prev

Pair Trade: Long Lorillard (LO) vs. Short Philip Morris (PM)

As we head into year-end, one pair trade we like in particular is long LO and short PM (Note: LO is already in our portfolio; we’re waiting on price with PM).

 

Below is a breakout of the two names:

 

Lorillard:

  • Outperformance based on an advantaged cigarette portfolio and leading share in the e-cig category.
  • Continued strong demand for its full-flavored offerings and dominant share of menthol (~85% of its portfolio). Both are contributing to volume outperformance versus the industry (in the last quarter LO’s vol. +3.5% versus industry’s avg. -4%).
  • Growth in menthol supported by positive demographic shifts to the menthol category:
    • According to 2012 data from the National Survey on Drug Use and Health (NSDUH), over the last decade, the number of adult African-American menthol smokers has increased at a 2% CAGR, and at a 7% CAGR for Hispanics.  As of 2012, this equates to 84% of African-American smokers smoke menthol; the figure for primary menthol smokers among Hispanics is 47%.
    • Over the last decade, the adult African-American smoking population has increased at a 0.4% CAGR, whereas the adult Hispanic smoking population has increased at a 0.3% CAGR. We expect these trends to continue which should support the outperformance of LO’s menthol portfolio.
  • Lorillard continues to push gross profit margins higher through pricing and cost savings, improving 80bps to 37.1% in the quarter.  
  • The domestic retail share of the menthol market rose to 40.4%, an increase of 0.8 share points versus the prior-year quarter.
  • We’re bullish on Lorillard’s rollout of “Newport Gold” – a non-menthol compliment to “Red.”
  • We expect the FDA to punt on banning menthol cigarettes over the intermediate term given the lack of definitive and recognized studies that menthol is more harmful than non-menthol cigarettes. We also believe that the EU Parliament’s decision to ban menthol does not provide a useful guide to FDA policy given the sheer market size difference (Menthol = 31% of the U.S. cigarette market vs. 1-2% in Europe).
  • E-cigs: Lorillard was the first Big Tobacco company to market with the acquisition of “Blu” branded e-cigs in April 2012 for $135MM.
  • Despite only representing 4.9% of the portfolio, last quarter Blu saw strong sales growth of 11% quarter-over-quarter (+350% year-over-year) to $63MM.
  • LO CEO Murray Kessler’s e-cig strategy appears to forgo short-term profits for long term gains: he sold e-cigs at break-even in the quarter and was able to boost Blu’s market share to 49% from 40% in the previous quarter. We expect similar trends as LO attempts to capture brand loyalty. Over time, we do think that e-cigs can be margin-enhancing to the combined cigarette category.
  • The company became an international e-cig dealer through its purchase of UK-based SKYCIG in October 2013 for £30MM in cash, plus an additional £30MM to be paid in 2016 based on the achievement of certain financial benchmarks.
  • SKYCIG is a three year old company with ~ 300,000 users in the UK (there exists around ~ 10MM smokers in the country) that also happens to have nearly identical branding to Blu.
  • LO is trading above our intermediate term quantitative TREND level of support. We see the stock appreciating to $60 to $65 over the intermediate term.

Pair Trade: Long Lorillard (LO) vs. Short Philip Morris (PM) - vvv. LO

 

 

Philip Morris:

  • PM is plagued by a series of headwinds. To wit: a weak macro environment, challenging FX, excise tax hikes, and volume declines in key geographies.
  • While last quarter the company saw the top line perform in line with consensus, and showed a big improvement sequentially of +0.1% versus -2.5% in Q2 2013, Q3 was against a very easy comp of -5.3% in Q3 2012. We see tougher comps ahead.
  • PM is taking volume declines: last quarter -5.7% was a deceleration vs the previous quarter’s -3.9% and underperformed the industry’s -4%. We expect Philip Morris has taken much of its pricing and will struggle to stem volume declines.
  • We expect weakness in core geographies to continue to weigh on results, not least of which is the EU which is forecast to be down -7% to -8% in 2014. France has been a negative outlier and we continue to believe that the tax policy of President Francois Hollande will impair consumer confidence.
  • PM will also be hit with increased excise taxes in key geographies like Russia (the impact to volume est. -9% to -11%) and the Philippines (no guidance, could be larger than Russia),
  • Philip Morris recently disclosed that there has been an uptick in illicit trade, which we expect to push higher alongside additional tax hikes. 
  • In December, PM announced that it is acquiring a 20% interest in Russian Megapolis Group for $750M. Longer-term, we believe this is positive for the company (Russia is the world’s second largest market behind China and Megapolis handles 70% of Russia’s cigarette volumes through its distribution agreements).
  • PM also announced in late November that it will accelerate the launch of an electronic cigarette to mid-2014 (versus previous guidance of 2016/7) at a cost of $100MM.
  • We see 2014 setting up to be a year of investment (Russian acquisition and e-cig platform) and 1H results to drag in concert with this investment and the continuation of broader macro headwinds.
  • The level of uncertainty in PM’s earnings power has been clearly reflected in its EPS guidance: the company has revised its 2013 guidance lower over each of the last three straight quarter this year! Consensus is currently at $5.57 for 2014.
  • PM is trading below our intermediate term quantitative TREND level of resistance. We’ll be managing its trading range on the downside.

