Below are the latest comments from our Sector Heads on their high-conviction stock ideas.
BNNY – Consumer Staples analyst Matthew Hedrick says there is no significant news to report on Annie's this week. Hedrick stands solidly behind his bullish long-term call on BNNY saying, "Consumers want healthy, better-tasting foods and are willing to pay a premium for it." Hedrick says there could be some bumps along the way, but the secular story here is intact and this trend isn't going away anytime soon.
BYD – Gaming, Leisure & Lodging sector head Todd Jordan says Boyd Gaming shares continue to work in a difficult stock market. The macro backdrop supporting the company’s largest market, Las Vegas Locals, looks better and better, with a potential substantial boost to BYD’s business. Jordan’s focus is on housing, where Nevada delinquencies and negative housing equity are turning sharply lower. The wealth effect is usually delayed, notes Jordan, and we are now only beginning to see a positive turn in gaming revenue growth despite over a year of housing improvement. As the worst performing segment during the Great Recession, the Las Vegas Locals market maintains the most upside to peak revenues and profits
FDX – FedEx shares have moved sideways following the company’s recent earnings beat. Industrial sector head Jay Van Sciver put out an interim call to take profits and lighten up on this position last week [_HERE_], but FDX still tops his Favorites list in a number of categories. Van Sciver notes that diesel and jet fuel prices have continued to decline, a benefit for the lagged impact of fuel surcharges on this quarter’s results. Hedgeye’s Macro work indicates oil could break down further in the near term. For investors looking to profit from a drop in fuel prices, Van Sciver says that besides being an impressive management turnaround, FDX also has a sizeable airline of its own, and jet fuel costs are a meaningful part of their expenses.
HCA – Health Care sector head Tom Tobin says demand for the ACA Exchanges appears high in the early days. There are differing views as to demand versus real technical issues driving the all-too-brief period from 8:00AM October 1st and 8:05AM later that morning when Tobin was on line trying to find out what plan pricing would be for his family in New York. Tobin and his team ran an analysis of the uninsured, comparing those with existing health problems and higher medical costs, and those with excellent to very good health. The conclusion is that unless a vast majority of the healthy sign up for insurance, rather than pay a small fine, profits for participating insurance carriers look challenging. In some cases they may end up paying out 20% more in costs than they collect in premiums. This is not an immediate problem for HCA Corp and other hospitals, but worth watching. Hospital stocks have been per forming well in recent weeks into what is widely expected, even by Tobin, to be a weak Q3. Balancing price, near term catalysts, and the long term opportunity is always tricky, but for now Tobin is staying with HCA.
HOLX – Tobin updated his proprietary Tomo Tracker which measures the number of mammography facilities who have purchased a 3D Tomo. Q3 results accelerated nicely with 70 new facilities versus 50 last quarter. Physician utilization among OB's appears stable to positive, although Tobin notes weakness in surgical volumes. The bar has been set very low by the new Hologic CEO and Tobin doesn’t expect any negative surprises in the quarter. As long as that’s true, Tobin is sticking with HOLX as an overlooked way to play the ACA, participate in a resurgent capital cycle in mammography, and witness a turnaround in sentiment.
MD – Tobin says “another week has passed without an announcement of an acquisition by Mednax,” who remain short of their goals for 2013. Given that acquisitions are the most significant driver of revenue growth, it remains a positive catalyst for the future. The shutdown over the ACA this week appears to be progressing well for MD as President Obama has adamantly refused to negotiate with House members asking for a delay or defunding. MD benefits under the ACA across a number of business lines, but primarily through getting paid for Medicaid patients the same as Medicare. The policy, called Rate Parity, is a big deal to MD. The company has been slow to collect the new and higher rates from states, but they are on their way. Tobin says this is yet another aspect of MD’s business that holds future promise.
