Investing Ideas Newsletter

Short: HZO, MPW, PEB, TSLA, RVLV, STLD, DE, KNX, DLR, ONON, GOLF, ULTA, SBUX, ODFL, REXR, POOL Long: NEM, DKNG

We added Ulta Beauty (ULTA), Starbucks (SBUX), Old Dominion Freight Line (ODFL), Rexford Industrial Realty (REXR) as well as Pool Corporation (POOL) to the Short Side and DraftKings (DKNG) to the Long Side of Investing Ideas this week. We also removed The Hershey Company (HSY), Arbor Realty Trust (ABR) and Clorox (CLX) from Investing Ideas this week.

Below are updates on our 18 current high-conviction long and short ideas. We will send a separate email with Hedgeye CEO Keith McCullough's refreshed levels for each ticker.

HZO

HZO Short Thesis Overview: This is definitely a play on "shorting the rich." MarineMax (HZO) is a retailer of new and used boats as well as aftermarket parts, maintenance, storage, financing and some other small business pieces. Consensus straight-lined peak 32% margin into perpetuity and is modeling that $7 in EPS power holds steady over a TAIL duration. This company has reversion risk all through the P&L from peak revenue growth to peak margins to peak earnings power. A consumer facing high macro level spending headwinds along with a normalization of the inventory position and a mix reset back to normal selling will likely see gross and operating margins fall back to historical levels and presents ~40% downside in the stock – entirely from a massive negative earnings revision.

The consumer credit cycle continues to get worse. This week COF reported May credit trust metrics, delinquencies up 142bps yy accelerating from +139bps last month.  The credit quality metrics are showing clear deterioration, which has led lenders to by tighter and tighter on lending standards.  Tighter lending means less access for consumers to buy big ticket goods.  Access to credit will be an building headwinds to boat consumption alongside the greater pressure on consumer discretionary income.  Setup remains bearish on for MarineMax (HZO) boat demand.

MPW

Short Thesis Overview: Medical Properties Trust (MPW) is not a traditional triple-net REIT, rather an investor in hospital systems ("WholeCos" using the company's own words). In the process MPW removes the arbitrage from a traditional PorpCo-OpCo arbitrage. These investments are structured as loans + equity investments to the operator tenants, which are in many cases distressed and owe significant rent payments back to MPW as landlord. The arrangement is circular and depends on MPW's ability to raise attractively-priced external capital. Assuming all goes perfectly for MPW and there are no tenant issues, and with an updated distressed cost of capital, we estimate the stock is worth no more than $5-$6/share today.

We still think Medical Properties Trust (MPW) shares are worth no more than ~$3/share AT BEST assuming no further tenant issues, and there is a non-zero and rising probability that MPW's equity is worthless. Its MATH, not speculation - with assets generating ~5.5-6% unlevered cash-on-cash yields for the foreseeable future, leverage on cash EBITDA above ~9x and remaining above ~8x, a cost of debt pushing 10%+ or higher, negative credit rating agency outlooks, credit spreads 2-3x versus April 2022, etc. the model does not work.

MPW will likely not get its cost of debt capital back until it reduces its non-covered dividend (with true cash flow) and begins to repair its balance sheet. Absent reducing the dividend, the company will likely be forced to borrow at least ~$800-900 million on its RCF through the end of 2024. In other words, MPW has become a "perma-short" that will just continue to "bleed out" as it secularly takes up leverage over time, allowing us to use the RRs to risk manage a bearish TREND.      

PEB

Short Thesis Overview: Pebblebrook Hotel Trust (PEB) has a highly leveraged balance sheet, challenging exposures (heavy urban mix), extremely difficult resort property comps, and rather full valuation as compared to peer set + history. We see regression toward the mean in the cards on valuation + estimate reductions, which makes for a challenging combination over the NTM.

With most of the calendar noise (positive and negative) in the rear view until July 4^th, we can look a little closer at the trending data to discern any material adjustments “under the hood” for the industry.  As mentioned above, Q2’23 is tracking below where some of the macro data had indicated and for us, it comes down to more of the weakness we’re seeing in certain scales and geo segments.  Lower end scales continue to roll over and soften, while most business RevPAR proxies remain firmly in the red.  Even on the leisure side there’s been some weaker data but on balance, that data remains healthy and above prior year levels. 

