TheChek News Flow

Weekly Market Update: Solid Economic Gains Promise Imminent Taper

- After data released this week, it is more than likely the Fed will taper QE spending at the Dec 17-18 or the Jan 28-29 meetings. The highlights of the week were the second reading of US Q3 GDP and the November jobs report. The GDP numbers were good and the jobs figures were very good, and taken with the already unambiguously positive housing data, it's hard not to see that the US economy is seeing substantial improvement. After Friday's jobs report, PIMCO's Bill Gross said that he believes there is a 50% chance of a December taper at this point, while Goldman Sachs Chief Economist Hatzius opined that the numbers were not a blockbuster and that the Fed would not taper in December. Retail names suffered all week thanks to a few bad quarterly reports and a rather tepid view of Thanksgiving holiday sales. ShopperTrack saw sales on Thanksgiving and Black Friday up just 2.3% y/y, while the National Retail Federation saw weekend spending falling to $57.4B from $59.1B y/y. Stock indices spent much of the week well into the red with tapper talk and profit booking identified as the likely catalysts, but Fridays jobs report opened to door for rally that recouped much of what had been lost. For the week, the DJIA declined 0.4%, while the S&P500 and NASDAQ were essentially unchanged.

- The second reading of US Q3 GDP looked very good on first glance, coming in at +3.6% versus the +2.8% advance reading seen back in early November, but there were real caveats to the strong reading. The gains were driven by upward revisions to inventories, which increased by one third over the initial estimate. Meanwhile, the key residential fixed investment and export components were both lower than the advance readings. These key distinctions take some of the shine off the headline figure.

- The November jobs report was unambiguously positive, with the 203K gain in NFPs well above the 180K expected. The unemployment rate fell to 7.0% from 7.3% in October and the labor force participation rate rose slightly to 63% from 62.8%. The WSJ's Hilsenrath pointed out that markets are much more well-disposed to a taper now than they were in September. The Fed's low rate pledge has sunken in, and fed fund futures suggest markets do not expect a rate hike until Q4 of 2015, whereas in September rate increases were expected by the end of 2014. Nevertheless the US benchmark 10-year yield backed up 14 basis points on the week towards 2.88% with many predicting another run at 3% likely.

- China's official PMI matched an 18-month high, topping expectations of a slight decline from last month's strong figures, with output, inventories, and employment components all hitting multi-month high levels. The HSBC final PMI was also better than expected, and the HSBC chief economist said new business gains were accelerating.

- Oil futures climbed to one-month highs in a big breakout early this week. WTI crude had fallen into the $92 handle late last week, while on Monday and Tuesday the front-month contract rose back to $97. Traders said strength came from news that TransCanada would initiate service on the new Cushing-to-Port Arthur pipeline in early January, helping to drain the surplus of US light sweet crude. There was a big 12M bbl drawdown seen in the weekly API crude inventories, which some suggested went to help fill the line. Additionally, OPEC oil ministers agreed in Vienna to sustain output at 30M bpd regardless of the fact both Iran and Libya are expect to ramp production in the near term.

- November auto sales reports from the big three US automakers all topped expectations. GM sales were up 19% y/y, Chrysler sales rose 16% y/y and Ford's were up only 7% y/y. A Ford sales executive November retail sales were the company's best going back to 2004. Toyota's sales momentum continues to be pretty tepid, up in the low single digits, while Nissan saw a respectable 10.7% y/y gain.

- The remaining firms that report monthly same-store sales disclosed tepid comps for the month of November. Note that the reports are for the four weeks ended Nov. 30th of this year, which compare to the four weeks ended Dec. 1st, 2012, so this year's comps did not include Thanksgiving Sunday or Cyber Monday, unlike the 2012 reports. JC Penny trumpeted what it called a strong Thanksgiving weekend comp gain of +10.1% y/y, but investors were looking for much better results coming off such an easy comp. Krispy Kreme, Big Lots and Abercrombie & Fitch all reported weak Q3 results, including terrible guidance statements and warnings that not much would improve in the retail environment in 2014.

