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INVESTING IDEAS - LEVELS

Takeaway: Here are Hedgeye CEO Keith McCullough's refreshed levels for our high-conviction stock ideas.

INVESTING IDEAS - LEVELS - ii44


INVESTING IDEAS NEWSLETTER

Takeaway: Current Investing Ideas: CCL, FDX, FXB, GHL, HCA, MD, RH, TROW and WWW

Please see below the latest comments from Hedgeye analysts on their high-conviction stock ideas.

 

INVESTING IDEAS NEWSLETTER - hedge

 

CCL We are happy to report that it was a wonderful week for Carnival shareholders. The stock surged 8%. 

 

We have increased our 2014 FY EPS from $1.65 to a likely Street high $1.90 on the back of significant cost cutting.  Not surprisingly, our net yield (constant-currency) projection declines from +1.4% to +0.3%, due to continued Caribbean uncertainty and adverse FX impact.

 

Lower yield guidance was expected but the cost outlook was indeed a pleasant and major surprise.  The management reorganization paid dividends much sooner than expected.  Already, new management is driving cost synergies and efficiencies in the fuel, operations, and procurement areas under new CEO Arnold Donald. 

 

 

FXB – Being bullish on the British Pound versus the US Dollar remains one of Hedgeye’s favored macro themes in Q4. The position is supported over the intermediate term TREND by prudent management of interest rate policy from Mark Carney at the BOE (oriented towards hiking rather than cutting as conditions improve) and the Bank maintaining its existing asset purchase program (QE).

 

Meanwhile, data out this week confirms the underlying performance of the economy which we believe will translate to currency strength: Q3 Final GDP was revised up to 1.9% Y/Y vs an initial estimate of 1.5%; CPI dropped to 2.1% Nov. Y/Y vs 2.2% Oct. (reducing the consumption tax); and Retail Sales were up 2% in Nov. Y/Y vs 1.8% Oct. Over the immediate term TRADE we expect the USD to strengthen on Bernanke’s “unexpected” decision to taper this week, and an above-consensus Q3 U.S. GDP print, however over the medium term we expect the uber dove Yellen to issue weak USD policy.  

 


FDX – FedEx reported its fiscal second quarter results, missing expectations because of a late start to the Christmas shopping season. Management raised full year guidance, showing confidence that it will recoup that volume in FY3Q. Critically, FedEx Express generated solid YoY margin expansion, a likely reason the shares have remained strong following the report. We continue to see upside for FDX shares as the company shows investors the profit potential of the Express segment. 

 

We added FDX to Investing Ideas on 3/29/13. Our thesis centered on the potential for the Express division to be made significantly more profitable.  At the time, FedEx Express was 'free' in our valuation, presenting an attractive risk/reward. After a 45% rally in FDX shares since then (compared to 16% for the S&P 500), we still think FedEx Express has some additional value to be recognized by the market.  Importantly, we now have some evidence that they are making progress - albeit slow.

 


GHL Greenhill & Company announced a good sized advisory mandate during the week, winning a $2 billion mandate to advise AT&T in the sale of its wireless assets in the state of Connecticut.  This was the largest advisory win for GHL since October.  The company also put up two other additional mandate wins during the most recent 5 day period for a total of 3 new deals won this week, the most active week of new deal mandates for the firm since September. 

 

INVESTING IDEAS NEWSLETTER - ghl

GHL shares are Senior Financials sector analyst Jonathan Casteleyn’s favorite way to invest in a cyclical uptick in the mergers and acquisition market (M&A) which has been dormant for the past 3 years. Says Casteleyn, “M&A activity has historically benefited in an environment with higher interest rates – which may have started with the Fed now starting to back off of the fixed income curve – as corporations focus less on dividends and buybacks, and more on strategic M&A activity to reward shareholders.”

