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INITIAL CLAIMS: CREDIT CARD TAILWINDS PERSIST

Takeaway: Cards remain a safe spot on the long side for now. Claims, and by extension credit trends, show no sign of turning at the moment.

Long in the Tooth, but OK for Now ...

Both SA and NSA initial claims posted sharp improvement in the latest week. In the past we've shown how initial claims are the best leading indicator for forward delinquency metrics at credit card lenders, on a 13-week lead/lag. Clearly, card results were better than expected in 1Q13 and the claims data we're seeing currently suggests further progress in 2Q from DFS and COF, and AXP to a lesser extent.

 

We've argued in the past that renormalized delinquency levels, i.e. reaching DQ levels consistent with 2005/2006 averages, would herald an end to reserve release tailwinds, and, by extension, usher in earnings growth headwinds. This ongoing positive trend in claims, however, coupled with Krugman's "Jobless Trap" - the segment of the population now perpetually long-term unemployed - has enabled a continued fall in DQ rates since this former core subprime cohort is now "non-underwriteable".

 

This curious confluence of positive selection (vs. adverse), fast turning assets and secular credit tailwinds has pushed operators to take down coverage further than we would have thought prudent or possible. While this sets the stage for ongoing improvement in the short/intermediate term, we continue to fret about the long-term implications of making all-time lower low DQ rates in a low-growth, highly competitive asset class. Auto is perhaps an even more glaring example, as we noticed in the weekend paper a local credit union offering 0.99% on terms up to 48 months. How that will even cover normalized credit losses in this newly emerging environment of falling used car collateral values I have no idea. But for now, everything's good. 

 

The Numbers

Prior to revision, initial jobless claims fell 13k to 339k from 352k WoW, as the prior week's number was revised up by 3k to 355k.

 

The headline (unrevised) number shows claims were lower by 16k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -4.5k WoW to 358k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -6.3% lower YoY, which is a sequential improvement versus the previous week's YoY change of -3.8%

 

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Yield Spreads

The 2-10 spread rose 0.2 basis points WoW to 147 bps. 2Q13TD, the 2-10 spread is averaging 152 bps, which is lower by -16 bps relative to 1Q13.

 

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Joshua Steiner, CFA


CL, Better than PG, Better than Feared, but no EPS Upside and No Reason to Chase the Multiple

CL reported Q1 2013 EPS this morning and we would expect a bit of a “relief” (if you can call it that after the move the stock has had recently) rally in the name on strength of a very good organic sales growth number (+6.0%) and an EPS result that matched consensus ($1.32).  However, at 20.7x calendar ’13 earnings, there seems to be a whole lot of good news already in CL’s stock price, and we can’t come up with any reason to be involved in this name at these levels any way other than on the short side.



What we liked:

  • EPS met consensus
  • +6.0% organic revenue growth versus a reasonably difficult comp (+6.5%)
  • Organic volume growth across segments and regions (even Hill’s)
  • 33 bps improvement in gross margins (against the easiest comparison of the year)
  • Some modest leverage as +2.7% reported sales growth translated into +3.7% operating income growth
  • 13.5% increase in FCF despite higher capital spending

What we didn’t like:

  • Most difficult sales comp of the year coming up in Q2 (+8.0%) on both a one and two year basis
  • Gross margin comparisons get substantially more difficult as the year progresses
  • Margin weakness in Latin America and Hill’s

It’s tough for us to get excited about CL at these levels, even with a good organic sales growth number in the books – however, we said that at $110 as well.  Bottom line, the results are reasonable, the multiple is not.

 

Call with questions,

 

Rob

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

E:

P:

 

Matt Hedrick

Senior Analyst



CAKE ON TOP OF ITS GAME

The Cheesecake Factory remains on Hedgeye’s Best Ideas List as one of our favorite ways to play our macro team’s bullish view on US consumption.

 

The Cheesecake Factory reported 1Q EPS of $0.47, easily beating the $0.42.  As explained on the earnings call, about $0.03 of the EPS upside reflected a greater-than-expected 2Q to 1Q sales shift related to an earlier Easter and related spring breaks.

 

Up and down the P&L, food costs, labor costs and G&A were well controlled. This contributed to what was a high-quality earnings quarter.

 

Same store sales rose 1.4% (Cheesecake up 1.6% and Grand Lux Café down 90bps) including a 50 bps benefit from the spring break shift.  The company also mentioned 60 basis points of negative weather impact, centered in the Northeast. The two year average trend at The Cheesecake Factory and Grand Lux both improved sequentially from 4Q12.

 

We continue to believe that the international story is underappreciated by the street. On the call, the company emphasized the strong performance of its three international units, with higher than planned volumes being delivered at these locations.  Three additional Middle East locations are due to open this year. Management stated that for each Middle Eastern restaurant that open for a full year, it expects $0.01 in incremental annual earnings per share.

 

The company lowered expectations for 2Q13, due to the sales shift mentioned above, and raised its full year slightly. The midpoint of the EPS guidance range was raised by $0.01. There was nothing in this quarter to suggest that the story has changed and we are keeping “Long CAKE” on the Hedgeye Best Ideas list.

