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PEY 2Q13 Review: Ops Remain Top Notch, but Commodity Prices Weigh

Summary Bullets:

  • Long Peyto Exploration & Development Corp. (PEY.TO) remains a Hedgeye Best Idea.
  • PEY raises YE13 exit rate production to ~70,000 boe/d, up from prior 62,000 – 67,000 boe/d, impressive in light of poor weather conditions in 2Q;
  • First look at new Deep Basin area, Brazeau, is positive, and can potentially be a new leg to the stool with already ~200 identified locations;
  • AECO natural gas, propane, and butane prices are weak and have weighed on the stock recently – but as the low cost producer, Peyto is in the best position to weather the weakness, and take advantage of low services, land, and materials costs.
  • Looking to 2014, we expect another year of record activity, capital spending, and production.  Equity deal in 4Q13 or 1Q14 to finance the growth?


Production guidance……Peyto raised the YE13 exit rate for production to ~70,000 boe/d, up from the prior guidance of 62,000 – 67,000 boe/d.  The back half of 2013 will be the busiest in the Company’s history, running 10 rigs and completing three infrastructure projects in October.    


First look at Brazeau looks good……Peyto has built up a 55,000 net acre position at Brazeau, which is in the Deep Basin about 100 miles south of its core Sundance area.  The area is prospective for the sweet gas Wilrich, Falher, and Notikewin zones.  Peyto quietly, methodically put this contiguous block of acreage together over the last three years for under $300/acre.  So far, it has drilled 3 Wilrich wells, and the results compare favorably to the higher-pressured Wilrich areas in Sundance.  Peyto will continue to delineate Brazeau in 2H13 and 2014, and is building a 20 MMcf/d facility there to bring the newest wells on stream.  Peyto currently has 2,500 boe/d behind pipe.  The Company believes that there could be an additional 200 locations at Brazeau, and we are still early days.


Commodity prices weigh……The recent weakness in NYMEX gas, the blow out in the AECO basis differential, and continued pressure on the lighter ends of the NGL barrel (propane and butane) have weighed on Canadian gas stocks of late (PEY, TOU, POU, TET, etc.).  Peyto noted that many of its small working interest partners have lately gone penalty on Deep Basin wells owing to the weak gas price (Peyto is more than happy to pick up their interests).  We tend to view commodity price weakness, especially when it seems transitory like the blow out in the AECO basis differential, as an opportunity to add to core positions in high quality, low-cost producers like Peyto.


An early look at 2014……We believe that 2014 will again be an aggressive activity/capex/growth year for Peyto, as the low natural gas price environment has slowed down its peers, leading to cheaper services and equipment, and ultimately, low F&D costs (all-in PDP F&D ~$2.00/Mcfe).  With its counter-cyclical investment approach, this is when Peyto wants to push the pace.  We assume that Peyto runs 10 rigs in 2014 (flat from the 2H13 run rate), spending ~$650MM, producing (on average) 76,000 boe/d for 26% Y/Y growth, and generating CFPS of $3.60 (23% Y/Y growth).  With dividends and capital spending exceeding cash flow by ~$250MM in 2014, we believe that Peyto may raise $100 – 150MM of equity in 4Q13  or 1Q14.  At the current share price ($29.00), such a raise would be 2 – 3% dilutive to the share count.  With its aim of being the low cost producer, low leverage is important to the Company; in each of the last three years, Peyto raised ~$115 -125MM of equity in the fourth quarter; we think that it’s reasonable to expect a similar raise again this year.  We model that total debt/cash flow at YE14 will be at 1.7x, flat from today.


Kevin Kaiser

Senior Analyst


Takeaway: New Priceline survey indicates optimism on lodging and leisure industry.

This note was originally published August 15, 2013 at 10:47 in Gaming

Priceline.com's annual Summer Travel Survey showed that the number of Americans who are planning to take a "staycation" in 2013 - choosing to vacation near home - declined to 17%.  This was much lower than in the past five years when some surveys cited as high as 50% of Americans choosing to take a break close to their homes.  


STAYCATION DEAD? - staycation 


While Americans are aware of rising airfare, gasoline, and hotel rates, the survey said that some are saving some money on their vacation travels by driving nonstop to their destination and stretching their food budget.


We believe this is a positive trend for hotels, Las Vegas, cruiselines and online travel agencies.  Americans continue to be quite resilient on leisure spend.



Takeaway: The number of people filing initial jobless claims continues to drop at an accelerating rate. It's what happens on the margin that matters.