 

 

HCA – Holy $#&*@! Admissions stink! Or so says Citi's Hospital analyst quoting a recent survey of hospitals.  Apparently volumes are the "weakest ever." Not to poo-poo Citi's survey, but there are a few things to consider before flushing HCA.  Q412 has some very difficult comparisons for volumes including the one of the "worst ever" flu seasons and the only quarter of the last 6 years to see a positive year over year change in maternity volume.  Both of these cases come with extremely low margins, and possibly negative margins in some cases.  We recently did an analysis of what is an important driver of hospital profitability, names US Orthopedic surgery, the largest revenue driver for hospitals, a trend that looks likely to continue accelerating. 

 


MD – MD finally got around to making another acquisition today.  While they won't meet their guidance for deal flow with the deal in Q413, we continue to expect more deal announced in the coming weeks, offering some catch up in revenues in the next few quarters.    

 

RH and WWW

 

Below we take a detailed look at sentiment for our two retail investing ideas. The primary tool we use is our Hedgeye Sentiment Monitor. What it does is uses a quantitative scale to combine Sell-Side Ratings, Buy Side Short Interest, and Insider Trading activity. We pretty much catch all angles.

 

We use this tool in two different ways; 1) First, we look at directional changes in sentiment for each stock. 2) Second, we analyze the absolute level for each security. A reading above 90 has statistically proven to signal that the market is overly bearish on a name, and that it’s often advantageous to go the other way. Conversely, a reading below 10 suggests that the market is overly bearish, at which time it is usually prudent to go long. 

 

RH – For Restoration Hardware, even though we only have only 14 months worth of data, we see that the sentiment reading is near its all-time low. No doubt the recent management shake-up contributed, but even before then, people were finding every reason they could to be bearish. We continue to view RH as the name in retail with the greatest upside. Currently at $67, we thing that RH will touch $200 over 3-years. 

 

 

INVESTING IDEAS NEWSLETTER - RH investingideas SENTIMENT

 

WWW – With Wolverine World Wide, the sentiment chart is much more clear cut. Simply put, everyone hates it! Sentiment has been drifting lower and lower, and occasionally touches the 10x mark (that’s when people are way too bearish – no Buy ratings, high short interest). While not the same expected percent gain as RH, we’re still looking for WWW to go from $32 to $55. Not half bad.

 

INVESTING IDEAS NEWSLETTER - WWW investideas Sentiment


TROW T. Rowe Price shares had a strong week with the Fed’s tapering and acknowledgement of an incrementally improving U.S. economy.  Senior Financials sector analyst Jonathan Casteleyn says “with the U.S. central bank now signaling that it will be adding less liquidity to fixed income markets, which could eventually lead to short term interest rates rising over time, it is valuable to understand that equities have drastically outperformed bonds in past rate raising cycles.”  (See chart below).  As the country’s leading equity asset management firm, Casteleyn says TROW shares will start to discount this potential forward opportunity for equities versus bonds in the United States with the new Fed signaling of smaller subsidies for fixed income. This positively disposes TROW shares for a good start to 2014.  Separately, Casteleyn spoke to TROW management this week and says “all our checks for a solid 4th quarter earnings print are in line in late January.”

 

INVESTING IDEAS NEWSLETTER - trow

 

Macro Theme of the Week – Bernanke’s Mini-Taper: The Ultimate Morning-After Pill?

Q:  When is a Taper not a Taper?

 

A:  When it’s a Bernanke.

 

First, allow us to cop to the obvious fact that we at Hedgeye have a little egg on our face.  Having told anyone who would listen that the Fed was not about to announce a Taper going into year end, we watched Bernanke announce a teeny-weeny, itty-bitty reduction in QE of $10 billion per month at his final press conference.  It could be simply that they wanted to mark the institution’s 100th birthday with a token gift to We The People, but if the reaction of the equity markets is at all proportional, we should see the S&P index approaching… oh… a billion or so sometime next summer.

 

Chairman Bernanke exits having attained Sinaitic status at the Fed, whose motto is now “In Ben We Trust.”  Let’s face it, did God write a PhD thesis on the Great Depression?  Did God make the markets shoot to an all-time high this week?  The issuance of money, the direction of the financial markets – even the easing or tightening decisions in such far flung capitals as London and Tokyo – all are subject to the whims of the Chairman.  Together with unprecedented monetary and economic influence, the Fed has a team whose intellectual power and academic credentials are unmatched. 

