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R3: FL, OSTK, PSUN, SKX, Puma

R3: REQUIRED RETAIL READING

August 25, 2010

 

With signs pointing towards another challenging holiday season for retailers expect creativity, content, and positioning to prevail. 

 

 

RESEARCH ANECDOTES

  

- In less than a year, Barnes & Noble’s market share in digital books has eclipsed that of the company’s physical bookselling share which currently stands at 17%. Management believes online book sales for the industry will top $500 million this year.

 

- According to Nielsen, kids under the age of 18 text 90 times as much as those over 65. Not surprising to some, but eye opening when you consider those under 18 send 2,800 texts each month! Some quick math suggests that’s about 100 texts per day.

 

- Keep an eye on the progress of “visual search” following Google’s acquisition of Like.com. The company’s technology allows consumers to comparison shop based on a image. So if you find a pair of jeans online and then hit the visual search button, the results will pop up based on finding items similar to the original pair of jeans. So much for search engine optimization based on keywords.

 

 

OUR TAKE ON OVERNIGHT NEWS 

  

Outlook on Holiday is Cautious at Best - While still early to predict holiday sales with any degree of certainty, several retailers and analysts contacted said single-digit gains in the 2 to 4% range would be attainable, slightly better than last year, when retailers on average were up 2.1%. People are nervous and retailers are already pretty aggressive promotions happening, particularly in jeans. One thing is certain: This holiday will be no less promotional than last year, although it is unlikely to approach the 70% panic markdowns seen in the dismal days of 2008. Retailers say their goal is to plan them better, although in the end, the level of promotions will depend on consumer demand in the run-up to Christmas. The list of concerns is long and includes: Hot items in hard and soft goods don’t seem to be materializing, consumers are saving more than spending, most retailers for b-t-s seem to be dragging though some department store executives said early fall fashion is doing well, there are no signs of significant economic recovery soon, with job creation and the housing market remaining weak, credit is still hard to get, recent government data show consumers are saving 6.4% of their aftertax income, which is three times the rate of savings seen in 2007. <wwd.com/retail-news>

Hedgeye Retail’s Take: With lackluster BTS results to date and housing figures that caught many consumers by surprise, expect retailers to start getting more aggressive in order to counter signs of potential consumer retrenchment as we head into the holidays.

 

Random House Gets Ebook Rights From Wylie Agency - The publisher says it will again do business with the agency, which it severed ties with in July after Odyssey Editions signed an exclusive deal with Amazon to sell electronic versions of 20 classic books, 13 of which were Random House titles. The Random House titles will now be available at other ebook sellers, as well. The article does not indicate that the agreement has resolved the more fundamental question of who owns the rights to publish ebooks for works published at a time when publishing contracts did not specify who owns those rights. <nytimes.com>

Hedgeye Retail’s Take: The proliferation of the e-book astounds me. 2-years ago it was unheard of to the masses. Now I can't even count the number of e-readers. And that's coming from a guy who owns a kindle. 

 

Overstock Launches a Private-Sale Site - Eziba.com offers limited quantities of home goods for a set time period, typically between 48 and 72 hours. Eziba is Overstock’s first private-sale site. The company will market the site to existing customers. <internetretailer.com>

Hedgeye Retail’s Take: With less exclusive brands relative to similar models al la Gilt Groupe and RueLaLa, price will be the key driver to ‘lower luxury’ concepts such as this. Perversely, exposing the masses to this model is likely to also drive traffic to the original players as consumers adjust buying patterns.

 

PSUN Partners with Modern Amusement Brand - Pacific Sunwear of California Inc. hitched its merchandising fortunes to Mossimo Giannulli’s Modern Amusement brand. PacSun will hold exclusive rights as licensee to Modern Amusement for apparel, accessories and footwear through 2013, with an option to renew through 2020. The Anaheim, Calif.-based specialty store will work in tandem with Modern Amusement’s parent company, Dirty Bird Productions Inc., to develop additional licensing and distribution opportunities, the parties said, and will share in royalties generated by the association. They also will share approval rights for such arrangements. <wwd.com/business-news>

Hedgeye Retail’s Take: A step up for PSUN in terms of content with upside in channels that have given little thought to carrying the brand prior to the its partnership with Mossimo’s Modern Amusement brand typically carried in higher end department stores.

