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NKE: IDEA ALERT. DURATIONS CONVERGING

Takeaway: $NKE is our top idea in Retail, and now both quantitative and qualitative factors are converging to the upside.

We think that price and fundamentals are positively converging for Nike on both a quantitative and qualitative basis. We like the name on both a TRADE, TREND and TAIL basis, and added it to the Hedgeye Virtual Portfolio accordingly. Here’s our rationale…

 

 

TAIL: Nike’s growth algorithm over the next three year time period based on our model is unmatched. With a revenue CAGR of 10% leveraging to EBIT growth of 15%, EPS of 19%, and Free Cash Flow over 30%, it’s tough not to be impressed. Considering that this formula belongs to what is likely one of the top 10 brand names in the world, and the leader of a duopoly in a GDP plus industry (sports apparel) with a bullet proof balance sheet, it is tough to not be impressed. If we’re right, the Street is underestimating earnings by 10% over this time period. That’s enough for us to get excited about the name here – even at a seemingly lofty multiple.

 

NKE: IDEA ALERT. DURATIONS CONVERGING - nkechart1a

 

 

 

TREND: We think that gross margins -- the biggest factor impacting NKE’s sentiment and performance – will turn up meaningfully over the next three quarters. As the chart below shows, Futures has always seemingly been the biggest stock driver.

 

NKE: IDEA ALERT. DURATIONS CONVERGING - nikechart2

 

But it’s clear that something has taken over in the past six quarters, and it is clear to us – both quantitatively and anecdotally based on discussions with big institutions – that this is Gross Margin. Others might argue that it is China, or the sustainability of the ‘sneaker cycle’. We see the logic, but don’t agree with it. Our strong view is that once Gross Margins turn, then the stock will follow.  

 

NKE: IDEA ALERT. DURATIONS CONVERGING - nikechart3

 

Inventories have already started to move in the right direction, and we think that they’re cleaner today than they’ve been in two years. The relationship between inventories and margins is abundantly clear. FX also plays a big role, and at the current rate we’ll be back to yy parity within 2 months’ time.

 

Ultimately, the real delta to watch is ‘Futures less Inventories’ vs Gross Margins.  That accounts for demand (Futures) as well as the company’s ability to manage those orders in the form of inventory. That’s something that we’ve started to see turn, and we expect to increasingly move to the upper right as soon as 2Q which is reported in 3 weeks.

 

NKE: IDEA ALERT. DURATIONS CONVERGING - nikechart4

 

TRADE: The company reports the quarter in late December. We think that the 2-quarter streak of EPS growth rolling over will finally come to an end, and the consensus expectation for a flat quarter will be proved wrong. We think that expectations for Europe, China and even Emerging Markets remain very grounded. We’re at $1.06 versus the Street at $1.00, and we think that the company will be bullish about its look into calendar 2013.

 

VALUATION: The stock is trading at about 17x NTM earnings, well ahead of the 13x market multiple. That might seem unreasonable, but a) the stock is closer to 15.5x our numbers, and b) the market does not have the same characteristics as Nike with a path for a 10% sales CAGR leveraging to 30%+ Free Cash Flow.

 

NKE: IDEA ALERT. DURATIONS CONVERGING - nkechart7


YUM: Built To Last

Yum! Brands (YUM) is selling off strong today after worse-than-expected preannounced China comps spooked analysts and investors last night.  Several downgrades from the Street today have added to the fear, creating what we have seen time and again in this stock: the China scare buying opportunity. 

 

YUM is geographically diverse from an operating income perspective  (first chart, below) but not so much from a sentiment perspective.  The perception among many investors is that this is a “China stock”.  While China is important for YUM, we would highlight that previous sequential decelerations in China’s Real GDP Growth and YUM’s China comps have not resulted in corresponding deceleration in earnings growth (second chart, below).  EPS growth has been remarkably consistent over the past number of years with economic growth rates in China and other markets varying over time.

 

YUM: Built To Last - YUM1

 

With today’s sell off, a spate of downgrades, and what seems to be a full baking in of worse China growth expectations, we believe that YUM represents a very attractive opportunity on the long side. 

 

YUM: Built To Last - YUM2


Energy and Volatility

We’ve already discussed the importance of the CBOE Volatility Index (VIX) hitting 14 and how it affects stocks, but what about other markets like energy? With volume and volatility moving lower, risk increases. Energy is a high beta sector, meaning that when the broader market sells off, energy sells off further and faster (and vice versa). The Energy Select SPDR ETF (XLE) is heading lower and when the VIX hits 14, it’ll likely take a beating.

 

Energy and Volatility - xle vix


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20 Proprietary Risk Ranges

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Watching The VIX

 

Hedgeye CEO Keith McCullough appeared on CNBC’s Fast Money earlier this week and discussed the markets and America’s debt ceiling issues. One topic that’s more important than ever today is volatility in the market. The CBOE Volatility Index (VIX) is the de facto measurement of market volatility and when the index is at 14 (it’s currently at 15), it becomes a clear indicator to sell stocks. Keith calls it one of the most “obvious, clean-cut sell signals” out there. We short the S&P 500 when the VIX hits the low 14s and will continue to do so when the VIX hits those levels.

 

Watch Keith's full take on the VIX and when to sell stocks in the video posted above.

