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TEX: Close Enough To Be Worth A Look

Summary & Overview

TEX can be a volatile name and we have been waiting since our March 2013 Mining & Construction Equipment call for an entry opportunity below our fair value range.  We think $26 is close enough to put a toe in the water.  See here for a more detailed discussion of our views on TEX and the niche construction equipment industry.  In the machinery space, we think TEX is a good swap for CAT – keep construction equipment, dump mining/resources equipment.

 

TEX: Close Enough To Be Worth A Look - zz7

 

 

Backgroud

 

Construction Concerns Likely Overblown:  The Architectural Billings Index has moved back into positive territory, suggesting that the rebound in commercial construction is likely to regain momentum and persist well into 2014.  Residential construction is also likely to continue its robust recovery, despite increases in mortgage rates.  Construction equipment sales have rebounded a bit, but should retain a cyclical tailwind for some time.

 

TEX: Close Enough To Be Worth A Look - zz1

 

 

Cycles Are SlowPotential can get ahead of reality in cyclical recoveries, as we think happened to TEX in early 2013.  For example, the Architectural Billings Index leads nonresidential construction by 9-12 months.  The index only turned sustainably positive in 4Q 2012, indicating just the start of a rebound 2H 2013.  It takes time, but disappointment at the pace of recovery can provide entry opportunities.

 

TEX: Close Enough To Be Worth A Look - zz2

 

 

Already Pre-Announced:  Expectations for TEX have already been reset to more reasonable levels with its mid-June preannouncement.  Management may still abandon its long term goal of >$5/share/$10 billion in revenue for 2015.  But, as they have said, that target is a “goal” and not “guidance”.  While dropping the target is a potential negative catalyst, we do not think investors expect TEX to achieve it.  For example, 2015 consensus is only at $3.80. 

 

Great Sale of Mining Exposure:  Much of TEX’s remaining “mining” exposure is from its Materials Processing business, which we believe is more exposed to construction, quarrying, and recycling than to traditional mining (copper, iron ore etc.).  The unit is a small part of the TEX mix.  TEX sold its traditional mining equipment business to Bucyrus, now part of CAT, in early 2010.  While they may not have exactly top-ticked the mining capital spending bubble, they came very close.  Management that gets cyclical businesses is a tremendous asset.

 

AWPs International Penetration:  Over-time, increasing worker safety regulation should drive greater use of aerial work platforms (AWPs) in less developed markets.  The AWP market is dominated by TEX and OSK, and both would likely benefit from higher AWP demand growth outside of North America and Europe.  In developed markets, easing small business credit conditions should facilitate the acquisition of equipment by smaller rental companies. As the large rental companies are fond of pointing out, there are still lots of small equipment rental companies.

 

 

TEX: Close Enough To Be Worth A Look - zz3

 

 

Municipal Spending Environment:  Municipal finances should generally improve with rebounding home prices, Detroit aside.  This key end-market for TEX and OSK has been depressed for some time.

 

 

TEX: Close Enough To Be Worth A Look - zz4

 

 

Port Investment:  Global trade growth has been unusually weak since the financial crisis.  Historically, global trade has grown at a faster clip than global GDP.  We expect that growth to eventually resume, with port equipment investment following.  The expansion of the Panama Canal is also a potential boost for port investment.

 

Well Structured Markets:  Many of TEX’s businesses compete in industries structured for favorable long-term returns.  Cranes and AWPs are notably consolidated.

 

 

TEX: Close Enough To Be Worth A Look - zz5

 

 

Cyclical Tailwind and Valuation Upside:  We value TEX in the $26-$52 range.  Given several positive cyclical tailwinds in the pipeline, we think that the recent decline provides an interesting point to consider an initial position.   

 

 

 

(Both TEX and OSK suffered from the decline in cement mixer demand, which was pretty spectacular)

TEX: Close Enough To Be Worth A Look - zz6

 


THE WEEK AHEAD

The Economic Data calendar for the week of the 1st of July through the 5th 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.

