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Is U.S. Economic Activity Accelerating?

Takeaway: February durable goods orders were +5.7% m-o-m and home prices were up 8.1% y-o-y. Accelerating growth is officially in play.

Our baseline view on domestic growth and consumption remains constructive.  Labor market trends have accelerated, home price appreciation should continue to be supported by rising demand and tight supply, and further dollar strength holds the potential to drive ongoing commodity deflation and support real, sustainable consumption growth. 


Our outlook is dynamic, particularly at growth inflection points, and remains data and price dependent, but the early data suggest #GrowthAccelerating may, indeed, be taking the hand-off from #GrowthStabilizing.   The slope of growth in today’s durable goods and Case-Shiller releases is supportive of an acceleration trend.   


Durable and Capital Goods:  However you parse the index and its sub-components, the slope on new order demand for durable and capital goods continues to improve. New Durable Goods orders in February came in at +5.7% M/M, ahead of expectations for +3.9% while January was revised higher from -5.2% to -3.2%.  On both a 1Y and 2Y basis, growth in 1Q13 is registering a positive sequential acceleration.  If you exclude Transports, Defense, or Defense & Non-defense Aircraft, the positive growth trends all look the same thru the February data. 


The takeaway for Business Investment was positive as well with Core Capital Goods growth (Nondefense Capital Goods, excluding Aircraft) accelerating on both a 1Y & 2Y basis through the first two months of the quarter.  Accelerating capital and durable goods demand rhymes with recent PMI trends and agrees with the Fed’s 1Q13 senior Loan Officer Survey which showed rising demand for both Auto and Business C&I loans.  As a quick math reminder, PCE accounts for approximately 70% of GDP and the durable goods component of PCE represents ~11% of the total. 


Is U.S. Economic Activity Accelerating?   - Durable Goods 032613


Is U.S. Economic Activity Accelerating?   - Durable Goods Scatter 2 032613



Housing: The S&P/Case-Shiller HPI continued to accelerate in January, rising 8.1% y/y against expectations for +7.8% and 6.8% prior.   Given the continued improvement observed in the more concurrent housing metrics (Mortgage Apps, NAHB HMI, New, Pending, & Existing Home Sales), the upside to the January Case-Shiller numbers isn’t particularly surprising.  We continue to like our 1Q13 #HousingsHammer investment theme and expect further pricing upside in the intermediate term.  


In our view of housing as a Giffen good, demand and price interact reflexively as demand chases price higher which, in turn, drives further price appreciation in a virtuous cycle.   The dynamics underpinning our bullish view on housing remain in place currently as the positive demand-price feedback loop continues to play out alongside further inventory tightening. 


Underneath the positive housing fundamentals, household formation growth remains elevated, Birth Trends are rising, Fed Policy remains explicitly supportive, and further improvement in labor market trends should remain supportive of housing consumption and loan demand growth.  We continue to like consumer facing and housing derivative domestic equity exposure.



Is U.S. Economic Activity Accelerating?   - Case Shiller


Source: Hedgeye Financials

Is U.S. Economic Activity Accelerating?   - 2yr comps normal  1


Christian B. Drake

Senior Analyst 


Pinnacle Foods IPO - What's it Worth? (Updated)

Pinnacle Foods is offering 29 million shares of common stock (4.35 million additional shares in the overallotment) in an initial public offering set to price on Thursday the 28th.  The Blackstone Group is the selling shareholder and will continue to own 68% of the shares outstanding subsequent to the IPO.  The shares are expected to be offered in the range of $18-$20 per share, with a total market capitalization of $2.227 billion at the middle of the range assuming exercise of the overallotment (all of our math does).  Proposed ticker is "PF".


