Investing Ideas Newsletter

Short: MPW, PEB, TSLA, RVLV, STLD, DE, KNX, DLR, ULTA, SBUX, ODFL, REXR, CF Long: DKNG, DDOG, MTCH, ATVI, CCL, LFST

Below are updates on our 19 current high-conviction long and short ideas. We will send a separate email with Hedgeye CEO Keith McCullough's refreshed levels for each ticker.

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.

A summary of REITs analyst Rob Simone's July 9 note on Medical Properties Trust (MPW):

Some "Real Talk" on MPW As We Begin 3Q23

• Subscribers will recall that we said in Fall 2022 that we thought the time to revisit this short idea would be post-2Q23. We are here, so we are going to stay consistent with that statement.
• To be clear, we think MPW remains a short here – there are simply too many items that combine to create the most potentially combustible situation for a REIT that we have ever seen:
• Steward Health remains an unbelievably large risk, and still accounts for roughly ~25%+ of MPW's cash EBITDA. Our view has been that Steward is actually or effectively insolvent. 
• An unbelievable cash burn rate of ~$200-300 million annually for a REIT that is over-distributing relative to taxable income. Even if Steward gets its ABL facility refinanced, the cash burn will continue as it just ensures the current rent stream flowing into MPW, which we estimate is not enough to service all of it's obligations.
• As a result, MPW needs to raise capital. They have to, there is no other option. The high yield bond market is effectively closed to them, a secured offering may be possible but is another case of "adverse selection" and would also crush the equity, and asset sales are a heavy, low-probability lift (the company is always talking about transactions on the table, but there are very few tangible examples of voluntary arm's-length asset sales being executed). 
• The dividend also needs to be cut, and in our view it is only a matter of time.
• Leverage remains ridiculously high at 8-8.5x net debt-to-cash EBITDA, pro forma for the resumption of cash rent paid from the Prospect CA hospitals. Leverage relative to cash flow remains essentially unchanged since we became involved in the name in 1Q22. Absolute dollar leverage on a pro-rata basis is flat-to-up y/y depending on timing of asset sales. Think about that. 
• The unlevered cash return profile of the business is inferior. 
• Capital allocation remains terrible. 
• And finally MPW's behavior / outward stance towards critics, in our opinion, is not consistent with a company without "issues." Put more directly, we think it is reprehensible and indicative of a company devoid of any fundamental arguments to support its business, and so therefore resorts to attacking critics rather than engaging on the arguments (because they know they will lose).  
• Now with that said, a few words of caution on the equity short:
• Admittedly, we are absolutely shocked at the resilience of this stock. Subs who have followed along over the past year will know precisely what we are referring to. If you had told us in November/December 2022, when we were saying that MPW would likely have to lend additional funds to sustain it's largest tenant Steward amidst an existential debt maturity, that not only would the company deny having done so to institutional investors but retroactively disclose that it HAD made such loans ... well, let's just say we would have predicted that a low-single-digit stock price would be the best outcome for MPW. We are not alone in this view, as another independent sell-side analyst more or less called the company out on the 1Q23 call for misleading him and other investors (see Figure 2 below). That's a FACT, that actually happened, and it's remarkable. It takes exceptional circumstances for sell-side analysts to take that approach on an earnings call. Yet here were at ~$9/share. 
• On top of this, the second largest U.S. tenant in Prospect failed and MPW has lent / made available to them ~$225 million in the aggregate over the past year. Yet here we are. 
• The company is doing whatever it can do to "get the shorts" rather than just focusing on running it's business. This includes publishing this ludicrous NAREIT investor deck which reads like a penny stock marketing pitch, and certain parties in the market engaging in what we and other institutional investors consider to be intimidation tactics to try and "force a squeeze." Indeed, the only bull thesis on the stock right now appears to be the potential for a short squeeze. That is a BAD place to be for MPW, but that does not mean it cannot happen. 
• Time is the company's friend. The more time that elapses, the more likely it is that MPW somehow finds an "escape hatch" or "kicks the can down the road" as it has in the past. We still think all of these things catch up to MPW in the end, but as we know with other cases like this it can take a long time to play out. It is not impossible that MPW finds some room to breath for a time.    
• We think this means that, if subs want to short the name, it needs to be as a relatively small position. If the company somehow manages to pull another rabbit out of a hat and save it's equity, such an outcome will not mortally wound a portfolio. If, however, something catastrophic happens to MPW, which we think is merely a function of time and space, investors will gain several hundred basis points of attribution and the position will size itself up. 

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.

We have been negative on hotel REITs, including Pebblebrook Hotel Trust (PEB) in particular. Gaming, Leisure & Lodging analyst Todd Jordan will host a Hotel Industry Black Book at 10 a.m. ET Tuesday, July 18 to discuss PEB and other hotel shorts. 