Pair Trade: Long Lorillard (LO) vs. Short Philip Morris (PM) - vvv. PM

 

Matthew Hedrick

Associate


ICI Fund Flow Survey - Year-To-Date Tallies Display Great Rotation Underway

Takeaway: Redemptions continued in bonds last week and equities had slight inflows. YTD the rotation is underway with bond outflows and equity inflows

Investment Company Institute Mutual Fund Data and ETF Money Flow:

 

Total equity mutual fund flow for the week ending December 4th was $1.9 billion, a below average weekly inflow for stock funds this year but none-the-less a slightly positive indication. Within the total equity inflow result, domestic equity mutual funds lost $1.0 billion, the second consecutive weekly outflow in U.S. stock funds with International equity funds posting a $2.9 billion inflow, on par with last week. Total equity mutual fund trends in 2013 however now tally a $3.2 billion weekly average inflow, a complete reversal from 2012's $3.0 billion weekly outflow 

 

Fixed income mutual funds continued persistent outflows during the most recent 5 day period with another $4.4 billion withdrawn from bond funds. This week's draw down improved slightly sequentially from the $4.7 billion outflow the week prior but ongoing redemptions have now forced the 2013 weekly average for all fixed income funds to a $1.2 billion outflow, which compares to the strong weekly inflow of $5.8 billion throughout 2012

 

ETFs experienced mixed trends in the most recent 5 day period, with equity products seeing slight inflows and fixed income ETFs seeing moderate outflows week-to-week. Passive equity products gained $207 million for the 5 day period ending December 4th with bond ETFs experiencing a $331 million outflow, an acceleration from the $251 million redemption the 5 days prior. ETF products also reflect the 2013 asset allocation shift, with the weekly averages for equity products up year-over-year versus bond ETFs which are seeing weaker year-over-year results

 

With year-end tallies almost complete with only 2 full work weeks left in 2013, we have compiled the annual totals from the ICI for mutual fund results and also from Bloomberg for ETF production throughout 2013. In the Hedgeye Asset Management Thought of the Week below, we outline the resurgence in stock fund inflows, the emerging outflows in bond funds, and the record years for equity ETF inflow and commodity ETF outflows


 

ICI Fund Flow Survey - Year-To-Date Tallies Display Great Rotation Underway - ICI chart 1

ICI Fund Flow Survey - Year-To-Date Tallies Display Great Rotation Underway - ICI chart 2

 

 

For the week ending December 4th, the Investment Company Institute reported slight equity inflows into mutual funds with over $1.9 billion flowing into total stock funds. The breakout between domestic and world stock funds separated to a $1.0 billion outflow into domestic stock funds and a $2.9 billion inflow into international or world stock funds. These results for the most recent 5 day period within stock funds were bifurcated, with the outflow in domestic stock funds below the weekly average of a $551 million inflow and with world stock fund production slightly above the $2.6 billion weekly inflow average. The aggregate inflow for all stock funds this year now sits at a $3.2 billion inflow, an average which has been getting progressively bigger each week and a complete reversal from the $3.0 billion outflow averaged per week in 2012.