Well-Known, Center of the Store Brand Portfolio


Pinnacle Foods is a single geography (the U.S. represents $2.454 billion of the company’s $2.478 billion in 2012 sales), center of the store grocery company that operates in 12 major product categories (as defined by the company):


Pinnacle Foods IPO - What's it Worth? (Updated) - Pinnacle Foods Summary


The company claims leading positions in 10 of the 12 major product categories in which it competes, though we think the definition of “product category” has to be tortured a bit to make that claim.  For example, “frozen complete bagged meals” (25.1% share of market, #2 player according to the company) seems like a subset of “frozen” that is somewhat arbitrary.  Further, within the Duncan Hines Grocery Division, we accept the company as the market share leader (31.3%) in shelf-stable pickles, but don’t see the category as particularly attractive.


We think investors should view the company as a pure play on the center of the grocery store or, said another way, the section of the grocery store with the least attractive growth profile and margin structure.

Company May Struggle to Grow Revenue

The company acquired Birds Eye Foods in December of 2009, adding approximately $1 billion in net sales to the company.  In the years subsequent to that acquisition (’11 and ’12), the company grew revenues +1.3% and +0.4% respectively – given the categories in which it competes, we have a difficult time seeing the company with anything more than 1-3% organic revenue growth profile over time and that may be generous on our part.  Our forecast for 2013 is 1.5%.

Based on our preferred metrics, we see the company as a well-run asset with brands that are well-supported by advertising and R&D (see charts below).  Unfortunately, that means that we don’t see much opportunity for SG&A leverage going forward, particularly in light of our modest top line assumptions for the company.


Pinnacle Foods IPO - What's it Worth? (Updated) - PF chart2


Pinnacle Foods IPO - What's it Worth? (Updated) - PF Chart3


Margin Opportunities?

The company has cited on each of its last two quarterly conference calls a moderating cost inflation environment.  This commentary is largely consistent with the sentiment coming out of CAGNY across consumer staples.  Further, the company does have initiatives in place that focus on productivity savings in procurement, manufacturing and logistics that can serve to magnify any benefit to the gross margin line that might accrue from lower input costs.


That is a good thing, as we think any operating margin expansion is likely going to have to come from the gross margin line, and we do see some opportunity there as we move through 2013.  The company faces some easy gross margins comparisons in 1H ’13, and we expect that the moderating commodity environment that we are currently in will start to benefit gross margins in 2H ’13, so we see a full year opportunity for gross margin expansion for the company – our assumption is 50+ bps of gross margin expansion in ’13.  When we couple our gross margins assumption with our modest top line forecast and the lack of leverage in SG&A and other line items, our forecast is for EBIT to grow 5.5% in ’13 (approximately $100 million of EBITDA get us to a 2013 EBITDA forecast of a little more than $450 million).


What's it worth?


At $19 per share, the company is trading at 9.3x EV/EBITDA with the broader food group at 11.1x, so a discount to the broader group and one that we feel is deserved.  We struggle to see material upside given the company's margin structure and brand portfolio and the current state of the grocery industry.  Having said that, a couple of non-financial considerations may drive the valuation beyond the point we see as reasonable.  To begin with, the yield at $19 will be 3.79%, not outsized, but chunky enough to provide support for the shares in the $18-19 range, limiting the downside.


The company also has about $1 billion in NOLs, shielding the company from cash taxes through 2015 - however, the S-1 doesn't make it clear that the NOLs would survive incremental sales by Blackstone (change of control), making the value difficult to determine.  As it currently stands, the NOLs will preserve about $80-$85 million per year (assuming 100% utilized against a 36% tax rate) of income from taxes, through 2015 and "modest" amounts thereafter.


The company may benefit from a dearth of small and mid-cap names in the packaged food space.  With a market capitalization of approximately $2.22 billion at the mid-point of the proposed offering range, PF will lie between POST (market cap $1.36 billion) and HSH ($4.16 billion) on the market cap spectrum.  HAIN ($2.83 billion) is a different animal given its position in the faster growing natural and organic space.