The below heatmap succinctly captures what’s going on across the industry right now through some different business travel and leisure travel proxies.  For now, no changes to our broadly negative views on our hotel shorts – with Pebblebrook Hotel Trust (PEB) among our favorite shorts.

TSLA

Short Thesis Overview: TSLA numbers are messy with far too much inventory, improbable OpEx containment, and flat to lower margins. But Musk’s salesmanship has become increasingly goofy.  Tesla is just a "pandemic liquidity" driven bubble stock that is likely already in the midst of a downward revaluation.

Some quick notes on Tesla (TSLA). If Tesla weren’t a momentum-driven retail mania, the stock would be far lower. Most of the ‘news flow’ and fundamental developments for Tesla have been very negative.

• TSLA is facing intense competitive entry in EVs, including TM, and is cutting prices and overproducing relative to demand.
• Delays in new product launches and reliance on a stale Model 3/Y product has left to company selling access to its supercharger network, removing a key differentiation.
• A data leak and regulatory comments have raised concerns about the safety of the company’s autopilot & FSD products.
• TSLA’s fig leaf of corporate governance is wilting.

EPS are down, often a sign an equity will exit the ‘growth’ arena (growth holders have come down).

RVLV

Short Thesis Overview: Revolve Group (RVLV) has a problem with rising returns and rapidly building inventories. The company notes it has high quality inventory, and that it will retain its value, but because of softening demand, and the desire to reduce that inventory, there will be some measured promotions.  Maybe this is possible in a normal environment, but EVERY APPAREL COMPANY HAS TOO MUCH INVENTORY. Good luck moving inventory in a measured fashion when every company is trying to clear product at the same time.

Revolve Group (RVLV) opened its FWRD pop-up in Los Angeles last week that runs through mid-August. It is the first ever in-person shopping experience for FWRD, with a curated selection by Kendall Jenner and exclusive products.

RVLV is also testing out in-person returns during this pop-up. This is a big marketing spend on FWRD, especially with the launch party last week that invited influencers to celebrate and post about the opening. The goal here is to increase awareness and cross-shopping between Revolve and FWRD, which, at least with awareness and interest, seems to be working.

Google interest trends accelerating over the last three weeks, from down 16% to up 16% this past week. But Google interest doesn’t directly translate to sales, and FWRD still has an inventory problem. Last week at one of its conference appearances, management said that with goal of getting inventory rebalanced by mid-year Revolve is much further along than FWRD. It’s more difficult to reposition at FWRD given the type of inventory and the brands it carries. While it’s positive to see the company spending on marketing for FWRD, if the inventory isn’t properly assorted for the consumer, the increased awareness won’t translate into profit growth.

We continue to expect slowing demand, sales declines YY, and margins to be hit over the upcoming few quarters. Given the context of these company factors as well as the economic landscape, this stock is still trading too high at 24x PE. 

STLD

Short Thesis: Base metals have been deeply cyclical for decades and, most likely, centuries. We think all of the bullish catalysts will fail, once again, in the face of "the cycle." Construction and consumption drive demand, with higher rates and tighter credit an inevitable dampener. Credit tightening, more expensive borrowing, and inflationary/supply pressures limit the upside in total construction spending. It is difficult to build a scenario where the infrastructure package and the war in Ukraine support steel markets. These factors have instead emboldened investors to pay absurd valuations for among the most deeply cyclical companies (albeit often well-run) in a largely no growth industry at all-time highs. We expect greater than 50% downside in the shares of Steel Dynamics (STLD).

A domestic production narrative has led to significant capacity increases for mature metals alternatives, like Steel producer Steel Dynamics (STLD). At the same time, Steel names are among the most straightforward correlations to CPI…which is likely to slow markedly. Betting on inflation re-accelerating here seems low probability. The Macro environment appears to be very unfriendly for the Materials sector with the Fed appearing to be tightening into a 2023 recession. Cyclicals tend to follow the target rate

DE

Short Thesis: Low rates helped fuel profits at Deere & Company (DE) and other agriculture equipment suppliers. Ethanol-blending mandates, falling/negative real rates and investor interest led to a NASDAQ-like bubble in farmland values. Farmers have been able to tap that value to borrow and supplement spending. Farming is as mature and sub-GDP growth as Industrials get. Consensus expects higher EPS for DE, which we believe is a very unlikely scenario in #Quad4 for a company already trading at peak. We see DE EPS missing substantially over the next several quarters.

