Staples Dodgeball

With a good majority of consumer staples companies having reported their quarterly results, below we give a round-up of our highest conviction ideas on the long and short sides over the intermediate term TREND. As we begin sizing up company performance in the quarter, we note a few key take-away themes that are largely a continuation of last quarter:

  1. Investors chasing yield
  2. M&A speculation (more recently around PEP and MDLZ and in the wake of the HNZ acquisition)
  3. Declining commodity prices and expectations for improvement in gross margins

While we believe points two and three can both help fuel investor appetite, point one remains an area of concern for the broader sector given our macro team’s Q3 theme call of #RatesRising. We see the prospect of rates rising as unfavorable for the XLP (and other sectors that have been targeted 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.


With so many factors at play, analyzing names within this space can feel like playing dodgeball. Below, we go through the names we expect to outperform, and those we expect to underperform, over the TREND duration.  Valuations for the sector remain stretched but we still see some opportunities on the long side (valuation charts below, also).



Long Ideas

  • LO – we expect Lorillard to continue to see outperformance on strong demand for its full-flavored offerings and dominate share of menthol, both contributing to volume outperformance versus the industry (Q2: -1.7% vs -6.1%). We think FDA rulings around menthol will be pushed out to at least the intermediate term. LO’s first-to-market (of big tobacco) e-cig Blu is enjoying top market share, which should help to boost interest in the stock given the excitement around the category.
  • HSY – the company’s portfolio is benefiting from lower input costs and see strong volume gains; we expect strong merchandizing around Halloween and the holidays to further benefit 2H results. The fruits of the Brookside acquisition should continue to pay dividends (expected to contribute 1 pt of growth in 2013).
  • TSN – consumers preferring the value of chicken versus other proteins is a dynamic we expect to continue in 2H. The company has been able to pass on or well manage input costs given its diversity in protein offerings and geographic exposures.  Protein over carbs remains an import component of health and wellness trends that TSN has at its back.
  • SAM – the maker of Boston Lager had surprisingly strong Q2 results and wet investor’s pallets with news that given excessive demand and capacity constraints, the company is increasing its cap-ex guidance to expanding its brewery production. Despite the craft category growing ever more competitive, we like SAM’s positioning in the market and management’s ability to profit from an establish brand as it mixes in new tea and cider offerings.


Short Ideas

  • PM – we expect continued FX headwinds given our #StrongDollar call. PM revised down its FY guidance as it forecasts larger volume declines in the year across its geographies, including due to increased excise tax headwinds in key geographies like Russia and the Philippines, and an uptick in illicit trade in Turkey.
  • DPS – the company’s portfolio is ~ 80% carbonated soft drinks (CSD), a category that continues to be challenged as consumers switch to both healthier carbonated and non-carbonated offerings. The company is hopeful around the launch of its 10 calorie DP 10 offering, but we do not expect it to offset the declines across the portfolio.
  • CCE – on-going macro weakness in Europe and the continued impact of the French excise tax, along with competitive pressures, have hampered the company’s results. We do not expect to see an inflection in weak trends as we’re forecasting at best only slow and modest economic improvement in Europe.  
  • K –Kellogg reduced its FY guidance on increased FX headwinds and its results reflect weakness in key categories and geographies that we expect to persist in 2H. The U.S. business remains particularly challenged, especially in cereal. K needs to realign its marketing spend and innovation, which may take at least a couple of quarters to turn around.
  • KMB – Kimberly Clark reported disappointing earnings in July and has underperformed since then. FX and competitive pressures will continue to weigh on earnings growth as inflation sequentially accelerates. We see downside risk to the company’s FY13 estimates, with personal care volumes in the U.S. and other developed markets particularly concerning for shareholders.


Our quantitative real-time set-up for consumer staples (etf: XLP) is bullish, trading above its intermediate term TREND line. 


Staples Dodgeball - z. xlp


Staples Dodgeball - zz. stap pe


Staples Dodgeball - consumer staples subsector px



-Rory Green and Matt Hedrick

Solid: U.S. Macro Growth Data

This note was originally published August 13, 2013 at 15:58 in Macro

Conclusion:  Today’s Retail Sales and Small Business Confidence numbers were solid, extending the trend of broad improvement observed across the balance of the domestic macro over the last two quarters and offering some positive confirmation of the early 3Q13 strength signaled by the Labor Market and ISM figures for July.    





U.S. MACRO -  Solid Start to 3Q13:   The Labor Market (initial claims) continued to show accelerating improvement in July while the ISM manufacturing and services surveys reflected a broad recovery off the lackluster activity that characterized the April-June period. 


As can be seen in the Economic Indicator Summary Table below, 3Q13 has started off solid with the preponderance of growth/activity indicators released thus far showing improvement on both a TRADE & TREND basis.  On balance, the July Macro releases have come in ahead of expectations according the Citi and Bloomberg Economic Surprise Indices.  


Solid: U.S. Macro Growth Data - drake1


Solid: U.S. Macro Growth Data - Economic Suprise Index 


RETAIL SALES:  Monthly Retail sales are volatile, subject to notoriously large revision, and reported in nominal dollars but, still, it’s hard to ignore a component responsible for roughly a third and a quarter of PCE and GDP, respectively.   


The first read on consumer spending in 3Q13 came in healthy with July Retail sales ex-Autos accelerating to 0.5% MoM (vs. 0.1% in June) while Sales excluding Autos & Gas accelerated to +0.4% MoM (vs. 0.0% in June).   


On a year-over-year basis, growth slowed modestly across each of the primary aggregates with Total Retail Sales, Sales ex-Autos, and Sales ex-Auto’s and Gas slowing 50bps, 30bps, and 40bps, respectively.  On a 2Y basis, however, all three measures accelerated modestly in July. 


All in, not a game changer or positioning catalyst, but a positive update for consumer spending to start the third quarter.   


We’ll be interested to see the Personal Income data for July (8/30 Release) and the impact of the furloughing of federal workers on aggregate disposable income growth – which has been treading water at a lackluster  ~+2% YoY.   As a reminder, we expect income growth for federal workers (~2% of the total workforce) to grow approx -7% over the balance of the fiscal year due to the combination of  furloughs and employment declines.  The impacts, while moderate, should constrain the upside in disposable income growth and consumer spending in 3Q13.  


Solid: U.S. Macro Growth Data - Retail Sales Table July


Solid: U.S. Macro Growth Data - Retail Sales


NFIB Small Business Optimism:  The NFIB Small Business Optimism Index climbed to 94.1 in July from 93.5 in June.  Under the hood, the outlook for general business conditions deteriorated sequentially although (somewhat incongruously) hiring plans, sales expectations, and job openings all advanced. 


The directional TREND in the consumer and business confidence metrics provides a better read on sentiment than any one data point in isolation and the larger trend in small business confidence remains positive and in agreement with the ongoing advance in the lead measures of consumer confidence.  


Solid: U.S. Macro Growth Data - NFIB Table


Solid: U.S. Macro Growth Data - NFIB Optimism



With labor, credit, and confidence trends all showing ongoing improvement and with a diminishing fiscal drag and easier comps as we annualize sequestration and the tax law changes into 2014, the growth dynamics for the U.S. economy,  and prospects for the U.S. Dollar and U.S equities remains favorable.  Consumption growth faces some constraints in the near term and congress will likely re-emerge as a negative catalyst in some form in the coming weeks, but, fundamentally the data continues to support a constructive outlook for domestic growth



Christian B. Drake

Senior Analyst 



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)


Early Look

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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

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