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DF - Sayonara to the S&P 500

Yesterday evening, Standard & Poor’s announced that Kansas City Southern will be replacing Dean Foods in the S&P 500 while DF will take KSU’s places in the S&P Midcap 400.  This little bit of index musical chairs will take place after the close on May 23rd, coincidental with DF’s distribution of WWAV shares to DF holders.



We wrote about this earlier in the week, and while we expect that index funds have likely gotten ahead of this change, we still may see some selling pressure.  Any weakness in DF (or DF when issued, for those folks that can buy it) represents an opportunity, in our view.

 

We are also going to take this opportunity to provide some more granularity with respect to the current values of the various moving parts of this situation.  We continue to see material upside to the EV/EBITDA multiple covering the fluid milk business at DF.

 

DF - Sayonara to the S&P 500 - DF math

 

Call with questions,

 

Rob

 


Department Stores: JCPenney Winning?

Takeaway: After the noise around earnings relative to expectations, JCPenney looks good compared to its peers, at least on one metric.

This note was originally published May 17, 2013 at 11:03 in Retail

 

 

Performance in the department store group (JCPenney, Kohl's, Macy's, Nordstrom) this quarter diverged as meaningfully as we've seen in recent memory. We don't think its appropriate to simply look at where the companies came in relative to the Street, i.e., guidance. The best thing for us to do is triangulate the sales/inventory/margin performance for each of the four major department stores, and see how they have changed over the past four quarters relative to one another.

 

Bigger picture, each department store has a point where inventories are intersecting with margins.  None of those points are within a stones throw of one another. Not even close. The trends are becoming more divergent as to the other way around.

 

  • Kohl's (KSS): Widely viewed to be a positive print, margins headed back to zero-barrier (even with last year) but inventories slid the most out of the group -- so mush that we had to readjust the vertical axis on the chart.

 

  • Nordstrom (JWN): Conversely, viewed as the biggest disappointment of the group. Yes, margins eroded sequentially, but JWN also showed proportionally the best improvement in inventories out of the group. In another two quarters, compares get much easier for JWN, and it's on a trend of improving inventories.

 

  • Macy's (M): The steady performer in the group, but proportionally showed the worst inventory move aside from KSS. This is more of a concern for M given that it has been in the upper right hand quadrant for five-quarters and margins remain positive. In other words, it has more to lose.

 

  • JCPenney (JCP): Lastly, JCP is in its own little cycle. Earnings-per-share were a disaster this quarter, and both inventory and margins are triangulating with sales in the dangerous lower left quadrant of this analysis (inventories up, margins down). But it is the only company that sequentially posted a moved headed up and to the right. When evaluating stock price movements, it does not matter as much which quadrant a company is in, but rather which one it is pointed toward.  Ironically enough, out of all four, JCP comes out ahead in the 'incremental rate of change' contest.

 

Department Stores: JCPenney Winning? - department store sigma


JCP/KSS/M/JWN: JCP Winning?

Takeaway: After the noise around EPS relative to expectations, we see that of all four, JCP comes out ahead in the 'rate of change' contest.

 

 

 

Performance in the department store group this quarter diverged as meaningfully as we've seen in recent memory. We don't think its appropriate to simply look at where the companies came in relative to the Street (ie guidance). The best thing for us to do is triangulate the sales/inventory/margin performance for each of the four major department stores, and see how they have changed over the past four quarters relative to one another.

 

Bigger picture, each department store has a point where inventories are intersecting with margins.  None of those points are within a stones throw of one another. Not even close. The trends are becoming more divergent as to the other way around.

 

  • KSS: Widely viewed to be a positive print, margins headed back to zero-barrier (even with last year) but inventories slid the most out of the group -- so mush that we had to readjust the vertical axis on the chart.

 

  • JWN: Conversely, viewed as the biggest disappointment of the group. Yes, margins eroded sequentially, but JWN also showed proportionally the best improvement in inventories out of the group. In another two quarters, compares get much easier for JWN, and it's on a trend of improving inventories.

 

  • M: The steady performer in the group, but proportionally showed the worst inventory move aside from KSS. This is more of a concern for M given that it has been in the upper right hand quadrant for five-quarters and margins remain positive. In other words, it has more to lose.

 

  • JCP: Lastly, JCP is in its own little cycle. EPS was a disaster this quarter, and both inventory and margins are triangulating with sales in the dangerous lower left quadrant of this analysis (inventories up, margins down). But it is the only company that sequentially posted a moved headed up and to the right. When evaluating stock price movements, it does not matter as much which quadrant a company is in, but rather which one it is pointed toward.  Ironically enough, out of all four, JCP comes out ahead in the 'incremental rate of change' contest.