 

CAKE ON TOP OF ITS GAME - cake pod 1

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst


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The Cycle of Deflation

Client Talking Points

Deflation Continues

The great commodity bubble brought forth by the monetary policy of the Federal Reserve has popped. Since the "Bernanke Top" of mid-September, commodity prices have come down considerably across the board. The CRB Commodity Index, which measures 19 different commodities, hit a fresh year-to-date low yesterday and can continue that trend quite easily. The fall of oil and ag prices drastically drags down markets (Russia, Korea, etc.) highly levered to commodity prices.

Pain in Spain

Spain continues to drag the European Union down with a slew of bad economic data. No wonder investors are nervous - the country just reported an unemployment rate of 27.2%. That's more than 1 in 4 people out of work. Whether that's by choice of their own is up to the imagination. So what's next? The ECB will likely cut rates again, giving global markets a shot of adrenaline that's welcomed by everyone.

Asset Allocation

CASH 23% US EQUITIES 25%
INTL EQUITIES 18% COMMODITIES 0%
FIXED INCOME 6% INTL CURRENCIES 28%

Top Long Ideas

Company Ticker Sector Duration
IGT

Decent earnings visibility, stabilized market share, and aggressive share repurchases should keep a floor on the stock.  Near-term earnings, potentially big orders from Oregon and South Dakota, and news of proliferating gaming domestically could provide near term catalysts for a stock that trades at only 11x EPS.  We believe that multiple is unsustainably low – and management likely agrees given the buyback – for a company with the balance sheet and strong cash flow as IGT.  Given private equity’s interest in WMS (they lost out to SGMS) – a company similar to IGT that unlike IGT generates little free cash – we wouldn’t rule out a privatizing transaction to realize the inherent value in this company.

FDX

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

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

TWEET OF THE DAY

"$LINE $LNCO probably closes up today, just because nothing about how these stocks act makes sense to me" -@HedgeyeENERGY

QUOTE OF THE DAY

"I have long been of the opinion that if work were such a splendid thing the rich would have kept more of it for themselves." -Bruce Grocott

STAT OF THE DAY

US Initial Jobless Claims fell 16,000 to 339,000 last week, the lowest level in 5 years.


STRONG BYI Q - IGT READ THROUGH?

Systems drove most of the beat but there were a few positive takeaways for IGT.

 

 

BYI posted a great quarter last night and expressed its confidence in the future through the announcement of a big stock buyback.  The stock should be up big this am and we continue to like the name for the long-term.  However, after BYI pops on the open, IGT may be the more interesting stock over the near-term.  Much of BYI’s beat was driven by systems which is less important for IGT.  However, some of BYI’s conference call comments gave us more confidence in IGT’s FY2013 and upcoming quarterly earnings announcement.  BYI indicated a large video poker order in the quarter – IGT dominates the video poker segment – and expressed confidence in accelerating replacement demand and improving international orders.  IGT will report FQ2 earnings tonight after the close.

 

Back to BYI, on the back of record results in its systems business, BYI’s reported a quarter that handily beat consensus and our expectations.  A lower tax rate in the quarter helped offset some “unusual” but unelaborated SG&A expenses as well as a few cents of FX drag. 

 

In addition to reporting a solid quarter, BYI raised guidance, announced an Accelerated Buyback Program (ala IGT), upsized its share buyback program, and issued an upsizing and extension of their credit facility on more favorable terms.  All-in-all, the business continued to do well and BYI’s management team put their money where their mouths are in reinforcing confidence in the business with an aggressive share repurchase program.

 

 

Details:

  • Gaming equipment sales came in below our estimate on the back of softer ASPs.  Unit sales were spot in-line with our estimate with NA being slightly better and International coming in a little softer. 
    • BYI shipped more Canadian units than we expected but replacement sales were weaker than we would have thought.  BYI mentioned that there was a large order for video poker replacements that took some capital out of the market.  This bodes well for IGT, which likely got some large video poker orders on the back of some heavy promotions they are running. 
    • Weaker replacements were offset by better market share in new and expansion units
    • We got the impression that international sales should show some signs of a pulse in coming quarters if not next quarter
  • Systems was by far biggest upside surprise in the quarter and based on the commentary on the call it sounds like next quarter will be better with higher margins
  • Gaming operations was slightly ahead of our estimates with upside coming from better WAP placements/yields and what seems to be a lift from Pawn Stars.
  • Other:
    • SG&A:  based on the BYI commentary, the quarter’s $72MM included about $3MM of unusual expenses
    • R&D was higher than we expected
    • The 31% tax rate was below the 36.5% we were modeling
    • We assume that FX losses were in the “Other” expenses
  • We have them at 98 cents for 4Q which is 2 cents above their guidance range
    • That assume growth in systems revenue and margins
    • Improvement in international sales
    • A nice sequential lift in replacement sales
    • Continued growth in WAP placements
    • 2.5MM share reduction from the Accelerated Buyback Program


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