“In the taiga there are no witnesses.”
-Dersu The Trapper
That’s the opening volley from a book I just cracked open, The Tiger – A True Story of Vengeance and Survival (by John Vaillant). The “taiga” is not to be confused with the Amur Tiger. Both are to be feared, in different ways.
The taiga is where these killers prowl, in “the mixed broad leaf and conifer forests of Siberia.” As for the Siberian tiger itself, people “fear it, revere it, tolerate it, and sometimes hunt it.” (pg 19)
If you want something to scare the hell out of you, I’m betting that one of these hungry cats does it better than this market can.
Back to the Global Macro Grind…
If I take you out back into the black bear bushes of Thunder Bay, Ontario (in the dark, with no crackberry or gun) I bet I can scare the hell out of you too. To be clear, there are times to fear – and yesterday wasn’t one of them.
After banging the top-end of our immediate-term risk range (immediate-term TRADE overbought on Tuesday, where we sold at 1530 SPX), the US stock market corrected for 2-days (from the all-time high in the Russell2000) and people were freaking out.
Or are they freaking out because they missed a +177 point move in the SP500 from the November lows, chased the February high, then got snow plowed? People have baggage, I get it. But let’s get real here – nothing about our bull case has changed.
- We are bullish on global #GrowthStabilizing (especially in Asia and the USA, not France)
- We are bullish on both US Housing and US Employment (Existing Homes Inventory reported -25% y/y yesterday!)
- We are bearish on Commodities, particularly Gold, Silver, and Food
So, if you want to get bearish on something, get bearish on something that’s actually gone down for more than 48 hours. Commodities and their related equities have been a relative train wreck for not only February, but since Bernanke’s Top.
Since Bernanke’s money printing top (September 14, 2012 - #timestamp it):
- The CRB Commodities Index (19 commodities composite) is down -8.7%
- And in the last 3 months, Gold and Silver are down -8.7% and -13.9%, respectively
- Wheat, Cocoa, and Corn are down -14.7%, -15.3%, and -6.8% in the last 3 months too
And if you don’t care on Cocoa (I don’t) and are a little shorter-term than that with a US stock market focus:
- For FEB to-date, Basic Materials (XLB) is down -3.3%
- The SP500 is +0.3% for the month-to-date
Wanna get nuts? I can get nuts. I can rip into a 40yr US Dollar Debauchery cycle rant like you have never seen. I can throw more historical data at you on what perpetuated the all-time highs in Commodities (2011) than you can shake a stick at. I can yell. I can scream. I can probably even win a butt-kicking contest versus a one-legged commodity bull on this, dammit!
(interviewing for Santelli’s job, so thanks for reading that)
Back to reality – I keep getting asked “well, Keith what about your call on US Dollar Correlation Risk from 2010-2012.” A: correlations in markets are never perpetual, and it’s 2013.
What do I mean by that? It’s just math. Here’s what’s happening in our immediate-term TRADE correlation model (vs USD):
- CRB Commodities Index vs USD correlation = -0.98! (uber negative correlation)
- Eurostoxx600 vs USD correlation = -0.68
- SP500 and MSCI Asia (Equities) vs USD correlations = +0.13 and +0.55 (note, they are positive)
So stop freaking out. Like the Reagan (1) and Clinton (1) US #GrowthStabilizing (then eventually accelerating) periods, Strong Dollar can become a pro-growth signal. Oh, and China likes Strong Dollar, down food prices too. Don’t you?
If you want to get scared, fear the biggest thing of all that can screw this all up - the government.
Out immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, UST10yr Yield, and the SP500 are now $1, $112.59-117.02, $80.63-81.53, $1.31-1.33, 92.87-94.39, 1.97-2.05%, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on February 08, 2013 for Hedgeye subscribers.
“I hated every minute of training, but I said, ‘Don’t quit. Suffer now and live the rest of your life as a champion.’”
Winning is never easy. It requires early mornings and working hard. That is true regardless of what your field of competition. It may be producing research, it may be investing, it may be athletics, and so on.