 

Fed boosters claim it would have been far worse without the fine-tuning and meddling of this team of academic geniuses.  Critics say the whole thing is wrong – that central bank monetary policy, which is market-based by definition, must be overseen by market practitioners.  They say the Fed’s academic experiments (Bernanke has used the word in public) have held back economic growth, trashed the Dollar and hurt American consumers, small businesses, homeowners and a vast army of the long-term unemployed.  They say the economy is still tottering.  A small monetary move on the coattails of years of mismanagement is not a one-dose Morning After Pill, they say, and does not solve the welter of problems created under successive Fed chairmen.  Contemplating the massive scope of the Fed’s powers and abilities, they chide “Never have so many done so little with so much.”

 

Hedgeye CEO Keith McCullough offered a brief mea culpa on Thursday morning.  “I was dead wrong on the no-taper call yesterday,” wrote McCullough.  Despite reading the Fed tea leaves wrong, Hedgeye’s Real-Time Alerts trade signals ended up positioned right, overwhelmingly long the surging market.  “Where I was brought up,” wrote Keith, “being right for the wrong reasons is called luck.”

 

Not to sugar-coat it, but anyone can be wrong about the market.  Many observers note that no one has made a more successful career out of being wrong on the markets than “Maestro” Alan Greenspan, with the possible exception of Professor Ben Bernanke. 

 

This week Hedgeye TV debuted a new occasional series “Real Conversations.”  Just in time for the Fed centenary, Hedgeye CEO Keith McCullough hosted an extended conversation with Andrew Huszar, he of Wall Street Journal opinion page “I’m sorry, America” fame.  In case you have been holed up in a cave, Huszar penned “Confessions of a Quantitative Easer” on 11 November admitting that he was in charge “of the Fed’s first plunge into the bond-buying experiment known as quantitative easing.”  The interview is well worth a look.  And please don’t just pick on the bit where Huszar and McCullough agree that the Fed won’t taper before year end.  Like we said, anyone can be wrong.

 

In the midst of the Fed news conference, Huszar tweeted “Dec. taper is clearly a legacy move for Bernanke. Don't read more near term moves into it. Yellen was QE3's biggest advocate.”  We think this is an important insight – from someone who has been center-ice with this same team.  Let’s face it, $10 billion is a whole lot of money to anyone reading this (if you have $10 billion, you don’t need anyone’s help with your investments).  But to the Fed, with a $4 trillion balance sheet, it’s barely a rounding error.  Which begs the question of why the markets reacted so enthusiastically.

 

“True or False:” asked McCullough.  “Ben Bernanke did the right thing in tapering yesterday?  True.  Whether or not his obeying the US 2013 #GrowthAccelerating data on a lag (he’s 3 months late in making a decision he should have made in September) proves to be right is up to history.”

 

“Should have made in September,” you say?  Yes.  Because in September the markets were eager for the Taper to begin.  Bernanke observed in his deadpan press conference, “I’m a historian,” which was an academic’s dodge.  Translation: “I know a lot about ducks.  The minute I see a webbed foot, I treat whatever’s attached to it like a duck.”  By Bernanke’s own admission (now that he’s leaving, he can say it in public) he failed to recognize the depth of the recession, failed to recognize the profound danger to America’s financial markets, and failed to appreciate that this shot would reverberate ‘round the world for years and years – and trillions and trillions of dollars – to come.

 

Professor Bernanke with his PhD and his academic publications does not appreciate what every junior trading desk assistant knows within a week of coming to the desk: The Trend Is Your Friend.  Put in terms that an academic might comprehend: markets respond unfavorably in an environment of uncertainty.  In other other words, as we have written numerous times: when uncertainty reigns, markets go down.  Whatever the economic consequences of ending QE, the broad financial markets were eager for the certainty of having the supports kicked out from under bonds.  When the expected Taper failed to materialize, they uttered a moan of despair and went back to behaving badly, which is what uncertain markets do.

