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Editor’s Note: We have made some changes to your Investing Ideas newsletter this week to serve you better. We have added a section called Investing Ideas Updates, which incorporate the latest comments from our research team’s Investing Ideas’ stocks. We have also included links to the latest Stock Reports, which discuss each Investing Idea stock in detail.






  • CAG: Consumer Staples sector head Rob Campagnino (@HedgeyeStaples) says ConAgra’s earnings “disappointment” – they reported $0.55, a penny less than consensus – is a high-quality problem.  The company continues to do the right thing, increasing their marketing spend in their core business by a third, and maintaining full-year earnings guidance. (Please click here for the latest CAG Stock Report.)
  • HOLX: Health Care sector head Tom Tobin (@HedgeyeHC) sees new replacement of diagnostic mammography units for the first time since late 2008.  Hologic is poised to ride the crest of this replacement cycle wave, which Tobin believes is the start of a long-term growth trend in this critical health technology.  As the recognized leader in accurate detection of cancers, and elimination of false positive results, HOLX should benefit from additional insurance spending under the Affordable Care Act. (Please click here for the latest HOLX Stock Report.)
  • DRI: Restaurants sector head Howard Penney (@HedgeyeHWP) says casual dining trends should improve as housing continues to strengthen – housing mirrors the formation of new family units, and families eat out.  Darden’s quarterly earnings beat Wall Street expectations, though on a double-digit revenue decline. (Please click here for the latest DRI Stock Report.)
  • FDX: Industrials sector head Jay Van Sciver (@HedgeyeIndstrls) says with margins at a 30+ year low, and trailing the competition by as much as 7%, FedEx has abundant opportunities for cost reductions.  Meanwhile, FedEx Ground continues to take market share from UPS.  In a breakup, either the Ground or Express could be worth more than the whole company trades for today. (Please click here for the latest FDX Stock Report.)
  • MPEL: Gaming, Lodging & Leisure sector head Todd Jordan (@HedgeyeSnakeye) says recent highs in this stock should not fool investors: Melco Crown Entertainment continues to be misperceived.  Jordan says management has done an effective job and multiple expansion should take the stock higher, reflecting the more stable reality of this company. (Please click here to see the latest MPEL Stock Report.)



Hedgeye CEO Keith McCullough (@KeithMcCullough) wrote Friday morning, “We are well aware that this week’s news on the jobs front (both Non-Seasonally-Adjusted Rolling Claims and the Monthly Jobs Report) weren’t good; at least not as good as the employment news has been.  That’s now another market opportunity – what if next week’s jobless claims improve?” 


McCullough warns Friday’s market downdraft, triggered by weak non-farm payrolls, could be a head fake.  The S&P index held Keith’s support levels (using his proprietary quantitative models) and signaled a higher overhead resistance level.  What if oil prices continue to fall?  What if the dollar continues to strengthen?  What if mortgage rates get pushed back down again?


What, indeed?



THE GOOD NEWS   Call it “not as bad as you thought news.”  Financials sector head Josh Steiner says the labor market looks much softer than it really is.  Labor statistics are confusing right off the bat, because More Jobs is not at all the same as Less Unemployment – Friday’s non-farm numbers highlights the lopsided relationship between the measures. 


Looking at some key measures of GDP at year-end 2012, there are upward trends in overall demand for US products, both domestic and for export, and increased domestic investment.  The Government component of GDP was flat to slightly down, perhaps partly related to the Sequester.  Hedgeye has said the Sequester is fundamentally positive because it cuts government spending.  The markets seem to agree, driving recent strong action in both the Dollar and US equities.  Against this, Thursday’s Initial Jobless Claims number was widely viewed as a negative surprise, while Friday’s non-farm payrolls report added to fears the recovery is running out of steam.


THE BAD NEWS   Analysts generally track Initial Jobless Claims using seasonally-adjusted figures.  On that basis, this week’s Claims number was pretty dismal.  Steiner favors non-adjusted figures, and using these, Steiner says Initial Claims continued to improve, if only mildly.  Steiner notes that Easter came early this year – March instead of April – throwing off seasonally-adjusted comparisons in everything from employment, to food and entertainment, to retail and beyond.  So there’s Bad News, and Less Bad News: the seasonally-adjusted figures looked awful, while the non-adjusted figures were still trending slightly positive over last year.  Friday’s report shows labor growth is cooling, but one statistic does not a bear market make. 




