Book the tidy 3.9% gain. We are simply risk managing the range in one of Hedgeye Jedi’s Kevin Kaiser's best short ideas. He remains “The Bear” on Linn Energy.
Takeaway: WOOF’s fundamentals appear to be improving into 2Q13; we’re leaning long on the stock, but remain on the sidelines for now.
This note was originally published June 07, 2013 at 12:00 in Healthcare
04 JUNE 2013
We have been stalking WOOF on the long side for some time given our expectation for accelerating volume trends in 2013. However, we had been expecting 1Q13 weakness, which is why we have avoided the name to date.
Fundamentally, our view hasn’t changed. We’re still expecting a recovery in 2Q13 SS Animal Hospital Metrics; partly because the 1Q13 comp was so difficult, but also because the 2Q13 comp is artificially deflated by utilization pull-forward into 1Q12 from the unusually warm winter. Additionally, 2H13 will also have additional tailwinds (see link below for more detail)
WOOF: 1Q13 Headwinds Preceding the Recovery
03/15/13 11:52 AM EDT
We are already seeing signs of a rebound. Veterinary Employment (our best read into WOOF SS Animal Hospital trends and one of two inputs in our WOOF regression model) is accelerating on a y/y basis into 2Q13.
Stock Setup Mixed
While 1Q13 results disappointed (worse top-line miss in almost 3 years), the stock rallied on the company's newly-created stock buyback program and a synthetic guidance raise (WOOF began excluding acquisition-related amortization from non-GAAP EPS).
The stock is no longer screening as a clear-cut long given its recent outperformace. However, we have a bullish bias on the stock given our expectation for accelerating organic growth, which do not believe the Street fully appreciates.
POSITION MONITOR: The Hedgeye Healthcare Position Monitor is a reflection of our fundamental view on the stocks listed. The TOP IDEA’s section represents our highest conviction ideas.
6/07/13 - Nonfarm Payrolls, Consumer Credit
Thomas W. Tobin
Hesham Shaaban, CFA
Takeaway: Here's a quick look at Keith's top tweets.
Get the Dollar right, and you'll get a lot of things big Mac-ro right
@KeithMcCullough 3:22 PM
@KeithMcCullough 3:10 PM
$AAPL acts like 100 lbs of poop in a zip lock bag
@KeithMcCullough 10:11 AM
Biggest opportunity in the market is that everyone has to do Macro, and few have a macro process- long-term opportunity
@KeithMcCullough 10:07 AM
This market is in its most confusing spot of 2013 - doing a lot of watching now $SPY
@KeithMcCullough 10:02 AM
This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.
Takeaway: The real question for VFC...Why remain an 'above-avg' portfolio instead of entering the seller's market and downsizing to a GREAT portfolio?
CONCLUSION: We think that VFC succeeded in focusing investors on the big picture at its Analyst Day, but there is still a massive 'trust me' element to this model. Granted, management has earned the benefit of the doubt, but a lot needs to go right to hit its targets. We think the bigger question people are not asking is why this company has five different Brand Coalitions and is operating an 'above average' portfolio, instead of downsizing to a portfolio that is truly 'great'. After all, it's a seller's market.
We've read through a lot of commentary about the VFC analyst day, and as quantitatively concise as the company's targets are, there were elements of the presentation that we don't think are well represented in the risk/reward. The general sentiment sounds something like a) Same 'ol great quality management, b) aggressive 10% global sales growth targets (presuming acquisitions come through), c) a hockey stick acceleration in EBIT margins from 13.5%-16.0%, d) $18.00 in EPS in 5-years (better than the $17.00 in '17 that they are setting as 'official' goals), and e) a 300-400bp improvement in ROIC.
Presuming the company hits its goals, the stock is trading at 10x that earnings number today, or 17x 2013. IF you believe these targets and think that current peakish multiples can hold for another 5-years, you're looking at about a $300 stock in 5-years (1827 days, but hey, who's counting?), or a 10-12% CAGR in VFC's stock. That's nice, but a lot needs to go right for it to happen, and the end result is a return that we'd consider 'about average'.