 


Mo' Money, Mo' Problems

Client Talking Points

The Vix

Not to be confused with the ‘80s band The Fixx, the CBOE Volatility Index (VIX) is at 15 and fast approaching the key level of 14. When the VIX is at 14, it’s a clear level to sell stocks for us and the rest of the institutional crowd out there. As we head into the weekend, keep an eye in the index in today’s trading. Provided there are no blowout catalysts in today’s market, volatility should remain at current levels.

Turning Japanese

With politicians debating what to do about the Fiscal Cliff on a daily basis and less than a month left until we hit the debt ceiling, things aren’t looking cheery for the United states right now. We’re beginning to look like Japan in ways as population growth slows along with our GDP numbers. The Federal Reserve’s agenda of printing money to solve problems hasn’t fixed anything and has artificially inflated commodity prices and the stock market while devaluing our currency over the years. With the US dollar down two weeks in a row, dollar bulls can’t call the currency the Comeback Kid just yet.

Asset Allocation

CASH 49% US EQUITIES 6%
INTL EQUITIES 0% COMMODITIES 9%
FIXED INCOME 21% INTL CURRENCIES 15%

Top Long Ideas

Company Ticker Sector Duration
TCB

After a long downward slide, TCB has finally turned the corner. The margin has stabilized after the balance sheet restructuring. Loans are growing thanks to the equipment finance business. Non-interest income is more likely to go up than down going forward, a reversal from the past 18 months. Credit quality has a tailwind from a distressed housing recovery in TCB’s core markets: Minneapolis, Detroit and Chicago. On top of this, the CEO, Bill Cooper, is one of the oldest regional bank CEOs, which raises the probability that the bank will be sold. Expectations are bombed out at this point, so we think it’s time to move from bearish to bullish on TCB.

IGT

There is improving visibility on 20%+ EPS growth with P/E of only 11x with better content leading to market share gains. New orders from Canada and IL should be a catalyst. Additionally, many people in the investment community are out in Las Vegas at the annual slot show (G2E) and should hear upbeat presentations by management.

HCA

While political and reimbursement risk will remain near-term concerns, on the fundamental side we continue to expect accelerating outpatient growth alongside further strength in pricing as acuity improves thru 1Q13. Flu trends may provide an incremental benefit on the quarter and our expectation for a birth recovery should support patient surgery growth over the intermediate term. Supply costs should remain a source of topline & earnings upside going forward.

Three for the Road

TWEET OF THE DAY

“I wish one politician would call it what it is..taxes, not revenues” -@upsidetrader

QUOTE OF THE DAY

“It is amazing what you can accomplish if you do not care who gets the credit.” -Harry Truman

STAT OF THE DAY

Unemployment in the Eurozone hit a new high of 11.7% in October.


YUM: BEST POSITIONED LARGE CAP RESTAURANT COMPANY

Takeaway: YUM headlines this morning are an overreaction to last night's release, in our view.

As we said on our Yum call yesterday the company has been, and continues to be, a stock that you buy on China scares. The sell off this morning, in the wake of yesterday’s release from the company, presents another opportunity to buy the best Large Cap restaurant stock.  With regard to China, same-restaurant sales is a critical metric but unit growth is more important, in our view, that allows the company to achieve its stated guidance. 

 

YUM stated that SRS in 4Q are expected to be +4% at YRI, +3% in the U.S., and -4% in China.  The China numbers are missing consensus by 600bps and represent a +8.5% on a two year basis.  Both YRI and the USA results are better that consensus and consistent with our thesis.

 

On the development front, international development is expected to be at least 1,850 new units for the year, including at least: 800 new units in China (upside surprise), 950 at Yum! Restaurants International (upside surprise), and 100 at Yum! Restaurants India.

 

YUM is also lapping a Q4 headwind due to an additional week in 2011 fiscal year which produced a combined $26M operating profit benefit to the U.S. and YRI.

 

The company reaffirmed its guidance for 4Q12 of “at least” $0.82, but the Street was ahead of the company at $0.85.  The reaffirmation of FY12 guidance highlights one of our points during yesterday’s call: the company’s geographically diverse business model allows it to achieve targets despite weakness in certain markets.  In this case, it is its most important business, China, that is seeing weakness but the company is still expecting to achieve its FY12 guidance. 

 

FY13 guidance contained no material surprises:

  • The company expects at least 10% in EPS growth (street modeling more)
  • At least 1,800 new international units, including at least: 700 new units in China, 950 at YRI, and 150 at Yum! Restaurants India (as per our theses we expect upside to these numbers)
  • Estimated tax rate of about 27% with quarterly fluctuation
  • Foreign currency translation expected to be flat
  • Global capital expenditures of over $1B
  • Interest expense expected to be flat
  • 2% reduction in average diluted shares outstanding as a result of share repurchases
  • Worldwide G&A increase of 3% due to continued growth in China

This morning, the stock was cut to Neutral vs Buy at UBS, Neutral vs Positive at Susquehanna, and Underperform vs Market Perform at UBS.  We would buy the stock on these downgrades.

 

YUM:  BEST POSITIONED LARGE CAP RESTAURANT COMPANY - yum china srs

 

YUM:  BEST POSITIONED LARGE CAP RESTAURANT COMPANY - yum yri srs

 

YUM:  BEST POSITIONED LARGE CAP RESTAURANT COMPANY - yum us srs

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 

 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.28%
  • SHORT SIGNALS 78.51%
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