Industrials sector head Jay Van Sciver highlights private equity in a sector that is generally neglected by big money.  He cautions that KKR’s buyout last month of industrial pump maker Gardner Denver shouldn’t be read as open season across the sector, but there may be some momentum.  “The best LBO shops in the industrials sector go after idiosyncratic deals,” writes Van Sciver.  A highly cyclical sector “can be death sentences for highly leveraged entities,” he writes.  Think of paying $75 million a year for a star outfielder, then seeing him bat 0 for 30.  You’re sure you’ll get your money’s worth some day. 

But the waiting…!


Two additional factors in favor of private equity deals in industrials: it’s an unlikely sector, which means there may be hidden value waiting to be discovered, and there is some $1 trillion in Private Equity cash waiting to be invested.  Unlike you and me, PE managers can’t sit on their cash.  They charge investors a 2% management fee, even on uninvested funds.  You’d better believe there’s pressure to put that money to work.


Other items from the sector:

  • Recent manufacturing and rail data flash a slowdown in March, after rapid growth in January-February.  This may lead companies to issue conservative guidance for the current quarter.
  • Early truck tonnage stats show an upswing after a poor showing last year.  Continued growth in the sector could somewhat mitigate the dour outlook from manufacturing and rail – but a downturn will be seen as confirmation.
  • Factory orders, while probably priced into the markets, are further confirmation of stabilization in industrial activity, after a poor 2012.
  • North American agricultural equipment sales appear well above replacement demand, indicating the sector may be immune to stimulus from agricultural prices.
  • Housing activity continues strong, which continues to bolster Van Sciver’s bullish view on outdoor power equipment.
  • Last, but not least – domestic airlines are supposed to be “reaping the benefits of consolidation through strong pricing.”  Van Sciver says they are really just repeating the tired old narrative of “We’ve changed!  We’ve restructured!  We’ll make lots more money now!”  We remind our readers that the corollary is: “Unless we don’t.”



The SEC requires public companies to make “full and fair disclosure” of material information.  In the past, senior executives would have a “one-on-one” their favorite Wall Street analyst – whose research would magically have the best projection of the company’s earnings.  Now many companies issue Guidance, a public disclosure of management estimates of future revenues, expenses and earnings.


This is an improvement, but still far from perfect.  There’s a “guidance game,” where certain companies always come in with actual earnings reports that are just a little bit better than their guidance.  There are special cases, such as publicly traded oil & gas Master Limited Partnerships who provide guidance on how much they expect to distribute to shareholders.  Again, distribution targets can be met from sources other than actual business revenues, further muddying the accounting waters.  And there are companies that miss their guidance numbers altogether – though note that Wall Street only calls it a “miss” if the actual earnings are below the guidance levels.  Apparently investors don’t mind if companies use accounting skullduggery, as long as their stock prices go up.


While guidance is intended to level the playing field, note that the biggest investors can still purchase an edge, as reported in the Financial Times (April 1st,  “US Research Highlights ‘Cash For Access’ Risks.”)  Citing an academic study released in January, the article says some hedge fund managers “are paying as much as $20,000 an hour to meet a chief executive,” and “informed hedge fund managers… typically generated an excess return of 3.7 per cent in the month following a meeting with management.”  This practice, known in the trade as “corporate access,” indicates the SEC still has a way to go in the realm of Full and Fair Disclosure.


The Wall Street Journal called attention to trends in guidance (April 1st, “Investors Ignore Negativity at Their Peril”) noting that, though the S&P 500 had recouped all its bear market losses, “people in the market with legal inside information are surprisingly cautious.”  FactSet reports the highest ratio of companies in the S&P 500 issuing negative guidance (over 3 ½ to 1) since they started keeping records, in 2006.  And though analysts’ earnings outlooks for these companies has ratcheted down considerably, the average stock price for companies issuing negative guidance is practically unchanged – half of them actually went up in the days immediately following negative guidance announcements.  There seem to be excessive upside reactions when companies issue positive guidance (Netflix stock was up over 60% following enthusiastic guidance) and not enough of a negative reaction to downward guidance. 


