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

As we look at today’s set up for the S&P 500, the range is 19 points or -0.64% downside to 1127 and 1.03% upside to 1146. Equity futures are trading lower tracking a sell off among European indices. Concerns resurface over the state of the European economies. Banking stocks lead the sell off as Bank of America Merrill Lynch lowers its estimates for US investment banks. Also caution prevails ahead of the jobless claims. Other macro highlights include August Existing Home Sales.

  • Bed Bath & Beyond (BBBY) raised FY 2011 EPS growth forecast to 20% from 15%
  • BioMed Realty Trust (BMR) is offering 13.5m shares to fund acquisitions and repay debt
  • DineEquity (DIN) reported domestic comp sales up 2.7% 3Q through Sept. 19
  • Edwards Lifesciences (EW): Sapien valve prevented more deaths than standard treatment, according to study
  • Red Hat (RHT) reported 2Q rev. $219.8m vs estimate $211.5m
  • Steelcase (SCS) forecast 3Q rev. $625m-$650m vs estimate $627.7m
  • Tessco Technologies (TESS): Discovery Group offered to buy remaining shares outstanding at 31% premium to September 21st close
  • Vertex Pharmaceuticals (VRTX) plans to sell $375m senior convertible notes


  • One day performance: Dow (0.20%), S&P (0.48%), Nasdaq (0.63%), Russell 2000 (1.20%)
  • Month-to-date: Dow +7.24%, S&P +8.10%, Nasdaq +10.43%, Russell +9.08%
  • Quarter-to-date: Dow +9.88%, S&P +10.05%, Nasdaq +10.68%, Russell +7.75%
  • Year-to-date: Dow +2.98%, S&P +1.72%, Nasdaq +2.88%, Russell +5.03%


  • ADVANCE/DECLINE LINE: -764 (+75)
  • VOLUME: NYSE - 954.65 (-8.91%)  
  • SECTOR PERFORMANCE: 4 sectors up and 5 down.  While another meaningful pullback in the dollar offered some semblance of support for the XLB, it failed to underpin the broader risk trade amid heightened concerns about the potential global economic backlash surrounding a competitive currency devaluation push.
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: Carmax +8.46%, Sears +5.31% and Alcoa +4.74%/Adobe -19.23%, New York Times -6.52% and Gannett -6.15%
  • VIX: - 22.51 +0.72%  YTD PERFORMANCE: (+3.83%)          
  • SPX PUT/CALL RATIO:- 2.14 from 2.01 +6.33%


  • TED SPREAD: 14.03 0.304 (2.218%)
  •  3-MONTH T-BILL YIELD: 0.16% -0.01%
  • YIELD CURVE: 2.12 from 2.18


  • CRB: 278.89 +0.19%
  • Oil: 74.71 -0.35% - oil continues to flash bearish intermediate term TREND in our model w/ TREND line resist = $76.29; bodes bearish for US economic growth.
  • COPPER: 356.50 +2.41%  
  • GOLD: 1,289 +1.23%


  • EURO: 1.3366 +1.81%
  • DOLLAR: 79.83 -0.76% - US Dollar getting annihilated; breaking to lower-lows like it did in April and August when Dollar Down = bad (as opposed to reflation)



  • UK may be close to introducing additional quantitative easing measures.
  • Disappointing PMIs from across the Eurozone exacerbated the declines.
  • Financial, mining and construction sectors bore the brunt of the limited selling pressure although turnover remains light
  • The Irish Examiner reports, Finance Minister Brian Lenihan, has given the strongest indication yet that the riskiest lenders to Anglo Irish Bank will soon be told they will not get all their money back.
  • Astrazeneca announced positive phase II results for Fostamatinib (Rheumatoid arthritis), sees phase III beginning soon
  • French Economy Minister said that a capital surcharge was not a "panacea" for addressing the risk of systemically important banks, and she favored resolution mechanisms and tighter regulation.
  • Eurozone Sep Advanced Services PMI 53.6 vs cons 55.5, Manufacturing PMI 53.60 vs cons 54.50
  • Germany Sep Preliminary Services PMI 54.6 vs cons 57.0, Manufacturing PMI 55.3 vs cons 57.6
  • France Sep Preliminary Manufacturing PMI 55.4 vs cons 55; Services PMI 58.8 vs cons 60.0



  • In quiet trading with the major bourses across the region closed, Asian markets did not move much today.
  • Australia finished barely higher as the effect of stronger miners marginally outweighed the effect of weaker banks.
  • Taiwan finished flat.
  • South Korea was closed for Chusok.
  • China is closed through 24-Sep for Mid-Autumn Festival.
  • Hong Kong was closed for the day after the Mid-Autumn Festival and will re-open tomorrow.
  • Japan was closed for the Autumnal Equinox.
  • The yen is trading at 84.46 to the US dollar. 
Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends













Nike: Got An Umbrella?

