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ICR: A Whole Lot of Complacency

Takeaway: The lack of a major theme out of ICR is itself a theme. We think this is the year where you're paid for the stock call, not the group call.

We think that this is the first ICR conference in at least 5-years where there is the absence of a major theme to carry the group – up or down – for the year. Management teams seemed complacent in their lot of ‘slightly better than average’ business trends, with few companies (FNP and URBN are two) who stand out with an exceptional process to drive their business to the next level.

 

Our top longs remain FNP, NKE, RH, URBN, and believe it or not – JCP is even gravitating to our bench of ideas.

On the short side, we like department stores – M, KSS, as well as GPS, and GES.

 

DETAILS 

The tone of this week’s ICR conference seemed positive overall to us, with a far more favorable preannouncement cadence than last year, and notable commentary on good inventory positions despite mixed sales results. You could drive a truck through the range in quality of the management teams there, and we were specifically impressed with discussions with both FNP and URBN as it relates to their respective views as to what it will take to more than double the size of their businesses, and the categories and selling methods it will take to get there.

 

But there was one big trend that hit us hard – and that was the absence of a recognizable trend at all. That might seem like a ridiculous statement, but let’s look at past ICRs and add some context.

 

  • 2008 and 2009: We were in the depths of the Great Recession. Positive datapoints were few and far between. The sentiment was almost uniformly negative, and the stocks behaved accordingly. Into the 2009 ICR conference alone, the group (as measured by the RTH – cap weighted S&P Retail Index) was off by almost 15%. The MVR (equal-weighted index of 30 retail stocks) was off by over 30% into and around the conference.
     
  • 2010: This was a big recovery year. Sales accelerated and inventories fell. That sent gross margins up high and earnings revisions higher. This is clear as day in Exhibit 2 below. The stocks started to work in earnest two quarters before the conference, but were still up 5-10% on the event as the recovery continued.
     
  • 2011: The Raw Material Scare. This is when people thought that cotton, which had just doubled in price over the shortest time period in history, would stay at $2 in perpetuity. The ‘recession earnings recovery’ slowed, at the same time the outlook for Average Unit Costs (AUC) went grossly out of favor. Translation = negative tone at ICR, and decelerating stock price performance.  
     
  • 2012: This was an interesting one. There were more severe preannouncements than any year yet, but more often than not companies chalked this up to the lingering impact of higher costs – which was the ultimate excuse because the fact of the matter is that it was valid. But at the same time the companies gave positive unofficial outlooks on getting pricing power in 2012 and the gap between AUR and AUC turning positive. The bottom line is that it gave people reason to believe, the tone of the event was upbeat, and the stocks traded up.
     
  • 2013: This year, as shown in Exhibit 2, Inventory/Sales trends are back to zero-barrier after a strong four-quarter trajectory upward. Gross margins are still down, but are within 100bp of peak and unlike last year, clean inventories won’t likely provide a tailwind. We’re not looking to paint a big negative call here, but just can’t come up with something positive, either. We’re pretty much ‘retail-agnostic’. The market seems to agree, as the stocks are only up 3% on the event – which is less than usual. We may get more GM improvement in 2013, but by and large, we need a strong consumer for the group to work en masse from here. The lack of strong proactive plans by many companies seems to support this.

 

Exhibit 1: S&P Retail Index vs. Past ICR Conferences

ICR: A Whole Lot of Complacency - icr1

 

Exhibit 2: Sales/Inventory Spread vs. Gross Margins (60 Company Average) vs. Past ICR Conferences

ICR: A Whole Lot of Complacency - icr2



Stand On Your Hands

 “When torrential water tosses boulders, it is because of its momentum”

-Sun Tzu

 

To invert is to change from one position, direction, or course to the opposite position, direction, or course.   Within the context of yoga, the art of inversion includes using breathing and your core mussels to control the mind and the body; inversion allows for efficient brain stimulation.

 

Blockages of blood flow to the brain can sometimes result in cognitive difficulties or, in extreme cases, serious health issues.  Performing daily inversions combats this by forcibly flushing old blood out of the brain and replacing it with freshly oxygenated, nutrient rich blood coming directly from the heart.  Performing the ritual of Adho Mukha Vrksasana has been empowering and beneficial for me.  The state of relaxation that follows can lead to gratifying periods of reflection. 