 

West 49 Shareholders Approve Billabong Take Over - West 49 shareholders voted almost unanimously in favor of Billabong's $99-million takeover bid for the Canadian clothing retailer. West 49 said 99.9% of its shareholders were in favor of the sale to Australia's Billabong International. <sportsonesource.com>

Hedgeye Retail’s Take: As expected – but it’s worth noting that while West 49 is Canadian-based, it will significantly add to Billabong’s footprint with 300+ stores globally with approximately half mall-based.

 

SKX Wraps Up 20 City Tour - Skechers USA Inc. on Thursday wrapped up a 20 city tour in New York City's Times Square. Denise Austin, America's favorite fitness expert, hosted the festivities in Times Square. <sportsonesource.com>

Hedgeye Retail’s Take: Between the new television ad campaign and multi-city tour, Skechers is putting its marketing muscle behind the new SRR resistance runner for men. As trend data begins to track sales of the product, we’ll see just how successful the effort and interest will be.

 

FL Opens 2nd RUN by Foot Locker - Foot Locker Inc. has opened its second RUN by Foot Locker store in Menlo Park Mall in Edison, NJ. The first RUN by Foot Locker opened in February on 14th Street in New York City.  <sportsonesource.com>

Hedgeye Retail’s Take: With the first RUN store having opened over 6-months ago, don’t expect it to take as long before we see RUN stores #3, #4 & #5 as FL rolls out this initiative as part of its store optimization strategy.

 

Puma Keeps Usain Bolt Through 2013 - Puma’s love affair with Jamaican track-and-field star Usain Bolt continues. The three-time gold medal winner renewed his contract with the athletic company Tuesday. It will now continue through the end of 2013. Although terms were not disclosed, Puma did say Bolt will receive more than any track-and-field athlete has earned.  Bolt, 24, has been with Puma since he was 16. As part of the new deal, the runner will appear in ad campaigns, including the company’s London 2012 Olympic program, expected to launch in 2011. And he will continue to collaborate on such product lines as the Bolt Collection of footwear, apparel and accessories. <wwd.com/footwear-news>

Hedgeye Retail’s Take: Pay day! After taking a firm hold of the world’s fastest man title in 2008 at the Beijing Olympics, Bolt has quickly become synonymous with running and a key element in Puma’s resurgence.

 

Facebook Usage Still Rising in Europe, But Growth Slows in UK - The Facebook juggernaut rolls on in Europe, but the first sign of declining growth rates has appeared. In particular, the site’s meteoric expansion in the UK is tailing off. The social network gained more than 2.2 million active UK users in May 2010, according to Inside Facebook—an 8.9% rise that took total UK user numbers to 27.1 million on June 1. Growth was higher in the UK than anywhere else in Western Europe. By midsummer a different pattern was emerging. In France, user numbers continued to climb, reaching 19.4 million on August 1, according to data from Inside Facebook. In the UK, by contrast, the tally of active users fell in June, and rose only 1.8% in July. <emarketer.com>

Hedgeye Retail’s Take: At 44% penetration in the UK let’s be real, growth is going to show signs of slowing at some point. I’m more interested in two other figures, the countries with the highest growth rates. With India up +9.4% and Brazil +12.1% and penetration of only 1% and 3% respectively…looks like plenty of runway for growth from this seat.

 

R3: FL, OSTK, PSUN, SKX, Puma - 1


CMG: COSTS HEADED UP

Chipotle’s bottom line is highly vulnerable to a continued rise in food prices.