 

The response to the mini-Taper, says McCullough, is to stick with the Macro process, which takes us back to where we were positioned from December 2012 through September of this year: Long Growth (Equities) and Short Gold, Bonds, and Equities that look like Bonds, such as MLPs, Utilities, and other high-dividend payers.

 

The Taper heralds an environment of rising interest rates, and indicates that, while the Dollar may not muscle up immediately, it will not go down in flames.  This mix is bad for Gold, and bad for Bonds.  Hedgeye’s Macro work indicates fund flows out of Gold and out of fixed income – and into US growth stocks – should dominate well into the new year, especially if there’s any follow-through in Fed hawkishness.

 

But, you might ask, isn’t Gold a good hedge in uncertain times?  And isn’t there still plenty of uncertainty?  Says McCullough: yes, and yes.  But don’t reach for the bullion just yet.  Bernanke’s mini-Taper has not definitively established a new direction for the markets.  It has, rather, ushered in the era of The New Uncertainty.  The bias of the New Uncertainty is towards higher rates, which also translates into a stronger Dollar.

 

This is like Hedgeye’s reaction to the Sequester.  Yes, all kinds of really important programs were hurt by the forced cuts.  And yes, lots of horribly wasteful items survived intact.  But the simple reality of the Sequester was that it imposed forced austerity on an out-of-control government.  All around, much more a Good Thing than a Bad Thing.  Only when  you put a lid on spending can you even start the process of determining which expenditures are actually necessary, and which are utterly wasteful.  It was time to slam on the brakes.

 

The bias of the New Uncertainty is to nudge bond yields higher, while stabilizing the Dollar.  Rather than listen to gold bugs and survivalists, look at the price signals.  The day after the mini-Taper, the 10 year Treasury yield went to 2.88%, up 112 basis points for the year.  Gold was down more than 28% for the year.  McCullough’s Macro model shows that, breaking below $1200 an ounce, the price of Gold doesn’t see real long-term support until around $880.  It’s gonna take a heap of good old-fashioned uncertainty to defy that much gravity. 

 

On the global macro front, the Japanese Yen has crashed 17% versus the Dollar this year – translating into a shot of amphetamine for Japanese equities, with the Nikkei up nearly 55% for 2013. 

 

Emerging Market mavens can not fail to note the correlation between a strengthening Dollar and deteriorating equity prices in the EM markets (the MSCI Emerging Markets index was down 5.9% year to date in the wake of the Fed announcement.)  And as the US Equity market ripped to all-time highs – with the S&P up 26.9% for the year, Emerging Equity markets in Asia and Latin America were down after Bernanke’s press conference. 

 

This is pretty straightforward stuff.  Investments flow out of Emerging Markets as developed markets become more attractive, alongside rising interest rates.  As EM outflows grow, local currencies are depressed while inflation starts to move higher.  At same time local consumption and investment spending begin to flag.  Many of these markets are overexposed to a single resource – oil, minerals, cheap human labor – and when the Dollar goes up, the relative price of those resources goes down, whacking equity prices tied to these economies.

 

“In other words,” wrote McCullough on The Morning After, “as soon as you saw the word ‘taper’ yesterday, you got the Dollar right (up) and that helped you get a lot of other things Global Macro right.  The truth,” concludes McCullough, “is always in the balance of your account. It’s there, each and every market day, whether you played lucky or not.”

 

If you’re like most investors, you’d rather be lucky than smart.  But since you can’t always rely on being lucky, do the smart thing and stick with Hedgeye.

 

-  Moshe Silver

Moshe is a Hedgeye Managing Director and author of the Hedgeye e-book Fixing A Broken Wall Street


 



THE WEEK AHEAD

The Economic Data calendar for the week of the 23rd of December through the 27th 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 - The Week


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#EMERGINGOUTFLOWS: MORE PAIN TO COME?

Takeaway: Our #EmergingOutflows theme has legs. There will be clear winners and losers from here.