 

THE WEEK AHEAD - WeekAhead1


RISK MANAGING #EMERGINGOUTFLOWS: IS THIS JANUARY 2008?

Takeaway: The time will come to aggressively fade the current relief rally/dead-cat bounce(s) across EM asset classes.

SUMMARY BULLETS:

 

  • In our most recent globally-interconnected macroeconomic scenario analysis, our #EmergingOutflows theme should continue trending relatively unabated in three of the four most probable outcomes with respect to the TREND duration (NOTE: not all probabilities are the same):
    1. The Chinese economy continues to suffer from structural financial sector headwinds: that would be a clear headwind to EM investor sentiment and EM economic growth;
    2. US economic growth markedly accelerates: that would keep our US monetary renormalization theme (i.e. #StrongDollar and #RisingRates) firmly intact, which has historically been the death-knell for EM asset classes;
    3. The 2013 bears get what they’ve been calling for the entire way up and the US economy finally implodes: That would be a headwind to global risk taking sentiment and liquidity. In that scenario, we’d likely see broad-based asset price deflation and a demonstrably stronger USD on a flight-to-perceived quality in the US Treasury market.
    4. Just about the only scenario where we see EM assets meaningfully rebounding from here is a TREND-duration inflection in US growth expectations that brings about an explicit promise of more QE from the Fed. Quantitatively speaking, neither the US Dollar Index, US Treasuries nor Gold view that scenario as a probable outcome at the current juncture, but we will change as the facts do.
  • For now, we remain the bulls on the USD and the bears on Gold. We also hold the axe on emerging markets and are inclined to keep chopping away on the short side. Specifically, there’s +2.9% upside to the EEM’s immediate-term TRADE line of resistance and +8.8% upside to the TREND line from last price. Barring scenario #4 as laid out above, we would short EM equities with impunity if they were to bounce all the way up to the latter of the two resistance levels.

 

EM OUTFLOWS ACCELERATE… TO AN ALL-TIME HIGH!

According to data from EPFR Global, emerging market equity funds saw $5.6B of outflows in the week-ended JUN 26, good for the fifth consecutive week of outflows. The four week total for JUN-to-date came in a $19.9B, which set a new record for monthly outflows, surpassing the previous record of $18.7B in JAN ’08.

 

Two quick points to make in light of this data:

 

  1. Anyone who bought EM stocks hand-over-fist in JAN ’08 because they were “cheap” probably is: A) not necessarily inclined to do so now (scar tissue); or B) no longer around to do so this time around.
  2. EM stocks are not “cheap”.

 

Regarding point #2: Even after the recent bloodbath across the EM asset allocation spectrum, EM stocks are still only roughly in line with their historical mean valuations when analyzed on a relative basis to DM equities (NOTE: we pulled the charts back as far as we can find comparable data (i.e. 1999)). Net-net, “cheap” can get a lot cheaper from here.

 

RISK MANAGING #EMERGINGOUTFLOWS: IS THIS JANUARY 2008? - 1

 

Regarding point #1: EM equities (using the EEM ETF as a proxy) were disgustingly oversold at the start of the week and have bounced valiantly during the current WTD relief rally. It’s interesting to note that the EEM recorded a “nice” dead-cat bounce at the end of JAN ’08 too…

 

RISK MANAGING #EMERGINGOUTFLOWS: IS THIS JANUARY 2008? - 2

 

PICKING THE “SLIMMEST OFFENSIVE LINEMAN”

We’re often asked by our long-only clients which emerging markets we would overweight/underweight. While our answer has been and remains “underweight all of them”, we obliged the request by initially favoring consumption-oriented economies across Asia (e.g. Philippines).

 

Pull up a six-week chart of the PSEi Index and you’ll know exactly how wrong that call has been. Amid broad-based capital outflows, investors have clearly been reducing their EM exposure more-or-less indiscriminately.

 

Analyzing our Hedgeye Macro EM Equity Market Factor Model, which contains all 21 of the countries in the MSCI EM Index (plus Argentina, for good measure), we see that low-yielding, slow-growth countries that probably had relatively tighter monetary policy (at the margin) over the trailing 18-24 months (hence the low CPI and high LTM FX performance) are precisely the markets that are outperforming on a 1M basis.