Highly Levered Asset

Even subsequent to the repayment of approximately $550 million of debt (mostly 9.5% coupon debt, so expensive, to be sure), the company will still be a highly levered asset, trading at 4.5x net debt to trailing 12 months EBITDA.  In 2012, FCF (cash from operations less capital expenditures) was $124.6 million – out of that, the company will have to pay approximately $84.4 million in dividends (proposed dividend is $0.18 per share, quarterly), leaving approximately $40 million per year to pay down debt (conservatively, as it assumes no growth).  The company is a deleveraging story, though certainly not a rapidly developing one.


The level of debt currently on the balance sheet will likely make it difficult for the company to pursue any acquisition of meaningful size.  At 4.5x net debt to EBITDA, PF is near the level where most consumer staples companies end up subsequent to doing a deal.  Any acquisitions are likely to be relatively small in nature and not transformational, and that is even before taking into account an elevated valuation environment in the staples space.


Timing is everything they say


The Pinnacle IPO has been threatened for some time – beginning in early 2012.  But, as they say, timing is everything and Blackstone has the wind at its back with takeover speculation rampant in the consumer staples space, strength in the broader market and valuations at a multi-year high.  Further, and though no one could likely have timed the IPO so fine, the style factors that have been working in the market recently are high short interest (not applicable), low P/E (suggesting low growth) and high debt/EBITDA – or basically everyone’s short book and Pinnacle Foods.  Bottom line, there is a good bit supporting this IPO.

While we expect some speculation that Pinnacle could be a target, we don’t see it right now.  As we mentioned above, low-growth, center of the store company doesn’t check off any of the boxes that the bigger companies in the space are looking for – emerging market exposure, health and wellness, and categories with pricing power, to name a few.  KRFT is a likely consolidator of grocery assets going forward, but that was a pretty easy call to have been made before the IPO.


Where does that leave us?

PF is a highly-levered, low-growth asset trading at only a slight discount to an already inflated peer multiple of EBITDA, and that is giving credit in our forecast to both top-line growth and gross margin expansion.  We don't see the name a particularly compelling long-term investment though neither do we see significant downside from the proposed offering price range.  Finally, buying from a private equity firm that seems to have timed the market well with regards to its sale doesn't strike us as a particularly good idea.


Robert  Campagnino


Managing Director










Matt Hedrick

Senior Analyst 


As the shift in American attitudes towards "traditional" fast food has become more pronounced in recent years, Panera has emerged as one of the happy campers of the restaurant industry.  Wounded bears, in the form of MCD, WEN, and others, pose a danger for PNRA. 


In February, we wrote that Panera’s mix growth outlook was negative.  Further evidence is emerging that competitors from QSR and Casual Dining are looking to challenge Panera’s position as the “healthy” option, a factor that could represent an added headwind to Panera comps going forward. 


Panera Bread’s position as a healthy QSR option that is relatively free of competitors is gradually changing as casual dining chains offer lower price points and chains like Wendy’s upgrade their menus to include items that are cheaper than Panera’s core offerings but are marketed as healthy eating options.  McDonald’s offering healthier menu alternatives, such as the McWrap, and investing in marketing the item aggressively, further underscores the industry-wide focus on healthier options that are sought by millennial consumers.  





Happy Camper, Meet Wounded Bear(s)


We believe that the market has been shifting away from Wendy’s, McDonald’s, and other “traditional” QSR players for years.  The impact of this shift in consumer preferences on McDonald’s has been masked, to a degree, by successful but transient products like frappes and smoothies.  McDonald’s “millennial problem”, well described by Maureen Morrison at Adage, is front-and-center for the company’s marketing strategy.   


We are not optimistic that McDonald’s marketing shift will solve its issues but we do believe that Panera’s traffic trends are likely to be, on the margin, negatively impacted.  Ultimately, when MCDonald’s hand is forced, the company will invest more meaningfully to change its brand’s perception among millenials who, increasingly, want fresh and organic food offered in a customizable manner. 





