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Still Bullish: SP500 Levels, Refreshed

Takeaway: Bearing bearish because we are at a certain price level isn’t a catalyst.

POSITIONS: 12 LONGS, 6 SHORTS @Hedgeye

 

I’ve been on the road all week seeing clients in California. I’ve been told, multiple times, “you are the most bullish firm we pay right now.” That’s kind of weird to hear. But I kind of like it.

 

Bearing bearish because we are at a certain price level isn’t a catalyst. Neither is trying to call tops or managing career risk associated with not wanting to make the mistakes that were made the last time we were at these levels (i.e. the 2007 top). That’s called baggage.

 

The career risk (draw-downs) we think will be in missing growth stabilizing and accelerating (draw-downs in being long Gold, Treasuries, Yen, etc.). Strong Dollar (6 weeks in a row to a YTD high) is perpetuating Commodity Deflation (6 down weeks in a row). That’s an explicit pro-growth signal; especially for Consumption Growth.

 

Across our core risk management durations, here are the lines that matter to me most:

 

  1. Immediate-term TRADE resistance = 1565
  2. Immediate-term TRADE support = 1527
  3. Intermediate-term TREND support = 1468

 

In other words, there is no resistance to the all-time closing high for the SP500. This market continues to make higher-lows and higher-highs, as the US economic growth picture continues to improve.

 

Enjoy your weekend,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Still Bullish: SP500 Levels, Refreshed - SPX


LV STRIP: EVEN WORSE

Takeaway: Sorry folks but Vegas is not in recovery. MGM numbers at risk

 

 

 

January LV Strip gaming revenues fell 19%, worse than our projection of -8-12%.  If we adjust table and slot hold to historical norm this and last January, gaming revenues fell 20%.  Baccarat was a major contributor of the decline as volumes fell 49%. More troubling was that slot volumes fell 2.4%, reversing two straight months of YoY growth.  We believe February slot volumes will also decline.  Not exactly the start to the year the bulls were expecting.

 

Strip Details:

  • Slot handle fell 2.4% (+1% on a rolling 3-month average).  
  • Slot win was flat as hold was 8.9% compared with 8.7% in January 2012 - both well above average
  • Table volume excluding baccarat dropped 5% YoY (+3% on a rolling 3-month average).  Table hold excluding baccarat was 11.6%, compared with 12.0% on a trailing twelve month average.
    • Baccarat volume tumbled 49% (compared with +163% growth in January 2012)
    • Baccarat win dropped 51% on hold of 12.0% (TTM: 11.9%, 12.5% in January 2012)

 

LV STRIP: EVEN WORSE - Screen Shot 2013 03 12 at 4.11.51 PM


When Can We Short Food Stocks Again?

This note was originally published March 06, 2013 at 18:13 in Consumer Staples

Is this the start of something big?



The question we have received most in the wake of Heinz being acquired by 3G with financing provided by Berkshire Hathaway is “who is next?”  We attempted to answer that question specifically in a prior analysis that highlighted some of the characteristics of Heinz that might have made it attractive to a cost-minded acquirer such as 3G.  Here, we attempt to answer the question behind the question which is whether or not we are poised for a wave of acquisitions across staples, specifically packaged food.

 

We are of the opinion that merger waves are a consequence of industry “disruptions”.  These disruptions don’t have to be single events, but can be built up over a longer duration and comprised of multiple smaller events, rather than a single significant event.  There isn’t a great deal of academic research to fall back on with respect to this topic – Mitchell and Mulherin (1996) argued that industry-specific merger waves occur as a “common response to regulatory, technological and economic shock.”  The new competitive dynamic requires a reallocation of capital within in an industry.

 

Interestingly, most “waves” occur during strong, broader markets with varying theories for this – access to capital or perhaps  a desire on the part of managers to trade “expensive” paper for “real” assets - Maksimovic and Phillips (2001) and Jovanovic and Rousseau (2001).  Interestingly, research suggests (unsurprisingly) that engaging in merger activity in strong markets and subsequent to prior deals in the same industry may not necessarily be a recipe for creating shareholder value.



Looking back at the wave of consolidation in packaged food in 2000 (see below), it appears that it was in response to a shift in the balance of power between manufacturers and retailers brought about by a prior wave of consolidation within food retail.  From 1996 to 2000, assets representing nearly $75 billion of retail sales were consolidated in US food retail, including two of the biggest combinations in history (Albertson’s/American Stores and Kroger/Fred Meyer).



Packaged food manufacturers were faced with a sea change in terms of relative power versus retail counterparts (recall that Wal-Mart was becoming an increasingly more significant participant in food retail at this time as well).  Scale mattered again, and, in fact, became an imperative versus larger retail partners.  The packaged food industry responded in kind.