If you’re one of the half dozen people who can look through any form of near-term volatility – then congratulations. You can stop reading this now. If you’re part of the other 99% who has to at least carry an umbrella when there’s rain in the forecast, then read on.



My phone always rings off the hook in advance of Nike’s print. One thing that’s different this time around is that I’m worried about the event. Don’t get me wrong -- I think fundamentals look great. I’m at $1.08 vs. the Street at $1.01. Futures look fine. The business is in check, and I remain convinced that estimates for the next 2-years are 10-15% too low.


If you’re one of the half dozen people working at a shop that completely looks through any form of near-term volatility – then congratulations. You can stop reading this now. If you’re part of the other 99% of the population who has to at least carry an umbrella when there’s rain in the forecast, then consider these factors.

From a near-term perspective...

  • We all know that this is a company that HAS TO beat numbers. This is Nike, after all -- exceeding expectations is what they do (and how they’re compensated). We’ve had some analysts come up to our EPS level, and salespeople at one major buldge-bracket Firm going out with a message that this will be a ‘blowout – i.e. between $1.14ish ps’ quarter.
  • Then there was a very bullish preview by another major Firm who laid out the case as to why this is such a great three-year call. Some of the verbiage around the drivers and cadence of growth at Nike was conspicuously spot-on (to the extent that one client called me at 7am that morning laughing) with what we came out with in February when Keith first added Nike to the Hedgeye Virtual portfolio. Dare I say that the call from 9-months ago has become the consensus?
  • Sell-side sentiment is extremely bullish, with only 3 months over the past 5-years where the Street was more positive. (See chart below).
  • Short interest is near all time lows of 2.5% of float. The one saving grace is that management stock sales have been minimal since spring. That’s a good sign; actually, as this management team is not afraid to sell stock when the time is right (restricted stock and options play a major role in executive compensation).
  • FX is not a disaster – but based on our proprietary index of Nike’s sales by country vs. blended forex rates, NKE is about to print a quarter that includes the most unfavorable second derivative in FX since summer of 2008. Assuming current rates prevail, we’ve got another quarter of slight erosion, then a slight pickup in 3Q.


Nike: Got An Umbrella? - NKE Fx 9 21 10


  • As it relates to guidance, keep in mind that Nike is far less impacted by industry margin pressure than the average company in retail given a) disproportionately low cotton exposure, b) better supply situation in Asia associated with footwear, c) better R&D cycle helping demand for footwear in the US, and most importantly d) simply having a superior brand with pricing power that just stripped the ball from the QB and is once again on offense. But mark my words, the simple fact that these outside pressures exist will be all management needs to point to in order to get expectations to be beatable in 2Q.  
  • Lastly, keep in mind that today we’re looking at a sales + GM improvement story. But as the year progresses and GM improvement eases on the margin, Nike starts to get SG&A leverage as it anniversaries the World Cup. Then it also starts to benefit from better non-operating income due to the mark-to-market of its FX hedges. My sense is that there less room for error from a valuation perspective when it’s a sales + SG&A +other income story as opposed to sheer sales and GM improvement.


Synching With the Long Term Call

Perhaps I’m being a bit too anal (can I use that word in a note? Wikipedia says Yes) around unusually positive near term sentiment factors. The reality is that this story dwarfs most others in Global Consumer as it relates to the company’s ability to grow profitably and consistently.


Yes, the sentiment is bullish, but I still think that many longer-term investors underestimate the real 3-year call here.

I think that people ‘sort-of ‘get whole concept of how Nike is changing its ‘go to market’ strategy, and how it impacts the business at wholesale, retail, and dot.com. Same goes for global impact on top line.


Do people get the upside in GM% as Nike executes? I don’t think so.


The kicker is this… The average ‘long and strong’ PM I talk to that is scared about the consumer and looking for something to own out there still gets a bit of a ‘wide eye’ factor when we collectively lay out the long term call.  “This is the leader of a global duopoly in a GDP plus industry that is about to see considerable strengthening in its structural low cost advantage. Why? Nike has outsized sales exposure to China, while having disproportionately low cost exposure. Case in point… Of Nike’s $10bn in COGS, only about $2.6bn are Yuan-denominated. Yet the company has close to $2bn in sales in China. That gap is narrowing, and should be closed within 2-years. That would make Nike one of the only Global companies that would have a structural sales and margin benefit as the Yuan floats higher.” When you can point to an improving R&D cycle, consensus numbers that are too low by 10-15% in each of the next 2-years, and $5bn in net cash on the books, this name is a pretty darn safe place to be.


