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The Deuce

"Nobody can really guarantee the future. The best we can do is size up the chances, calculate the risks involved, estimate our ability to deal with them and make our plans with confidence."

- Henry Ford II


Staying as far away as I can from America’s professional politicians on Washington’s Sunday talk shows, this morning I’m rolling with an outstanding risk management quote from the man they called “The Deuce”, Henry Ford’s grandson, Henry Ford II.


According to my good friend who is currently working for Ford, Henry Ford II “doesn’t quite get the historical credit he deserves and is often remembered for his personal gruffness and feud’s with Lee Iacocca in the 1970’s, but his leadership and accomplishments during his era at Ford were amazing.”


After serving in the Navy in WWII, Henry Ford II came home to rid his family’s company of complacency and bureaucracy. He may not have been as “experienced” or as “polished” as some of America’s corporate executives are today, but as President of the Ford Motor Company (1) then CEO (1), he definitely sized up chances, calculated risks, and executed his plans with confidence.


Ford came public under Henry Ford II’s leadership in 1956. Don’t worry, I’m not wasting this morning’s missive on General Disaster’s pending IPO.  Instead, I’m going to get right into the math associated with last week’s macro market moves and focus specifically on the impact of another deuce – the US Dollar not going down for the 2nd week in a row!


Now before we get into some Dollar correlations, let’s first realize this: a deuce does not a TREND make. In our TRADE, TREND, and TAIL risk management process we are wed to 3s. In order for us to start thinking about shifting a strategy point of view (like covering our short position in the USD), we need to see at least 3 consecutive weeks confirm the direction of price.


Last week the US Dollar Index was barely up week-over-week (by +0.13%) for just the 2nd week in the last 12, closing out the week at $83.06. This followed the prior week’s significant +3.2% week-over-week move off of its recent 12-week low after Ben Bernanke didn’t give into the Fiat Fools begging for quantitatively easing America into becoming the debt-laden bureaucracy of Japan.


Measuring the math associated with a US Dollar Index not going down on our most immediate term risk management duration (TRADE = 3-weeks or less) is actually quite revealing.


The following are the 3 most negative TRADE (or inverse) correlations to the US Dollar:

  1. SP500 = -0.97
  2. Crude Oil = -0.94
  3. Commodity Index = -0.93

Here are the 3 most positive TRADE correlations to the US Dollar (again, using 3-weeks or less as our duration):

  1. Coffee = +0.85
  2. Cotton = +0.79
  3. Gold = +0.75

In other words, the decision by the Fed NOT to obliterate the credibility of America’s currency in one fell swoop has really hammered US stocks and the price of oil. The size of the Fed’s balance sheet actually contracted for once last week by $13.9B to $2.32 TRILLION.


Maybe not so ironically, prices at the pump going down also lifted US Consumer Confidence. In the last 2 weeks, despite stocks going down, the ABC/Washington Post Consumer Confidence reading has improved from minus -50 to minus -45.


In the very immediate term, could it be that The Deuce  of Dollar UP has provided Americans with some things that they really want?

  1. The value of their currency stopped burning.
  2. The price of oil is down -8.6% in the last 2 weeks.
  3. The probability of their least favorite American politician being voted out keeps going up.

Food for thought on a Monday morning in America where all that is conventional wisdom about the Fiat Republic’s dollar devaluation policy is ripe for change. It’s time we “estimate our ability to deal” with change and start leading this country with confidence.


My immediate term TRADE support and resistance lines for the SP500 are now 1059 and 1087, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Deuce - cat


TODAY’S S&P 500 SET-UP - August 23, 2010

As we look at today’s set up for the S&P 500, the range is 28 points or 1.2% (1,059) downside and 1.4% (1,087) upside.  Equity futures are trading above fair value in response to gains seen across Europe as a rise in basic materials temporarily offsets deeper economic concerns.

  • PERFORMANCE LAST WEEK: Dow (0.87%), S&P (0.70%), Nasdaq +0.29%, Russell +0.21%
  • PERFORMANCE MONTH-TO-DATE: Dow (2.41%), S&P (1.5%), Nasdaq (3.32%), Russell (6.16%)
  • PERFORMANCE QUARTER-TO-DATE: Dow +4.5%, S&P +3.98%, Nasdaq +3.34%, Russell +0.21%
  • PERFORMANCE YEAR-TO-DATE: Dow (2.06%), S&P (3.89%), Nasdaq (3.94%), Russell (2.34%)
  • ADVANCE/DECLINE LINE: -502 (+1408) Breadth positive on a down day
  • VOLUME: NYSE - 1124.11 (+4.7%) - Volume up on a down day
  • SECTOR PERFORMANCE: Every sector down but the XLU; XLE notable to the down side
  • MARKET LEADING/LAGGING STOCKS LAST WEEK: McAfee +57.0%, Salesforce.com +15.95% and Intuit +15.66% - Devry -11.07% Supervalue -8.28% and Sears -7.45%


