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PCAR: Don't Drive with the Rearview Mirror

Takeaway: In our view of capital equipment, orders matter and sales don't. Trading on historical sales is like driving with a rear view mirror.

Wait for Forward-Looking Data in the 10-K


  • Mostly ‘Takes’ on Quarter:  PCAR reported a quarter that initially reads quite well.  However, the EPS beat was mostly due to a lower than expected tax rate (29.2% vs. the ~32.2% imbedded in consensus estimates).
  • Capitalization Item:  Another negative is a footnote below the income statement reading :  “The fourth quarter 2012 includes the benefit of a $12.7 million reduction in cost of sales related to the capitalization of new product tooling that had been expensed in the first nine months of 2012. The positive effect on net income for the fourth quarter was $9.0 million ($0.03 per share)."  It is difficult to know how to interpret this item and management should have expanded on it on the conference call, in our view.  It could be viewed as PCAR slightly understating its profitability in the first nine-months.  Or it could be viewed as 'goosing' the quarter.  Regardless, the benefit was not in expectations and adds to the quarter's miss.
  • A Miss, Adjusted:  PCAR missed by a penny or two when the lower tax rate and capitalization items are backed out.  The street 'hates' it when these items are not clearly presented, leaving the shares to get hit harder, in our view.
  • Ignore the Quarter:  PCAR has a lot of things going well for it in 2013-2014 and 4Q 2012 was already well known to have been weak for the truck OEMs globally.  In the near-term, we estimate that Navistar has lost significant market share in orders through late 4Q.  That should benefit PCAR, among others, in early 2013.  Further, we see the end of tail pipe emissions regulations and a rebound in construction activity as significant potential benefits.  In addition to a record-old Class 8 fleet, there are a number of reasons to expect PCAR to perform extremely well over the next couple of years, in our view.  (See here for additional information on PCAR or ping us for more background).

PCAR: Don't Drive with the Rearview Mirror - navshare



  • Industry Improving:  The Class 8 market appears to have bottomed in late summer.  With recent and anticipated production curtailments amid a rebound in orders, industry dynamics look to have improved heading into 2013.

PCAR: Don't Drive with the Rearview Mirror - btob



  • Ahead of Itself:  We believe PCAR shares have room to run, but have been cautious on the rapid move in valuation ahead of fundamentals (see here for our recent note on PCAR valuation).  For mature companies, increasing share prices usually mean increasing risk, in our view.  A decline in PCAR shares to the mid-low 40s could provide an attractive entry opportunity for investors.
  • Look Forward:  In addition to the Volvo (2/6/13) and Daimler (2/7/13) earnings reports, we are interested to see the backlog data in the PCAR 10-K at the end of next month.  Backlog data should give us a better sense of order trends and market share with respect to NAV, which we expect to be an important upside driver for PCAR.  In our view of capital equipment, orders matter and sales usually don't.  Trading on sales is like driving with a review mirror, while anticipating order trends is key.


Jay Van Sciver, CFA

Managing Director

111 Whitney Avenue

New Haven, CT 06510


DOJ Complaint (ABI/Modelo) - We Read it So You Don't Have To

What the DOJ did…

After reading through the complaint filed by the DOJ, it seems clear to us that the DOJ was more interested in appearing to do SOMETHING rather than examine the facts of the case.  The DOJ has a long history of wanting to appear sympathetic to the little guy that buys beer and baby food.


The DOJ gave ABI/Modelo/STZ virtually no credit for the indirect nature of the control that ABI would have had subseqent to the transaction closing.  Instead, the focus was placed on the supply agreement, and how that might allow ABI to influence Corona pricing.


So, the deal has become contentious, with the potential to drag out beyond Q1.  If this moves to trial, we won't likely see a start for 2-4 months.  However, both sides can and likely will continue to talk.  We fall back on our initial assessment based on the following factors:


  1. Modelo is an asset that ABI has long coveted (multi-year owner/partner)
  2. If not now, when does ABI act? Waiting for changes in the regulatory winds doesn't seem like a sound business strategy on the part of ABI
  3. Modelo is a multi-billion global opportunity for ABI

Walking away seems unlikely, if you accept our fact pattern.  Therefore, what has to be done.  First off, the call option on the business has to go -- the DOJ mentioned it about a half dozen times in the complaint.  The DOJ was focused on premium and premium plus pricing, so ABI might have to give up a brand in that segment - we have suggested Michelob.  Finally, we fall back to our analysis of the InBev/Budweiser deal where InBev sold and then brewed Labatt's for a period of three years for North American Breweries.  In short, the DOJ's concerns regarding supply have to be met in some fashion (selling a brewery or searching for an alternate supply for Crown).


What the DOJ said...