Why should you position defensively on the cyclical side of Industrials? Because manufacturers are generating revenue by delivering orders accumulated during supply constraints in 2021 and 2022.  Most mid-cycle/short-cycle book-to-bills started to slip below 1 in 4Q 2022. CAT was all the way down to 0.90 (adjusted for dealer inventories) in 1Q2023.  Deere & Company (DE) likely slipped below 1 in their FY1Q23, with visibility muddled on a lack of “order bank” disclosure. The pricing in those orders, accepted by panicked customers in an operating environment with accelerating inflation for manufacturers, is abnormally rich.

KNX

Short Thesis: While earnings at truckload carriers in 2H22 declined more than for the average Industrial sector constituent, the share prices remained firm and often near all-time highs. Transportation data have deteriorated into 2023; there is little cause for optimism either in Macro or micro trends. Rails are the most out-of-favor group in the sector on some definitions; we expect them to be among the best performing industrial transports, we chose to fade hysteria from non-chemists who do not understand railroad operation and regulation. That matters to KNX since a 10% increase in Rail speeds takes ~5pts of margin from KNX.

Why have shares of Knight-Swift Transportation (KNX) not come in more on the deterioration of its profitability? We suspect some see this as a temporary period of pressure against the potential for a inventory restock (or something) later in the year. There is remarkably little evidence for it.  Capacity is the issue for trucking…and the industry is sodded with it.  Fleets are still growing, capital spending is up, and utilization is plummeting.  Spot rates should pull contract rates lower.  Consensus for KNX for this year is already down from about $5 at the start of 2022 to $3.33…and it continues to drop.  A recession amid already excess capacity could take estimates down toward zero. 

DLR

Short Thesis: We found an "AI REIT" (within the Data Center subcategory) to fade, and it remains a fundamental short. Our view, and it's less a view and more guaranteed by simple math, is that (1) leverage will continue to increase secularly through at least mid-2024 amidst a large funding need and mismatch in cash NOI recognition on a lag, (2) a follow-on equity offering may be needed, and (3) the economics of the DC business do not warrant DLR's multiple (we will go into that later).

We are hosting an institutional Black Book presentation on Digital Realty Trust (DLR) on Monday, 6/26 at 10am ET. More details to come on the DLR short thesis in the weeks to come.

ONON

Short Thesis: The On Holding (ONON) valuation of 32x EBITDA is banking on TAM that doesn’t exist. The brand is growing too quickly and recklessly, with inventory up 190%. With too much like-for-like product being pumped into wholesale doors, discounting is inevitable. As the wholesale full-price model breaks down, DTC will ultimately slow as well, so sales will slow, inventories will bloat, GM declines, and the management team deleverages SG&A. None of that is in the stock right now. This reminds us of a few different companies. One of them is Kors, which blew up in 2015 when it oversold into wholesale resulting in discounting and slowdown in high margin DTC sales. Also similar to Under Armour in the early days when it was billed as “the next Nike”… clearly that didn’t work out. But at least UAA was a real brand; we aren’t so sure that’s the case for ONON. ONON is more of a product. The brand awareness is exceptionally low, but the awareness of the Cloud product is 4x higher. We estimate that the main Cloud product accounts for 60-80% of sales. The company hasn’t been tiering product by distribution channel or retailer, and when this +190% inventory flows through the channel this year that will start to be a problem with discounting. We think this cracks in CY23, with 50% downside over a TAIL duration.

Looking at the latest Google interest trends below, lately Hoka has been making higher highs while On Cloud has been seeing lower highs.  On its own, lower highs aren’t that big of a deal but it causes more of a rub when comparing these two exponentially growing companies. Recently Hoka has been growing DTC faster than wholesale, while On Holding (ONON) is growing more rapidly in wholesale. ON continues to expand rapidly with wholesale partners, which we think presents a risk for over distribution and a building inventory/markdown risk for this single product company (ON cloud silhouette being the vast majority of sales). If demand declines slightly with the combination of elevated inventories, a lot of incremental wholesale distribution, challenged consumers, and potential cooling of brand heat, there will be inventory management problem of excess supply and therefore markdown risk throughout the retail channel. If markdowns start happening with even just moderate product discounting, the stock will rerate to a much lower multiple.

