“If someone picks on your brother and you don’t stand up for him, don’t bother coming home.”
-Larry Bird, quoting his father (paraphrased)
From a stock research perspective, the last couple of months at Hedgeye have been interesting. Specifically, our Senior Energy Analyst Kevin Kaiser has been knees deep in a classic battleground stock: LINN Energy. Kaiser has done an immense amount of independent work on the stock and concluded that the Company is overvalued. In fact, our fair value estimates are more than 40% lower than the current stock price.
This research has raised the ire of the Company’s management who has publicly refuted our thesis, has led to numerous ad hominem attacks from the likes of Jim “The Entertainer” Cramer, and also led to a letter to the editor of Barron’s from a large hedge funds that has accused the short sellers of LINN to be “unprincipled”. (Ironic from a hedge fund that routinely shorts securities.)
Now, admittedly, when we think we are on to something we tend to go all in. In this instance, that included presenting on the idea a couple of times, participating in the Barron’s article, and publicly defending our research and our analyst. To Larry Bird’s quote above, if you are not going to defend your ideas and your teammates, don’t bother coming back to Hedgeye headquarters.
Late last night, we were rewarded for our hard work as LINN Energy announced:
“… that they have been notified by the staff of the Securities and Exchange Commission ("SEC") that its Fort Worth Regional Office has commenced a private, non-public inquiry regarding LINN and LinnCo. The SEC has requested the preservation of documents and communications that are potentially relevant to, among other things, LinnCo's proposed merger with Berry Petroleum Company, and LINN and LinnCo's use of non-GAAP financial measures and hedging strategy.”
Now to be fair, this is America, and certainly the Company is innocent until “proven guilty” by the SEC, but nonetheless this was part of our point in warning investors that some of LINN’s practices were likely to attract the scrutiny of the SEC.
As always, though, Mr. Market will ultimately let us know if we are correct in our research on this name. After all, in the short run the stock market is a voting machine and in the long run it’s a weighing machine.
Back to the global macro grind . . .
Not surprisingly, one of our third quarter themes will be related to Asia, which has been home to much of the global equity market pin action this year. As Keith noted this morning, the Yen is down for the fourth straight day versus the U.S. dollar. In that time period, the #WeimarNikkei is up +6.4% and is once again back above our TREND line of support of 13,389.
The other noteworthy equity move in the region was from Australia. In the land down under, Aussie stocks had their largest 1-day move in the last two years, up more than 2.5%.
The Reserve Bank of Australia left rates unchanged and also indicated that they are maintaining an easing bias with a scope to cut again. So, yes in U.S. dollar terms kangaroo pelts are cheap and getting cheaper!
The data flow out of Europe this morning is also universally supportive of more easing from the ECB. First, French car sales came in at literally 20-year lows. Second, Portugal’s Finance Minister resigns due to public discord over austerity. Finally, it seems Greece may not be able to satisfy the Trioka in the next 3 days and concession will have to be reached on its next aid tranche. This later point was obviously foreshadowed by Greek equities which are down -26% since May.
On a relative basis, the actions in both Japan and Australia, and data from Europe, are supportive of our bullish view of the U.S. dollar. Currency trades on marginal moves in policy and, on the margin, the U.S. appears to be getting more hawkish as the rest of the world stays or gets more dovish. Of course, as the facts change so will we and this is a big week for incremental data with U.S. payrolls being reported on Friday and the ECB meeting on Thursday.
Coming into the year, one of the asset classes we were most negative on was gold. Primarily, this was due to expected U.S. dollar strength. This thesis has played out in spades with gold down more than -25% in the year-to-date. Currently, we have no position in gold, but continue to look for a re-entry point on the short side. Consensus is still trying to call the bottom, but the reality remains that prolonged strength in the U.S. dollar will be a major headwind for gold.
Switching gears to the U.S., we will be hosting a call next week on July 9th to introduce a new investment theme on defense spending entitled, “Torpedoes in the Water?” In summary, we are introducing a bearish view on many defense contractors, which have been outperforming industrials broadly, as we believe the earnings estimates are likely to go lower as a long term reduction in procurement spending sets in. Email if you’d like to attend.