TSLA

Short Thesis Overview: Tesla (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.

Tesla (TSLA) is expected to report 2Q earnings after the close on Wednesday, July 19.

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) stock pushed one-month highs this week, up over 7.5% on Tuesday alone and closing out the week about 10% higher than it did last week. This stock squeezed higher on no new business news or increased social media buzz. High short interest stocks across the market were up this week, the majority without any fundamental news backing it. So it was not unique to RVLV. In this Quad 4 market, those squeezes historically have been opportunities on the short side. An upper-teens stock price and a 26.2x PE multiple is too high for this company that has seen slowing revenue and slowing customer addition trends, as well as weakening margins and elevated inventory. We would press the short here.

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).

Steel Dynamics (STLD) is expected to report 2Q earnings after the close on Wednesday, July 19.

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.

Used equipment inventory data for June is out, and production of new automobiles is normalizing. This relieves some pressure from the used market. Inventories of used equipment are no longer declining and are going up a bit. The biggest rate of change is in Ag equipment. Large Ag tractors are soaring, with inventories up more than 50% YTD after bottoming out in early to mid-2022. Deere & Company (DE) is an active participant in the used market and remains a short.

Industrials analyst Jay Van Sciver discussed DE in the July 12 edition of The Call @ Hedgeye. Click here to watch the 5-minute video.  

KNX | ODFL

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.

Preliminary orders for heavy-duty trucks came in at 13,800 for June, which is about half the build rate. An exceptionally large backlog has been helping the industry of late, but they're now chewing into that backlog of about 15,000 per quarter. Knight-Swift Transportation (KNX) remains a short.

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).

Digital Realty Trust (DLR) is in the process of needing to raise capital. One approach was through the selling of a JV interest in their Chicago portfolio. This is needs-driven transaction, the company is making out of necessity, not by choice. We think DLR is overvalued; doing dilutive deals and having to raise capital. We think there will be a downward revision cycle. DLR remains a short.

REITs analyst Rob Simone discussed DLR in the July 10 edition of The Call. Click here to watch the 7-minute video.

ULTA

With the elevated level of promotions Ulta Beauty (ULTA) is having (Summer Sale lasting a full week longer than it did last year with more product assortment included) margins will take a hit here, but margins are increasingly impacted by an elevated level of shrink. On its last conference call, management said that it had expected the level of shrink to lessen throughout the first quarter but that’s not how the quarter played out and now the company is expecting an elevated level of shrink for the remainder of the year. The company has said that it plans to roll out new display cases for fragrance in order to help protect against this theft, which means additional CAPEX expense and additional employee expense to have employees available to help customers when purchasing fragrance, and can also hurt conversion rates. The issue of elevated shrink isn’t one that will likely exist in perpetuity, but it is an additional near-term margin risk that cannot be discounted.

SBUX

Starbucks Continues to Face Backlash on Labor Front

Howard Schultz did not solve the Union issue, and some might argue made it worse. The latest setback for the company was a ruling from NLRB judge Arthur Amchan that the shutdown of a store near Cornell University's campus was primarily done to discourage unionization efforts in Ithaca and elsewhere.

The judge said Starbucks failed to prove that it would close the store "absent its animus toward the pro-union employees who worked there." Of note, all three stores in Ithaca voted last year to unionize. Subsequently, the company announced it would shut down the College Avenue store in Ithaca, and this year, it said it would close the other two as well. The company issued a statement indicating that it plans to appeal the ruling.

"We strongly disagree with administrative law judge's recommendations," the company said in an email. Starbucks has said the Ithaca stores had experienced numerous absences and high worker turnover.

Separately, the NLRB sued SBUX last Thursday over an alleged refusal by the company to rehire 33 workers as it reorganized three stores in Seattle, including the well-known location in Pike Place Market. In a petition filed in Seattle federal court, the NLRB called Starbucks' plan to reorganize the stores an illegal response to unionization efforts at another store in the region. The company defended the actions and noted workers could seek to unionize through an NLRB-supervised election. 

On July 10, Reuters ran a story saying "Pro-union baristas at Starbucks are taking their campaign on the road on Monday and trying a new tactic along the way: asking the coffee chain's customers to organize pickets at non-unionized U.S. cafes."

REXR

Rexford Industrial (REXR) investors are paying a sub-3.5% implied net effective cap rate for a platform that:

(1) in our view is very likely to see a deceleration from record high leasing spreads;

(2) is essentially ~100% exposed to a market that had been leading the nation but is slowing down;

(3) is particularly at risk in our view given the reliance on external growth; and

(4) in our view, will likely not generate 2024 earnings close to where consensus stands, leading to a downward revision cycle and a relatively unfavorable RoC profile. 