 

RISK MANAGING #EMERGINGOUTFLOWS: IS THIS JANUARY 2008? - 3

 

Low-yielding, slow-growth countries with relatively tight monetary policy hasn’t exactly been the “flavor of the moth” for equity investors – particularly not in the context of why people choose to invest in emerging markets in the first place. Thus, we can reasonably conclude that the countries with the worst fundamental stories are actually the ones performing the best of late.

 

And when you consider that Malaysia, Mexico, Hungary, Taiwan and Morocco are actually leading the charge on a 1M basis (in USD terms), you can see exactly what we mean. We don’t have a call on Hungary or Morocco specifically, but I do cover the other three countries closely and each of them has had their fair share of fundamental headwinds of late:

 

  • Malaysia: political consternation surrounding the recent election rounded out by a trip to Quad #3 (i.e. Growth Slowing as Inflation Accelerates) on our GIP chart;
  • Mexico: political consternation weighing heavily upon a once-proud economic reform agenda; and
  • Taiwan: just pull up a chart of China or AAPL, given Taiwan’s economic sensitivity to China’s economic slowdown and banking woes or given tech’s weighting in the TAIEX Index.

 

RISK MANAGING #EMERGINGOUTFLOWS: IS THIS JANUARY 2008? - 4

 

What’s not working? Basically everything. What’s underperforming? Countries that have recently unearthed new economic financial market headwinds due to social unrest, banking woes or commodity deflation. If you’ll recall our industry-leading work on EM Crises, that’s essentially Pillars #4, #3 and #1 in action.

 

Lastly, it’s important to bear in mind that in times of crisis, investors generally sell what they can – not necessarily what they should.

 

WHERE TO FROM HERE?

The time will come to aggressively fade the current relief rally/dead-cat bounce(s) across EM asset classes.

 

In our most recent globally-interconnected macroeconomic scenario analysis, our #EmergingOutflows theme should continue trending relatively unabated in three of the four most probable outcomes with respect to the TREND duration (NOTE: not all probabilities are the same):

 

  1. The Chinese economy continues to suffer from structural financial sector headwinds: that would be a clear headwind to EM investor sentiment and EM economic growth;
  2. US economic growth markedly accelerates: that would keep our US monetary renormalization theme (i.e. #StrongDollar and #RisingRates) firmly intact, which has historically been the death-knell for EM asset classes;
  3. The 2013 bears get what they’ve been calling for the entire way up and the US economy finally implodes: That would be a headwind to global risk taking sentiment and liquidity. In that scenario, we’d likely see broad-based asset price deflation and a demonstrably stronger USD on a flight-to-perceived quality in the US Treasury market.
  4. Just about the only scenario where we see EM assets meaningfully rebounding from here is a TREND-duration inflection in US growth expectations that brings about an explicit promise of more QE from the Fed. Quantitatively speaking, neither the US Dollar Index, US Treasuries nor Gold view that scenario as a probable outcome at the current juncture, but we will change as the facts do.

 

RISK MANAGING #EMERGINGOUTFLOWS: IS THIS JANUARY 2008? - 5

 

RISK MANAGING #EMERGINGOUTFLOWS: IS THIS JANUARY 2008? - 6

 

RISK MANAGING #EMERGINGOUTFLOWS: IS THIS JANUARY 2008? - 7

 

For now, we remain the bulls on the USD and the bears on Gold. We also hold the axe on emerging markets and are inclined to keep chopping away on the short side. Specifically, there’s +2.9% upside to the EEM’s immediate-term TRADE line of resistance and +8.8% upside to the TREND line from last price. Barring scenario #4 as laid out above, we would short EM equities with impunity if they were to bounce all the way up to the latter of the two resistance levels.

 

Have a fantastic weekend,

 

Darius Dale

Senior Analyst


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 80.30%
  • SHORT SIGNALS 78.51%

Krugman’s Crazy Math

Takeaway: Economic history refutes Paul Krugman. Again.

