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FedEx Idea Alert: Degrees of Freedom Skewed To Upside

Takeaway: $FDX is a top long idea. Inventories are flashing a buy signal and cost opportunities could drive significant upside, among other positives.

FedEx Idea Alert: Degrees of Freedom Skewed To Upside

 

Levels:

TREND = 88.52

TAIL = 86.23

 

 

FDX A Top Long Idea:  FedEx is our top transport idea and we believe it is one of the best investment opportunities in the Industrials sector.  We have put together a Black Book on the Express & Courier Services industry here and written a note detailing how FDX fits into our investment process here.   FDX has many more positive degrees of freedom than negative ones, in our view, and we review the key aspects of our thesis below.

 

Inventories:  Inventory levels in the broader economy are a key driver of express volumes.  Businesses generally do not pay to express an item that they already have on hand.  Relative to trend, inventories have risen to a level that has historically signaled a good entry point for the Airfreight & Logistics sub-industry.  If you buy cyclicals when times are bad and sell them when times are great, the chart below indicates that it is currently lean times for express carriers like FedEx.  Note that this inventory signal is rare, breaching this level only half a dozen times in the past 30 years and remaining below it for about 86% of observations.

 

FedEx Idea Alert: Degrees of Freedom Skewed To Upside - 6

 

 

FedEx Ground Set to Dominate Industry:  UPS is not the first company to stand at a competitive disadvantage because of uncompetitive union labor costs.  FedEx Ground appears destined to dominate the US ground parcel industry as UPS’s iconic franchise loses share to a more nimble competitor, in our view.  Similar dynamics have occurred in many other unionized industries in recent decades.  FedEx Ground has ~18% operating margins and a clear revenue growth trajectory, positioning the unit to be a significant value driver for shareholders.

 

FedEx Idea Alert: Degrees of Freedom Skewed To Upside - 7

 

 

Express Cost Cuts:  FedEx Express has ~$26 billion in revenue at a rough 4% operating margin run-rate in fiscal 1Q 2013.  UPS and DHL have much higher margins (about 5 points) and there is no reason we see why FedEx cannot match or exceed competitors’ profitability.  Management is targeting ~$1.6 billion in P&L improvement at FedEx Express.  If management hits that target, which looks achievable to us in a normalized operating environment, the value of just the Express division could exceed the firm’s current market value, by our estimates.  We would happily take FedEx Ground for free.

 

TNT Deal Divestitures:  Since UPS’s future appears to be in express services, we expect the firm to pursue the TNT merger aggressively.  Divestitures of European operations are almost certainly needed to obtain EU antitrust approval for the deal.  FedEx would benefit from a stronger presence in Europe and is the only real buyer for the assets, in our view. 

 

FedEx Idea Alert: Degrees of Freedom Skewed To Upside - 8

 

 

Other Factors:  We also explore the impact of containerized freight rates vs. airfreight rates, airfreight capacity and global trade in our Express & Courier Services Black Book.

 

Valuation Scenarios Suggest Positive Risk/Reward:  We may be a little early in terms of the inventory cycle, but the cost reductions, FedEx Ground growth and TNT divestitures more than assuage our anxieties.  Our bear case FDX valuation is ~$85, suggesting limited downside from current levels if our thesis fails to play out.  Our base case valuation range of $120-$150 suggests healthy reward potential and upside to ~$180 if our thesis really comes together.   

 

 

 

 

 

 

Jay Van Sciver, CFA

Managing Director


HEDGEYE RISK MANAGEMENT
120 Wooster St.

New York, NY 10012


 

 

 

 


Weekly European Monitor: Padding Greece’s Pocket

Takeaway: There’s no prospect of this being the last bailout or concession thrown Greece’s way.

-- For specific questions on anything Europe, please contact me at to set up a call.

