CAT: Blinded by the Sun



A traditional sell side firm upgraded CAT today in a lengthy report that we suspect most longs won’t read in its entirety.  Rather than respond to a boring write-up with another boring write-up, we will mostly focus on what is missing from that report: all the bad stuff. 


Calling the bottom in CAT is a strategy that is not working.  Investors and sell siders have been making that call since before Resource Industries had even reported a down quarter (See It Hasn’t Started, So It Isn’t Over).  CAT is the 3rd worst performing Industrial YTD in the S&P 500, so arguing that the bottom is in because the shares are holding 80 as the market rips to all-time highs is a bit facile.  Why even bother trying to call a bottom when being long CAT is not working? 


CAT: Blinded by the Sun - bh1



Of course, we were not born yesterday.  Management provides special access to a sell sider and select clients.  Shortly after, said analyst upgrades the stock and writes a glowing report.  We are sure that the SOLAR/dealer visit trip was great.  We’ll leave the rest to the reader’s imagination.



Leaving Aside the Bad Stuff, CAT Is Great!



Trough Earnings


We see the $4.50 2014 EPS figure is a straw man.  We agree that CAT should produce more than $4.50 in 2014 EPS, excluding charges and any issues at CAT Financial, but why does that matter?  2014 was last interesting six months ago.  The battleground has moved to 2015 and later, where we see little hope of a rebound.  It has also moved to the CAT boardroom and CAT Financial.  The assumption that Power Systems is a stable source of profitability is deeply flawed, as is the assumption that Resource Industries cannot operate at a loss, in our view.


Multiple of Trough Not Useful For Generating Alpha


CAT underperformed the market nearly continuously from the late 1970s until 1992.  The peak/trough multiple analysis is unrelated to generating Alpha, so it is worthless.  It gives a buy signal in ’82-’83, ’84-’85, ’87, then finally successfully in ’91-’92.  Alternatively, our process – understanding the cycle, the industry structure and the valuation – has worked well and we have published real-time write-ups demonstrating it for the past year and a half (when we joined Hedgeye).


CAT: Blinded by the Sun - bh2



Cyclical Industries Can Lose Money


The Armageddon scenarios presented are really not that bad in the context of a deep cyclical like CAT.  Why exactly can’t Resource Industries operate at a loss?  Resource Industries margins are collapsing amid vast industry overcapacity.  Pricing is increasingly competitive, with the decline slow to hit the Income Statement as the company works off better priced orders in backlog.  Resource Industries revenues have only declined for three quarters, so it is still very early in the adjustment process.  What would Resource Industries profitability look like with industry capacity utilization at, say, 30%?   Mining capital spending is likely to remain at around maintenance levels, i.e. normal levels, for something like the next decade, as we see it. 


Where Is CAT Financial?


The recent credit metrics have looked questionable at CAT Financial, so we guess it was probably easier just to leave it out.  It is just the leveraged division which comprises about 40% of the firm’s assets and is a key focus for bears and short sellers.  Given the endless focus on the comparatively tiny (in terms of assets and risks) SOLAR turbine business, a few sentences might have been in order.


Mining Exposure Outside of Resource Industries


Part of the reason for weakness at Construction Industries is that larger pieces of equipment were often sold to the mining industries at high margins.  Locomotives at Power Systems are also sold to mines on occasion (see EMD website).  Mine site power is also a factor at PS.


Acquisitions & Capital Allocation


Comparing old CAT to current CAT is not exactly apples for apples.  CAT has gone through a period of terrible capital allocation, in our view, with vastly overpriced acquisitions and soon-to-be-unutilized capacity additions.  The misallocated capital is likely >$10 billion in the last few years and has yet to be recognized, by our estimates.


Management Credibility & Strategy


Given what has happened at CAT in the last year or two, some discussion of management strategy or credibility should probably have been included, right?  We expect a management change at CAT in the next year or two, with a new team coming in to lower the performance bar.  How do you write a 47 page report about a company that needs a turnaround without mentioning the name of the CEO or discussing strategy?


Competitors Missing


Komatsu, Hitachi and other competitors seem to be conspicuously absent from the discussion, which is an important omission for both Resource Industries and Construction Industries.  As mining equipment demand dries up, these competitors are refocusing on construction equipment, negatively impacting price.  In the instance where Komatsu is mentioned, it is about their coal commentary, not their competitive response to an evaporating mining equipment market.