We read the complaint so you don’t have to, and we have selected some comments that we believe highlight how the DOJ has attempted to shoehorn a conclusion into a fact pattern that is several sizes too small.  To begin:

“As the two largest brewers, ABI and MillerCoors often find it more profitable to follow each other’s prices than to compete aggressively for market share by cutting price. Among other things, ABI typically initiates annual price increases in various markets with the expectation that MillerCoors’ prices will follow. And they frequently do.  In contrast, Modelo has resisted ABI-led price hikes.”

The DOJ has embraced a temporary market share vs. price strategy as a structural imperative of the US beer industry.  It is just as likely that Modelo, satisfied with recent share gains, seeks to improve profitability through pricing for a period of time.

“The loss of this head-to-head competition would enhance the ability of ABI to unilaterally raise the prices of the brands that it would own post-acquisition, and diminish ABI’s incentive to innovate with respect to new brands, products, and packaging.”

ABI competes in a global market place with shifting demographics and consumer taste preferences.  Further, consumers across all staples categories are demanding different varieties and taste profiles.  Finally, the growth of the craft brewing segment has been a driver of innovation across the industry, not the competition between ABI and MillerCoors.  In this case, the DOJ has mistakenly viewed a structural imperative of virtually all staples sectors (innovation), as a temporary market condition.

“For no substantial business reason other than to avoid liability under the antitrust laws, ABI has entered into an additional transaction contingent on the approval of its acquisition of the remainder of Modelo. Specifically, ABI has agreed to sell Modelo’s existing 50% interest in Crown Imports LLC (“Crown”)”

This one is a real head-scratcher – of course there was no business reason.  Any incremental concessions won’t have any substantial business reason either.

“Constellation has already shown through its participation in the Crown joint venture that it does not share Modelo’s incentive to thwart ABI’s price leadership. In fact, Constellation consistently has urged following ABI’s price leadership.”

This is simply a difference of opinion between JV partners, neither position is permanent (see earlier point) nor is one necessarily the correct or incorrect course of action at any point in time.

“The acquisition gives complete control of Modelo to ABI, and gives ABI full access to competitively sensitive information about the sale of the Modelo brands in the United States – access that ABI does not currently enjoy.”

Really?  I have access to pricing information on Modelo brands.  Not real time, nor in advance, but does the DOJ believe that the largest brewer in the U.S., with a network of distributors across the country, is unaware of the actions of its competitors, whether it owns a portion of them or not?

“Beer is a relevant product market and line of commerce under Section 7 of the Clayton Act. Other alcoholic beverages, such as wine and distilled spirits, are not sufficiently substitutable (emphasis added) to discipline at least a small but significant and nontransitory increase in the price of beer, and relatively few consumers would substantially reduce their beer purchases in the event of such a price increase.”

Again, really?  I have to assume that the DOJ just missed the spirits companies talking about targeting beer occasions.  Someone needs to tell Brown-Forman that no one who drinks beer is a potential consumer of any of their products.  It would save the company a lot of time, money and effort.  Someone should also point out the consistent and multi-year loss of share of liver on the part of beer to wines and spirits.

“Brewers are able to price differently in different locations, in part, because arbitrage across local markets is unlikely to occur.”

I’m confused – is beer pricing local, or is it uniform across the country?

“Crown executives have recognized the differing incentives, as it relates to pricing, of their two owners. As one Crown executive observed in a March 2011 email, “Modelo has a higher interest in building volume so that they can cover manufacturing costs, gain manufacturing profits and build share as the brand owners.” Constellation, however, “is interested primarily in the financial return on a short-term or at the most on a mid-term basis.”


Of course STZ was short-term focused; it wasn’t clear what the status of the Crown JV was much beyond the next couple of years.  The nature of the transaction changes the incentives and durations of the parties involved.


Where does that leave us?


In summary, it appears that the DOJ is focused on pricing (naturally), the fact that there is no brewing facility associated with the transaction (ABI controls supply) and the 10 year call option (mentioned several times, that thing really has to go).   We think that there is a middle ground to be had here that preserves the illusion that the DOJ actually accomplished something and that allows for ABI/Modelo/STZ to realize significant value from the transaction.


Call with questions, please.




Robert  Campagnino

Managing Director





Matthew Hedrick

Senior Analyst

HSY Q4 - Not a Whole Heck of A Lot Wrong

HSY’s 4Q2012 adjusted EPS of $0.74 missed Bloomberg consensus by a penny with the main drag coming from a +19% increase in SG&A (excluding marketing), which was above initial estimates.


For its important Halloween and Christmas quarter, organic sales grew +9.3% (price +2.3%, volume +7.0%), and net sales rose +11.7% inclusive of the Brookside acquisition (+2.1%) and +0.3% of FX).  Gross margin improved +140bps to 43.1%.