- Once again, there were no unexpected developments seen in the BOE and ECB rate decisions. Both institutions left key rates unchanged, and the ECB press conference was low key. Note however that the ECB staff revisions were a point of interest: inflation forecasts were revised lower for both 2013 and 2014, but the revisions were much smaller than some expected and analysts saw little prospect of deflation in the new forecasts. EUR/USD saw four-week highs around 1.3700 by week's end.

- The Japanese government approved a $182B package of stimulus spending to supplement its huge 'Three Arrows' campaign launched back in April. Initial reports of a smaller package helped knock USD/JPY down from the six-months highs seen on Monday, strengthening the yen. In addition, it emerged that the bulk of the package includes loans from government-backed lenders and spending by local governments that was already scheduled. USD/JPY dropped to around 101.65 on Thrusday, before fresh yen weakness in the face of the better US jobs report helped push USD/JPY to just shy of 103.

Gilead Sciences Inc FDA Approves Gilead’s Sovaldi™ (Sofosbuvir) for the Treatment of Chronic Hepatitis C - FDA has approved Sovaldi(sofosbuvir) 400 mg tablets, a once-daily oral nucleotide analog polymerase inhibitor for the treatment of chronic hepatitis C (CHC) infection as a component of a combination antiviral treatment regimen. Sovaldis efficacy has been established in subjects with hepatitis C virus (HCV) genotypes 1, 2, 3 or 4 infection, including those with hepatocellular carcinoma meeting Milan criteria (awaiting liver transplantation) and those with HCV/HIV-1 co-infection.

Closing Summary - Stock Market Rallies Around Jobs Data A solid November employment report translated into a solid day of gains for the major averages. While there was some talk that the encouraging job growth raised the odds of the Fed announcing a tapering at its December meeting, the message of the markets today was either that it didn't believe there would be a tapering this month or that it doesn't fear a tapering this month.

It was just one day, yet there was ample meaning wrapped up in the connection that the 10-yr Treasury note (+3/32, 2.87%) and the stock market both pushed higher. Gold prices and the US Dollar Index, meanwhile, were little changed.

The headlines for the employment data were reassuring on just about every front. • Nonfarm payrolls increased by 203,000 (consensus 188,000) and were revised up for September (to 175,000 from 163,000) and down slightly for October (to 200,000 from 204,000) • Nonfarm private payrolls increased by 196,000 (consensus 200,000) • The unemployment rate fell to 7.0% from 7.3% • Average hourly earnings increased by 0.2% (consensus 0.2%) while aggregate earnings increased 0.6% (a good portent for consumer spending) • The average workweek edged up 0.1 to 34.5 hours (consensus 34.5) and factory overtime increased 0.1 to 3.5 hours The employment report drowned out the Personal Income and Personal Spending report for October, which was released at the same time. That report was mixed with personal income declining 0.1% (consensus 0.3%) and personal spending rising 0.3% (consensus 0.3%).

There was nothing mixed, however, about the stock market action. It was decidedly positive throughout the day and featured broad-based participation that saw every S&P sector finish higher, every Dow component finish higher, and all major indices gain at least 0.7%.

Remarkably, the S&P 500 made up almost the entirety of the ground it lost in its five-session losing streak and came within a whisker of ending higher for the ninth straight week. The consumer staples (+1.5%), industrials (+1.5%), financial (+1.4%), materials (+1.4%), and health care sectors (+1.4%) led today's winners. The energy sector, which gained 0.5%, was the weakest performer -- but it wasn't weak.

Weak areas were few and far between today. A number of retailers, though, were caught in the selling crosshairs after issuing disappointing guidance. Big Lots (BIG 32.50, -4.63), American Eagle Outfitters (AEO 14.85, -1.55), and Five Below (FIVE 45.30, -2.45) were such offenders. J.C. Penney (JCP 8.09, -0.76), meanwhile, got hit hit hard after a 10Q filing revealed an SEC request for information regarding the company's liquidity, cash position, and debt and equity financing.

