“They might more than ever in the future engage in hunting beavers.”
-Samuel de Champlain
Samuel de Champlain was most definitely a big game hunter. On a basic level, he lived from the period of 1574 – 1635, so he had to hunt big game to eat. On a broader level, he founded the Canadian province of Quebec and was the first person to map the east coast of Canada. Founding and mapping a large part of Canada is most certainly big game hunting.
In the investment world, this was the week of big game hunting. Earlier in the week we had the Ira Sohn Conference, which Keith went through yesterday in the Early Look, and now we have the Salt Conference. And if you aren’t in the hedge fund industry, you probably don’t know what I’m talking about right now!
The Ira Sohn Conference is a charitable conference at which some of the top money managers come and pitch ideas. Meanwhile the Salt Conference is a for profit conference organized by Anthony “Gucci” Scaramucci at which money managers also talk ideas, for the monetary benefit of the organizers (and the casinos in Vegas!). Incidentally, Gucci was the nickname bestowed upon him by President George W. Bush. (When I met President Bush, he called me the much less creative, “Big D”.)
So, what exactly do I mean by big game hunting? Well, in this industry it is when a money manager with some sizeable funds behind him (aka ammo) comes out and pitches a unique investment idea. More often than not the best and most controversial ideas are those on the short side. Over time, markets go up so if you are going to pitch a short idea, you are best off doing your homework.
So this morning I’m going to take a break from the global macro grind to talk about a certain big game short idea that we are hunting. This animal goes by the name of LINN Energy and the ticker is $LINE. Our energy analyst Kevin Kaiser has been all over this for the past couple of months and last weekend he gained even more notoriety as his work was highlighted in Barron’s.
The indomitable Jim Cramer then attempted to provide the counter argument to Kaiser by bringing the CEO of Linn on to his nightly show, Mad Money. And it was somewhat apropos from our perspective, as the CEO’s performance in defending himself against our short thesis was a little mad. You can find that video here: http://video.cnbc.com/gallery/?play=1&video=3000166362.
So what was our take on the interview? Overall, we thought Ellis' defenses were weak, which is not a surprise to us (there aren't any good ones). No change in our view here - LNCO/LINE is still one of the best sells/shorts in the energy sector today. In the chart of the day we’ve outlined their cash funding needs and Kaiser’s play-by-play of the Cramer interview is outlined below:
“Jim Cramer: “Are [the bankers advising LINN Energy and Berry Petroleum on the pending merger] saying that [LINE] is worth $18 like Barron’s says?”
Mark Ellis, CEO of LINN Energy: “Absolutely not, Jim. They’ve done a complete independent analysis; we’ve had three different independent analyses done. They are all coming in with valuations in the high 30’s to mid 40’s for the Company. We’ve done our own valuation, it’s in the mid 40’s to as high as $60 per unit depending on how far you go into the 3P reserves.”
Hedgeye: You are citing the fairness opinions of the bankers that are getting paid to work on the merger? Really? We are independent, don’t get paid banking fees from LINN or Berry, and believe that LINE is worth $5 – $18/unit.
Ellis: “Our accounting is in strict adherence to GAAP measures.”
Hedgeye: We agree.
Ellis: “We’ve been very clear and transparent as it relates to our non-GAAP measures that we use to measure the performance of our business. And in our most recent 8-K’s we’ve given total transparency in terms of how those measures are calculated.”
Hedgeye: We disagree. How LINN excludes the cash cost of put options from “distributable cash flow” by amortizing them through the unrealized loss on commodity derivatives line has neither been adequately explained nor justified (it's complex and most LINE investors don't understand it). Further, “maintenance capex” is still very much a mystery; we are not able to calculate or estimate this number on our own. In fact, LINN’s IR team has told us that it’s not possible with publicly available information. This is hardly transparent.
Cramer: “[Kevin Kaiser] says that ‘LINN can’t keep production flat despite $260MM of capital expenditures, yet the amount of capital spending that is deducted from their definition of distributable cash flow was only $110MM.’ He’s saying that your free cash flow was actually negative $40MM…”
Ellis: “Jim, what you have to understand in our business is that one quarter does not make a company. One quarter is not the appropriate measure for determining whether or not your maintaining your asset or not [sic]. You have to look at the body of the work over the course of a full year; so I think he’s taking a pretty short view of our business.”
Hedgeye: This is a weak argument that is not supported by the data. First off, LINN is a pretty standard E&P company – spud-to-sales times are ~30 - 60 days. There are no significant upfront costs to be followed by a large increase in production months or years later. Second, let’s do what Mr. Ellis suggests and look at the Company's performance over a longer duration. LINN says that maintenance capex should be considered on an annual basis, but let’s look at the last two quarters plus the guidance for 2Q13; this is an instructive exercise because the Company did not close any material acquisitions over these three quarters, so we have three straight quarters of organic numbers. Production averaged 800 MMcfe/d in 4Q12, 796 MMcfe/d in 1Q13, and management has guided 2Q13 production to 780 – 820 MMcfe/d. After adjusting the 2Q13 guidance for the Panther divestiture (expected to close on 5/31/13), the midpoint of the 2Q13 guidance is 806 MMcfe/d (by our estimates). So for three consecutive quarters LINN will have essentially no production growth, and total capex will exceed maintenance capex by $491MM. "Distributable cash flow” over these three quarters equals $497MM. In our view, if maintenance capex was anywhere near what it is really costing LINN to maintain production, there would be no distributable cash flow (see table below).
