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Losers Assemble

“Losers assemble in small groups and complain about the coaches and other players. Winners assemble as a team and find ways to win. "

-Bob Stoops

 

Bob Stoops, or Big Game Bob, as he is known in the collegiate football arena is the head coach of the Oklahoma Sooners. As head coach of Oklahoma, he’s coached one of college football’s storied programs through one of the most successful decades ever, going 179-29 from ’99 – ’09 and winning a national championship in 2000. That same year, he was awarded the Paul "Bear" Bryant Award for Head Coach of the Year, in addition to the 2000 and 2003 Walter Camp Coach of the Year awards.

 

Unfortunately, for him, he’s earned the moniker for what he has not accomplished on the field, rather than his prowess on the gridiron. After having won the title in 2000, he took three more Oklahoma teams to the BCS National Championship game (2003, 2004 and 2009) – losing each time and “earning” his sarcastic nickname.

 

As any good football coach will tell you, however, you must have a Short Memory to excel in the sport. Whether it’s a quarterback who throws an interception or a cornerback that gets beat deep, you’ve got to be able to shake it off and refocus on the task at hand. I myself gave up a few sacks earlier in my collegiate career on the blind side, but I never once dwelled on any negative play, always focused on my next assignment. I was, however, careful not to have Too Short a Memory, as I was determined never to get beat by the same move twice.

 

When it comes to fiscal and monetary policy in Japan and the U.S., there have been plenty of mistakes made throughout the past few decades (i.e. near zero interest rates fueling asset bubbles; Piling Debt Upon Debt; Fiat Foolery in Financial Markets, etc.). Those mistakes have led to balance sheet recessions, depressed economic growth, and increased volatility in financial markets.

 

Unfortunately for the citizenry of Japan and the U.S., the Fiat Fools in charge have memories that are either too long (U.S.) or too short (Japan). Take Japan for example – after two decades of below trend GDP growth which largely stemmed from Piling Debt Upon Debt, the Professional Bureaucrats there are fighting with one another to see who can offer the biggest stimulus and government intervention package. Two decades of lessons not learned…

 

In response to Prime Minister Naoto Kan’s recently-unveiled 920 billion yen stimulus program, Ichiro Ozawa kicked off his campaign to become Japan’s new prime minister (sixth since 2006) by pledging to “stop the rise in the yen by all means”, which includes intervention in the currency market. In addition, he also one-upped Kan by promising a 2 TRILLION yen stimulus program to attract voter support from those that think the government isn’t doing enough to spur the economy. Unfortunately, for him, the citizenry of Japan supports the more fiscally responsible Kan by a factor of 4:1 – a clear vote against even bigger government.

 

Having a long enough memory reminds us that despite over 100 TRILLION yen in stimulus spending from 1, Japan was still mired in below trend GDP during the decade (an average of 1.5% Y/Y vs. an average of 4.6% Y/Y during the 1980’s). The Bank of Japan’s quantitative easing program (March 2001 through March 2006) which took excess reserves on Bank Balance Sheets from $53B to $386B (+628%) and accelerated purchases of long term government bonds failed to spur the kind of credit expansion that one would expect with a already flat yield curve that compressed a further 63bps from the start of QE until the trough on 6/12/03. What happened, however, was investment as a % of GDP fell ~200bps from 1Q01 to 1Q04 and the bond bubble burst in mid-2003, which sent the 10-year JGB yield up 119bps in less than three months.

 

Fast forward to today, we see that in typical loser fashion, both Kan and Ozawa have assembled in their respective subgroups to complain – Kan whining about Ozawa’s connection to a funding scandal; Ozawa whining about Kan’s inability to do what is “necessary” to support the Japanese economy. Needless to say, we believe Japan is too short on memory and political wherewithal to “find a way to win”, and, as a result, we are short both its currency and equity market in our Hedgeye Virtual Portfolio.