 

Listening to restaurant companies present at the ICR XChange conference is another ritual than can lead to soul searching.  “What am I doing?” “Does this matter?” “Did he really just say that customers love getting a free bucket of peanuts?” 

 

After many years of attending the ICR XChange conference, I decided not to attend this year.  As part of a new approach in 2013, I am trying to do things differently.  Being a restaurant analyst that is not at the ICR conference is analogous to performing an inversion; in part, it represents the avoidance of group-think that can lead to poor investment ideas.

 

The truth is, the #OldWall process is broken and, other than secret one-on-one meetings with management, which I have no desire to attend, little-to-no incremental insight is available from listening to restaurant company executives at ICR this week.  The ICR Exchange Conference is as #OldWallSt as it gets.  All 21 sponsors of the 15th Annual ICR XChange are the biggest investment banks on Wall Street.  Before each presentation, an industry analyst takes the podium to say a few kind words about the presenting company and its future prospects.  There are countless intelligent people to learn from at the event but, at its core, it represents the inherent conflict of interest that typifies the traditional sell-side research model from Wall Street. 

 

Listening from afar, I am realizing that I have made the correct decision.  Listening to endless generic presentations, getting to Chipotle’s “break out” table 30 minutes early just to get a seat, knowing in advance that commentary will be uniformly bullish whatever the underlying reality, becomes a meaningless exercise eventually.  After yesterday’s preannounced EPS miss from Chipotle, anyone could have written the script for today’s conference: “Everything is fine, we are still changing the industry, and our growth opportunity is still as great as ever.  This EPS miss was merely a blip”.  The bar scene in Miami definitely had a Wall Street influence last night.  A lot of conviction can be gathered on an idea while having a few drinks.

 

The “read through” and “takeaway” from a company meeting at ICR is often meaningless.  We are getting passed a lot of notes from the sell-side stating that “our meeting with management gives us confidence” in our buy rating.  If you ever receive a note from ICR saying that management meetings have bolstered confidence in a short thesis, call me collect.

 

That’s the problem with the #OldWall, it is very difficult to speak one’s mind about a company.  As an analyst, your incentives should line up with your clients’: produce effective research on the value of the securities in question and assist those paying clients in making their stock selections.   Unfortunately, the incentives of an analyst are too often in conflict with the clients.  Getting paid and retained is what matters; if clients happen to do well, that’s a happy coincidence.  Ask yourself how your sources, and their firms, get paid.

 

Coming out of events like ICR, the momentum in certain stocks can build and get a lot of people paid in the short run.  If there is one stock in the restaurant space that has embodied momentum over the past few years, it has been Chipotle. Today, management hinted at raising prices in 2H 2013 to absorb food inflation.  Yesterday, the stock reacted very favorably to that news, we think, in error.  The following is a checklist of questions that we think investors need to become comfortable with before getting behind this move in CMG:

  • If they decide to take price, do they have pricing power?
  • How much sensitivity is there?
  • Is new unit volume growth coming back?

On December 12th, we wrote that the CMG bottoming process was likely to take several quarters and that we would be more constructive on the stock at $250.  We know that over the past number of years, new unit AUV growth has led the inflection points in revenue growth, which has sequentially decelerated over the last two reported quarters.  Until new unit AUV growth bottoms, we expect top line growth to remain sluggish. 

 

The ICR XChange posed an opportunity for management to hint at taking price and, as usual, the congregation was more than willing in their acceptance of the myth.  Chipotle has to operate, like everyone else, in the real world.   CPI for Food Away from Home has rolled over and, with the share-of-stomach battle in casual dining heating up, there could be limited upside from here.  We see significant risk to Chipotle’s traffic, which sequentially decelerated from 3Q to 4Q, even with price coming off the menu, if price is raised meaningfully.

 

Standing on my hands, over 1,000 miles from Miami, those are the points that I think matter for Chipotle’s shares going forward.   The stock ripping yesterday was predictable but we would caution against chasing it unless you can get comfortable with our checklist above.  

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, USD/YEN, UST 10yr Yield, and the S&P500 are now $1, $109.28-110.83, $3.61-3.71, $79.19-79.98, $1.32-1.34, $88.51-90.27 (oversold), 1.84-1.93%, and 1, respectively.

 

Function in disaster; finish in style,

 

Howard Penney

 

Stand On Your Hands - hp1

 

Stand On Your Hands - hp2


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Foot Soldiers Or Generals?

