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GIS – Investor Day Take-Aways

Today GIS presented at its Investor Day in NYC; there were, however, few updates today versus its commentary on the Q4 2013 earnings call on 6/26/13. We will be looking to the next quarters to evaluate returns from its yogurt and cereal businesses, in particular, and its margin management results in the face of COGS headwinds in a year in which the company expects to raise the dividend 15% and buyback 2% of shares outstanding. Our fundamentally bearish view of the company remains, as expressed in the note titled “GIS – Not Much To Like”, however our quantitative model signals a bullish formation in the stock across its immediate term TRADE and intermediate term TREND levels.

 

GIS – Investor Day Take-Aways - vvv.gis

 

Here are the points of the business we are focused on:

  • Gross margins remain under threat for cereal, yogurt, and convenience meals
  • Cereal, its largest category, remains under pressure from demographic headwinds, particularly in America, despite increased advertisement spending; GIS is bullish on gradual improvement in the category following strong merchandizing from competitors in the beginning of year
  • Yogurt has more room to show improvement, following the Yoplait acquisition; we like the innovation and marketing push behind its new Greek style yogurt and the runway in the U.S. given the lower share penetration versus other geographies (like Canada or France)
  • Convenience meals remain off track and the company acknowledge the importance of returning to Helpers (core) versus its previous push towards a more artisanal offering
  • Input cost pressures of 3% will remain a headwind in 2014, which the company hopes to overcome through cost savings initiatives via Holistic Margin Management (HMM); expect some pressure on promotions
  • We like the expanding international footprint (34% outside of U.S. today vs 25% 5 years ago) and opportunity to increase cereal consumption in emerging markets. [Currently one half of GIS cereal volume is in the UK, Australia, Canada, and the U.S., which collectively only account for 6% of the world’s population]
  • Company’s consumer outlook is one of improvement in which shopper seeks best value, which GIS can capture with its reach across retailers: Grocery (50%); Supercenter (30%); and Other Channels (20%) = Costco, Walgreens, Dollar General, and Whole Foods

Matthew Hedrick

Senior Analyst


#RatesRising - Sector Study

We’ll introduce our detailed view on #RatesRising and the cross-asset class implications of the reversal in the 30Y bull cycle in bonds on our 3Q13 macro Themes call next Tuesday (July 15th, 11am). 

 

As a visual preview and for some historical context, the sector study below shows the average, relative Q/Q sector performance during periods in which the factor combination of:  Rising 10Y Yields, Expanding Yield Spread, and $USD appreciation all prevailed.  At n=7, the sample population isn’t overly large but we’d still view the output as instructive. 

 

General underperformance in defensives and outperformance in cyclicals isn’t particularly surprising.  Additionally, we’d note that given the policy catalyzed, positive relative performance in yield chase assets, the downside for sectors such as Utilities and Staples is likely larger than historical precedent would suggest.  

 

Further, in the context of our #StrongDollar and Bearish China/Emerging Markets view, the relative performance risk for Materials and select Energy & Industrials is likely to the downside vs the historical mean.  

 

In short, alongside continued TREND improvement in domestic Labor Market, Housing, Confidence and Credit metrics, we’re viewing the back-up in Treasury rates and expansion in the yield spread as a pro-growth signals.  

 

In terms of positioning, the 1H13 playbook remains largely in-tact with Consumer Discretionary and Financials the best way to find positive $USD and domestic consumption leverage at the sector level.  While equities are immediate-term overbought here (see today’s note: Overbought: SP500 Levels, Refreshed) we continue to like the absolute and relative growth setup for the U.S. and pro-growth oriented asset exposures.

 

#RatesRising - Sector Study - Sector Performance Rising Yields   Expanding Yield Spread    USD Appreciation

 

#RatesRising - Sector Study - 2013 MACRO FLOW

 

 

Christian B. Drake

Senior Analyst 

 


Growth Is Getting Paid

Takeaway: Beware the Antichrists of Growth.

The Antichrists of Growth (Gold, Treasuries, Utilities, etc) are still underperforming.

 

Just to give you an idea: Utilities (XLU) are down 0.5% on the month, whereas pro-growth Consumer Discretionary (XLY) is up 3.4%. A not-so-subtle 400-basis point divergence there.

 

Growth Is Getting Paid - Growths Dichotomy

 

Pro-growth Financials (XLF) are up 2.67% July-to-date. Gold? Hell on earth, scorched over 25% YTD.

 

As for Bill Gross, his 10-Year Treasury is down about 6% in the last three months; the S&P 500 is up over 5%.

 

Last but not least. The Russell 2000 is breaking out to new all-time highs, notching its second consecutive record high in as many days. It’s up 19% YTD. Many would acknowledge that the Russell 2000 breaking out is probably a pro-growth signal.