Ellis: "I think many of the facts were misleading.
Hedgeye: Freudian slip?”
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1, $100.07-106.05, $82.17-83.12, 98.65-101.78, 1.77-1.88%, 12.12-14.41, and 1, respectively.
Enjoy the weekend.
Keep your head up and stick on the ice,
Daryl G. Jones
Big Game Hunter
Initial indications are that April may have been another sluggish month for casual dining. For some people this might come as disappointing news. What happened to the Easter “shift” from March to April? Knowing some chains weakness at the end of March, this had shifted to strength in early April. This suggests that balance of April was weak.
Sluggish sales trends are not being borne out in the casual dining stock, which have outperformed the S&P 500 by 340bps over the past month and 1080bps year-to-date. Over the same time period, the average earnings estimate has increased 1.1% and 3.3%, respectively, implying a significant multiple expansion for the group.
Black Box Intelligence released its casual dining numbers for April this week. Same-restaurant sales gained 0.4% in April, versus 0.5% in March, which implied a sequential acceleration in two-year average trends of 70 bps. Sale-restaurant traffic declined -1.7% in April, versus -2% in March, which implied a sequential acceleration in two-year average trends of 80 bps. The “Willingness to Spend” Index, reported by Black Box, also registered a sequential acceleration in April.
Our favorite names in the group remain CAKE, EAT, and DRI.
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TODAY’S S&P 500 SET-UP – May 10, 2013
As we look at today's setup for the S&P 500, the range is 32 points or 1.02% downside to 1610 and 0.94% upside to 1642.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.64 from 1.59
- VIX closed at 13.13 1 day percent change of 3.71%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:25am: Fed’s Evans speaks at Chicago Fed conference
- 9:30am: Fed’s Bernanke speaks at Chicago Fed conference
- 11am: Fed to purchase $1.25b-$1.75b debt in 2036-2043 sector
- Noon: WASDE crop report
- 1pm: Baker Hughes rig count
- 2pm: Monthly Budget Stmt, April, est. $110b (prior $59.1b)
- 2pm: Fed’s George speaks on economy in Jackson, Wyo.
- 2pm: G-7 finance ministers, central bankers meet in U.K.
- House not in session
- 8:45am: ADP news conference with Moody’s Analytics Chief Economist Mark Zandi, to announce report on regional, state private sector employment trends
- 9am: U.S. Chamber of Commerce economic briefing
- 10am: Rep. Jim Moran, D-Va., briefing on current human rights situation at Guantanamo
WHAT TO WATCH
- Icahn, Southeastern challenge Silver Lake’s offer for Dell
- Dish said to secure Jefferies to help finance Sprint deal
- SoftBank CEO says Dish’s bid full of “wishful” numbers
- Yahoo’s Mayer said to explore bid for Hulu
- Zell sees overvalued cos., fewer opportunities in real estate
- Schaeuble signals support for easier European austerity at G-7
- ANA 787 ads aim to lure back flyers as services resume June 1
- American’s $3.25b in bankruptcy loans win court approval
- ResCap bankruptcy probe to clarify $25b threat to Ally
- ABB CEO announces sudden departure for “private reasons”
- Verizon in talks w/media cos. to subsidize mobile usage
- SEC money-fund rule said to make riskier funds float shr value
- Lenovo will debut first African smartphone in Nigeria this yr
- DuPont CEO weighs pigment swings in considering divestment
- Mirvac buys GE’s Australian office properties for A$584m
- U.S. Retail Sales, Pakistan Vote, Cisco: Wk Ahead May 11-18
- Lexicon Pharmaceuticals (LXRX) 6am, $(0.05)
- Enerplus (ERF CN) 6am, C$0.17
- TMX Group (X CN) 6am, C$0.78
- Sirona Dental Systems (SIRO) 6:30am, $0.72
- EV Energy Partner (EVEP) 6:39am, $0.18
- Onex (OCX CN) 7am, $0.11
- Beacon Roofing Supply (BECN) 8am, $0.01
- DiamondRock Hospitality (DRH) 8am, $0.09
- American States Water (AWR) 8am, $0.52
- Silver Wheaton (SLW CN) 5:33pm, $0.39
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Rubber Near Bull Market With Yen Breaching 100 as China Restocks
- Gold Traders Divided Amid Worst ETP Rout Since ’04: Commodities
- WTI Crude Drops a Second Day; Goldman Sees Brent Gap Narrowing
- Gold Extends Weekly Decline as Stronger Dollar Curbs Demand
- Copper Swings Between Gains and Drops Amid Stimulus Speculation
- Wheat Declines as Rainfall Improves Crop Conditions in Australia
- Cocoa Falls on Speculation Prices Climbed Too Far; Sugar Gains
- Vietnam Robusta Crop Seen at Two-Year High as Drought Ends
- Palm Oil Climbs to Four-Week High as Stockpiles in Malaysia Drop
- Crude May Fall Next Week as U.S. Stockpiles Climb, Survey Shows
- Zinc Premiums in Europe Said to Rise as Price Drop Spurs Demand
- Best Oil Bet Fades as Ecopetrol Guerrilla Peace Elusive: Energy
- OPEC Crude Production Rises to Five-Month High on Saudi Increase
- Brent Pressured by U.S. Tripling Crude to Canada: Energy Markets
The Hedgeye Macro Team
Takeaway: We bought FXB, an investment vehicle that the tracks the British Pound, late in the trading day.