Tapering Probability Grows 

There remains no let-up in the positive data flowing from the initial jobless claims series. The most recent week saw non-seasonally adjusted claims drop by -11.7% year-over-year (YoY), an improvement vs the preceding week's change of -9.9%. The last 10 weeks of data have averaged 9.3% improvement YoY, so this week's change is strong. While the rolling 4-week average non-seasonally adjusted (NSA) data showed a modest acceleration to -7.8% from -7.6%, next week is likely to show sharp improvement as we'll be replacing the one week data point in the last 17 weeks of data with a presumably stronger number next week. 




It's worth noting that as the rate of improvement in the labor market accelerates, so too does the expectation for the Fed to taper asset purchases. Hence the sea of red on the screen today in response to such healthy labor market data. Next week, my colleague Jonathan Casteleyn is planning on putting together an analysis of the likely tapering impact on equities across different durations. Stay tuned.


Last week we commented that based on our analysis of the seasonality distortions shifting from headwind to tailwind from September through February, we thought the seasonally-adjusted (SA) number, with no underlying fundamental improvement, will drop from 333k to around 305-310k. Given this week's SA print of 320k, we think the seasonality distortion dynamics may actually push the series sub-300k with no further fundamental improvement, even though there is considerable fundamental improvement occurring based on the NSA data stream. For perspective on what a sub-300k claims series means, historically, since 1975 we've observed sub-300k data in 2Q06, 2H99, 4Q88, 3Q78, or less than 5% of the time. Specifically, 93 of the last 2,015 weeks have seen sub-300,000 SA IC weekly prints. 


Joshua Steiner, CFA




Jonathan Casteleyn, CFA, CMT




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Buyem: SP500 Levels, Refreshed

Takeaway: Evidently, #RatesRising for the right reasons is the new bear case for stocks... Still, I cover shorts and buyem here.



People are always asking me why about this and why about that – “if you are so bullish on US #GrowthAccelerating and #RatesRising, why aren’t you longer?” Well, the 1st answer is that I’m as imperfect as the rest of you at this, and the 2nd is I like to buyem when they’re really red.


What’s fascinating about today’s selloff (taking us -2.8% from the all-time closing high in SPY – I know, end of the world type stuff) is that it came on precisely the opposite reason 2013 stock market bears have been begging for (slowing growth).


In terms of how we score it (NSA rolling jobless claims) this was the best employment #GrowthAccelerating print of the year (see our Macro note on employment today for details). Rates ripped on that and now, evidently, #RatesRising for the right reasons is the new bear case for stocks.


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


  1. Immediate-term TRADE resistance = 1691, then 1709
  2. Immediate-term TRADE support = 1659
  3. Intermediate-term TREND support = 1631


In other words, I cover shorts and buyem here. And I don’t know what else to tell you other than that.


Enjoy your summer Thursday,



Keith R. McCullough
Chief Executive Officer


Buyem: SP500 Levels, Refreshed - SPX


Goldman Sachs upgraded shares of Carnival this morning.  Here's our take on some of its points.



In what amounted to primarily a valuation upgrade, Goldman raised its investment rating from neutral to outperform today. We're generally against valuation upgrades unless there is an associated catalyst.  Unfortunately, we don't see one on the horizon for CCL.  


Here are some of the main points from Goldman's upgrade along with our analysis.



With the potential for upside to be much more dramatic than in many of our other sectors and the EPS still meaningfully depressed, we think CCL deserves a higher multiple. We are assigning a 17.8X P/E multiple (vs. 14.25X previously) to our revised 2014E EPS to reflect this. At 17.8X this is only 10% above its long-term average of 16.1X and a 38% discount from its peak achieved in 1999. Using this multiple provides a new 6-month price target of $42 (vs. $31 previously), suggesting 14% upside from current levels.


Stretching the historical valuation by 10% to get to only 14% upside is not very compelling in our view.  On a relative basis, should CCL really trade at a 6x premium (P/E) to RCL and 3x premium to NCLH? In the past 5 years, RCL has traded at a 2-3x discount to CCL.  Since the Concordia incident, that premium remains at 3x on average.  Yes, CCL's EPS may be more depressed but there is also more risk to its numbers.  Moreover, Goldman is projecting 50% EPS growth for the valuation year of 2014 so he is already assuming a big recovery.


Underperforming other leisure/travel names

We broadened our analysis of CCL’s performance to other travel sectors beyond the cruise industry, namely the US hotel industry and the Las Vegas Strip; our review yielded the same results, which is that CCL’s performance coming out of the recession has lagged. If we look at what has happened to other travel and hospitality operations, nearly all of them are back to their peaks.