Another area of notable weakness was the CBOE Volatility Index (VIX 13.84, -1.24). It dropped 8.2% as portfolio protection bets were taken off in the risk-on advance.

Today's gains came on lighter-than-expected volume. To that point, NYSE volume totaled 671 mln shares versus 700 mln on Thursday. • Nasdaq +34.5% YTD • Russell 2000 +32.9% YTD • S&P 500 +26.6% YTD • DJIA +22.1% YTD

Jobs Report Tees Up a Taper

Market Reaction Shows Investors Believe 'Tapering' Won't Presage Rate Rise

The strong jobs report was seen as good news by investors. For the Federal Reserve, that is good news in itself.

The economy added 203,000 jobs in November, the Labor Department said Friday, about matching the previous month's gain of 200,000 jobs, while the unemployment rate slipped to a five-year low of 7%. The index of aggregate earnings—an early read on income trends—rose 0.7%. Suddenly, any compunction Fed policy makers might have felt over reducing the central bank's bond purchases seems likely to have been swept away.

They will probably still opt to leave the bond-buying program untouched when they meet later this month, but the jobs report clearly sets the stage for them to start tapering at their January meeting—earlier than many economists had been forecasting.

To judge from the action in the Treasury and stock markets, the possibility of any earlier taper wasn't weighing too heavily on investors' minds Friday. The 10-year note barely budged, with the yield rising slightly but staying below 2.9%. Meanwhile, the Dow Jones Industrial Average registered a triple-digit gain.

That is an indication investors have taken to heart the Fed's message that reducing bond purchases shouldn't be taken as a prelude to raising its target on overnight rates. Contrast that to the summer, when investors' fits over tapering led to a rapid rise in interest rates that ended up weighing on the economy.

Considering the inflation backdrop, the date the Fed finally raises its overnight target seems farther away than ever. In a separate report Friday, the Commerce Department said consumer prices were up just 0.7% in October from a year ago. Prices excluding food and energy—the core measure of inflation the Fed watches closely—were up 1.1%. That is well below the central bank's 2% target.

The low pace of inflation is a bit of a puzzle for Fed policy makers, especially in light of the recent improvement in the jobs market. Last December, they predicted core inflation would be up 1.6% to 1.9% in the fourth quarter of 2013 from a year earlier and the unemployment rate would average 7.4% to 7.7%—forecasts that were too high on both counts.

That is probably a sign employment still has a lot more room to grow before the Fed has to worry about inflation pressures and that the threshold of 6.5% it has said the unemployment rate must pass through before it starts raising short-term rates is far too high. Indeed, whenever the Fed decides to scale back its bond purchases, it may also lower the unemployment-rate threshold as a way of further distinguishing tapering from tightening.

Even so, faith in the Fed's commitment to keeping short-term rates low may not have a very long shelf life.

A string of heartening data this week, including the Institute for Supply Management's manufacturing-activity index, November car sales and the Reuters/University of Michigan consumer-sentiment index, as well as the jobs figures, suggest the pace of the economy may be quickening. With the effects of this year's government spending cuts and tax increases waning, that sets the stage for a stronger 2014.

Convincing investors that it won't tighten until it sees the whites of inflation's eyes may soon be harder for the Fed.

Diego Della Valle Gives Back to His Country

The Colosseum is one of Italy's most treasured landmarks, but it's been crumbling for centuries. Now the billionaire president and CEO of luxury group Tod's, is making history by funding its restoration

THE FIRST TIME Diego Della Valle visited Rome's Colosseum, he was 11 years old and arrived in a bus stuffed with clamoring kids from his grammar school in Casette d'Ete, a village in Italy's central Marche region. The journey, which required circumventing the rugged Apennine mountain range, took over eight hours.