 

Shifting gears to our side of the Pacific, we see a similar setup in Washington, where the mid-term elections have set the stage for an almost unbearable amount of finger pointing and whining amongst Democrats and Republicans alike. Much of it has to do with the expansionary monetary and fiscal policy coming from the Fed and the White House, where Helicopter Ben and his Über Long Memory has the Fed running plays not seen since the Great Depression.

 

The amount of finger-pointing in the last two weeks alone would derail any solid team’s championship hopes. Below are a few of the more notable ones:

  • Obama (8/17): “We have a choice between the policies that got us into this mess and the policies that are getting us out of this mess.”
  • House Republican Leader John Boehner (8/24): "President Obama should ask for and accept the resignations of the remaining members of his economic team, starting with Secretary Geithner and Larry Summers, the head of the National Economic Council… Now, this is no substitute for a referendum on the president's job-killing agenda. That question will be put before the American people in due time. But we do not have the luxury of waiting months for the president to pick scapegoats for his failing 'stimulus' policies."
  • Obama (8/30): “Unfortunately the [jobs] bill has been languishing in the Senate for months – held up by a partisan minority that won’t even allow it to go to a vote. That makes no sense… and there’s no reason to block it other than pure partisan politics.”
  • Rep. Paul Ryan, R-Wis., ranking Republican on the House Budget Committee (8/30): “The Democrats' stimulus policies are failing miserably and the spending will buy the United States a lost decade similar to Japan's.” 

It’s obvious the leaders in Modern Day Rome are more focused on each other’s perceived failures to effectively implement a winning strategy. And, as to be expected, the scoreboard is running in the wrong direction for Team U.S.A. 2Q GDP was revised down 80bps to a modest 1.6%; unemployment is at 9.5% and looks to trend higher after yesterday’s ADP employment report miss and the trailing four week average of initial jobless claims rose to a YTD high of 504k; ABC Consumer Confidence fell wk/wk to (-45); and the Rasmussen Presidential Approval Index averaged (-16) for the entire month of August – one point off the all-time low on a monthly basis.

 

Despite what Jeremy Siegel and Barton Biggs tell you this morning, evidence of slowing growth is all around us. Considering, can we count on the Fiat Fools in Washington to come together as a team and lead us to a fourth quarter comeback for the ages?

 

I wouldn’t bet on it. Keep managing risk.

 

In the meantime, our CEO Keith McCullough and Managing Director Daryl Jones will be joined by former White House Deputy Chief of Staff Karl Rove to discuss the midterms elections on Tuesday, September 7th at 2:30pm. If you are a institutional subscriber or a prospective institutional subscriber and would like to join email us at

 

Darius Dale

Analyst

 

Losers Assemble - ddchart


RRGB – PREDICTABLY UNPREDICTABLE

I know I am not alone on my bearish stance on RRGB.  Nearly 30% of sell-side analysts rate the stock as a sell, which is the highest percentage of sell ratings among all of the casual dining names.  Short interest also remains high relative to its peers at 12%.  That being said, I would not view the nearly 20% pullback in RRGB’s stock price since reporting sequentially better 1Q10 same-store sales trends on May 20 or the company’s relatively low NTM EV/EBITDA multiple of 5.5x versus the casual dining group average of 6.1x as a reason to become incrementally more positive on the name.

 

RRGB – PREDICTABLY UNPREDICTABLE - cd sell side ratings

 

Same-store sales trends continue to be choppy and unpredictable.  After showing a sharp improvement in comp trends during the first quarter, same-store sales during the second quarter slowed 115 bps on a two-year average.  The company attributed its improvement during the first quarter to the success of its spring LTO, which was supported with four weeks of TV advertising.  It is important to remember that RRGB spent about $6.7 million on its TV campaign during 1Q10 and expects to spend about $15.6 million for the full-year versus $2.5 million during 2009.  The increased advertising has driven improved comp results in the weeks the company is on air with its promotion but has not led to sustained improvements in the weeks following the campaign. 

