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PEP/MDLZ Speculation – Intuitively Compelling, But Not so Fast…

This morning, The Telegraph in the UK reported that Nelson Peltz’s Trian Funds has taken a position in both MDLZ and PEP, with the hope of agitating a merger between the two companies.  We would like to make a couple of quick points on the topic:

  1. The Telegraph is a legitimate source, so this strikes us as more than the normal spivvy hedge fund rumors that bubble up occasionally across the pond, meaning that the positions mentioned have a decent shot at being real
  2. We have to balance that with our innate distrust of Friday rumors toward the end of the quarter
  3. Mr. Peltz has owned PEP as a passive investor previously (November 2011) and the speculation back then was that he would agitate for a separation of the beverage and snack assets (his duration as a shareholder was very short, in that case)
  4. PEP separation speculation makes sense, and may be a matter of if not when, but it has been a matter of speculation for a long time (multi-year duration) but faces several hurdles, not the least significant of which is management reluctance
  5. PEP CEO Indra Nooyi, while a source of frustration for some shareholders, does have the benefit of a reasonable share price performance (+12% YTD) to help keep some potential wolves at bay
  6. MDLZ may be a passive position as well, though we should point out that the legacy Cadbury business is one that Mr. Peltz knows well, so the possibility of more active role in that company is the better possibility, in our view
  7. Mr. Peltz has an intimate knowledge of the beverage business, having bought and sold Snapple, then sold again (sort of) as an activist investor in Cadbury
  8. In this case, PEP takes on the role of the old KFT (business to be broken up) while MDLZ, well, is the old (and new) Cadbury business – circle of life
  9. MDLZ CEO Irene Rosenfeld has been a source of frustration as well for investors in recent quarters, but does deserve credit for the separation of the Kraft assets and the associated valuation creation there – we suspect she has a longer rope with MDLZ shareholders than Nooyi does with PEP shareholders to the extent that she has actually done something in recent years with respect to reshaping her company
  10. The second level of speculation that we have heard regarding PEP is that as part of the separation of snacking and beverage assets, Anheuser-Busch InBev would look to acquire the beverage business, though we are not sure ABI desires either the competitive positioning or the growth profile.
  11. Finally, to wrap all the speculation of the last couple of months into one note, we suspect investors may try to weave POST into this narrative as well, as break up of PEP may be into three parts – snacks, beverages and cereal, with cereal combining with the POST assets
  12. Finally, we think investors have to contextualize all these rumors within the current market valuation of staples post-HNZ, recognizing that being the second company to make an acquisition in a consolidation “wave” makes it much more difficult (or unlikely) to create value for shareholders

Bottom line, the speculation as outlined in the article makes sense to us, but intuitively compelling and likely are often two very different things and we would caution against basing a shorter-term investment thesis based on this type of speculation.  Of the two companies speculated, we prefer MDLZ on a longer-term basis, but think that near-term earnings expectations may be too optimistic.


Also, the current multiples in the staples group makes us loathe to chase anything.


Here is the article:






Robert  Campagnino

Managing Director





Matt Hedrick

Senior Analyst

Signals from Oil and China

Client Talking Points

Oil and the Dollar

If you want to get freaked out about something, keep a close eye on oil, not at something inconsequential like Cyprus. In fact, Cyprus might even be the biggest pretend crisis in a decade. Right now, according to our models, the price of Brent crude is nearly perfectly inversely correlated to the US dollar. That means if the US dollar moves higher, oil prices move lower. Look at Brent oil’s price since February 1 – it’s been declining.

China Calling

Oil and China are the two most bullish items from a global macro perspective this week, and they’re interconnected. The Shanghai composite index closed higher for the third consecutive day, thanks in part to lower oil -- as money is flowing out of places like Cyprus and back to the US and elsewhere.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Darden stands to be a beneficiary from a housing recovery and an improved employment picture, which boosts casual dining trends. Darden reported earnings today that beat Wall Street expectations, though net income declined 18%.


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.


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.