There's something about the crux of the presentation that did not sit well with us, and that's the lack of detail around how VFC is going to achieve these targets. We understand that it's hard to give such specific detail for a company with a portfolio of 27 brands. But there was very much a feel of 'trust us…we'll do it.' In fact, their overall tone was about as bullish as we've heard any management team in a long while. And when we marry such a bullish tone with high yet unsubstantiatiated targets (that the Street will blindly bake right into their models), it makes us a bit weary.
In fairness, this is a management team that has earned our respect in executing upon its promised goals. So when they say they're going to do something, it means they're probably going to do it. But adding $5.2bn to a $5.9bn Outdoor and Action Sports business over just 5-years? That's a big big number, and the supporting context was sparse.
The BIG Question
Regardless of the targets, here's a bigger question for us… The company plans to add $6.4bn in revenue over 5-years. Yet $5.2bn, or 81% of that is in the Outdoor and Action Sports arena. They are making it clear that the Outdoor business is diversifying both geographically and seasonally to maximize growth potential while mitigating volatility. It accounts for 55% of sales today, and within 5-years' time should be 64% of sales. That's great. But the simple question is…"Why not 100% of sales instead of 64%? Why do they have the other four brand coalitions a all?"
We could justify being in the denim business. It owns two of the most stable and steady brands in the business in Wrangler and Lee. In addition, it has a mid/high-teens margins and the highest ROIC at the company since it owns a significant portion of its own manufacturing facilities.
But as for its' other three Coalitions? Contemporary (7 for all mankind), Sportswear (Nautica), and Imagewear (Majestic)… why is it in these businesses at all? The brands are all what we'd consider 'average to above-average.' But we're only interested in owning brands that are truly 'Great'. VFC has three great brands. The North Face, Vans and Timberland, and they are all in the Outdoor Coalition. The other brands that are on the bench as being 'potentially great' (such as Smartwool, Napapijri, Reef, and Lucy) also happen to be in the Outdoor group.
We're not suggesting that VFC gets out of the 'portfolio of apparel brands' business. But simply that a more focused 'portfolio of Outdoor/Action Sports brands' might make a lot more sense. At a minimum, we'd pay a higher multiple for it. For example, the company is now trading at about 14x TTM EBIT. Two points of multiple expansion on a smaller, but more focused portfolio of outdoor and Jeanswear brands yields an immediate return 14% above current levels -- and that's before considering what we think would be between $1.5bn and $2bn ($13-$18/share) in proceeds from the rest of the portfolio. This is wishful thinking, as we don't think VFC would ever consider going there. But this is where we think the most value would be created for shareholders.
Takeaway: The US Dollar is the most important thing in my model right now.
(Excerpted from this morning's Hedgeye conference call)
The US Dollar is the most important thing in my model right now. It is literally sitting right on its trend line. To a penny.
This is like a golf ball sitting right on the edge of a hole.
What are you going to do? Blow on it? You’ve got to wait. You’ve got to watch.
If you’re an intermediate term, or long term investor, you should just wait. Why wouldn’t you just wait? Eventually someone’s going to blow on that ball one way or another. It’s either going to go into the hole, it’s going to go in the hole or it’s going to break down.
The point here is that if the USD breaks its trend line, that would be something new. That’s not something we’ve seen for six months. It’s our Hedgeye Chart of the Day. It’s the most important thing in my notebook this morning. It’s obviously something I am focused on.
Bottom line: I’ll say this until I’m blue in the face. If you want to get Global Equities right, you have to get the US Dollar right.
Takeaway: Turkish protests are creating a lot of headlines, but we think they will have little impact on long term fundamentals.
"Turkey is not a second-class democracy.”
