The Economic Data calendar for the week of the 13th of May through the 17th is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.
Takeaway: Keith booked a nice profit in this financial stock, selling it, in part, because TCB’s CEO had done the same.
Keith sold TCF Financial (TCB) at 12:53pm today at $14.55 a share, booking a whopping 26.3% gain after holding the stock for six months.
Keith writes, “After a great run in the stock, I'll say goodbye to TCB today - primarily because their CEO (partly) did. (CEO William) Cooper selling 12.5% of his stake up here implies he probably isn't selling the company anytime soon. That takeout premium is why we held it. Fundamentals are good here, but the stock's valuation and six month return reflects most of that.”
Takeaway: Our bull case remains the non-consensus one.
This note was originally published May 10, 2013 at 12:09 in Macro
POSITION: 12 LONGS, 7 SHORTS @Hedgeye
The latest bear market correction lasted for 6 hours of trading. While we’re finally seeing an end to everyone and their brother trying to call the top, we aren’t getting any explicit sell signals other than very immediate-term TRADE overboughts.
The fundamental bull case (#StrongDollar, Commodity Tax Cut, Employment/Housing #GrowthAccelerating) is now strengthening as the market rises. And now Treasuries and Oil are starting to look like Gold did, before the epic fall.
Across our core risk management durations, here are the lines that matter to me most:
In other words, I keep getting signals for higher-lows of immediate-term support as the market continues to signal higher all-time highs of resistance.
Our bull case remains the non-consensus one.
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Takeaway: Today's preannouncement is in line with why we like RH so much. While we wouldn't chase it now we still think this is at least a $60 stock.
It's pretty safe to assume that the few analysts that actually like RH just saw the stock blow through their price targets. We, however, still think that this is at least a $60+ stock over 2-years. Our note from a few weeks ago was titled #CONFIDENCE (see below), and today's positive preannouncement -- and 41% comp (WHAT?!?) certainly support our view. In short...
"This remains one of our favorite longs. Its so rare to find a defendable high-end brand with such an obvious, yet fixable, distribution problem. Having stores that are only large enough to showcase 20-25% of the company’s product is like having a fleet of Ferraris and only a two-car garage. This is the one instance in retail where bigger stores is not only a positive, but it is a necessity. As these stores grow, the company can scale into new categories (kitchen, kids, art, flooring, art, collectibles, textiles, etc…), and subdivide existing ones to drive productivity.
We think that the earnings guidance of $1.29-$1.37 for the year will prove conservative by at least 10%, and ultimately this is a company with $3 in earnings power over 3-years. If that’s right, we’re looking at over a 20% CAGR in EPS, which makes 20x $3 in the realm of possibility. Granted, that is by the end of 2014, so there’s some time to go. But until people start to realize this potential, we’re not concerned about the stock being expensive."
The biggest obstacle at this point is timing. With over 1mm shares short at the same time we're seeing decreased opacity in the model, an equity offering that cures one of the biggest points of pushback we've gotten on the name (sparse liquidity), and such a material step-up in business levels (comps going from +26% in 4Q to +41% in 1Q) -- it's no shocker that the stock is behaving like it is today.
That said, we would not chase it right here, right now. We'd treat this one like a fine wine -- simply let it breathe for a little while. At a minimum, we'd wait to see how it reacts when another 4-4.5mm shares enters the float with the company's secondary. If the stock trades down, then we'd look to get involved. If it holds current levels, then we'd buy it anyway.
RH: # CONFIDENCE
Takeaway: Several near-term risks were mitigated this qtr. In addition, we're taking up our 'already high' long-term growth forecast. 2 yrs = $60.
RH’s $0.02 ps beat far understates the significance of the company’s earnings report. After running the numbers and listening to the call, we walked away with the following thoughts:
1) Confirmation that this management team is executing on one of the most intriguing business opportunities in retail. Comping 26% on top of a 22% in the same quarter last year, and that’s before the launch of new businesses like Tableware and Objects of Curiosity.
2) Not only is the Design Gallery pipeline robust, but management seemed to have a (borderline odd) epiphany that it could open significantly larger stores with far more favorable rent structures than previously anticipated. Given that increased furniture sales will put a natural damper on margins over time, lower occupancy hurdles are a nice offset.