NKE – Nike is hosting an analyst meeting on October 9th at its World Headquarters in Beaverton, OR. Retail sector head Brian McGough notes that several firms have already come out with positive research on what to expect at the meeting. But, says McGough, the reality is that they are not bullish enough. The Nike brand has more momentum now than it has had in years. Notably, says McGough, “When we’re seeing a) such a strong order backlog combined with b) easing raw materials costs and successful pricing initiatives, on top of c) slowing growth in inventories – it has extremely bullish implications for Gross Margins and earnings. Consensus estimates are simply too low.” McGough says NKE is the leader in a global duopoly in a GDP+ growth industry, with solid brand momentum, meaningful upside to earnings, and 25% return on invested capital. Oh and by the way, one of the best brand names in the world. Not bad.
RH – Retail sector head Brian McGough calls Restoration Hardware a real earnings power mismatch story. McGough says “we think RH can, and will, earn $8.00 per share in 5-years.” That compares to only $1.45 today and works out to over a 40% earnings compound annual growth rate. McGough says there’s no retailer out there that comes anywhere close to this rate of growth. “Not with UA, LULU, or even in CMG,” he says. RH is growing in a multi-dimensional model – through a massive acceleration is square footage growth (from 0% today to 20% within 3-years), and then through category growth (kitchen, tableware, art, flooring, etc…) which also meaningfully boosts its consumer-direct business, currently about 47% of the total. McGough is currently in the process of conducting a proprietary, very detailed consumer survey on the home furnishings space. Look for an overview of the results to be reported here in the coming weeks.
SBUX – Hedgeye Sector head Howard Penney remains the bull on Starbucks. He likes the Seattle-based company's growth prospects and says the company will continue to achieve impressive long-term growth as long as it continues to focus on its core business. As an aside, Penney has been aboard the SBUX train since April 2009 when it was trading around $11.50. Shares have risen approximately 570% since then.
TROW – Hedgeye Financials director Jonathan Casteleyn continues upbeat on T. Rowe Price. With jobless claims this week continuing to improve at an accelerating rate year-over-year (see Investing Term of the week, below), the trajectory of the stock market continues to have an upward bias over the intermediate and long term. Casteleyn says this potential stock market appreciation means investors would do well to own shares in this leading equity asset manager which can experience both asset appreciation on its existing asset base, and the ability to bring in net new client asset inflow as the rotation out of bonds and into stocks proceeds. Casteleyn says “TROW continues to have the industry’s best stock performance which can attract net new client assets and also ride a rising stock market which can increase existing assets-under-management.” Casteleyn remains bullish on shares of TROW as U.S. economic data continues to improve, which can continue to drive U.S. stocks higher over the long term.
WWW – Wolverine World Wide prints its 3Q earnings on Tuesday October 8th, and will be hosting a conference call at 8:30am. Retail sector head McGough thinks two things are a near-certainty. 1) The company “annihilates” the consensus earnings expectation of $1.01 per share, and 2) The company guides down materially for the fourth quarter. As it relates to the beat, they will do because they have to. As it relates to the guide-down, they will do so because they want to. There’s a big distinction there. McGough says WWW will try to come up with real reasons to scare people into taking numbers down for 4Q – that’s what they do. If the stock is weak, McGough would see it as a real opportunity for aggressive buyers willing to stay with this growth company for the long haul. McGough is sticking to his thesis that WWW will earn $5.65 in three years time, compared to the consensus expectation of $4.20.
Macro Theme of the Week – Eye Of Newt
Amidst the clamor, the vitriol, the deep personal rancor – and the notable lack of intelligent discourse – emanating from Washington, Hedgeye continues to hold firmly to what we believe to be America’s best interests: a strong dollar, and a government that puts protecting its citizens’ interests first. This requires both good faith, and fortitude on the part of our elected (and un-elected) officials who must be willing to set aside personalities and pet agendas in the interest of the American people and – dare we say it? – the Constitution. Some would go so far as to characterize this stance as “American Exceptionalism.” So be it. Guilty as charged.
