KMB - What’s The Right Multiple for Cost Savings?

KMB reported Q4 EPS of $1.37 versus consensus of $1.36 and provided 2013 guidance - $5.50 to $5.65 versus consensus of $5.59.  Ho-hum, enough with the Old Wall earnings recap.

The good – constant currency organic sales growth was +5.0%, against a +3.0% in the lapping quarter.  The sales result was at the high end of the 3-6% range we saw in the prior three quarters.

The deterioration in earnings quality that we highlighted earlier in the week continues to manifest - $39 million of EBIT growth year over year, provided courtesy of $80 million of cost savings and a $15 million commodity tailwind  (this with the benefit of 5% top line growth).  The commodity benefit is a decline from Q3 ($55 million) and Q2 ($30 million) reflecting the fact that core commodities have begun to creep up again.


KMB - What’s The Right Multiple for Cost Savings? - KMB EBIT

What’s the Bull Case?


We get that sales were solid this quarter, and that the KCI International business continues to be an opportunity.  Also, Q4 was a robust FCF quarter ($2.01 per share in Q4, $5.54 per share for the full-year) and that the company continues to deploy its FCF to the benefit of shareholders via dividends and share repurchases.  That sort of profile certainly has an appeal to a certain group of investors.

To those investors, we ask a couple of questions:

  1. What’s the right multiple for cost savings, recognizing that all of KMB’s EBIT growth is from restructuring savings? (4-6x earnings is what we are thinking).  We recognize that there is a stability and consistency to that EBIT growth, but there is also a limited duration that should be reflected in a far lower multiple relative to EBIT growth derived from operations.
  2. What happens if sales weaken?  When things are going well at a consumer products company, sales growth should drop to the bottom line in substantial fashion.  That is clearly not the case with KMB.  If sales weaken, declining core EBIT should overwhelm the level of cost savings.
  3. Are the company’s increases in strategic marketing really strategic?  We have seen investments in strategic marketing decline sequentially throughout 2012 – is the company using that investment tactically to manage earnings, or is it truly viewed as long-term in nature? We consider the former to be a distinct possibility.

With commodities moving against the company and the multiple at 15.5x 2013, we continue to believe that people should not be paying up for 3-4% top line growth and EBIT growth that is largely derived from restructuring savings.  Our bias remains to be short.


KMB - What’s The Right Multiple for Cost Savings? - pulp prices

KMB - What’s The Right Multiple for Cost Savings? - crude oil


Call with questions.


 - Rob


Robert  Campagnino

Managing Director




BWLD: Playing Chicken

Buffalo Wild Wings (BWLD) is under pressure as chicken wing prices move sharply higher to start the year. With the $2 per pound mark being surpassed with the possibility of further upside, we worry about risk to BWLD’s multiple. Hedgeye Restaurants Sector Head Howard Penney notes the difference in price change compared to 2012:

“In 2012, during the first 24 days of the year, chicken wing prices gained 14%.  For much of the remainder of last year, prices stayed within a range of roughly 180-190 cents per pound.  Year-to-date in 2013, wing prices are again moving higher: +7.2% YTD.  During the 3Q earnings call, management warned that the price of wings was trending to $2.07 for the first two months of the fourth quarter and stated that they expected it to exceed that level heading into the super bowl.”


BWLD: Playing Chicken - image004


The question is whether or not this expectation is baking in the possibility of McDonald’s expanding its testing of wings, currently in being sold in Chicago after a successful run in Atlanta, to its national system.  BWLD’s guidance for earnings growth of 20% seems dependent on a number of factors, one important one being some moderation in wing prices in 2H13, per remarks from CFO Mary Twinen in October.  MCD getting in on the act won’t help that happen.