Our immediate-term Risk Ranges are now:
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
This note was originally published at 8am on June 18, 2013 for Hedgeye subscribers.
“If you are a short seller, that’s cacophony of negative reinforcement. You’re basically told that you’re wrong in every way imaginable every day. It takes a certain type of individual to drown that noise and negative reinforcement out and to remind oneself that their work is accurate and what they’re hearing is not.”
As many of you know, short selling is not for the faint of heart. We've learned that in spades recently on a position we added to our Best Ideas list in late March called Linn Energy (LINE).
Barron's got to the name before us, but their write-up piqued our interest, so our energy team, led by Senior Analyst Kevin Kaiser, rolled up their sleeves and dug in. Needless to say, after looking under the proverbial cover we didn't like what we saw.
The position itself has worked out well for us and on a price basis is down more than 15% as the company reported soft earnings and has had delays closing its merger with Berry Petroleum (BRY). Unfortunately our analysis has raised the ire of the indefatigable Jim Cramer, who has had the misfortune of being on the wrong side of the trade in Linn Energy in his charitable trust.
In recent days, it has become Cramer's bully pulpit on CNBC versus Hedgeye's analysis. If the stock price action is an indicator, we like our odds in the battle.
Unfortunately, as is sometimes natural when backed into a corner, Cramer has resorted to ad hominem attacks in trying to discredit our research. Things like calling us too young to do professional analysis, implying we are violating the Securities Act of 1934 (my Compliance Officer Rabbi Moshe Silver vehemently disagrees there), and this is by far the best, he's been tweeting that we are leading an orchestrated "Bear Raid".
Don't worry you’re not the only one that doesn't know what the term "Bear Raid" means. But, then again, we don't know what Booyah means as it relates to investing either. Although, we could offer some guesses . . .
That all said, being the friendly young (Cramer's emphasis not mine) analysts we are, we would like to cordially invite him to our 11am call today on Linn Energy. (Jim, Feel free to email me for details - firstname.lastname@example.org). Incidentally, we have also invited the management teams of Linn Energy, Berry Petroleum, and many of the largest shareholders. At the very least, Cramer will have a hard time saying that we aren’t transparent.
Back to the Global Macro grind . . .
At 11am eastern, Kaiser will go through his “Linn Energy Not Top 10” and we will give you a little preview, with a top three selection:
1. Using LINE’s 2012 organic F&D cost of $3.66/Mcfe, LINE has to spend $1,093 in 2013 to replace produced reserves. This exceeds LINE’s 2013 maintenance cap-ex estimate by ~$636 million.
2. On a $/acre basis. LINE’s NAV suggests $35,000 - $55,000 per acre for its Granite Wash play. The most Granite Wash deal – Laredow/Enervest in May 2013 – was done at $4,000/acre.
3. Cramer is recommending you own LINE. (Joke!)
As it relates to global macro news flow, the last 24 hours have been relatively quiet. Draghi spoke in Jerusalem earlier today and reiterated his “whatever it takes” pledge saying that the ECB has an “open mind” on non-standard monetary policy if circumstances warrant. Last week, we gave an update on European economy and we wouldn’t take “whatever it takes off the table”.
We see more evidence European sluggishness this morning with EU27 New Car Registrations that were down -5.9% year-over-year in May. For those that are keeping track, that is the lowest level since 1993, or about two decades. To the extent that new car sales are a gauge for consumer sentiment and willingness to spend, this was not a great data point.
Not that we want to be known as the curmudgeon short sellers that pile on the bad news, but the other key data point from Europe relates to Spain. First, Spain sold about €5.04B of 6- and 12-month bills on Tuesday. This was at the high end of the range, but saw yields increase dramatically from last month (0.492% -> 0.821% on the 6-months and 0.994% -> 1.395% on the 12-months). As well, Spanish banks reported that banks bad loans as percentage of total credit rose to 10.9% in April from 10.5% in May. With unemployment north of 20%, this is not really a big surprise.
