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Bullish: SP500 Levels, Refreshed

This note was originally published July 17, 2013 at 12:24 in Macro

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Best news of the day is that Bernanke wasn’t dovish enough to satisfy the begging from Gold Bond bulls. #StrongDollar is holding support, and that, ultimately, is a good thing for what’s been working for 6 months – long US Growth.

 

Across our core risk management durations that matter, here are the lines that matter to me most:

  1. Immediate-term TRADE resistance = 1701
  2. Immediate-term TRADE support = 1661
  3. Intermediate-term TREND support = 1602

Higher-lows of support and higher-all-time-highs of resistance will continue to be bullish until they are not.

  1. We want to be buying growth on red days (bought TSLA and NKE on red yesterday)
  2. We want to be shorting bounces in bearish growth trades (Gold, Bonds, etc) on green days

Staying with our 2013 process because it’s still working,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Bullish: SP500 Levels, Refreshed  - keithchart


WEN – THE CURRENT PAIN TRADE

As highlighted in the two charts below, WEN short interest has risen from 7.9% at the end of 1Q13 to 13.97% today.  In addition to the high short interest, 19.0% of analysts currently rate WEN a Sell compared to 23.8% of analysts that rate stock a Buy.

 

We were previously of the view that the run in WEN was over and the stock was likely “to take a breather,” as its price performance was largely driven by multiple expansion rather than earnings revisions.  Admittedly, there are a lot of names in the restaurant industry currently trading with stretched valuations.  However, our opinion on Wendy’s is changing as the new Pretzel Bacon Cheeseburger appears to be exceeding expectations.  Since the July 4th launch, we are hearing that same-store sales are running well into the double digits thus far.

 

How much of the recent spike in the stock is due to short covering rather than new buyers remains unclear.  That being said, at 13.97% short interest, we anticipate more short covering and potentially some upgrades coming out within the next few weeks.

 

The recent success of Wendy’s new product launch gives us more conviction that MCD continues to struggle amidst an increasingly competitive environment.

 

WEN – THE CURRENT PAIN TRADE - WEN SI2

 

WEN – THE CURRENT PAIN TRADE - WEN RATE

 

 

Howard Penney

Managing Director

 


KMB HEADWINDS BUILDING

An aggressive share repurchase program and strong share price momentum year-to-date has led to some discomfort for KMB bears. We would avoid the long side in this name ahead of the 7/22 2Q earnings print.

 

 

Conclusion

 

A bear case is emerging in this stock; a steep valuation (17.5x NTM earnings) with 3-5% top line growth and the commodity headwind stiffening. EBIT growth has largely been driven by cost savings and benefit from raw materials costs over the last year. We would not be short – yet – but believe that investors looking for longs in staples should look elsewhere. According to our macro team’s quantitative levels, the stock has climbed back above its TREND line, on low volume. A chart illustrating these levels is below.

 

KMB HEADWINDS BUILDING - kmb levels

 

 

1Q Strength Likely Faded in 2Q

 

We would expect 2Q results to be sequentially weaker in terms of operating leverage and sales growth as the company recently highlighted a “cautious” U.S. consumer. Slowing growth in emerging markets (over 20% of KMB revenue) is likely to weigh on consensus’ outlook on K-C International (KCI) for the balance of the year. The value of the US Dollar, over the intermediate- and long-term, is important for KMB as it looks to grow its presence in emerging markets. That said, 1Q was the most difficult compare of the year, so we will be watching EBIT growth and listening for any related commentary on how income growth is likely to trend over the balance of the year.

 

 

EBIT Growth Puts and Takes

 

Management has stated its confidence in finding cost savings in the $250-300 million range, annually, going forward. This will help the company leverage its sales growth but we believe, unlike in 2012, raw material costs are likely to offset cost savings for the remainder of the year. As we mentioned in our 6/10/13 note, “KMB – REMOVING FROM OUR BEST IDEAS LIST”, “[in February] KMB gave its planning assumption of northern bleached pulp at $890 - $910 per metric ton and oil at $90 - $100 per barrel. In total, the Company guided to $150 - $250 million in cost inflation.” With crude oil prices at $105 per barrel and NBSK Pulp steadily rising year-to-date to $947 currently, we will be interested to see if management addresses the topic of input costs on July 22nd.

 

The first chart, below, offers an illustration of year-over-year EBIT growth, in dollars, versus the year-to-year impact of cost savings and raw material costs on the P&L. Those line-items, in aggregate, are likely to be less of a tailwind in each of the remaining quarters.

 

KMB HEADWINDS BUILDING - kmb ebit growth

 

KMB HEADWINDS BUILDING - kmb raw materials

 

Rory Green

Senior Analyst

 


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Our Bear Call on Cat Gets Some Company

Editor's note: The following research note on Caterpillar (CAT) by Hedgeye Industrials Analyst Jay Van Sciver was originally published June 24, 2013, which also happens to be the date we added CAT to Hedgeye's "Best Idea" list. As you may have heard, earlier today famed short-seller Jim Chanos outlined why he's now shorting Caterpillar which sent the stock tumbling over 2%. We have a great deal of respect for Mr. Chanos. We welcome him to the bear camp on CAT.

 

Our Bear Call on Cat Gets Some Company - jimbo

 

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

 

Summary

 

We have published a number of reports outlining the bear case on CAT (for example, see herehere 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 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.

 

Our Bear Call on Cat Gets Some Company - cat1

 

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.

 

Our Bear Call on Cat Gets Some Company - CHART2


Bullish: SP500 Levels, Refreshed

Best news of the day is that Bernanke wasn’t dovish enough to satisfy the begging from Gold Bond bulls. #StrongDollar is holding support, and that, ultimately, is a good thing for what’s been working for 6 months – long US Growth.

 

Across our core risk management durations that matter, here are the lines that matter to me most:

  1. Immediate-term TRADE resistance = 1701
  2. Immediate-term TRADE support = 1661
  3. Intermediate-term TREND support = 1602

Higher-lows of support and higher-all-time-highs of resistance will continue to be bullish until they are not.

  1. We want to be buying growth on red days (bought TSLA and NKE on red yesterday)
  2. We want to be shorting bounces in bearish growth trades (Gold, Bonds, etc) on green days

Staying with our 2013 process because it’s still working,

KM

 

Keith R. McCullough
Chief Executive Officer

 

 

 

Bullish: SP500 Levels, Refreshed  - SPX


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