 

Here's another way of looking at it.

 

Growth Is Getting Paid - Risk Managing the Growth Trade

 

In other words, growth is getting paid. 

 

(This is an excerpt from Hedgeye Risk Management CEO Keith McCullough's morning call. If you would like more information on our services and how Hedgeye can help you please click here.)


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FDX: If Ackman Isn’t Buying FDX, He Should (Market Speaks)

Takeaway: If Ackman is not buying FDX, he should take a look. The move in FDX today indicates that FDX matches his criteria well.

Summary

 

We do not know if Pershing Square is planning to invest in FDX, but many of the characteristics described appear to be a solid fit.  FDX trades at a meaningful discount to UPS, despite having a more impressive franchise in many ways.   In concept, FDX offers a simple service and competes in an industry with very high barriers to entry.  The company’s topline is fairly predictable and FDX could generate substantial free cash flow if it ramped down capital spending (perhaps an issue for activism). The market cap is right, too.   If Ackman is not buying FDX, he should take a look.  The move in FDX shares today may be indicating just that – FDX matches his investment criteria well.

 

To review the opportunity at FDX, see our black book call here and write-up here.  We have also had expert calls on independent contracting at FedEx Ground and on FedEx’s relationship with an evolving USPS.  After all, if DHL can match competitor margins, FDX certainly can.  In short, we think FDX is one of the best long-term opportunities in the sector.

 

 

Timing Matters 

 

10-K Filing:  FDX is scheduled to release its 10-K around July 15th.  That matches the commitment timing for the Pershing investor commitments  of July 17th.  Reviewing the data released in the 10-K would be important before taking a concentrated, long-term position.

 

FY 4Q Express Margin:  As we expected and noted, FedEx delivered on its goal to improve the Express division margin in its FY4Q 2013 earnings release.  Gains should continue into FY2014 and FY2015 as the restructuring continues.  It is less risky to commit after the company has already made headway on a critical restructuring.

 

 

Upside in Restructuring

 

Revaluation Potential:  FDX matches peer margins in its Express division, we estimate that there is >50% upside in the shares (best case valuation of ~180, base case of 120-150, and a favorable  sum of the parts approach).  FDX has already started to generate improvements as of FY4Q 2013 results.  There is no point in activism without the potential to unlock value and even following today’s move, FDX has that potential in abundance.

 

Expectations Low:  FDX seems broadly misunderstood, with some analysts holding funny ideas about networks, leverage and contracts.   Investors have trouble trusting FDX and an activist might help with that.  Intentionally (in our view) weak guidance in the FY4Q earnings release has kept FY14 expectations for FDX very low relative to recent results.  If Ackman could just get management to guide less conservatively, there could be significant upside.

 

 

Activism at FDX?

 

Unwelcome, but Likely Useful:  We are not sure that activism at FDX will be especially welcome, but outside scrutiny of the Express segment restructuring is positive for shareholders.  FedEx can be a bit insular and may not pay enough attention to the wishes of shareholders (e.g. FY3Q earnings were a tough comp because of a previously undisclosed insurance reserve reversal at FedEx Ground in the prior period – that is not helpful). 

 

 

If He Isn’t, He Should

 

Ackman should buy a stake in FDX.  The move in the shares today should make that clear. 

 

 

 

P.S. BGG Could Use Some Activism, Too

 

In the event Mr. Ackman receives this, Briggs and Stratton should sell its Products segment.  Even declaring it a discontinued operation could make the shares pop, we think.


WWW: 2Q Another Milestone to $100

Takeaway: 2Q spot-on with our call that this is a $100 stock over 2-yrs. But we need some serious context around some overblown near-term factors.

WWW's 2Q print was spot-on with what we needed to see to remain confident in our call that this is a $100 stock over 2-years.  We think that the revenue hammer is cocked to add $1bn in sales over three years. This is accentuated by the margin story that reared its head meaningfully in 2Q and will get return on capital moving in the right direction after a 2-year decline.

 

One thing that became abundantly clear to us in listening to the conference call is how bifurcated the perception is on this name. We all know that Wall Street is naturally short-sighted, but easily 80% of the time on this marathon 80-minute call was allocated to near-term puts and takes that have no real bearing on what we think is relevant to the appropriate money-making thesis.

 

There were two factors in particular that were a big focus (and shouldn’t be). 1) The lack of guidance, and 2) Commentary around accretion of the PLG brands.

    1. WWW bowed out of the quarterly earnings game, and simply reaffirmed an annual revenue range while upping annual EPS guidance by a dime after a $0.13 EPS beat Q2. Combined with unidentified/unauditable expenses that were supposedly pushed out, and unquantified revenue that was pulled forward, WWW succeeded in spooking the Street into keeping back half estimates low.  We're at $2.86 vs. a consensus range for the year between $2.60-$2.75.
       
