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Is McCormick Leaving a Bad Taste?

Takeaway: Here's why we're concerned about McCormick stock at the moment.

This note was originally published March 12, 2013 at 11:40 in Consumer Staples

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.

 

Is McCormick Leaving a Bad Taste? - 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.

 


Herbalife: Math Trumps Fear

This note was originally published March 12, 2013 at 18:27 in Consumer Staples

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.

 

Herbalife: Math Trumps Fear - HLF EV.EBITDA

 

Herbalife: Math Trumps Fear - 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: rcampo@hedgeye.com

 

P: 203.562.6500

 

 

 

Matt Hedrick

Senior Analyst


All That Giltters

Client Talking Points

China Belittles

For a while now, China has been one of Hedgeye’s top long ideas, but some of the recent data has sent some mixed signals. Specifically, industrial production, fixed asset investment and aggregate financing (a driver of money supply) were marginally below expectations and saw sequential declines. Now to be fair, many of these economic metrics are showing year-over-year growth rates, that relative to the rest of the world, are outstanding. We’ll continue to keep a close eye on China, particularly on new policy initiatives that come from the government there.

 

 

 

Gold Confirms

While China is belittling us a bit, our call on gold is playing out as we expected. The breakdown of gold has been a key asset call on the back of our view that global growth is stabilizing.  This hasn’t been a popular call as many institutional investors have been over allocated to  gold based on the idea that as growth decelerates, expectations for future QE rise, the dollar depreciates and investors flock to gold as protection against further dollar debauchery.

Asset Allocation

CASH 36% US EQUITIES 20%
INTL EQUITIES 20% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 24%

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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

“That smoke out of the Vatican chimney, that mean a Darrelle Revis trade is near?” -- @Adam Schefter, ESPN NFL Insider.

QUOTE OF THE DAY

“There’s a great consumer fan base that hasn’t declined.” – Metropoulos & Company on Twinkies. Metropoulos is one of the two investment firms that has agreed to buy Hostess Brands.

STAT OF THE DAY

1.1%, the amount US retail sales rose last month, the biggest jump in five months


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Belittling Gold Markets

“Keep away from people who belittle your ambitions. Small people always do that, but the really great make you feel that you, too, can become great.”

-Mark Twain

 

The quote at the top of this note is certainly true for my experiences in life.  Every time I have met someone who has truly succeeded, whatever their domain, I’ve noticed they do their best to encourage others on the path to success. In the past week, I had a very good example of this when I met Senator John McCain.

 

Now setting aside your political affiliation, I think it is fair to say McCain has been one of the more successful politicians of this generation.  In this instance, I met him briefly in a small T.V. studio as he was going on to do a clip for CNN and I was waiting to go on for CNBC.  As we waited, he wolfed down a bag of chips, hopped on and off various calls, and planned out his town hall appearance in a small Arizona town for later in the day.

 

So, yes, at 76 years of age and after 26 years in the Senate, McCain is still grinding.  Therein lies the point of greatness and great people, they understand that the path to success is based on hard work and repetition. Investing in the public markets epitomizes this idea. 

 

The one market that has belittled us as of late is China.  Chinese equities remain one of our top long ideas, but as my colleague Darius Dale wrote in an update on the idea on Monday some of the recent economic data from China does give us pause. Specifically, industrial production, fixed asset investment and aggregate financing (a driver of money supply) were marginally below expectations and saw sequential declines.

 

Now to be fair, many of these economic metrics are showing year-over-year growth rates, that relative to the rest of the world, are outstanding.  In the Chart of the Day, we highlight this by showing Chinese Fixed Asset Investment for the last three years.  As the chart shows, in the most recent period fixed asset investment was up 21% year-over-year and remains well off its lows.

 

As it related to fixed asset investment in China, as the chatter out of China over night is that Shenzhen may implement a price cap at every housing project within 2013.  This pressure on Chinese property stocks was then compounded by the fact that Governor Zhou of the People’s Bank of China said he is on “high alert” in regards to inflation.  So the belittling point on China is that while growth remains relatively strong, the outlook for inflation and policy (the other two key factors in our country models) are more belittling to discern.

 

An investment asset class that has been less belittling for us to analyze recently is gold.  Yesterday, my colleague Christian Drake wrote a note titled, “Gold: Anatomy of a Breakdown”.  The breakdown of gold has been a key asset call on the back of our view that global growth is stabilizing.  This hasn’t been a popular call as many institutional investors have been over allocated to  gold based on the idea that as growth decelerates, expectations for future QE rise, the dollar depreciates and investors flock to gold as protection against further dollar debauchery.

 

The reality of the interplay above is that both the dollar and gold are large driven by economic data versus expectation and the view of future monetary policy.  As the note emphasized:

  • Gold versus Federal Reserve 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 (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 and 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; and
  • Gold ETF Flows:  Gold flows to the GLD and ETFs 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.

