Hello darkness my old friend, it's good to talk to you again... Yup. That’s right. Hedgeye Jedi Kevin Kaiser reiterates the bear case on LinnCo. And all its insecurities. Timber.
Takeaway: At 5x EBITDA with an under leveraged balance sheet, we think DF has a conservative 20 – 30% upside from here.
Our Consumer Staples team has been touting Dean Foods (DF) for the past couple of months and although the stock has moved, we believe there remains significant value and upside in the name. Before getting into an updated valuation analysis, we wanted to tell you why we like this business (especially at 5x firm value / 2013E EBITDA).
We think DF is a compelling business for the following reasons:
That all said, DF is still a commodity company, even if a branded one, so we do need to consider that fact when evaluating the business along with the highlights above. In our view, the current valuation provides substantial downside protection and fully accounts for the commodity nature of the business.
In the table below, we provide an upside / downside analysis based on 2013E EBITDA and multiples of enterprise value / EBITDA. Currently, we think the stock is at a price in which the risk / reward is compelling. On the downside, absent a dramatic change in the milk market or poor management execution (unlikely), we think the reasonable downside is 4.5x EBITDA, or ~16% from current levels.
In terms of the upside, as noted we do acknowledge that this is a commodity company with only modest top line growth rates, but we do believe given the compelling business characteristics and high free cash flow yield reasonably justify a multiple in the 6.5X – 7.0x EBITDA range, which implies 32% - 44% upside from current levels. From our perspective, a situation in which there is 2:1 upside / downside with fundamentals trending our way is a compelling investment.
The argument for the upper end of the multiple range of course is based on the generous free cash flow nature of this business. While 2013 is a bit of an odd year given the corporate activity (notably the spin-off of WWAV), we believe that on a normalized basis DF will generate in the range of $140 - 150 million of free cash flow to the equity annually. This implies a rough 8% free cash flow yield. In combination, a 8% free cash flow yield and a debt-to-EBITDA ratio of just over 2x makes this a compelling LBO candidate. (Moreover, the debt-to-EBITDA is closer to 1x if we net out the WWAV stake.)
In addition, DF’s publicly traded debt seems to validate our view of the stability of the cash flow, and potential to add more debt to the balance sheet in a LBO type scenario, as all three tranches are trading well above par and tight versus Treasuries. In fact, 5-year DF paper is trading at only 210 basis points above comparable Treasuries.
The key pushback from many is that DF is a “value trap”, or a business in decline, so it is a cheap stock that can get cheaper. Indeed, there have been a number of publicized articles recently that highlight that per capita milk consumption has been in decline since 1970. Even if this is accurate, total volumes have shown a steady increase in recent years, which is more relevant for a market share leader like DF. In fact, in the chart below we show that total volumes have increased by 20% over the last nine years. Not stellar, but definitely the kind of growth and cash flow that gets a private equity firm licking the milk off their moustache!
Daryl G. Jones
Director of Research
Takeaway: A quick highlight reel of today's top tweets to @KeithMcCullough.
TV embarrassment to the max. You are the only one on my feed or tv this week that didn't say get long $GLD but short it.
Do you plan on wearing jorts to bed tonight? Does Mrs. Mucker approve of the look?
@PetersenRChris 3:54 PM
I don't always agree with your calls. But you've been on fire. Well done.
thanks for the GLD short. Used options made 30% this week. Have good weekend.
You and your Hedgeye crew are leading a very positive paradigm shift in accountability in the investing community. Kudos!
it takes stones to make the calls u make in the face of all this hate and you keep crushing it! Cheers
Hedgeye is kicking A$$ and taking gnomes..oops I mean names..sorry freudian slip
@ExtraDividends 9:46 AM
Am thinking @KeithMcCullough is the hottest lighting rod in Twitterdom. It’s a love/hate scenario of epic proportions.
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McDonalds is set to release its May sales results before the market open on Monday. We expect sales to disappoint versus consensus expectations as the difficult competitive environment in the U.S., as well as economic malaise in Europe, continues to impact results.
We’ve been the lone bears on Wall Street when it comes to MCD since turning negative on the name on 4/25. For May, much of the downside in global same-restaurant sales growth expectations comes from Europe. See our recent work on this here. For 2013, we still believe MCD is not going to hit the numbers that Wall Street is expecting.
Below, we provide charts with our estimates for each region of the world versus consensus expectations. We will follow up Monday’s release with our thoughts on the data and our updated view of the stock. The long-term trend in MCD’s sales trends needs to reverse. As things currently stand, we believe the data suggests a strategic failure on the part of the company as well as a disconnect between investors’ expectations and the reality of the company’s fundamentals. As this continues, we are looking for more underperformance versus peer consumer and S&P 500 benchmarks.
Takeaway: Japan is a completely dysfunctional country. If you live there, you may want to consider moving.
If you’re living in Japan, you should probably think about moving. It is a completely dysfunctional country. My favorite guy over there right now, Finance Minister Taro Aso (the guy who is going to rip his country a new one) came out yesterday and basically said, “We’re not going to intervene – yet.”
