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Dean Foods: Compelling Opportunity?

Takeaway: Here's our take on the value and potential opportunity around the stock of Dean Foods.

This note was originally published May 13, 2013 at 11:52 in Consumer Staples

With Dean Foods (DF) reporting last week, we wanted to take the opportunity to update our thoughts with respect to the value and opportunity surrounding the fluid milk business at DF (DF less WhiteWave (WWAV), or the DF stub).



We expect a good bit of volatility in both DF and WWAV as we move toward the May 23 distribution date (WWAV shares to be distributed to DF shareholders on a pro rata basis).  Holders of DF as of May 17 will receive a total of 115.6 million shares of WWAV, or approximately 0.62 shares of Class A and Class B WWAV shares for every DF share held.  DF will retain an approximately 19.9% ownership interest in WWAV subsequent to the distribution, with plans to monetize that portion at some point over the course of the next 18 months.



Admittedly, it’s tough to isolate the value at DF – buying DF and shorting WWAV is difficult because WWAV is such a tough borrow at this point.  Fully half the float is short, but note that it likely isn’t “squeezy” short as a significant portion of those shares won’t need to be covered in the market, but will be covered through the distribution.  Still, eliminating the value of WWAV over the near term is likely to be dodgy.



Also, DF is currently an S&P 500 component, but its continued inclusion post-distribution is an open issue given what will be a much lower share price and reduced market cap.  Forced selling by index funds and closet indexers is a consideration, adding to the complexity of trading the stub in the near term.  In terms of the lower share price, DF announced on its first quarter earnings call last week that it would seek approval for a reverse stock split with the appropriate split ratio to be determined.



So, lots of moving parts, but let’s keep our eye on the prize.  In Q1, the DF stub generated $116 million of EBITDA, putting it squarely on track to exceed our forecast of $415 million of EBITDA for 2013. DF currently has a market cap of $3.540 billion, which represents both the value of the fluid milk business and the ownership of 86.7% of WWAV.  Excluding the value of WWAV (86.7% times WWAV market capitalization of $3.108 billion) from the market cap of DF gets us to a stub equity value of approximately $845 million.  The stub has net debt of $1.034 billion and therefore an associated Enterprise Value (EV) of $1.898 billion covering over $400 million of EBITDA, or right around 4.5 times EV/EBITDA.  That’s just too cheap, in our view.  Admittedly, we have never liked the fluid milk business and are loathe to put an sort of significant multiple on it, but even a reasonable 7.5 times multiple makes this a compelling investment.

 

Dean Foods: Compelling Opportunity? - DF Stub



Part of the reason it’s cheap is precisely because it is so difficult to isolate the value.  However, we believe that investors should be prepared to move if any of the near-term volatility presents an opportunity (short-covering at WWAV, forced selling at DF because of index considerations).  Further, once we move past the distribution date, we think it makes sense for long-only small and mid-cap investors to become involved in what is a very compelling opportunity.


DF - Math Makes Even More Sense Post Q1

With Dean Foods (DF) reporting last week, we wanted to take the opportunity to update our thoughts with respect to the value and opportunity surrounding the fluid milk business at DF (DF less Whitewave, or the DF stub).



We expect a good bit of volatility in both DF and WWAV as we move toward the May 23rd distribution date (WWAV shares to be distributed to DF shareholders on a pro rata basis).  Holders of DF as of May 17th will receive a total of 115.6 million shares of WWAV, or approximately 0.62 shares of Class A and Class B WWAV shares for every DF share held.  DF will retain an approximately 19.9% ownership interest in WWAV subsequent to the distribution, with plans to monetize that portion at some point over the course of the next 18 months.



Admittedly, it’s tough to isolate the value at DF – buying DF and shorting WWAV is difficult because WWAV is such a tough borrow at this point.  Fully half the float is short, but note that it likely isn’t “squeezy” short as a significant portion of those shares won’t need to be covered in the market, but will be covered through the distribution.  Still, eliminating the value of WWAV over the near term is likely to be dodgy.