The punchline? If you have an umbrella, definitely keep it handy over the next 24 hrs. Sentiment is so bullish – but for some of the wrong reasons. You might have an opportunity to buy more of an underappreciated story at a lower price.


Nike: Got An Umbrella? - nke

BBBY: Reality Isn't So Bad

Solid quarter for BBBY across the board.  Beat our $0.67 estimate driven almost entirely by leverage on better than forecast sales.  Comps came in at 7.4%, street was looking for just below 6%.

  • GM’s improved 56bps.  First quarter that results prove they can expand gross margins on top of last year’s gains.  Important event our view given that this provides less reason to be concerned about tougher near-term compares.  On a two year basis, GM’s were up 107bps, but still below 2006 peak 2Q levels of 42.2%.  To get back to peak, there is still room to expand GM’s by 130 bps.
  • SG&A leveraged better than expected on better topline results.  Absolute dollars came in line with our projections, up 4.8%.  Same dollar increase % as reported in Q1.  On a rate basis, SG&A improved by 174 bps as a % to sales.
  • Inventories up 8.5%, sales up 11.6%.  Sales/inventory spread continues to erode, although still positive on an absolute basis.  See SIGMA below for the trend.
  • Biggest surprise to us was the same store sales results and the share buyback activity. BBBY purchased $193 million or 4.9 million shares in the quarter, the biggest commitment to the buyback we’ve seen in a long, long time.  The balance sheet remains in solid shape, ending the quarter with $1.6 billion in cash/securities. There is more room to go here.
  • Guidance for 3Q of $0.61-$0.65, Street at $0.64 within the guided range.  Management took up full year to 20% EPS growth, which equates to $2.75.  Street currently at $2.71.  We still see results coming in closer to $2.80 for the year.

All in a solid quarter.  Incremental positives include gross margin gains on top of gross margin gains, stepped up share repurchase, and less than expected conservatism from management on the outlook.  Incremental negative is the erosion of the sales/inventory spread.  Yes, the latter point is nitpicky.  This was a solid result all around and it is consistent with the results we’ve seen over the past four quarters.  We continue to believe the de-layering of the multi-year period in which BBBY engaged in aggressive promotional activity and couponing remains key to driving EBIT margin expansion over the next year.  The quarter only adds confidence to this view.


BBBY: Reality Isn't So Bad - bbby2q


Eric Levine



Full-year same-store sales and commodity guidance seem to be at risk.


DRI reported a relatively strong fiscal first quarter with blended same-store sales up 1.1% and EBIT margin improving nearly 130 bps YOY.  One area of continued concern, however, stems from performance at Red Lobster, which lagged the industry benchmark as measured by Malcolm Knapp by 170 bps during the quarter on a reported basis and by 70 bps when you adjust for the timing mismatch around the concept’s Endless Shrimp promotion.  During the prior quarter, Red Lobster lagged the industry by only 30 bps.


The company attributed its weaker-than-expected results at Red Lobster to ineffective promotional tactics in the quarter.  Specifically, management referred to its June promotion, which it said did not offer a compelling enough dish and its July promotion, which featured too high of a price point at $14.99.  Helping to offset the weakness at Red Lobster were same-store sales trends that continued to get better at LongHorn and improved trends at the Olive Garden after reporting a sales shortfall during fiscal 4Q10. 


The two biggest risks to Darden’s numbers this year stem from the company’s ability to achieve its full-year blended same-store sales growth guidance of +2-3% and rising commodity costs.  There were a lot of questions on the call about the company’s ability to meet its comparable sales targets for the year after coming in below the full-year guided range during the first quarter when the company was lapping its easiest comparison from the prior year.  This was a concern I had going into the quarter; full-year comp guidance seems aggressive as it implies a sharp improvement in two-year average trends.  And, given the fact that Red Lobster’s top-line trends decelerated even further during the quarter on a two-year average basis, even when you adjust for the promotional timing issue, this full-year guidance seems even less obtainable.