Last night I joined the men of Ivy League Football for a few cocktails post the dinner they hold every two years. Now I’m going to admit it, I definitely would have preferred to continue to sleep in this morning (so, yes, perhaps I had too many cocktails), but the only type of winning I understand is that which requires getting up and grinding. So here I am.
As usual when I get up, I’m greeted by a few emails from my colleague Keith McCullough regarding the global macro news and data flow. The most notable one this morning related to the Stoxx 50, which is the “blue chip” index for Europe. (Think Dow Jones with a few more names.) His email simply stated, “The Stoxx 50 snapped.”
For those of you that have been subscribers for awhile, you know that the price of securities and indices in our model are critical to determining future outlook. When something snaps, that is not a good thing for those investors that are long of that market. So, yes, as it relates to Europe, oh snap indeed.
Should any of us be surprised that the blue chip European index has snapped this week? Well, not really given that the European Union leaders were all convening in Brussels and that T.V. cameras were omnipresent. In fact, according to the news releases this morning, they actually pulled an all-nighter last night. I was out late with the boys from the grid iron, but I certainly didn’t pull an all-nighter, so kudos to them.
That said, the fundamental problem with politicians getting too much air time is that it is usually not great for equity returns. Or, really, any asset price returns. The funny thing about policy and policy makers is that they actually do influence markets and sometimes to a greater degree than they realize. The perfect recent example of this phenomenon is the Japanese Finance Minister, Taro Aso.
Mr. Aso has been quite explicit since coming into office that he believes Japan needs to devalue and create inflation. That is obviously all fine and good, until the market corrects more than said policy maker hopes. As it relates to Mr. Aso and the Yen, it seems that has happened this morning. According to this Aso:
“It seems that the government's policies have fueled expectations and the yen weakened more than we intended in the move to around 90 from 78.”
Markets are funny critters, aren’t they? They often do more than we expect. (And sometimes less for that matter.)
This morning, there is a fair amount of pin action. As Keith also highlighted this morning:
“Plenty of cracks in my country level TRADE and TREND signals (Equities) now – tops are processes, not pts:
1. FX WAR – Draghi is now trying to do precisely the opposite of what helped Germany recover, jawbone the Euro back down; overlay the slope of German economic recovery w/ the Euro in the last 3 months and you will see the pt western academics don’t get – currency has a POSITIVE correlation to growth expectations.
2. INDIA – India’s Sensex joins the KOSPI (and Italy, France, Spain, Brazil) as the latest Equity market to snap my immediate-term TRADE line of 19,839 support. In isolation, I wouldn’t bother w/ a signal like this – but when the big country indices start to pile up, I move. Took down our Global Equity asset allocation yesterday.
3. 10YR - the long bond looks almost identical to the VIX on price/volume/volatility factors – both signaled their first higher-lows of the yr in the last 48hrs. The upside down of that now makes last week’s closing high for the 10yr of 2.01% immediate-term TRADE resistance. Brent Oil > $115 is a headwind to global growth. Period.”
Incidentally, if you are not on the Direct from KM email list, ping firstname.lastname@example.org and let them know you want to be upgraded.
As for the points above, the most noteworthy callout from my seat is that the Indian equity market has also snapped. When equity indices start to snap, it is time to reduce equity exposure.
Despite some of these major indices snapping, not all is negative this morning. In fact, China reported some solid economic data. Specifically, Chinese trade data for January beat expectations as exports rose +25% versus estimates of +17.5% and imports were up +28.8% versus estimates of +23.5%. Those are darn good numbers, even if it is the year of the snake!
I’m going to cut it a little short this morning as I’m sure many of you are busy prepping for the snow storm. As always, let us know if you need help with anything.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, UST 10yr Yield, and the SP500 are now $1651-1684, $115.78-118.03, $79.79-80.29, $1.33-1.35, 92.20-94.29, 1.92-2.01%, and 1492-1516, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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Takeaway: The stock doubled, and it should double again. We need to be mindful of duration, but all the building blocks for $FNP are there.
We think that FNP investors debating the fate of Juicy Coture, or whether Kate Spade will be a stand-alone entity ‘is so 2012’. At $17 you need to believe that the company’s real earnings power can be well north of $1.00 over 2-3 years. We happen to be in that camp, with an estimate of $1.15 vs. the Street at $0.39 in 2015.