  • VIX - 25.49 -3.59% and down 2.86% for the week
  • SPX PUT/CALL RATIO - 2.03 up from 1.31  


  • TED SPREAD: 17.348, -1.070, (-5.812%)
  •  3-MONTH T-BILL YIELD .15% -.01%
  • YIELD CURVE: 2.13 from 2.09


  • CRB: 267.01 -0.45% and -0.66% for the week - 2nd down week in a row
  • Oil: 73.82 -1.27% and down -2.57% for the week - 2nd down week in a row
  • COPPER: 331.15 -0.84% - up 1.19% for the week - Up 4 of the last 5 weeks
  • GOLD: 1,227 -0.42% - up 1.09% for the week; now 3 straight weeks


  • EURO: 1.2712 -0.87%; down 0.33% for the week (2nd down week)
  • DOLLAR: 83.057 +0.74%; up 0.13% for the week (2nd up week)


  • ASIA - Most markets closed mixed with economic concerns offset by strong resource sector. In Japan, the Nikkei extended losses amid worries a strong yen will threaten the economic recovery. Shanghai closed flat after moving in a narrow range as investors took profits in stocks which recently outperformed.
  • EUROPE - Regional markets were firmer boosted by stronger resource and financial sectors with ongoing M&A news/speculation also helping to counter-balance concerns about the sustainability of the economic recovery. Economic data out from the Eurozone proved mixed. Volume remains light.
Howard Penney
Managing Director
THE DAILY OUTLOOK - levels and trends


MGM’s leverage and cash flow troubles are well-known in the credit community.  However, it’s not really an imminent issue if MGM can sell its stake in Borgata and IPO a piece of MGM Macau.



Actual free cash flow is negative.  Even when MGM’s EBITDA improves over the coming years, much of the increased income will go towards catch up maintenance spend (see 8/22/2010 note, "MGM: MAINTAINING LOW CAPEX").


Since 2006, MGM’s FCF (Consolidated EBITDA pre-ESO less gross interest expense (reported interest expense + capitalized interest)) has been on a rapid decline.  In 2006, MGM’s FCF before debt service peaked at $973MM, before declining to $594MM and $410MM respectively in 2007 and 2008. To be fair, the drop is exaggerated by a period of elevated capital expenditure spending.   In 2009, despite meager capex spending, FCF before debt service continued to plummet to just $65MM. 




For the next several years, we’re projecting that FCF before debt service turns negative, especially as maintenance capex returns to more normalized levels.  Over the next 3 years, MGM could burn through about $730MM of cash before debt service.  When you layer in $1.25BN of debt maturities through 2012, MGM's cash burn jumps up to approximately $2BN.  However, this in of itself may not be an immiment problem if MGM is successful in selling its 50% stake in Borgata and IPOing part of their stake in MGM Macau in 2011 (including getting back that ~100MM receivable).  Although by 2012, even after generating a combined $900 million from these two transactions, we estimate that cash balances fall to uncomfortably low levels of roughly $400 million.  In addition, after $1.2BN of MGM's bank debt matures in Oct 2011, they will only have a $3.6BN facility, which we estimate will be fully drawn.  Therefore another debt issuance or equity offering seems like a certainty.



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Here's a chart from a insight created for RISK MANAGER subscribers (originally posted on August 18, 2010).




The Week Ahead

The Economic Data calendar for the week of the 23rd of August through the 27th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - c1

The Week Ahead - c2

DKS & HIBB; A Bit Flat-Footed


In looking over the results out of both Dick’s and Hibbett’s it would be disingenuous to say that we weren’t a bit disappointed. Both came in light on the top-line, each have their respective margin considerations, however, they both raised outlook for the full-year. Rather than looking through the quarter and chalking up favorable guidance adjustments to positive trend momentum and hopeful execution we’ve highlighted the key deltas both in the quarter and 2H as we look forward. For DKS our ‘we’re not against owning it’ positioning remains unchanged, though for HIBB, a lack of upside in margins in the quarter and marginally higher costs curb our expectation for further upside at least in the near-term. As always, our view changes as prices do, but the key is we’ll need to see an improvement in footwear trends as we enter the 2H and as the product cycle starts to pick up meaningfully before these names move up in our queue.