2000 Was a Huge Year for Packaged Food M&A

 

Unilever approached Best Foods in May of 2000, with the deal price ultimately agreed to in June (approximately 10% higher than the original offer, total consideration of $24.3 billion).    Later that same month (June), Philip Morris (at that point still the tobacco/food conglomerate) agreed to acquire Nabisco for $15.5 billion.  The bidding for Nabisco was robust, with Danone and Cadbury as other engaged parties.



Though not the purchase of a public company, General Mills agreed to purchase Pillsbury from Diageo at the end of July for $10.5 billion.



In a smaller transaction relative to the food deals in 2000, Kellogg acquired Keebler Foods for $3.9 billion in October.  The year wasn’t quite over, as Pepsi acquired Quaker Oats in December for $13.4 billion.



Does the same imperative exist now?

 

We would argue, no.  If anything, we believe that food retail’s relative position has only weakened over the last decade.  Channel blurring is a familiar term for most investors and we have seen data that suggests that fully ¾ of consumers shop more than 5 CPG channels regularly.  Fewer trips and smaller tickets per trip to each retail channel has “spread the wealth” among various retailers and retail concepts to the point where conventional grocers (the catalyst for the last wave of packaged food consolidation) continue to struggle.  Certainly Wal-Mart’s importance continues to grow, but we see an acquisition that could successfully balance a supplier against Wal-Mart as being highly unlikely, if at all possible.



Further, since 2000, an entirely new channel has emerged – the natural and organic store.   The trend toward health and wellness has certainly represented a “shock” in some sense of the word.  Capital has been reallocated by the packaged food manufacturers to address this competitive disruption, but the size of the channel doesn’t allow for “mega” deals, so we don’t see this trend, while certainly powerful and ongoing, as a catalyst for large scale M&A.



Is age a factor?

 

There is some work that suggests that the age of CEO’s within a particular industry might be a catalyst for merger activity.  We only mention this because, Bill Johnson of Heinz, at age 64, was the oldest of the CEO’s in large cap packaged food.  Denise Morrison at Campbell Soup and Irene Rosenfeld at Mondelez are “next in line” at age 59, with Ken Powell of General Mills close behind.

 

Where does this leave us?

 

It appears that some conditions have been met for a “wave” of merger activity – a strong market, access to liquidity and perhaps the age of the relevant CEOs.  However, we are simply not seeing the “shock” to the system that forces companies to pursue acquisitions in an environment where current valuations make the creation of shareholder value through mega deals an uncertain prospect at best.

 

If no more deals, what’s next?

 

We decided to take a look at the performance of the S&P Packaged Food Index into and subsequent to some recent, large transactions, as well as the performance of the indices in 2000.  No question, if we are at the start of a wave of consolidation within packaged food, there is room to run – trough to peak relative performance in 2000 for the index was +46%.  Wrigley in 2008 as a “one off” event represented far less compelling relative performance, but as everyone is well aware, ’08 is a difficult year to which one can (or should) draw analogies given market conditions.  Ralcorp (the first time around) is useful - +8% relative performance; 27 days later (call it a month).  Right now, with Heinz, the numbers stand at +6% relative performance, 14 trading days post-deal.  That suggests to us, using Ralcorp as an example, that we have some more time and price before it becomes “safe” to short packaged food stocks again.



 

When Can We Short Food Stocks Again? - Merger Wave

 

When Can We Short Food Stocks Again? - Wrigley

 

When Can We Short Food Stocks Again? - Cadbury

 

When Can We Short Food Stocks Again? - Ralcorp1

 

When Can We Short Food Stocks Again? - Ralcorp2

 

When Can We Short Food Stocks Again? - Heinz

 

 


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Another Day

Client Talking Points

Up And To The Right?

Anyone who has been a perma-bear or has suggested going to 100% cash has been wrong. Plain and simple. The Dow Jones Industrial Average continues to make new highs every day this week, which is an impressive feat unto itself. Next in line for the all-time high prize is the S&P 500, which could get there today. It's almost like a perfect storm is happening right now: you have the US dollar getting stronger and driving commodity prices down which help drive consumption and stocks keep going up and to the right. Just when you thought good couldn't get better, it does. Hence why we continue to be bullish on US equities.

Asset Allocation

CASH 24% US EQUITIES 24%
INTL EQUITIES 24% COMMODITIES 4%
FIXED INCOME 0% INTL CURRENCIES 24%

Top Long Ideas

Company Ticker Sector Duration
ASCA

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

FDX

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

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

"US Dollar +3.6% since December FOMC 6% unemp tgt. Markets move first, fundies follow, now down to 7.7% on Feb report." -@Chicagostock

QUOTE OF THE DAY

"There is absolutely no inevitability as long as there is a willingness to contemplate what is happening." -Marshall McLuhan

STAT OF THE DAY

U.S. economy adds 236,000 jobs in February. Unemployment falls to 7.7%, the lowest level since December 2008.