We came into the print saying that HSY, at 21.4x ’13 EPS, was expensive but had very good business momentum, and the quarter largely proved this out across its Chocolate, Non-Chocolate, Mint, and Gum segments.


The company’s outlook for 2013:

  • Net sales growth of 5 to 7%, including FX, unchanged versus previous estimates
  • Adjusted Gross Margin expansion of 180 to 200 bps, driven by “productivity, cost savings initiatives and overall input cost deflation.”
  • Advertising expected to increase 20% with a larger share going to Brookside and China
  • Adjusted EPS growth of 10 to 12% versus previous guidance of 8 to 10%, or EPS of  $3.47-$3.56 versus consensus at $3.60

We think the name finds buyers on any pullback (HSY is up +1.6% intraday).  We don’t find its 2013 sales growth target particular challenging which could lend to upside surprises. In 2013 we could expect the USA to grow around +4%, to get +1 point from innovation, and +2% from international, which very quickly takes you to the top end of its guidance range. The company last took a major price increase in 2011. We suspect HSY, like many of its peers, will see larger volume gains as pricing comes in. We are bullish on HSY getting more shelf space internationally, especially in China, and expect continued sticky consumption from its convenient store channel despite such headwinds as an increase to the payroll tax.


Call with questions.




Robert  Campagnino

Managing Director






Matthew Hedrick

Senior Analyst

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Wave has a decent start but are expectations for RCL’s 2013 guidance too high? 



With CCL offering disappointing 2013 net yield guidance of +1-2% yield for 2013, RCL has a chance to reassure cruise investors of a strong 2013 outlook.  However, we think the commentary will be mixed, which may not be good enough given the 8% run up in the stock since they last reported.  Thus, the Q1 earnings next week may actually be a negative catalyst.  As we mentioned in 2013 EARLY WAVE SEASON PRICING (01/31), RCL's Alaska and Europe pricing (mass brand) are underperforming. 


We understand there is an expectation that pricing should pick up in February and March, thanks to easy Concordia comps.  Travel agent surveys have been quite optimistic regarding the start of Wave Season.  The Street is looking for close to 3% yield growth in 2013.  It is an achievable target but European pricing will likely need to stabilize.  Unfortunately, we see European pricing trends continue to deteriorate relative to October.  


An interesting trend we’re noticing is the relative pricing outperformance of the premium brands (Celebrity/Azamara) versus the mass brand (RC) in Europe and the Caribbean.  The 2013 payroll tax hike is probably playing a role in the mass weakness especially in the Caribbean.  The RC brand accounts for 64% of RCL’s total capacity in 2013.


We believe RCL would need to guide 3%+ in net yields to beat Street expectations and continue the momentum.  We think yields closer to 2% is more reasonable.  The continued Oasisizing and Solsticizing in the 1st half of 2013 will pressure costs and higher airfares to Europe may continue to crimp demand and lead to shorter booking windows.  The stock is not overly cheap at 13x which is in-line with its historical average.




Our pricing survey shows a mixed picture



Wave Season has officially begun and there seems to be much optimism in 2013, particularly on a stronger pricing recovery in Europe.  While we’re seeing solid gains in Costa and the premium brands—Celebrity, Azamara, and Princess—in European pricing, the mass brands are discounting pretty heavily.  Investor optimism may go partially unfulfilled. 


Our proprietary pricing database tracks over 12,000 itineraries across six major geographic regions.  We analyze YoY trends as well as relative trends, determined by pricing relative to those seen near the last earnings date for a cruise operator.  Here are some highlights we’re seeing:




Caribbean:  Overall, the trend is improving in the 1st month of Wave Season.  F1Q 2013 will be down YoY due to strong Caribbean performance in F1Q 2012. Celebrity (premium) pricing is outperforming RC (mass) by a wide margin. 


Europe:  Europe just cannot get a firm footing on pricing. The relatively stronger Celebrity and Azamara brands are offsetting substantially weaker RC pricing.  The RC brand represents roughly 50% of RCL's European capacity in F2Q and F3Q.


Alaska:  With the Celebrity brand holding twice as much capacity as the RC brand, it is discouraging to see prices move significantly lower.  We estimate 2013 Alaska overall capacity to be unchanged from 2012 capacity.


Asia:  Solid pricing  






Caribbean:  Not much movement in trend in January.  Similar to RCL, F1Q 2013 will be tough for CCL.  We’re seeing moderately higher pricing in the latter half of 2013.


Europe:  As expected, Costa is doing well, particularly in 2H 2013.  We’re seeing price increases of +20-30%.  Princess is also seeing nicely higher YoY price gains.  Cunard pricing continues to lag, a carryover from 2012.  However, while YoY pricing remains healthy, the overall price momentum since last Q has been decelerating, which doesn’t bode well for Wave Season.