Also, DF is currently an S&P 500 component, but its continued inclusion post-distribution is an open issue given what will be a much lower share price and reduced market cap.  Forced selling by index funds and closet indexers is a consideration, adding to the complexity of trading the stub in the near term.  In terms of the lower share price, DF announced on its Q1 call last week that it would seek approval for a reverse stock split with the appropriate split ratio to be determined.



So, lots of moving parts, but let’s keep our eye on the prize.  In Q1, the DF stub generated $116 million of EBITDA, putting it squarely on track to exceed our forecast of $415 million of EBITDA for 2013. DF currently has a market cap of $3.540 billion, which represents both the value of the fluid milk business and the ownership of 86.7% of WWAV.  Excluding the value of WWAV (86.7% x WWAV market capitalization of $3.108 billion) from the market cap of DF gets us to a stub equity value of approximately $845 million.  The stub has net debt of $1.034 billion and therefore an associated EV of $1.898 billion covering over $400 million of EBITDA, or right around 4.5x EV/EBITDA.  That’s just too cheap, in our view.  Admittedly, we have never liked the fluid milk business and are loathe to put an sort of significant multiple on it, but even a reasonable 7.5x multiple makes this a compelling investment.

 

DF - Math Makes Even More Sense Post Q1 - DF Stub



Part of the reason it’s cheap is precisely because it is so difficult to isolate the value.  However, we believe that investors should be prepared to move if any of the near-term volatility presents an opportunity (short-covering at WWAV, forced selling at DF because of index considerations).  Further, once we move past the distribution date, we think it makes sense for long-only small and mid-cap investors to become involved in what is a very compelling opportunity.

 

Rob

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

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Matt Hedrick

Senior Analyst



RESTORATION HARDWARE: MORE CONFIDENCE

Takeaway: Restoration Hardware raised its first quarter revenue and earnings forecast on Friday. Here's our take on the company.

This note was originally published May 10, 2013 at 15:32 in Retail

It's pretty safe  to assume that the few analysts that actually like Restoration Hardware (RH) just saw the stock blow through their price targets. We, however, still think that this is at least a $60+ stock over two years. Our note from a few weeks ago was titled #CONFIDENCE (see below), and today's (Friday May 10) positive pre-announcement -- 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 three years.  If that’s right, we’re looking at over a 20% CAGR in EPS, which makes 20 times $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 one million 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 (Friday).

 

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 to 4.5 million shares enter 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.

 

 

(Our Note from April 18, 2013)

RH: # CONFIDENCE

Takeaway: Several near-term risks were mitigated this qtr. In addition, we're taking up our 'already high' long-term growth forecast. two years = $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.

  1. First, simple as it may be, the fact that RH finally ended what may be the longest quiet period in modern retail history is a positive. Other retailers are getting ready to report 1Q in 3-4 weeks, and RH is just getting out its 4Q numbers. It’s been a black hole of info, and it has not helped sentiment one bit. That’s over.
  2. IPO-related charges are out finally known, booked, and out of the way.  They made financial modeling a bear – and now that’s no longer an issue.  
  3. While we usually could care less about company guidance, the fact that RH issued quarterly and annual guidance is a massive positive for a levered and newly public company like this.

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 20 times $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.


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European Banking Monitor: Financial Swaps Mostly Wider

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .

 

For our most recent outlook on Europe titled "Where's Europe At?" please see: http://app.hedgeye.com/feed_items/28511  

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European Financial CDS - French, Spanish and Italian banks saw swaps mostly widen last week. Overall, swaps were wider, by a median of 6 bps.

 

European Banking Monitor: Financial Swaps Mostly Wider - y. banks

 

Sovereign CDS – Italy, Portugal and Japan all dropped 6-8 bps WoW. Elsewhere, swaps were flat to down 2 bps. The world remains a calm place for now.