Exhibit 1: FNP EPS ESTIMATES. HEDGEYE VS. CONSENSUS
FNP might seem expensive at 15x our estimate, but the reality is that if our estimates are correct, the company will be putting up triple digit growth rates (see assumptions below), which can sustain a multiple at least what we’re seeing today. In fact, we question how some Analysts could possibly have ‘Buy’ ratings while suggesting that the company’s earnings power is only $0.30-$0.40. They’ll be taking up numbers.
Interestingly enough, when we look at the sum of the parts, we get to a value based on current year earnings of only a buck or two above where it’s trading today. That’s just 10%, and hardly anything to write home about given FNP’s more volatile style factors (not to mention short interest at the lowest level in four years and a beta of 1.8x).
Exhibit 2: SUM OF PARTS ANALYSIS
But when we use our significantly higher 2014 estimates, we get to a value of $28 (60% above current levels), and a year later we’re at $38 using our 2015 model.
When the stock was at $10, we said specifically that 'it would double, and then would double again'. And we completely agree that the stock has far less room for error given the recent run. As such, throwing out a $38 value in 2-years is not thesis morph for us. It’s sticking to the same story. We’d be concerned if there was a tight gap between us and consensus. But as long as we’ve got the growth trajectory and earnings upside in Exhibit 1 above, we’re cool with the valuation.
Here are some of the key assumptions behind our model.
1) Juicy: For modeling purposes, we assume that it is in growth purgatory for the foreseeable future, with EBITDA bottoming at $10mm and rising to $16mm (less than a 3% EBITDA margin) over 3-years.
a) That’s probably not the best way to look at it, because the reality is that if it turns in such performance, the division will be history. If it improves slightly, then it’s still likely gone. If it improves dramatically, then our numbers go up.
b) Actually, even if FNP divests at current levels, we think it’s reasonable to assume that FNP strikes an arrangement for something in the 0.5x sales range. That sounds rich at a mid-teens EBITDA multiple, but we think a buyer would be rational enough to assume that the real earnings power is higher (else they would not touch it). The key to that transaction, we think, would be that it would allow better than 60% of net debt to go away.
c) Our analysis of FNP using Sum of Parts only assumes that debt comes down as a result of cash generated by the company’s own free cash flow (i.e. from divisions that are actually throwing off cash). Anything else would be gravy.
2) Lucky: This is one where the number of growth initiatives in the pipe has caught us by surprise. Admittedly, out of the three divisions, this has garnered the least attention. It’s never been a problem child – at least not lately. But it’s never been a rock star, either.
a) Yet suddenly, the company’s assortment seems to be more fashion forward, with two major innovations (that management was tight-lipped on). They are also taking what is working from Kate and applying it to Lucky – with a handbag line, for example, which makes perfect sense. It is also expanding geographically – into six new territories starting in 3Q.
b) With all of this, the company put out mid-high single digit comp guidance for the year, which is the most upbeat we recall in a while. We have comps at 7% for the year, but driven by a back-end loaded 8% and 10% in 3Q and 4Q, respectively. Then we’re got 10% in 2014. Through all of this, we’re giving zero EBITDA margin improvement in our model, which seems like a conservative assumption to us.
3) Kate Spade: Kate just put up a whopping 27% comp on top of a 58% comp a year ago. That momentum won’t continue forever. Management knows it, and they don’t want to step in front of the freight train of missing an ambiguously aggregated consensus estimate by a point and having people get bent out of shape by asking ‘why is Kate slowing?’. That’s why they put out a ‘low teens’ comp rate.
a) We look at it by pegging an appropriate sales productivity rate, and then backing into what comp rate will get it there. After all, that’s how the company manages its business.
b) Right now, productivity at Kate is running at about $1,100. That might seem like a lot. It is. But KORS is running at about $1,700 this year, and if you believe in consensus estimates over the next 2-3 years (which we are inclined to believe) then they’ll approach $2,400/square foot.
