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HLF - What Happens When We Replace Fear with Math?

Looking Back to Look Forward



We are taking a page from our prior experience as a dedicated tobacco analyst, recalling the days when litigation threatened the domestic tobacco business at then Altria (combined international and domestic tobacco as well as Kraft Foods).



The argument was that at some point the market was applying a negative value to the domestic business and that even in a worst case scenario (a bankrupting decision against the U.S. business), the value of the other entities would be preserved on the other side of the corporate veil.  Further, structural differences in the legal systems outside the United States made the export of any bankrupting litigation unlikely, preserving the multiple associated with the international assets.



We see the situation with Herbalife is broadly analogous, as the current share price reflects some material degradation of the earnings power of the business – with the US business being the most likely source of the decline.  We are somewhat less secure in our belief in the case of HLF that consumer protection litigation/regulation can’t be exported outside the U.S. (versus product liability litigation in the case of the tobacco industry), but we believe that the international assets are likely far more secure than the domestic assets in the case that Pershing Square’s allegations prove to have some merit (an open issue, to be sure).



Recall that it is our belief that the Herbalife debate has become too high profile to be ignored by the powers that be – the FTC, SEC any of the State Attorneys General.  We see some sort of investigation as highly likely, an event that the market will not likely treat kindly.

 

The Math

 

Consensus EBITDA estimates for 2013 EBITDA are $794 million (7.9% growth versus 2012) – of that number, we estimate that nearly $190 million in EBITDA will be generated in the United States (23.5%).  It’s a bit of a chore to get to EBITDA by region and the company’s disclosures could certainly use some improvement – we agree with Pershing Square in that regard.



The company’s average forward EV/EBITDA multiple since 2007 is 7.5x – applying that multiple to the EBITDA forecast for the company ex-U.S. ($604 million) gets us to a share price of $42.50 for HLF’s business outside of the US, implying a negative value of $1.70 per share for the US business currently imbedded in the share price.  At any multiple greater than 7.1x EV/EBITDA for the rest of the world, the U.S. business is “free” as currently reflected in the stock price.  We think a multiple closer to 8.5x EV/EBITDA is more appropriate given peers and the growth profile.

 

HLF - What Happens When We Replace Fear with Math? - HLF EV.EBITDA

 

HLF - What Happens When We Replace Fear with Math? - HLF Sum of the parts

 

We think replacing fear with math is always a useful exercise, and while emotions can drive stock prices beyond where the math would suggest, we think having some sort of analytical framework to look at what is currently being discounted is the best way to be right more often than not.

 

-Rob

 



Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

E:

P:

 

Matt Hedrick

Senior Analyst


GOLD: ANATOMY OF A BREAKDOWN

Takeaway: Growth, $USD Strength & incremental Fed hawkishness are bearish for Gold. ETF Flows & CFTC Data are collapsing & USD correlations tightening

This note was originally published March 12, 2013 at 15:47 in Macro

 

GOLD:  ANATOMY OF A BREAKDOWN - Screen Shot 2013 03 12 at 4.57.47 PM


On the other side of our #GrowthStabilzing theme and our bullish TREND view on the Dollar and consumption oriented equities has been a bearish view on Treasuries, Commodities, and Gold. 

 

GOLD:  ANATOMY OF A BREAKDOWN - USD vs GLD

 

We’re not self-proclaimed gold experts but we’d argue the fiat currency devaluation hedge underpinning the parabolic gold trade over the last five years has been fairly discrete.   In short form, the Gold bug thesis can be adequately described as:

 

Economic growth stagnates/decelerates further --> Expectations for further QE initiatives rise --> $USD Depreciates --> Gold rises as investors discount erosion in the currency value and prospective future inflation and seek hard asset stores of value.    

 

Within this framework, both the dollar and Gold become a function of the interplay between reported/expected economic conditions and expectations around monetary policy.  When it plays out on a global level, as it has in the wake of the Great Recession, the variable mapping gets more complex and the price action exaggerated but the idea framework is still the same. 