Thematic Call Outs:

Store Expansion: Both players remarked that 2011 will be a year of considerably more aggressive growth relative to 2010. Dick’s expects 30% store growth next year resulting in a reacceleration of square footage growth to a HSD rate up from low-to-mid single digit over the last two years. HIBB also sees opportunity primarily rooted in existing real estate opportunities at Movie Gallery and Blockbuster locations as well as adjacent states. Interestingly, while HIBB maintained its goal of closing 10-15 underperforming stores by year-end, DKS announced that it will be closing 12 Golf Galaxy locations in 3Q – an incremental and positive change that will be immediately accretive to profitability and earnings albeit small. Most importantly, while some will call for Dicks increasing focus on expanding into smaller format stores as a direct threat to the Hibbetts model, the reality is that just isn’t the case. While the new format is similar in size to new Sports Authority stores at ~35,000 sq. ft., it remains well above the average 5,000 sq. ft. Hibbett store and will still be targeted for considerably larger markets.


Category Trends: The bottom-line here is that while all three categories (footwear, apparel, and hardlines) comped positively for both companies, footwear came in softer and is clearly not materializing at the rate we have been expecting. Comps across three key retailers over the last 2-days (DKS, FL, HIBB) have all come in lighter than our expectation particularly those with greater exposure to footwear. While much of the new product that we’ve been highlighting during the year isn’t expected to start hitting floors until now, without commensurate demand sales could be softer yet again in the 2H.


Product: The outlook for basketball appears mixed with DKS far more upbeat reflecting strong momentum with Nike collaborations while HIBB was more cautious on the category citing weak launches as the cause for a challenging 2Q and modest participation in 2H launches. In addition to Nike product, the new Under Amour shoe and Reebok’s Zig remain key launches in basketball. Running continues to be the standout category with both retailers optimistic on toning, particularly in Q4 driven by accelerated marketing initiatives.


In apparel, Columbia’s OmniHeat commands all the buzz. DKS has significantly more exposure to the brand and is positioned to benefit more significantly if consumers believe the technology is as evolutionary as Columbia suggests. Importantly, Hibbetts committed to Columbia earlier this year and expects to have the brand in ~50 stores by year end as compared to some 350 stores in which North Face is carried. This is the most significant apparel launch to note for sporting goods retialers heading into the 2H hands down. 


Inventories:  As seen in the SIGMA chart below both company’s sales/inventory spread remains positive and little changed from last quarter suggesting that inventories remain relatively clean. While management systems are playing a key role in driving comps with considerably less inventory than in years past, HIBB is further into the process leaving DKS with an opportunity for additional and more meaningful margin gains over the next 12-months.


Company Specific Call Outs:


  • Mgmt is getting more aggressive on the long-term outlook for the business announcing that after another review, there is an opportunity for 900 DKS stores (up from their original view of 800).
  • Will be looking toward smaller format stores to get there (~25% of the incremental 100 oppty).
  • Decided to take the pain and shutter 12 of the 91 Golf Galaxy stores that were underperforming in Q3 (too costly, bad local or both) – lots of questions on this, but good call for profitability both near and long-term.
  • Chick’s renovation will take another 2-years to complete (longer than expected) to get profitability up to corp. avg.
  • Like FL and FINL, DKS also working on concept shops with NKE (Fieldhouse – more premium and Evolution) and initial steps are going very well. Nike recently commented that it’s the best and most complete representation of the brands worldwide. Already have 5 Fieldhouse prototypes operational.



  • Comps came in +11.9% with a significant deceleration in July despite easier compares (May up +12.8%, June up +13.3%, and July up +9.5%). However, the first 19 days of August suggest a robust start to Q3 up low double-digits. With August accounting for 40% of the quarter and BTS largely complete management’s expectation of a HSD/LDD comp is better than we were expecting heading into the quarter and an incremental positive.
  • While both traffic and transactions were up, average ticket was down.
  • Product margins up +60bps in Q2 were ahead of the company’s internal plans though less than we expected given the level of clearance activity during the same time last year. Given the benign promotional environment this is reflective of either an overall shift towards lower priced product, or is evidence that retailers are absorbing higher costs – our gut tells us it’s the later.
  • Georgia’s non-participation in the tax holiday season impacted comps by 80-100 bps in Q2.
  • Management expects to once again raise its outlook for the full-year again next quarter maintaining that year-end guidance is "very attainable." With Q2 coming in lighter than expectations, our confidence in the 2H is incrementally lower. That said, August trends have been strong out of the gate and account for a disproportionate portion of the quarter.  

So where does this leave us – a bit flat-footed actually. We’re adjusting our models for the full year with DKS shaking out at $1.52 and HIBB at $1.51 down from our prior estimates of $1.58 and $1.60 respectively. While both companies raised the outlook for the full-year, confirmation of trends through August from our trend data over the next several week will be critical before these names move up in our queue.


- Casey Flavin, Director


DKS & HIBB; A Bit Flat-Footed - DKS HIBB Q2 S 8 10



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