 

During the second quarter, same-store sales growth improved to +1.6% during the last four weeks of the quarter when supported by three weeks of TV advertising relative to the 2.6% decline during the first eight weeks of the quarter with no TV support.  This implies a 225 bp improvement in two-year average trends from the first eight weeks of the quarter to the last four weeks, but for the entire second quarter, two-year average trends still decelerated 115 bps.  During the first four weeks of 3Q10, same-store sales increased 1.4%, which management seemed bulled up about as it shows a marked improvement from the -1.2% number in 2Q10.  However, given that the company is lapping a 15.3% decline from the first four weeks of 3Q09, the +1.4% actually implies continued deceleration in two-year average trends to -7% from -6.4% during 2Q10.  And, the first four weeks of 3Q10 included one week of TV support for RRGB’s summer LTO.

 

Advertising is Addictive…I have been highlighting this problem for some time as RRGB continually changes its strategy around whether or not to spend behind advertising.  Although the company often experiences a lift in comp results as a result of its incremental spending, the company cannot increase its level of spending forever.  And, the returns do not always justify the spending.  In 2008, RRGB spent about $18 million on TV advertising, up from $11.5 million in 2007.  After a difficult 2008, the company decided to not invest so heavily behind TV support and only spent about $2.5 million in 2009.  Now, in 2010, they are upping the spending drastically to $15.6 million. 

 

When the company first introduced its 2010 media plans, it said “Based on the results of the spring LTO promotion, television advertising may be used to support the remainder of Red Robin’s LTO promotions in 2010, but no decision on subsequent campaigns has been made.”  The spring LTO did drive sequentially better trends during the first quarter, but the company has lowered its comp guidance two times since initially providing its FY10 guidance.  Current same-store sales guidance is -0.5% to +0.5%, down significantly from the company’s initial +2.4% to +3.4% range.  In addition to the need to lower full-year same-store sales guidance, management said that macroeconomic conditions during the second quarter diminished the impact of the company’s Q2 TV media support.  And yet, the company is going ahead with its planned spending to support the final fall LTO in the back half of the year.  Management will not walk away from this spending because it needs the LTO and TV support in order to even come close to achieving its new comp target.

 

What happened in 2Q10 relative 1Q10? 

 

Management stated that macroeconomic challenges worsened during the second quarter and negatively impacted consumer spending consumer confidence.  Specifically, management stated, “We believe these challenges diminished the impact of our Q2 TV media support, compared to the impact of the TV in Q1, specifically the widely-publicized downturn in consumer confidence in June and July, as well as the underemployment and unemployment levels, have continued to create headwinds to strengthening guest count and sales trends.”  This is a valid point, but this will continue to be a headwind over the next couple of quarters. 

 

The company’s spring LTO, which ran during the first quarter, featured a $5.99 price point whereas the 2Q10/early 3Q10 summer LTO promoted a $6.99 price point.  Although this higher price point is more beneficial to average check and margin, it does not drive the same level of traffic.  The company reported that the summer promotion represented about 7% of total mix versus 10% mix for the $5.99 LTO in 1Q10.  The company is sticking with the $6.99 price point for its fall LTO, which will begin in September and will be supported by two weeks of TV advertising during 3Q10 and two weeks in 4Q10.

 

Highlighting the significant volatility in results in the post-media period early in the second quarter, management commented that it saw large spikes both up and down during the second quarter, as much as 15% swings either way from week to week.  Such volatility hurt margins in 2Q10 as the company was unable to adjust it labor levels accordingly as such swings were unpredictable.  This will likely continue to be a problem in the back half of the year as the company goes on and off air with its support around the fall LTO.

 

Given the slow start to the third quarter on a two-year average basis, which included one week of TV advertising, and the growing pressure on consumers, I am modeling +1.5% same-store sales growth during 3Q10, which implies a slight deceleration in two-year average trends from the second quarter.  On a full-year basis, I am modeling a 0.9% decline in comps, which falls short of management’s -0.5% to +0.5% guidance.  For reference, a 50 bp decrease in same-store sales growth equates to a $0.11 decrease in EPS.   My full-year EPS estimate is currently $0.75, below the street’s $0.85 estimate. 