McDonald’s and other traditional QSR players are scrambling to change with the times.  Beverage initiatives at McDonald’s have worked as short-term panaceas but we contend that soft sales growth is symptomatic of a changing business environment as well as MCD's business becoming overly-complex.  We believe that traditional QSR management teams see Panera’s brand positioning as an attractive path for the future.  Given the deep pockets of this industry and the highly competitive nature of the companies involved, this will present a headwind to Panera’s same-restaurant sales going forward.



Howard Penney

Managing Director


Rory Green

Senior Analyst

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Dick's Sporting Goods: 10K Takeaway

Takeaway: The rate at which DKS has been de-risking its real estate portfolio has halted in its tracks. DKS remains a value trap. Avoid it.

This note was originally published March 25, 2013 at 21:44 in Retail

Conclusion: We think the biggest takeaway from the Dick's Sporting Goods (DKS) 10K is the one that noone will talk about.  Specifically, the rate at which the company has been de-risking its real estate portfolio has halted in its tracks. We recently turned negative on DKS -- and that was before having this data point. A negative change on the margin in its lease portfolio on top of weak comps, peak margins, and a dramatic increase in capital intensity is a great formula for returns to go negative. DKS remains a value trap. Avoid it.


Here’s Our Logic

One things we focus a lot on is a given company’s ‘Lease Flexibility Ratio’, which is a term we use to measure the weighted average duration of a company’s operating lease portfolio. We calculate this by dividing the total lease obligations by the payments obligated in year one. Simply put, in almost all cases, the shorter the Lease Flexibility Ratio, the more flexible and healthier it is for the company in question.  This does not mean that the asset is not secured for a longer time period, but simply that the minimum financial obligation associated with the asset is low.


Why would a company have a high ratio (ie very inflexible)? One of two reasons. 1) Either it has extremely long-dated leases. Target and Whole Foods are both at 20x, while Kohl’s is 26x (JCP is only 11x -- bad for KSS). 2) The other reason would simply be that a given retailer wants to secure real estate that it can’t afford. If such is the case, then one of three things happens.


a)      The retailer signs up for a significantly escalating minimum payment each year, or

b)      It signs up for a location before competitors, and accepts the obligation well before it sees associated sales, or

c)      It removes kick-out clauses or other safety features that would otherwise reduce certain obligations in the out-years of a lease agreement.  


We think DKS is a combo of a) and b).


Dick's Sporting Goods: 10K Takeaway - dks lease


We look at these ratios to compare two things; 1) a given retailer’s lease structure versus competitors, and 2) how a company’s lease portfolio changes on an annual basis versus itself. That’s where Dick’s is interesting.


Historically, DKS has had a Flexibility Ratio that we’d call egregious.  5-years ago, for example, DKS’ average portfolio duration was over 12-years. That’s nearly as high as Costco – which sits at 14x. Costco is a destination if there ever was one in retail. Dick’s may be a nice store, but it’s no Costco.


The good news is that over the past 4-years, DKS’ weighted average duration has come from 12.2 years down to 8.0 years. That’s been very bullish for DKS’ ability to leverage occupancy with a lower comp than the 4-5% it needed back in 2007. We’ve seen that hurdle rate come down closer to 3% over the past few years. Again, good news.


The bad news is that in 2012 it ticked back up again.  It only went up by 0.2x, which is hardly enough for us to cry wolf. But make no mistake, the reduction in its lease minimums is one of the factors why we’re been positively predisposed to owning DKS at certain times throughout the past few years.


But today, margins are at peak, comps are trending only in the +1-3% range, and management admitted that it needs catch-up investment to acquire the appropriate omni-channel strategy. As such we’re seeing capex trend up this year by almost a third to $300mm, without an obvious near-term payoff.  Maybe we’d be patient for a retailer with above-average defendability in its business model, but unfortunately, we think that over a third of DKS’ business is at very significant risk from web-based competition (not to mention brands’ own direct brands – mind you, Nike is 17% of sales).


Our research call here is clearly negative.