The reason CCL has lagged behind many other travel/hospitality names is more firm-specific; so it cannot be a fair comparison.  We would argue that from an industry perspective, gaming was hit harder.  Umm, MGM was a $90 stock in 2007.


Arnold Donald

Mr. Donald has already begun to demonstrate a willingness to reexamine and potentially change CCL’s prior practices. For example, he announced that he is meeting with all of the operating executives to assess strengths and weaknesses and whether certain operations should be more centralized. He also stated that he is examining CCL’s capital allocation

strategy. Although his comments have been more general than specific, as it is early in his assessment, in our view he seems genuinely engaged and open to making the changes he deems necessary.


While we acknowledge how new management can be a refreshing opportunity for positive change, Mr. Donald's approach as described by Goldman doesn't appear to be anywhere near ground breaking.  It remains to be seen how far removed Micky Arison will be.  We would look favorably on a more aggressive cash return to shareholders, however.

Negative news shouldn’t impact the brands forever

While these negative events will likely continue to be a dark cloud over the brands for a period of time, we don’t think it will last forever. Management has already suggested its own polling indicates an improvement in brand perception. If we look at other brands that have been damaged, ultimately they typically recover. At this point, investor sentiment is low and as long as additional negative events do not occur we think comparisons are easy for CCL to show a return to net yield growth.


Who knows if and when the Carnival brand can ever regain its brand stature. Carnival’s depressed pricing to fill up cabins will last in the Caribbean for a while.  The company itself is alluding to a return to normalcy in the 2H of 2014 but that's a guess and what's the rush to buy into that theory?


Marketing spend

We point out that CCL has allocated more marketing dollars to the Carnival brand in the back half of 2013 to improve its perception among consumers before the booking focus starts in earnest in Q1 2014. In 2014, the company also plans to spend more marketing dollars beyond just the Carnival brand. The lack of a negative event during the wave season could be a very big positive, especially if the marketing programs make consumers more receptive towards the Carnival brands.


It will be difficult to change customers’ perception of the Carnival brand given that it’s been ingrained in their minds as the incident-prone brand. Carnival can always shell out heavy promotional deals to ‘build brand awareness’. The result is margin decline. North America Cruise brand margins have fallen for four straight quarters.



We expect accelerating GDP in both the US and North America, with Europe turning from negative to positive in Q4 2013.


We do not disagree with this one but there are a lot of stocks to buy if one believes in an improving macro environment. However, we would like to see if the positive momentum in Europe can be sustained for the rest of the year and into 2014.


Free Cash Flow

While we have noted that our contrarian upgrade is based principally on catalysts and a recovery from depressed results, we would also note some other positives. First, at 2.7% CCL’s dividend yield is one of the highest in our coverage universe. With $667mn of free cash flow in 2013E and $1,540mn in 2014E the dividend seems sustainable and could even show some upside. Carnival is slowing down its ship-building program and focusing on boosting same ship returns. The net result is higher free cash flow.


If you want to boast about the dividend yield, you have to look at Free Cash Flow after the dividend payment.  By our estimates, FCF post dividend will be negative in FY 2013 and FY 2014.


Sell-side Sentiment

This call is contrarian from a sell-side perspective (only 36% of the Street ratings are “Buy” versus 64% for RCL). Over the past four years, CCL has never had such a low percentage of “Buy” ratings vs. “Neutral” or “Sell”. CCL has gone from one of the most recommended sell-side stocks within the hospitality and travel sector to one that is viewed more critically

by both investors and the press. In our view, this negative perception creates upside potential to both earnings and sentiment.


We like to play contrarian against the Street as well but only when we have an unrecognized catalyst.  We don't think Goldman has one either.


Takeaway: The Labor Market is the most critical piece in Economic (Inverse) Jenga, and it continues to show accelerating improvement.

In the game Jenga, each player, in turn, pulls a wooden block out of a stacked tower with the goal of not causing the tower to collapse.  It idiom speak, its tantamount to trying to avoid pulling the straw that breaks the camel’s back. 


The economy over the last 4 years has been a kind of Inverse Jenga with policy makers, economists, and strategists speculating on what combination of policy and macro factor(s) need to be in place for the ethereal economic edifice to not only not re-implode, but to propagate a positive reflexive economic cycle. 


Are those requisite ‘pieces’ in place currently?


