The Week Ahead

The Economic Data calendar for the week of the 9th of September through the 13th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - weekahead

The Draghi Shift: Door Open for An Interest Rate Cut

Bullish: Germany (EWG) and UK (EWU) equities


Draghi pivoted substantially in the ECB’s tone on monetary policy expectations in his press conference yesterday in which he kept rates on hold, presenting a dovish tone in which he said that interest rates should remain “at present OR lower levels for an extended period of time.”  In his commentary, he referred to the green shoots of economy (terminology he has not used this year) as “very, very green” and that there’s still no indication of domestic demand recovery across the whole of the Eurozone.


In short, Draghi has reset market expectations that were suggesting a hike in rates over the intermediate term, rather than a cut. Our assessments is that Draghi will continue to watch the data roll in and will need a number of months to confirm or change his outlook that could influence his monetary policy stance.  


Two pressing areas of concern remain the repayment schedule of LTROs and lack of credit across the region. While the swift repayment of the LTROs has boosted the health of the ECB’s balance sheet, it represents a tightening of liquidity, some of which is reflected in the poor data observed from ECB loans to corporations and households (chart directly below). The larger credit clog across the region should continue to suppress economic expansion and we believe that in the coming months Draghi may issue a facility to better extend loans to small and medium sized enterprises, the lifeblood of the Eurozone economy.  [Draghi’s full prepared remarks can be found here.]


The Draghi Shift: Door Open for An Interest Rate Cut - zz. rates


The Draghi Shift: Door Open for An Interest Rate Cut - zz. ECB balance sheet


The Draghi Shift: Door Open for An Interest Rate Cut - ZZ. LOANS



UK and Germany Bulls on Gradual Eurozone Improvement

As we’ve noted in previous notes, Eurozone data has improved over recent months, however we’ve tempered expectations that given the still very weak underlying structural state of the Eurozone, in particular the periphery, the data suggests an improvement off the bottom but still at low levels.  We see this clearly with PMI results, which we’ve forecast to make mild improvement and hover around the 50 level (dividing contraction and expansion), and outperformance from Germany and the UK given their stronger underlying fundamentals (see the chart below).


The Draghi Shift: Door Open for An Interest Rate Cut - ZZ. PMIS


We continue to be bullish on German and UK equities. Along with our U.S. call of #RatesRising, we’ve seen a similar trend in many European credit markets, which has solidified our call to stay in equities.  Of note, German’s 10yr bund yield reached a high of 2.04% this week (that level was last seen in DEC 2011!) and are up 26bp M/M, while UK 10yr Gilts are up 45bps M/M and France’s 10yr yield is up 30bps M/M.  While we expect yields to contract as follow-through to yesterday’s announcement, we do expect rates to remain elevated over the intermediate term as investor push into equities.



Given Draghi’s shift to a dovish interest rate outlook, we wouldn’t be surprised to see more follow-through selling in the EUR/USD, however we still very much think that Draghi’s OMT firepower has put great support in the common currency and expect the cross to trade in a tight range of $1.29 – $1.33 over the intermediate term.


Below we show CFTC data on the EUR/USD net non-commercial positions outstanding.  Regrettably the data is a bit stale (the newest as of 8/27), however the level suggests migration to the neutral level, consistent with an increasingly bullish outlook on the region’s improvement.


The Draghi Shift: Door Open for An Interest Rate Cut - zz.eur


The Draghi Shift: Door Open for An Interest Rate Cut - zz. cftc



An Italian Political Mess on Monday?

As a quick warning as you head into the weekend, we want to make you aware of what may develop on the Italian political front on Monday and the impact it could have on the market. Reuters has suggested that former PM Berlusconi has prepared a video message that could announce a decision (along with his PdL party) to bring down PM Letta’s coalition government (which has been in a tenuous state at best since elections in February) if on Monday the special Senate committee votes to strip Berlusconi of his seat in the chamber.


It’s hard to say just what may be decided on Monday, but certainly the situation creates potentially more downside than upside across Italian capital markets.  It’s such political risk that has largely kept us away from taking an investment position in Italy for many months. We’ll sleep deeply this weekend without a position in Italy.  We hope you can too.


The Draghi Shift: Door Open for An Interest Rate Cut - zz. silvio


Enjoy your weekend!


Matthew Hedrick

Senior Analyst

Stock Report: Annie's, Inc (BNNY)

Stock Report: Annie's, Inc (BNNY) - HE II BNNY table 9 6 13


Despite slightly disappointing top and bottom line Q1 2014 results (released on 8/8/13), the company maintained its FY revenue outlook of +18-20% and EPS range of $0.97 to $1.01. We believe that BNNY’s premium valuation is justified by higher growth rates across organic offerings, of which Annie’s is a leader, especially as it increasingly moves its products to the mainstream aisle from the organic aisle.