 

CMG is a popular brand and their management team has done a great job in many respects.  One significant factor buttressing the bottom line since the stock price troughed in 4Q09 has been food prices.  As I wrote in my June post, “CMG: WATCH MARGINS”, the favorable commodity environment enabled CMG to attain higher margins from 1Q09 onward.  The company is not locked into many of its ingredients and continued food inflation will likely impact CMG’s earnings potential significantly.  

 

CMG: COSTS HEADED UP - cmg food margins crb

 

CMG: COSTS HEADED UP - crb foodstuff

 

Maintaining comparable restaurant sales in this economic environment will be difficult for all restaurant companies.  There is virtually no pricing (one tenth of one percent) in Chipotle’s comp but it seems that management would be hesitant to carry out such a move with unemployment this high.  As the chart below shows, positive traffic momentum has been instrumental in driving Chipotle’s top line.  If the company can maintain high single digit comparable restaurant sales trends, margins will likely remain healthy.  Slowing comps, however, will amplify the negative effect of food inflation on margins and make leveraging other parts of the income statement more difficult. 

 

CMG: COSTS HEADED UP - cmg comp detail

 

Below is a rundown of Chiptole’s commodity setup.  While they are largely unlocked on some items such as proteins and dairy, smaller items like rice, tortillas, and corn are locked for the remainder of this calendar year.  Should prices in these contracted commodities continue to trend higher, margins could come under additional pressure when the contracts expire at year end.

 

Looking at Chipotle’s commodity setup:

  • Rice is contracted through at least two more quarters (through 4Q).   Clearly, this is a good thing to have contracted given recent climate events in Pakistan and China.  
  • Soy oil and corn are also contracted through two quarters while tortillas have also been locked in for the remainder of 2010.
  • Chicken prices in the second quarter were held lower because the company, due to supply issues, only served 80% naturally raised chicken.  The company is “optimistic” that they can return to 100%.
  • The inadvertent change in chicken sourcing was margin accretive (by 20 bps) and partially offset the higher year-over-year cost of avocados and beef, which are not currently contracted.
  • CMG has not locked in cheese or sour cream. 

 

Howard Penney

Managing Director


EARLY LOOK: Focus on Risk

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.

 

 

____________________________________________________________________

“The best investors in the world do not target returns; they focus first on risk.”
-Seth Klarman

 

 

EARLY LOOK: Focus on Risk - Screen shot 2010 08 25 at 9.13.37 AM

 

 
Seth Klarman founded Baupost in 1982. He’s one of the best players who are left playing this game. He’s not your huckleberry if you are looking for someone to get levered up long. He’s conservative. He likes cash and he has no problem moving to a cash position greater than 50% of his assets.
 
I’m not Seth Klarman, but I like cash too. I currently hold plenty of cash in our asset allocation model. I get that some investors have (or think they have) leverage figured out. I have yet to see a levered long equity or commodity fund perform in a bear market, but that certainly doesn’t mean one may not exist. Please forward details if you know of one that’s generated absolute returns in both 2008 and 2010.
 
Yesterday we invested 6% of the Cash position in the Hedgeye Asset Allocation model, taking our recommended Cash position down from 61% to 55% (buying DJP and IHE). When we started getting bearish in April/May, our allocation to cash peaked at 79%. In bear markets like these, I fundamentally believe in managing a large cash position dynamically.
 
I’m not ready to say “buy-and-hold” is dead. I don’t think it will ever be. Whether it’s investing in Hedgeye in 2008 or buying Starbucks (SBUX) in early 2009, I doubt I’ll ever sell these positions. However, I will say that buy-and-hope is dead. Buying on valuation alone in a slowing growth environment is rarely a catalyst and hope is not an investment process.
 
Managing risk in an interconnected global ecosystem of colliding macro factors is a repeatable risk management process that we can all apply. If we are accountable to our investors in focusing “first on risk”, that is…
 
Every day the score is re-calibrated. I’m pretty sure that the triumvirate of Google, Wikipedia, and YouTube will be holding us all accountable to how we managed risk on both the downturns of 2008 and 2010. History will decide whether Hedgeye was useful to your investment process long after I am dead.
 