It’s the last Friday afternoon before Christmas and you probably need to get started on some last-minute holiday shopping. As such, we’re guessing you probably don’t feel like reading through a long diatribe on emerging markets. That’s great, because I certainly don’t feel like writing one.

 

With that in mind, please enjoy this ~3 minute @HedgeyeTV update on our #EmergingOutflows theme: http://www.youtube.com/watch?v=Q0e0zAfk1YU.

 

In the video, we outline the three most probable intermediate-term global macro scenarios – two of which are clearly negative for emerging market assets. Lastly, we outline the asset classes, regions and countries we think are poised to outperform from here, as well as those we think are poised to underperform.

 

We’re also releasing a new, 56-slide presentation containing updates, incremental analyses and fresh conclusions within the construct of this theme. CLICK HERE to download that presentation.

 

Email us if you have any questions; we’re always around to help.

 

Happy Holidays,

 

DD

 

Darius Dale

Associate: Macro Team

 

#EMERGINGOUTFLOWS: MORE PAIN TO COME? - 1


DRI: CLARENCE'S LEGACY, A HALF-BAKED PLAN

Takeaway: The CEO took his best shot at fixing the company and fell short. Who will come to the rescue?

Otis’ legacy will be defined by his unwillingness to make the changes necessary to create significant value for shareholders.


The writing has been on the wall for quite some time that DRI needs to make significant changes to the operating structure of the company.  We didn’t believe Clarence would pull the trigger this quarter.  In fact, we didn’t think he would ever do it.  We were wrong.  However, the plan announced yesterday stops well short of what really needs to be done.  What Clarence presented made little strategic sense and didn’t get at the heart of the problem.  Darden is still a company with an inefficient operating structure.

 

INCONSISTENCIES IN OTIS’ STRATEGIC RATIONALE


“Transaction transforms the portfolio into two independent companies that can each focus on separate and distinct opportunities to drive long-term shareholder value.”


HEDGEYE – What about our plan instead!  The "HWPenney" transaction transforms the portfolio brands into four independent companies that have leading market share in their respective categories.  Each company will be driven by intensive focus on a single operating priority and shareholder value creation. 

 

According to Otis, the “Old Darden” had 8 brands with “divergent operating priorities” and now the “New Darden” will have 7.  Management admitted they can’t manage 8 brands, yet they think it’s a good idea to manage 7? 

 

 

“Separation will allow ‘New Darden’ and ‘New Red Lobster’ to better serve their increasingly divergent guest targets.”


HEDGEYEWhat about the divergent guest targets between Olive Garden and Yard House?  We understand that a changing consumer dynamic creates the need for intensive focus on key guest targets, but the “New Darden” is anything but focused.  Our plan creates three companies focused on: Steak, Italian, and Seafood.  This would allow for intensive focus on key guest targets and specific brand priorities in each category.

 

DRI: CLARENCE'S LEGACY, A HALF-BAKED PLAN - 12 20 2013 11 57 12 AM

 

 

“Separate organizations enables ‘New Darden’ and ‘New Red Lobster’ to better focus on their divergent value creation levers.”


HEDGEYE – This is nothing more than a bunch of filler.  It’s embarrassing they think they can spin this idea as a strategic opportunity.  Leading full-service restaurant companies are outperforming Darden because they have stronger business models and create more value for shareholders.

 

 

“Announced compensation changes for ‘New Darden’ and planned program for ‘New Red Lobster’ will result in appropriate incentives for management teams passionate about their respective businesses”


HEDGEYE – You don’t need to split the company to do that.  If the “Old Darden” wanted compensation closely tied to each respective business, this would have already been in place.  Does this suggest the “Old Darden” team members were not passionate about their respective business?

 

 

“Separation repositions the business to better serve differing shareholder investment requirements (growth and income vs. income/yield) and maximizes total shareholder value.”


HEDGEYE – This is a classic example of investment banker BS.  The guidance for the “New Darden” looks the same as guidance for the “Old Darden.”  How does this strategic plan better serve the different investment requirements of its brands?