c) Never in a million years will we suggest that Kate is KORS. But even Coach is at about $1,800/sq ft in the US, and is pushing $2,800 in Japan.
d) Something to keep in context is that the Kate Japan license that FNP just brought back in house is running at about $1,400/sq ft in productivity. Yes, this is a higher-end market and almost always commands higher prices. But this is a business that FNP has not even directly controlled. When RL took in its geographic licenses it saw sales lifts of 40-50%.
e) We can go on with this exercise for a while, but the point is that it is that $1,100 in productivity does not seem maxed out to us by any means, especially with 45% of the stores having come on to the P&L within the past 3-years – and they reach peak productivity in between 4-6 years. If Kate put up a low teens comp for 3-years, it’d still be below $1,600 in productivity. We’re closer to 20% in our model.
f) We’re modeling margins down 200bp at Kate this year, which is pretty much what management guided. We don’t think that they’re sandbagging, as the costs to integrate the Japanese business are real. Where we could be overly conservative is if comps come in meaningfully ahead of our 20% model, in which case they’d leverage occupancy to a greater extent that we think.
4) Other Notables
a) We have ‘Other Income’ ticking up by about $1-2mm per quarter, in part because of foreign currency gains, but also because this is the area where minority interest shows up. Believe it or not, we expect some of those business to contribute (albeit on a small scale).
b) Conversely. We have interest expense down by about $1mm per quarter as net debt levels tick down slightly from year-ago levels starting in 2H.
Hedgeye CEO Keith McCullough appeared a guest host on CNBC's The Kudlow Report this evening. Among the topics discussed was the ongoing currency wars and how a strong US dollar helps deflate the commodity bubble created by the Federal Reserve's quantitative easing programs. If you look at the dollar on a 40-year basis, the all-time low was in 2011 and coincidentally, commodity prices hit an all time high in 2011. If we get the Federal Reserve out of the way or introduce spending cuts, we'll drive down inflation which in turn will drive stocks higher as consumption increases through lower food and gas prices, etc. Get the dollar right and you get a lot of other things right.
Watch Keith's full appearance on Kudlow Report on the video above.
We have observed a good bit of NWL CEO Mike Polk’s professional career, from the old Kraft to Unilever and now NWL – we like the story he told and the way he thinks about the business.
International Flavors & Fragrances (IFF)
Since HNZ apparently couldn’t get out of CAGNY fast enough, IFF stepped up to the plate and took the morning presentation. It’s a good story, and to the extent that innovation has been a consistent theme throughout the conference (we call it the cost of doing business), IFF is the innovation backstop for most of the companies in the staples universe. Total business grows 2-3% globally, and IFF tends to be a consistent share gainer over time (16% share of market). Scale matters in this business (IFF has it) as the global companies that IFF partners with want the ability to deliver local solutions on a global scale. What also struck us was that IFF was an underappreciated emerging markets story, which only stands to reason as the global CPG companies drag preferred suppliers along as the business expands into emerging markets. The company is at a low point in the leverage cycle in a global consolidating industry – possibility exists for accretive deals.
Procter & Gamble (PG)
Company focused on some overdue innovations – again we go back to our comment that innovation is the lifeblood of the staples sector. Company seems to realize (finally) that you can only take pricing or price at a premium when you offer compelling value to the consumer and communicate that value. Value needs to be communicated to retail partners as well – make it a win/win (really hate that phrase). Rate of change of innovation is increasing, and thinking globally about those innovations. Company basically admitted that productivity had taken a back seat when results were more robust – I see productivity as a process of constant improvement, and it will be interesting to see just how ingrained this process becomes in PG once the big savings program runs its course. There are some bad habits that have been ingrained in this company over a long period – pricing without value and using that pricing umbrella as an excuse to be less diligent about costs. The process of change at PG is well-begun, let’s see how well the lessons of the past are learned. At least the company is no longer relying on sales growth in order to leverage the company’s SG&A base.