 

Asset Class Performance:

  • Equities:  The STOXX Europe 600 closed up +0.9% week-over-week vs +4.0% last week. Top performers:  Austria +2.7%; Hungary +2.2%; Czech Republic +2.1%; Switzerland +1.6%; Netherlands +1.5%; Germany +1.3%; Sweden +1.3%; Poland +1.3%; Italy +1.1%.  Bottom performers:  Cyprus -12.2%; Greece -4.2%; Portugal -1.3%. [Other: UK +0.8%].
  • FX:  The EUR/USD is up +0.22% week-over-week vs +1.84% last week.  W/W Divergences:  HUF/EUR +0.45%; CZK/EUR +0.40%; RUB/EUR +0.38%; PLN/EUR +0.30%; TRY/EUR +0.18%; DKK/EUR -0.03%; CHF/EUR -0.09%; GBP/EUR -0.28%; NOK/EUR -0.39%; SEK/EUR -0.66%.
  • Fixed Income:  The 10YR yield for sovereigns were down across the region week-on-week. Spain declined the most at -30bps to 5.38%, followed by Portugal -29bps to 7.62%, Italy -25bps to 4.53%, Greece -23bps to 16.21%, and Belgium -22bps to 2.07%. France fell -11bps to 2.05% and Germany declined -5bps to 1.37%.   

Weekly European Monitor: Padding Greece’s Pocket - cc. yields

 

 

EUR/USD: Our TRADE range is $1.29 – 1.31 with a TREND resistance of $1.31.

 

  • Our call - the EUR/USD will trade within our quantitative levels and reflect much of the daily headline risk (from Spain, Greece, and Italy in particular), however ECB President Mario Draghi’s September announcement that “the ECB is ready to do whatever it takes to preserve the euro” and the resolve of Eurocrats to maintain the Union will prevent levels falling anywhere near parity.
  • We believe there is a high likelihood that no significant policy action comes in the remaining weeks of 2012, which could support the band the cross has been trading in over the last weeks.

Weekly European Monitor: Padding Greece’s Pocket - cc. eur usd

 

Weekly European Monitor: Padding Greece’s Pocket - cc  cftc

 

 

Padding Greece’s Pocket:

 

For updated thoughts on Europe, and in particular Greece’s most recent hand-out, see Thursday’s Early Look Titled Europe’s Shell Game.

 

 

The European Week Ahead:


Saturday - Beginning of the Russian Presidency of G20

 

Sunday - Nov. UK Lloyds Business Barometer and Hometrack Housing Survey

 

Monday - ECB Governing Council Meeting; Eurogroup Meeting in Brussels; Nov. Eurozone PMI Manufacturing – Final; Nov. Germany PMI Manufacturing – Final; Nov. UK PMI Manufacturing, BRC Sales Like-For-Like; Nov. France PMI Manufacturing – Final; Spain Manufacturing PMI; Nov. Italy PMI Manufacturing, Budget Balance, New Car Registration; Greece Manufacturing PMI

 

Tuesday - Oct. Eurozone PPI; Nov. UK PMI Construction, BRC Shop Price Index; Nov. Spain Unemployment

 

Wednesday - Nov. Eurozone PMI Composite and Services Final; Oct. Eurozone Retail Sales; Nov. Germany PMI Services – Final; UK Chancellor Osborne Makes Autumn Statement in Commons; Nov. UK Official Reserves, PMI Services; Nov. France PMI Services – Final; Spain Services PMI; Oct. Spain Industrial Output; Nov. Italy PMI Services

 

Thursday - ECB Announces Interest Rates, ECB Deposit Facility Rate; 3Q Eurozone Household Cons, Gross Fix Cap, Government Expend and GDP – Preliminary; Oct. Germany Factory Orders; UK BoE Announces Interest Rates, BoE Asset Purchase Target; Nov. UK New Car Registration; Oct. UK Visible Trade Balance, Total Trade – Preliminary; 3Q France ILO Unemployment Rate; Sep. Greece Unemployment Rate

 

