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Pinnacle Foods – What Do Pickles and Pancakes Tell Us About Consumer Staples?

Pinnacle Foods has traded from an IPO price of $20 per share to over $24 in under a week.  What does that tell us?

 

Priced Right

 

The deal was priced “right” – at a discount to the group in terms of EV/EBITDA – that gap has now narrowed, with PF trading at 10.6x EV/EBITDA (our estimate of EBITDA of $450 million).  The packaged food average is 11.4x and the large cap packaged food average is 10.7x.  Based on the company’s growth profile (or lack thereof) we think it should trade closer to the large cap number, but we also recognize that reasoned views of valuation are largely meaningless in staples these days.

 

Scarcity Value

 

Though we mentioned it in our prior note, we apparently underestimated the scarcity value of a relatively high yielding asset in the small–mid cap space.  We have spoken with more than a couple of people that have capital that needs to be deployed and are faced with limited alternatives in the sector.  This probably also serves as at least a partial explanation for MKC’s performance in the wake of, at best, a mediocre quarter and guide.



Yield is a Driver

 

With today’s move above $24 per share, the yield with the proposed dividend is now below 3.00% (2.96%) versus the yield at the IPO price of 3.60%.  For reference, SJM (2.10%), MKC (1.86%), CHD (1.73%), ENR (1.61%) and HRL (1.65%) are the relevant peer group in terms of yield, suggesting further upside to the extent that the performance of PF is related to a paucity of yield in that cap segment of staples.

 

High Debt/EBITDA Has Outperformed

 

Companies with higher debt/EBITDA ratios have outperformed in the staples sector since the beginning of February, and PF is at the higher end of the staples range with a debt/EBITDA ratio of 4.2x.  The market seems to have embraced deleveraging stories (or lower “quality” assets).

 

Pinnacle Foods – What Do Pickles and Pancakes Tell Us About Consumer Staples? - Debt to EBITDA

 

What Have We Learned?

  1. Don’t fight money flows
  2. Yield still matters
  3. Valuation matters, but only when there is a discount (warranted or otherwise) to be exploited
  4. Crap is still beating quality

To be honest, we kind of knew all those things, but we appreciate the proof of concept.

 

Call with questions,

 

Rob

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

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P:

 

Matt Hedrick

Senior Analyst


NORTH KOREAN SABER-RATTLING "ON"

Takeaway: The latest saber-rattling out of North Korea is likely little more than a desperate plea for incremental international aid.

SUMMARY BULLETS:

 

  • Our analysis and interpretation of history suggests the most appropriate risk management exercise at the current juncture is to broadly fade any fears associated geopolitical risk emanating from the Korean Peninsula.
  • Specifically, it is our view that this latest saber-rattling is merely just North Korea throwing a glorified temper tantrum in order to bring international organization such as the UN back to the negotiating table. Securing incremental humanitarian aid is likely their ultimate goal and promoting geopolitical conflict has historically been their primary tool for accomplishing that goal.
  • We could obviously be wrong here, but anyone not named Kim Jong-un that proclaims they know exactly what the North’s intentions are now is probably unaware of his/her own ignorance with respect to the situation. That is paraphrased directly from Yale Professor Charles Hill (arguably the world’s foremost source on Korean Peninsula geopolitical risk), with whom we hosted a conference call with back in late MAY of 2010 on this very same topic. In the note below, we list a handful of his key takeaways from the call. 

Less than 18 months on the job (specifically in his role as Supreme Commander of the Korean People’s Army), Kim Jong-un has taken after his late father by selling what old-timers like to call “wolf tickets” in the international community.

 

North Korea’s latest attempts to promote beef include “reentering” a “state of war” with South Korea over the weekend; it should be noted that this act is impossible, as, technically speaking, both sides have remained at war since their 1950-53 conflict ended in an armistice rather than a treaty.

 

Overlooking this misstep, it should be noted that North Korea’s state-run Korean Central News Agency expressed that "every issue raised between the North and South will be dealt with in a wartime manner".

 

Naturally, South Korean President Park Geun-hye (the country’s first female president) said that South Korea would respond to any North Korean attacks on its territory. Not bad for her first 45 days on the job.

 

In addition to the aforementioned wartime proclamation, North Korea announced today that it would restart its only nuclear reactor – a decision that was immediately condemned by regional counterparties, such as China, Japan and, of course, South Korea.

 

It’s actually worth noting that Kim Jong-un’s first real bout of outward aggression is actually rather tame relative to his father’s tactics. Recall that back in 2010, the int’l community came to the conclusion that a North Korean torpedo was responsible for the sinking of the ROKS Cheonan, killing 46 South Korean sailors in the process. This was in addition to an artillery attack that killed four South Koreans and the country’s hosting of a tour by foreign experts to their uranium enrichment facility.

 

Our analysis and interpretation of history suggests the most appropriate risk management exercise at the current juncture is to broadly fade any fears associated geopolitical risk emanating from the Korean Peninsula.

 

Specifically, it is our view that this latest saber-rattling is merely just North Korea throwing a glorified temper tantrum in order to bring international organization such as the UN back to the negotiating table. Securing incremental humanitarian aid is likely their ultimate goal and promoting geopolitical conflict has historically been their primary tool for accomplishing that goal.