The summary of the points above are that gold will go down for exactly the same reasons it went up – slow growth and loose monetary policy.  So if the dollar continues to strengthen and growth continues to stabilizes, the record outflows from gold ETFs will only continue.  Thus as Mark Twain wrote:

 

“Moralizing, I observed, then, that "all that glitters is not gold."

 

Indeed.

 

Our immediate-term Risk Range for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1, $109.02-110.78, $82.36-82.97, 93.76-96.82, 1.96-2.09%, 11.21-13.83, and 1, respectively.

 

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

 

 

Belittling Gold Markets - Chart of the Day

 

Belittling Gold Markets - Virtual Portfolio


Not This Week

This note was originally published at 8am on February 27, 2013 for Hedgeye subscribers.

“Not this week, thank God.”

-Dwight D. Eisenhower

 

That’s what the President of The United States said to one of his senior advisors “with beads of sweat on Eisenhower’s forehead during the tense debate over whether and when to intervene” in Vietnam in 1954. (Ike’s Bluff, pg 131)

 

As many of you know from your risk management experiences, it’s what you don’t do under pressure that often defines your performance. “Eisenhower was an expert in finding reasons for not doing things recalled Andrew Goodpaster.” (pg 130)

 

That’s why I study the history of great leadership. It helps me empathize with and learn from what Teddy Roosevelt called “the struggle” of other men and women when they were under pressure. It also gives me confidence in making decisions. That doesn’t always mean I’ll make the right call. It just means I’ll have known why I made it.

 

Back to the Global Macro Grind

 

Eisenhower’s legacy is that he didn’t let the French suck US casualties into Vietnam in 1954. He also avoided playing the end of the world card (releasing the bomb) during a time when plenty of Americans had US politicians (LBJ) freaking them out about outer space.

 

If the world ended this morning, I am pretty sure A) I wouldn’t be writing this and B) you wouldn’t be reading anything else. So, with that in mind, and the entire manic media focused on what is so 2010-2011 (Italian Bond auctions), what happened?

  1. Italian Bond Auction was better than “expected”, so bond yields fell, making another lower long-term high
  2. Italian Equities stopped going down right at our immediate-term TRADE oversold signal of 15,511 (MIB Index)
  3. US Equity Futures held onto yesterday’s gains; the 2nd up day in the last 3 (+4.9% YTD)

I’m not trying to be complacent about Italy’s economic risks (just don’t be long Italy, and get over it). I’m well aware of what Eisenhower himself coined as The Domino Theory. We made this call on Europe around this time in Q1 of 2010 don’t forget. It’s 2013, and  we don’t see Italy being the domino that knocks down our bull case for Asian and US Equities right now.

 

That could change. The plan is always changing. And when it does, I’ll be the first to let you know. But, for now, let’s focus on doing more of what we did when people were freaking out about Congress at the end of December:

  1. Buy Asian (China and Singapore) and US Stocks (EWS, CAF, XLF)
  2. Short US Treasuries (TLT)
  3. Short Japanese Yen (FXY)

Why buy American instead of Italian?

  1. US #Housing is ripping (New Home Sales shocked the bears to the upside yesterday with inventory falling, again!)
  2. US Employment #GrowthStabilizing (our rolling non-seasonally adjusted jobless claims model continues to be bullish)
  3. If you have to choose between a criminal, comedian, and Congress, I’d actually choose Congress

Yep, that’s how sad and embarrassing Italy’s #PoliticalClass has become. And neither France nor Japan are too far behind them.

 

So, if you are shorting Treasuries, can’t buy European or Japanese Sovereign Debt, and have to buy something else, why not Asian or American stocks? To be clear, I don’t have to buy anything. But when I do buy something, both the signal and research back it.

 

The last point I want to make this morning is about volatility expectations. I get the front-month VIX is different than the term-structure of volatility’s curve. Looking at expectations, across durations, will amplify my point:

  1. VIX (front-month) TREND resistance = 17.18, and that was only violated to the upside for ½ a day
  2. VIX topped on Monday at another lower long-term-high (on DEC28, 2012 the lower-high = 22.72)
  3. VIX was at 40 in Q1 of 2010 after we were legitimately concerned about European Dominos

As you can see in the Darius Dale’s Chart of The Day, front-month Volatility (VIX) continues to make a series of long-term lower highs as the volume of the manic media’s freak-outs make higher-highs. Think they’ll make the call on the end of the world, together?

 

If this is just a mini-mania of what you saw in November-December (substitute Italy for US Congress), what is it, specifically, that you have a as a catalyst that would stop the VIX from going straight back down to 12 from here?

 

It’s not going to 12 this week. I get that. But the VIX is probably not going back to 22.72 or 42.96 (the SEP2011 freak-out) this week either. If I see anything real developing that changes my view on this, I’ll just change my mind. I don’t have to do that yet, thank God.

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST10yr, Shanghai Composite, and the SP500 are now $1552-1612, $112.55-116.12, $81.12-82.23, 91.55-94.49, 1.84-1.96%, 2204-2349, and 1486-1512, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Not This Week - Chart of the Day

 

Not This Week - Virtual Portfolio


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