We’ve been bearish on US Equities and now we are accountable to our clients in recommending where they book gains in these bearish positions. Making calls on US GDP or housing slowing is only one part of the risk management process. The most critical part of the investment process is getting the timing right.
 
We had the timing right on the way down. The question now is can we get the timing right on the way out? Here’s how I thought this through yesterday as I was covering 5 of the 14 short positions in the Hedgeye Virtual Portfolio (SPY, XLI, HOT, IWM and XLY):


 
1.      Math: Immediate term TRADE support (our most immediate term risk management duration – 3 weeks or less) in my macro model for all of the aforementioned short positions was 2.5 standard deviations oversold. This is not to say that 3 and 4 standard deviation moves couldn’t occur this morning, but looking at the macro calendar of events today, I made a conscious decision to bet against those low probability events.

 

2.      Risk/Reward: For the sake of this illustration I’ll use the SP500 (SPY) short position – moving to a 3 standard deviation level of downside support I was coming up with 1040 (the 2.5 standard deviation level = 1053), and in terms of immediate term TRADE upside I was registering 1077 on a 2 standard deviation move. Net net, I saw 2.5:1 upside versus downside in getting longer and I thought that was worth taking.

 
3.      Volatility: The inverse relationship between the VIX and the SP500 continues to be a heavily weighted risk management signal in our 27-factor baseline model. It hasn’t always been – it just is now because the inverse correlation between the two remain very high on an intermediate term basis. At the same time as I’d call the SP500 immediate term oversold anywhere south of 1053, I was registering the VIX immediate term overbought anywhere north of 27.57. Since the VIX closed at 27.46, that was close enough for me to stick with my cover/buy signal.

 

Now all this starts and ends with risk management. I wasn’t trying to decide whether or not we should drop our net long exposure from 140% to 107% yesterday. I was risk managing how to A) get out of 1/3 of my short positions and B) get into some long exposure to US Equities. There is no rule saying I can’t re-short any of these positions at anytime today. This doesn’t make me bullish either.
 
Again, it’s a lot easier to think this through from a position of strength. I’m certainly not always in a position of strength either. Yesterday I was, and my risk management task was to focus on risk first. Don’t get squeezed on the short side and focus on investing cash when markets are oversold.
 
I realize that this is unconventional. I realize that sometimes it’s hard to read about my team’s wins. I am very aware of the confidence interval I have in this team’s risk management process, and I can assure you that the hardest part about all of this is how hard I am on both my team and myself. Showing you what we do, when, and why isn’t easy. Neither is modern day risk management.
 
As of last night’s close, our Hedgeye Asset Allocation portfolio had the following positions and weightings:
 
1.      Cash 55%

2.      International FX 21% (Chinese Yuan (CYB) = 15%, British Pound (FXB) 6%)

3.      Commodities 9% (DJUBS Commodity Index (DJP) = 6%, Gold (GLD) = 3%)

4.      Bonds 6% (all TIP)

5.      US Equities 6% (Utilities (XLU) = 3%, US Pharma (IHE) = 3%)

6.      International Equities 3% (Brazil (EWZ) = 3%)

 
Best of luck out there today,
KM


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 80.33%
  • SHORT SIGNALS 78.51%

Focus On Risk

“The best investors in the world do not target returns; they focus first on risk.”

-Seth Klarman

 

Seth Klarman founded Baupost in 1982. He’s one of the best players who are left playing this game. He’s not your huckleberry if you are looking for someone to get levered up long. He’s conservative. He likes cash and he has no problem moving to a cash position greater than 50% of his assets.

 

I’m not Seth Klarman, but I like cash too. I currently hold plenty of cash in our asset allocation model. I get that some investors have (or think they have) leverage figured out. I have yet to see a levered long equity or commodity fund perform in a bear market, but that certainly doesn’t mean one may not exist. Please forward details if you know of one that’s generated absolute returns in both 2008 and 2010.