 

Its also important to note strength of the growth-policy-USD/Gold connection is stage or cycle dependent.  For example, in the throes of economic or market distress the correlation between the USD & Gold tends to be positive as the safe haven trade plays itself out.  However, outside of crisis conditions,  fundamentals (growth, interest rates, policy, etc) become the prevailing drivers and moderate-to-strong inverse correlations between Gold and the Dollar have predominated, empirically.     

 

So, as straightforward as we think the bullish case for gold has been is as simple as we think the bearish case that has been playing out currently in gold is.   If you buy into the idea that weak growth, unconventionally easy monetary policy initiatives, and investor expectations around forward policy have been the principle drivers of gold price appreciation since 2008, then a reversal in these factors – stable/accelerating growth, a cessation & eventual unwinding of easing initiatives, a strong dollar, & rising interest rates  - should serve to drive a correction in Gold prices.   

 

What does the anatomy of that correction look like?

 

Summarily, it looks like more of what we’ve been seeing in Gold Prices, Dollar-Gold correlations, CFTC data, and gold ETF flows over the last four months – trends we’ve seen accelerate over the last five weeks as the economic data has flashed some upside and the dollar has begun to break out.  

 

Consider the chart below which shows physical gold outflows from the GLD (SPDR Gold Trust) vs. the dollar.  

 

GOLD:  ANATOMY OF A BREAKDOWN - USD vs GLD

 

Looking across a host of relevant factors, all of the charts (unsurprisingly) reflect a similar dynamic:

 

Gold vs Fed Balance Sheet:  The correlation between Gold and the Fed’s Balance Sheet is strong across durations with an R^2 = 0.92 over the last 14 years.  If you think this relationship makes common and economic sense (we do), a deceleration and unwind of policy intitiatives (or the expectation for) on the back of an improving growth outlook is a decidedly bearish catalyst for gold.

 

Gold vs. Dollar:  Gold’s Inverse correlation to the dollar has been moderate-to-strong across durations.  Gold is levered to the USD directly given that gold generally settles in dollars, and indirectly via expected inflation & policy impacts on fiat currency value.   Correlations aren’t perpetual – they build and decay - but when they start to tighten alongside other relevant/corroborating factors, it’s generally worth paying attention.  Gold’s 30D correlation to the dollar is currently -0.90. 

 

Gold - CFTC Data:  Bullish Speculative positioning looks like its capitulating as net length in combined non-commercial futures & options contracts has collapsed since November.  It hasn’t paid to speculate on the end of the world (again) as extremes in bullish positioning (>1STDEV) have been followed by negative subsequent price performance in gold 100% of the time over the last year.  Net length is currently down ~62% from the late 2012 highs. 

 

Gold ETF Flows:  Gold flows to the GLD and ETF’s in aggregate, have rolled over since the beginning of the year and  have accelerated to the downside over the last month.  For example, total Gold Holdings in the SPDR Gold Trust (GLD) are down ~114 Tonnes (-8%) from peak 2012 levels according to bloomberg data.   

 

This weekend, my brother, a sharp guy and passive retail investor, made the following rhetorical comment (paraphrased) “that jobs number was pretty good….who will be the marginal buyer of gold?”.   Good Question. 

 

The bull case for Gold was straightforward and price was reflexive on the way up.  Reflexivity, by definition, works both ways and big crowds and small doorways still don't make great bedfellows.       

  

If the growth data can continue to confirm, the USD remains in bullish formation and policy makers (Congress & the Fed) can stay out of the way, we think gold continues to hold some further downside.  

 

In the more immediate term, equities are overbought and Gold/Treasuries oversold. From a quantitative perspective, Trade Resistance for Gold sits ~1.3% higher at $1612 with TAIL resistance up at $1681.  If gold fails to recapture those lines on the bounce, and domestic housing and labor market trends remain positive, we’d be interested in playing any strength from the short side.  We currently hold no position in gold in our Real-time alerts.  