 

JCP/KSS/M/JWN: JCP Winning? - department store sigma


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HOUSING: DATA SOFTENS, BUT NOT REALLY

Takeaway: Housing starts appear to have weakened sharply, but here's our take on what the data is really telling us.

This note was originally published May 16, 2013 at 14:57 in Financials

Do Starts Matter More than Permits?

Yesterday (Wednesday), after the close, we published a note on why we think it's increasingly likely that housing starts will work their way back to a 2.0 million run rate in the coming years. The timing of that note could have been better, in light of this morning's (Wednesday morning's) 16.5% month-over-month decline in April housing starts. Our view on getting to 2 million, however, is unchanged, and we'd encourage you to take a look at our note when you have a chance. Here's our take on today's data.

 

The first point is that the weakness in the starts data this morning was on the multi-family side, where starts dropped 155k MoM. Single family starts fell by 13k to 623k. The second point is that while starts were weak, permits were strong. The second chart shows permits. Single family permits rose 18k MoM while multi-family permits rose 109k. The strength in permits largely offsets the weakness in starts, and the single-family starts/permits dynamic is much less of an "event" than the multi-family data. In looking at the trend lines in the permits chart, we see little cause for concern.

 

For those curious which is the better indicator, starts or permits, we've looked into this question in the past. It turns out the answer is neither. Our analysis found no discernible lead/lag relationship between starts and permits. We realize it's intuitive that permits lead starts, but in practice they don't. We've run correlations between the series at varying lead/lag intervals and found that the strongest relationship occurs on a no-lag basis. 

 

One interesting consideration, however, is that the Census dept points out that you need only 2 months of permits data to draw conclusions, whereas 4 months of starts data is needed. On that basis, we'd be slightly more inclined to believe the permits numbers.

 

Here's the full disclosure they provide: In interpreting changes in the statistics in this release, note that month-to-month changes in seasonally adjusted statistics often show movements which may be irregular.
It may take 2 months to establish an underlying trend for building permit authorizations, 4 months for total starts, and 6 months for total completions.

 

HOUSING: DATA SOFTENS, BUT NOT REALLY - 1

 

HOUSING: DATA SOFTENS, BUT NOT REALLY - 2

 

HOUSING: DATA SOFTENS, BUT NOT REALLY - 3

 

HOUSING: DATA SOFTENS, BUT NOT REALLY - 4

 

HOUSING: DATA SOFTENS, BUT NOT REALLY - 5

 


China Calling, Dollar Matters

Client Talking Points

China Calling

Don’t look now, but the China stock market closed up 1.4% overnight, its third consecutive winning day. The market there is now up, albeit barely, for the year-to-date. That’s telling us that while things might not be great there, the world isn’t ending, either.

Dollar Days

With the US dollar falling yesterday after powering to year-to-date highs earlier in the week, the S&P lost a bit of ground yesterday. As has been our call, a strong dollar leads to a strong US equity market. We’re seeing that this morning as the dollar is back up, and futures are heading higher.

Asset Allocation

CASH 42% US EQUITIES 18%
INTL EQUITIES 15% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 25%

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.  

WWW

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. 

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.

Three for the Road

TWEET OF THE DAY

“It’s all about the storytelling, folks.” -- @KeithMcCullough

 

QUOTE OF THE DAY

“Well begun is half done.” -- Aristotle

STAT OF THE DAY

$92.24, the price of each share of Tesla’s 3.39 million share secondary offering


Renaissance Man

This note was originally published at 8am on May 03, 2013 for Hedgeye subscribers.

“Self-control is more indispensible than gunpowder.”

-Henry Morton Stanley   

                                                

Henry Morton Stanley was one the most well known African explorers of the late 19th century.  He is probably most famous for finding the lost Scottish missionary David Livingstone in the small village of Ujiji after an eight month search.  Stanley reported that the first words he uttered when finding Livingstone were the now famous, “Dr. Livingstone, I presume?”

 

To say Stanley was a remarkable man would be an understatement.  He was orphaned at an early age and spent his formative years in a work house in Wales.  At the age of 15, he crossed the Atlantic as a crewman of a merchant ship and jumped off in New Orleans where he befriended a local merchant and took his name.  He then fought in the Civil War before launching a career in journalism.  Clearly, Stanley was a bit of a 19th century “Renaissance Man”.