BWLD: Playing Chicken - image003

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Stay The Course

Client Talking Points

Follow Through

It’s important to stay the course once you’ve put a plan into action. Do you think Lord Nelson turned his ships around when difficulty stared him in the eye? Absolutely not. Our three Q1 2013 Macro Themes are #GrowthStabilizing, #HousingsHammer and #QuadrillYen. Japan is getting their currency devalued in favor of the Nikkei hitting astronomical levels on the upside, the housing market continues to put up solid data week after week showcasing the recovery, and growth is still stabilizing. With regards to the latter, a lot can change very quickly if crude oil is $130 a barrel and if the debt ceiling debate in late February can’t get sorted out appropriately. For now, we’ll stay the course and will continue to trade the risk and the range we’re comfortable with, whatever the stock.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

We believe ASCA will receive a higher bid from another gaming competitor. Our valuation puts ASCA’s worth closer to $40.


ADM has significantly lagged the overall market in 2012 over concerns that weakness in the company’s bioproducts (ethanol) and merchandise and handling segment will persist. Ethanol margins suffered from higher corn costs, as well as weak domestic demand and low capacity utilization across the industry. Merchandising and handling results were at the mercy of a smaller U.S. corn harvest. Both segments could be in a position to rebound as we move into 2013 and a new crop goes into the ground. With corn prices remaining at elevated levels, the incentive to plant corn certainly exists, and we expect that we will see corn planted fencepost to fencepost.


HOLX remains one of our favorite longer-term fundamental growth companies given growing penetration of its 3D Tomo platform and high leverage to the 2014 Insurance Expansion from the Affordable Care Act.

Three for the Road


“@Hedgeye Cake at the office today? We wouldn't want to forget Big Alberta @HedgeyeDJ's birthday now would we#HappyBirthdayBigGuy #ToGrowth” -@BrennanDTurner


“The only way to make a man trustworthy is to trust him.” -Henry Stimson


Procter & Gamble (PG) fiscal-second-quarter earnings more than doubled to $4.06 billion or $1.39 a share.


"Most of the time ‘I don’t know’ is the right answer.”

-Wesleyan University Professor, 2008


It was nearing midnight and towards the end of a ten hour stint in a 4’ x 8’ freezer on a winter night in early 2008 that I realized I wasn’t going to be a career research doctor.   


At the time, I was a PhD candidate performing an RNA isolation as part of some larger work on DNA enzyme kinetics.  What that means exactly isn’t really important, but it takes a long time and the work flow requires that most of that time be spent inside a walk-in ice box. 


Tired, bored, and numb, I was thinking more about the puts I bought in NLY (REIT/Mortgage Investor) earlier in the day than on the final mix components for the experiment.  I ended up aliquoting (fancy science term for “added in”) way too much of the wrong substrate into the mix.  No take-backs or mulligans in experimental biochemistry - Game over, reset clock, 10 more hours of overnight freezer duty.  A short-time later I joined Hedgeye. 


Similar to probing the populous on their view of functional Enzyme Kinetics, I imagine that asking the average person how the U.S. calculates inflation conjures images of Good Will Hunting scenes, blackboard equations and chalk dust mathematical revelation.  


Reality, however, more often resembles a bearded, middle-aged Robin Williams than it does a svelte, young Matt Damon.   Consider the following question: 


“If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”


That gem of a perfectly subjective question, asked as part of BLS’s monthly price survey process, drives the calculation of “owner’s equivalent rent” and singularly represents approximately one quarter of the index used to calculate CPI inflation in the United States.   


China reports official GDP numbers 5 minutes after the quarter ends, we have owner’s equivalent rent.  Next. 


Parsing the reality from the illusory in reported domestic labor market data and understanding the subtleties of the seasonal and other statistical adjustments presents its own unique challenges.   



‘Tis the Season(ality)


As we’ve highlighted previously, strong and quantifiable seasonal adjustments have had a meaningful impact on the temporal trend in reported economic and employment data over the last four years.  In short, the shock in the employment series in late 2008 – early 2009 which occurred alongside the peak acceleration in job loss during the Great Recession has been captured, not as a bona fide shock, but as a seasonal factor.   


The net effect of this statistical distortion is that seasonal adjustments act as a tailwind from September – February, then reverse to a headwind over the March-August period.  From a positive seasonal adjustment factor perspective, we’ve got about one month left. 


