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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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Jobless Claims On The Decline

An unusually strong initial jobless claims number came out this morning, with claims falling 37,000 to 335,000 after posting the largest one-week decline since this same week last year. Compared with 2012, claims declined further the following week followed by a bounce, so 2013 is essentially following in the footsteps of 2012 just as we had predicted. We believe that from March through August, initial jobless claims will face strong headwinds following tailwinds we're seeing now through late February.

 

 

Jobless Claims On The Decline - 1

 

 

Remember: positive economic indicators are a boon to the market until they’re not. The good times are rolling but it will become increasingly difficult to put up numbers like today's on a consistent basis.

 

 

Jobless Claims On The Decline - 2

 

Jobless Claims On The Decline - 7


JOSHUA STEINER: INITIAL CLAIMS TAKE THEIR CUES FROM 2012, FOLLOWING LAST YEAR'S PATTERN TO THE DAY

Takeaway: Initial claims were unusually strong today, yes, just as they were this time last year. Here's what to expect.

I Know I've Seen This Before ...

Initial jobless claims posted their largest 1-week decline since this same week last year. Claims fell 37k to 335k. For reference, in the corresponding week in 2012, claims fell 46k (to 356k) only to then bounce higher by 23k in the following week. That said, in the five weeks that followed that 23k bounce, claims trended lower by a further 25k. This is precisely the Jan/Feb tailwind we've been describing, and why we would expect a bonce in claims next week, but a strong tailwind to re-emerge through February-end.

 

Beginning in March and running through August, initial jobless claims will shift from having the wind at their back to the wind at their front. The effect will be subtle at first, but it will build compounding momentum. We'd expect the next six weeks of strong tailwinds (next week notwithstanding) to fuel the rally in Financials.

 

The Numbers

Prior to revision, initial jobless claims fell 36k to 335k from 371k WoW, as the prior week's number was revised up by 1k to 372k.

The headline (unrevised) number shows claims were lower by 37k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -6.75k WoW to 359k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -7.0% lower YoY, which is a sequential deterioration versus the previous week's YoY change of -9.7%

 

 

JOSHUA STEINER: INITIAL CLAIMS TAKE THEIR CUES FROM 2012, FOLLOWING LAST YEAR'S PATTERN TO THE DAY - 1

 

JOSHUA STEINER: INITIAL CLAIMS TAKE THEIR CUES FROM 2012, FOLLOWING LAST YEAR'S PATTERN TO THE DAY - 2

 

JOSHUA STEINER: INITIAL CLAIMS TAKE THEIR CUES FROM 2012, FOLLOWING LAST YEAR'S PATTERN TO THE DAY - 3

 

JOSHUA STEINER: INITIAL CLAIMS TAKE THEIR CUES FROM 2012, FOLLOWING LAST YEAR'S PATTERN TO THE DAY - 4

 

JOSHUA STEINER: INITIAL CLAIMS TAKE THEIR CUES FROM 2012, FOLLOWING LAST YEAR'S PATTERN TO THE DAY - 5

 

JOSHUA STEINER: INITIAL CLAIMS TAKE THEIR CUES FROM 2012, FOLLOWING LAST YEAR'S PATTERN TO THE DAY - 6

 

JOSHUA STEINER: INITIAL CLAIMS TAKE THEIR CUES FROM 2012, FOLLOWING LAST YEAR'S PATTERN TO THE DAY - 7

 

JOSHUA STEINER: INITIAL CLAIMS TAKE THEIR CUES FROM 2012, FOLLOWING LAST YEAR'S PATTERN TO THE DAY - 8
 

JOSHUA STEINER: INITIAL CLAIMS TAKE THEIR CUES FROM 2012, FOLLOWING LAST YEAR'S PATTERN TO THE DAY - 9

 

JOSHUA STEINER: INITIAL CLAIMS TAKE THEIR CUES FROM 2012, FOLLOWING LAST YEAR'S PATTERN TO THE DAY - 10

 

JOSHUA STEINER: INITIAL CLAIMS TAKE THEIR CUES FROM 2012, FOLLOWING LAST YEAR'S PATTERN TO THE DAY - 11

 

Joshua Steiner, CFA


FNP: Something to Chew On

Takeaway: We expect FNP to undergo meaningful structural change in 2013 that will continue to unlock shareholder value.