Friday - Oct. Germany Industrial Production; Nov. Germany Wholesale Price Index (Dec. 7-12); 3Q Germany Labor Costs Workday Adj, Labor Costs Seas. Adj; Dec. UK CBI Trends Total Orders, Trends Selling Prices and Reported Sales (Dec. 7-15); Nov. UK BoE/GfK Inflation Next 12 Mths, NIESR GDP Estimate; Oct. UK Industrial Production, Manufacturing Production; Oct. France Central Govt. Balance, Trade Balance; 3Q Greece GDP - Final

 

 

Extended Calendar:


DEC 12-13 –          First public consultation between the Russian government, B20 Coalition and international civil society representatives on G20 agenda for 2013 (in Moscow)

DEC 20 –               ECB Governing and General Council Meeting

APR 2013 –           Parliamentary elections in Italy

MAY 2013 –           Presidential elections in Italy

 

 

Call Outs:


Spanish Banks - The European Commission approved the restructuring plans for four Spanish banks - Bankia, NCG Banco, Catalunya Banc and Banco de Valencia (which will be sold to CaixaBank). The approval will allow the banks to receive aid from the ESM.

 

Spanish banks - Cut their government bond holdings by €5.2B in October after an €8.8B increase in September. Total sovereign holdings, adjusted by market value, fell to €253.7B last month.

 

Spain - Bankia said that holders of preferred shares will have to take a write-down of 39%, while holders of perpetual subordinated debt will face a write-down of 46% and holders of subordinated debt with a maturity date will have to take a loss of 14%. According to estimates by Barclays, ~€30B of these products were sold to individual savers/retail investors before the crisis by small Spanish banks, including Bankia.

 

Spain - Bank of Spain noted that Spain experienced a capital inflow of €31B in September (August saw an outflow of €11.8B).

 

OECD  - Slashes 2013 growth forecast for advanced economies (1.4% versus 2.2% forecast in May).

 

ECB and OMT - Vice President Constancio said that the central bank expects Madrid to apply for support, triggering the OMT. While he noted that this is the ECB's base scenario for Spain, he reiterated that it is up to the Rajoy government to make a request.

 

UK - Bank of Canada Governor Mark Carney was named head of the Bank of England.

 

 

Data Dump:

 

Eurozone Services Confidence -11.9 NOV (exp. -12.5) vs -12.1 OCT

Eurozone Business Climate -1.19 NOV (exp. -1.60) vs -1.61 OCT

Eurozone Industrial Confidence -15.1 NOV (exp. -17.1) vs -18.3 OCT

Eurozone Economic Confidence 85.7 NOV (exp. 84.5) vs 84.3 OCT

Eurozone Consumer Confidence -26.9 NOV Final (inline)

 

Weekly European Monitor: Padding Greece’s Pocket - cc. manu and serv conf

 

Weekly European Monitor: Padding Greece’s Pocket - cc. business conf

 

Weekly European Monitor: Padding Greece’s Pocket - cc. consumer conf

 

 

Eurozone CPI 2.2% NOV Y/Y vs 2.5% OCT

Eurozone M3 3.9% OCT Y/Y vs 2.6% September

Eurozone Unemployment Rate 11.7% OCT vs 11.6% SEPT

 

Weekly European Monitor: Padding Greece’s Pocket - cc. unemploy eur and italia

 

Germany Unemployment Rate 6.9% NOV vs 6.9% OCT

Germany Unemployment Change 5K NOV vs 19K OCT

Germany Retail Sales -0.8% OCT Y/Y (exp. -0.3%) vs -3.4% SEPT   [-2.8% OCT M/M (= most in ~4yrs)  (exp. -0.4%) vs 0.5% September]

Germany GfK Consumer Confidence 5.9 DEC (exp. 6.2) vs 6.1 NOV

Germany CPI 2.0% NOV Prelim Y/Y (inline) vs 2.1% OCT

Germany Import Price Index 1.5% OCT Y/Y vs 1.8% September

 

France Consumer Confidence 84 NOV vs 84 OCT

France Producer Prices 2.9% OCT Y/Y vs 2.9% SEPT

France Consumer Spending -0.5% OCT Y/Y vs -0.3% September

  