Mexico:  Pricing has been pretty healthy.


Alaska:  Holland and Princess pricing has been trending lower in F3Q.  CCL guided to 24% of its capacity in Alaska in F3Q.


Asia/South America:  There is some pressure in the Asia/Australia itineraries in F2Q.  South America has held up relatively well. 




IGT should be releasing a (punchy?) response to the Ader Group soon.  Here we take a stab at what that response could include.



We have no idea whether shareholders will vote in favor of the Ader Group proposal but we are pretty sure of two things:  the process will be entertaining and should be good for the stock.  The presence of agitating shareholders is typically good for stocks, especially cheap stocks.


As we’ve discussed numerous times, IGT has made some questionable acquisitions but management appears to be on the right path.  We actually think the buyback was quite cleverly executed.  However, we like the idea of an agitator on the Board and we also think some capital markets experience and pure gaming experience could only help the Board focus management on creating shareholder value.  The stock is unnecessarily cheap and management deserves some blame for that.


Hedgeye is obviously not privy to the contents of IGT management’s response but that doesn’t mean we don’t have an educated guess.  The following is a point by point response that we think IGT could issue as soon as tonight:

  • ADER GROUP:  IGT has failed to focus on the core business
    • IGT:  Our share in North America been increasing for the last two years and our product pipeline is in great shape.  That’s more than we can say about the former management team which overspent on Server Based Gaming and contributed to a plummeting stock price.  Comparisons to 2004, when our market share exceeded 60%, is irrelevant since the competitive landscape is completely different. 
  • ADER GROUP: Our proposed Board members have the gaming experience that IGT’s current Board lacks
    • IGT:   The one person in Ader’s Group with great gaming experience is very old and was directly involved in the gaming industry at a very different time.
  • ADER GROUP:  IGT missed out on significant opportunities in the Asian EGT space
    • IGT:  The entire EGT market generates revenues in the ballpark of $200MM and has lower margins than our existing product sales business.  Even if IGT was able to garner 30-40% market share, this business would contribute a lot less than what Double Down is also doing.  Prior management made a strategic investment in DigiDeal, an electronic table game platform, back in April 2007.  Three years later, in May 2010, IGT ended our relationship with DigiDeal to focus on “core” products.  Reasons for terminating the partnership were part of a broader strategy of IGT exiting low ROI markets and products including Barcrest and Japan.  IGT still has a small domestic electronic table games business we were not interested in investments in low ROI product lines
  • ADER GROUP:  IGT overpaid for DoubleDown and could have created the same business for a fraction of the price. 
    • IGT:  We paid $250MM to date for the acquisition of Double with an additional $250MM to be paid out in retention and bonus payments over the next few years.  DD’s revenues are already doing over $165MM/ year on an annualized basis and the business should produce around $200MM by FY14.  Gross margins are 60% with room for upside. Operating margins should be north of 25% when the business is mature and by 2014 the deal will be accretive.  Unlike Zynga, our business is growing and did 31 cents of booking per average daily user compared to Zynga’s 6 cents.  This business will prove to be a high ROI acquisition for us.
  • ADER GROUP:  Key personnel departures and brain drain at the company - Joe Kaminkow specifically, the former head of one of IGT’s 5 internal game development labs.
    • IGT:  Kaminkow wanted to be the head of social gaming and wanted to do it himself.  He formed a company called “Spooky Cool Labs” (http://spookycool.com/index.html ) which is focused “on creating cutting-edge social games built on great brands and industry-leading design for social networking services and mobile devices.”
  • ADER GROUP:  Entraction shut down just 18 months after purchase is a perfect example of IGT’s misallocation of capital
    • IGT:  Ok, Entraction wasn’t the greatest acquisition of all-time, but it’s not the only business that suffered after Italy and France ring-fenced online wagering.  We were also able to recognize a $40MM tax benefit in 2012 from the write-down of Entraction and still own the technology and know-how so it’s not a complete failure.
  • ADER GROUP:  Our Group will own 300x more stock than the existing Board
    • IGT:  It’s true that the current Board doesn’t own a lot of stock.  However, Ader’s group ownership is spread pretty thin.  75% of the stock they own comes from one long term investor, 9% is owned by an 84 year old former Chairman (Chuck Mathewson), 10% is owned by trusts controlled by the former Chairman, and only 6% is owned by Ader and Associates.  That 6% owned by Ader represents less than 20bps of the total shares outstanding.  Two of the 3 Board members that the Ader group has proposed directly own less than 0.5% of the stock.
  • ADER GROUP:  Accelerated buyback execution left a lot of money on the table
    • IGT:  We bought back the stock at an average price of $13.22, which is 16% below the current price.

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