 

On the fixed income side, bond funds continued their weak trends for the 5 day period ended December 4th with outflows staying persistent within the asset class. The aggregate of taxable and tax-free bond funds booked a $4.4 billion outflow, a slight sequential improvement from the $4.7 billion lost in the 5 day period prior. Both categories of fixed income contributed to outflows with taxable bonds having redemptions of $3.0 billion, which joined the $1.3 billion outflow in tax-free or municipal bonds. Taxable bonds have now had outflows in 23 of the past 27 weeks and municipal bonds having had 27 consecutive weeks of outflow. While the sharp redemptions that marked most of the summer and the start of the third quarter have moderated, the appetite for bonds has hardly rebounded. The 2013 weekly average for fixed income fund flows is now a $1.2 billion weekly outflow, a sharp reversal from the $5.8 billion weekly inflow averaged last year.

 

Hybrid mutual funds, products which combine both equity and fixed income allocations, continue to be the most stable category within the ICI survey with another $894 million inflow in the most recent 5 day period, although the past 2 weeks have been below year-to-date averages. Hybrid funds have had inflow in 25 of the past 27 weeks with the 2013 weekly average inflow now at $1.5 billion, a strong advance versus the 2012 weekly average inflow of $911 million.

 

 

ICI Fund Flow Survey - Year-To-Date Tallies Display Great Rotation Underway - ICI chart 3

ICI Fund Flow Survey - Year-To-Date Tallies Display Great Rotation Underway - ICI chart 4

ICI Fund Flow Survey - Year-To-Date Tallies Display Great Rotation Underway - ICI chart 5

ICI Fund Flow Survey - Year-To-Date Tallies Display Great Rotation Underway - ICI chart 6

ICI Fund Flow Survey - Year-To-Date Tallies Display Great Rotation Underway - ICI chart 7

 

 

Passive Products:

 

 

Exchange traded funds had mixed trends within the same 5 day period ending December 4th with equity ETFs posting a slight $207 million inflow, a drastic drop from the $11.4 billion subscription the week prior. The 2013 weekly average for stock ETFs however is still a $3.3 billion weekly inflow, nearly a 50% improvement from last year's $2.2 billion weekly average inflow.

 

Bond ETFs experienced a moderate outflow for the 5 day period ending December 4th, with a $331 million redemption a sequential acceleration from the week prior which produced a $251 million outflow for passive bond products. Taking in consideration this most recent data, 2013 averages for bond ETFs are flagging with just a $253 million average weekly inflow for bond ETFs, much lower than the $1.0 billion average weekly inflow for 2012.

 

 

ICI Fund Flow Survey - Year-To-Date Tallies Display Great Rotation Underway - ICI chart 8

ICI Fund Flow Survey - Year-To-Date Tallies Display Great Rotation Underway - ICI chart 9 

 

 

Hedgeye Asset Management Thought of the Week: 

 

Some analysts as well as media outlets are still in denial about the start of a rotation from U.S. fixed income into U.S. stocks, however the debate in our minds is a short one. With only a few weeks left in 2013, we have compiled the year-to-date flow totals from the Investment Company Institute for mutual funds and from Bloomberg for exchange traded funds. The trends from our perspective are quite clear. Within mutual funds, the $1 trillion that has come into bond funds since 2008 (or the start of the Fed's quantitative easing program) has started to unwind with the first outflow in fixed income funds within the ICI data since 2007. The fixed income outflow of $63 billion through the first 49 weeks of 2013 still pales in comparison to the $303 billion inflow that came into fixed income last year in 2012 (can you say blow off top?) and also the record year of 2009 when the Great Rotation from stocks into bonds started and $379 billion came into fixed income funds. While the over $155 billion outflow in the back half of 2013 has been the sharpest bond outflow in history (most significant 27 week ouflow sequence), the first half of 2013 experienced nearly $100 billion of inflow into fixed income to net to the fairly insignificant outflow year-to-date of $63 billion currently. Our regression model of bond performance to bond outflows continues to forecast a total outflow of $200 billion through 2014 meaning that this current rotation from bonds into equities could have quite a tail to go.