BNNY caters to a higher income demographic, one we think will continue to pay a premium for organic foods despite fluctuations in macroeconomic conditions. 


INTERMEDIATE TERM (TREND) (the next 3 months or more)

Q2 may see another quarter of challenged gross margins (expected to fall -100 to 150bps), however we expect a rebound in the top line (Q1 is typically the weakest revenue quarter) as advertising spend increases, and it further rolls out its frozen pizza and family sized frozen meal offerings, and continues to take share across mac & cheese, crackers and fruit snacks from more traditional branded players.


LONG-TERM (TAIL) (the next 3 years or less)

We believe that BNNY’s strategy to innovate everyday foods and create healthier and better tasting options than its competitors is one that should sustain long-term growth versus traditional CPG innovation that focuses on new and “different” SKUs that may miss consumer trends.


Organic product offerings will become more competitive in the coming years, however we believe that Annie’s can maintain its market leadership and take share from more traditional brand players as it moves more of its items to the center of the store. 


Stock Report: Annie's, Inc (BNNY) - HE II BNNY chart 9 6 13

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Stock Report: Restoration Hardware (RH)

Stock Report: Restoration Hardware (RH) - HE II RH boxes 9 6 13


We think that RH is to home furnishings what Ralph Lauren is to Apparel and what Nike is to Athletic Shoes. It's the preeminent brand in the space, and sets/leads consumer style trends/wants/needs but with very little fashion risk. From a maturity perspective, we think that RH is 5-10 years behind RL, and 10-15 years behind NKE. Its got the runway. And even though it has such minimal market share across its categories, the competitive set is actually not very strong, and it is creating high competitive barriers.


INTERMEDIATE TERM (TREND) (the next 3 months or more)

There are some intermediate-term trends worth noting.

  1. RH announced last quarter that it is launching two new businesses -- again.  Does this sound familiar? In RH's first quarter out of the IPO gate it announced the launch of RH Tableware, RH Objects of Curiosity, and RH Fine Art. Now we've got RH Kitchen and Tableware and RH Antiquities. Both of these are massively fragmented businesses and present huge opportunities for RH. These are in addition to RH Leather and RH Rugs, two new catalogue drops this fall. #growthaccellerating
  2. RH managed to snag Richard Harvey from Williams-Sonoma to be CMO for RH Kitchens and Tableware. The simple fact that RH's share of this category is close to zero today, and they went ahead and hired the person with the best track record in the world in brand-building, sourcing and merchandising in the kitchen space….that's just huge.
  3. RH is fresh off the ICSC conference in Vegas and it proved to be a game-changer for the company. They not only had far better success in finding landlords/properties to fit their new Design Galleries. But they found that there are more opportunities for larger properties (as large at 50k square feet) at far lower prices than their business model originally called for. Not only does it take up the number of Galleries we're likely to see over time (over 50), but we think it also takes up the average size per store. These two factors are a critical on a combined basis as it relates to our margin of safety on the RH growth algorithm (see below). With more favorable availability of sites comes more favorable rents and cap rates -- it's economics 101.

LONG-TERM (TAIL) (the next 3 years or less)

One thing that makes the RH model stand out is the growth algorithm over the next 5-years. Specifically…

  1. Square footage has not grown for five years. But RH should finally start to report square footage growth starting in 3Q13 – at which point it should start to climb aggressively.
  2. But our point is that today it is the comp that's driving the model. We can clearly see where that's coming from.  We can map out additional sales as new businesses come on line, and we can draw out the comp curves for new higher productivity entering the comp base and hitting more mature productivity levels. We're modeling sales per square foot going from $846 last year to just shy of $1,500 in year 5.
  3. Ultimately, comps will slow. It's a mathematical certainty. But at the time comps slow we're likely to see square footage growth accelerating to peak rates of growth. Square footage is shrinking slightly today, and should be up at a rate near 20% by year 3.
  4. So you see…we can safely model the comp today due to reasons discussed above. Then as that starts to level off, we have square footage ramping up. We can safely model that too. As the second chart shows, that gets us to just over 20% annual revenue growth with comp and square footage flip-flopping their importance to the model as time passes.


