Philip Morris (PM) put up a solid quarter for the fourth quarter of 2012, exceeding expectations for many. PM had constant currency organic revenue growth accelerating to 6.8% versus the tough comp of +8.2% a year ago. EPS exceeded expectations by $0.02 but guided below consensus (range of $5.68 to $5.78) versus consensus of $5.79 - our guidance estimate is $5.71. PM’s results in the quarter shame a number of other large cap staples names whose multiples exceed that of PM.
THE HEDGEYE EDGE
We see CAG as a relatively inexpensive name (16.5x calendar 2013 EPS versus the large cap packaged food group trading at 17.8x). We believe that CAG had additional upside to earnings on a standalone basis and is now in the process of layering in a transformative acquisition that recently closed in Q1 2013 that should provide investors a path to a higher EPS profile through accretion and synergies. The combination of synergies, accretion and deleveraging should provide a clear path to EPS growth over the next 1-2 years.
CAG recently closed the acquisition of RAH for $90 per share in cash. The transaction transforms CAG into the largest private label food manufacturer in North America. Private label grows faster (about 2x the growth of branded in the United States over the past decade), but is much more volatile in terms of top line trends and margins. RAH competes in a number of center of the store categories – cereal, pasta, snacks, sauces, etc.
Finally, as commodities continue to decline, both the branded and private label business at CAG should see gross margin tailwinds at a rate disproportionate to the balance of the staples group.
INTERMEDIATE TERM (the next 3 months or more)
The combined entity will have $18.2 billion in revenue, and should be able to grow top line in the 3-5% range, including 1 pt. from private label acquisitions. We estimate that the transaction could be between $0.15 - $0.20 accretive, conservatively and, as mentioned, above we saw upside to consensus prior to the deal with RAH.
LONG-TERM (the next 3 years or less)
Merger synergies alone could provide 4% EPS growth. We estimate that deleveraging could provide another 1 to 1.5 pts to EPS growth. Bottom line, the combined business could deliver 8-10% EPS growth without the benefit of any margin expansion associated with a more benign commodity cost environment.
ONE-YEAR TRAILING CHART
Client Talking Points
Can You Take Me Higher?
The Russell 2000 made another all-time high on Friday as the US stock market marked its sixth consecutive week of upside. Anyone in the perma-bear camp should reconsider their game plan, as you can only fight the broader market for so long before you get creamed. With the US dollar strengthening and heading back into bullish formation, we should continue to see positive momentum in stocks. Strong Dollar, Strong America. Keep in mind that the Bernanke commodity bubble popping and the 10-year yield hovering above 2.0% are a result of #GrowthStabilizing. Provided oil doesn’t hit $130 a barrel, the bulls will continue to win.
|FIXED INCOME||5%||INTL CURRENCIES||15%|
Top Long Ideas
We believe ASCA will receive a higher bid from another gaming competitor. Our valuation puts ASCA’s worth closer to $40.
With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view.
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
TWEET OF THE DAY
“BTW very sneaky for Obama to schedule the State of the Union Address for Mardi Gras” -@harmongreg
QUOTE OF THE DAY
We live in a society exquisitely dependent on science and technology, in which hardly anyone knows anything about science and technology.” -Carl Sagan
STAT OF THE DAY
The CRB Commodity Index fell -1.3% last week while CRB futures/options contracts shot up +11%.
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Takeaway: Tightening muni swaps and widening yield spreads are two notable positives helping to offset modestly growing weakness in Europe.
* U.S. Financial CDS - Bank of America, Citi, Morgan Stanley and Goldman all widened by 8-13 bps, reflecting the marginal deterioration in EU conditions. On the other side, we again saw mortgage insurers tighten, reflecting the ongoing positive perception around housing's recovery.
* 2-10 Spread – Last week the 2-10 spread widened to 174 bps, 2 bps wider than a week ago.
* Markit MCDX – Last week spreads tightened 7 bps, ending the week at 100.49 bps versus 107.83 bps the prior week.
* Euribor-OIS spread – The Euribor-OIS spread widened by 2 bps to 12 bps.
* High Yield (YTM) Monitor – High Yield rates rose 15 bps last week, ending the week at 6.11% versus 5.96% the prior week.
Financial Risk Monitor Summary
• Short-term(WoW): Negative / 3 of 12 improved / 3 out of 12 worsened / 7 of 12 unchanged
• Intermediate-term(WoW): Positive / 6 of 12 improved / 4 out of 12 worsened / 3 of 12 unchanged
• Long-term(WoW): Positive / 8 of 12 improved / 0 out of 12 worsened / 5 of 12 unchanged
1. American Financial CDS - Swaps widened for 20 out of 27 domestic financial institutions. Bank of America, Citi, Morgan Stanley and Goldman all widened by 8-13 bps. This was the largest week-over-week increase we've seen in some time among the large cap U.S. financials, reflecting the marginal deterioration in EU conditions. On the other side, we again saw mortgage insurers tighten, reflecting the ongoing positive perception around housing's recovery.