 

We could obviously be wrong here, but anyone not named Kim Jong-un that proclaims they know exactly what the North’s intentions are now is probably unaware of his/her own ignorance with respect to the situation. That is paraphrased directly from Yale Professor Charles Hill (arguably the world’s foremost source on Korean Peninsula geopolitical risk), with whom we hosted a conference call with back in late MAY of 2010 on this very same topic. Below, we list a handful of his key takeaways from the call:

 

  • “The problem with the Korean Peninsula is really unique. There’s nothing comparable to it anywhere in international relations, so it’s really hard to know how to deal with this because the problems created by North Korea do not fit any of the mechanisms [or] the expectations that are built into the international system. And we don’t much about North Korea because it is such a closed society. So any kind of prediction is really difficult to come to.”
  • “North Korea is a criminal state – and there’s no [other] state like that… It uses those state powers to run a criminal operation, which no other state formally does. In a sense, it has a monopoly on criminal activity (counterfeiting, drug production and proliferation, abductions, money laundering and illegal arms dealings)… That’s been a major problem for the outside world for 25-30 years.”
  • Not unconnected to that is the nuclear question. In a sense, what North Korea has done is turn a nuclear program into a criminal activity. They’ve figured out that if they violate international norms or international law in the production of nuclear weapons and if they issue threats periodically or actually take action such as tests of missiles that could carry nuclear weapons, then they could get the outside world to pay them off in return for promises to change their ways. And this has happened again, and again, and again. It’s a cycle that repeats itself and it’s really extortion: ‘we threaten you and you give us money or food aid or fuel and we’ll promise to subside for a while and then we’ll come back and do the whole thing all over again.’”

 

To listen to the KOREAN RISK AND GLOBAL MARKETS, WITH PROFESSOR HILL call held May 28, 2010 please CLICK HERE (Professor Hill’s commentary begins at the 9:50 mark).

 

To view the accompanying presentation “RISK ON THE KOREAN PENINSULA: IMPLICATIONS FOR GLOBAL MARKETS” please CLICK HERE.

 

ABOUT PROFESSOR CHARLES HILL

Charles Hill is a diplomat in residence and lecturer in International Studies at Yale University. He is a career minister in the U.S. Foreign Service, serving in a variety of roles such as Deputy Assistant Secretary for the Middle East at the State Department, Chief of Staff of the same, and executive aid to former U.S. Secretary of State George P. Shultz. Dr. Hill has been a fellow at the Harvard University East Asia Research Center, a Clark fellow at Cornell University, and is currently a research fellow at the Hoover Institution. He served as special consultant on policy to the secretary-general of the United Nations from 1992 to 1996. He received an A.B. degree from Brown University in 1957, a J.D. degree from the University of Pennsylvania in 1960, and an M.A. degree in American studies from the University of Pennsylvania in 1961.

 

Darius Dale

Senior Analyst

 

NORTH KOREAN SABER-RATTLING "ON" - 1


Testing The 10-Year

The yield on the 10-year US Treasury tested the low-end of our immediate-term TRADE risk range this morning and held above 1.83%. Where the 10-year goes from here is very important; yields bounced yesterday as US stocks traded lower and that trend is likely to continue if the US equity market begins to falter. Expect a big rally in bonds on Friday if the unemployment report comes in below expectations.

 

Testing The 10-Year - 10yr yield


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Retail Sales Soar Higher

The latest reading from the International Council of Shopping Centers (ICSC) is the strongest we've seen in nearly 15 years. Despite dismal weather in late March, the week leading up to Easter showed positive data that indicates shoppers are out there willing to spend money at retail chain stores.

 

We're bullish on retail in general despite the risk of peak margins and increase capital spending; top-line growth is what's in play right now. We like Nike (NKE), Urban Outfitters (URBN) and Walmart (WMT) as long ideas. The names to look for right now are companies that have higher sales and aren't blowing through a ton of cash.

 

Retail Sales Soar Higher - icsc1


'Long Retail' Is an Out of Consensus Call

Takeaway: If you can find 'higher sales, lower capital intensity' we think that's where you want to be. Short the inverse -- now more than ever.

This morning’s ICSC retail sales reading (out of a sample of 80 retailers) was the strongest we’ve seen in nearly 15-years. There was some noise due to weather and the calendar shift (week leading up Easter helped), but the data is telling us that we’re seeing higher highs and higher lows.

 

The out-of-consensus call right now is to be bullish on retail. As much as we find it difficult to get there given peak margins and increased levels of capital spending and SG&A (both of which would erode returns and multiples), we need to be open to the potential for outsized top-line growth that could drive the group higher. At a minimum, it seems like there’s a story of have’s and have nots, like Nike and Urban Outfitters showing strength, and others like Guess? And Carter’s showing incremental sales weakness.

 

If you can find something that exhibits 'higher sales, lower capital intensity' we think that's where you want to be. Short the inverse -- now more than ever. 

 

Longs: NKE, RH, RL, FNP, FL, KORS, URBN, WMT, and for those with a high risk tolerance and longer duration, JCP.

 

Shorts: DKS, UA, GES, CRI, M, KSS, GPS, LULU, GPS, FDO

 

'Long Retail' Is an Out of Consensus Call - icsc1


Still Bullish: SP500 Levels, Refreshed

Takeaway: Don’t expect me to join the Professional Top Calling #PTC Committee.

POSITION: 14 LONGS, 7 SHORTS @Hedgeye

 

Bullish is as bullish does. Higher-lows holding all lines of support on no-volume down days combined with higher-highs on rallies – that’s bullish.

 

#StrongDollar continues to have causal impact on both Commodity Deflation (good for US Consumption Growth) and the SP500’s return. On a 60-day basis the correlation between the US Dollar Index and the SP500 is now +0.81. That’s really bullish.

 

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

 

  1. Immediate-term TRADE resistance = 1576 (higher-highs)
  2. Immediate-term TRADE support = 1557 (higher-lows)
  3. Intermediate-term TREND support = 1501

 

In other words, when higher-highs are A) probable and B) within the context of all-time highs, don’t expect me to join the Professional Top Calling #PTC Committee.

 

KM

 

Keith R. McCullough
Chief Executive Officer

 

Still Bullish: SP500 Levels, Refreshed - SPX


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