We expect most companies issuing negative guidance to report within – or slightly better than – the range of expectation.  Earnings guidance is what management wants you to think of their company right now.  While you don’t have to agree with them, you shouldn’t ignore them.



Today we bought the S&P 500 (SPY) at $153.96 at 10:19 AM EDT in our Real-Time Alerts. S&P 500 is holding the low-end of our risk range as the VIX signals immediate-term TRADE overbought. We remain bullish on US Consumption stocks. 


TRADE OF THE DAY: SPY - image001


Data from the BLS pertaining to March employment trends suggest that employment growth is becoming, on the margin, less of a tailwind for restaurant sales. 


Sequential Softening


According to Christian Drake, Senior Analyst on the macro team at Hedgeye, today’s data “confirmed the sequential deceleration observed in both the ADP and NSA Jobless claims numbers earlier in the week.  On balance, the labor market trends for March have followed the broader trends in the domestic macro data (ISM, PMI, Auto’s) where strong January and February numbers have been chased by been sequentially weaker March reports.”


For the restaurant industry, this sequential deceleration is a negative, on the margin. Casual dining same-restaurant sales have been decelerating and this is being confirmed by a deceleration in hiring in the industry. 





Employment Growth by Age


Employment growth by age data implied a relative strength in QSR versus casual dining, on the back of positive growth in the employment of younger age cohorts, albeit sequentially slower versus January and February.  The chart below illustrates continuing (slight) employment growth in the 20-24 and 25-34 YOA cohorts while employment growth in the 35-44 YOA and 45-54 YOA cohorts declined in March. 





Restaurant Industry Employment


If we assume that hiring within the restaurant industry serves as a proxy for operator confidence, it seems that QSR operators have a much different outlook than casual dining operators.


The Leisure & Hospitality employment growth decelerated in March, suggesting that overall trends for the restaurant industry may be turning negative.  The QSR industry is still hiring at a much faster rate than the full-service industry but February (the more narrow data is on a lag) was the first month since August 2012 that the spread between the respective employment growth rates declined month-over-month.







Howard Penney

Managing Director


Rory Green

Senior Analyst




This note was originally published April 05, 2013 at 16:01 in Gaming

  • Macau stocks have slumped 5% due in part to worries about the latest swine flu epidemic which has caused 6 deaths so far
  • The last time we had swine flu fears (June 2009-November 2009), gross gaming revenues (even excluding the opening of City of Dreams) actually continued to improve on a growth level
  • With the two SARS outbreaks (Nov 2002-July 2003, Dec 2003-May 2004), Macau GGR growth accelerated from 19% in 2002 to 44% in 2004
  • Macau stocks could continue to be under pressure but in terms of the fundamentals, precedent suggests business as usual




  • Macau stocks have slumped 5% due in part to worries about the latest swine flu epidemic which has caused 6 deaths so far
  • The last time we had swine flu fears (June 2009-November 2009), gross gaming revenues (even excluding the opening of City of Dreams) actually continued to improve on a growth level
  • With the two SARS outbreaks (Nov 2002-July 2003, Dec 2003-May 2004), Macau GGR growth accelerated from 19% in 2002 to 44% in 2004
  • Macau stocks could continue to be under pressure but in terms of the fundamentals, precedent suggests business as usual



FedEx: Countering Negative Narratives, Bears Lost in the Weeds

Takeaway: Bears seem lost in quarterly minutia and badly structured regressions.

FedEx: Countering Negative Narratives, Bears Lost in the Weeds




Below, we respond to some of the criticism that FDX has received from the traditional sell-side following FY3Q earnings.  Broadly, we are suspicious of anyone who thinks it is useful to write a report detailing how their model differed from actual results.  More specifically, we think the negative reports have gotten the timing and magnitude of the FDX opportunity wrong.  We think they have gotten bogged down in quarterly detail and meaningless regressions.  Below, we respond to these details and try to place them in the context of the broader FedEx value opportunity.  If we have missed key points of the bear thesis, feel free to let us know.