 

His expeditions into Africa, which among other things established the sources of the Nile and Congo, were widely considered the most grueling of that era.  Unlike many of his contemporaries, observers marveled that Stanley never lost his discipline or civility on these long perilous expeditions in the dark heart of Africa.  Biographers discovered an interesting fact about Stanley – he spent most of life, as he called it, “experimenting with will.”

 

As Roy Baumeister writes in “Rediscovering the Greatest Human Strength – Willpower”:

 

“Having piously lectured his men about the perils of drunkenness and the need to shun sexual temptations in Arica, he knew how conscious his own lapses would be.  By creating the public persona of himself as Bula Matari, the unyielding Breaker of Rocks, he forced himself to live up to it. As a result of his oaths and image, Jeal said, “Stanley made it impossible in advance to fail through weakness of will.”

 

This concept of pre-commitment as a way of maintaining discipline and hitting goals has been proven in spades by Yale economists Ian Ayres through a company he started called stickK.com.  Ayres’ company allows individuals to create commitment contracts.  The company has found that when a contract is drawn up without a penalty, the person succeeds about 35% of the time.  Conversely, when the contract includes a referee (so is public) and a monetary penalty (so accountable) the individual succeeds 80% of the time.

 

So for you young hedge fund analysts that spend too much time partying in the wilds of Manhattan on the weekends, a quick stop at stickK.com may not be the worst idea to re-establish some discipline. 

 

Back to the global macro grind . . .

 

This market year has certainly been one that has required the willpower of sticking with what works.  There have been many times that all of us could have been shaken out of the investment themes that have been effective this year, but growth stabilizing and strong dollar continue to play out in spades.  Nowhere is this seen more clearly than within U.S. sector performance.  On the positive have been healthcare and consumer staples which have outperformed the SP500 by about 50%.  On the negative, materials is up less than half of the SP500.  Unless the macro trends change meaningfully, the right discipline will be to continue to stick with what has been working.

 

My colleague, and Hedgeye’s U.S. focused economic guru Christian Drake, gave an update on this key theme of growth stabilizing yesterday when he looked at the trifecta of housing, labor and consumer confidence.  Specifically, he highlighted:

  • Employment - The positive acceleration in labor market trends continued this week with both the seasonally adjusted and non-seasonally adjusted Initial Jobless Claims series showing sharp sequential improvement.   The headline number fell 15K to 324K w/w versus the prior week’s unrevised number while the 4-week rolling average in SA claims fell -16.5K w/w to 342K.
  • Confidence - The Bloomberg Consumer Confidence Index (Chart of the Day) made a new 5Y high two weeks ago with confidence measures across age and income demographics showing broad improvement.  The index held those gains last week and made a new 5Y with this morning’s reading improving to -28.9 from -29.9 w/w.  The Conference Board Consumer Confidence as well as the University of Michigan Consumer Sentiment readings were confirmatory with the latest April readings accelerating sequentially to 68.1 and 76.4, respectively. 
  • Housing - Incremental data over the past week has reflected more of the same as Mortgage Purchase Applications remained at their YTD highs while the Pending Home Sales and Case-Shiller HPI data both accelerated sequentially.  The Purchase application data and Pending Home sales numbers both suggest forward housing demand should remain strong.  Additionally, President Obama’s likely nomination of Congressman Mel Watt to replace Ed DeMarco as head of the FHFA should be taken as a positive catalyst for housing.  DeMarco has opposed underwater principal forgiveness for GSE borrowers – a stance that may be lightened should Watt be confirmed.  

Now to be clear, not all economic data has been positive and certainly much of the European data has been depressing.  The primary push back we got with this update yesterday is that regional PMIs have been decelerating and sequestration remains a major headwind. 

 

While these points are valid, we continue to believe that the performance of consumer related economic indicators trump other weakness in an economy that is 70% consumption.  Last week’s GDP report validated our view as Consumption was up +3.2% year-over-year versus +2.8% and contributed +2.24% of the growth (or 90% of the incremental growth).

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, UST10yr Yield, VIX, and the SP500 are now $1394-1489, $98.13-103.85, $81.46-83.29, $1.29-1.32, 97.11-100.63, 1.63-1.71%, 12.06-14.51, and 1585-1610, respectively.

 

Enjoy your weekends and stay disciplined!

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Renaissance Man

 

Renaissance Man - Chart of the Day

 

Renaissance Man - Virtual Portfolio


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