This note was originally published at 8am on January 04, 2013 for Hedgeye subscribers.

“His outward appearance seemed indifferent and unconcerned over the wretchedness of his soldiers…although French and Allies shouted into his ears many oaths and curses about his own guilty person, he was still able to listen to them unmoved.”

-Jakob Walter, German soldier under Napoleon

 

Two hundred years ago, following one of the most brutal military campaigns in history, thousands of young European men traipsed through the snow of East Prussia, half-dead.  The Diary of a Napoleonic Foot Soldier, by Jakob Walter, is a harrowing but thoroughly enjoyable account of what it was like to serve in Napoleon’s Grand Armée during the ill-fated invasion of Russia in June 1812.  Given that one is as likely to be born in one country, at one time, as another country at another time, I am particularly grateful I was not one of the 600,000 Napoleonic soldiers that crossed into Russia in mid-1812.  Of the 140,000 that were left to retreat from Moscow, only 25,000 actually crossed back over the border in December 1812 to begin the long walk home.

 

Few individuals have left as indelible a mark on history as Napoleon Bonaparte.   That he was born in Corsica of Italian heritage but went on to gain the title “Emperor of the French” is indicative of the strength of personality he possessed.  All of his courage and decisiveness meant little without the contribution of his subjects.  Napoleon understood this; it is estimated that between 1800 and 1815, he raised approximately two million conscripts, or 7% of the population, in France alone.   Was the future of 18th Century France (or 1930’s Germany or Russia) dictated by the common man’s wishes or a charismatic leader dragging a country toward his vision?  This question has no definitive answer but it can serve as a loose metaphor for policy versus demographics in our contemporary economy.  While demography is concerned with the passive role people play in economies, the roles of the common man and policy maker in driving economic growth are important to consider in 2013.  Harry Dent, author of several books on demographics and its importance states: “it’s Homer Simpson that drives our economy, not Ben Bernanke or Barack Obama!”

 

I recently did some long overdue reading on demography.  While my understanding of the subject is tenuous at best, it is clear to me that understanding the role of demographic and technology cycles is key to understanding what drives our economy over the long term.  Hedgeye Healthcare Sector Head Tom Tobin and his team have produced some excellent research that anchors off these topics.  Recently, his work has suggested that household formation, maternity, and pet ownership (WOOF) rest on a similar age demographic and are likely to see corresponding strength.  While the increasingly short-term nature of our industry has marginalized such thought processes, we continue to believe that identifying investment themes that deviate from consensus but are supported by long-term cycles can lead to highly actionable ideas.

 

Considering some of the key demographic trends pertaining to the consumer economy offers interesting long-term insights.  In terms of the sector my team covers, restaurants, the core demographic of casual dining companies tends to be the 45-65 YOA cohort.  For any consumer industry executive, decelerating population growth among age cohorts with a high propensity to spend money on your goods or services will act as a top-line headwind.  Pertaining to the restaurant industry, it is clear that for many years executives’ lives were made easier by a rising demographic tide.  We believe that casual dining is facing a painful adjustment due to excessive unit growth.  Trading opportunities on the long side will remain, on immediate-to-intermediate-term bases, but we see casual dining as a group that will experience consolidation for a number of years.  It is no coincidence that the management teams that are most demonstratively aware of the demographic headwind are running the companies whose shares we are relatively positive on (EAT – at a price).  Darden Restaurants (DRI) is one company that we became bearish on in July.  One of the key issues we took with management’s strategy was its growth trajectory and we continue to believe that it is overly aggressive relative to the fundamental performance of its chains and the overall health of the industry.  The quote, below, from Brinker (EAT) CEO, Guy Constant, highlights the reality of the situation facing his industry and his company’s awareness of it:

 

“…We've had to deal with those questions internally because as a company that's only ever been in a growth space, it's been an adjustment for us to adjust to running a business in a more mature space now than we did before. But knowing then that history, we believe, is repeating itself, that helps you understand what you need to do in order to survive in this space.”

 

While long-term demographic and technology cycles dictate economic growth, from an investment perspective, it is self-evident that policy has a significant impact on market prices as well as the duration and amplitude of economic cycles.  The market, after all, is not the economy.  Previously, I have wondered if forming an opinion on government policy is a worthwhile exercise.  Long-term cycles seem to bear out over time regardless of government policies (give or take a few years).  In recent times, our macro team’s process of focusing on Growth, Inflation, and Policy has proven effective in identifying key inflection points in markets, globally.  Moreover, the level of government intervention in markets implores investors to form an opinion on policy and to update it, regularly.  For example, investors in gold that have ignored policy, and the expectations around it, have had a difficult time of late. 