Bears Missing the Broader Opportunity


Stepping back, the value opportunity in shares of FedEx is clear, at least to us.   The market ascribes little value to any FDX business other than FedEx Ground, in our view.  This is odd, for example, because the market does not appear to ignore the value in UPS’s express revenue or its competitively disadvantaged ground revenue.  While there are probably better ways to show it, FDX currently trades at an EV/Sales of 0.67 while UPS trades at 1.56.  In our view, the primary differences are the multi-decade low margin at FedEx Express and a persistent rich valuation given to shares of UPS since its IPO (and, no, not leases).


There is no structural reason that the FedEx Express division cannot match competitor’s margins over the next few years, in our view.  Capital spending and management focus are now being directed toward that end, and faulting management for not doing it sooner is pointless.  The FedEx Express division has ~$27 billion in revenue and produces little income relative to its potential.  It flies expensive, outdated aircraft and maintains excess capacity, both of which are fixable.  The division could also get a margin boost, we think, from better balancing its network through a TNT acquisition.  Deutsche Post was able to improve its express margins from much, much worse levels in a few years.  If Deutsche Post can do it, anyone can, right?  Importantly, the express industry is highly consolidated and is, excepting an unlikely-to-reoccur >300% increase in fuel prices in the last decade, structured for very solid returns. 


FedEx Ground enjoys a substantial competitive advantage from its non-unionized labor force, among other factors, which has allowed it to steadily take market share.  There is little reason to expect that to stop, in our view, which is to say we expect FedEx Ground to eventually take UPS’s spot as the largest ground delivery service in the U.S.  (Has a heavily unionized company facing non-union competition in the U.S. ever succeeded?)  Given the e-commerce driven prospects for package volume growth, FedEx Ground is likely to remain a valuable franchise. 


Too much data can be toxic to clear thinking.  While we do not precisely subscribe to the cocktail napkin requirement, a great value opportunity can rapidly get lost amidst 20 basis points here and 15 basis points there.  Business and economic results are noisy, so we look for very large value opportunities relative to the uncertainty in our estimates.  FedEx Express margins are running at over 700 basis points behind UPS, by our estimates.  That is quite large.  Our bull case valuation for FDX tops out around $180/share, with a conservative base case valuation in the $130-$150 range.  Most importantly, our bear case shows little downside from current levels – an asymmetry even bearish reports agree with.  We think that is the signal amidst all of the noise.



Bearish Minutia: FedEx Ground


  • Lack Gains from Scale/Margins Weaker:  Those negative on FedEx have correctly pointed out that FY3Q2013 Ground margins were sequentially weaker.  Somewhat correctly, they highlight the prior period lack of clarity on the change in self-insurance accruals (annoying, yes, but you can see the reduced current and non-current self-insurance accruals in the 10-Ks, and those reductions fall almost directly to the operating income line. By our estimates, the companywide impact was an added $30-$40 million in fiscal 2012.  It was not allocated to Ground, though, and the company should do better than that, in our view.)  They also highlight that increased scale has recently not driven higher margins.   But, does any of this matter? 
    • Current High Teens Margins Are Great:  In 2007, FedEx Ground had a 13.5% operating margin and 2012 was a peak at 18.4%.  Reduced spending on the independent contractor realignment and greater scale likely drove the gains.  In a few quarters, margins can bounce around, but the trend is generally favorable.
    • Mix Will Lower Margins (but in a good way):  SmartPost and other e-commerce related services have lower margins – at least for now.  These are the fastest growing components of Ground.  We do not expect margin expansion at Ground because of this mix shift.  These low cost services are market expanding, much the way the drop in time definite service prices were in the 1970sIf an investor has an issue with FedEx Ground’s margins vs. market expansion, we would expect that they are heavily short ground services customer AMZN.
    • Why is 20% Needed?  The fixation on 20% margins seems odd.  We find FDX to be undervalued without assuming 20% Ground margins.
    • Ground Value Proposition b/t FDX and UPS Converging?  FedEx Ground is roughly half the size of UPS’s ground service and yet has equivalent margins.  FedEx Ground moves packages faster – and has been getting even faster.  To the extent that FedEx is bundling air and ground to increase channel density, the issue is the empty space/lack of channel density (i.e. excess air capacity, which is being addressed), not the value proposition offered by FedEx Ground.
    • Ground Margin Gains Will Slow:   Of course FedEx Ground margin gains will slow.  Much of the margin improvement since 2006 related to the need to restructure its independent contractor model.  As that spending dissipated, margins popped.  See here for a summary and replay of our expert call on FedEx Ground’s independent contractor model.  This is also covered in our Express & Courier Services black book.  Presenting a regression on per piece cost vs. volume without factoring in the origin of prior margin gains (e.g. completing the spending to restructure the IC model, which doesn’t relate to volumes or scale) is problematic and misleading.  Scale is far from the only or most important factor driving average cost per piece at FedEx Ground. 


