The Estée Lauder Companies (EL) reports fourth quarter and full year fiscal 2013 earnings tomorrow before the market open. Fundamentally, we hold a favorable view of this stock but, at current levels, are waiting for price to confirm above the intermediate-term TREND line illustrated in the chart below.





Recent Underperformance: Over the last year, EL has underperformed versus the S&P 500 as well as Consumer Staples (XLP) and Prestige Cosmetics peers. Recent downgrades, coming as a result of a top-line miss in 3QFY13 and less consistent sales performance – according to industry data – have weighed on the stock’s performance.


EL – WAIT AND WATCH - EL px vs peers



What Would Get Investors Behind The Name: Our fundamental outlook for EL over the intermediate-term TREND duration is positive but we would stop short of taking on “open-the-envelope” risk ahead of the quarter. We believe the company’s demonstrated ability to grow its market share while improving operating leverage will continue to warrant a premium multiple.  Best-in-class earnings growth and a geographically well-diversified business model are key components of the story going forward. We expect investors to be focused on the following points during the upcoming earnings release and conference call:

  • Continuing margin expansion (SMI initiative)
  • Resolution of challenges stemming from SMI initiative
  • Growth runway in emerging markets
  • Resilience even in softer economies
  • Continuation of strong operating leverage



Rates Dynamic Makes Staples Less Attractive, What About EL? As discussed on Hedgeye Macro’s 3Q themes call, the prospect of rates rising is unfavorable for the XLP (and other sectors that have been sought after for yield). During 2009-2012, the data suggested that many investors sought out staples and other dividend-yielding, stable, sectors for a steady return on investment.  This would suggest that much of the capital flowing into staples may have been more focused on yield than fundamentals, which could result in that same capital exiting the group as expectations increase that the Federal Reserve tapers. We would argue that EL is likely to be less impacted by this individual factor than many other staples stocks because, unlike others in the space, the company has been rapidly growing earnings, expanding margins, and paying a meager dividend compared to its peers.


EL – WAIT AND WATCH - XLP vs 10 yr yield


EL – WAIT AND WATCH - EL vs 10 yr yield



Valuation is not a catalyst but we believe that EL, trading in line with slower-growth stocks such as CL and PG, could represent an opportunity on the long side, certainly relative to the XLP. At this point, however, we’re waiting to learn more tomorrow (8/15) as the company releases earnings and hosts its final earnings call of FY13 at 09:30 ET.




Rory Green

Senior Analyst




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NTI: A Lesson in DCF Management

Northern Tier Energy (NTI) – a variable distribution refining MLP – released 2Q13 results yesterday, with the key number being distributable cash flow (DCF) of $63MM, or $0.68/unit.


While the distribution declined 45% from 1Q13, the result was better-than-expected considering the collapse in the 3-2-1 crack (see chart below) and the fact that throughput was down 35% QoQ due to a planned turnaround at the Company’s lone refinery in St. Paul, MN.


This was a nice result for the General Partner (GP), and, coincidentally (or not), NTI announced after yesterday’s close that the GP (indirectly owned by ACON Refining, TPG, and NTI’s CEO) would sell another 11.5MM units (plus a 1.75MM underwriter’s option) to the public.  So far in 2013, the GP has sold 37MM units (including the deal announced yesterday), ~61% of its stake as of YE12 and ~40% of the total units out.


In our view, NTI may have played some games in the quarter to boost the distribution above what it otherwise would have been.


First, NTI did not take a reserve for turnaround expenses in the quarter.  NTI adds back actual turnaround expenses to DCF, but typically deducts a reserve for it each quarter so that there are not large, spurious declines in DCF owing to turnarounds (this makes sense if NTI is actually consistent with this process).  In each of 3Q12, 4Q12, and 1Q13 NTI deducted $10.0MM from DCF to reserve for turnaround expenses.  This quarter NTI reserved $0.0.  As a result, NTI is currently under-reserved for turnaround expenses by $18.1MM, having reserved $30.0MM but spent $48.1MM in the quarters since coming public.


On the conference call, management noted that they will again begin reserving for turnaround expenses in 3Q13.


The second curious item in the quarter is that capital expenditures deducted from DCF ("maintenance" and "regulatory" capex) came in at $13.5MM, 37% below the guidance of $21.3MM.  This was not a “beat.”  These capital expenditures were pushed out into future periods (or possibly considered expansion capex?).  Capital expenditures not deducted from DCF ("expansion" capex) came in at $28.9MM, $11.1MM above the guidance of $17.8MM.  In short, total capex was above guidance, the capex deducted from DCF was below guidance, and the capex not deducted from DCF was way above guidance.  That's a little suspect, in our view. 


These two items alone increased DCF in 2Q13 by ~$17.8MM ($0.19/unit), or 28%.


We were wondering yesterday why NTI would do this – after all, it is a variable distribution MLP (it shouldn’t be trying to smooth DCF).  But the announcement of the GP selling after yesterday’s close has given us a clue...


We think that NTI has now set itself up for even worse 2H13, beyond the collapse in refining margin (see chart), due to these moves to boost the distribution in 2Q13.  The maintenance and regulatory capital projects got pushed back and the Company will again be reserving for turnaround expenses to make up the delta between what’s been reserved for and what’s been spent ($18.1MM).  The manufactured DCF gains in 2Q13 will be DCF losses in future periods.


NTI: A Lesson in DCF Management - nti crack  


Kevin Kaiser

Senior Analyst

Early Look

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Bridgewater: When Good Ideas Go Bad

(Editor's note: Hedgeye Jedi Christian Drake from our Macro Team offers some thought-provoking observations regarding Bridgewater's issues with its All Weather fund (see Bloomberg story "Dalio Patched All Weather’s Rate Risk as U.S. Bonds Fell" for additional background)).