For thought experiment sake, let’s suppose you just recently crawled out from under your Edward Snowden hideout rock to find the following dynamics.  While you don’t want to be long everything equities at every price, on balance, would you provide a persistent short bid given the following macro realities?


  • Labor Market:  Breaking a 4 year trend and showing accelerating improvement in the face of a negative seasonal headwind and a discrete fiscal policy drag
  • Credit:  Household Debt/GDP has retraced back to trend, household credit growth has moved back to the zero line and consumer and commercial loan demand and credit availability are both improving.
  • Confidence:  After a 5 year tread-sideways stint, all measures of consumer and business confidence are legitimately breaking out.
  • Private Sector Balance Sheet:  Financial assets are making new nominal highs (largely a boon to the top 10%) and home prices (broad populace ownership) are retracing their losses and now growing double digits.  Some measure of wealth effect should follow on the back of significant NTM asset re-flation.  Corporate cash remains solid, corporate balance sheets have been buttressed by a multi-year cost cutting run, and corporate earnings as a % of GDP are still near peak.  Mean reversion from peak margins remain an obvious risk to prices, but an acceleration in investment spending presents an similarly positive prospect for TREND economic growth. 
  • Flows:  Flows can amplify and/or dominate fundamentals for extended periods and, at present, flows to equities, and U.S. equities in particular, have inflected.  Funds continue to flow out of Fixed Income alongside #RatesRising, EM equities/bonds/currencies hold negative leverage to both #StrongDollar & #RatesRising, as does Gold the broader commodity complex.    
  • Fed:  Central Bank intervention, despite its supportive role, has increased market uncertainty and served to both shorten economic cycles and amplify market volatility.  The Fed has used its ‘communication tool’ and consensus has begun to accept the impending end of unprecedented market intervention – whether they are doing it b/c organic trends are good or to avoid burgeoning asset price imbalances is probably a secondary point.  In reality, it is probably some combination of the two. 
  • Valuation:  Market valuation is getting a bit rich on a measure like the Shiller P/E, but still has headroom for a turn or two on a convention P/E basis, earnings yield basis, etc.  Valuation, in itself, is not a catalyst over the immediate and intermediate terms.  


Of course, on the other side, muted Inflation, stall-speed real wage growth, slack capacity, rising oil/gas prices, Congress and rest of world risk - among others - remain ongoing concerns. 


The Jenga question is whether the confluence of the positive dynamics above represent a macro factor cocktail sufficient for catalyzing a self-reinforcing upswing domestically?  


YTD market performance has clearly backed pro-growth positioning, and with sentiment still middling, the domestic macro data coming in good, and the quantitative setup for equities still bullish, we’re inclined to stick with a constructive outlook for the U.S.   


In short, we don’t think improving employment,  #StrongDollar, #RisingRates are negative dynamics and expect an equity sell-off to be met with a bid as we move towards support.   The levels we’re watching for on the SPX are TRADE Support at $1659 and TREND support down at $1631.    





NSA:  Non-seasonally adjusted claims, our preferred read on the underlying labor market trend, made a new absolute low for the cycle at 280K -  marking its third consecutive sub-300K reading in a row and the lowest since September 2007.  On a YoY basis, initial claims accelerated to -11.7% from -9.9% the week prior with the 4-week rolling average improving 50bps to -8% from -7.5% the week prior. 


Excluding the (seemingly) anomalous data point for the week ending 7/19, the average YoY improvement over the last twelve weeks is -9.8% - a very strong rate of improvement and one that continues to defy the trend of the last three years (see the slope of the linear trend lines in the 1st chart below).  Improvement in the 4-wk rolling measure of YoY Claims should show marked improvement next week as the one weak data point of the last 17 weeks rolls off.  


SA:  The seasonally adjusted, headline claims number printed its best number of the year, and best number since October 2007, at 320K.  This weeks data represents an accelerating YoY rate of improvement of  -12.8% YoY (vs -9% the week prior) with 4-wk rolling average down 4K WoW.   


As Josh Steiner and our financials team re-highlighted last week:


Based on our analysis of the seasonality distortions shifting from headwind to tailwind from September through February, we think the SA number, with no underlying fundamental improvement, will shift from 333k to around 305-310k. There is, however, clear underlying fundamental improvement, so we wouldn't be surprised to see a 2-handle on the SA initial jobless claims reading by late 1Q14.


The Labor Market is probably the most critical piece in Economic (Inverse) Jenga, and it continues to show acceleratign improvement. 


INITIAL CLAIMS:  JENGA - Claims 081513








Christian B. Drake

Senior Analyst 


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