 

Our view of policy makers in the US (and almost everywhere else) has been decidedly negative.  Keith wrote in yesterday’s Early Look: “What if Bernanke is what he usually is – wrong on his growth forecasts? What if unemployment rate expectations start to fall towards 6.5% in 2013 instead of in 2017? Inquiring Bond and Gold bulls would like to know…”  Yesterday we saw gold and bonds get crushed on the expectation that Bernanke could be forced to call back his troops if expectations of employment growth improve sufficiently.  Every general meets his Waterloo.  The only question is when.

 

Timing, as always, is the critical factor in investing but even more so in life.  After all, if not for timing, we could have been Napoleonic foot soldiers.

 

Have a great weekend,

 

Rory Green

Senior Analyst

 

Foot Soldiers Or Generals? - Chart of the Day

 

Foot Soldiers Or Generals? - Virtual Portfolio


COF: FOURTH QUARTER WIPEOUT FOR THE FIFTH YEAR IN A ROW

Takeaway: $COF - If guidance just came down 15%, will a 7% correction in the stock be enough?

This Is Why Cap One Trades at a Discount to Discover

Capital One reported disappointing 4Q12 results that were made worse by issuing 2013 guidance well below expectations. Looking ahead the company said to expect $22.5 billion in 2013 revenue vs. expectations for $23.0 billion. Meanwhile, they said to expect opex of $12.4 billion vs expectations for $12.0 billion. Finally, they dumped a bucket of cold water on capital return expectations when they said they were only requesting an increased dividend through CCAR (no buyback). 

 

The weakness this quarter stemmed principally from a sharp sequential decline in revenue margins attributable to significant revenue suppression. Revenue suppression is sneaky and obviously caught the market flat-footed, not understanding that prior to 4Q it was artificially propping revenue up by benefiting from the SOP 03-3 credit mark on acquired loans. In management's defense, they had indicated last quarter that margins would come down through the first half of 2013 by 35 bps, but clearly that was overly optimistic as margins dropped by 45 bps in one quarter. Moreover, the Street had been steadily conditioned to ignore these warnings as management had been making similar negative margin commentary, off and on, for the last several quarters only to then show stable to rising margins.

 

Set A Calendar Reminder for 350 Days From Now to Sell Ahead of 4Q13

Capital One seems to have an uncanny knack for disappointing investors with their fourth quarter results. Looking back over the last several years, the stock has had, on average, a -3.5% drop following the 4Q print (closer to -8% if you include 4Q08), a +6.0% rise following the 3Q print and a roughly flat response to the 1Q and 2Q prints. We show this in the first chart below. Interestingly, in the second chart below, we profile the stock following the last three 4Q reports. In all three instances, the stock was under pressure for a few additional days following it's first post-print tick, but then went on to recover, on average, all its losses by 20 days out. We think that poses an interesting opportunity for those thinking about the short-term outlook.

 

Fundamentally, We Think Estimates May Still Be Too High

Fundamentally, post the quarter and the new guidance, we're still shaking out below Street numbers. We are now at $5.76 and $5.56 for 2013 and 2014. Prior to this evening, the Street was at $7.00 and $7.31. If we tax effect the $900mn guidance reduction ($500mn revenue cut and $400mn expense boost vs consensus) and divide by a flat YoY sharecount of 585mn, it lowers guidance by $1.08. That should take numbers down to $5.92 and $6.23, but our numbers are still coming in light of that, particularly in 2014. It's also interesting that guidance came down by 15%, effectively, and the stock is off 7% in the after-market. We wouldn't be surprised to see some selling follow-through in the days ahead. Our model is below for reference. 

 

COF: FOURTH QUARTER WIPEOUT FOR THE FIFTH YEAR IN A ROW - px chart 1

 

COF: FOURTH QUARTER WIPEOUT FOR THE FIFTH YEAR IN A ROW - px chart 2

 

COF: FOURTH QUARTER WIPEOUT FOR THE FIFTH YEAR IN A ROW - cof model

 

Joshua Steiner, CFA


MJN – EPS Thoughts and More

With MJN catching two Old Wall downgrades in two days, it made sense for us to start poking around for reasons to get more constructive, rather than follow the crowd and drive while looking in the rear-view mirror. 