 

Conversely, the nascent production in stock funds (while consistently dismissed) has been historically quite impressive being double that of the $74 billion that came into equity mutual funds in 2007. While the $159 billion running inflow into stock funds thus far in 2013 has had an international fund bend ($131 billion has gone into international stock funds versus just $28 billion into domestic equity funds), there is still ample reason to think that U.S. stocks can continue this turn in redemptions that has plagued them for all 6 years of ICI data before '13 (still record amount of cash on U.S. corporate balance sheets, generally low yields can allow stocks higher multiples, and the unwinding of the commodity super cycle and U.S. bond fund outflows needing to be invested somewhere). Bloomberg's annual tally of ETF information has equally interesting thematic value with the strong mutual fund trends in equities being validated on the stock ETF side, with another record year for ETF inflow (equity ETFs for 2013 have netted $173 billion in '13, higher than the $117 billion in '12 and a new record from the prior high of $127 billion in 2008). Fixed income interest in ETFs is matching its mutual fund brethren as well with passive bond products taking in a paltry $11.3 billion in 2013, a drastic drop from the record $56.4 billion last year (even the new fast growing ETF vehicle is not summoning up new interest from investors with the potential multi-year down cycle in fixed income). Commodity ETFs have had a year to forget with the formerly exuberrant gold market having been knocked down for a 20% plus loss and incrementally higher U.S. interest rates broadly supporting a higher dollar which has sent overall commodity indices lower. Commodity specific ETFs have had a record $25.1 billion redemption this year, the first negative year since the start of our data set in 2007, and a far cry from the formerly worst year of just a $600 million inflow in 2011.

 

We don't estimate that a substantial change from these current trends will occur until mid 2014 (these current themes are intact with forthcoming Fed tapering to continue to hurt the demand for fixed income and that U.S. stocks can at least have a positive start to 2014). Thus our favorite long idea remains T Rowe Price (TROW), a manager with industry leading equity performance to hoover up new industry equity flows and also a strong balance sheet to seed new products and also continue its streak of 26 consecutive years of dividend increases.

 

 

ICI Fund Flow Survey - Year-To-Date Tallies Display Great Rotation Underway - ICI chart 10

ICI Fund Flow Survey - Year-To-Date Tallies Display Great Rotation Underway - ICI chart 11

 

 

Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA


Volatility Returns

Client Talking Points

VIX

After making a series of higher-lows since August, front month VIX (volatility) broke out above our Hedgeye TREND resistance of 14.91 yesterday. Fed confusion is going to breed contempt. This equity market is as complacently positioned as I have seen it in six years. Yesterday’s II Bull/Bear survey hit a fresh year-to-date high of +4390 basis points to the Bull side!

DAX

Germany broke its immediate-term TRADE line of 9,148 support this week. I have no idea why (other than the machines chase price momentum). So, I’m going to stay out of the way of European Equities for the timing being. No one goes broke with no position.

GOLD

Gold prices are whipping around with rates – taper on, taper off. The UST 10-year yield up 4 basis points in 24 hours and Gold down on that. It makes sense. We sold our trading long in GLD on Tuesday at $122.12. We would like to buy it back closer to the low-end of Gold’s current 1216-1260 immediate-term risk range.

Asset Allocation

CASH 58% US EQUITIES 6%
INTL EQUITIES 6% COMMODITIES 0%
FIXED INCOME 8% INTL CURRENCIES 22%

Top Long Ideas

Company Ticker Sector Duration
FXB

Our bullish call on the British Pound was borne out of our Q4 Macro themes call. We believe the health of a nation’s economy is reflected in its currency. We remain bullish on the regime change at the BOE, replacing Governor Mervyn King with Mark Carney. In its October meeting, the Bank of England voted unanimously (9-0) to keep rates on hold and the asset purchase program unchanged.  If we look at the GBP/USD cross, we believe the UK’s hawkish monetary and fiscal policy should appreciate the GBP, as Bernanke/Yellen continue to burn the USD via delaying the call to taper.

WWW

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.

TROW

Financials sector senior analyst Jonathan Casteleyn continues to carry T. Rowe Price as his highest-conviction long call, based on the long-range reallocation out of bonds with investors continuing to move into stocks.  T Rowe is one of the fastest growing equity asset managers and has consistently had the best performing stock funds over the past ten years.

Three for the Road

TWEET OF THE DAY

Equity volatility starting to look primed to breakout into 2014 #VIX @KeithMcCullough

QUOTE OF THE DAY

"Success usually comes to those who are too busy to be looking for it." - Henry David Thoreau

STAT OF THE DAY

Foreigners are boosting holdings of Japanese stocks by the most on record. Buyers outside Japan pumped 12.9 trillion yen ($125 billion) into the nation’s stocks this year through November, Tokyo Stock Exchange data show, as the Topix index climbed 44% to lead developed markets.(Bloomberg)


get free cartoon of the day!

Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.