Top Down View of Energy Capital Spending


We discussed the long-term outlook for Energy-related capital spending in our Industrials Fishfinder note this morning.  Energy-related capital spending boomed along with other resources-related capital spending and has since started to decline.  We see some risk that Power Systems is in fact the next shoe to drop.


CAT: Blinded by the Sun - BH3


Dealer Inventories


Dealer inventories should be looked at on a dollar basis, not as a % of sales.  Finning has about 2x the value of inventories of Westrac and Toromont combined, by our estimates.  Finning still has a lot of inventory to work off as we see it.  CAT provides inadequate transparency on this issue, we think.


We’ll Stop Here…


If CAT were composed exclusively of the SOLAR turbine business, the company’s outlook might be rosier.  Unfortunately, SOLAR is a small part of total CAT.  Of course, if the sell side were composed entirely of analysts actually trying to make good calls, markets might function better.


Instead, we think there is little reason to expect that this is the inflection point for CAT or that all of the bad news is priced in.  Multiple of peak/trough work would be interesting if it generated useful predictions – it just doesn’t.  We see a scenario for CAT much more like the 1980s, where the boom in resource-related capital spending drops over a long period of time amid tough competitive pressures.  We also see serious strategy and management deficits at CAT, the eventual resolution of which may result in a greater capitulation in the shares.  Maybe then we join the search for a CAT inflection….




$WMT's New CEO: Thumbs Up

Takeaway: This is a win-win for Wal-Mart.

Editor's note: Hedgeye Retail Sector Head Brian McGough offers a quick take on news of Wal-Mart's new CEO below.

$WMT's New CEO: Thumbs Up - dmw

  • "Wal-Mart Stores, Inc. today announced that its board of directors elected company veteran Doug McMillon, 47, to succeed Mike Duke, 63, as president and chief executive officer, effective February 1, 2014. McMillon was also elected to the company's board of directors, effective immediately."
  • "Duke will continue serving as chairman of the executive committee of the board and, in the tradition of his predecessors, stay on as an advisor to McMillon for one year. The company plans to make an announcement on McMillon's successor as CEO of Walmart International by the end of the fiscal year."

Takeaway: McMillon's profile has been growing inside WMT for a while now, so this does not come as a complete shock. But we are definitely surprised by the timing. All that said, the idea of having a 47-year old CEO with heavy International experience is extremely appetizing to us. Let's face it, there's no more unit growth in the United States; and WMT can't comp consistently better than 1%. Bottom line is this guy can't exactly do any damage to the US business, and International will have a bigger profile. It is a win-win.


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European Banking Monitor: Winning Ways Continue

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .




European Financial CDS - Europe's banks resume their winning ways, dropping an average of 8 bps W/W. Italian, Spanish and UK banks led the charge lower.


European Banking Monitor: Winning Ways Continue - zz. banks


Sovereign CDS – Sovereign swaps were mixed last week with the biggest up moves in the US (+5 bps) and Ireland (+4 bps) and the biggest down moves in Spain (-9 bps) and Portugal (-7 bps).


European Banking Monitor: Winning Ways Continue - zz.sov1


European Banking Monitor: Winning Ways Continue - zz.sov2


European Banking Monitor: Winning Ways Continue - zz.sov3


Euribor-OIS Spread – The Euribor-OIS spread tightened by 2 bps to 9 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. 


European Banking Monitor: Winning Ways Continue - zz.euribor


Matthew Hedrick


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$TROW: Casteleyn Likes It

Takeaway: TROW is a prime beneficiary of the positively trending U.S. stock market.

Editor's note: What follows below is an excerpt from Hedgeye Financials Equity Analyst Jonathan Casteleyn in this weekend's Investing Ideas. Investing Ideas is for the longer-term investor looking for actionable long-only opportunities. With your subscription, you'll know immediately when one of our analysts uncovers a new idea or changes a current one. Every Saturday morning you'll receive our special newsletter full of all the important investing information of the week. Click here to subscribe.