"But it was like a party," the 60-year-old president and CEO of the luxury leather goods company Tod's says now, his smile softened with nostalgia. "We loved every minute of it."

Fifty years later, Della Valle has made the exact same journey in 30 minutes, this time zooming over the mountains in his private jet. "I would've taken the helicopter, which is even faster," he adds, "but I was worried about the weather."

Della Valle hops out of a shiny black Mercedes at the Colosseum's main northern entrance, once reserved exclusively for 2nd-century emperors and now closed to the 21st-century public. He's wearing a navy blazer with a linen handkerchief, a starched baby-blue shirt collar shooting up like a winged buttress over his silk paisley print scarf, tailored jeans and all-suede navy-blue Hogan sneakers. Transforming his family's small shoemaking business into the booming global brand Tod's—with investments as diverse as furniture, motorcycles and newspapers—has made Della Valle a billionaire. Of all his investments, however, the one most likely to immortalize him in Italian history books is the one in front of him today.

"The dimensions here make you feel small," the industrialist remarks, gazing up at the monument's huge travertine blocks stacked 164 feet above.

For a moment, he sounds like any one of the four million tourists who come annually to the 1,933-year-old amphitheater to gawk at it. In reality, he has put a significant amount of his company's money into saving it. In January 2011, Della Valle signed a Tod's group sponsorship contract that gave 25 million euros toward a long-awaited, desperately needed full-scale restoration of the monument. Now, two years later, with scaffolding covering a portion of the Colosseum's four-story-arched façade, he is finally witnessing his gift put into action.

"I'm someone who has had enormous luck in life and when I could give back, I did," says Della Valle. "This is a monument that not only belongs to Italy's patrimony but the entire world."

The historic structure, begun by Flavian Emperor Vespasian in AD 72 and inaugurated by his son Titus in AD 80, has been crumbling for centuries. From the Middle Ages onwards, its gilded bronze shields, painted statues and precious travertine stone were pillaged by robbers and damaged by earthquakes and fires. Recently, the monument has begun to crack and fall apart, precipitated by a noxious cocktail of increasing pollution and harsh weather patterns.

"Every once in a while we receive an 'extraordinary fund' from the government," says Pia Petrangeli, a member of the Ministry of Culture's general secretariat, who supervised the agreement with Tod's. "But it's never enough. We've never managed to do a thorough job that addressed all of the problems."

Starting with the soot-covered façade, phase one of an ambitious, full-scale restoration program is already underway. In a painstaking process that will take two-and-a-half years, only a vertical sliver consisting of 10 of the monument's total 80 arches will be worked on at a time. The travertine stone will be blasted at low pressure with purified water to reveal its original creamy golden hue. Detached fragments will be reattached and fortified with mortar and the cramp iron bars that dot the surface will be repaired. Unsightly metal rail tubing in each of the 69 ground-floor arches has been replaced by newly forged iron gates, and next, a tourist center and café will be built underground in front of the Colosseum's entrance. Lastly, in the Colosseum's cellar, where roaring animals and sword-wielding gladiators were once detained, the brick walls will be restored.

"I know a lot of brilliant entrepreneurs in Italy," says former Gucci Group CEO Domenico De Sole, who has known Della Valle for nearly two decades, "and they won't touch the [public] system with a 10-foot pole. The country is overwhelmed with debt. It's totally off the charts. Everyone talks about it, but no one does anything. The fact that someone is finally stepping in and saying, 'I'll start, I'll do it,' is amazing."

THERE ARE 5,668 archeological sites in Italy, including 30 in Rome that are considered to be of major scale and only 11 of which charge entrance fees. Though the Colosseum generated 28.8 million euros in ticket sales in 2012, it only received about 2 million euros for its annual operating costs. The balance of its income is siphoned off into a pool of money that Rome's local superintendent uses to sprinkle across the rest of the city's archeological patrimony.