Three for the Road


“Roll forward and stay current but keep those durations short.” -- @CAMLLCCIO



“Reality is merely an illusion, albeit a very persistent one.” – Albert Einstein


1, the number of games Harvard has now won in its history in the NCAA basketball tournament following last night’s win over New Mexico.

Nike: Three for Three in Q3

Takeaway: Nike delivered on everything we needed to see to keep pounding the table on the stock, and then some.

This note was originally published March 21, 2013 at 21:41 in Retail

There are three things we were looking for in Nike’s quarter; proof that 1) Nike is gaining share/driving consumer demand across its portfolio, 2) Gross Margins are improving at a rate well ahead of consensus expectations, and 3) that it is achieving these things with disproportionately less capital invested in its business (ie driving returns higher).  


Well, Nike showed us every one of these, topped our EPS estimated by a penny, and blew out the Street by $0.06ps. No changes to our above-consensus EPS estimates our thesis. Nike remains a top pick.


Some important points:

North America En Fuego. As it relates to demand, we saw North America sales up 18%, which was on top of a 17% growth rate last year. Importantly, futures were up 11% despite being up at a colossal rate of 22% this quarter last year. Think about it like this -- try to find another company with 45% share in its category that is growing its top line at a mid-teens rate while improving margins and lessening capital intensity along the way. Let us know what you find, we think you’ll come up dry.


China has definitely bottomed. Don’t let management’s caution fool you. They specifically made it a point to keep estimates grounded and said that that they still have a lot of wood to chop. But futures going from -6% and -5% over the past two quarters to +4% in 3Q is proof positive that this business has at least found bottom, and is likely trending higher once again.


Inventories still improving – driving better margins. Though pricing and easing raw materials costs helped gross margins, the spread between inventory and sales growth is getting better and will continue to drive gross margins higher. This is probably best evidenced by our SIGMA chart, where it shows Nike making a big move into the upper right quadrant of this analysis. Over time, triangulating margins with capital efficiency explains away 92% of stock moves in retail. Translation – it matters.


Nike: Three for Three in Q3 - nkeSIGMA


We think that the spread between inventories and margins will continue to diverge well into FY14

Nike: Three for Three in Q3 - nkegm




Here’s our previously-published comments on our expectations for 3Q.


NKE: Ahead of the Print

We think that the Q is in good shape, but if there are any fireworks we’re confident enough in our thesis to support the name.


Conclusion: Our analysis suggests that Nike’s quarter is in good shape. But let’s face it, Nike always manages to light off a firework or two. If that happens to be case on Thursday, we’re confident enough in our underlying thesis that we’d support any weakness.


Will the quarter be a blowout? Not exactly. We’re modeling $0.72 vs the Street at $0.67. Nice upside -- but not huge.  We’re about in line with the Street on the top line at about 11%, but we’re 50bp higher on the gross margin line. We think that’s fair given the easing product costs flowing through the P&L as well as 2Q ending with the most favorable inventory position in nine quarters.


Futures: As it relates to futures, bears are calling me with the expected ‘futures are decelerating’ concerns.  The company is going against a 22% North American futures number in this quarter, and +18% globally. It doesn’t take a genius to figure out that this is a ridiculously tough quarter to comp. On a 2-year run rate, a 7% North American or 5% Global futures number suggests an even underlying trend. We think Nike comes in 2-3 points above those levels. On a go-forward basis, keep in mind that after this quarter, we started to see China drop off precipitously. Beginning next quarter, we expect any slowdown in growth in North America to be offset by a rebound in China and an uptick in Western Europe (NKE is about to anniversary the latest downturn there, and FL recently noted a stabilization in Europe).


Sentiment is Flat-Out Bad: Lastly, we need to acknowledge sentiment and valuation. We agree that the stock isn’t cheap at 17x earnings. But let’s not forget that sentiment on Nike remains quite bad. Our sentiment monitor, which is based on both sell-side recommendations, short interest and insider trading activity, suggests that Nike is more hated today than almost any time over the past 10-years.