 

Yesterday we invested 6% of the Cash position in the Hedgeye Asset Allocation model, taking our recommended Cash position down from 61% to 55% (buying DJP and IHE). When we started getting bearish in April/May, our allocation to cash peaked at 79%. In bear markets like these, I fundamentally believe in managing a large cash position dynamically.

 

I’m not ready to say “buy-and-hold” is dead. I don’t think it will ever be. Whether it’s investing in Hedgeye in 2008 or buying Starbucks (SBUX) in early 2009, I doubt I’ll ever sell these positions. However, I will say that buy-and-hope is dead. Buying on valuation alone in a slowing growth environment is rarely a catalyst and hope is not an investment process.

 

Managing risk in an interconnected global ecosystem of colliding macro factors is a repeatable risk management process that we can all apply. If we are accountable to our investors in focusing “first on risk”, that is…

 

Every day the score is re-calibrated. I’m pretty sure that the triumvirate of Google, Wikipedia, and YouTube will be holding us all accountable to how we managed risk on both the downturns of 2008 and 2010. History will decide whether Hedgeye was useful to your investment process long after I am dead.

 

We’ve been bearish on US Equities and now we are accountable to our clients in recommending where they book gains in these bearish positions. Making calls on US GDP or housing slowing is only one part of the risk management process. The most critical part of the investment process is getting the timing right.

 

We had the timing right on the way down. The question now is can we get the timing right on the way out? Here’s how I thought this through yesterday as I was covering 5 of the 14 short positions in the Hedgeye Virtual Portfolio (SPY, XLI, HOT, IWM and XLY):

  1. Math: Immediate term TRADE support (our most immediate term risk management duration – 3 weeks or less) in my macro model for all of the aforementioned short positions was 2.5 standard deviations oversold. This is not to say that 3 and 4 standard deviation moves couldn’t occur this morning, but looking at the macro calendar of events today, I made a conscious decision to bet against those low probability events.
  2. Risk/Reward: For the sake of this illustration I’ll use the SP500 (SPY) short position – moving to a 3 standard deviation level of downside support I was coming up with 1040 (the 2.5 standard deviation level = 1053), and in terms of immediate term TRADE upside I was registering 1077 on a 2 standard deviation move. Net net, I saw 2.5:1 upside versus downside in getting longer and I thought that was worth taking.
  3. Volatility: The inverse relationship between the VIX and the SP500 continues to be a heavily weighted risk management signal in our 27-factor baseline model. It hasn’t always been – it just is now because the inverse correlation between the two remain very high on an intermediate term basis. At the same time as I’d call the SP500 immediate term oversold anywhere south of 1053, I was registering the VIX immediate term overbought anywhere north of 27.57. Since the VIX closed at 27.46, that was close enough for me to stick with my cover/buy signal.

Now all this starts and ends with risk management. I wasn’t trying to decide whether or not we should drop our net long exposure from 140% to 107% yesterday. I was risk managing how to A) get out of 1/3 of my short positions and B) get into some long exposure to US Equities. There is no rule saying I can’t re-short any of these positions at anytime today. This doesn’t make me bullish either.

 

Again, it’s a lot easier to think this through from a position of strength. I’m certainly not always in a position of strength either. Yesterday I was, and my risk management task was to focus on risk first. Don’t get squeezed on the short side and focus on investing cash when markets are oversold.

 

I realize that this is unconventional. I realize that sometimes it’s hard to read about my team’s wins. I am very aware of the confidence interval I have in this team’s risk management process, and I can assure you that the hardest part about all of this is how hard I am on both my team and myself. Showing you what we do, when, and why isn’t easy. Neither is modern day risk management.

