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Larry Summers = Bad News

Takeaway: This is not the guy you want running the Fed.

Earlier today, on Hedgeye's morning conference call, Hedgeye CEO Keith McCullough was asked the following question by a Hedgeye client.

 

Q. In the past few days you have remarked that Larry Summers would be unfit for the role of Fed Chairman. Can you explain exactly what the appointment of Larry Summers would mean to the markets?

 

 

Larry Summers = Bad News - summ1

 

KM: The problem with Larry Summers is number one, he’s not a risk manager. He blew up the Harvard endowment. Royally.

 

Number two, he’s equally, if not more dogmatic than Ben Bernanke. Number three, getting more of a personality, or more personal opinion into all this. That is is one of the big issues I obviously have with Bernanke and the Fed overall. It’s an unelected, unaccountable post.

 

If you have ever had a meeting, or done a breakout session with Larry Summers, and you have any knowledge whatsoever on the subject matter, you’re going to see pretty plainly that he is one of the more condescending guys out there in terms of talking down at people. When somebody does that, typically you would expect them to be like Tiger Woods used to be, somebody who is literally perfect, someone with a perfect track record. 

 

But this guy has been so wrong, for so long, but rarely, if ever in doubt. That’s the kind of thing that scares the hell out of me. He really is scary.

 

And I think if you were to fast-forward six to twelve months from now, and this guy is running the show, and the dollar is going down every day, that’s your bear case. He would be the biggest threat to the US currency since, well since Ben Bernanke. 

 


CAT: When 795F’s Fly

Summary

 

CAT reported a disappointing quarter and again lowered guidance.  Earnings summaries abound and we’ll keep our comments to just three key topics:

  • CAT On the Roof:  Guidance is still too high for 2013 and management is still letting us down easy.
  • Backlog Decline Matters, Too:  The drop in backlog more than offset the 2Q dealer inventory liquidation excuse.  When dealer inventories and backlog changes are stripped out, there is nothing particularly interesting about 2Q revenue (i.e. it reflects underlying demand).
  • Pricing Down:  CAT has often cited 2009 pricing strength as a reason not to worry about Resource Industries.  Pricing was down in 2Q and the incremental mining capex declines in 2014 are likely to accelerate pricing pressure.  We see risks to oil & gas capital spending in Power Systems, where pricing held in 2Q.

 

If you are interested in other items, like the growth in receivables with reserve release, lack of transparency, or the impairment charges/restructuring that we expect to be announced in the next month or so, feel free to ping us.  We have been negative on CAT for over a year and our thesis appears to be playing out well.

 

 

They Can’t Do $6.50, EitherTo hit guidance, CAT’s margins in 2H would need to improve ~30% vs. 1H with NEGATIVE MIX and NEGATIVE PRICING in Construction Industries and Resource Industries.  Sure, that might happen – and 795F Trucks might fly.   As we have written repeatedly – CAT is letting us down easy (gradually) and we have a tough time getting to $6.00 in 2013 EPS.  This is just a rough sketch of guidance - not what we expect, which we published here:

 

CAT: When 795F’s Fly - re1

 

 

Guidance also excludes whatever charges the company takes when it announces further cost reductions in the next month or so.  On the topic of a potential BUCY impairment, Bradley Halverson stated “we certainly wouldn’t be using a cyclical low straight-line going forward,” which we assume was meant to imply that these 2Q results are cyclical low results.  That is odd, because the survey CAT referenced suggested that mining capex is not at a cyclical low – it is going 20% lower next year.  Expect impairment charges in coming quarters.  (We would bet that a BUCY impairment charge comes with a CEO severance charge, too.) 

We factor in share repurchases in the table above.  However, on the call management said that “Repurchasing stock in a downturn has been a key part of our cash deployment strategy.” As we will see discuss below, there hasn’t been much of a downturn yet.  They have been repurchasing cyclically inflated shares, in our view.

 

Backlogs vs. Dealer Inventories – This Is Normal:  CAT said revenues in the quarter were negatively impacted vs. “end-user demand” by the decline in dealer inventories.  We are all supposed to back that out and expect an acceleration as soon as dealer destocking is finished.  However, revenues were puffed-up vs. “end-user demand” by the decline in backlog (i.e. revenues recognized in this quarter from end-user demand in prior periods).  Management doesn’t mention the draw on backlogs, but it undermines the dealer inventory drawdown excuse for the 2Q 2013 miss.