    2. PLG Accretion. Here's one where we've got to call a spade a spade. Either the company's forecast accuracy as it relates to acquisition accretion is simply horrendous, or they've artfully sandbagged the Street's expectations on a consistent basis. Consider the progression of expected accretion/dilution vs. actual results. Going into the year, WWW guided to Modest Accretion in 1Q, Slight Dilution in 2Q, and $0.35-$0.50 per share in accretion for the year. It ended up earning $0.34ps and $0.24ps in 1Q and 2Q, respectively, from PLG, or $0.58 combined. Now, even though at the beginning of the year it called for accretion in both 3Q and 4Q, it is taking down expectations for zero back half accretion.  Perhaps we'll fall victim to thinking there's a sandbag when one does not exist, but given the momentum of Sperry and Keds, we find it very difficult to get to a loss in 2H.

       

The near-term factor that mattered most, in our opinion, was the fact that the Performance division went from +8% in 1Q to -4.8% in 2Q. Simply put, Merrell, WWW's largest division, tanked.  We can talk all day about how a product like M-Connect is up double digits, but the reality is that Merrell has a huge division called Outdoor Lifestyle that sells the non-performance product in the portfolio.  We think that it was ignored immediately following the PLG acquisition, which is less than optimal given that it accounts for about 40% of the Merrell portfolio.  The good news is that the company made organizational changes over the past 3-6 months, and the order backlog for the brand in aggregate turned up to the point where management noted that it can grow low single digits for the year. We have no reason to believe that they're lying about order levels, and the channel is lean enough that we don't forsee outsized cancellation levels. In other words, we're going to give them the benefit of the doubt on this one.

 

Even better is that the full benefit of the Merrell reorganization will be seen at the beginning of 2014, which is also when we start to see a greater impact from the company scaling Sperry and Keds over the existing International infrastructure.  From a timing perspective, this is when we think people will really start to realize that WWW is much growthier than they otherwise think.

 

 

 

OUR THESIS

The Street is grossly underestimating the revenue growth opportunity as the legacy WWW scales its recently acquired brands over its global infrastructure.  We think WWW can and will add $1bn in sales to its $2.7bn base over 3-years. Under its former owner, Sperry, Keds, Saucony and Stride-Rite only generated 5% of its sales outside of the US, and most of that was in Mexico and Canada. Legacy WWW, on the other hand, is the most global footwear company in the world (yes, even more so than NKE and AdiBok), with 65% of units sold outside the US through an elaborate network of seamlessly-integrated third-party distributors. Given that the infrastructure is already in place, the incremental sales should be brought on close to a 20% incremental margin, versus 8% margin today. Similarly, minimal capital is needed on the balance sheet to grow these brands, making the growth trajectory over the next 3-5 years very ROIC accretive. The stock might look expensive at 20x earnings and 12x cash flow, but the street’s numbers are low by an incremental 10% per year. We're at $5.75 to the Street's $4.25 three years out.  We’d buy aggressively on a pullback, but are not so sure that will happen. We think WWW is a double over 2-3 years.

 

 

WWW: 2Q Another Milestone to $100 - 1

 

WWW PROFITABILLITY  ROADMAP (Components of RNOA)

WWW: 2Q Another Milestone to $100 - 2

 

 

 

 

 


SHORT BBEP and ROYT, Call Details

SHORT BreitBurn Energy Partners (BBEP)

SHORT Pacific Coast Oil Trust (ROYT)

 

CALL TODAY AT 1PM EST to discuss our theses on these two names.

  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 973882#
  • Materials: CLICK HERE (slides will download prior to the start of the call, email if issue)
  • Send questions to


Excerpt

 

We believe the high-yield energy equity space to be rich hunting grounds for short/sell ideas. 

 

The performance of Master Limited Partnerships (MLP) is particularly representative of the 2009 - 1H13 yield chase.

 

But behind the guise of what are commonly pitched to retail investors as low risk, high yield fixed-income alternatives, we are finding many instances of aggressive and irregular accounting (in most cases, non-GAAP measures and other “management metrics”), poor corporate governance, and grossly overvalued securities.  Many of these companies trade at ~30 - 50x earnings with low organic growth prospects, have low-to-negative FCF yields, and pay dividends/distributions well in excess of earnings or free cash flow. 

 

Our recent work on the short sides of LINN Energy (LINE, LNCO) and EV Energy Partners (EVEP) has provided a solid base to work from - we know what to look for. 

 

This report focuses on two high-yield energy short ideas: BreitBurn Energy Partners (BBEP) - an upstream MLP - and Pacific Coast Oil Trust (ROYT) - a BreitBurn-affiliated trust that is trading at 2x our 3P NAV.

 

Kevin Kaiser

Senior Analyst


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