Nike: Three for Three in Q3 - NKE sentiment

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

Persistent Illusions

“Reality is merely an illusion, albeit a very persistent one.”

-Albert Einstein


This has been an entertaining week at Hedgeye.  For those that have been reading the Early Look or following us on Twitter, you have noticed that we have been having some fun with a few of the old guard of Wall Street research.  One friend of Hedgeye actually wrote in and called Keith and myself: grumpy young men.


Candidly, that is probably more truth than illusion.  To be fair, though, getting up early and grinding hard throughout the week probably does rightfully make a guy or gal grumpy.   There is no doubt many of our subscribers can relate to this as well.  While we have the pressure of running a profitable business and making 50+ employees happy, the pressure that many of you have associated with the fiduciary responsibility of managing money is also no illusion.


Speaking of illusions, our Energy Analyst Kevin Kaiser actually identified a great one this week in the cash flow statement of a company called Linn Energy (LINE).  LINE is an upstream MLP, so in effect they use the tax advantage of a MLP structure to pay out large distributions.  This is fine for predictable and mature businesses.  Unfortunately, neither of those traits fit LINE.


In fact, LINE is an oil and natural gas producer.  So not only is it not a mature to slightly growing business, it is actually a business with natural decline rates that requires meaningful capital expenditures to maintain the cash flow stream.  In the Chart of the Day, we’ve included a slide from the presentation that looks at distributions paid from 2006 to 2012.


In that time period, LINE paid $2.2 billion in distributions.  Strangely, in the same period the company only generated $1.7 billion in cash flow from operations.  Moreover, if we look at free cash flow, which we define as cash flow from operations less capital expenditures, LINE generated a negative -$1.0 billion in cash flow.  Despite these cash flow deltas, LINE management has done a decent job pulling rabbits out of the proverbial cash flow hat and paying distributions, largely from financing cash flow.


So, as Kaiser summed up about the company at the end of his presentation:


The illusions:

  • LINN’s assets are mature oil and gas fields with low decline rates;
  • LINN’s cash flows are stable because of its hedging strategy;
  • LINN generates sufficient cash flow to pay and grow its distribution;
  • With an 8% yield, LINN is an attractive fixed-income alternative; and
  • LINN is creative and innovative.

The reality:

  • LINN’s base decline is 20 - 25% per year;
  • LINN’s cash flows are overstated because of its hedging strategy;
  • LINN does not generate any FCF, and must raise additional capital to pay its distribution;
  • LINN equity is more than 50% overvalued today; and
  • LINN is financially creative and innovative.

If Houdini were a hedge fund manager, he would likely be all over this company!


In the global macro world this week, the primary illusion has been in regards to the cash in Cypriot bank accounts.  Is it there? Will it stay? How much will the government take?  Coming in to the week, many pundits predicted that the arbitrary decision to “tax” money in bank accounts in Cyprus would lead to a run on the banks across the peripheral countries in Europe.  Much to the chagrin of alarmists, this hasn’t happened.


Of course, this is not to say that the EU decision to try and force a bank levy on Cyprus makes any sense.  The larger risk is not that the EU will do try to this in Greece, Portugal, or Spain next, but rather that the illusion is created that they will.  A run on banks across the peripheries is literally a worst case scenario for the EU.  Unfortunately, investor and depositor confidence erodes very quickly with seemingly arbitrary decisions.


The latest news flow suggests that the Cyprus situation will continue into next week.   Russians have a large amount of capital in the Cypriot banking system, but Cypriot Finance Minister Michael Sarris spent all week in Russia and returned with his hat in hand and no bailout monies.  The European Central bank has also said that effective this coming Monday they will cut off liquidity lines unless Cyprus gets a deal in place.  So yes, the illusion that ECB officials have the situation under control is alive and well.


As for the Cypriots, well as of this morning the statement the government was supposed to issue is now more than 60 minutes late, but according to Twitter they are working on it.  As for the average Cypriot, their bank withdrawals from ATMs are limited to literally a couple hundred Euros.  Talk about dysfunction!