Takeaway: Korea's KOSPI has been a good leading indicator of global growth, but the currency wars might be changing that.

This note was originally published March 25, 2013 at 15:25 in Macro



  • The impact of the Currency War is perpetuating mixed signals out of the KOSPI, which many Macro analysts consider a leading indicator for the slope of global growth.
  • The fact that the KOSPI chart is not up-and-to-the-right as a pro-growth signal (itself perpetuated by declining prices for energy and raw materials inputs) doesn’t necessarily imply global growth is destabilizing.
  • Rather, it implies a loss of international market share among South Korean manufacturers and exporters to their Japanese counterparts amid the sustained trend of yen depreciation, which remains firmly intact.


Manufacturers of “capital goods” (using the Industrials and Tech sectors as proxies) account for 41.9% of the market capitalization of South Korea’s benchmark equity index (the KOSPI). That compares to 29.6% for Japan – South Korea’s chief regional competitor across a variety of key industries and export markets – which itself is also well above the regional average of 20.4%.






Over the weekend, South Korea’s newly appointed finance minister, Hyun Oh Seok, revived his nation’s concerns over JPY debauchery said that the G20 should revisit the issue. On just his second day as finance chief, Hyun firmly proclaimed, “The yen is depreciating while the won is gaining and this is flashing a red light for Korea’s exports… While we will do what we can, we need international cooperation to deal with the weak-yen problem.”


Hyun’s whining may fall on deaf ears, however, as Japan was able to escape any semblance of int’l censure of its Policies To Inflate at the last G20 summit. Because Japanese officials have been very careful in their rhetoric that their economic policy agenda is targeted at overcoming domestic headwinds and not for the sake of currency devaluation, G20 finance ministers are broadly on board with Abenomics – making it very hard for South Korea to find reprieve in the form of int’l censure(s).


Even if Japanese officials weren’t as adept at sidestepping int’l criticism, it’s unlikely the G20 has the political ethos to censure Japan anyway; the US, Eurozone and the UK have each taken multiple turns at being the world’s biggest money-printers and currency debauchers over the past ~5 years.




Net-net, that should continue to perpetuate a loss of market share among many South Korean manufacturers that compete head-to-head on price with their Japanese counterparts. In effect, Hyundai’s loss is Toyota’s gain in a world where consumer demand for automobiles isn’t necessarily robust.






All told, the impact of the Currency War is perpetuating mixed signals out of the KOSPI, which many Macro analysts consider a leading indicator for the slope of global growth. The fact that the KOSPI chart is not up-and-to-the-right as a pro-growth signal (itself perpetuated by declining prices for energy and raw materials inputs) doesn’t necessarily imply global growth is destabilizing. Rather, it implies a loss of int’l market share among South Korean manufacturers and exporters to their Japanese counterparts amid the sustained trend of yen depreciation, which remains firmly intact.



Not the End of the World

Client Talking Points

Still Bearish on Commodities

Despite the fact that the end of the world crowd stayed vocal the past 24 hours, we, amazingly enough, pulled through and the end of the world isn’t here. What we do see is the same bearish trend in commodities that we have seen when the dollar remains strong. Gold, copper and oil all are weakening as the dollar strengthens for the seventh week in the last eight.

Korea’s KOSPI As a Leading Indicator?

We have looked to Korea’s KOSPI as a leading indicator of global economic growth. However, thanks to the global currency war, and specifically the ongoing depreciation of the Japanese yen, the KOSPI hasn’t performed as well as we might have expected. We think that’s a function of the competition faced by Korean manufacturers because of that weaker yen, and is not suggestive of a weakening global economy.

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%.


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 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


“Shorting European markets, selectively, on bounces is making money; shorting US stocks on that hasn’t” -- @KeithMcCullough


“Wall Street people learn nothing and forget everything.” – Benjamin Graham


$30 million, the price Yahoo! Reportedly paid to buy Summly, a mobile news app, from a 17 year-old British entrepreneur

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