 

CAT: When 795F’s Fly - re2

 

 

When adjusted for both the change in dealer inventories and the draw on backlog, 2Q results do not look nearly as weak.  They actually look fairly normal – even sequentially better.  We think this is a better metric for evaluating normalized results.  Second quarter results are not depressed so much as prior results were inflated.  With most of the mining down-cycle still ahead, 2Q results do not appear to be abnormally low, with a spring back just around the corner.

 

Importantly, the favorable back half guidance does not mark the bottom – it marks another pending guidance cut, as previously noted.  To hit the current revenue guidance, management will need to draw heavily on its order backlog (the effect of which we left at zero in the table).  CAT would need to draw backlog down by $1-$1.5 billion in each of the next two quarters to have a shot at hitting the new revenue guidance, in our view.  Leaving 2013 with a drained backlog would likely reset 2014 expectations much lower.

 

Some Additional Notes on Dealer Inventory Excuse

  • First, 2013 is not a bad year for the mining industry – that is delusional.  2002 probably was, when many mining companies were suffering heavy losses.  Mining can get really ugly. 
  • Second, one should ask why management allowed dealers to get stuffed with customized mining inventory and why they aren’t being more transparent on cancellations (A $19.3 billion order backlog and excess CAT inventory is an oddly tough position to get into). 
  • Third, the comparison of dealer deliveries to end-user demand is misleading, in our view.  Comments in the release like “would have needed to increase more than 50 percent to match what dealers were delivering to end users” mismatch the timing of that demand.  Deliveries are a function of demand when orders were placed, which might be quite a long time ago.  Aggregate dealer orders would be useful, but those are not provided.
  • Finally, from what we can see of dealer inventories (Finning, Toromont, other public dealers) they don’t look low at all.  We’ll see where they come out at 2Q end.

 

Pricing Down

 

Resource Industry Pricing Weakness:  A major leg of the “don’t worry, be happy” view of Resource Industries is that pricing actually increased slightly in the 2009 downturn.  It may have only been a ~1% decline in 2Q, but it is something they implied would not happen.  This industry has too much capacity and we believe that pricing will get much worse as volumes drop into 2014.  It is hard to model stable margins with price declines, excess inventory and overcapacity (and a lack of disclosure on aftermarket vs. new equipment).

 

On Mining Equipment - “Yes, I mean, if I go back to the end of the first quarter when we adjusted the guidance for the year, at that point in time, we talked about the price realization for the year being positive about 1%.  That's not much of a change from what we were thinking from January. It's been tight, but the idea that there is giant discounting or something like that going on is just not the case. Even in 2009 we had a 3% price increase. I mean, so it's not as sensitive, I think, as most people think either going up or going down.” - Michael DeWalt 6/5/2013 i.e. recently

 

Power Systems Next?  Oil & gas capital spending should follow a similar pattern as mining’s if oil & gas prices remain stagnant.

 

 

CAT: When 795F’s Fly - re3

 

 

Conclusion:  The decline in resources-related capital spending is a multi-year return to normal levels, not a decline from them.  CAT finally acknowledged that mining capex (a portion of resources-related capital spending) isn’t rebounding in 2014.  We don’t think it rebounds for – well- decades.  We also think that oil & gas related capital spending could be the next shoe to drop for CAT.

 

 

 

 


UA Nailed The Q, But Don't Chase It

Takeaway: In line with our view that UA would beat bc of revs and gross margins. But we definitely would not chase it here.

UA's beat was in line with our comments from earlier this week that revenue trends were looking strong, and the favorable spread between sell-in and sell-though on top of a lean inventory base headed into the quarter suggested a favorable gross margin set-up (see comments below). Lo and behold, UA came out and beat on revenue and printed its biggest gross margin improvement in three years. Simply put, UA continues to achieve its growth goals with impressive consistency. We've got to give credit where it's due.

 

Despite the solid numbers, there were a few things that bugged us.

1) Inventories were high -- +29% vs revenue growth of 23%. This reverses the positive sales/inventory trend we've seen for the past three quarters. Granted, it is consistent with the company's guidance that inventories would build to ensure that they have sufficient product headed into back-to-school and Holiday. But the dynamic is notable.


2) With all the talk about International opportunity on the conference call, you'd think that UA was knocking the cover off the ball outside the US. Yes, sales were respectable at 22%, but it grew modestly below the rate of the US business. UA made it clear that 2014 would be the year for Int'l to really accelerate. But the reality is that UA's Int'l success is kind of like Bigfoot -- lots of hype, but we have yet to actually see it.