When good ideas go bad……

Bridgewater: When Good Ideas Go Bad - Stormy Weather Saguaro Cactus

If you hold a canonical 60/40 portfolio of stock/bonds, the risk adjusted exposure to bonds is not 40% - it's something less than that given that bond volatility/risk is lower than that of equities.  If however, you lever up the bond portfolio you can magnify fixed income returns, equalize equity & fixed income risk, and increase risk adjusted portfolio returns.  This is the basic idea of Risk Parity (ie. Bridgewater) and risk parity style funds


Risk Parity is a cool idea – it is an especially cool idea when you are levering up exposure to an asset class in the midst of a 35-year bull run. 


“All Weather” strategies, however, suddenly see only rain when fixed income goes convex and cross-asset class correlations tighten (ie. you are levered long falling bond prices and stocks & commodities are declining as well) such as what happened in June post the Taper announcement.  Risk-parity strategies got smoked on both an absolute & relative basis.


Decades long Queen Mary based correlation strategies need to be re-thunk &/or remixed when queen mary starts her secular journey the other way.   


AQRIX/ABRYX are the lead risk parity mutual funds and a Risk Parity ETF is waiting in queue for SEC approval – keep an eye out for that as a short candidate if we move towards getting a repeat of June. 


…Just some thoughts as them there #Rates keep arisin’


Volatility Lives!

“Does man live from inside out or from outside in?”

-Erich Maria Remarque


I just got back from Thunder Bay and have that quote underlined in a post WWI German inflation novel that one of our clients in London gave me – The Black Obelisk. When I read it, I immediately thought of Global Macro investing legend, Ray Dalio.


Dalio’s signature quote about risk management is also a question: “What is the truth?” And whether it’s his, pardon the pun, All-Weather Fund’s issues, or performance problems most of us have faced over the course of our careers, there’s one thing that tends to answer all the questions we never knew we should have asked – it’s called volatility.


The number one thing that has created draw-down risk in every major hedge fund strategy since the beginning of time has been, and will continue to be, volatility. If your strategy assumes the wrong volatility parameters, you are assuming risks that you do not understand. On a percentage basis, did the biggest q/q change in 50 years in Treasury yields matter? Big time.


Back to the Global Macro Grind


Slides 15, 16 and 17 of our current #RatesRising Global Macro Theme deck outlined how massive outflows from Fixed Income related securities plays out:


1.   Quantitative Signal (Slide 15) – we show what we coined “The Waterfall” of rate risk as 10yr US Treasury Yields broke out across all three of our core risk management durations (TRADE, TREND, and TAIL – with the TAIL risk line = 1.92%)


2.   Causal Factor (Slide 16) – we show how unconventional Fed policy exacerbated a bond bubble (Fed Balance Sheet vs 10yr Yield over the last 10 years = R-square of 0.795)


3.   Correlation Factor (Slide 17) – we show that on a % basis, the most recent rate of change in the 10 year US Treasury Yield (quarter-over-quarter) was the largest in the last 50 years


Call us lucky or call us right. The truth is that we cut our asset allocation to Fixed Income to 0% for the aforementioned reasons alongside many more that were driving a regime change in terms of how our model values growth versus slow growth allocations.


When we were bearish on growth (until November of 2012) we were long US Treasuries; when our views on the slope of growth changed from slowing to stabilizing, we started to move to the dark side (in bonds).


#Process review:

  1. We get the market signal
  2. We do the long-cycle research to find asymmetric (phase change) risks
  3. We wait for the market to tell us when causal factors (expectations changes) drive correlation risk

This is no victory lap. I just feel that it’s important to show people what it is that we do in a transparent, open, and accountable forum of debate. The only all-weather protection against volatility ripping is getting out, before it rips.


Throughout the last 9 months (as US growth went from slowing to stabilizing to accelerating) markets have provided us plenty of opportunity to get into growth related asset classes and out of slow growth ones. August to-date is no different:


1.   Utilities (XLU) are the most overvalued slice of the slow-growth equity pie (with hyper-overvalued securities like MLPs within this Sector Style Risk). XLU is down -1.38% for August to-date (versus SPY +0.5%)


2.   Tech (XLK) and Basic Materials (XLB) are up the most for August to-date at +2.11% and +2.45% respectively. Both are traditionally considered “growth” sectors but for very different reasons. AAPL is not CAT.


There’s a lot of risk in assuming that long-cycle cyclicals (like mining related stocks) are in the right spot from a “growth” investor’s perspective. Then there’s GARP (“growth at a reasonable price”) where mining stocks might look “cheap” too. Just don’t forget that the Mining Capex Cycle was a decade long bubble. The risk here is grounded in the volatility of the underlying commodities.


Where could we be wrong? Our research on something like Caterpillar (CAT) has been bearish, but now the market signal is stress testing our conviction in maintaining that position. If CAT were to close above my long-term TAIL risk line of $88.67 and hold that level on some real volume, my risk management process stops me out of the position.


Do I live my market life from looking inside our portfolio of ideas or from the outside looking in? The truth is that I do both. It’s a learning process. Whenever I ignore the outside, top-down, macro market signals, I will be reminded that volatility lives on the other side of my position’s underlying assumptions. And not in a good way.


Our immediate-term Risk Ranges are now:


UST 10yr 2.64-2.75%


VIX 11.61-13.68

USD 80.92-82.18  

Gold 1

Copper 3.23-3.39


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Volatility Lives! - Utilities Yield Spread


Volatility Lives! - z. vp

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