Guess what? The market understands what that means. That’s the big move that really caught people offside’s yesterday—the currency move. It stoked a massive mean reversion move on the order of five standard deviations in my model. What did I do? I took the other side of it. I’m very comfortable with #StrongDollar. I’m even more comfortable #ShortYen relative to the USD.
Bottom line is that it was a freak out day and you’ve just got to deal with it. There’s nothing you can do about it, other than make a decision. You’re either not going to be short the Yen and long the Dollar, or you’re going to do more of both which is of course precisely what we’re telling you to do.
(Excerpted from Hedgeye's morning conference call)
Takeaway: If you weren’t long the dollar-yen rate prior to yesterday’s bloodbath, you’re getting an excellent buying opportunity here.
After a move like the one we saw in the USD/JPY cross yesterday (-2.1%; the largest 1-day decline since MAY 20, 2010), it would be natural for us to start this note off by pointing to how much the yen has declined since we introduced our bearish thesis late SEP ‘12. We have no intention of doing so; that would be embarrassingly akin to Tom Brady calling up ESPN to remind the world about how many Super Bowls he used to win.
Rather, we’d thought we take a few moments to dissect why we have had this call wrong in recent days and weeks; the JPY has traded up +3.2% WTD vs. the USD and is now up +6.0% from its YTD low on MAY 17. As a quick aside, we are keen to remind investors something we’ve been aggressively stating since we first opened the doors here @Hedgeye; specifically, Big Government Intervention has two very critical unintended consequences:
While the confluence of events that occurred this week to trigger yesterday's move are increasingly obvious in the rear-view mirror (Abe’s disappointing “Third Arrow” outline, rising US growth fears and ECB “hawkishness”), we think the events – or lack thereof – that perpetuated yesterday’s downside are even more important to elucidate:
1. NO LIQUIDITY
Breaking the 99 barrier on the USD/JPY cross looks like it triggered a massive stop loss program and, because of the new rules issued by Japan’s FSA last Friday (designed to “protect investors” and “limit speculation”), there’s hardly any liquidity left in the marketplace to take the other side of the trade via intraday speculation. Per StreetAccount:
“Under a self-regulation proposal to be adopted on Friday, forex firms will be required to settle a trade even when the move is in the trader's favor. The FSA also plans to restrict trading in binary option and as early as this year, the FSA will ban trades that are looking fewer than 2 hours ahead. The FSA also plans to strengthen oversight of forex companies which offer automated trade programs.”
2. NO KURODA
On monetary policy, it’s important to remember that the BOJ is already committed to monetizing ¥132 trillion through EOY ’14 (27.7% of 2012 nominal GDP) vs. the Fed’s $2.04 trillion (13% of 2012 nominal GDP) over the same time period – assuming the Fed continues at the current pace of $85 billion per month through EOY ’14 (a very unlikely scenario in our opinion). The BOJ’s relative aggression limits what they can do in short order due to international pushback with regards to the yen’s precipitous decline on a trade-weighted basis.
We believe the BOJ will have to wait to be disappointed on the nominal GDP and CPI front several quarters from now before they can reasonably justify any demonstrable, market-moving increase in the pace of their asset purchases – unless, of course, they use elevated JGB volatility as political cover to get more aggressive. Time will tell on that, but board members are indeed openly concerned with respect to that political headwind (as evidenced by them increasing the frequency of their JGB purchases in the current month).
At any rate, our best guess is that the BOJ board will be inclined to continue waiting and watching, and that’s clearly what forex market participants were betting on this week/in recent weeks. BOJ board members have been aggressively marketing the recent regime change which took place upon Kuroda’s arrival, so doubling down this soon would be a tacit admission of defeat and a return to the old days of ineffective, incremental easing.
3. NO TARO ASO
Overnight, Finance Minister Taro Aso was out stating that the MoF had no intention of direct intervention in the FX market. We don’t blame him; that would A) markedly increase the international scrutiny upon Japan’s Policies To Inflate and B) remind investors of the old days of ineffective one-off interventions.
The last thing the Abenomics agenda needs right now is another blow to market confidence – especially one that stems from them looking more and more like previous LDP regimes. Aso astutely recognizes this risk and is willing to take the short-term pain for the long-term “gain” that is outsized currency debauchery.
WHERE TO FROM HERE?
Since we are firm believers that relative monetary and fiscal policy deltas is the primary factor(s) in determining exchange rates, we continue to think the structural bear case for the yen is even better than the commensurate bear thesis for the USD was, say, over the past 3-4 years. Moreover, the USD/JPY cross more or less banged right off of our 95.66 TREND line of support this morning and is now a full +2% higher intra-day.
As long as that cross remains bullish from a intermediate-term TREND perspective, we are inclined to maintain our bearish bias on the Japanese yen and we will continue to fade any JPY strength at key risk management levels.
At this point, it's not a matter of "if" the Fed will tighten US monetary policy at the margins, but "when". More importantly, that "when" is sure to be well ahead of any tightening out of the BOJ. Layer on the impact of sequestration domestically and the impact of recent stimulus spending in Japan and we continue to have a meaningful fiscal policy bifurcation to layer on to the thesis as well. At any rate, we're still waiting to hear a legitimate bull case for the yen...
Global macro risk management is not easy, folks, but it sure is exiting!