 

The plan presented yesterday seemed reactionary and hastily put together.  It doesn’t even address declining margins and potential solutions. 

 

After a series of conversations with industry insiders and taking some time to digest the events, we’ve concluded that the strategic initiatives announced yesterday could actually end up creating more problems for the company.  To be blunt, this strategy could be a complete disaster and result in value deterioration rather than creation. 

 

 

POTENTIAL FOR VALUE DESTRUCTION:


Red Lobster may be less profitable and, as a result, less valuable.

By spinning-off the Red Lobster brand, management is essentially kicking a brand that is already down.  The brand is in decline and has been for quite a while.  For Darden to essentially say “we don’t want you” may send the wrong message to Red Lobster rank and file employees.  In our opinion, this could create a lot of angst within the employee base and could lead to further underperformance.  Everyone knows the brand is in trouble and by casting it off on its own is simply conveying to the Red Lobster team that they aren’t worthy.  The probability that Red Lobster sees an accelerated decline in profitability just went up significantly. 

 

The plan does not eliminate the issue of managing multiple brands.

This is why we’re here in the first place.  Darden’s current portfolio, which is too big and too complex to perform is largely intact.  This multi-concept structure has created significant inefficiencies in the operating structure of the company.  This separation doesn’t do anything other than remove an underperforming brand from the portfolio.  Our plan to fix Darden properly aligns the company’s brands and organizes the portfolio in a way that would be beneficial to each NewCo.  The “New Darden” brands aren’t focused to create maximum shareholder value!

 

Clarence is building a moat around his castle.

After years of underperformance, someone must be held accountable, right?  So Clarence has been deflecting blame on others and firing the people around him.  It is time someone holds him accountable.  He is the Chairman and CEO of a company that has vastly underperformed its peers for the past several years.  When will he accept responsibility for his decisions?

 

They are not cutting unit growth or costs as aggressively as they should.

Darden plans to halt unit growth at Olive Garden for a few years, slightly slow unit growth at LongHorn and expect unit growth to be slightly lower next year at the Specialty Restaurant Group.  This unit growth will save approximately $100mm in capital expenditures annually.  In our opinion, management doesn’t want to halt growth, but they need to in order to maintain Darden’s dividend.  We think they need to stop growing altogether and straighten out before they exacerbate the problems they are currently facing.  Further, through support cost management the team expects annual savings of $60mm beginning in FY15.  This is slightly up from the $50mm the company announced last quarter.  For a company riddled with excessive spending, it’s very discouraging that they were only able to find an additional $10mm in annual cost savings.  Management must cut costs more aggressively if they plan to unlock significant shareholder value.

 

There is no real plan to fix Olive Garden.

The company did not release any details around fixing Olive Garden.  This should be their number one priority, considering that the brand will make up approximately 60% of the “New Darden.”  We heard mumblings of the “Brand Renaissance” plan, but management failed to go into detail for competitive reasons.  Just last quarter we listened to Brinker management detail their plans to improve operations within their four walls.  The point is, this seems like a cop-out.  If investors want to get behind this company now, they need to know what management plans to do to turn around the Olive Garden brand.

 

Management has lost all credibility to hit its targets.

This was evident from the very beginning of the call.  But one analyst, in particular, directly confronted management about their lack of credibility:

 

It seems in the presentations that you gave us that the key to whether this could create value or not is on those operating income growth numbers, low to mid-teens at the New Darden and mid to high single-digits at the New Red Lobster.  Why are those credible given the track record?


We thought it was ridiculous management didn’t guide down FY14 projections after an abysmal 1QF14 and apparently, others are starting to feel the same way.  Why they were so reluctant to do so is beyond us and now their credibility is in question.  The concern here is, if Darden doesn’t hit the revised targets management announced yesterday, they will have failed to create any shareholder value despite the strategic rationale aimed at doing just that.

 

 

CLICK HERE TO WATCH

 

DRI: CLARENCE'S LEGACY, A HALF-BAKED PLAN - 12 19 2013 3 47 02 PM

 

 

Howard Penney

Managing Director

 



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