PCAR: Turning A Loss Into A Gain

Over the past year, Navistar (NAV) has lost considerable class 8 market share in the trucking sector. In August, Industrials Sector Head Jay Van Sciver noted that Navistar would likely lose significant market share following quality and strategy challenges. In turn, PACCAR (PCAR) is poised to pick up the pieces, turning Navistar’s loss into PACCAR’s gain by picking up market share that Navistar lost. PCAR will likely see the benefits of higher market share in 2013 and the stock remains one of our top long ideas.


PCAR: Turning A Loss Into A Gain - NAV

Idea Alert: FNP -- Go Long Now

Takeaway: We’re adding $FNP to Hedgeye's Virtual Portfolio as the quantitative setup and catalyst calendar synch with our bullish fundamental view

We’re adding FNP to the Hedgeye Virtual Portfolio as the near-term quantitative setup and catalyst calendar synch with our bullish intermediate and long-term fundamental view. Our estimates remain double the consensus for the next two years.


We think that the pre-ICR update is likely to be favorable, and that we’re more like than not to see a 25% upwards positive revision beginning by the time the company reports its fourth quarter in early January.


The crux of our call around FNP is that this is an out of favor stock with more unrealized value than perhaps any other name in retail. It has Kate Spade, which is one of the best growth stories in global retail today and is worth over 40% above where the stock is today based on our assumptions. Then it has Lucky Brand, which we view as an annuity. It is one of the few denim brands that might not take a big swing at the fences each year, but has muted fashion risk and it consistently contributes cash flow to cover roughly half of the parent’s capex. Then…there’s Juicy Coture. We think that the break here is not temporary, but that they have a customer problem that will be too much to overcome. That’s when bad news is good news because we think that CEO McComb has low tolerance for having his crown jewel (Kate) weighed down by the ugly red-headed stepchild.


Our point is that the chance is low that Juicy is still part of the company in six months’ time. We don’t think that having a new COO (hired last month) impedes this decision. In fact, it allows McComb to run the parent, not the sub, and also makes the bench more attractive for a buyer.


If we assume that Juicy gets a paltry $160mm on a $500mm revenue base, then we get to a scenario where 45% of FNP’s debt is gone and it takes any concern about the balance sheet right along with it.


Perversely, we don’t think that there will be as much value added if Juicy is fixed – but in the end, we think that the only risk to Juicy is no volatility. Improvement is good. Erosion is good (ie it gets sold). Status quo is like Chinese water torture.


But that's already priced in to the stock, and status quo on a third of the business while one third acts as an annuity, and the other third continues as one of the best growers in retail is not exactly a bad place to be. Our aggregate value for the company today – using a very realistic ‘sell it now’ price for Juicy is $20 per share, and we think that either corporate action or the upwardly revised earnings power of the company will get it there in 2013.


Idea Alert: FNP -- Go Long Now - 12 20 2012 11 18 59 AM

Jobless Claims: Happy Holidays

Jobless claims rose 18k to 361k last week, but the 4-week rolling average declined 14k to 368k bringing us back to pre-Hurricane Sandy levels. If we examine state data for NY, NJ and PA, the areas most affected by the storm, they’ve fully re-normalized. Despite the first rise we've seen the past five weeks, we expect claims data will continue moving lower in the coming months thanks to a seasonality distortion tailwind (i.e. holiday help). Add in the positive growth we’ve seen in the housing market recently and financials like Bank of America (BAC) and Citigroup (C) should benefit from the data.


Jobless Claims: Happy Holidays - 1 normal


Jobless Claims: Happy Holidays - 12 normal


Jobless Claims: Happy Holidays - 3 normal


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Bullish: SP500 Levels, Refreshed

Takeaway: Bullish is as bullish does.

POSITION: Long Consumer (XLP, IGT, ADM), Short Commodities (XLE, OIL, CLB)


Bullish is as bullish does, and this market continues to hold all 3 durations of support (TRADE, TREND, and TAIL). Buying stocks at VIX 17-18 has worked for the last few months too (sell at VIX 14-15).


Across our core durations, here are the lines that matter to me most:


  1. Immediate-term TRADE overbought = 1449
  2. Immediate-term TRADE support = 1429
  3. Intermediate-term TREND support = 1419


In other words, the refreshed immediate-term risk range = 1, and there’s more upside than downside from here (there was more downside than upside from yesterday’s highs).


Keep making high probability gross and net exposure decisions – and keep moving.



Keith R. McCullough
Chief Executive Officer


Bullish: SP500 Levels, Refreshed - SPX

Warming Up For Winter

Despite the relatively mild temperatures here in the Northeast part of the United States, winter is fast approaching and as more of the population keep their homes heated, the price of natural gas and oil are on the rise. However, in recent weeks, both commodities have bucked tradition and dropped in price as the US dollar strengthens and the commodity super cycle we’ve experienced begins to deflate. Currently, natgas stands at 3.45/MMBtu and Brent crude oil at $110.06/bbl. We believe that oil will continue to fall in price over the coming weeks and is in for a particularly nasty drop.