In other news, our #EmergingOutflows theme continues to play out. Brazil’s Bovespa dropped below 50,000 yesterday and is now in full blown crash mode (down more than -22% since January 3rd). This is on the back of some of the largest Brazilian protests in some twenty years. In China, foreign direct investment slowed to trickle in May, which is likely a sign that foreigners are recognizing the precarious debt situation in China.
But, alas, all is not terrible in the world. In fact, we believe we have discovered what we think may be the next great consumer growth market in the United States . . . electronic cigarettes. Your eyes are not deceiving, e-Cigs have the potential to be an almost 10-bagger in terms of market share growth over the next decade. On Wednesday, we are hosting a call with the CEO of one of the few e-cig pure plays who will give us an update on the market. Email email@example.com for details.
We’d be remiss if we didn’t end this note with a line from one of our favorite songs from Johnny Cash:
“I keep a close watch on this heart of mine,
I keep my eyes open all the time.
I keep the end out for the tie that binds.
Because you’re mine, I walk the $LINE.”
Our immediate-term Risk Ranges for Gold, Oil, US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1361-1404, $103.74-106.22, $80.09-81.21, 93.24-96.42, 2.07-2.29%, 14.57-18.69, and 1605-1652, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
daily macro intelligence
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TODAY’S S&P 500 SET-UP – July 2, 2013
As we look at today's setup for the S&P 500, the range is 42 points or 1.42% downside to 1592 and 1.18% upside to 1634.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.11 from 2.13
- VIX closed at 16.37 1 day percent change of -2.91%
MACRO DATA POINTS (Bloomberg Estimates):
- 7:45am/8:55am: ICSC/Redbook weekly retail sales
- 9:45am: ISM New York, June (prior 54.4)
- 10: Factory Orders, May, est. 2% (prior 1%)
- 10am: IBD/TIPP Economic Optimism, July, est. 50 (prior 49)
- 11am: Fed to buy $1.25b-$1.75b debt in 2/15/36-5/15/43 range
- 11:30am: U.S. to sell 4W bills
- 12:30pm: Fed’s Dudley speaks on economy in Stamford, Conn.
- 4:30pm: API crude, oil product inventories
- 5:45pm: Fed’s Powell speaks on regulation in N.Y.
- Fed governors meet on final rulemaking for Basel III, 9:30am
- SEC holds closed mtg on enforcement matters, 11am
- House, Senate not in session
- Senate Appropriations Chairman Barbara Mikulski, D-Md.; Commerce Secretary Penny Pritzker hold news conference following tour of NOAA Center for Weather and Climate Prediction. Riverdale, Md., 10:30am
- USTR holds mtg on Japan’s participation in TPP talks, 9:30am
- Kerry participates in ASEAN Regional Forum in Brunei
WHAT TO WATCH
- Federal Reserve set to vote today on Basel capital ratios
- June auto sales; SAAR may be best since Dec. 2007
- Nielsen Holdings to replace Sprint Nextel in S&P 500
- Linn, LinnCo disclose informal SEC inquiry over Berry deal
- Honda, GM to jointly develop fuel-cell systems, Nikkei says
- Tyco gets notices increasing co.’s taxable income by ~$2.9b
- AMR-US Airways deal investigated by 19 state attorneys general
- Immigration bill details to benefit contractors, WP says
- Swiss Re, Lloyd’s examined for possible Iran violations
- L-T care insurance rates rise on fewer providers, WSJ says
- Constellation Brands (STZ) 7:30am, $0.40
- Acuity Brands (AYI) 8:25am, $0.89
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Gold Climbs for Third Day to Extend Rebound From 34-Month Low
- Gold Traders Seeking Floor After $66 Billion Rout: Commodities
- WTI Crude Trades Near Two-Week High as Stockpiles Seen Falling
- Wheat Snaps Slump as Egypt Issues First Tender Since February
- India Urges Resisting Gold as Curbs Fail to Stem Currency Slump
- UBS Starts Gold-Vault Service in Singapore Amid Bullion Rout
- Goldman Outlook Right as Brent-WTI Narrows to $5: Energy Markets
- Palm Oil Drops to Six-Week Low as Weak Rupee Curbs Indian Demand
- Rebar Rises on Higher Ore Prices, Town Redevelopment Optimism
- 90% of EU Oil Demand Growth Stems From Outside OECD: Bear Case
- Crude Supplies Fall to Four-Week Low in Survey on Refinery Runs
- Palm Oil Seen Dropping to Lowest Since May: Technical Analysis
- Chinese Aluminum Production at All-Time High in May: BI Chart
- Tin Reaches a Two-Week High Before Report on U.S. Factory Orders
The Hedgeye Macro Team
With the exception of Burger King, the Street is expecting a continued recovery in same-store sales trends for the biggest QSR chains in 2H13. The following is a look at what each chain will be promoting for the balance of 2013 in order to drive incremental customers.