Whatever your politics – and we will try to remain apolitical today, since our job is to help guide your investments, not your opinions – we suspect you will agree that the current circus in Washington redounds to the credit of no one.
What exactly is a “partial” government shutdown?
Some folks seem to think “partial” refers to that part of Congress that actively wants to shut down the government. Others may believe it is an acknowledgement that, at best, the government anyway only ever partially does their job (Do you like our “old neighborhood” turn of speech? Could we go to Washington and write speeches for your Congressperson? Does that depend on what the definition of “is” is?) But many bits of government that many folks find truly essentially appear to be functioning normally – and note that for many folks, “normally” is already a perpetual state of partial shutdown. Unless you are a WWII veteran trying to pay your respects to fallen comrades, or an Australian couple on a long-awaited vacation trying to see the Statue of Liberty, you may not have noticed any difference at all. This has led some to voice concern that there may not be sufficient public pressure to get things moving again.
This week, Hedgeye was honored to host an exclusive one-hour conference call with former Speaker of the House Newt Gingrich – famous, among other things, for spearheading the “Contract With America” that resulted in the federal government shutdown of 1. Speaker Gingrich put today’s deadlock in perspective and raised a number of baseline issues that really help to contextualize the current situation.
To his credit, Speaker Gingrich stressed that his version of history is a conservative Republican’s version of history – and his view of current events is likewise that of a conservative Republican. Readers who were sentient when Speaker Gingrich led the gung-ho group that forced the 1995 shutdown may take exception with his recollection, but we prefer to present Gingrich on his own terms – it’s hard enough trying to get the markets right; we’re not going to also try to sway your political opinions. But whatever your politics, the opportunity to hear from one of the key players in national politics – himself a former history professor – offers an important perspective on events unfolding today.
Casting his politician’s eye over today’s landscape, Speaker Gingrich sees a fundamental shift from his days on the Hill. First elected to Congress in 1978, Gingrich was made Speaker after the 1994 elections, where he led the “Republican Revolution” that led to the last shutdown of the federal government. Speaker Gingrich remained in Congress until his resignation in 1999.
Going Nowhere Fast
Speaker Gingrich’s first observation was that the timing of this shutdown may well leave us stranded. No matter how urgent the business at hand, every politician is always keenly aware of where they are in the election cycle. The next Congressional elections are a little over a year from now – an eternity in political time – and, perhaps more significant, President Obama is not running for re-election. This creates a lack of urgency, says Gingrich: no matter how crazy things get, there will be plenty of time for it to cool down. Speaker Boehner’s seat appears quite safe, as long as he doesn’t give up the farm entirely, and Senator McConnell appears confident that, worst case, he will be able to tough his way out to another win.
Without the Sword of Damocles of We The People hanging over their heads, Gingrich says all the players are free to press their own narrow agendas, a situation that is exacerbated by a media revolution that has occurred since the 1990s.
His second main point addresses the tenor of discourse. The newsmedia, says Gingrich, are in a state of shock over what’s going on in Washington. While he did not directly touch on it, we have made no secret of our disgust over the lack of subtlety and analysis generally offered by the main media outlets. Perhaps there is a chain reaction at work, with politicians not speaking to each other, then spouting pugnacious battle cries to the press, and the press only too glad to flog inflammatory slogans – because that’s what sells newspapers (for those of you who remember that ancient medium).
Gingrich likened today’s society to a dumbbell – an all-too-apt simile – where one group of extremely noisy folks get their information exclusively from Fox News, while another equally noisy group get their information only from Jon Stewart’s “Daily Show.” Gingrich stressed that these two groups do not represent the majority of Americans. But they are the majority of screamers, and they run roughshod over a large, and largely silent, middle who do not engage in the screaming match – not because they think it isn’t important, but because they are busy with inconsequential stuff like taking their children to doctor appointments, meeting with teachers, and juggling 2 or 3 jobs apiece. Every generation has its “Silent Majority.” Ours appears to be those who continue to struggle to remain Middle Class – for many, an increasingly bleak vista.