 

GOLD:  ANATOMY OF A BREAKDOWN - USD vs GOLD LT

 

GOLD:  ANATOMY OF A BREAKDOWN - Gold Price vs Fed Balance Sheet

 

GOLD:  ANATOMY OF A BREAKDOWN - GOLD Prive vs F O

 

GOLD:  ANATOMY OF A BREAKDOWN - GOLD Price vs F O Scatter

 

GOLD:  ANATOMY OF A BREAKDOWN - Gold Levels

 

Christian B. Drake

Senior Analyst 

 


GOLD: ANATOMY OF A BREAKDOWN

Takeaway: Growth, $USD Strength & incremental Fed hawkishness are bearish for Gold. ETF Flows & CFTC Data are collapsing & USD correlations tightening

On the other side of our #GrowthStabilzing theme and our bullish TREND view on the Dollar and consumption oriented equities has been a bearish view on Treasuries, Commodities, and Gold. 

 

We’re not self-proclaimed gold experts but we’d argue the fiat currency devaluation hedge underpinning the parabolic gold trade over the last five years has been fairly discrete.   In short form, the Gold bug thesis can be adequately described as:

 

Economic growth stagnates/decelerates further --> Expectations for further QE initiatives rise --> $USD Depreciates --> Gold rises as investors discount erosion in the currency value and prospective future inflation and seek hard asset stores of value.    

 

Within this framework, both the dollar and Gold become a function of the interplay between reported/expected economic conditions and expectations around monetary policy.  When it plays out on a global level, as it has in the wake of the Great Recession, the variable mapping gets more complex and the price action exaggerated but the idea framework is still the same. 

 

Its also important to note strength of the growth-policy-USD/Gold connection is stage or cycle dependent.  For example, in the throes of economic or market distress the correlation between the USD & Gold tends to be positive as the safe haven trade plays itself out.  However, outside of crisis conditions,  fundamentals (growth, interest rates, policy, etc) become the prevailing drivers and moderate-to-strong inverse correlations between Gold and the Dollar have predominated, empirically.     

 

So, as straightforward as we think the bullish case for gold has been is as simple as we think the bearish case that has been playing out currently in gold is.   If you buy into the idea that weak growth, unconventionally easy monetary policy initiatives, and investor expectations around forward policy have been the principle drivers of gold price appreciation since 2008, then a reversal in these factors – stable/accelerating growth, a cessation & eventual unwinding of easing initiatives, a strong dollar, & rising interest rates  - should serve to drive a correction in Gold prices.   

 

What does the anatomy of that correction look like?

 

Summarily, it looks like more of what we’ve been seeing in Gold Prices, Dollar-Gold correlations, CFTC data, and gold ETF flows over the last four months – trends we’ve seen accelerate over the last five weeks as the economic data has flashed some upside and the dollar has begun to break out.  

 

Consider the chart below which shows physical gold outflows from the GLD (SPDR Gold Trust) vs. the dollar.  

 

GOLD:  ANATOMY OF A BREAKDOWN - USD vs GLD

 

Looking across a host of relevant factors, all of the charts (unsurprisingly) reflect a similar dynamic:

 

Gold vs Fed Balance Sheet:  The correlation between Gold and the Fed’s Balance Sheet is strong across durations with an R^2 = 0.92 over the last 14 years.  If you think this relationship makes common and economic sense (we do), a deceleration and unwind of policy intitiatives (or the expectation for) on the back of an improving growth outlook is a decidedly bearish catalyst for gold.

 

Gold vs. Dollar:  Gold’s Inverse correlation to the dollar has been moderate-to-strong across durations.  Gold is levered to the USD directly given that gold generally settles in dollars, and indirectly via expected inflation & policy impacts on fiat currency value.   Correlations aren’t perpetual – they build and decay - but when they start to tighten alongside other relevant/corroborating factors, it’s generally worth paying attention.  Gold’s 30D correlation to the dollar is currently -0.90. 

 

Gold - CFTC Data:  Bullish Speculative positioning looks like its capitulating as net length in combined non-commercial futures & options contracts has collapsed since November.  It hasn’t paid to speculate on the end of the world (again) as extremes in bullish positioning (>1STDEV) have been followed by negative subsequent price performance in gold 100% of the time over the last year.  Net length is currently down ~62% from the late 2012 highs. 