 

Restaurant-level margin will come under increased pressure during the second half of the year as a result of continued pressure from lower check averages as a result of the summer and fall LTOs and due to higher ground beef and dairy prices.  Year-over-year restaurant-level margin compares get easier, however, in the back half of the year and although I would expect another quarter of declines during the third quarter, YOY restaurant-level margin will likely turn positive during 4Q10 for the first time in eight quarters. 

 

Increased visibility…

 

Although RRGB could potentially move out of Hedgeye’s Deep Hole during 3Q10 (after being there for seven consecutive quarters), I don’t think this name will really work until it pursues a strategy that drives more predictable top-line trends.  I am expecting the casual dining names in general to have a tough back half of the year from a demand perspective, but RRGB’s volatility in results exacerbates investor anxiety.  The company announced that Stephen E. Carley will be RRGB’s new CEO, effective September 13.  In the near-term, this transition could amplify the company’s lack of consistency.  New direction, with time, however, could lead to increased visibility and consistency, but we will have to wait to see.

 

RRGB – PREDICTABLY UNPREDICTABLE - rrgb sigma

 

Howard Penney

Managing Director


Europe’s August Woes and Germany’s Austerity Bill

Conclusion: European Manufacturing PMI and German retail sales show a negative inflection, in line with our call for European data in August to roll. We expect a decline in consumer consumption across Europe post the exuberance of the World Cup and in response to the enactment of austerity measures that should induce individual belt-tightening and hamper confidence. Also, we continue to favorably view Germany’s fiscal austerity; however we recognize its negative impact on select industries and overall growth.

 

European PMI – Manufacturing

Of the 16 countries reporting PMI this morning:

  • 9 countries fell month-over month: UK, Spain, Italy, Switzerland, Norway, Sweden, Ireland, Hungary, and Turkey
  • Germany was flat at 58.2 and the Eurozone average improved only 10bps month-over-month to 55.1
  • 5 countries rose month-over-month: Russia, Poland, Czech Republic, France, and Denmark

 German Retail Sales

  • fell -0.3% in July M/M, versus a decline of -0.3% in June M/M
  • Year-over-year, sales were up +0.8%

German Austerity

Today, Chancellor Angela Merkel and her cabinet approved budget cuts and revenue-raising measures worth 80 Billion Euros ($102 Bill.) through 2014, following an initial outline in June. The draft legislation will now go to the lower house of parliament for consideration. (Upper-house approval isn’t needed).

 

A decision on the controversial issue of the “nuclear tax” or the tax on nuclear-fuel rods was postponed to later this month. The tax remains a contentious issue opposed by utility companies that run the country’s 17 nuclear power plants, but a possible bargaining chip to extend the running life of nuclear power in Germany.  Germany’s largest operators include:  E.ON AG, RWE AG, EnBW Energie Baden Württemberg AG, and Vattenfall Europe AG.

 

Expectations of the levy have sent utility stocks plummeting, including for DAX-listed E.ON AG and RWE AG, down -24.3% and -24.8%, respectively, year-to-date. 

 

Germany’s austerity measures include:

-Financial tax on banks of about 2 Bill. EUR per year beginning in 2012

-Air passenger tax

-Welfare cuts

-Reductions in defense spending

-Delay in the rebuilding of Berlin’s royal palace

 

Matthew Hedrick

Analyst

 

Europe’s August Woes and Germany’s Austerity Bill - rolling over


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Sports Apparel Data: Pre Sales Day Scoop

Sports Apparel Data: Pre Sales Day Scoop

 

While we don’t read too deep into a single week’s sales as reported by POS data vendors, there’s a couple of items worth calling out for you to bake into your process for handling the sales-day onslaught tomorrow.