The slow and steady recovery of U.S. economic activity continues to be solidly in the category of non-illusions.   The key data point we received this week was in the way of non-seasonally adjusted jobless claims, which declined by -7.5% year-over-year for the week.   In aggregate, the improvement in jobless claims is starting to mirror 2012. 


Our Financials Sector Head Josh Steiner has noted many times, improving jobless claims are one of the best leading indicators for housing trends, credit quality, and loan growth.  Even as the dysfunction in Europe percolates, the U.S. economy stabilizing is no illusion. This is a key reason U.S. equities remain one of our favorite global asset classes.


Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1, $107.01-108.99, $3.39-3.49, $82.23-83.39, 94.12-97.08, 1.89-1.98%; 10.73-14.74, and 1, respectively.


Enjoy your weekends.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Persistent Illusions - Chart of the Day


Persistent Illusions - Virtual Portfolio


TODAY’S S&P 500 SET-UP – March 22, 2013

As we look at today's setup for the S&P 500, the range is 23 points or 0.25% downside to 1542 and 1.24% upside to 1565.        










  • YIELD CURVE: 1.67 from 1.67
  • VIX  closed at 13.99 1 day percent change of 10.42%

MACRO DATA POINTS (Bloomberg Estimates):

  • 11am: Fed to purchase $3b-$3.75b notes 2018-2020 range
  • 12pm: Revisions to Fed’s industrial production data
  • 1pm: Baker Hughes rig count


    • Obama to meet w/ King Abdullah II of Jordan
    • 7:30am: Fed Gov. Sarah Bloom Raskin, CFPB Director Richard Cordray, FDIC Chairman Martin Gruenberg speak at Natl Community Reinvestment Coalition conf.


  • BlackBerry Z10’s U.S. debut marks biggest test of comeback
  • Dell go-shop period for other offers expires today
  • FCC Chairman Julius Genachowski said to be leaving agency
  • Cyprus lawmakers to debate bailout bill as deadline looms
  • Euro area said to weigh closing Cyprus banks, asset freeze
  • Boeing faulted by 787 investigators for battery fix comments
  • Samsung said to be in talks to sell Liquavista to Amazon
  • Sharp extends deadline for 2nd Qualcomm payment to June 28
  • Citigroup says pay plan holders rejected helped keep Corbat
  • Life sale said to shift to strategies; some buyout firms exit
  • German business confidence unexpectedly drops from 10-mo. high
  • Australia probes pricing by Apple, other tech cos.
  • Goldman Sachs raises U.S., Japan growth forecasts
  • Deutsche Bank, Goldman miss $129m fee in Evonik IPO snub
  • U.S. Spending, Supreme Court, BRICS, AMR: Wk Ahead March 23-30


    • Tiffany (TIF) 6:59am, $1.36
    • Stella-Jones (SJ CN) 7am, C$0.93
    • Darden Restaurants (DRI) 7am, $1.01


  • Brent Crude Set for Second Weekly Drop to Shrink Premium to WTI
  • Gold Seen Extending Rebound as Cyprus Revives Bulls: Commodities
  • Biggest Crisis Since 2008 Looms for South African Mines: Energy
  • Gold Falls From 3-Week High as ETP Drop Overshadows Cyprus Woes
  • Palm Oil Heads for Weekly Gain as Inventories Seen Declining
  • Industrial Metals Advance as Economies in U.S., China Improve
  • Rubber Declines for Second Week on Yen, Europe Debt Concerns
  • China Soybean Imports Seen Lower Than USDA Forecast Amid Delays
  • Copper Fees Climb in Shanghai as Metal Seen Moving to Malaysia
  • Rebar Declines as Demand Seen Curbed by Slowing Chinese Economy
  • Diesel Best Returns in Two Years Waning on China: Energy Markets
  • Brazil Gold Allure Puts Australia’s Beadell in Play: Real M&A
  • Traders Cut Paulson Gold Favorite on Liquidity: Chart of the Day
  • Mistry Sees Palm Rally Through May on Ringgit, Reserves Drop






















The Hedgeye Macro Team










Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.