 

 



Renaissance Men

“The dramatic modernization of the Asian economies ranks alongside the Renaissance and the Industrial revolution as one of the most important developments in economic history.”

-Larry Summers

 

Candidly, over time I have found myself disagreeing with a lot of what Larry Summers has said publicly. That said, the above quote definitely resonates with me.  As I touched on earlier this week, the story of development in Asia over the last twenty years, and in particular in China, is really unprecedented in economic history.

 

In North America over the last few decades the Renaissance Men, for lack of a better word, have been the private equity firms and hedge funds partners that have generated outsized returns and been paid handsomely.  Like any Renaissance, though, this one too will end.  This end is evidenced by some recent studies that highlight hedge funds returns are correlated to the SP500 with a more than 0.9 r-squared. If true, this renaissance may be ending sooner than many expect.

 

With such a tight R-squared, an emerging risk is actually how much each hedge fund owns of a particular stock.  Many quantitative managers have actually gone on to categorize this as “hedge fund risk”.  In effect, this equates to the amount of stock outstanding that is in the hands of a series of hedge fund managers.  So if a lot of the stock is held with hedge fund managers, then the hedge fund risk is high.

 

So speaking of Renaissance men, Hedgeye has a few, but perhaps the most legitimate one is our own Matt Hedrick, who covers European equities.   Matt hits our internal team with an update on Europe every morning and today his key points were limited.  This is actually positive because what it means is there is a not a lot going on in European and her sovereign debt crisis.

 

In fact, in the Chart of the Day we highlight this by showing Spanish 2 and 10 year yields over the last year.  The fact is that credit risk in Europe has been steadily declining.  As the chart shows, Spanish yields are well of their peak, but not only that, they are also below the levels of a year ago.  The key take-away from this is that while Europe sill matters, it only matters to a point as European credit risk, broadly, has improved.

 

With peripheral yields improving, we are also seeing an improvement in capital flowing back to certain countries. 

Specifically, in Italy private sector deposits were up 7.7% year-over-year in the last month.  While this is not a number that is going gangbusters per se, what it does show is that capital is coming back to the certain at-risk sovereigns in the Euro-zone.  This ultimately is a positive for broader credit risk in the EU.

 

On the flip side, some of the European data was less than positive night-over-night.  For instance, German industrial production declined -1.5% from last year.  This is an acceleration from December, which declined -0.5%.  Are these freak out type numbers? No, but they are indicative of a European economy that continues to struggle in its recovery.

 

I often quote my colleague and Hedgeye Financials Sector Head Josh Steiner in the Early Look.  Once again I want to highlight a big call he made yesterday in a note titled, “BAC, C, MS - LONG THE BIG CAP BETA RENORMALIZATION TRADE”.  As Josh wrote:

 

“There’s a paradox in global U.S. banks right now, and that is that they hold more capital today than they’ve held in a very long time. We show this in a chart below, which looks at Bank of America. The red line shows BofA’s tangible equity ratio going back ten years. You can see on the right hand y-axis that capital fell steadily from the high fives in 2003 to a low of 3% in the belly of the crisis and has since risen to around 7%. Capital ratios are much higher on a regulatory basis, but we like tangible equity for its simplicity – in other words, unlike risk-weighted capital measures, it’s more difficult for banks to manipulate this ratio in their favor. The point is that capital levels are very high today and, in fact, are still headed still higher for the foreseeable future (we'll know how much more after the close). The second line on this chart shows Bank of America’s rolling one year beta going back ten years. The takeaway here is that it has risen from its tight range around 0.8 from 2003 through 2007 to around 2 today (1.93 as of this morning). Capital is the inverse of leverage, and leverage is risk. High capital equates to low risk. Now let’s use beta as our proxy for cost of capital, and by the transitive property we find that the the market is charging the highest cost of capital at a time when the risk is, in fact, lowest. This is clearly paradoxical, and a dynamic we don’t think will last.”

 

So to summarize:  capital ratios for large U.S. banks are improving and these stocks are poised to continue to lead the U.S. equity rally.  While I enjoy having a few drinks with my colleague Josh, I’m not sure he (or me for that matter) is a Renaissance man, but what he is definitely is very accurate in terms of his view of the U.S. banking system.  If you’d like more of his thoughts, please email .

 

As you all head into the weekend, I wanted to leave you with one last quote, which is related to a quote from the Early Look earlier this week:

 

“Marxism is like a classical building that followed the Renaissance; beautiful in its way, but incapable of growth.”

 

Indeed.

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1, $109.07-111.73, $81.98-82.54, 92.11-95.81, 1.94-2.04%, 11.67-14.91, and 1, respectively.

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Renaissance Men - zz. chart des tages

 

Renaissance Men - zz. vp


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