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Short: MPW, PEB, TSLA, STLD, DE, KNX, DLR, ULTA, REXR, CF, CHH, CFG Long: DKNG, DDOG, MTCH, ATVI, CCL, LFST, HCA |
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
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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. |
Medical Properties Trust (MPW) itself (uniquely among U.S. REITs, as we understand it) explicitly highlights "loans treated as equity" by the IRS as a potential threat to its REIT status. Maintaining REIT status is an affirmative covenant under the RCF. Hedgeye's view is that, while honoring the "letter" of the rules should be treated as an open question, this company specifcally for sure does not follow the "spirit" of the rules. Therefore, it should not be valued as a REIT, but rather as a "hybrid" of healthcare real estate owner and operator.
- But why does it matter? Among other things, like most REITs MPW has an affirmative covenant in the Revolving Credit Facility (RCF) agreement in which it commits to maintain REIT status. If the IRS were to challenge MPW's REIT status and MPW was unable to cure, it would likely constitute an event of default under this affirmative covenant in the RCF. This for a company that is already capital constrained and will likely have to draw significant amounts on the RCF through the end of FY24.
- This is a real risk. MPW itself highlighted loans-as-equity treatment in the "Risks" section of the 10-K. We are not aware of any other REITs with similar language. We suspect MPW's auditors may have required such language as a "CYA" for the auditors themselves (not MPW), but cannot be sure. All we know is that it is highly unusual.
PEB
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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. |
Pebblebrook Hotel Trust (PEB) earnings slightly beat severely reduced numbers. They're themselves up for a 3Q and 4Q miss because they didn’t want to guide below the Street. Our negative thesis on hotels overall remains intact.
Gaming, Lodging & Leisure analyst Todd Jordan discussed PEB on the July 28 edition of The Call @ Hedgeye. Click here to watch the 4-minute video.
TSLA
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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 selling a lot more cars for less revenue. The company had its lowest gross margin since the pandemic. Auto production is up 86%, revenues are up ~45% Y/Y and average selling prices down ~20%. Operating income is down 2.6% Y/Y, which doesn't sound bad, but it's down ~40% since 4Q despite more factories and production. This company is supposed to be ramping production but they are making less money and talking about further price cuts.
From Keith McCullough's Early Look on July 24: There was no fundamental reason for TSLA to be straight up ahead of reporting reality. It was up because of A) The Flows of The Machine and B) #MOAB (Mother of All Bubbles) Behavior (performance chasing) on Wall Street. Yep. Onto the next.
STLD
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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) reported earnings, and shipments are decelerating notably despite production continuing to grow 6%; seeing some pressure here.
DE
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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. |
Coming off a 52-week high stock price, Deere & Company (DE) ended the week with three straight down days. We believe this stock is highly overpriced. 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. DE is an active participant in the used market and remains a short.
KNX
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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. |
Knight-Swift Transportation (KNX) management noted that they have never seen freight demand fall so fast without a subsequent recession as part of their material guidance cut. KNX lowered its full-year EPS outlook to a range of $2.10-$2.30, a significant downward revision from the prior earnings forecast for $3.35-$3.55 per share.
DLR
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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. |
On The Pitch this week, REITs analyst Rob Simone presented a high-conviction short case of Digital Realty Trust (DLR).
Click here to watch Simone's 10-minute pitch to Keith McCullough.
ULTA
Ulta Beauty (ULTA) traffic trends have started to decelerate over the past few weeks. We think traffic and demand trends will continue to slow, leading to slowing revenue growth for a company and category that has seen outsized accelerations in growth over the last year and a half due to people going out again post-pandemic. The unit growth here is approaching a critical level, where it will cannibalize its own store base and enters into subprime markets. On top of that, the Kohl’s Sephoras are opening up right on Ulta’s doorstep, creating, what we think is, real incremental competition for beauty spending dollars. Kohls beauty on its own wasn’t much of a threat, but Sephora (owned by LVMH) is much better retail brand, and to maintain and grow market share, ULTA will do whatever it takes, which will be increased promotions. The consensus is underwriting an elevated margin story, which is just another reason why we are bearish behind ULTA here.
REXR
Rexford Industrial (REXR) is very over-owned. They were 100% exposed to what was the hottest industrial market in the country. These trends are now decelerating. REXR remains a short.
- Turnover costs per annum have doubled since early-2021, and TIs + LCs psf as a % of initial rent is in a clear uptrend. We wonder if this space is becoming more expensive to lease on the margin, even after significant redevelopment, which is pressuring net effectives "from below."
- Bad debt remains low, but is also trending in the wrong direction on the margin. Over the last 5 quarters bad debt has moved from a slight benefit over 2Q22-4Q22, to a -0.2% and -0.4% drag against gross rental income in 1Q23 and 2Q23. So again it is low and not an issue, but indicating increased credit issues at the tenant level on the margin. With that said occupancies obviously remain elevated near peak levels.