The presentation started out as your basic business overview – yawn. Some of the global demographics were interesting, for example - sweet spot between $10,000 and $20,000 in GDP per capita in terms of adoption of the company’s products – a number of emerging markets entering into and currently in the sweet spot for the company. Company followed up with familiar chart – the opportunity to get per capita consumption up to the levels seen in Mexico – this charts never sit all that well with us, truthfully. A single number never seems to do justice to the substantial differences between consumers in different geographies. Next we move on to the obligatory commentary on innovation – have to say that the Doritos/Taco Bell shells rock hard. And what do you know – commentary on productivity. No need for large scale M&A – stated twice, it was so nice.
Avon Products (AVP)
I like leading in with the mea culpa for years of disappointing stakeholders – probably understated the level of frustration a bit. The company has some very aggressive financial goals, but seems to have the strategy in place to execute against the plan, starting with – you guessed it – innovation. The company has seen some market share challenges across multiple categories – but the categories are attractive in terms of the long-term growth, but need to get fair share of growth. Innovation for AVP is a little more complicated, because there is a component of educating the representatives as to the benefits of the innovation. Representative is social connection between product and consumers and need to upgrade the capabilities of the representative. All things considered, it was a very comprehensive and confident presentation with a focus on products, people and places.
The company basically took a victory lap for what it had accomplished since 2008 - double digit EPS growth, 2-3% consistent top line growth. Interesting, and obviously true, but we are not big on rear-view mirror stuff. The company shared some very interesting data on bleach compaction and incremental advertising on bleach, with the data on advertising suggesting that advertising targeted at adults under age 35 actually drove an uptick in usage of bleach. Who says advertising doesn’t work? The “give your home a flu shot” campaign and healthcare solutions make sense and are certainly on trend. Further, the company’s opportunity outside the U.S. appears reasonable and on trend with respect to health and wellness. Management seemed very confident about the margin opportunity and the ability to execute against those plans for the foreseeable future, in part because of a more benign commodity environment.
Newell Rubbermaid (NWL)
The company outlined a fairly compelling investment thesis to start, a tail wind behind categories - housing starts is a relevant indicator for 1/3 of NWL's categories. Second, cost savings provide a reasonable clear line of sight to EPS growth. Next, innovate and invest to move closer to the virtuous cycle to which all staples companies aspire. The company is focusing efforts behind key categories that represent material growth opportunities with superior margin structures. The rest of the portfolio has to run lean and mean (used to be run as autonomous business units with associated cost structure). This year will be a transition year, with progress accelerating throughout the year – NWL, weak Q1, stronger Q2 – just pacing. Good management, good story.
Church & Dwight (CHD)
CHD boasts that they are a smaller player at CAGNY (2012 Rev. $3B, Market cap $8B) and are “Total Shareholder Return (TSR) Junkies” with 12 consecutive years of 10%+ EPS growth. The company describes its portfolio of brands as recession resistant, 40% in the value category, with a compelling offering to meet the “new normal” consumer. Alongside its 8 Power brands that equate to 80% of profits, CHD is looking to make condoms, lubricants, and vibrators its next megabrand and grow its recent acquisition of Avid Health in vitamin gummies. Its 2013 Outlook is 3-4% Organic Sales; GM 44.2% (core business ex-Avid +25-50bps vs ’12); and 14% EPS growth to $2.79 on a marketing spend that is flat at 12.2% vs last year. CHD’s balance sheet is “under levered” at 1.4x. The company did not signal any acquisition targets but is confident in its ability to find targets that it can make earnings accretive within the first 12 months.
Successful innovation and restructuring projects – it certainly sounds familiar, but it is a fairly new concept for ENR. A familiar name to most of us (Schick Hydro) is the example of successful innovation provided by CEO Ward Klein – multiple market share examples were provided across various line extensions. Presentation moves to a build-up of the organic growth and acquisition growth that has created the Energizer of today – moved on to the tale of woe that is the secular challenges of the battery category. Interesting that it appears that restructuring was forced on the company by the challenges of the category, rather than any discipline with respect to costs. The meat of the presentation was familiar – manage batteries for cash, generate growth from personal care. At the end, it was also nice to see the company continue to acknowledge the bare minimum required of them as a public company in terms of investor relations, eschewing the company’s prior history where it acted more like a quasi-private company. Golf clap?
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