Meanwhile, the government's "ordinary," or base, budgets allocated for the restoration of the country's thousands of cultural and archeological sites (not to mention libraries and archives) have been on a steady, precarious slide over the last decade, from a high of 201.1 million euros in 2004 to 55.9 million euros for 2013.

In August 2009, Rome's mayor, Gianni Alemanno, began soliciting private funding, packaged as corporate sponsorships, to address the critical situation throughout Rome. In characteristic brash style, Della Valle was the first to raise his hand and the first to point at the splashiest, most prominent structure in town.

A formal auction, however, was required. From the 20 companies that were initially interested, final bidding came down to Tod's and the budget Irish airline Ryanair RYA.DB +2.40% —which intended to wrap the monument in advertising banners. In January 2011, a contract was signed with Tod's, which stipulated non-advertising use. A gift of 25 million euros was now earmarked for a single monument—nearly half of the government's entire budget for such projects.

" I see [this donation] as an obligation. Italians who have had success and luck in life should give back to their country. "

—–Diego Della Valle

Hunter Becomes Hunted (and Still Hunts)

Louis Meyer (Oscar Gruss) Friday, December 06, 2013 1:39:22 PM On 12/5/13, Jos. A. Banks Clothiers, Inc. (Nasdaq-JOSB) announced 3Q FY14 results of $0.51 adjusted EPS (top end of $0.49-$0.51 guidance). Men’s Wearhouse, Inc. (NYSE-MW) announces 3Q results on 12/11/13; consensus is $0.86 EPS ($0.84-$0.92 range). JOSB made a non-binding $48/share cash offer for MW on 9/18/13; their rejection was publicly disclosed on 10/9/13, at which time MW announced it had adopted a shareholder rights plan. After some further prodding (such as a request to perform due diligence), JOSB withdrew its proposal on 11/15/13; MW had stated that it was reviewing the proposal but JOSB responded that the MW Board had "failed to engage in good faith discussions". In an unexpected turn-of-events on 11/26/13, MW made a $55/share cash proposal for JOSB. Last, on its 3Q earnings call, JOSB stated it could not provide a timeline for responding to MW (as they were focused on the holiday selling season) and that their proposal was not the only acquisition opportunity for the company.

Since the initial proposal was publicly disclosed on 10/8/13, the MW and JOSB stock prices have increased 45% and 36%, respectively. In comparison, the S&P Retail Select Industry Index (SPSIRE) is up 9% and the more narrowly-focused Bloomberg North America Specialty Apparel Stores Index (BINASAPV), which includes both MW and JOSB (3.9% and 3.3% weightings, respectively), is down 1.5%. The relative outperformance is quite spectacular, especially given the specialty retailing sector has performed poorly in 2H13 due to weak-to-negative same store sales comps as well as lower earnings guidance from many companies. The deal proposal premiums, combined with cost savings for the potential acquirer, have kept the MW and JOSB stock valuations fully inflated. However, the net effect of the strategic maneuvering by both companies over the past couple months, other than ratcheting up both share prices, appears to be a zero-sum game as we feel this will all end in a stalemate.

We believe this takeover battle has become a crowded trade; JOSB offers a safer haven than MW at this juncture. Although the Pac-Man tactical move resulted in a 7.5% higher share price the day in was announced, we are hard-pressed to identify a value-creating alternative for MW assuming JOSB is not receptive. MW shareholder activist Eminence Capital has hired a financial advisor and filed a preliminary solicitation statement (for a special meeting to amend the by-laws to remove directors without cause); this governance cattle prod may move the beast but does not stop it from kicking back. As we previously stated, we feel the MW Board and senior management has near-term cover of executing the strategic plan presented to investors in October 2013; the alternative to buying JOSB may be fill-in transactions (like Allen Edmonds) rather than a signature takeover deal. At $51/share, the MW implied FY15E valuation multiples are 7.9x EV/EBITDA ($286M, down 8% YoY, 11.4% margin) and 20.7x P/E ($2.46 EPS, down 4% YoY). Valuation multiples using 6.5x-7.0x EBITDA and 15x-16x EPS imply MW standalone values in the $39.30-$42.30 and $36.90-$39.35 price ranges, respectively.