As part of this whole phenomenon of personal media exploding in real time into viral messages – one person’s bad attitude gets tweeted to a couple of hundred followers and suddenly goes viral – politics has descended to a level of personal vitriol. During his tenure as Speaker, says Gingrich, he and President Clinton were able to sit down to lunch together and enjoy one another’s company while wrangling through extremely tough negotiations.
He spoke of commonality of interests – as students of history and politics – and of actual personal respect, despite their being on opposite sides of the table. Gingrich finds this notably absent from today’s political scene, where a “conversation” between Speaker Boehner and the President amounts to ten minutes in the Oval Office with the two of them refusing to look one another in the eye. “The only thing these fellows have in common,” says Gingrich, referring broadly to today’s politicians, “is golf.”
Whether or not you fully buy Gingrich’s somewhat rosy depiction of his personal friendship with President Clinton, it is undeniable that the two spent many hours together during some of the most fraught days of their tenure. Today, notes Gingrich, no one in Congress has a personal relationship with the President, which bodes ill for genuine communication, and worse for actual compromise.
Gingrich sees a substantive disconnect between the politics of the 1990s and today. Using President Clinton as an example, he calls his own years in Congress the era of “professional politicians,” men and women who were able to set personal feelings aside and negotiate difficult issues. Today, he says, “instead of working very hard to promote their political agenda, they actually get personally angry at each other.” No wonder there’s a shutdown.
Over My Fed Body
Speak Gingrich’s third point has to do with power, who actually wields it, and what this bodes for the country. He believes Senate Majority Leader, Democrat Harry Reid, holds an unprecedented degree of power, far greater than Majority Leaders of the past. The consternation in the press, and the clash of opposing one-sided media streams, make it almost compelling for the leadership on both sides to refuse to negotiate.
The Speaker took special aim at the Fed – a favorite Hedgeye target. Calling himself a student of economic history, Gingrich says “the transfer of real power to the Fed has been extraordinary,” having avoided any type of reining in by the people or Congress. Gingrich states flatly that almost no one in Congress understands anything about what the Fed actually does, and that no one wants to take the time to do the very difficult work of educating themselves. Thus, while many in Congress are angry at the Fed and Chairman Bernanke, they don’t even really know what it is they are angry about. They have real concerns, but don’t even know what questions to ask.
This leaves a tragic leadership gap. Americans are living through the worst prolonged economic conditions since the Great Depression. Even at higher income levels, people are just plain scared. In the midst of this confusion, Gingrich says Chairman Bernanke has arrogated to himself an astonishing amount of real power. Even Chairman “Maestro” Greenspan, says Gingrich, “had maybe half as much power” as Bernanke wields.
In the climate of fear – and with Congress failing to ask educated, probing questions of the Fed – people are more afraid of what might befall without Chairman Bernanke than they are of continuing down this ruinous path. This is, indeed, The Evil You Know. But the comfort is cold, indeed. Given the massive volume of paper money the Fed has pumped into the global economy, says Speaker Gingrich, “I don’t see how they can possibly believe this will end well.”
Speaker – or perhaps in this instance Professor – Gingrich’s analysis is that the Fed is pouring paper money (“fiat currency,” with no solid collateral to back it) into the economy at a rate far in excess of economic productivity. The effect is that the velocity with which money moves through our economy has declined at about the same rate that the volume increases. This creates a perilous steady state, sort of like a clogged toilet bowl with a small leak. As long as it is filled at the same rate as the leak allows liquid to escape, it won’t overflow. But, says Gingrich, the moment velocity slows substantially, we will be hit with massive inflation. “Interest rates going back to their historic averages” says Gingrich, “would have a catastrophic impact on the federal budget.”
Dancing On The Ceiling
Finally, addressing the pending hysteria over the Debt Ceiling, historian Gingrich says that no one seriously believes the President has the authority to unilaterally cancel the debt limit. To do so, he says, would trigger a Constitutional crisis. We presume that professor of Constitutional law Obama would concur, and that the convergence of the debt ceiling debate, and the wearing down of the social fabric in the coming days, will lead to an interim resolution – perhaps even by the time you read this.