“A country without a memory is a country of madmen.”  

- George Santayana

 

My friend Jimmy Pethokoukis wrote this morning that while he doesn’t like Paul Krugman’s tone or personal attacks, Krugman's core economic point is correct in his recent piece, Non-inflation Denial.

 

I respectfully disagree with Jimmy. Krugman’s argument is a crock.

 

Krugman’s Crazy Math - krug

 

The NYT’s Nobelist is saying there is no inflation now, using the highest period of food price inflation ever recorded (2003-2012). Folks, food prices hit an all-time high in 2012—deflating Bernanke’s Bubble doesn't mean there's no food inflation.

 

In essence, Krugman is misrepresenting (aka “cherry picking”) the economic data by using a time period that doesn't show the actual truth about food inflation. He’s using a 10-year chart, instead of a 20 or 30-year chart. Some people call this lying.

 

Krugman really ought to take a look at our chart below.

 

History refutes him.

 

Krugman’s Crazy Math - Chart of the Day

 

Why did Krugman disguise the truth?

 

Perhaps he hopes Americans will forget history in lieu of his latest political narrative. Perhaps he hopes Americans don’t actually pump their own gas, shop for their own groceries, pay their own heating bills, pay their own visits to the doctor, pay for their childrens’ education, etc, etc.

 

Facts don’t lie; political people do.


CAT: Beware EM Crisis

Takeaway: Emerging market turmoil should accelerate the downside in CAT, likely leading investors to reassess inflated 2014 expectations.

This note was originally published June 24, 2013 at 15:31 in Industrials

Summary

 

We have published a number of reports outlining the bear case on CAT (for example, see here, here and even here).   We do not want to rehash the whole thesis, but we do think the current issues in emerging markets will accelerate the readjustment in expectations for CAT. As a result, we are adding CAT to the Best Ideas list.

 

CAT: Beware EM Crisis - cat

 

CAT has been an underperformer over the past year as commodity prices stalled.  After a decade of being a primary beneficiary of the boom in commodity prices through increased resource-related capital spending, CAT appears very vulnerable.  Emerging-market growth, particularly the fixed asset investment bubble in China, has been a major driver of commodity demand.  

 

The real bite will come to 2014 expectations, we think, as investors realize that the decline in resources-related capital spending is a return to normal levels, not a decline from them

 

 

Resources-Related Capital Spending Falls Substantially When Commodity Price Flatten

 

The decline in mining capital spending in coming years is likely to be on the order of 60%-80% from peak, by our estimates.  Such a decline will lead to overcapacity, competitive pricing and (obviously) lower volumes for OEMs like CAT supplying mining capital equipment.  CAT has also made many peak-of-cycle acquisitions in resource-related capital equipment.

 

 

EM Crisis Accelerates Our Thesis

 

The recent developments in China are clearly not positive for sentiment among EM investors; nor are they supportive of EM economic fundamentals, particularly given that so much of EM growth was perpetuated by China’s fixed asset investment bubble – which we clearly view as in the process of popping.” – Darius Dale, Hedgeye Macro Team (i.e. the guy who got the current EM situation right)

 

China’s fixed asset investment bubble has been a major driver of physical commodity demand over the past decade.  It isn’t as though European, US or Japanese steel demand growth led the tripling of iron ore output in the last decade.  Emerging market demand has.  The financial stress currently underway is likely to crimp fixed asset investment for quite a while, and with it resources-related capital spending.   If the emerging market challenges continue, expect those CAT order delays to turn into cancellations.

 

CAT: Beware EM Crisis - vn2

 

 

Resources-Related Capital Investment Is Where CAT Makes Its Money

 

As the chart below shows, when you take out Resource Industries and Power Systems, there is not much left of CAT’s operating income.  Those two segments are dominated by energy, mining and other resource-related products, in our view. CAT dealers own much of the service and parts revenue from the existing installed base, a meaningful difference from JOY, Sandvik and other equipment suppliers.  Construction Industries competes in a more fragmented, lower margin industry that has its own emerging market exposures.   For CAT, commodity-related capital spending, and with it the emerging market growth story, are critical.   The declines that are likely to evolve from the current EM crisis are a very serious issue.