 

  • The punchline is that the back half of the month stabilized after a steep drop at the start of August.  
  • On the whole, the month does not appear to be meaningfully worse (or better) than July. But keep in mind that this sample is drawn from the sporting goods category – which consistently outpaced retail overall for the whole year.
  • Channel trends are consistent with what we’ve seen in the past, with the sporting goods channel proper leading the numbers. But as it relates to a read-through for the rest of retail, it’s worth noting that the discount and mass channels are getting ‘less horrible’ on the margin. That’s probably a decent sign for inventory.
  • There is fair consistency amongst regions, with the Middle Atlantic as the biggest negative callout. The Pacific region had a tough finish to the month, but that’s a wash as it also avoided the severe dropoff the rest of the country saw in week 2.

Sports Apparel Data: Pre Sales Day Scoop - 1

 

Sports Apparel Data: Pre Sales Day Scoop - 2

 

Sports Apparel Data: Pre Sales Day Scoop - 3

 

Sports Apparel Data: Pre Sales Day Scoop - 4

 

Sports Apparel Data: Pre Sales Day Scoop - 5

 

 


SLOWER GROWTH IN MACAU

August was up a disappointing (at least for us) 40% in Macau.  With slowing growth, market share may again be a more important metric. Not good for Wynn.

 

 

Frankly, I’m disappointed in Macau’s August performance, not because +40% in and of itself is disappointing, but that mid-month trends indicated a bigger growth rate.  We should be getting our proprietary detail by property shortly so we do not yet know whether the second half slowdown was related to hold, volume, or both.  We are pretty sure that Wynn’s market share will be low with both hold and volume to blame.

 

The following chart shows monthly YoY change in total Macau gaming revenues.  We’ve also included a line that shows the monthly VIP hold percent since hold variances can drive big moves in revenues.

 

SLOWER GROWTH IN MACAU - ggr1

 

So what should we expect going forward?  On the chart, we’ve put in our estimates for the remaining months of the year and it is clear that we expect growth to slow.  Growth will still be solid though.  However, we may have to revise our estimates if the 2nd half of August slowdown was volume related.  That would be disconcerting.  As it stands now, we are projecting recent revenue levels will continue, adjusted for seasonality. 

 

Some may be surprised by our projection of 35% September growth since the month faces a +54% comparison last year.  However, September 2008 revenues were ridiculously low at HK$6.9 billion with a low hold percentage.  November should be the slowest growing month until we reach 2011, which will present its own challenges.


EARLY LOOK: Follow the Trail

This note was originally published at 8am this morning, September 1, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

 

 

________________________________________________________________________

“Do not go where the path may lead, go instead where there is not a path and leave a trail.”
-Ralph Waldo Emerson


A college hockey coach sent me a nice recruiting letter about fifteen years ago with the quote above handwritten on it.  Although I ended up not going to the college he coached at, he did catch my attention with the quote.  At the time, as a rangy defenseman from a small town in Alberta, I’m pretty sure I didn’t know who Emerson was and I had certainly never seen the quote before.  As a result, I was quite moved by the concept and idea embedded within the quote.
 
Emerson was known as a passionate individualist and a “prescient critic of the countervailing pressures of society”.  He spread his gospel via dozens of essays and many hundreds of public lectures across the United States.  According to Wikipedia, Ralph Waldo Emerson was an American philosopher, lecturer, essayist, and poet.  Were he alive today, I think he may have been a Hedgeye.
 
In the short history of our firm, we’ve been accused of many things.  On the political front, we’ve been accused of being both Republican and Democrat.   On the market front, we’ve been accused of being bullish and bearish, and sometimes both at the same time.  We’ve also been accused of being grumpy (well, mostly Keith before his coffee) and overly negative.  The bottom line is that we have opinions, which are sometimes offensive to people, but those opinions aren’t to make ourselves feel better.  They are based on data and analysis with the objective of producing high quality and accurate research.  We express that research with our opinions, and when the facts change, so too do our opinions.

Currently as we survey the global macro landscape, we see a number of markets making trails that both concern us and really inform our broader perspective.  This morning I want to highlight three of those: the yield curve, the Swiss Franc, and copper.