$TROW: Casteleyn Likes It - trowe

T Rowe Price

During our recommendation of T Rowe Price as a core long position, we have solely been using industry information on equity flows from the Investment Company Institute (ICI), the trade group for the asset management industry.  However, there is a private survey of asset management performance and flows called Simfund which we don’t use that projected a very positive outlook for TROW separately from our research process using ICI data.


Last week, this private Simfund survey calculated that in October alone that T Rowe has netted over $1.8 billion in new net inflows, more than the prior 3 months combined which totaled just $1.2 billion. Thus it is safe to say that the fourth quarter has started in very strong fashion for this leading equity manager.


$TROW: Casteleyn Likes It - cast888


In addition, Simfund projected that TROW’s industry leading performance gap has widened favorably, meaning TROW’s mutual fund families have increased their lead as the best performing mutual funds of the public asset managers. According to Simfund, now 70% of TROW’s assets are 4 or 5 star Morningstar rated, the only mutual fund products that have historically generated any significant inflow (see annual 4 and 5 star inflow versus 1 to 3 star rated products below).


In a nutshell, TROW stock is a prime beneficiary of the positively trending U.S. stock market with industry leading performance and improving retail equity mutual fund flows.


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What's New Today in Retail (11/25)

Takeaway: Great CEO move by WMT. WWW’s McCarthy refocuses Merrell. JCP purposefully irreverent in dispute with Kmart. ANF fire in Paris. JNY SHLD LTD



CHS - Earnings Call: Tuesday 11/26 8:30 am

DSW - Earnings Call: Tuesday 11/26 8:30 am

TIF - Earnings Call: Tuesday 11/26 8:30 am

BWS - Earnings Call: Tuesday 11/26 9:00 am




WMT - Doug McMillon Elected New Chief Executive Officer of Wal-Mart Stores, Inc.



  • "Wal-Mart Stores, Inc. today announced that its board of directors elected company veteran Doug McMillon, 47, to succeed Mike Duke, 63, as president and chief executive officer, effective February 1, 2014. McMillon was also elected to the company's board of directors, effective immediately."
  • "Duke will continue serving as chairman of the executive committee of the board and, in the tradition of his predecessors, stay on as an advisor to McMillon for one year. The company plans to make an announcement on McMillon's successor as CEO of Walmart International by the end of the fiscal year."


Takeaway: McMillon's profile has been growing inside WMT, so this is not a complete shock. But we definitely are surprised by the timing. All that said, the idea of having a 47-year old CEO with heavy International experience is extremely appetizing to us. Let's face it, there's no more unit growth in the US, and WMT can't comp consistently better than 1%. The guy can't exactly do any damage to the US business, and Int'l will have a bigger profile. This is a win-win.


JCP - J.C. Penney Will Be Replaced by Allegion in S&P 500 After Drop



  • "J.C. Penney Co...will be replaced in the Standard & Poor’s 500 Index by Allegion Plc., S&P said in a statement today."
  • "The S&P 500 change will take place after the close of trading on Nov. 29…"
  • "J.C. Penney will bump Aeropostale Inc. from the S&P MidCap 400 Index, and Aeropostale will displace Corinthian Colleges Inc. from the S&P SmallCap 600."


Takeaway: Not a surprise for two reasons…1) JCP can't be in the S&P with its current market cap for too much longer, and 2) The stock dropped like a stone headed into this announcement. Someone had the information.


JNY - Sycamore in talks to buy Jones Group for less than $16/shr-sources



  • "Private equity firm Sycamore Partners LLC is in advanced talks to acquire apparel retailer Jones Group Inc and is working toward a deal in the next few weeks, according to sources familiar with the process."
  • "Sycamore is discussing a price of less than $16 per share - or roughly $1.3 billion based on shares outstanding - and is in the process of lining up financing for the deal, two people said on Friday."


Takeaway: Looking back as far as 10-years, JNY has managed its M&A pricing through the press. Whenever it sold an asset, there was always a lot of noise around how many bidders there were, and what they were willing to pay.  It seemed as if WWD was their banker, and not Morgan Stanley. This one is no exception. The press talked about 3 bidders at a price North of $16, and now we're down to 1 bidder at a price South of $16. We won't miss JNY after it goes private.