  
3) Footwear surprised us on the downside. While 21% growth is respectable, we think it should be at least 2x that rate for a company with UA's growth runway. On one hand, we like that it is being very deliberate and cautious with the launch of Speedform -- and not flooding the market with product. But we balance that with the simple fact that UA has 1% share of an industry that is absolutely begging for someone to step up and become a viable alternative to Nike.

 

When all is said and done, we like the TAIL call on UA -- as there are not many companies that we think can grow top line in excess of 20% for 5+ years. On the flip side, this is absolutely not a margin story. What you get in top line is what you get in EPS growth. That's all, and  nothing else. That's not half bad given that the company can feasably triple in size.  But there are other names like RH, FNP, (and to a lesser extent) WWW that have similar Blue Sky opportunity but with significant margin and return upside as a kicker. We can justify the higher multiples with those stories more easily than with UA. We'd prefer to step in and buy UA when there's more controversy on the name, or  when the company is hitting a near-term speed bump in one of its new business initiatives. That's certainly not what we have today.

 

UA Nailed The Q, But Don't Chase It - uafinstat

 

 

 

07/22/13

UA: OUR THOUGHTS HEADED INTO THE PRINT

Takeaway: Expectations aren't low into UA's print, but based on trends we're seeing, they shouldn't be. If we were forced to bet, it'd be positive.

 

CONCLUSION: UnderArmour footwear and apparel trends look solid headed into Thursday's print, especially in comparing wholesale sell-in versus retail sell-through. Retail inventory implications are bullish, and combined with a positive sales/inventory spread trend at UA, it's left with a particularly positive Gross Margin set-up. That's a big plus, because at 35x EPS it needs to beat, and expectations aren't low. If we had to make a bet one way or another (which we don't), we'd come out with an upwards bias.

 

DETAILS 

We think that UA's trends look quite positive headed into its print on Thursday.  Our analysis shows that a) sell-through of apparel continues to outstrip sell-in, b) footwear is doing so at even a greater rate (and the Speedform launch is gaining traction), and c) the Gross Margin set-up is bullish given easing product costs and a favorable sales/inventory spread.  All that said, we think that these trends are necessary to materially beat consensus estimates (a beat is critical for a 35x p/e growth stock). The good news is that our sentiment monitor suggests that this name remains extremely hated, which is a bullish stock setup.

 

One of the few risks we'd point to is if UA comes out and takes up SG&A requirements to grow the business as initiatives into Footwear and International markets become more important. This had been a concern of ours for a while, but after the company's analyst meeting last month we threw in the towel and altered our view (and our model) such that it could attain 20% top line growth without having to take the margin levels of the company sub-10%.  But if it nudges up spending rates again after just having the investment community in Baltimore to sell its strategy -- then there are going to be credibility issues. We'd be surprised if this turns out to be the case.

 

So when we put it all together, we think that this is one of times where the consensus has it about right,  but if we had to make a bet one way or another (which we don't), we'd have an upward bias. 

 

UNDERARMOUR'S APPAREL RETAIL SALES HAVE BEEN GROWING AT A RATE FASTER THAN ITS WHOLESALE SELL-IN

UA Nailed The Q, But Don't Chase It - ua app sellin

Source: SportscanINFO and Hedgeye

 

UNDERARMOUR'S FOOTWEAR BUSINESS HAS BEEN OUTSTANDING -- AGAIN, WITH RETAIL OUTSTRIPPING WHOLESALE

UA Nailed The Q, But Don't Chase It - fwsellin

Source: NPD and Hedgeye

 

SPEEDFORM HAS BEEN A RECENT DRIVER FOR THE FOOTWEAR BUSINESS. THIS IS THE MOST COMMERCIAL LAUNCH UA HAS HAD TO DATE

UA Nailed The Q, But Don't Chase It - uafast

Source: UnderArmour

 

THE GROSS MARGIN SET-UP IS SOLID THANKS TO AND EXTREMELY FAVORABLE SALES/INVENTORY SPREAD AND FAVORABLE PRODUCT COSTS

UA Nailed The Q, But Don't Chase It - uagmsis

Source: Company Reports and Hedgeye

 

OUR SENTIMENT MONITOR SHOWS THAT THIS STOCK REMAINS VERY HATED

UA Nailed The Q, But Don't Chase It - uasentiment

Source: Hedgeye


Early Look

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LO – Strong Newport Performance and E-Cig Excitement

Lorillard saw strong share and pricing gains and big volume improvement over the industry in its Q2 results.  Total domestic volume decreased -1.7% compared to the prior-year quarter, versus a -6.1% decline for the industry, and versus -6.0% for RAI, on the back of strong performance from Newport, with a volume decline of -1%.