UK Q3 GDP Preliminary -0.1% Y/Y vs -0.5% in Q2   [1.0% Q/Q vs -0.4% in Q2]

UK Nationwide House Prices -1.2% NOV Y/Y vs -0.9% OCT

UK M4 Money Supply -3.2% OCT Y/Y vs -3.7% September

UK GfK Consumer Confidence -22 NOV (exp. -30) vs -30 OCT

 

Italy Consumer Confidence 84.8 NOV (exp. 86.3) vs 86.2 OCT [new record low]

Italy Unemployment Rate 11.1% OCT vs 10.8 SEPT

Italy CPI 2.6% NOV Y/Y vs 2.8% OCT

Italy PPI 2.6% OCT Y/Y vs 2.8% SEPT

Italy Hourly Wages 1.5% OCT Y/Y vs 1.4% SEPT

Italy Business Confidence 88.5 NOV vs 87.8 OCT

Italy Economic Sentiment 76.4 NOV vs 77.1 OCT

 

Spain Retail Sales -8.4% OCT Y/Y (exp. -10.0%) vs -12.7% September

Spain Total Housing Permits -51.3% SEPT Y/Y vs -31.7% AUG

Spain CPI 3.0% NOV Prelim. Y/Y vs 3.5% OCT

Spain Mortgages on Houses -32.2% SEPT Y/Y vs -28.5% AUG

 

Switzerland Q3 GDP 1.4% Y/Y vs 0.3% in Q2   [0.6% Q/Q vs -0.1% in Q2]

Switzerland KOF Swiss Leading Indicator 1.50 NOV (exp. 1.60) vs 1.64 OCT

Switzerland UBS Consumption Indicator 1.31 OCT vs 1.04 SEPT

 

Austria Producer Prices 0.7% OCT Y/Y vs 0.7% SEPT

Belgium CPI 2.26% NOV Y/Y vs 2.79%

Ireland Property Prices -8.1% OCT Y/Y vs -9.6% SEPT

 

Portugal Consumer Confidence -59 NOV vs -55.3 OCT

Portugal Economic Climate -5 NOV vs -4.6 OCT

Portugal Industrial Production -4.3% OCT Y/Y vs -9.5% September

Portugal Retail Sales -6.9% OCT Y/Y vs -5.9% September

 

Sweden Manufacturing Confidence -18 NOV vs -16 OCT

Sweden Economic Tendency Survey 86 NOV vs 92.7 OCT

Sweden PPI -2.3% OCT vs -1.9% September

Sweden Household Lending 4.5% OCT Y/Y vs 4.5% SEPT

Sweden Q3 GDP 0.7% Y/Y vs 1.3% in Q2   [0.5% Q/Q vs 0.7% in Q2]

Sweden Retail Sales 1.2% OCT Y/Y vs 4.5% September

Sweden Consumer Confidence -7.4 NOV vs -2.9 OCT

 

Finland Business Confidence -14 NOV vs -12 OCT

Finland Consumer Confidence 1.0 NOV vs -1.6 OCT

Denmark Q3 GDP Prelim -0.5% Y/Y vs -0.6% in Q2   [0.1% Q/Q vs -0.7% in Q2]

Norway Consumer Confidence 25.4 in Q4 vs 23.4 in Q3

Netherlands Producer Confidence -7.0 NOV vs -7.7 OCT

 

Greece Retail Sales -10.7% SEPT Y/Y vs -7.2% AUG

 

Hungary Unemployment Rate 10.5% OCT vs 10.4% SEPT

Slovakia Consumer Confidence -33.1 NOV vs -38.0 OCT

Slovakia PPI 4.2% OCT Y/Y vs 4.4% SEPT

Czech Republic Business Confidence 0.3 NOV vs 2.6 OCT

Czech Republic Consumer and Business Confidence -5 NOV vs -3.3 OCT

Czech Republic Consumer Confidence -26.3 NOV vs -27 OCT

 

Poland Retail Sales 3.3% OCT Y/Y vs 3.1% SEPT

Poland Unemployment Rate 12.5% OCT vs 12.4% SEPT

 

 

Interest Rate Decisions:

 

(11/27) Hungary Base Rate Announcement CUT 25bps to 6.00%

 

 

Matthew Hedrick

Senior Analyst


THE WEEK AHEAD

The Economic Data calendar for the week of the 3rd of December through the 7th is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.

