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Morning Reads on Our Radar Screen

Takeaway: A quick look at some stories on our radar screen.

Keith McCullough – CEO

Ray Dalio Patched All Weather’s Rate Risk as U.S. Bonds Fell (via Bloomberg)

Europe exits recession (via CNNMoney)                      

Venezuela Names Third Central Bank President This Year (via Bloomberg)

Israel Strikes 2 Gaza Sites Hours Before Start of Talks (via New York Times)

Chinese Billionaire Huang Readies Iceland Bid on Power Shift (via Bloomberg)

 

Morning Reads on Our Radar Screen - ray dalio

 

Kevin Kaiser – Energy

Energy Firm Makes Costly Fracking Bet—on Water (via WSJ)

Apple: The Secret Reason It Has So Much Cash (via CNBC)

 

Matt Hedrick – Macro

Merkel Blasts Tax Rises as ‘Poison’ as She Starts Campaign (via Bloomberg)

 

Josh Steiner – Financials

New York and U.S. Open Investigations Into Bitcoins (via New York Times)

Softer U.S. Mortgage Rule Said to Be Proposed at End of August (via Bloomberg)

 

Jonathan Casteleyn – Financials

Dalio Patched All Weather’s Rate Risk as U.S. Bonds Fell (via Bloomberg)

 

Jay Van Sciver – Industrials

U.S. Moves to Block US Airways-American Airlines Merger (via WSJ)

 


EL – WAIT AND WATCH

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.

 

EL – WAIT AND WATCH - EL levels

 

 

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

 

 

 


[PODCAST] Keith's AM Call: Stocks & Bonds

Hedgeye Risk Management CEO Keith McCullough delivers his morning investor call and offers his latest thoughts on stocks, Treasury yields ripping higher and where investors should be putting their money right now.

 


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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


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’

 



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