WEN - Wendy’s
- Pretzel Bacon Cheeseburger – the national rollout of the summer LTO will begin by July 4th weekend in the U.S. and Canada and could potentially become a permanent menu item
- Berry Almond Chicken Salad – returned at the end of May for its yearly appearance
- Strawberry Tea and Strawberry Lemonade
- Waffle Cone Frosty
HEDGEYE – Expectations are high for the Pretzel Bacon Cheeseburger. The product is different enough to potentially generate significant trial. The retail price for the burger is expected to be $4.69, which is an expensive burger, particularly when most consumers are looking for items with better value. Given the extremely difficult comparisons in 2Q13 and 3Q13, management is relying upon the new burger to drive traffic and check. Street expectations are for a 1.0% increase in 2Q13 same-store sales. We believe that the turnaround at Wendy’s is going to take time.
Given that this recent run has been driven largely by multiple expansion rather than earnings revisions, we expect the stock to “take a breather” at this point. Due to a lack of catalysts, it will be difficult for the stock to continue on its current trajectory. We believe the next two quarters are likely to see choppy top line performance from WEN.
YUM - Taco Bell
- Will continue to build on the Doritos Locos Tacos and Cantina Bell platforms
- Cool Ranch Doritos Locos Tacos – expected to be a strong performer in 2Q13
- Will release a third flavor of Doritos Locos Tacos “soon”
- New Cantina Double Steak Quesadilla
HEDGEYE – Taco Bell is up against a 13% comparison from last year. The trends in 1Q13 suggest that Taco Bell will be see same-store sales down by 1% in 2Q13 compared to Street expectations of a 1.3% increase. While this might be slightly disappointing, it is insignificant relative to the poor trends the company is seeing in China. YUM has underperformed the S&P 500 by 820bps year-to-date and it is our view that the company’s performance in 2Q13 will do little to change the Street’s perception.
MCD - McDonald’s
- New variations of the Quarter Pounder will replace Angus Burgers
- New Egg White Delight option on breakfast sandwiches
- McCafe Blueberry Pomegranate Smoothie
- McCafe Dulce de Leche Shake
- Premium McWraps
HEDGEYE – Despite all that MCD has going on, we don’t believe the company’s performance is going to match the lofty expectations embedded in the numbers for 2H13. While expectations are reasonable for McDonald’s USA to post 1.6% same-store sales in 2Q13, we suspect that 3% same-store sales estimates for 2H13 are too aggressive. We remain bearish on MCD.
BKW - Burger King
- Soft Serve Cones – $0.50 item will be available through August 4th
- New Summer BBQ-themed menu
- New Rib Sandwich (reminiscent of the MCD McRib)
- Return of the Memphis BBQ Pulled Pork Sandwich
- Carolina BBQ Whopper
- Carolina BBQ Chicken Sandwich
- Return of Sweet Potato Fries
- Buffalo Chicken Strips
- Frozen Lemonade and Frozen Strawberry Lemonade
HEDGEYE – We do not see anything in Burger King’s new product pipeline that suggests the company will separate itself from others in a very competitive QSR landscape. BKW is comparing against 4.4% same-store sales growth and we believe the Street estimate of a 1.4% same-store sales decline in 2Q13 is too conservative. It is very possible that 2Q13 same-store sales could be down nearly 2%. We continue to believe the fundamental issues in the business model and the cash flow pressure on franchisees will prove to be two major headwinds sometime in the future; in the meantime, however, positive restaurant industry and macro data continue to support the stock.
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