The Chinese must be chuckling over our predicament. It appears we have been born in interesting times. Hedgeye expresses its thanks to Speaker Gingrich for appearing as a special guest and sharing his insights and analysis.
Sector Spotlight – Health Care: Obama-where?
Touching on the furor around the Affordable Care Act, Speaker Gingrich said that trying to launch program on that scale without a beta test “guarantees a disaster.” As long as the program moves forward, the kinks will be worked out. Ultimately, the incidence may not be unacceptably high from a broad statistical point of view. But the kinks are being worked out in real time, and with real people, and if you are one of those data points, you’re going to be mighty frustrated while you are waiting to lose your “kink” status and revert to being yourself. Instead of a beta launch, said Gingrich, “the opening test was live and in color – and there were 47 states in which not a single person got registered the first day.”
As a real-time test, the Hedgeye Health Care team, ably captained by sector head Tom Tobin, has been attempting to sign up on on-line exchanges. As of Speaker Gingrich’s appearance on Thursday morning, they had not been successful, though they did receive a tweet saying the federal equivalent of “thank you for your interest, your call is important to us...”
Putting aside politics – and the wisdom of a direct launch – we offer some highlights of Tobin’s analytic work around the Affordable Care Act. Tobin says universal coverage is actually the only step the government could take to begin the process of fixing health care. Says Tobin, “the bigger problem with health care in America is not the ACA.” Our health care system is plagued by problems of allocation of resources, high incentives to collusion and other fraudulent behavior, and a structure that guarantees excessive charges and wildly uneven distribution of services.
This is partly driven by myths that, says Tobin, are so deeply rooted in people’s awareness that even showing them actual numbers often fails to convince them to relinquish their beliefs.
One key myth is the notion that older Americans consume disproportionate levels of health care resources. Having tracked demographics versus health care consumption throughout his career – and reviewing similar studies across a range of scholars of the industry – Tobin says the actual increase in health care consumption associated with an aging population is less than one per cent. Recalling Speaker Gingrich’s point about a news media that has thoroughly discredited sophisticated analysis, casting it aside in favor of strident name-calling and finger-pointing, we note that older Americans are a growing percentage of the population, and that health care costs are increasing at rates. In the current climate of mindless comparisons, people seem to be jumping uncritically to the conclusion that old folks use more than their fair share of health services.
But statistical “correspondence” is not the same as “causality,” and large numbers of studies by a large numbers of health care experts – Tobin among them – have concluded that older Americans do not significantly suck up health care services, to the detriment of everyone else.
So where is the sinkhole in medical care? Tobin says hospitals overcharge for procedures because they can, insurance companies withhold payment for reasonable treatments because they can, and medical practitioners prescribe unnecessary procedures and tests – often because they can, and just as frequently because, in the current atmosphere of medical liability, they must. Says Tobin, the only way to bring the problems in America’s health care system to the surface is to force them out. And the only sure-fire way to flush them out into the open is to roll out coverage across the entire population. Tobin says it is only once everyone has coverage that the problems with the coverage will become apparent.
Many of the groups driving health care costs higher are not the end users, but reside along the chain of payers and providers. And many of these actors also benefit overwhelmingly from those excessive costs – not a massive conceptual surprise. Equally unsurprising, they benefit the most from the lack of clarity around health care costs. And, ergo, they really don’t want the Affordable Care Act to take root (wonder who’s behind this whole shutdown thing, anyway…?)
Tobin’s read is that the first to sign up for the ACA will be those with the most urgent immediate needs. His thumbnail review over a broad range of uninsured Americans suffering from fair-to-poor health is that this group have medical expenses ranging anywhere from twice as much, to eight times as much as the healthy uninsured. The first to sign up will overwhelmingly be those in need of immediate care, which means the costs associated with the ACA will be heavily weighted to the early period – perhaps a few years.