 

As of last night’s close, our Hedgeye Asset Allocation portfolio had the following positions and weightings:

  1. Cash 55%
  2. International FX 21% (Chinese Yuan (CYB) = 15%, British Pound (FXB) = 6%)
  3. Commodities 9% (DJUBS Commodity Index (DJP) = 6%, Gold (GLD) = 3%)
  4. Bonds 6% (all TIP)
  5. US Equities 6% (Utilities (XLU) = 3%, US Pharma (IHE) = 3%)
  6. International Equities 3% (Brazil (EWZ) = 3%)

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Focus On Risk - risk


THE M3: GALAXY MACAU STILL ON SCHEDULE

The Macau Metro Monitor, August 25th 2010


GALAXY MACAU 'AFFECTED' BY LABOR SHORTAGE Macau Daily Times

 

Galaxy's vice chairman, Frances Lui, said the 1:1 imported labor rule and the illegal workers cases have "slightly affected" construction for Galaxy Macau, pushing the project behind schedule. However, he reiterated the Galaxy Macau's opening for "early next year."  Lui also said Macau GGR will rise 50% this year.


THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - August 25, 2010

As we look at today’s set up for the S&P 500, the range is 37 points or 1.13% (1,040) downside and 2.39% (1,077) upside.  Equity futures are trading modestly above fair value following Tuesday's sharp sell-off; the positive tone is being set by a steadier open in Europe.

Today's macro highlight will be July Durable Goods and July New Home Sales.

  • PERFORMANCE ONE DAY: Dow (1.31%), S&P (1.45%), Nasdaq (1.66%), Russell 2000 (1.17%)
  • PERFORMANCE MONTH-TO-DATE: Dow (4.07%), S&P (4.51%), Nasdaq (5.81%), Russell (8.50%)
  • PERFORMANCE QUARTER-TO-DATE: Dow +2.73%, S&P +2.05%, Nasdaq +0.69%, Russell (2.28)%
  • PERFORMANCE YEAR-TO-DATE: Dow (3.72%), S&P (5.67%), Nasdaq (5.12%), Russell (4.77%)
  • ADVANCE/DECLINE LINE: -1571 (-785) - continues erosion yesterday
  • VOLUME: NYSE - 1175 (+35%) - volume accelerated as stocks moved lower
  • SECTOR PERFORMANCE: XLU only sector positive and up the last three days; XLB breaks TREND
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: Southern Co +1.51%, Lennar +1.42% and Ameren +1.37%.  Medtronic -10.80%, Stryker -6.37% and Sandisk -6.04%

EQUITY SENTIMENT:

  • VIX - 27.46 +7.01%          
  • SPX PUT/CALL RATIO - 0.87 down from 1.78 (matching the 7/15 low)  

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD - 17.16 0.913 (5.621%)
  •  3-MONTH T-BILL YIELD .16% unchanged
  • YIELD CURVE - 2.00 from 2.11

COMMODITY/GROWTH EXPECTATION:

  • CRB: 262.46 -1.34% down 7 of the last 8 days
  • Oil: 71.63 -2.01%
  • COPPER: 326.20 -1.52% - biggest down day in a week
  • GOLD: 1,230 +0.34%

CURRENCIES:

  • EURO: 1.26728 +0.03%
  • DOLLAR: 83.146 +0.03%

 OVERSEAS MARKETS:

  • ASIA - Most markets closed lower. China closed down 2% following the move in the USA.  A pre-open report that the Bank of Japan is considering taking additional monetary easing steps before its scheduled policy meeting in early Sep provided a little support for Japanese markets but failed to counteract the effects of the strong yen. Yoshihiko Noda, Japan's finance minister, said he was considering “appropriate action” on what he described as “one-sided” moves in the yen
  • EUROPE - Most markets are flat to slightly higher; Ireland up 0.85% following S&P's downgrade of Ireland's sovereign rating to 'AA-' from 'AA'.  Germany's business confidence indicator has offered some support along with some solid corporate earnings. Construction sector outperforming, with oil & gas lagging.
  • LATIN AMERICA - Argentina and Mexico are down 3.1% and 2.4%, respectively.  Yesterday, in Mexico retail sales rose 1.5% in June from the same month a year earlier, the statistics agency said yesterday, below the median forecast in a Bloomberg survey for a 4.3% increase.
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


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

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