WWW - Merrell's Gene McCarthy Spells Out His Plans



  • "The company has to return to something very simple: hiking and trail, outdoor and performance. So my message internally and externally will be this 'Out.Perform' message. It can be a tagline, but it needs to be more of a mantra. Everything we do needs to be tethered to the idea of outdoors and performance. We want to keep these legacy items, like the Jungle Moc or the Moab, but we want to keep them in their rightful place. I don’t want to lead with them."
  • "I need to integrate apparel and footwear. And that, to me, [means] I don’t want to be a footwear, apparel and accessories brand. I just want to be a brand. Apparel needs to have a visual place with footwear [in our stores] because you need to create mindshare with apparel before you can get market share."


What's New Today in Retail (11/25) - chart3 11 25


Takeaway: So nice to hear that McCarthy is not going to lead with a dinosaur like the Jungle Moc. We wish it would go away, but the reality is that it's a great comfort shoe for people that don't care how they look and are too lazy to tie their shoes.


JCP, SHLD - JC Penney Gets Sassy With Kmart Over 'Jingle Bells' Ad



What's New Today in Retail (11/25) - chart1 11 25

What's New Today in Retail (11/25) - chart2 11 25


Takeaway: This exchange speaks for itself. JCP remains irreverent in its marketing (which is a good thing).


WMT, AMZN - Wal-Mart Lowers Free Shipping Minimum to Compete with Amazon



  • "Effective today, Walmart has lowered its free shipping minimum price on from $50 to $35 just in time for the holiday season. The new price makes Walmart's online shipping minimum exactly the same amount as Amazon's."


Takeaway: The key consideration is not a war between AMZN and WMT, but rather the precedent that WMT is setting for every other retailer than competes with either of the two goliaths. 


LTD - L Brands, Inc. (Formerly Known As Limited Brands, Inc.) Announces New Stock Ticker Symbol



  • " L Brands, Inc. announces today that in relation to the March 2013 announcement in which the company changed its name from Limited Brands, Inc. to L Brands, Inc., the company will change its NYSE stock ticker symbol from LTD to LB, effective Dec. 2, 2013."


SHLD, SCC - Eddie Lampert considers sale of Sears Canada



  • "Lampert is interviewing multiple banks including Goldman Sachs about conducting a prospective process, according to sources close to the situation. Spokesmen for Sears and Goldman declined to comment."


Takeaway: This is a no-brainer. SHLD has nearly 4,000 stores, and can't turn a profit. They need to monetize anything that's not nailed down.


Moncler - Moncler Gets Green Light for IPO



  • "Moncler SpA on Friday received the green light from the Italian Stock Exchange to proceed with its public listing."
  • "The Italian luxury brand still needs to wait for approval from Consob, Italy’s equivalent of the Securities and Exchange Commission, which is expected next week, before it kicks off its two-week road show."
  • "Sources indicate that the IPO is expected to take place in mid-December and that the company will float around 30 percent of its total shares. Industry sources said Moncler’s IPO could value the company at around 2 or 2.4 billion euros, or $2.68 to $3.22 billion at current exchange."


ANF - Fire Ravages Abercrombie Flagship in Paris



  • "A fire has ravaged the Abercrombie & Fitch Co. flagship on Avenue des Champs-Elysées in Paris, and the store will require a full refit before it can reopen, according to a spokesman for the Paris fire brigade."
  • "The blaze broke out in a clothing display section on the second floor of the four-story unit shortly before 7 a.m. on Sunday and destroyed 1,075 square feet of retail space, said Lieutenant colonel Frédéric Grosjean."




U.S., Bangladesh to Sign Accord



  • "The U.S. and Bangladesh are set to sign a Trade and Investment Cooperation Forum Agreement on Monday that is said to provide an important mechanism for the two countries to discuss bilateral trade and investment issues, as well as be a forum to pursue cooperative activities."
  • "In July, the U.S. and Bangladesh agreed to a Bangladesh Action Plan, along with a statement by the U.S. on 'Labor Rights and Factory Safety in Bangladesh.' The USTR said at the time that the implementation of the actions outlined in the plan could provide a basis for the President to consider reinstatement of the Generalized System of Preferences trade benefits for Bangladesh that were suspended in June, which went into effect in September. Apparel and textiles were not covered by GSP, which included imports such as tobacco, sports equipment, porcelain china and plastic products."







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