The economic success of the Act depends on a majority of the healthy uninsured signing up, thereby lowering the per-participant cost to the pool, and the government will have to come up with strategies to induce, entice, and ultimately force people to enter the program. This is the simple principle underlying any insured population. The difference here is that, unlike major insurance companies, who do not get their stock prices higher by paying out claims, the ACA will have to pay as claims are presented.
Speaking on the eve of the partial shutdown, President Obama said “a couple of years from now, this program will be a success. People will like it, they will want to participate, and it won’t be costing the taxpayers anything to provide universal medical coverage. When that happens,” he said, “no one will want to call it ‘Obamacare.’”
Place your bets, Ladies and Gentlemen. Le jeux sont faits. Rien ne va plus.
Investing Term – Non-Seasonally Adjusted Claims
“Due to the lapse in funding,” said the Labor Department this week, “the Employment Situation release which provides data on employment during the month of September will not be issued as scheduled on Friday.” The Department adds, “An alternative release date has not been scheduled.”
If you are capable of putting 2 alongside 2 and arriving at 4, you will recognize that the Labor Department, and the statistics it continually posts on the nation’s employment condition, fit Congress’ definition of “non-essential services.” We concur.
Financials sector head Josh Steiner has steadfastly held to his use of Non-Seasonally Adjusted (NSA) initial jobless claims as the best indicator of growth in the labor markets. As we have observed in this space, Seasonally Adjusted numbers (SA) – used by the Fed, the Labor Department and other government agencies as a policy planning tool – and the raw NSA numbers ultimately must add up (or subtract, as the case may be) to the same number come year end. And while the Fed relies on the SA numbers as its (alleged) trigger for tapering, Steiner’s long-term data series indicate that NSA data consistently present a more accurate picture of actual labor market conditions.
Put simply, NSA claims tell us how many people find themselves out of work right now. It is a raw number, not smoothed to account for historically observed seasonal variations, not broken out by segment and sub-segment of the economy – categories which may be significant in one cycle, but which may quickly become irrelevant through technological progress or social change.
Other statistics more frequently relied on by policy makers include the unemployment rate, the non-farm payrolls number, and of course the SA jobless claims. And, since these data series are invoked for policy decisions, they are the ones most often reviewed by analysts in projecting the strength of the labor market.
Wrong, says Steiner. Wrong, wrong. Put differently, when is the last time that, rather than find an independent reliable source of information, you preferred taking the government’s word for something? For anything?
Steiner’s work clearly indicates that seasonal adjustments to employment and unemployment numbers distort the data. One effect of this is that SA numbers tend to act as a drag on reported employment in the March-August period, and then reverse to become a tailwind in the September-February period. Thus, the most recent data the Fed is looking at suggests the labor market is weaker than it actually is.
Since both the SA and NSA numbers must match over the course of the full year, you may be wondering why the government jumps through all these statistical hoops. Our simple read is that policy initiatives tend to succeed (or not) over longer periods of time, and thus comparing SA figures projected backwards and forwards looks like a like-to-like comparison. Where this breaks down, says Steiner, is in economic forecasting – something that, according to Hedgeye’s analysis of his track record, Fed Chairman Bernanke is notoriously bad at. Policies are formulated based on extrapolations from long-term statistical series. This works well as academic justification for policy recommendations, but it tells us little about how many people actually believe themselves to be out of work right now, and with no immediate prospect of employment. Note to Chairman Bernanke: the actual number has been going down. Shouldn’t we be expecting a taper?
Steiner is featured this week in a new Hedgeye video. In this market analytic Haiku – short and precise – Steiner explains the current strength in the jobs market, together with a graphic presentation of implications for your portfolio. Hedgeye TV – don’t touch that dial!
- By Moshe Silver
Moshe is a Hedgeye Managing Director and author of the Hedgeye e-book Fixing A Broken Wall Street