 

With 74% share of the full-flavor menthol market, Newport continues to be its profit center, however there was much excitement about its electronic cigarette (e-cig) Blu as it increases distribution (more below).

 

The company gave very little FY guidance beyond similar performance to Q2. Below we present our quantitative levels for the stock and think that the recent pullback based on the FDA’s announcement on menthols (more below) is overdone, at least over the next 60 day period of public comment. If LO can close above its TRADE line of $44.84, we think there is immediate term upside in the range of $47-48.

 

LO – Strong Newport Performance and E-Cig Excitement - VV. LO

 

 

On the FDA and Menthol: questions on the call centered around the FDA’s announcement on Tuesday on menthol cigarettes. Given that LO has 80% of its portfolio in menthol (versus  ~ 30% for RAI and ~18 for MO), LO was quick to acknowledge that its stance is broadly in line with the FDA, namely that if one looks at the body of science on menthol versus non-menthol cigarettes, there is not enough data to conclude that there’s a disproportional health effect from menthol versus non-menthol . LO also agrees with the FDA’s conclusion that it needs more data to make this determination. As it stands, there is a 60 day public comment period, and neither the FDA nor LO have any indication on a time-table for future releases or announcements from the FDA on the issue, but LO expects the process to be massive.

 

 

On E-cigs:  e-cigs were a hot topic on the call (similar to RAI yesterday).  LO acquired its e-cig brand Blu Ecigs in April 2002 for $135MM.  LO reported that Blu achieved net sales of $57MM in the quarter with over a 40% retail market share. In the quarter it added its e-cigs to30K retailers to bring its total to 110K retailers.

 

LO said Blu’s topline grew year-over-year, but was flat sequentially due to the rollout of its new rechargeable kit. LO only sold rechargeable Blu units in 2 of the 3 months of the quarter as it took one month to draw-down inventory of its old model before the June 24th launch of its new model to replace the older version.

 

LO, unlike RAI or PM, was very bullish in its commentary on repeat purchases of its e-cig, and confident that although the new rechargeable kit is sold at break-even for the company, the razor-razor blade model of the kit-cartridge will prove profitable.  As of Q1 2013 (no update on the call), disposables accounted for 51% of its e-cig sales. Clearly the company will be pushing to expand its more profitable rechargeable business at the expense of less profitable disposables, and we think the new rechargeable is a catalyst for this shift, and should be margin enhancing as distribution and investment behind the brand expand.

 

Feedback according to CEO Murray Kessler on e-cigs from retailers is very positive given the opportunity for higher margins versus other tobacco offerings.  On who is switching to e-cigs, Kessler offered up its typically users of less tar cigarettes. He added, this is another reason why he expects less cannibalization with its full-flavored menthols or even its new Newport non-menthol Golds.  

 

 

What we liked:

  • In the quarter, net sales increased 4.2% over last year to $1.804 billion. EPS grew 15.3% to $0.83
  • Volume outperformance of -1.7% versus industry at -6.1%
  • Total Lorillard retail market share of cigarettes increased 0.6 share points to 14.9% driven by Newport menthol, even as the menthol category becomes increasingly more competitive
  • Domestic retail share of the menthol market reached 40.2%, an increase of 0.9 share points versus the prior-year quarter
  • Cigarette net sales increased $24 million, or 1.4%, to $1.747 billion
  • The increase in cigarette net sales resulted primarily from higher average net cigarette selling prices, partially offset by lower cigarette unit sales volume
  • Blu Ecigs achieved net sales of $57MM and over a 40% retail market share

 

Matthew Hedrick

Senior Analyst


RCL 2Q 2013 REPORT CARD

In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance

 

 

OVERALL:  

  • IN-LINE:  As seen by our recent pricing surveys, weaker Caribbean market and aggressive pricing is being offset by a steadily improving Europe market for Royal Caribbean. FY 2013 guidance remains relatively unchanged.  Caribbean pressures should not be any comfort, particularly to Carnival. 