Warming Up For Winter - energychart


Darden Restaurants released its full 2QFY13 results this morning.   There were few surprises in the press release but the earnings call made for some interesting listening.


“There will be more rejoicing in heaven over one sinner who repents than over ninety-nine righteous persons who do not need to repent.

-Luke 15:7



First Thing’s First


The big news from this morning’s earnings call is that the company is cutting its capex budget for FY14 by ~10%, driven mainly by a reduction in new unit growth.  FY13 new unit growth is now expected to be 100 units, versus prior guidance of 100-110.  The reduction in capex is being carried out to ensure the maintenance of “solid debt metrics that preserve our investment grade credit profile”. 


The company is still guiding to $1 billion in operating cash flow this year.  This will be helped by working capital turning to a source, from a use, of cash this year versus last year.  It should also be a source next year.  We believe it could be difficult to achieve this level of cash flow, given current fundamentals at the “Big Three”, and believe that investors’ expectations of the dividend’s growth trajectory may be at risk.


For the long-term, is this slide from the company’s most recent Annual Report still representative of management’s expectations?  The blade on that hockey stick seems to be getting longer.  We will be seeking more specificity on this going forward (chart below).


On the point of capital budget reductions for 2014, there seemed to be some incongruity in the message being delivered to shareholders.  Brad Richmond, Darden’s CFO, said that FY14’s capital budget is likely to come down by “as much as 10%”.  In response to the first question of the Q&A segment of the call, Clarence Otis, Darden’s CEO, stated that this figure would be “at least 10%”.  We can only deduce from this that 10% is, as the questioner suggested, the “opening bid” and a more drastic reduction in growth is possible if restaurant-level performance does not improve.


DRI ALMOST REPENTS - darden cash flow table annual report



Top-line Numbers Speak to Greater Strategic Issues


Recognizing the need to slow growth is one step on the path to redemption for this company but this quarter did not represent a full mea culpa.


The pre-announced same-restaurant sales numbers highlight significant challenges being encountered at OG, RL, and LH.  This morning’s earnings call brought us more of what we have heard before: unclear and meandering statements that fall well short of reassuring investors of the company’s position.  While the capex budget will be cut, management’s repeated claim that there has been “meaningful progress” made at each brand over the last three years is not supported by the facts.  The effectiveness of management’s promotions has, as we have been arguing for several quarters, been hit-or-miss at best.  The company’s ability to discern what products will perform well at market is under much doubt this morning:


“We've got a much more dynamic market than we have historically. And so, consumer confidence moves around a lot more. The competitive dynamic is such that people are in and out with things a lot more than they used to be. And so for sure, as we test something, we have to discount those results more than we've had to do in the past because the environment where we launch may have some pretty important differences from the environment where we tested and so, we recognize that.”

-Clarence Otis, CEO of Darden, 12/20/12


DRI ALMOST REPENTS - og comp detail




DRI ALMOST REPENTS - red lobster comp detail




DRI ALMOST REPENTS - lh comp detail





Recognizing that the margin profile of the company needs to change is also an important step for the company to regain its footing.  Olive Garden’s value leadership position has been eroded over the last few years but, clearly, repositioning a system as large as Olive Garden will take time.  The turnaround will likely involve recalibrating the consumer’s perception of the brand and this could take time.



The “Big Three” Are What Matters For Now; The Rest Is Noise


This is a company that derives roughly 87% of its revenue from its three largest concepts: Olive Garden, Red Lobster, and LongHorn Steakhouse.  While yesterday’s article in The Wall Street journal highlighted the Specialty Restaurant Group, which constitutes 12% of the consolidated revenue, and its growth potential for Darden, clearly the company’s share price will continue to be primarily driven by the performance of Olive Garden (OG), Red Lobster (RL), and, to a lesser extent, LongHorn (LH), over the next number of years.



What Now?


We believe that the takeaway from this earnings call is that casual dining is embarking on a period of war between the largest chains.  Nobody wins in a nuclear war and we expect lower prices at Darden’s chains to have a significant impact on all of casual dining. 


We remain unconvinced that Darden’s dividend is safe or, indeed, that the question about the dividend is how much it will grow by, as Clarence Otis suggested this morning.  Tough times lie ahead for Darden and, while we are not stating that we believe the dividend is definitely getting cut, we are placing the burden of proof squarely on management’s shoulders.


This stock, for us, has been a “show me” stock for several quarters as the company’s reactionary strategies have yielded disappointing results.  Confirmed by the line of questioning on today’s call, we believe that the investment community is adopting a similar stance, becoming less and less willing to give management the benefit of the doubt.


For much of calendar 2012, earnings revisions have been negative.  The stock price has largely ignored this as some analysts touted the yield and “stable cash flows” of the company as reasons to buy.  If confidence erodes further in the security of the dividend, expect the share price to correct significantly.





Howard Penney

Managing Director


Rory Green

Senior Analyst


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