Stock Report: Restoration Hardware (RH) - HE II RH chart 9 6 13

BNNY - Bullish on Annie’s

There’s lots to like about Annie’s, even with a rich valuation. Highlights include:

  • Q1 results were disappointing, but typically Q1 is its weakest quarter of the year; management reaffirmed its FY revenue growth guidance of 18-20% and adjusted diluted EPS range of $0.97 to $1.01
  • We believe that BNNY’s premium valuation is justified by higher growth rates across organic offerings, of which Annie’s is a leader, especially as it increasingly moves its products to the mainstream aisle from the organic aisle
  • BNNY is in a bullish breakout, with the stock price trading above our immediate term TRADE and intermediate term TREND levels (see chart directly below)
  • The company remains ahead of health and wellness trends in its product offerings
  • BNNY’s innovation is focused on taking everyday foods that people like to eat (ex. mac & cheese and cheddar snacks) and making healthier and better tasting products than its competitors; we think this strategy should be advantageous and sustain long-term growth versus traditional CPG innovation focused on new and “different” SKUs that may miss consumer interest
  • The company caters to a higher income client who can afford or trade up to the premium pricing of organic, despite swings in the macroeconomic landscape
  • It is poised to take a greater share across mac & cheese, crackers and fruit snacks; the introduction of frozen pizza early in the year and last month’s release of four new frozen meals offer excitement to the category. It is yet to be seen if BNNY can buck the trend of low profitability in the frozen section

BNNY - Bullish on Annie’s  - zz. bnny



Performance Outlook

Annie’s reported Q1 pro forma EPS of $0.13 on (8/8), one cent below Bloomberg consensus and revenues underperformed expectations (13.8% versus consensus 17.1%). Despite the softness in the top-line, management reiterated its FY guidance and we expect with its increased advertising spend slated for 2H (especially on pizza), a rebound in top-line in the coming quarters.  Note too that Q1 is typically its lowest revenue quarter of the year.


We continue to state that despite the lofty valuation of Annie’s (P/E of 37.4x vs food peer group average of 18.0x), organic food companies are deserving of a premium over the group due to their outperforming growth profile. BNNY enjoyed revenue growth greater than 20% over the last three years and has grown revenues at an average rate of 17.5% over the last 5 years. These figures are simply not anywhere near the much lower rates of growth for its peers in the food category,  most of whom have recorded average revenue growth south of 10% over the past five years. 


For a company that is virtually debt free, investing in cap-ex to grow the business, and increasing its work force, while maintaining a leading position in organic foods as it expands to the mainstream aisle to meet consumer demand for organic, we think BNNY rightly deserves to trade at a premium multiple.


For reference, below we show how BNNY stacks up against its competitors in the food category. Admittedly we are comparing BNNY, a small cap, to large cap non-organic companies, yet this snapshot serves as a reference point.


While gross margins slipped -190 bps to 37.8% in Q1, and we expect Q2 to be down slightly less (~100-150bps) versus the year ago comp of 38.3%, we expect a slow rebound towards 40% in the back half of the year.


BNNY - Bullish on Annie’s  - zz. comp sheet



On the Annie’s Brand

What’s not to love about a company that has been able to get ahead of the biggest consumer trend of customers better understanding what they’re eating and how what they eat may affect their overall health? 


Health and wellness is the industry’s buzzword and has been the focus of all consumer companies over the last 3-4 years. While some portfolios have been challenged to meet this trend (think: PEP, KO, CEE), BNNY is now enjoying the movement of its products from the natural and organic aisle to the mainstream (center of the store) aisle and the opportunity to take share from traditional branded players, especially those without organic offerings.


With 47% of its sales from Meals, 39% from Snacks, and 14% from Dressing, Contaminants, and Other, Annie’s sales growth has come from its strategy to take everyday products that consumers love to eat and improve the taste while using all natural and organic ingredients.  We see this as a huge competitive advantage as its innovation is focused on improving what the consumer already likes, rather than innovation for the sake of creating something “new” that may fail with the customer. We think this innovation should equate to increased household penetration.


And the movement of its products to the mainstream aisle (Mac & Cheese was first to do so in 2011) has not only met consumer demand for organic but also benefitted retailers (offering in most cases a higher margin structure). Annie’s now enjoys number one share position in national organic products in mac & cheese, snack crackers, gram crackers and fruit snacks.


Annie’s has over 135 products in 26,500 stores in the U.S., with initial inroads into Canada, across all major retailers (mass and grocery) and natural and organic stores. Given its nationwide distribution, its focus is on adding SKUs to existing channels and driving products to the mainstream aisle.


We like Annie’s ability to maintain and grow its market share as it caters to a higher income customer (typically better educated and more health conscious) that has the discretionary dollars to pay up for the price premium of organic.  Broader U.S. economic trends, with the unemployment rate at 7.6% and record highs in food stamps, suggest that lower income earners remain very price constrained since the economic downturn. Therefore, BNNY is in less competition with its branded rivals that cater to a lower income demographic. (Note: Annie’s products are sold on average at a 25-30% premium to more traditional brands across categories).