Dinner with a management team rarely (if ever) shifts ones’ investment thesis on a stock, and our’s with FNP last night was no exception. But we definitely walked away with confirmation that the management team is deploying assets to the areas that will fuel growth, and will do what it needs to do in order to purge parts of the portfolio that are simply not working. The bottom-line is that we expect FNP to undergo meaningful structural change in 2013 that will continue to unlock shareholder value.     

 

The only negative point we could really think of is that with a ~20% hit to EBITDA guidance (Juicy plus general conservatism) and a resulting 12% increase in the stock price, it would be flat-out dishonest of us to not admit that this latest update started the clock and set expectations that something strategic will, in fact, happen this year. Fortunately, we think it will happen, and when it does the path to a $20 stock will be apparent.


In the process of reflecting on his current “State of the Industry,” CEO Bill McComb highlighted that apparel is becoming increasingly commoditized requiring brands to become more differentiated in a consumer-direct format with a focus in part on accessories to shape how he runs each of his portfolio brands for tomorrow. In listening to McComb talk strategyvabout the future of the business, he most similarly sounds like Dick Hayne of URBN. Not a bad stock chart overvthe past year to follow.

 

Here are a few musings from last night:      

  • As for branded commentary, while Kate continues to be the fastest growing, Juicy remains the most dynamic. McComb put new Juicy CEO Paul Blum in place to set a path for the brand’s approach to market and its product allocation/mix across categories. This leadership has been sorely missed in recent years, which has lead the brand to run astray under Chief Creative Officer Leann Nealz in 2012. Simply put, a creative designer has been running the brand, and our opinion is that she had too much latitude to skew the brand up and down in price point and age. The brand needs a business person to instill a process to methodically target a consumer and procure product accordingly. We’re not declaring victory for Juicy. But we think that it has more going for it today as it relates to touting leadership to make it salable.
  • The upshot is that Paul is setting the course, but that’s just the start. In order to execute effectively, 1) the role of Chief Merchant still needs to be filled, and 2) the chief creative visionary has to be onboard and willing to follow the course set before her. Any deviation there would likely result in a replacement.
  • At Lucky, it’s clear that the focus beyond core denim (i.e. more fashion product) is critical to driving store productivity from $460 up to and beyond management’s $650 per sq. ft. target. In addition, e-commerce will be the primary driver of comp over the next 12-months as the team integrates successful initiatives at both Kate and Juicy.
  • As for Kate, there’s a ton of moving parts over the next year or two that drive brand growth, but McComb remains focused on the bigger picture – investing to ensure the Kate Spade business achieves a critical mass not necessarily managing to profitability. We’re not talking about a $460mm brand at 10% margins getting to 12% overtime, but a path and vision for sub $500mm brand to ultimately achieve $3Bn in revenues at margins over 20%+. We don’t think that investors are looking at the big picture here with what this brand can become. Focusing on the baby steps is an opportunity cost.

 

As we look ahead to the upcoming catalyst calendar, we expect confirmation shortly that a Kate Spade analyst day will take place over the next 3-months. Given the transformation and multitude of moving pieces underlying Kate’s growth trajectory, the added detail and visibility will be a net positive in light of the discounted multiple the market assigns to this brand.


Prior to then, we wouldn’t be surprised to see the addition of a Head Merchant at Juicy. Beyond 3-months is when we suspect more significant divestiture events are most likely. Among the assets likely to be monetized first are the Adelington Group and then Juicy.


The impact of these events on the balance sheet and P&L would be substantial and set free FNP’s most important asset i.e. Kate Spade. Keep in mind that a 0.5x sales multiple on Juicy Cotoure would net $250mm, which would eliminate 65% of debt, and leave FNP with debt to total capital of under 15%. That’s definitely consistent with what investors want to see from an early cycle high growth story. A better informed market following a 1H analyst day is more likely to reward the remaining business with an appropriate market multiple, which could in turn reward investors with a 40%-65%+ return from current levels and a stock worth $20-$24 per share. FNP remains one of our top longs for 2013.



 

 


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