GOLF

Short Thesis: We think we’ll see a tempering of how core golfers are spending on new equipment; build up of used equipment; had some insider sales; CFO is planning to leave next year; GOLF remains a short.

Acushnet Holdings Corp (GOLF) reacted positively to the Saudi PIF investment into the PGATour last week.  The DOJ is now taking a close look at the deal to see whether it violates anti-trust laws.  The details of the deal are ambiguous, and there is no official ‘merger’ of the 2 tours.  But the ‘partnership’ definitely looks sketchy, and the DOJ is likely to have some issues with it as it relates to competition, let alone the potential political stance.  We’re bearish GOLF on the reversion risk in equipment consumption after elevated replacement of these long lived products, and pressure on higher income discretionary spend.  But given the rally last week we think and blockage/restrictions on the deal by the DOJ should also be a negative for GOLF stock. Also this week, the head of Footjoy at GOLF sold ~$400k worth of stock taking advantage of last week’s rally… that comes about a month after the head of Titleist Golf Balls sold ~$1.5mm in stock.  These execs see we are at a golf cycle peak. 

NEM

Long Thesis: In addition to GLD and Physical Gold, we remain bullish on Gold Miners (GDX) and Newmont Corporation (NEM), the world's largest gold mining company.   While the broader commodities complex is a notable underperformer amid Quad 4 environments, tend to be the exception. Gold’s flight-to-safety appeal is most pronounced in Quad 4, an environment that historically corresponds to declining real rates.

Below are three key thesis points on why be long Newmont Corporation (NEM):

1. Large Gold Miners Are Good Longs Amid Stress, Otherwise Not-So-Much

NEM and other large, established gold miners are Quad 3 and Quad 4 outperformers, but laggards in Quad 1 and Quad 2. Miners are seen as defense in portfolio allocation, not positioning for a risk-on market environment. Costs and supply dynamics tend to matter much less than marginal/investor demand, as well as central bank actions. ‘Junior’ gold miners can deliver excess returns…sometimes very positive, other times very negative. NEM and GOLD are not likely to surprise too much on the asset side, even with spending on exploration and new resource developments. More rigorous safety and environmental regulations, as well as more autonomous equipment, do favor large, respected gold miners in a period of populism.

2. Gold Prices Aren’t As ‘Economically’ Driven As, Say, Steel Or Copper Prices

Demand for gold tends to correlate to geopolitical risks, financial system stress, interest rates, and consumer interest. In general, higher defense spending and greater geopolitical tensions are associated with rising gold prices – a situation in which we find ourselves. Financial reckonings for ‘substitutes’ for gold, like cryptocurrencies or NFTs, could well drive demand back to precious metals. The fraud and shaken faith in many digital assets in the absence of crisis raises a question of how one would access the internet without, say, electricity. Realistically, a Quad 4 macro backdrop and a mid-fourth turning geopolitical environment portend relatively strong gold prices and outperformance for Gold and Defense Primes.

3. Gold Has Never Been Higher, NEM/GOLD Valuation Diverged From Product

While not technically ‘cyclicals’ in the standard sense, gold miner profits are driven by product prices – a dynamic that leads to high multiples at low product prices. For now, we aren’t pairing off gold miners…the exercises around individual mine evaluation, cost comparisons, and the like doesn’t drive market-relative performance/alpha. Getting the Gold Price, factors exposures, and a reasonable handle on the operations will. NEM has the Newcrest deal, a transaction that vaults NEM into a different scale category… and the company has had some success with earlier integrations. We see ~30% relative upside as NEM revalues to reflect the current gold price dynamics…without as much downside risk as other metals and mining names.

***We'll have updates next week on Ulta Beauty (ULTA), Starbucks (SBUX), Old Dominion Freight Line (ODFL), Rexford Industrial Realty (REXR) as well as Pool Corporation (POOL) (on the Short Side) and DraftKings (DKNG) (on the Long Side).