6-Handle - Wkly Claims



Sell in May & Go Away (Until September)


From a strategy perspective, the temporal pattern in market dynamics, despite being rather obvious to any market observer, hasn’t been insignificant. 


The annual déjà vu pattern in market prices, reported economic data and monetary policy announcements observable over the last 4 years isn’t particularly surprising when considering the reflexive interaction between the associated dynamics: 


reported economic data begins to inflect, market prices move higher, confidence and optimism measures begin to improve alongside stock prices and reported econ growth, the marginal bid moves from treasuries to equities as improving conditions pull expectations around a Fed exit timeline forward, equities benefit further while the reported data continues to confirm - until it doesn’t - and then the dynamics reverse, culminating with a new QE announcement in late Q3 just as the data and seasonal adjustments impacts hit trough. 


Compressed economic cycles and amplified market volatility at its statistically distorted and centrally planned best. 


6-Handle - SPX Deja Vu





As the domestic employment and housing data has continued to confirm our 1Q13 Macro Theme of #growthstabilizing, a risk management question we’ve been considering is the possibility of seeing a 6-handle in the unemployment rate in 2013.  With Bernanke offering an explicit employment target of 6.5% for a cessation in QE initiatives, a significant decline in unemployment over the NTM may augur higher yields as the bond market attempts to front-run a prospective Fed exit.  


A material, mean-reversion back-up in yields is of obvious import for asset allocation decisions and remains the principal candidate catalyst for a driving a large-scale rotation to equities.


Further, in so much as an end to money printing is dollar bullish, we could see a perpetuation of the USD Higher --> Energy/Commodities lower --> Real Earnings/Real Growth Higher dynamic we think needs to persist for sustainable real consumption growth.  A step function move lower in commodity prices would also be equity supportive from a rotation perspective.


In a recent analysis we framed up the variable dynamics and put some quant around the magnitude of change in the relevant unemployment rate drivers necessary to take unemployment below 7.0% over the NTM (email us if you’d like a copy of the note). 


In short, while we wouldn’t necessarily view a 6-handle on the unemployment rate by 2013 year-end as our baseline case, the reality of the math suggests that it wouldn’t take extraordinary improvement in the factors that drive the unemployment rate to take it below 7% over the NTM.


In terms of how we model unemployment, we effectively need to see 2 of the 3 input variables to trend favorably with respect to their impact on the unemployment rate.


For example, scenarios in which Employment Growth accelerates a reasonable 20bps (2Y basis) on average in 2013 and growth in the Civilian Non-institutional Population (CNP) declines linearly to the historical average over the NTM or the Labor Force Participation Rate (LFPR) continues to decline at the 3Y CAGR both result in a move to/below the 7% unemployment level in 4Q13. 


In the chart below we provide a timeline view of the 2013 Unemployment Rate under a selection of progressively favorable scenarios. If you’d like to observe the impact of your own growth and participation rate assumptions on the unemployment rate timeline you can link to the associated model here >> Unemployment Rate Variable Analysis_HEDGEYE


6-Handle - U.S. Unemployment Rate



Yesterday on CNBC Ray Dalio remarked that the question for investors now, as always, is how events will transpire relative to what the market has discounted.    


We continue to like our 1Q13 Macro themes of #growthstabilizing and #housingshammer.   Ultimately, however, Investment perspective remains wedded to last price. Now a hundred SPX points higher from where we first penned the #growstabilizing hashtag back in early December, the relevant risk management question is whether growth can organically and sustainably accelerate from here.


On my first day in the freezer in grad school, my professor offered the following piece of memorable advice with respect to evaluating one’s place within the program’s intellectual pecking order:   


“Regardless of what they say, nobody really knows anything.  Most of the time ‘I don’t know’ is the right answer”


Stay Tuned. 


Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now, $1, $111.51-113.95, $3.65-3.71, $79.41-80.14, 1.32-1.34, 1.84-1.91%, and 1, respectively.


Christian B. Drake

Senior Analyst


6-Handle - vpp


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 80.52%
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