3) We made a rather significant change to our model, in that we took the average size of a Design Gallery up from 25,000 square feet to nearly 35,000 over the next three years. The Boston store, for example, is nearly 50,000 square feet. With a weighted average of 35k sq feet and our estimate of 15 Galleries by the end of 2015, it gets us to weighted average square footage growth of 15% by that time period. The interesting element here is that bears (and even common logic) will say that current comp trends will roll, and over 2-3 years we’ll be looking at a stabilization in sales/square foot trends. With that being the case, the acceleration in square footage still drives 15-20% top line growth through this model. We think that’s the biggest part of this story that people are missing.
4) Find us a company that is taking UP expectations for both revenue and earnings for the upcoming quarter and year. It would have been easy enough for them to give initial guidance right in line with existing estimates. #confidence.
5) De-risking Sentiment. Like it or not, sentiment is a major factor with this stock. We’ve been positive on the name since the IPO, and when we bring it up with investors it’s pretty clear to us that it’s not too far from JCP as it relates to being hated. The two most common reasons. 1) There’s not enough float. 2) The company is probably going to do a secondary (that probably explains why 1.4mm shares of the 4.2mm float is short). That’s ironic when you think about it. Half the people don’t like the lack of float, and the other half don’t like the one event that could fix the ‘small float’ problem.
Regardless, there are three things that happened this quarter that we think de-risk sentiment and improves ownership characteristics for RH.
The reality is that so many people have had zero appetite for the name given such little float, funky accounting, no guidance, and such a huge delay in the earnings report. The 4Q print ameliorated many of these concerns.
In the end, this remains one of our favorite longs. Its so rare to find a defendable high-end brand with such an obvious, yet fixable, distribution problem. Having stores that are only large enough to showcase 20-25% of the company’s product is like having a fleet of Ferraris and only a two-car garage. This is the one instance in retail where bigger stores is not only a positive, but it is a necessity. As these stores grow, the company can scale into new categories (kitchen, kids, art, flooring, art, collectibles, textiles, etc…), and subdivide existing ones to drive productivity.
We think that the earnings guidance of $1.29-$1.37 for the year will prove conservative by at least 10%, and ultimately this is a company with $3 in earnings power over 3-years. If that’s right, we’re looking at over a 20% CAGR in EPS, which makes 20x $3 in the realm of possibility. Granted, that is by the end of 2014, so there’s some time to go. But until people start to realize this potential, we’re not concerned about the stock being expensive.
DOMESTIC CREDIT: THE VERY TOP DOWN VIEW…Simple Can Dictate the Trend
From a Long-cycle and very Top Down perspective the underlying drivers of credit are fairly straightforward. As Ray Dalio and Bridgewater have highlighted, and would we agree, fundamentally, a lender needs to believe 1.) they have a reasonable chance of being paid back an amount greater than the rate of inflation and 2.) that they will be paid back with dollars of similar purchasing power. Given where we are in the cycle, this simplified approach can help explain much of the directional trend in household credit.
Into and out of the financial crises, credit tightened as lender’s were justifiably worried that debtor’s wouldn’t be able to repay obligations or generate required returns on capital and, with the fed in full easing mode, it was also exceedingly uncertain that the purchasing power of the dollar would hold. With the domestic macro data showing sustained, albeit modest, improvement and the Fed turning more hawkish on the margin, both credit and currency devaluation risk continue to reverse.
Incomes are rising as employment continues its slow grind higher, household debt and debt service ratio’s continue to decline while household net worth has returned to nominal, pre-crises highs alongside higher savings and real estate and financial asset re-flation.
In short, the drivers of incremental household capacity for credit – rising incomes and asset (collateral) values – drive demand with lending standards and bank credit policy reacting pro-cyclically. Capacity for household credit expansion has improved, loan demand has begun to percolate, and credit standard easing remains ongoing.
In the immediate/intermediate term, the flow of credit should remain supportive of consumption and positive growth in nominal debt could occur alongside a further decline in household debt ratio’s.
2Q13 Senior Loan Officer Survey: Demand Steady, Credit Standards Ease Further
The Fed released its 2Q13 Senior Loan Officer Survey earlier this week. On balance, the release was positive as lending standards continued to ease alongside pockets of relative strength for loan demand. The Highlights:
Stronger: Net percentage of banks tightening credits standards for Commercial Real estate (CRE) loans in 2Q13 declined -20.9%, the lowest level since the crises, while CRE loan demand remained strong with 40.3% of banks reporting stronger sequential demand. On the Residential Real Estate side, net easing of standards on prime mortgage loans continued with 7.8% of banks reporting lower standards. Home loan demand from prime borrowed rose significantly with (net) 39.1% of banks reporting increased demand.
