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RCL: Cruising Ahead

Royal Caribbean Cruises (RCL) is set to report in-line Q3 results this Thursday due to better cost management. It has had six straight quarters of better-than-expected expenses sans fuel; we expect it to continue. Here are some takeaways from our Gaming, Leisure and Lodging Team on RCL:

 

·Despite a 6.5% increase in bunker fuel prices since their guidance on July 20, RCL should report in-line 3Q results Thursday due to better cost management

·RCL has had six straight quarters of better than expected expenses ex fuel, and that streak should continue, 2012  guidance should be intact but F4Q may be lowered slightly due to continued pricing weakness in North America (i.e. Caribbean) and higher fuel prices

·But investors may not care much about this fiscal year as all ears will be on Fiscal 2013 commentary

·Bookings continue to be solid and will likely improve in 2013, F1Q 2013 is a difficult comp as yields were up 7% last year with much of the business booked before the Costa Concordia incident

·We’re seeing slightly higher Caribbean pricing YoY for 1H 2013, though it is losing steam recently,69% and 37% of capacity is in the Caribbean for 1Q 2013 and 2Q 2013, respectively

·The recovery in European pricing has been steady

 

RCL: Cruising Ahead  - image003


TGT: Terms Don't Look Good For Credit Sale

Takeaway: $TGT's credit card sale is finally done. But at a price well below what we think is acceptable at this point in the cycle.

So, Target is finally selling its credit business in a transaction with TD for $5.9bn. All in, it looks like a bad deal for Target. Par value is the low end of the range for what we should be seeing in deals like this, especially at this point in the cycle. A good deal would have been a mid-to-high single digit premium to receivables.

 

Mind you, it's not like this is a poor quality portfolio. TGT's REDcard, which offers 5%discounts and gives cardholders free shipping for online orders accounted for 12.8% of sales in the latest quarter vs 8.7% a year ago. Perhaps the quality of that growth is less than what the Street otherwise thought.

 

In the end, the cash in in, and the distraction is gone. But the price is low. 


COH: Price Changed, Research Hasn’t

Takeaway: No thesis-changers in this $COH print. There’s some for the bulls and some for the bears. But the only thing really to change is price.


The punchline for us is that we’d short more Coach on strength following the quarter. It’s not that we’re trying to find the bad in this event to justify our call – we don’t do that. But very simply that nothing has really changed except the price – and even that is coming back down to earth after giving back most of initial gains.

 

Quantitatively, the stock needs to break $58.81 and hold that level for bulls to have anything meaningful to hold on to from a near-term perspective, but  the fundamentals won’t support that. The stock initially traded like this was a blow out quarter. In reality, revenue was in-line, margins were down -209bps, EPS grew at a whopping 5%, and inventory growth outpaced sales by 5pts. Guidance – whatever little Coach gives – was very much unchanged, and there was not a whole lot of new information on the call. We’d be surprised if consensus operating estimates change meaningfully following this print.

 

There were a few notable call outs from where we sit.

  1. The first is that the new (high cost) Legacy product line is ‘off to a good start’, meaning that the chance of it falling  flat on its face is minimized. This is important because it’s Coach’s biggest product launch in years, and it is spending accordingly. If the product line did not catch on, it would be a disaster for Coach. They can’t declare victory yet. But they can check the box that it was not a failure. Positive
  2. They could have really muddied the water with their new reporting structure, but did not. The door was wide open for them to add an element of opacity to mask the real underlying trend in their business, but that did not materialize. Positive
  3. While they averted a negative development with perception of disclosure, the reality is that guidance remains very slim. The ‘trust me’ factor remains high and it’s not good enough for us that they’re simply buying the stock. Negative
  4. While comps came in at a respectable +5.5% in NA, the company is slowing store growth on the margin from 30 to 25 stores. Negative
  5. Coach’s SIGMA looks ‘putrid’. This is the 10th quarter in a row where inv/sales has been in a bad space, or headed towards one. The margin move looks awful, and the compares over next 3 quarters get tougher. Tough margin compares with higher inventories is never a great set-up.  Bulls will point to the fact that COH bought it its Korea and Malaysia distributor in the quarter which caused the margin erosion and inventory hit. That’s acceptable, but it does not change the fact that more product needs to be sold at the best margin possible to comp last year’s trend. Negative

Apparently, a low quality 2-cent beat on in-line revenues and weak gross margins with elevated SG&A was good enough to get the stock up in this morning’s session. But the reality for us is that revenue is still slowing, and the cost of those sales is going higher. COH looks cheap ‘relative to history’ where it is today. But valuation is not a catalyst.