Management justified its comp guidance and the implied sequential improvement by saying that the industry is recovering faster than it had expected.  Excluding Darden, the industry, as measured by Malcolm Knapp, reported flat same-store sales during DRI’s fiscal first quarter, up from -1.4% in the prior quarter.  On a two-year average basis, this implies a 20 bp improvement making fiscal 1Q11 the fourth consecutive quarter of sequentially better industry trends on a one-year and two-year basis.  This sequential improvement in industry comps during the quarter is, in fact, better than I would have expected but I don’t think it guarantees that trends will continue to get better from here. 


Management highlighted recent GDP growth, as opposed to decline, and its correlation to consumer spending as one reason why industry trends should continue to improve.  I would argue, however, that although GDP growth may be positive this year versus negative last year, the rate of growth is decelerating and the Hedgeye expectation is for it to soften further in 2H10, which on the margin will be bad for the economic recovery and will limit the improvement in industry trends.  Even if industry comp trends do improve to -1%, as management guided to, DRI’s 2-3% blended same-store sales guidance assumes 300 to 400 bps of outperformance during the year after reporting only 110 bps of outperformance during fiscal 1Q11.  Red Lobster’s softening trends will make it that much harder to achieve such a wide gap to Knapp.  Management did say that with industry trends improving faster than expected, driven primarily by higher average check growth, that it expects Darden’s full-year gap to Knapp to come in slightly narrower than it initially expected.  That being said, its guidance still assumes sequentially better industry trends and continued outperformance.


During fiscal 1Q11, operating margin improved nearly 130 bps YOY.  The company achieved better leverage during the quarter on the food and beverage, labor and restaurant expense lines that I had anticipated.  Management said that positive comp growth, of course, helped in that regard along with the company’s cost saving initiatives related to automating its supply chain, centralizing facilities management and driving sustainability to reduce water and energy usage. 


Lower food and beverage costs as a percentage of sales drove the most upside relative to my numbers, which management attributed largely to lower commodity costs.  Management expects to benefit from a similar level of food cost favorability during 2Q, but then expects food costs to be up about 0.5% in the back half of the year.  There is little risk to the company’s 2Q food cost outlook as Darden is locked in on about 90% of its needs through the end of calendar 2010.  Right now, the company is only contracted for about 40% of its commodity needs for fiscal 2H11.  Although management believes that current levels of some commodities it uses are unsustainable and is therefore, not yet locked in, this commodity exposure poses a risk to Darden’s 2H11 numbers.









Howard Penney

Managing Director



Comping The Comp - Athletic Trends Robust

As a follow up to last week’s athletic trend update, sales accelerated again this week a trailing 3-week basis in athletic footwear and apparel as well as at retail according to ICSC weekly retail sales. Perhaps most noteworthy is the growth in athletic footwear up +8.3% on a trailing 3-week basis despite facing materially more difficult compares (+3.7%). Importantly, this growth came on higher ASPs suggesting new product flow is starting to gain traction. Recall that next week marks the last tough comp (+4.8%) before footwear has the wind at its back with considerably more favorable compares over the next 2-months until holiday sales in December. In addition, all three channels were strong with discount/mass going positive for the first time in nearly a year. As a result, we expect the athletic space and athletic footwear in particular to outpace overall retail and continue to be a preferred subsector within retail.


Comping The Comp - Athletic Trends Robust  - FW App Industry Data 1yr 9 22 10


Comping The Comp - Athletic Trends Robust  - FW App Industry Data 2yr 9 22 10


Comping The Comp - Athletic Trends Robust  - FW App Industry Data Brand 1 9 22 10


Comping The Comp - Athletic Trends Robust  - Fw App Ind AppChan 9 22 10


Comping The Comp - Athletic Trends Robust  - FW App Industry Data Channel 9 22 10


Casey Flavin



Retail: Scary Chart Of The Day


Out of Howard Penny's wheelhouse this morning: 99 weeks of unemployment benefits running out and no jobs.  This is the scenario facing many Americans heading into year-end.


Whatever your view on the role of government in today’s economy, it is undeniable fact that government intervention is having a dramatic impact on current conditions as well long term prospects.  With the creation of the Emergency Unemployment Compensation program in 2008, the government provided income for thousands, then millions, of Americans who would have otherwise been left with no source of income.  The result has been a propping up of consumer spending and the chart below shows that story.  The beneficiary, struggling to make ends meet, will spend a large portion of the check he/she receives.  That has helped stimulate consumer spending as more and more people joined the program.


These benefits expiring (in the absence of legislative action), will provide a year-over-year headwind for consumer spending.  As of the most recent data points, there are ~500,000 people receiving benefits under the Tier 4 category of the Emergency Unemployment Compensation program. 


Retail: Scary Chart Of The Day - Howard Atlas Penny


Howard Penney

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