 

MJN is set to report Q4 2012 EPS on January 31st, and this looks to be one of the more closely scrutinized EPS announcements of the upcoming reporting period.  MJN is coming off two substandard EPS results associated with market share, pricing and distribution issues in China.  While we have longer-term concerns regarding the sustainability of the margin structure in China, we believe the issues in China that have been the catalysts for recent, negative EPS revisions to be shorter-term in nature and now largely in the past.  We prefer to look at a potential tailwind that is emerging in a market that has likely been left for dead by investors – the good ole’ USA.

 

The company’s margins in the mature markets of North America and Europe have declined from 32.62% at the end of ’09 to 19.76% in the most recently reported quarter.  Low birth rates, broader economic issues and increases in breastfeeding rates have forced manufacturers to aggressively pursue share in a declining volume environment.  Drafting off of some of the consistently excellent work done by our Healthcare vertical, we can see reasons why the issues of low birth rates and breastfeeding might move from a headwind to tailwind.

 

Increases in breastfeeding rates have been a headwind in the United States – some of that is secular, some cyclical.  The secular component is a well-documented and often times aggressive (I say that as a relatively newly-minted father within the past five years) campaign on the part of various public and private health care organizations regarding the health benefits associated with breastfeeding.  The cyclical component is less obvious, but no less important – intuitively, unemployed women are more likely to initiate breastfeeding and women who work full time are more likely to terminate breastfeeding earlier.  Therefore, improvements in female employment trends would be a benefit to the infant nutrition sector.

 

MJN – EPS Thoughts and More - ee. breastfeeding

 

Our healthcare team has done great work to show that maternity should accelerate, as outlined in the chart below. It estimates that “the drop in births since 2007 has led to a backlog of upwards of 700,000 to 1,500,000 maternity cases, which is significant when compared to an annual rate of 4M annual births.  Additionally, the best macro indicator is the employment of women between the ages of 20 and 34.  A growing demographic and the backlog in births should lead to accelerating births in the US over the coming quarters and years.”

 

MJN – EPS Thoughts and More - ee. women employ

 

Additionally, increases in birth rates among women in the age group of 30-45 years old has been constructive as older, more financially stable parents are presumably able to spend on children at a higher rate than younger, first time parents.

 

We have some concerns about how the market reacts to the company’s initial 2013 earnings guidance (historically provided on the Q4 conference call).  Consensus currently contemplates $3.37 in 2013 vs. $3.04 in 2012 (one quarter remaining, and Q4 may be too high as currently modeled by consensus).  This represents 10.9% growth.  For perspective, the company has never guided to double digit EPS growth at the midpoint of the range with its initial guidance– 5.4% 2010 vs. 2009, 7.4% 2011 vs. 2010 and 9.3% 2012 vs. 2011.  Sales growth guidance has historically been at least 7% (7-9% was the initial guide for 2012, the most aggressive the company has been).  Consensus is looking for 8% sales growth.  We view management as a reasonable, conservative “guider” and would be surprised if the leopard decided to change its spots.

 

Assuming a base of $3.00 in 2013, 9% EPS growth at the mid-point would represent $3.27 – consensus is $3.37.  Under more normal circumstances, we suspect that a guide below consensus would be largely shrugged off by investors – it’s unclear to us that would be the case, particularly if coupled with a below consensus result as we are modeling.  Investors are justifiably a little shaken given some hiccups over the past year, so the benefit of the doubt may be in short supply, even if history suggests it is warranted.  Ultimately, we don’t see consensus for 2013 as being unreasonable – we are at $3.35.  We recognize that Q3 provides some easy comparisons as we move through next year, but we don’t think management will guide that way.

 

Looking at all this, we are going to stay on the sidelines as we approach the company’s earnings release with the stock hovering close to the $70 mark, preferring, if our math and thinking are correct, to wait for an opportunity lower.  Closer to or below $60 per share, with consensus presumably corrected, we think the name makes sense as we move through 2013.  At $60 per share, MJN would be trading at 18.0x our EPS estimate for next year, which in our view would make it a far more compelling investment than names like CLX (17.3x ’13), KMB (16.5x ’13), HNZ (16.6x ’13), or CL (18.5x ’13) that do not share as compelling a growth profile as MJN.

 

-Rob

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

 

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

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