New Product Inroads

In January 2013 Annie’s launched frozen pizza in Whole Foods. In the same month it issued a voluntary recall of its frozen pizza after small metal fragments were identified in the pizza dough from a third-party flour mill it sourced.  Despite the challenges of its launch, frozen pizza is making strides (with build-out in Target and natural retails in particular), and a strong repeat rate of 70% according to the company. The one great challenge for BNNY will remain the value perception within the frozen pizza case, but the company is optimistic that television advertising slated for 2H 2013 will help to drive sales.


The company also just launched four varieties of family sized frozen meals, intended for parents who  need a quick dinner option, but still want a “healthy” meal. We acknowledge that BNNY may be competing for a different (higher income) consumer with its frozen meal offerings versus traditional frozen offerings, but we are well aware of how challenged frozen has been for the industry. We’ll have to wait and see how performance plays out.


Finally, the company is reporting strong results in snacks, in particular Cheddar Squares, launched two months ago, that target an older aged customer (versus the success of Cheddar Bunnies for kids).



Matthew Hedrick

Senior Analyst

August Employment: Something For Everyone

Ahead of this morning’s Employment Report, Keith tweeted All that matters in the BLS # is the market reaction to it”.  That seems especially fitting for the August employment data.  There was something for everyone. 


Consider the following:  The unemployment rate dropped to 7.3%, but did so on the back of a lower participation rate and negative household employment gains.  Private Payrolls declined sequentially and NFP missed estimates, but on a YoY & 2Y growth basis both measures were actually flat to slightly better sequentially.  The two month revision was negative at -74K, but PT employment for economic reasons declined, U-6 unemployment fell below 14%, weekly hours ticked higher and hourly earnings accelerated sequentially.  The Business Survey (which drives the NFP figure) showed a net gain of +165 but the Household Survey (which drives the Unemployment Rate) showed employment declining by -115K.


What do we do with that equivocality?  From a positioning or allocation perspective, not much unless the price signal changes.  


The Quantitative Risk Management setup remains positive for equities here and, on balance, today’s data doesn’t materially impact our Trend view of fundamentals – particularly with the initial claims data continuing to show accelerating improvement, the preponderance of domestic macro data in July/Aug strengthening, the seasonal headwind (which impacts the NFP data also) beginning to reverse in September, and a diminishing fiscal drag moving tangibly closer on the timeline.    


Maybe there’s a case that today’s data adds some incremental uncertainty to Taper prospects, maybe Putin vs. Obama escalates, maybe Congress delivers a negative policy surprise.  Maybe not.  


All in, similar to last month, we wouldn’t view today’s employment data in isolation as a real catalyst in either direction. 


We provided a more detailed analysis of the Labor Force Participation Rate in today’s Early Look.  You can link to that here >> Early Look: Cyclical vs. Secular


A summary review of the August Employment data below:

NFP:  Net Non-Farm payrolls gained sequentially coming in at +169K - holding flat on a YoY growth basis at +1.65% and accelerating marginally to 1.67% on a 2Y basis

NFP Revision:  The net two month revision was -74K with June revised from +188K to 172K and July revised from +162K to +104K.  

Household Survey:  The net employment gain as measured by the Household Survey was negative at -115K vs. +227K in July

Employment by Age:  Employment growth accelerated for 20-24 yr. olds and 65+ yr olds, decelerated for 55-64 year olds, and held flat for the balance of age cohorts

Unemployment Rate:  The Unemployment Rate dropped to 7.3% from 7.4%  as the total labor force declined -312K alongside a -198K decline in Total Unemployed and -115K decline in Total Employed. 

Labor Force Participation:  A positive +203K change in the working age population alongside a net decline in the labor force pushed the Labor Force Participation Rate down to 63.22% from 63.40%.

Part-time/Temp Employment:  Part-time employment declined by -234K while Temp employment gained +13K, registering its 11th consecutive month of net gains.  

Industry Employment:  Information and Finance were the only losers with employment declining 18K and 5K, respectively in August.  Manufacturing gained +14K on the month, reversing a 5 month run of net job loss.

Ave Weekly Hours for Private Employees:  Hours increased to 34.5 from 34.4 MoM and were up 0.1 vs  year ago levels.


August Employment:  Something For Everyone - Employment Summary Table


August Employment:  Something For Everyone - Cycle Profile


August Employment:  Something For Everyone - NSA Claims 090613


August Employment:  Something For Everyone - Employment by Age


August Employment:  Something For Everyone - Unemployment Rate 


August Employment:  Something For Everyone - CES vs CPS 2Y


August Employment:  Something For Everyone - Employment CES vs. CPS


August Employment:  Something For Everyone - Unemployment Rate vs LFPR


Christian B. Drake

Senior Analyst


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