1. The Yield Curve - Yesterday in our morning call, our Financials Sector Head Josh Steiner noted that the yield curve was narrowing to a point where banks were going to potentially see an impact on their earnings.  Remember, banks borrow short and lend long, so as the yield curve narrows, so inherently do their margins. So it’s no surprise given this move in the yield curve that the financial sector ETF has been the worst performer of all the sector ETFs in the last three months (down 7.9%) and broken from both a Trend and Trade perspective.   

From a global macro perspective though, the yield curve narrowing is typically a leading indicator for slowing economic growth.  When we analyze the yield curve, we focus on two durations specifically - 10s and 2s. In the parlance of the nonfinancial world, that is 10-year treasuries and 2-year treasuries, or as we like to call it, The Piggy Banker Spread.  We've highlighted this point in the chart below, but the Piggy Banker Spread has narrowed dramatically through the course of the year from ~290 basis points at its peak to ~210 basis points now.  This narrowing provides further support for our view that global growth is going to slow as it is a real time indicator for which direction long term rates are going, and the answer seems to be lower.

As a side note, we read with interest quotes from Thirdpoint’s Dan Loeb's recent letter to his investors (Dan, if you get a minute, please email us a copy).  Dan's letter, from what we could tell, went off on the system being rigged and on government intervention generally.  Admittedly, this is a point we have been very vocal on and it does worry us as we analyze and try to infer research information from markets that are managed by the U.S. government because, to be frank, we don't trust the Fiat Fools in Washington.

Nonetheless, the yield curve is a trail that is leading us to slow growth. For now, we'll accept that for what it is.

2. Swiss Franc - We highlighted this point in a note to our subscribers yesterday and want to re-emphasize it today.  The Swiss Franc has had a massive move against the Euro in the last three weeks.  In fact, the Swiss Franc is up over 7% in the time period (that's a big move in currency land) and is now back at levels not seen since the May time frame when everyone and their mother was worried about sovereign debt issues.  Well, sovereign debt issues don't go away over night, or because of ECB interventions.

The rapid move in the Swiss Franc, in conjunction with widening of credit default swaps in Europe over the past few weeks, is signaling that we may be hearing and seeing more sovereign debt issues in Europe in the coming months.  The explicit buying of the Swiss Franc and selling of the Euro is a direct vote against the Euro, and an attempt by those institutions with large currency exposure in Europe to hedge or protect the relative value of those European assets.

3. Copper
- Dr. Copper over the past three months is up 9.9%, while its global commodity brother, Oil, is only up 1% on the same duration.  This isn't surprising since copper inventories globally, most specifically measured by the London Metals Exchange, are at nine month lows.  Moreover, based on normalized demand patterns and underinvestment over the past couple of years, we expect a global copper deficit next year for the first time in four years. Most importantly, this price divergence is a trail that is leading us to China. For the first time this year we are long China in the Hedgeye Virtual Portfolio via the etf, CAF.

Copper is verifying its trail this morning as it is up another 2.1%.  That is not necessarily a surprise given the Purchasing Managers Index report from China, which is an indicator of industrial activity.  This report saw a small increase sequentially going from 51.5 to 51.7.  While this is by no means massive, it does indicate stabilization.  In a country with 1.3 billion people growing at north of 10%, stabilization is perhaps all we need to be comfortable from a growth perspective.

Taken together these paths are leaving trails that we need to contemplate before our own portfolio trails.

 

 

EARLY LOOK: Follow the Trail - chart1

 

 

I'm not sure if Ralph Waldo Emerson ever traded a P&L, but I'm guessing if he did he’d have an investment notebook, and his quote inscribed on the inside:

"A hero is no braver than an ordinary man, but he is brave five minutes longer."

Sometime that's all we need in this interconnected global market place, five minutes.


Yours in risk management,

Daryl G. Jones


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 80.64%
  • SHORT SIGNALS 78.61%
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