JOSB continues to be cash-rich and have no debt; the company had $377M in cash and short term investments (~$13.45/share) as of 11/2/13. This available liquidity gives the company flexibility to make acquisitions, repurchase shares or pay a significant one-time dividend; it is an issue for shareholders given its de minimis earnings contribution. Based on the MW $55/share proposal price, the implied JOSB valuation multiples are 7.4x EV/EBITDA (157M, up 10% YoY, 14.1% margin), 18.6x P/E ($2.96 EPS, up 10% YoY) and 14.2x cash-adjusted P/E ($2.93 adjusted EPS). The JOSB Chairman said he would consider a similar premium right after the MW proposal was announced (low-$60s price). We expect that JOSB, in responding to the MW proposal, will make the case that their stock price should be trade in the $50s on a standalone basis. JOSB Valuation multiples of 6.5x-7.0x EBITDA, 15x-16x EPS and 12.5x-13.5x cash-adjusted EPS imply JOSB standalone values in the $49.91-$52.70, $44.40-$47.35 and $48.60-$51.55 price ranges, respectively. 

While merging the two companies may make conceptual sense, the cultural rivalry between the two organizations seems to make a combination unlikely. JOSB appears to be mimicking the stalling game played by MW prior to the merger proposal being terminated; this tit-for-tat implies there is no love lost between these companies. JOSB claims it has better customer demographics than MW, but its current marketing campaign ("buy one, get three free") has a low-brow, bait-and-switch appearance (at least from the Ohio Attorney General’s viewpoint). MW is focusing on the fashion forward customer segment (with the addition of Joseph Abboud), but the messy mid-year exit of its founder (following disagreements with the Board) rankled its customer base. JOSB is expanding into tuxedo wear (to compete directly with the MW unit), but it has not gotten enough traction yet to report it as a separate segment. JOSB is also expanding into big and tall men clothing, mostly through direct sales. We still feel that JOSB should consider an acquisition of Destination XL Group Inc (Nasdaq-DLGX) as a defensive alternative to the MW proposal.

JOSB has better growth prospects (given its smaller sales base) from expansion into areas which MW is more mature (tuxedo rentals/sales and big/tall men). We note that MW is still marketing its K&G operations for disposal (announced mid-March 2013); Sycamore Partners was reported to be the leading contender but we have very low expectations on the potential price (which could be well under $100M) and do not view this potential divestiture as a valuation catalyst. Rather, the big kahuna being proffered to MW holders is an acquisition of its specialty apparel retailing rival. This is as much a defensive action (i.e. the Eminence Capital activism) as it is offensive (EPS accretion from $100M-$150M run-rate cost savings). Using $42M pre-tax savings (one-third of $125M midpoint) and a 7% blended interest rate on $1.22B deal debt (net of existing cash and assuming $50M deal expenses), we estimate MW P/F FY15E $3.60 EPS (46% accretion). P/F Debt/EBITDA would be ~2.5x leverage; the JOSB cash cushion would be no more. A MW P/F 13x-15x P/E multiple implies a $46.80-$54.00 MW share price. Based on a half stock/half cash deal consideration (price bump to $58/share and $52/share MW price) and a 5.5% blended interest rate, we estimate P/F FY15E $3.25 EPS (32% accretion); a 14x-16x P/E multiple implies a $45.50-$52.00 MW share price. Overall, while the Pac-Man defense may conjure fond memories of prior era takeover battles, we do not feel that is the case here. Rather, the MW proposal for JOSB appears to be a market elixir that has had an immediate price effect but may not support longer term sustenance.