg.com/news>

Hedgeye Retail’s Take: Surging higher following Thursday’s USDA crop report and continued flood damage in Pakastan, the rising cost of cotton is exceeding all estimates despite expected cost inflation in the 2H. Recall, Gildan with ~30% of COGS exposed to cotton noted last week that ~$0.80/lb. cotton would impact earnings by $0.50 next year on a ~$1.60 base…less than a week later, that view appears increasingly optimistic. HBI notes that its exposure is closer to 6-8%, but keep in mind that this understates the true impact as HBI buys much of its cotton FOB (i.e. it’s an indirect cost instead of a direct cost).


Shopping Habits Forever Changed? - Marketing firm BrainReserve doesn’t see women going back to their ferocious shopping habits once the economy fully recovers. The entire consumer mentality has changed across the socioeconomic spectrum. So is this the dawn of a New Consumer Age, as many experts contend, one that will force brands and retailers to make tectonic changes in the way they do business and transform the nature of shopping in America. It’s clear the shopping rules have changed and key trends include:

• The boom in e-commerce, making it easier for consumers to buy from home — and to comparison shop.

• Technology is now more fashionable than fashion — in other words, teens and twentysomethings would rather buy an iPad than a handbag.

• Social networks are driving real consumption, with friends telling friends about hot products or brands — meaning brands have to enter the conversation.

• The Great Recession has forced everyone, even the rich, to alter their shopping behavior and buy less.

• High levels of personal and household debt continue to constrict the Baby Boomers, who are looking for simplicity and value. <wwd.com/retail-news>

Hedgeye Retail’s Take: Call it “ferocious shopping,” or whatever you want, but excessive spending is officially taboo and frugal is in – a trend we don’t expect to change anytime soon.   


Half of Local-Made Leather Shoes Disqualified in Recent Sampling Test - Shanghai Consumer Protection Committee has recently conducted a sampling test on locally manufactured leather shoes which revealed that about 45% of samples were not up to the standard. For the testing, twenty-nine pairs of shoe were sampled from Shanghai markets including five pairs of men’s shoes and twenty-four pairs of lady’s shoes that were made in Shanghai, Zhejiang, Jiangsu and Guangdong province. The test results found that thirteen pairs of leather shoes were defected in the nine technical parameters including appearance quality, peeling strength and heel fastness. <fashionnetasia.com>

Hedgeye Retail’s Take: Wage inflation isn’t the only reason for the shift of global manufacturing out of China towards countries like Vietnam and Indonesia. While we’re not certain quality standards are any better in these countries, an alternative is usually preferable to results such as these.


Nike Inks License Deal With Athlete Performance Solutions - Athlete Performance Solutions has teamed up with Nike for a line of pinnacle, performance footwear for sailing, rowing, fencing, weightlifting, boxing and shooting. The footwear is hitting retailers now. Discussions are in the works for retail partners in sailing and shooting, as well as premium retailers. <licensemag.com>

Hedgeye Retail’s Take: Why not? Footwears pre-eminent brand is targeting smaller markets albeit with considerably less competition.


H&M July Comps Improve by 10% - Hennes & Mauritz AB said same-store sales in July increased 10%, compared to 9% in June. Including new stores, total revenues for the month of July grew 21%, versus 20% in the previous month, showing a strong improvement on the same period last year. H&M had experienced a weaker-than-expected performance this April and May due to cold weather across key markets. <wwd.com/business-news>

Hedgeye Retail’s Take: Fast-fashion continues to be a relative outperformer within global retail.

R3: LOW: Gradual Fade (Expected) - 3


eBay Invests in General Manager of eBay Fashion - In an effort to grow its apparel business, eBay has made recent investments in technology. Now it’s investing in people. Miriam Lahage has been named general manager of eBay Fashion, a new position. A 20-year veteran of The TJX Cos. Inc., Lahage founded Koodos.com, an online discount luxury boutique based in the U.K. At eBay, Lahage will be responsible for growing and driving innovation across the site’s fashion category, which did $5.4 bn in worldwide gross merchandise volume last year. Part of her job will be to attract more brands to eBay to give a fashion and editorial point of view. Lahage wants to bring more consistency to the apparel presentation on eBay’s selling platforms. <wwd.com/business-news>

Hedgeye Retail’s Take: Creating a more consistent apparel presentation for a retailer that will always be known for its consumer generated auction supply sounds like an impossible task. If eBay can ramp its new offerings rather than used merchandise there in an opportunity to gain share, however that segment of the market is getting increasingly more competitive behind the likes of RueLaLa and Gilt Groupe – eBay is wading into deeper waters with this one.


Last week, 7 of the 8 risk measures registered negative readings on a week-over-week basis and one was positive.


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. Financials CDS Monitor – Swaps widened last week for all 29 reference entities.  Conclusion: Negative.


Widened the most vs last week: JPM, WFC, MBI

Widened the least vs last week: AON, PRU, CB

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

Tightened the most vs last month: MET, PRU, MBI




2. European CDS Monitor – In Europe, swaps for 37 of the 39 reference entities widened and 2 tightened, with an average widening of 9.0% week over week.   Conclusion: Negative.


Widened the most vs last week:  Societe Generale, Alpha Bank, National Bank of Greece

Tightened the most/widened the least vs last week: Danske Bank, DnB NOR, Nordea Bank

Widened the most vs last month: Hannover Rueckversicherungs, Banco Popular, Intesa Sanpaolo

Tightened the most vs last month: Nordea Bank, UBS, DnB NOR




3. High Yield (YTM) Monitor – High Yield rates rose 17 bps last week. Rates closed the week at 8.47% up from 8.30% the week prior. Conclusion: Negative.




4. Leveraged Loan Index Monitor – The leveraged loan index fell 2 points last week, closing at 1491 versus 1493 the week prior. Strong momentum in July appears to have eroded.  Conclusion: Negative.




5. TED Spread Monitor – Last week the TED spread fell 5 bps, closing at 22 bps versus 27 bps the prior week. Conclusion: Positive.




6. Journal of Commerce Commodity Price Index – Last week, the index fell 4.5 points, closing at 13.65 versus the prior week’s close at 18.11.  Conclusion: Negative.




7. Greek Bond Yields Monitor – We chart the 10-year yield on Greek bonds.  Last week yields rose 33 bps, ending the week at 1048 bps versus 1015 bps the prior week. Conclusion: Negative. 




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 includes a diversified pool of revenue and GO bonds from a broad array of states. Our index is the average of their four indices.  Spreads rose last week, closing at 213 versus 206 the prior week.  Conclusion: Negative.




Joshua Steiner, CFA


Allison Kaptur


The Macau Metro Monitor, August 16th, 2010



MGM Macau president, Grant Bowie, said that the company is "financially safe and secure" to invest in a "high-end integrated resort" project on Cotai.  MGM is still waiting for approval from the Government.  Bowie also said, “I don’t see Macao Studio City land as an option right now because it is owned by someone else,” Mr Bowie said.



According to the president of the Cross-Strait Tourism Exchange Association (CTEA) in China, China is currently discussing the potential to open up the individual traveling scheme to Taiwan.  Since 2008, Taiwan has allowed mainland tourists to travel on package tours with a stay of the maximum 15 days.



Local real estate agents in Macau are concerned that HK speculators who are shifting their focus to Macau because of new restrictions may overheat Macau's property market.  HK SAR government declared new curbing rules, starting August 13, that prevent purchasers of flats to re-sell, sub-sell or transfer the benefits of the agreements for sale and purchase before the transactions are completed.  The department also required buyers to forfeit 10% instead of 5% of the total purchase price if the transactions were canceled.

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