Late Friday, Constellation Brands provided an update regarding its joint (along with Anheuser-Busch InBev) negotiations with the Department of Justice. STZ announced that the parties had reached an agreement in principle that was “substantially in line” with the revised transaction and that the parties had approached the Court to request one final stay of the proceedings until April 23rd in order to finalize the documents associated with the DOJ’s consent decree.
This all but ends the drama associated with Anheuser Busch InBev’s acquisition of Grupo Modelo and the associated Crown transaction, after much hand wringing (some of it my own) and at least three downgrades of Constellation Brands (at $30/share). We won’t belabor our view of the companies involved, it’s been consistent from the start – we see STZ fairly valued at $50/share, but recognize that mid-cap managers may chase this name subsequent to the DOJ’s final approval. We prefer BUD toward $110 per share and suspect that the name could see money flows with the deal in the rear view mirror.
What we would prefer to comment on now, with tax day right around the corner, is what the Department of Justice has done for you, the U.S. taxpayer, during this process. From the DOJ’s website:
“The goal of the antitrust laws is to protect economic freedom and opportunity by promoting free and fair competition in the marketplace. Competition in a free market benefits American consumers through lower prices, better quality and greater choice. Competition provides businesses the opportunity to compete on price and quality, in an open market and on a level playing field, unhampered by anticompetitive restraints. Competition also tests and hardens American companies at home, the better to succeed abroad.”
Sounds reasonable, right? Or…
When the DOJ filed its lawsuit to block this deal, we took issue with more than a few statements made in the brief and saw them as counterfactual to the current state of affairs in the U.S. beer industry. At the heart of our disagreement with the DOJ’s position was this notion that the 6.5% market share owned by Grupo Modelo in the U.S. somehow represented a significant counterweight to the pricing intentions of the other 93.5% of the market. Or that the decisions made by Grupo Modelo on pricing were a permanent state of affairs. We could keep going, but you get the point. In an effort to combat an unlikely decrease in competition, here is what the DOJ has accomplished:
Here’s what would have happened had the DOJ done nothing, in our estimation – a better run Modelo increases sales in the U.S. through a more focused Crown, retailers and consumers are happier on the margin and the government collects a few extra bucks in terms of duties on increased beer imports.
Unfortunately, under our scenario, the DOJ doesn't get to puff its chest and say that it fought for Joe Six Pack (literally).
Happy Tax Day!
Enjoy the weekend,
HEDGEYE RISK MANAGEMENT, LLC
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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, DRI, FDX, HOLX, MPEL
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?
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:
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.
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.
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.
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