CF

Notable news out in the Ag suppliers’ space: FMC Corporation (FMC) cut guidance, noting a reduction in inventories in Europe, North America and Latin America. This is a negative sign on Ag product demand. We're seeing a down cycle in Ag, and think weakness in CF Industries Holdings, Inc. (CF) will continue.

DKNG

Bank of America upgraded DraftKings Inc. (DKNG) to "Buy" on July 12.

We look forward to DKNG's earnings release on Aug. 3.

"It's hard to say how much is in the stock given how fast it's moved, but turning profitable is a big catalyst for the industry and DraftKings, and we may see that in the second quarter," explains Todd Jordan. "We do see a higher earnings and revenue guidance going forward, so that should carry the momentum here. This is very much a catalyst-driven stock. That's the way we look at it. We're not overly concerned with valuation either way. Right now, we're focused on the catalysts, and so far, they're lining up positive."

DDOG

The bull case on Datadog (DDOG) is that Datadog has exhibited great vision through the years, including evolving into APM, and then fully shaping the Observability opportunity, in part via acquisition. The company continues to be at or near the top of its core market, catering to a DevOps centric audience, and justifying its high priced business model with a move into adjacent product markets in DevOps. We like the DevOps market which continues to exhibit growth in usage and key adoption metrics notwithstanding current macroeconomics.

We think Datadog has a chance to grow into what Gitlab so far is not, and we like innovative companies in fast growth markets that are engineering led, whose innovation can open up additional revenue markets.

MTCH

Long Thesis: Management has taken actions to turn Tinder's growth around, particularly through pricing actions the past two quarters. Hinge's growth has accelerated due to new country launches and the recent launch of a new premium subscription tier, HingeX. If we're right directionally, we expect to see the Match Group (MTCH) EBITDA multiple rerate back to the low-end of its historical range (15-20x) whereas it is currently trading around 12x FY 2024 EBITDA (up from 9x in May when the stock was around $30).

Since our black book, Match Group (MTCH) and NBCUniversal struck a deal to offer users of Match's portfolio of apps (Tinder, Hinge, Plenty of Fish, etc.) a free 3-month subscription to Peacock. The deal is also expected to editorial content and experimental events centered around big-name content like the Women's World Cup in the near future. This is not the first time the two companies have partnered to promote each other's businesses – last Halloween, they put on a sponsored date night on Tinder to promote Bel-Air and The Best Man: Final Chapters. While this partnership shouldn't drive long-term user acquisition, it should provide Match's portfolio with a short-term uptick in sign-ups coinciding with the roll-out of dynamic pricing actions we mentioned previously.

Additionally, Match appointed Sam Ahn as the Chief Innovation Officer of Match Group Asia this week. Match Group CEO Bernard Kim broke out Match Group Asia as its own business unit in January, with Malgosia Green (former CEO of Plenty of Fish) in charge. Amongst Match Group Asia’s flagship properties is Hyperconnect, the South Korean company that operates the live streaming platform Hakuna and the Video/Text chat app Azar. Match paid $1.7B for Hyperconnect in January 2021 – a transaction management has since acknowledged as an overpay. Sam Ahn, the new Chief Innovation Officer for Match Group Asia (and by extension, Hyperconnect) is no stranger to the business. Ahn was a co-founder and previously the CEO of Hyperconnect. Ahn will oversee hiring and expanding the Match Group Asia team for new product and innovation roles – specifically as it pertains to AI.

ATVI

Just as Telecom & Media Policy analyst Paul Glenchur anticipated, on July 11, a federal court (Judge Jacqueline Scott Corley) rejected the FTC's request for a preliminary injunction to prevent closure of the Microsoft merger with Activision Blizzard (ATVI). Microsoft has agreed to pay $95 cash per share pursuant to a merger agreement that expires July 18. Because the UK's Competition and Markets Authority is now indicating it will cut a deal with the companies and likely allow closure, an extension of the agreement will probably be unnecessary.

Cruise lines are still playing catch up to the rest of leisure, and Carnival (CCL) is doing well in the face of macro headwinds due to wallet share shift going toward cruise lines. CCL remains a long.

LFST

Lifestance Health Group (LFST) is expected to report 2Q earnings on Aug. 8.

Assuming a seasonal sequential decline in appointments per therapist will be balanced by strong secular demand and improvement in scheduling efficiencies as LFST addresses operational problems, 2Q23 revenue should come in well ahead of consensus. The Street expects 2Q23 revenue of $255M and our model is currently sitting at $271M.  Considering 1Q23 estimates went from $232.9M at the end of February 2023 to $246M the day LFST reported $252M, our estimate doesn't look so aggressive, and we may be low.