RCL 2Q 2013 REPORT CARD - 111

RCL 2Q 2013 REPORT CARD - 2

 

ONBOARD REVENUE

  • BETTER:  2Q onboard yields were up a whopping 8.2%.  Gaming, beverage, specialty restaurants, shore excursions all outperformed.
  • PREVIOUSLY:  "We saw improvement in all categories for onboard revenue. Ships that have been recently revitalized and vessels sailing on new itineraries did particularly well."

CARIBBEAN

  • WORSE:  Mgmt reduced Caribbean expectations for the rest of FY 2013 as pricing competition has picked up recently
  • PREVIOUSLY:  "Over the last few weeks though, we have seen an improvement in booking activity and we are still forecasting record yields for the Caribbean."

BOOKINGS CURVE

  • SAME:  Booking window has been expanding  
  • PREVIOUSLY:  "On average, our guests are booking their cruise about two weeks earlier this year than they were in 2011 and 2012. In fact, the booking curve has looked strikingly similar to 2008 for the last several months."

EUROPE

  • BETTER:  Mid single-digits ticket yield growth is above expectations.  Mgmt is more comfortable with the outlook on Europe and is optimistic on this market in 2014.  
  • PREVIOUSLY:  "We considered our European summer revenue projections to have more risks attached to them in comparison to other spheres of deployment. Although there is still somewhat limited visibility for all of our summer deployment, at this juncture, in Europe, we are sufficiently ahead of 2012 on both rate and occupancy, to be comfortable that our European deployment is of comparable risk to our other programs."

CHINA/JAPAN

  • SAME:  one of the drivers which lowered yield expectations for the year.  The terriotory disputes have resulted in 30 modified sailings and increased bookings volatility.  China is 3% deployment for 2013.
  • PREVIOUSLY:  "Turning to China, the region that represents 5% of our capacity in 2013. The hostility between Japan and China surrounding the disputed islands in the East China Sea continues to affect our itineraries and our demand generation. We have now removed the Japanese ports of call from nearly all of 2013's North Asia program. As a result, most itineraries from our China homeport of Shanghai and Tianjin are calling only on ports of call on South Korea."

AUSTRALIA

  • SAME:  Increased capacity continues to pressure yields in this market
  • PREVIOUSLY:  "In the near-term is flat to slightly lower yield outlook for us for this year. we would expect that Australia, as a southern summer market, would continue to grow and be a mainstay of the cruise industry going forward."

PULLMANTUR

  • SAME:  Has been lagging its competitiors.  RCL recently opened a new head office in Latin America.
  • PREVIOUSLY:  "Pullmantur's performance is inevitably affected by that [Spain] very strongly and that's been a big disappointment and I don't see any quick turn away from massive improvement given the economic situation."

Initial Claims: Good, But Less Good

Takeaway: The rate of improvement in the labor market slowed notably this past week, but we're not going to get excited by one week of data.

This past week, rolling Non Seasonally Adjusted (NSA) initial claims were 8.8% lower than the prior year. This marks a decelerating rate of improvement vs the prior week, when rolling NSA claims were better by 10.6%. On a single week basis, NSA claims were 0.8% lower than the previous year, a sharp deceleration vs the prior nine prints of: -9.9%, -13.3%, -9.4%, -9.2%, -7.7%, -11.7%, -9.4%, -7.6% and -8.0%. 

 

Initial Claims: Good, But Less Good - roll

 

A possible explanation is that we're eclipsing the auto plant closings, which create significant NSA volatility. Recall that this year, due to heavy demand, there were far fewer auto plant shutdowns than in the corresponding periods last year. That said, the auto dynamic is a two-week phenomenon, so it wouldn't explain the deviation from the trend we've been seeing the last nine weeks.

 

Bear in mind that in less than six weeks, we'll shift out of the seasonally-adjusted data headwind period into the data tailwind period, which will last six months from September through February, 2014.

 

The Data

Prior to revision, initial jobless claims rose 9,000 to 343,000 from 334,000 week-over-week, as the prior week's number was revised up by 2,000 to 336,000.

 

The headline (unrevised) number shows claims were higher by 7,000 week-over-week. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -1.25K week-over-week to 345.25K.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -8.8% lower year-over-year, which is a sequential deterioration versus the previous week's year-over-year change of -10.6%

 

Initial Claims: Good, But Less Good - roll2


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