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
HOLD % TREND CONTINUES UPWARD FOR ONLINE SPORTSBOOKS
As free play and promo led sports betting handle continues to burn off, the next big lever has been hold percent optimization (the percentage of money the house keeps for every dollar wagered). As noted by the below chart, the trend remains up and to the right and we expect that to continue for at least another year or so. May was a big month for online sportsbooks' hold percent tracking >10% and while June (reported to date) has given back some excess gains due to sports outcomes, the lasting benefits of operational shifts and product mix has still contributed to a very solid month of hold percent trends. There might be some doubters left in the industry, but there shouldn’t be … we continue to point to EU and international markets where online sportsbook hold percent is sustainably much higher than the U.S. and runs in the 11-12% range.
As of June, OSB hold percentage for the US industry is up to 9.4% on a TTM basis, a solid improvement from 8.1% in the prior year and 7.8% in the year prior. For the industry’s biggest operators in terms of market share, this hold percentage trend should remain a catalyst, and especially so for DraftKings (DKNG), a company that is still lagging MGM and FanDuel. DKNG remains a Best Idea Long heading into next week’s print.
DDOG
Datadog (DDOG) will report 2Q earnings on Aug. 8.
The bull case on 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
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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). |
Communications analyst Andrew Freedman will provide his latest update on Match Group (MTCH) and other names in his sector in the monthly Communications Wrap webcast at 2 p.m. ET Monday.
ATVI
Mergers and acquisitions (M&A) across big-cap tech has slowed in recent quarters. While several factors are in play, the regulatory agenda of the current administration has been a prominent driver. With the recent federal court rejection of the FTC's case to block the Microsoft deal with Activision Blizzard (ATVI), will antitrust enforcement risk to major tech deals decline? Strategic M&A is an important catalyst for the sector, more so than the Private Equity catalyst of eating the dead fruit off the floor, and both are factors in consolidating the sector and driving relative equity appreciation.
Too soon?... It could be dangerous to assume that the FTC's defeat in the MSFT/ATVI battle will pressure the Administration to back away from its aggressive competition policy agenda. Administration opponents, however, recognize an opening to escalate criticism of the current approach. In a call at 10 a.m. ET Wednesday, Tech analyst Ami Joseph and Tech Law analyst Paul Glenchur will discuss the timeline for potential large cap tech M&A and talk more about the MSFT-ATVI deal.
CCL
Carnival (CCL) might not have an “AI” story to pitch but it does have great potential for positive earnings revisions and importantly, some multiple expansion. Royal Caribbean (RCL) earnings this week and Norwegian Cruise Line (NCLH) earnings next week should be positive catalysts and could lead to more sell side upgrades. Price checks and industry checks should continue to be a net-positive as well.
LFST
Lifestance Health Group (LFST) dropped providers in June 2023 according to our tracker. The overall impact was modest to estimates. The pace of adds was strong the first two months of the quarter, so even with the softer finish, our revenue estimate is coming in at $268M compared to consensus of $255M. We are modeling a slightly higher clinician utilization rate in 2Q23 given the efforts by management to retain therapists and enhance their scheduling. LFST remains a long.
CHH
Hotel construction pipelines aren’t what they used to be. More than 50% of the C-Corp pipelines are at high risk, and in the case of Choice Hotels International (CHH), the number is 65%.
Unlike development in the early and final planning phases, rooms under construction are almost a sure thing to open. Unfortunately, the industry, and especially CHH maintain a small portion of their pipelines actually under construction relative to historical levels. Overall, CHH’s pipeline is smaller relative to its room base and contains far fewer projects with active shovels in the ground. No company is immune from industry issues and a lot of pipelines are “less real” vs. pre-Covid, but CHH is by far the worst here. CHH benefits from more conversion activity than the average hotel brand (represents 25-30% of development), but as it pushes more into new construction brands, the aforementioned dynamics will impact its ability to accelerate net unit growth at the same time RevPAR is decelerating.
CFG
Slowing loan growth, both due to planned run-off and weaker demand in retail and commercial banking resulting from historic credit tightening; rising deposit costs; new regulatory concerns around capital requirements; and normalizing credit accelerated by the dual vacancy and refinancing risk associated with general office exposure are plaguing the broader regional banking space.
The earnings impact of higher funding costs will be amplified by increased conservatism through tighter underwriting and shifting asset mix targeting higher precautionary levels of liquidity.
Despite our continued view that Citizens Financial Group (CFG) is indeed a well-run bank, as evidenced by the prudent run-off of its auto and unsecured personal installment loan portfolios, Quad 4 gravity historically imposes itself indiscriminately across the regional banking industry. We recall management's comments from the 4Q21 earnings call in which macro was appropriately cited as the the principal risk to its outlook, particularly around the Federal Reserve's delicate balancing act of controlling inflation and not harming the expected trajectory of real economic growth.
HCA
HCA Healthcare (HCA) had a decent beat on Revs and EBITDA. Medical spending is starting to come through at ~30% incremental margin driving better margins in 2H23. We expected a little stronger volume +3.5% outpatient; +2.5% inpatient, but overall volumes and margin expansion is positive. Margins coming in stronger with a solid setup for 2H so staying Long HCA and expect it to head higher.