 

Gold ETF Flows:  Gold flows to the GLD and ETF’s in aggregate, have rolled over since the beginning of the year and  have accelerated to the downside over the last month.  For example, total Gold Holdings in the SPDR Gold Trust (GLD) are down ~114 Tonnes (-8%) from peak 2012 levels according to bloomberg data.   

 

This weekend, my brother, a sharp guy and passive retail investor, made the following rhetorical comment (paraphrased) “that jobs number was pretty good….who will be the marginal buyer of gold?”.   Good Question. 

 

The bull case for Gold was straightforward and price was reflexive on the way up.  Reflexivity, by definition, works both ways and big crowds and small doorways still don't make great bedfellows.       

  

If the growth data can continue to confirm, the USD remains in bullish formation and policy makers (Congress & the Fed) can stay out of the way, we think gold continues to hold some further downside.  

 

In the more immediate term, equities are overbought and Gold/Treasuries oversold. From a quantitative perspective, Trade Resistance for Gold sits ~1.3% higher at $1612 with TAIL resistance up at $1681.  If gold fails to recapture those lines on the bounce, and domestic housing and labor market trends remain positive, we’d be interested in playing any strength from the short side.  We currently hold no position in gold in our Real-time alerts.  

 

GOLD:  ANATOMY OF A BREAKDOWN - USD vs GOLD LT

 

GOLD:  ANATOMY OF A BREAKDOWN - Gold Price vs Fed Balance Sheet

 

GOLD:  ANATOMY OF A BREAKDOWN - GOLD Prive vs F O

 

GOLD:  ANATOMY OF A BREAKDOWN - GOLD Price vs F O Scatter

 

GOLD:  ANATOMY OF A BREAKDOWN - Gold Levels

 

Christian B. Drake

Senior Analyst 

 


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LV STRIP: EVEN WORSE

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

This note was originally published March 08, 2013 at 10:25 in Gaming

 


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)

China and MKC

Last night, YUM reported Q1 (February) China comps of down 20%, with improvement in February versus the overall quarter.  The stock is getting a well-deserved bounce today, and we mention it only because one of the names in our staples coverage has some leverage to restaurants in China - MKC.  The big difference between YUM and MKC is that MKC has been bouncing hard for about a month now, on no news and with utter disregard for the direction of earnings estimates or the company's multiple.

 

MKC’s commentary relative to continued Q1 weakness (1/24):

 

“While the Asia Pacific region had a strong sales result for the Consumer business, demand from industrial customers, primarily quick service restaurants, was weak. This was largely an outcome of less new product and promotional activity versus the year-ago period. We expect this decline to extend into the first quarter of 2013, which has a tough year-ago comparison. If you recall, we grew base business industrial sales in the Asia Pacific region 22% in local currency in the first quarter of 2012.”


We get it – shorting mid-cap staples names is tough – the companies tend to have sticky shareholder bases, multiples tend to be elevated versus the large cap peer group (and seem to matter less) and the opportunity exists for relatively small deals to move the needle on EPS pretty dramatically.  However, it isn't often that you see such a dramatic divergence between the direction of EPS estimates and the direction of the multiple in a non-cyclical name.  Full-year 2013 consensus estimates have gone from $3.36 to $3.22 since the company reported back in January, and the multiple has expanded from 18.9x (immediately post EPS) to 21.7x.

 

China and MKC - MKC PE1

 

Perhaps you can make the case the company sandbagged 2013 EPS guidance, but even an earnings base closer to $3.50 puts this name at 20.0x '13, and we are having a difficult time coming to either that earnings base or that multiple.  It is our strong preference to deal in what is likely, and we think a more likely scenario is an EPS result for the full-year at or below current consensus.

 

Valuation is never a catalyst, but the combination of significant multiple expansion in the face of a declining EPS base confounds us, and we don't like being confounded.  MKC is fast moving up our list of names whose current price we can't justify or explain, but are inclined to short.

 

Call with questions,

 

Rob

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

E:

P:

 

Matt Hedrick

Senior Analyst


PODCAST: What Keeps Keith Awake at Night?

Keith answers questions from clients from this morning’s investment call. 

 


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