Below are the latest comments from our Sector Heads on their high-conviction stock ideas.
BNNY – On Monday night (10/21) after the close, Annie’s, Inc announced FY14 revenue growth to be at the high end of its guidance range of 18%-20%, and its EPS to be at the low end of a guidance range of $0.97-$1.01. It also announced a change in the CFO seat, hiring Zahir Ibrahim from $TAP. Consumer Staples senior analyst Matt Hedrick says his medium-term bullish outlook remains unchanged, despite the stock dropping single digits week-over-week in the wake of the announcements. Hedrick views the sell-off in BNNY shares as a buying opportunity for investors.
BYD – We’re still bullish on BYD as a recent NJ tax ruling will boost profits ahead. Boyd’s NJ property, Borgata, which it owns 50%, is getting a property tax refund of an estimated $40-50 million for 2009/2010 and likely a similar amount for 2011/2012. Importantly, that could mean net EBITDA gains of $20-25 million annually beginning in 2013. This could translate to a 8-10% uptick to the value of Boyd Gaming stock. Boyd reports earnings next Thursday.
FDX – Shares of FedEx continued higher this week following broker upgrades. Many analysts view FDX's buyback as a sign of greater shareholder focus. Hedgeye Industrials Sector Head Jay Van Sciver continues to see the Express restructuring as a long-term source of substantial profit growth
HCA – Hedgeye Healthcare Sector Head has no update on HCA Holdings this week.
HOLX – Hedgeye Healthcare Sector Head has no update on Hologic this week.
MD – Hedgeye Healthcare Sector Head has no update on Mednax this week.
NKE– We’d like to address the elephant that’s been quietly sitting in the back of the room since Nike’s analyst day on October 9th. Specifically, Nike finally outed a key initiative we’ve been talking about for two years – the ability to manufacture customized product (by color and size) at point of sale. Think about it – the model for footwear makers over the past 4 decades has been to design product in the US, and then to outsource to Asia – the entire process taking nine months at the earliest.
Now, NKE is introducing the capability for a consumer to walk into a store and build their own shoe at a kiosk. They’ve had that capability through NikeID at their own stores for a while. But those orders still go to one of its 700 third-party plants in Asia to be processed. Now the product is being manufactured right there…on the spot. So basically, a consumer could go into the store, build a shoe electronically, then go to Chick-fil-A for a bite to eat, and return an hour later and their shiny new kicks will be waiting. This is an absolute game changer, and it’s one that no other brands have the scale to compete with.
Sound expensive for Nike? Ask yourself this…what retailer on the planet would not give their left arm to have one of these Nike kiosks/mini-manufacturing hubs in their stores? It’s be a big competitive advantage, and one that we think would lead the Foot Locker’s of the world to lay out the capital needed on their own balance sheet. Nike only allocated 90 seconds to this at their meeting. It was worthy of three hours. We think that people will grossly underestimate the importance of this initiative (no one even asked any questions on it).
RH – Last week we released the results of our comprehensive consumer survey focused on Restoration Hardware and the home furnishings space. Our findings supported our thesis that RH has one of the biggest growth runways in the Consumer space. RH is in the process of transforming its estate portfolio, as they move away from their 10,000 square foot Legacy Store to their new 45,000 square foot Design Gallery.
In its current format, RH is only able to display approximately 25% of its product offerings. Many of the company’s current product lines have virtually no retail presence. So, how did consumers feel about RH’s presence in the home furnishings space? Well, it was pretty straight forward, consumers in general don’t know what products Restoration Hardware carries. In fact, consumers indicated that the only product category, of the twelve we asked about, that they would buy at RH vs. the competition was lighting. Now you may be thinking this is bad right, but we see it the opposite way. There is a significant amount of opportunity for RH to grow its existing and upcoming product lines as it expands into its growing real estate portfolio. Many of these underexposed offerings will finally get a spot on the floor and that means more consumer awareness.
SBUX – Hedgeye Restaurants Sector Head has no update on Starbucks this week.
TROW – T Rowe Price continues to fire on almost all cylinders after its earnings report this week that beat Street expectations on both revenues and on earnings per share. The firm did however see institutional outflows at the end of the quarter which was the only hang up in an otherwise strong release.