It’s guiding to 31% operating margins today. As it grows into more spaces outside the traditional core, margins are more likely to come down than go up. Mind you, 31% is exceptional. Even if they came all the way down to 25% that would still be exceptional by any standards in retail. But unfortunately, stocks don’t go up when margins come down.  

 

COH: Price Changed, Research Hasn’t - COH S

 

COH: Price Changed, Research Hasn’t - COH TTT

 

 


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Oil Sentiment Perspective

While no major change has occured in our key oil sentiment indicator, bullish sentiment is still correcting off its third spike in two years. On the downside, we’ve seen $80/bbl hold. Who knows when we’ll be able to break that? From a long-term perspective, it appears that hedge funds are still very bullish on crude oil. Between 1995 and 2000 the average net length was +15k contracts; between 2000 and 2010 it was +61k contracts; and the market has not been net short crude oil since 2003. 

 

Oil Sentiment Perspective  - oilsentiment


CAT: 9X Peak Earnings Is Not “Cheap”

Takeaway: 2012 now appears the "peak" of the EPS cycle for $CAT. At >9x peak EPS, this deep cyclical isn't cheap. 2013 EPS likely to head much lower.

CAT: 9X Peak Earnings Is Not “Cheap”

 

  • Revisions Negative:  This morning, we are seeing lots of revisions downward for CAT’s 2013 EPS.  Even though the company did not explicitly provide 2013 guidance for EPS, the commentary about mix and other trends suggest 2013 EPS will decline from 2012 record levels.  Flat sales and declining margins vs. 2012 imply lower 2013 EPS. 
  • How Much Lower?:  If the book-to-bill ratio of 0.69 in the quarter is any guide, 2013 EPS will head quite a bit lower than 2012.  That leaves 2012 as the “peak” in this cycle.
  • Peak EPS & Peak Multiple:  We dislike “peak multiple” valuation frameworks for a number of reasons (a multiple is just an inflexible implied DCF with all of the assumptions hidden, for one), but we would point out that deep cyclicals like CAT are unlikely to be seen as cheap at 9x peak EPS. 
  • Downhill:  In general, owning a deep cyclical right after “peak” earnings is unlikely to work out well. 
  • Orders Surprisingly Weak:  We found the weakness in CAT’s orders surprising yesterday – and we were very bearish on orders going in.  In retrospect, the significant declines in order activity probably drove CAT management to lay out their ultra-bearish scenarios at the MineExpo Analyst day.   Orders would have to rebound nearly 50% from the 3Q 2012 run rate for CAT just to hit its 2013 sales guidance, in our view. 
  • Better Industrials Longs:  We like many things about CAT the company: great products, good markets, good people etc.  The stock, however, seems a very bad long.  Many better Industrials are out there - see our Truck OEM Black Book on PCAR and our upcoming Novemeber 5th Black Book on Express & Courier Services for our take on better long ideas.

CAT: 9X Peak Earnings Is Not “Cheap” - btb

 

 

 

Jay Van Sciver, CFA

Managing Director


HEDGEYE RISK MANAGEMENT
120 Wooster St.

New York, NY 10012


 


Chinese Rebar Decline Continues

We like to compare the price of Brent Crude oil to Chinese steel rebar. Since the beginnning of 2012, there’s just been a massive drop in the price of both rebar and oil. And while oil got a legitimate bounce off the $90 level in June, rebar continued to head lower. Recently, there’s been a bounce in both rebar and Brent Crude, but we think it’s irrelevant as infrastructure spending is still on the decline. China isn't going to go on a building spree anytime soon.

 

Correlation does not equal causation, though this chart argues for Brent in the $70-80/bbl range. Something to think about. Rebar will have to climb higher and oil will have to head lower in order for these two to correlate closely again.

 

Chinese Rebar Decline Continues  - rebar


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