Weaker: C&I loan demand remained positive but cooled sequentially with banks reporting a net 5.9% increase in demand vs 19.1% in 1Q13.
CREDIT FLOW: The idea of the Credit Impulse, popularized by Biggs, Meyer & Pick (2010), centers on the idea that it’s the flow, not the stock, of credit that matters relative to economic growth. The implication is that if the change in net new credit is positive, credit can still support demand even if the nominal stock of total debt is still declining. Put differently, a deceleration in the rate of decline of debt equates to a positive change in net new credit that can give economic activity a boost. By and large, the empirical appears to bear out the theory.
The first chart below illustrates the Credit Impulse (Household and Non-Financial Corporate Debt, Flow of Funds data) vs. the Y/Y change in consumer and business demand (represented by the y/y change for the Consumption and Investment components of GDP) along with the Y/Y change in total household and Non-financial corporate debt. As can be seen, the trend in private sector demand growth tracks the credit impulse closely and leads the positive inflection in y/y debt growth.
The second chart shows the Credit impulse vs. the ‘Banks Willingness to Lend’ measure from the Senior Loan Officer Survey (above). Again, the Trend relationship is strong and with Willingness to Lend accelerating in 2Q13 the read through for credit catalyzed private consumption remains favorable.
Household Debt to GDP: Household Debt/GDP remains in decline as nominal debt continues to fall y/y alongside ongoing, modest GDP growth. We’re currently 16.7% off peak 2009 Debt/GDP levels and while there is still meaningful downside to the long-term average, we’ve nearly retraced back to (1) trend.
Household Debt vs. Consumption: Beginning in ~2000, growth in Household debt decoupled from household consumption as debt growth went exponential. As growth in household debt accelerated, debt became increasingly ineffectual in driving incremental consumption. That is, marginal consumption declined as a dollar increase in debt drove increasingly less than a dollar increase in consumption.
This dynamic is a typical antecedent of financial crises whereby incremental debt is used to speculatively acquire already overpriced (financial) assets instead of going towards entreprenurial or productive output/investment.
Household Debt Burden: Debt Service Ratio’s continue to trend lower due to a combination of organic delevering, low interest rates, and nominal earnings growth. Both the Household Debt Service and Financial Obligation ratio’s made new 30Y lows in 4Q12.
Debt Growth vs. Income Growth: In the long-term debt cycle, debt growth can exceed income growth until debt to income levels reach a critical upper bound at which point cash flows to service debt (income) become inadequate to meet debt service obligations and monetary policy is impotent to help as interest rates cannot be lowered further in support of easing household debt burdens.
In the wake of the financial crisis and through to the present, income growth has run at a positive spread to debt growth. Debt growth has already inflected and given positive mortgage, auto, and consumer loan trends YTD is likely to turn positive in 2013. The closing of the delta between income and debt growth represent the upside to credit driven consumption.
HEADWINDS: Corporate Profits, Real Wage Growth & Personal Savings…and a Valuation Reminder
Peak corporate earnings as a % of GDP, trend deceleration in Real Wages and a trough in Labor’s Share of national income obviously aren’t supportive of aggregate demand acceleration and credit expansion longer-term.
Despite Household deleveraging and a lower debt burden, negative-to-flat real wage growth and tax law changes have continued to drive the trend in personal savings lower. Higher payroll taxes in 1Q13 had a discrete impact on personal savings as individuals reduced savings to maintain consumption in the face of higher taxes.
A quick valuation reminder as it relates to peak returns to capital - while the SPX isn’t particularly expensive on a historical basis, its important to contextualize that “cheapness “ within the construct of peak margins and mean reversion risk to peak corporate profits.
Christian B. Drake
Below we hit on a number of topics and developments across Europe.
Call: Largely our bullish outlook on the capital markets across much of the region has not changed, anchored behind the ECB’s willingness to leverage its balance sheet at all costs to save the Union; the European Commission’s willingness to extend fiscal consolidation targets and abandon or lessen austerity programs; and Germany’s willingness to continue to write bailout checks versus the very adverse option of a strong D-Mark.