The outflow in the third quarter was improved from last quarter’s withdrawal and is again coming for only a small select group of sovereign wealth funds in Asia that are rebalancing their asset allocation after above benchmark performance from TROW funds. TROW continues to maintain the largest percentage of fund assets in 4 and 5 star funds, the only mutual funds that historically have received any new inflow.
As such with these sovereign outflows to be finished soon in our view, TROW will again return to positive net inflow which will be a positive catalyst for this leading fund manager. T Rowe has $1.6 billion in cash, forward free cash flow of $1.2 billion, and no debt which give this company leading financial stability in the group with the ability to raise its dividend again into 2014 as investors wait for net inflows to return.
WWW - We’ve spoken many times about Sperry being the second largest brand inside the Wolverine Worldwide portfolio – but we’ve always referred to shoes and sneakers. That’s changing. Specifically, WWW is starting an apparel line for Sperry – targeted at both women and men. Some of the more popular items on the site are men’s fleece vests for $80, but the price goes up to $200 on Sperry watches, and $185 on women’s outerwear. That’s not the only change for WWW this week, as the company is aggressively rolling out Ked’s kiosks in malls just in time for holiday. This will really do a number on its distribution. We continue to believe that Sperry is $475mm on its way to $800mm, and Keds is $100mm on its way to $400mm–
Macro Theme of the Week – The Fed: All Over But The Yellen
All the recent partisan posturing notwithstanding, we have concluded that it is not the Democrats’ excessive zeal to punish “Wall Street fat cats” that is holding back the economy. Nor is the uncertainty sowed by Republican intransigence preventing entrepreneurs from launching businesses and banks from funding them. And this week even the SEC came out in favor of small start-ups with a new crowd-funding rule proposal.
So if both the Republicans and the Democrats want economic growth – and if even the SEC is playing along – then where is the bottleneck?
By the time Alan Greenspan un-humbly admitted to Congress “I was wrong,” Ben Bernanke had succeeded him as the next fox to guard the henhouse of the US economy. Many long-time Fed observers express frank astonishment at the power Chairman Bernanke has arrogated to himself since being appointed. Inertia being among the most powerful forces in the universe, President Obama has not seen fit to rein in the Chairman’s powers. The result – as we see this week – is that Bernanke appears to have single-handedly pushed off the forces of nature. Unlike his predecessor, Professor Bernanke has yet to admit to making any mistakes.
Let us be blunt: at Hedgeye, we have a point of view. Our contention is that a strong US Dollar is both the emblem and the driver of domestic economic strength. Apologists in the media today are saying that the recent drop in our currency “is good for US growth” because it will make our exports cheaper, thus driving business. Hedgeye CEO Keith McCullough came out stridently against this whole muddied view of the world in a video featured this week on Hedgeye TV, exhorting Chairman Bernanke to “just get out of the way” and allow market forces to take their course. The markets have been signaling their willingness to charge ahead under their own steam.
But it was not to be. Which leaves us puzzled over many things. For one, the US economy is 70% driven by domestic consumption. If domestic consumers continue to see the value of their savings dwindle because there is zero return on their (insured) passbook accounts and (uninsured and inherently unstable) money market funds, then how exactly is that helping growth?
And statistics are not helping. Economists say Treasury debt held by individuals is decreasing as a percentage of total sovereign US debt outstanding. This is a positive, if it indicates that outsiders are buying our debt because they find it more attractive than other alternatives.
But wait. Because under Bernanke, the Fed has sucked up the lion’s share of Treasury issuance. The Federal Reserve currently owns over $2 trillion of Treasury debt, out of a total balance sheet that stands at over $3.7 trillion (Federal Reserve Statistical Release for 16 October 2013).
In fact, the Treasury is set to issue about $444 billion in new debt by the end of this year to fund the deficit. At the current QE pace of $45 billion per month of Treasury purchases, the Fed will purchase $270 billion of this newly-issued debt, or roughly 60%. And remember that the Fed continues to buy another $40 billion every month of mortgage-backed securities from Fannie and Freddie.