 

CAT: Beware EM Crisis - vn3


Refreshing the European Charts

Where are we at in Europe? We expect European equity and credit markets to trend sideways in the summer months, short of any blow-ups we could see from Italy, Portugal or spillover from Greece. We do not see any particular catalysts ahead: we’re forecasting the ECB to be on hold in wait-and-watch mode to see if economic conditions improve in the fall. Headline risk should remain a governing factor. Here we highlight Italy – both the tenuous nature of the existing coalition along with fears around its inability to establish a budget for next year. Sentiment could shift given the likelihood that the country delays a one percentage point hike (from 21% to 22%) in the VAT that was scheduled to take effect in July for at least three months.

 

Recent Italian sovereign bond issuance has priced debt higher versus previous auctions, a new development for the periphery versus year-to-date performance of mostly lower issuance. However, we expect both Italy and Spain, despite fluctuations, to remain grounded under 5% on the 10YR.  Draghi’s OMT put remains a force behind this call.

 


Another EU Summit completed—what was accomplished?   

  • EU leaders increase the funds set aside to combat youth unemployment to at least €8B from a previous target of €6B.

Hedgeye Takeaway:  While this funding is a start, the structural imbalances across the Eurozone, especially the need for labor market reform, will take years to amend, with no guarantee of success. We think the alarming rates of unemployment (Eurozone at 12.2%), especially youth unemployment that is above 50% across some peripheral states, will continue to guide long-term below-mean growth.

  • There were discussions around proposals by the European Investment Bank (EIB) and European Commission (EC) to generate €55B-€100B of new loans to small and medium sized enterprises (SMEs).

Hedgeye Takeaway: The ECB has had no success unclogging the credit channel. Loans to the SMEs are critical to restart and encourage lending; however we have our doubts on this sum given the unsuccessful LTRO packages that handed out 1 Trillion EUR in nearly free money.

  • Discussion around a framework for the Banking Union, including that bail-in agreements will exempt deposit holders of less than €100K.

Hedgeye Takeaway: Following Cyprus, Eurocrats are incentivized to ensure that deposit holders with less than €100K in deposits are not on the hook for a bail-in. We expect more guidelines on the shape of a Banking Union after German elections in September.


 

Data: The Haves versus the Have Nots


Continuing with our thesis on the region, the data out this week reminds us that our bullish bias on Germany versus our bearish bias on the periphery remains intact. 

  • Eurozone Confidence – figures will grind slightly higher throughout the summer, led by Germany.

Refreshing the European Charts - yy. euro econ vs consumer

 

Refreshing the European Charts - yy. euro manu vs service

 

Refreshing the European Charts - yy. euro business

 

 

Bullish Bias – Germany

  • Figures this week all looked better. The Unemployment Rate remained at 6.8% in JUN with the Unemployment Change down-12K to 2.94MM. The GfK Consumer Confidence survey rose to 6.8 JUL (exp. 6.5) vs 6.5 JUN. Retail Sales remain positive at 0.4% MAY Y/Y vs 2.7% APR and CPI rests at a healthy 1.9%  in JUN (Preliminary) Y/Y vs 1.6% MAY

Refreshing the European Charts - yy. germany cpi

 

 

Bearish Bias – The Periphery


Retail Sales fell across the periphery: Spain -4.5% MAY vs -2.6% APR; Greece -14.7% APR Y/Y vs -5.9% MAR; and Portugal -3.5% MAY Y/Y vs -2.1% APR.  Data across Italy continues to be atrocious, and Italy Economic Sentiment fell to 76.1 JUN vs 80.2 MAY. Also, Spain’s housing market continues to feel the hit, with the Total Housing Permits down -16.5% APR vs -35% MAR.

 

Refreshing the European Charts - yy. italy retail sales

 

Refreshing the European Charts - yy. spain housing

 

Enjoy the weekend,

 

Matthew Hedrick

Senior Analyst


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