Further, we’re seeing a decrease in the broader risk profile as Italy has named a new PM and works through a new budget; Slovenia is willing and able to take care of its own bailout needs; and Portugal has set forth a fiscal consolidation program and issued its own sovereign debt this week. Finally, peripheral sovereign auctions continue to price debt lower and data has looked mostly better in APR compared to MAR.
That said, the disconnect with muted to weak fundamentals remains anchored. The credit system across the region, in particular to small-and-medium-sized enterprises (SMEs), remains clogged; unemployment remains staggeringly high; and the Union of uneven countries under one monetary policy and currency remains flawed in its present set-up. This is in line with our call for a very protracted period of low to negative growth throughout Europe.
GBP/USD: On Thursday we added a real-time long position in the GBP/USD via the etf FXB given the BOE opted to leave rates and the QE program unchanged on Thursday. We also see the replacement of Mervyn King in July by the slightly more hawkish Canadian Mark Carney as a bullish catalyst.
ECB Playing Large
Following the 25bps rate cut last week from the ECB below are two statements that stood out this week. While the statements are bullish in terms of the Bank signaling it is ready to act, we expect Draghi to wait and watch the data over the upcoming months to assess the impact of the actions he’s already taken. One thing the bank has little control over is the rate at which it can help unclog the credit channel, especially to small-and-medium-sized enterprises (SMEs).
Austerity is Mostly Dead
One on-going theme remains the backlash against austerity. Below are some statements from this week:
In the charts below we show a snapshot of 2012 debt and deficit levels (as a % of GDP) across the region. What governments need to do is have a balanced approach to austerity and structural reforms. The problem is that structural reform is a broad term that means different things for different countries and given the current fiscal set-ups (and recent consolidation measures), it may be easier or harder to implement based on the country. Most governments are on very uneven terms with their constituencies (given the bite of austerity, or in the case of the Germany the open checkbook), so policy makers are advancing without great leverage. In June EU leaders will sign binding “contracts” on structural reform, yet we have our doubts and foresee little being accomplished.
On the argument for the need of unit labor costs to come down in the periphery, part of the problem is that inflation is typically higher, so it’s simply another competitive tax vis-à-vis Germany. While the idea of higher unit labor costs in Germany has been floated, what really needs to happen is to allow unit labor costs to inflate or at least remain flat (so the people don’t revolt) and to stoke inflation to minimize the debt repayment that much of the periphery owes. This naturally goes against the inflation mandate of the ECB, so here too we expect continued gridlock, with Germany benefitting over much of the region’s loss.
We think German Chancellor Merkel will continue to play her cards, toting the line of not giving up on other country’s need to implement austerity but at the same time not supporting austerity that fully chokes off growth. She’ll be cautious in her tone as she crafts her re-election face domestically and internationally ahead of elections this September.
This was a big week for Portugal. Into the end of last week Portuguese PM Pedro Passos Coelho outlined further austerity measures that involve €4.8B in spending cuts over the next three years. The plan includes:
While its passage may face opposition, we believe it’s the right directional step. Further, Portugal returned to the bond market on Tuesday, selling €3B of 10YR notes at 5.67%. Demand for the new paper was strong at more than €10B of orders. Portuguese Treasury Secretary Maria Luís Albuquerque said that foreign investors took down 86% of the issue. She added that traditional investors were the biggest buyers, while hedge funds purchased just 7%. Separately Portuguese Finance Minister Vítor Gaspar said that the country had already met its financing needs for this year and was “pre-financing” 2014.
Of note on the successful bond auction is that the 10YR maturity is symbolic because it is viewed as a key criterion for "market access" that the ECB has determined as condition for OMT eligibility.
While Final APR PMI figures looked better than initial readings, you’ll note the PMIs across Services and Manufacturing remain well below the 50 line dividing expansion (above) and contraction (below). The fundamental data continues to contrast with the strong performance from most European capital markets.
Slovenia Helps Itself
Slovenia on Thursday outlined a plan to help avoid an international bailout. The key elements of the plan included an increase in the VAT to 22% from 20% and the sale of about 15 state-owned companies. The funds will be used to recapitalize the banking sector, where the three state-owned banks together have about €7B in bad loans, equivalent to about 20% of the country's annual economic output.
The decision by the government confirms our thinking that Slovenia would not possess the spotlight Cyprus did given the limited leverage to the banking system in comparison. The EU has said that it will study the plans and issue its own recommendations later this month.
Enjoy your weekend!
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