-Turkish Foreign Minister to Secretary of State John Kerry
To say Turkish equity markets have been volatile over the last two weeks would be an understatement. In fact, on June 3rd the main Turkish equity index was down more than 10% as emphasized in the chart below. While Turkey was largely immune to the so called Arab Spring, the current series of protests that have been grabbing media headlines around the world appear to be a Turkish version of sorts, at least at first blush.
Stepping back, the Turkish economy has been the fastest-growing economy in Europe since the early 2000s. In 2002, current Prime Minister Recep Tayyip Erdogan won his first general election and since then the XU100 index is up almost 9x, which can be seen on the graphs presented. Turkey is now the 15th largest world economy on purchasing parity basis. The key components of the highly diverse Turkish economy include: agriculture which is 30% of employment (Turkey is food independent), the fourth largest ship building sector in the world, the 10th largest producer of minerals, and a very active tourism industry (with 11 of the top hotels in the world located there).
Turkey has also been much less affected by the financial crisis of 2008/2009 than many of its European peers. In fact, Turkish GDP grew 9.2% in 2010 and 8.5% in 2011 (long term growth rates are highlighted in the chart below), which were some of the highest growth rates in the industrialized world. The derivative impact of this economic growth is that the country level fiscal situation level is very healthy. In fact, Turkey has met the 60% debt-to-EBITDA criteria of the Maastricht Treaty every year since 2004. As a result of the healthy economy, the Turkish Lira has been stable over the past few years with inflation under control.
Much of the economic success over the past decade can be attributed to Prime Minister Erdogan, who has been in power for most of that period. Erdogan inherited an economy that was deep in recession in 2002 and with the help of Finance Minister Ali Babacan, Erdogan implemented a series of reforms. One key reform included dramatically reducing government regulations, which subsequently altered the path and outlook for the Turkish economy. Perhaps most telling on this front is the fact that inflation was at 35% when Erdogan gained power and CPI is now running sub-5%.
Given the economic backdrop and improving economic situation of the average Turk over the last decade, the protests against the government are somewhat counterintuitive. Regardless, they are occurring with increasing scale. The map and timeline below highlights this fact showing the spread of protests across Turkey. To date, these protests have led to 3 fatalities and 5,000 injuries.
The protests in Turkey, though similar to the protests against local governments that erupted in the Arab Spring revolutions seen in northern Africa with Tunisia, Egypt, and Libya, also hold some specific differences. The unrest shown against Erdogan and his government is different because in the Arab Spring countries the protests were directed to the dictatorships that ascended to power, rather than democratically voted into office. On the other hand Erdogan has won every important democratic election. As well, the Arab Spring was initially catalyzed by the poor economic situation of the broad populace.
To be fair, the AKP and Erdogan have lost some of their popular appeal and are being accused of infringing on personal freedoms in Turkey. Recently the government implemented a restriction on alcohol sales and has also been allegedly imposing conservative Islamic views in legislation. The protesters have stood up, and have fought against police brutality and restrictions on labor unions.
There are a few options to what will happen next in Turkey. A scenario similar to the Arab Spring does not seem plausible, where protests fueled by the dissatisfaction of government led to complete regime changes in Tunisia, Egypt, and Libya. It is unlikely because the Erdogan has had such a positive impact on Turkey’s economy and the violence in the Turkish protests are not to scale of the Arab Spring. In essence, there is no military or armed support to the protests.
Another option is for the protesters to eventually give in with no major changes being enacted or seen in the government. Erdogan has been visiting cities to gain more supporters so that he and the AK party will again win the popular vote in the Presidential elections in 2014.
Ultimately, we do not think these protests will trump the strong track record of Erdogan and will eventually pass, although he may have to acquiesce on the civil liberties front. The biggest tell to us on this front is a chart of credit default swaps on Turkish government debt. While they are elevated, they are still largely in normal territory and are not signaling imminent economic or fiscal stress, which would come from a broad popular uprising akin to what occurred across the Middle East during the Arab Spring.
We aren’t ready to advise buying Turkish equities just yet, but our Hedgeyes are watching and waiting.
Daryl G. Jones
Director of Research