 

European Banking Monitor: Financial Swaps Mostly Wider - y. sov 1

 

European Banking Monitor: Financial Swaps Mostly Wider - y. sov2

 

European Banking Monitor: Financial Swaps Mostly Wider - y. sov3

 

Euribor-OIS Spread – The Euribor-OIS spread was unchanged week-over-week at 13 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. 

 

European Banking Monitor: Financial Swaps Mostly Wider - y. euribor

 

ECB Liquidity Recourse to the Deposit Facility – Deposits declined week over week by 37.6 billion Euros. The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  

 

European Banking Monitor: Financial Swaps Mostly Wider - y. facility

 

 

Matthew Hedrick

Senior Analyst


MACAU NORMALIZES AFTER MAY HOLIDAY

As expected, average daily table revenues slowed from the May holidays but were up strongly over last year.  We’re still projecting 16-20% YoY GGR growth to HK$29.5-30.5 billion for the full month of May.  This past week’s ADTR of $798 million climbed 12% YoY, following up on May’s first week’s 24% YoY increase.  I was in Macau late last week and the operators were overwhelmingly bullish as were other market participants.

 

In terms of market share, MGM and Sands China made big jumps week over week, although LVS remains below trend albeit only slightly.  Thus far, MGM and Wynn are the big winners versus trend.

 

MACAU NORMALIZES AFTER MAY HOLIDAY - macau

 

MACAU NORMALIZES AFTER MAY HOLIDAY - macau2


MCDONALD'S NOT GOING TO HIT NUMBERS

Takeaway: If we're right on McDonald's numbers, the underperformance in the stock could become even worse for shareholders.

This note was originally published May 08, 2013 at 11:14 in Restaurants

The upside in McDonald’s stock is not being driven by the company’s fundamentals. The underperformance in the stock since we added it to our Best Ideas list on April 25, is likely to continue and, if we are right on the numbers, could become worse for shareholders.

 

The company has a lot of work to do to turn its operational performance around and we are not seeing any indication that this reversal will transpire any time soon. Management's recital of the (stale) tenets of the current Plan to Win, “optimize our menu, modernize the customer experience and broaden accessibility to brand McDonald's around the world”, as an answer to all ills, does not instill confidence that the current leadership is coming up with new ideas to counteract the company’s current operating headwinds. 

 

 

April SRS vs Consensus (Consensus Metrix)

  • US Beat: +0.7% versus consensus -0.1%
  • Europe Missed: -2.4% versus consensus -1.0%
  • APMEA Missed: -2.9% versus consensus -1.4%
  • Global Missed: -0.6% versus consensus -0.5%

United States: “Premium McWraps, compelling value options and the ongoing popularity of McDonald's breakfast contributed to the month's results.

 

Europe: “positive performance in the U.K. and Russia more than offset by Germany, France and other markets.”

 

APMEA: Results reflected “the impact of Avian influenza, primarily in China, and softer results in Japan and Australia.”

 

 

Without Sales Growth, Earnings Growth Will Be Difficult

 

In 1Q13, McDonald’s posted revenue growth of +0.9% on systemwide sales growth of 0%. One month into the second quarter, MCD systemwide sales have decreased -0.4%.  The Street is expecting 3% revenue growth in the second quarter.

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd sales eps leverage1

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd 13 eeg

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd systemwide sales

 

 

May and June will be crucial months for McDonald’s.  A sequential acceleration in two-year average trends of 105 bps is needed to meet May consensus comparable sales growth in the U.S. So far this year, the two-year trend in U.S. comps has decelerated every month by an average of 83 basis points.

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd global comps

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd us comps

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd eu comps

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd apmea comps

 

 

Long-Term Trend Remains Discouraging

 

MCDONALD'S NOT GOING TO HIT NUMBERS - mcd srs global ttm

 

 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.65%
  • SHORT SIGNALS 78.62%
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