If the Fed used all its planned QE spending just to buy Treasurys, it would be able to buy more than 100% of the planned issuance for the balance of 2013. The Fed earns interest on its Treasurys, then remits the interest back to the Treasury, which takes it as income. This "incestuous" process was detailed this week by Hedgeye senior analyst Christian Drake. Drake explains that “the U.S. benefits in two primary ways. First, with the Fed in the market, Treasury yields stay lower than they would otherwise and sovereign cost of capital remains artificially depressed. Second, because the Fed simply gives interest earnings back to the Treasury, debt is artificially lower than it would be otherwise as well.”
This exercise also artificially skews the metric of “percentage of Treasury debt owned by US individuals.” Treasurys bought by the Fed are not owned by US individual investors. But of course, the taxpayer is on the hook for every newly-minted penny of it. Smoke and mirrors, anyone?
“This has scale,” writes Drake. “So long as rates remain low and interest income rises faster than interest expense – the larger the Fed balance sheet grows and the larger percent of total debt outstanding the Fed holds – the larger the benefit to the Treasury on the back end.” And if the Fed’s balance sheet grows faster than the growth in deficit spending, the Treasury can continue to issue more net debt at a lower incremental cost.
If we survive the fourth quarter of 2013, next year will usher in a new Fed chair – most likely Janet Yellen, a highly qualified central banker who, many predict (and some fear) looks set to continue in the Bernanke mold “for as long as the economy needs.”
At mid-year, Hedgeye’s Macro work pointed very strongly to a generational rotation out of fixed income. Our Q3 2013 Macro Themes call, in July, featured the theme #RisingRates. It was a cogent call, based on both sound mathematics and detailed observation of the markets. It made us bullish on US growth. It pointed to a seismic shift as bond prices started to fall. It gave us hope. And Hope, as Keith is fond of pointing out, is not an investment process.
While consistently telling Congress and the American people that his policy decisions would be data dependent, Bernanke has equally consistently cherry-picked the data points that most strongly justify his policies. His reliance on seasonally-adjusted employment data, for example, enables him to smooth the growth out of the economy, just when actual trends (as measured by non-seasonally adjusted unemployment claims) are improving. Just when the Taper seemed to be exactly what was needed – indeed, just as the markets signaled they were both ready and eager to embrace the Fed tapering its purchasing program – Bernanke hit the markets with a monetary sucker punch, indicating that easing would be premature.
This game looks to go on. Who actually benefits? Holders of large bond portfolios look to gain, at least in the short term, as they can not easily divest hundreds of millions of dollars’ worth of bonds. One of our recent least-favorite sectors – energy master limited partnerships – look to gain, as low interest rates mean they don’t have to keep increasing the yield on their payouts to unitholders. So it’s steady as she goes. At least, until she doesn’t.
In addition to bolstering our economic figures through data manipulation (sucking Treasurys out of the market, recalculating the formula for GDP), the Fed’s buying program moves lots of cash through the system. Theoretically, they could just buy the bonds directly from the Treasury. Instead, they trade through the Treasury primary dealers, generating transaction fees to some of the biggest financial firms.
Where will this end? Assuming Janet Yellen takes over, there’s good news, and bad news. The good news is that President Obama is not running for a third term, so she would presumably feel less political pressure to push the incumbent’s agenda. The bad news is, with Obama not running, Yellen will have to second-guess the political agenda of whoever is most likely to end up in the Oval Office, a complex parsing exercise best undertaken by Las Vegas bookmakers.
To investors spooked by how much Treasury debt foreigners own, you can relax. In fact, you are already the biggest holder of Treasury debt – as well as the ultimate guarantor. The Social Security trust fund holds over $2.7 trillion, various federal employees’ retirement and insurance funds collectively own over $800 billion, the military and uniformed services retirement and health care funds own $600 billion… the list goes on. But those agencies can make the argument that they bought Treasurys as an investment, and that they use interest payments to fund payments to their various beneficiaries. The Fed holds over two trillion dollars’ worth with a much poorer excuse: they pay the interest payments to the Treasury. Even the magic 8-ball can’t predict whether Fed Chair Yellen will add, trim, or stand pat.
So much for the natural resilience of the US economy. So much for the much-needed break in artificially inflated bond prices. So much for the Dollar. We have met the Chinese, and they are us.
- By Moshe Silver
Moshe is a Hedgeye Managing Director and author of the Hedgeye e-book Fixing A Broken Wall Street