FedEx Express


  • Express Margins Weak: That FedEx Express margins are weak is the point of our FDX long thesis.  If Express margins were not weak, the stock price would be much higher and we would be writing about lawnmower engines (BGG) instead of FedEx.  That said, the margins were sequentially weaker last quarter.  Does this matter?
    • They Didn’t Tell Us To Expect Margin Improvement:  FDX management said we should start to see the benefits in FY4Q 2013, which is this quarter, not last quarter.  See here for how we were not “in” FDX for last quarter’s results.
    • Tougher Environment for Restructuring?  We look to buy structurally sound/competitively advantaged cyclical stocks when their industry is at or near a trough, as we think the Express industry is now.  We look to sell when the industry is peaking (~2005 for the Express industry).  The weak Express market is unlikely to add to either the restructuring burden or the investor performance burden.  If one buys into strong cyclical markets, one will end up buying peaking cyclicals – like FDX in 2005 or CAT in the middle of last year, in our view.
    • Lower Bar for Restructuring Guidance:  The $1.6B in restructuring benefit for FedEx Express is to be measured from FY2013 levels.  FY2013 could be lower by $50-$100 million relative to prior expectations.  Does anyone think that $1.5 billion in Express cost reductions wouldn’t be huge for FDX’s share price?
    • TNT Possible:  It is possible that FDX is orienting the Express restructuring around a potential TNT acquisition, lowering margins near-term for a positive long-term transaction.  Most analysts do not address the potential of a TNT transaction.
    • Breaking Eggs:  Last quarter, FedEx started the process of the Express restructuring, which is disruptive, but did not receive the cost reduction benefits.
    • How Patient Are Investors?  We would point out that UAL has been “integrating” United and Continental for several years now.  Yet, first quarter adjusted, ex-fuel CASM is supposed to increase double digit.  After billions in restructuring and integration-related charges, investors have not lost hope in UAL’s cost reductions, even though we think they should.  Giving up on the FDX restructuring now is absurd, in our view.  The FedEx Express restructuring has not produced results because it has not really started, as of FY3Q results. 



  • Guessing About Multiples:  Will FedEx ‘deserve’ a lower multiple once margins are higher?  Just asking the question sounds odd.
    • Backfilling P/Es:  Some have suggested that when FDX completes its restructuring, it should have a lower multiple.  They then proceed to pick a P/E number out of a hat that supports their bearish conclusion, with a narrative rationale for the arbitrary target P/E.  There is no reason to pick a P/E, since explicit discounted cash flow valuations can be generated that include return on capital, capital spending and market growth assumptions. 
    • Winners Win:  We would wager that if FedEx can execute on its restructuring, it is likely to have a higher multiple because it will be seen as a good company with a management team that can execute.  Of course, that’s another unsupportable narrative, but one that better matches our view... 
    • Argue Specifics:  We have presented the assumptions behind our scenario-based discounted cash flow valuations.  We think these valuations provide a “reasonable range” for FDX’s fair value in a framework that is consistent with how we look at the investment alternatives.  This approach allows the reader to disagree with, say, the reasonable range for long-term revenue growth at FedEx Ground (maybe 2% to 5%, but not 12%), instead of saying that the PE should be at a 20% discount to its 10-year average, whatever that means. 
    • Downside Limited:  Bears acknowledge that there is little valuation downside from current levels.  They just choose not to believe in the upside from a restructuring that has yet to flow through to a single earnings report and has been successfully executed by a competitor (DHL) in recent years. 

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