Fragile Markets

“I’d rather be dumb and antifragile than extremely smart and fragile”

-Nassim Taleb

 

The hyperbole of that quote is that Taleb thinks he’s extremely smart. I’m definitely dumber than he is. So I guess he’d agree that I should never hire him to do what I can do better myself – manage real-time market risk. It’s a great job for a dumb hockey player.

 

Back to the Global Macro Grind

 

The reason why I thought of Taleb this morning is that I was thinking about volatility. To his credit, he was one of the first to write about risk managing volatility from a market practitioner’s perspective. That doesn’t mean I agree with everything he wrote.

 

In terms of how we measure market entropy in real-time (multi-factor, multi-duration), yesterday was a one of the few critically bearish signal days for the US stock market.

 

To boil that down to 3 basic factors in our model (Price, Volume, and Volatility):

 

1. PRICE – SP500 A) failed to make a higher-high versus the 1808 all-time closing high and B) broke 1785 TRADE support

2. VOLUME – was +13% versus my immediate-term TRADE duration average (1st mini-volume spike on a down price move)

3. VOLATILITY – front-month VIX broke out above @Hedgeye intermediate-term TREND resistance of 14.91

 

This has never happened before (because the SP500 has never been at this all-time closing high before). But historically, countries, currencies, companies (anything with a ticker) do this frequently. And when they do, I respect Mr. Macro Market’s signal.

 

What is a bearish immediate-term signal @Hedgeye?

 

1. PRICE = down

2. VOLUME = up

3. VOLATILITY = up

 

Conversely,

 

1. PRICE = up

2. VOLUME = up

3. VOLATILITY = down

 

… is a bullish immediate-term signal @Hedgeye (especially when it’s happening within a bullish intermediate-term TREND).

 

Sure, I have been buying-the-damn-bubble #BTDB pretty much all year – but while I covered a couple of oversold shorts like CAT yesterday, I didn’t buyem on the long side. An intermediate-term TREND breakout in volatility is the #1 reason for that.

 

Are there tangible risk factors that could perpetuate an intermediate-term TREND move in US Equity Volatility back towards 20 on the VIX? Big time. Here are some behavioral ones that I discussed with clients in NYC yesterday:

 

1. VIX has been making a series of higher-lows since AUG as the Fed started to confuse with Taper-on/Taper-off in SEP

2. The average “net long” positioning of the hedge fund community is testing its all-time high zone of +60% again

3. The II Bull/Bear Spread just blew out to fresh 5 year highs of +4390 basis points to the BULL side

 

That last point is one of the more fascinating migrations I have seen in my career. To put a 44% spread between bulls and bears in context, that II Bull/Bear Spread was only +1710 basis points wide in the 1st week of September 2013.

 

Early September – that’s when people may have claimed to be “bullish” but they certainly weren’t positioned Bullish Enough. All this market needed to scare the hell out of the pretend bulls was a VIX rip to 17 in late August.

 

If the VIX goes to 17-18 tomorrow, people who are buying-the-damn-bubble #BTDB will get killed. So, if you have been in the habit of doing the buy on red, sell on green #GetActive thing, you want to be more careful buying now than you were last week.

 

How about fundamental research factors that could turn bearish in the next 1-3 months?

 

1. US Dollar being devalued and debauched (no-taper) towards its YTD lows

2. US GDP #GrowthSlowing from its cycle high of +3.6%

3. Down Dollar = Up Yen = Down Nikkei (another thing people didn’t enjoy in late AUG)

 

Rather than making up my own academic sounding word like antifragile, I’ll call managing real-time market risk this way what it is – being mentally flexible. If you can Embrace Uncertainty every market day, you might feel less dumb every once in a while too.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr yield 2.76-2.91%

SPX 1

VIX 14.31-15.67

USD 79.67-80.38

Pound 1.62-1.64

Gold 1

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Fragile Markets - Chart of the Day

 

Fragile Markets - Virtual Portfolio


December 12, 2013

December 12, 2013 - Slide1

 

BULLISH TRENDS

December 12, 2013 - Slide2

December 12, 2013 - Slide3

December 12, 2013 - Slide4

December 12, 2013 - Slide5

December 12, 2013 - Slide6

December 12, 2013 - Slide7

December 12, 2013 - Slide8

December 12, 2013 - Slide9

December 12, 2013 - Slide10

 

BEARISH TRENDS

December 12, 2013 - Slide11
December 12, 2013 - Slide12


investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

next