We bought FXB today at 3:14pm at a price of $152.49.
The British Pound has been shaping up on the long side ever since it was announced that Governor of the Bank of England Swervin' Mervyn King was leaving. We are long the Bank of England Governor designate, Canada's own Mark Carney, who assumes his new role in July.
In Canadian Goalies we (sometimes) trust.
Peyto Exploration & Development (PEY.CN) remains our best long idea among North American E&Ps, as it has been since May 2012. We think it’s the best run E&P company, as well as the best risk-adjusted return opportunity, in the entire sector; the 1Q13 results released last night strengthen our conviction.
On the Quarter and Outlook
Peyto delivered another solid quarter with production increasing 11% sequentially to 332 MMcfe/d (89% natural gas). Cash costs came in at $1.01/Mcfe, which is, again, industry-best.
Current production is just over 61,000 boe/d and Peyto has another 5,000 boe/d “behind pipe” that will be brought on as soon as break-up is over (late May). Assuming some natural decline over the final month of break-up, Peyto should be producing ~64,000 boe/d when those volumes come on-line in June/July. Year-end 2013 guidance is 62,000 – 67,000 boe/d, but at this point we think 67,000 – 70,000 boe/d is more realistic given where production will be exiting break-up, and the Company’s plan to run 10 rigs all summer and possibly throughout the fall and winter (pending capital efficiencies). If Peyto does run 10 rigs for the rest of the year (as opposed to the original guidance of 9) we expect full-year capex to come in ~$550MM vs. the $450 – $500MM guide. With AECO gas around $4.00/Mcf and activity levels in western Canada muted, Peyto is in the sweet spot, and we like to see the Company putting as much capital to work as it can, without compromising efficiency.
The big news in the quarter was the 33% dividend increase from $0.72/share annualized to $0.96/share annualized. We have mixed feelings about the decision – no doubt it will be applauded by the large Canadian investor base which holds dividends near-and-dear to its heart (a sentiment that we do not personally share, but whatever, to each his own), but good stewards of capital (return focused) are rare in the E&P sector and with Peyto being one of the best, we’d like to see that incremental $36MM per year invested back into the asset base.
However, we do appreciate that Peyto is growing production 30-40% per year and this year’s capital budget and 10 rig program is the largest in the Company’s history… Oh yeah, and that it’s doing this with only 40 employees and an annual G&A budget of ~$12MM (including capitalized G&A).
Peyto will be generating free cash flow in 2014, and there’s no reason to pay down the 3.5% credit facility. If the Company believes it’s growing as fast as it sensibly can, we’re in no place to doubt it, so perhaps the dividend increase was the second best option (we like buybacks better). Regardless, the fact that this is even a debate is a good thing.
Too Expensive? Broken Record
We get a lot of push back on valuation on Peyto – almost everyone tells us that it’s “too expensive”. We heard it at $18/share and we hear it today at $29/share. Frankly, valuation is one of the last things we consider in this sector because E&P NAVs involve so many assumptions that they’re almost arbitrary, and cash flow multiples can be misleading, as stocks are a claim on decades of earnings, not one year (COG and FST are great examples of misleading multiples). In this sector, cheap often gets cheaper and expensive stays expensive. Peyto’s industry-low cost structure, commitment to profitable growth (returns), unique corporate culture of creating shareholder value, and decades of drilling inventory is why we’re so bullish on this name. If any of that changes, that’s when we’ll sing a different tune.
Stats that Matter
- Production: 332 MMcfe/d, +35% y/y (per share +26% y/y) and +11% q/q
- Production mix: 89% gas/11% liquids, flat q/q. New liquids volumes from the Oldman Deep Cut facility were offset by a higher percentage of Falher and Wilrich wells drilled, which are deeper/gassier zones than the Cardium.
- Operating expenses (incl. transportation): $0.43/Mcfe, down $0.02 y/y and +$0.01/Mcfe q/q
- G&A expense: $0.02/Mcfe, down $0.02 y/y and flat q/q.
- Interest expense: $0.21/Mcfe, down $0.02 y/y and down $0.11 q/q.
- Funds from operations (discretionary cash flow) were $103MM, or $0.69/share.
- Capital expenditures were $167MM.
- Net debt at end of Q: $750MM, +$88MM from 12/31/12
Daily Trading Ranges
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