 

THE WEEK AHEAD - week


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MD: A "Short" Thing?

In recent weeks, we’ve noticed an increase of short interest in Mednax (MD). Short interest currently sits at 6.3 million compared to the prior two peaks of 3.5 million. Short sellers have had considerable luck with Mednax in the past and it appears they're of the belief that their winning streak will continue. Hedgeye Healthcare Sector Head Tom Tobin suggests Mednax is nearing a point where you could go long. Says Tobin:

 

“The best time to be long MD has been when the growth in short interest peaks and begins to decelerate and when the 3M change begins to decline.  So far the first condition has been met, but on a 3M sequential basis, short interest continues to climb higher.” 

 

 

MD: A "Short" Thing? - mednax

 

 

Another reason to consider going long is the recent re-acceleration in births. As it relates to our positive outlook for a birth recovery, we’ve notice a few positive datapoints in recent days that coincide with the same population that drives birth trends, the 20-35 year old age group:

 

1. Pier 1 Imports (PIR) posted better than expected same store sales (#1 purchaser of furniture)

2. Household formation accelerated to 1.8% in October (#1 source of new households)

3. MBA Mortgage Purchase Applications Accelerating (#1 source of first time home buyers)

 

 


NKE: Our Answer to ASP Debate

Takeaway: We understand why people want proof that $NKE can deliver on ASP growth before getting bullish. But waiting for proof will be too late.

One point of pushback we got on the road recently about our Long NKE call is that the company will be unable to cycle its price increases in footwear. We think the argument is moot for several reasons.

  1. You could have made this argument in 2011. Then again in 2012. You’d have been wrong. In making in 2013 we think you’ll be wrong again.
     
  2. In 2H11 it appeared as if the sky was falling as you can see in the chart below, and ASPs were on their way back down from consistent mid-single digit gains. That ended up being very wrong as the company launched products like FlyKnit and Nike+ They manage the business for either units or asp – rarely if ever do they happen simultaneously.
     
  3. ASP does not only mean price.  While Nike has certain evergreen product like Dunks and certain Bowerman running product in this business it is near impossible to put through price increases on like for like product. That’s in part because like for like product does not exist. 90% of the product line changes every 90 days. But overwhelmingly, we’re talking mix, not price. And most importantly, higher mix does not mean higher profitability. In fact, while ASP went up over the past two years, Gross Margin in aggregate went down. This was in large part due to apparel, but the so-called ‘strength’ in footwear profitability should have otherwise offset apparel weakness. It did not.
     
  4. The punchline is that there needs to be an element of trust here. We hate saying that, as trust is hardly an investment process. But the company manages its business around a top line number. There are times when it fuels this top line goal by higher average prices due to a new product launch at a high price (but at lower volumes), and then there are other times where the product works its way into ‘proliferation mode’ to a lower-price-point consumer and greatly accelerates unit growth in more mainstream channels of distribution (ie Kohl’s instead of Nike Retail). There are not many companies where we’ll front them any form of success in their business plan, but the fact is that Nike has an overwhelmingly successful track record in delivering on its expectations for managing the product price/volume curve (notably in footwear). We won't blindly trust that they hit their goal, but we'll give them the benefit of the doubt.

 

We understand why people want proof of the company’s ability to deliver on the top line before they get bullish. But in this instance, and at this price, we think that waiting for proof will simply be too late.    

 

NKE: Our Answer to ASP Debate - 11 30 2012 12 39 19 PM


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


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