Tightened the most WoW: MBI, HIG, RDN
Widened the most WoW: MS, BAC, C
Tightened the most WoW: GNW, AGO, MBI
Widened the most MoM: COF, BAC, MTG
2. European Financial CDS - Swaps were mostly wider among European financials last week. No individual companies stuck out, but broadly speaking the Spanish, Italian, and, to a lesser extent, French banks were all wider.
3. Asian Financial CDS - There was relatively little movement among Asian financials last week, with the exception of Daiwa, which tightened 21 bps.
4. Sovereign CDS – Sovereign swaps were mixed last week. We saw modest further widening from Italy and Spain, while Ireland tightened. Italy and Spain have widened 46 bps and 42 bps, respectively, over the past month. The U.S., Japan, Germany and France were all essentially unchanged.
5. High Yield (YTM) Monitor – High Yield rates rose 15 bps last week, ending the week at 6.11% versus 5.96% the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index fell -3.8 points last week, ending at 1765.43.
7. TED Spread Monitor – The TED spread fell 0.3 bps last week, ending the week at 22.4 bps this week versus last week’s print of 22.75 bps.
8. Journal of Commerce Commodity Price Index – The JOC index fell -0.1 points, ending the week at 11.45 versus 11.5 the prior week.
9. Euribor-OIS spread – The Euribor-OIS spread widened by 2 bps to 12 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk.
10. ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB. Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system. An increase in this metric shows that banks are borrowing from the ECB. In other words, the deposit facility measures one element of the ECB response to the crisis.
11. Markit MCDX Index Monitor – Last week spreads tightened 7 bps, ending the week at 100.49 bps versus 107.83 bps the prior week. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1.
12. Chinese Steel – Steel prices in China rose 0.9% last week, or 35 yuan/ton, to 3790 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.
13. 2-10 Spread – Last week the 2-10 spread widened to 174 bps, 2 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.9% upside to TRADE resistance and 1.5% downside to TRADE support.
Joshua Steiner, CFA
Todd Jordan (GLL):
Rob Campagnino (Consumer Staples):
Howard Penney (Restaurants):
No doubt the news from NJ is positive but the value will likely accrue to the bondholders. Interactive Spin-off? The answer is the same as last time.
It feels like a broken record, a movie sequel, a television rerun, Las Vegas companies claiming the Strip is in recovery…well you get the idea. Investors are hoping for a spin-off of CZR’s Interactive assets that would unlock equity value for shareholders. As we began discussing almost a year ago, any unlocked value would have to accrue to the bondholders, not the equity holders. Caesar’s stock is up 64% since February 6th on the high likelihood of NJ passing I-gaming legislation and speculation by investors that they will be able to spin off Caesar’s Interactive division to the benefit of stockholders. The New Jersey news is, indeed a positive, not worth a 64% move, but positive. However, the idea of an Interactive spin-off boosting equity shares is an unlikely one. A misleading article titled “Caesars Rises on Plan to Sell Stake in Online, New Casinos” printed on February 4thand redistributed by AGA Smartbrief the following afternoon added to the hype.
As we wrote about on February 28, 2012, “SPIN-OFF OF CAESARS INTERACTIVE? NOT SO FAST…” and again on March 16, 2012, “CZR INTERACTIVE SPIN MAY BE JUST “SPIN”, we do not believe that CZR can spin/split off the Interactive assets to benefit equity holders. Issues include tax consequences and upstream guarantees to Caesar’s Entertainment Corporation (CEC) from the Interactive subsidiary. That’s not to say that CZR’s cannot monetize their asset, just that the benefit will not go to shareholders.
In fact, that’s exactly what CZR is doing in their most recently proposed $1.5BN note issuance. In order to raise new debt, CZR’s is contributing some unencumbered and “under” encumbered assets as collateral. HIE Holding’s stock (a CEC subsidiary) in Caesar’s Interactive, the Baltimore option, Planet Hollywood (which is only 4.5x leveraged), and the bonds they bought back at a huge discount and currently clip a healthy coupon are being contributed as collateral to back the $1.5BN note offering. This is probably not exactly what stockholders had in mind when reading the title: “Caesars Rises on Plan to Sell Stake in Online, New Casinos”. In fact, this diminishes the probability of any spin-off as Caesar’s Interactive will no longer be an unencumbered asset. What shareholders viewed as a big option is getting “liened” up.
On a separate note, we think that the market is over-valuing the size and profitability of a legal NJ online gaming market. Nevada legalized online gaming back in June 2011 and we have yet to see any impact. Same goes with Delaware. New Jersey has a larger population but it would still need to pool with other States to accumulate enough liquidity. Legal hurdles will prevent that from happening any time soon. More states will have to legalize gaming before any pooling becomes meaningful.
This huge rally looks like it needs to be faded.
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