prev

INVESTING IDEAS - LEVELS

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

INVESTING IDEAS - LEVELS - sun

 

Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers.

  • "Trade" is a duration of 3 weeks or less
  • "Trend" is a duration of 3 months or more
  • "Tail" is a duration of 3 years or less

Anything longer than 3 years is unpredictable


INVESTING IDEAS NEWSLETTER

Takeaway: Current Investing Ideas: CCL, DRI, FXB, HCA, LVS, RH, TROW, WWW and ZQK

Please see below Hedgeye analysts' latest updates on our high-conviction stock ideas.

 

In this week's edition of Investing Ideas, we also feature a special market commentary based on our institutional client macro "Flash Call" earlier this week. In it, we highlight specific areas of economic vulnerability and why investors are rightfully nervous right now.

 

Finally, we are excited to announce the recent launch of Hedgeye's Internet & Media Sector spearheaded by analyst Hesham Shaaban. At the conclusion of this note, we highlight Hesham's latest research on the stock market's current "darling" and explain why we think "Icarus" is a far more appropriate name.

 

(Please note CEO Keith McCullough's refreshed "Trend" levels for each stock will be sent out later this weekend.)

 

IDEAS UPDATES

The latest on Hedgeye's high-conviction stock ideas.

 

CCL — Record bookings in January bode very well for Carnival Cruise Lines with the lowest expectations on the Street. The cruise operator said it took net bookings (new reservations minus cancellations) for more than 565,000 guests last month. That’s a 17% increase from January of 2013.

INVESTING IDEAS NEWSLETTER - ccl

Meanwhile, Carnival's website had 13 million visits during January, another record. It remains to be seen whether heavy discounting was the catalyst behind the strong bookings. Unseasonably cold weather likely played a positive role. It is critical for prices to hold steady during mid-Wave. We’ll be updating our proprietary cruise pricing database next week.

 

 

DRI — Veteran Restaurants Analyst Howard Penny has nothing material to add to his bullish long-term thesis on Darden this week.  We are eagerly awaiting the release of Starboard Value’s plan for value creation with respect to Red Lobster, Olive Garden, etc. We expect that to happen sometime within the next couple of weeks.

INVESTING IDEAS NEWSLETTER - redl

In the meantime, the company has been making headlines for offering "free babysitting" for parents while they eat at Olive Garden on Friday, Feb. 7th.  To be frank, this “Parent’s Night Out” special is another feeble (laughable?) attempt to drive customer traffic. 

 

A large part of Penney’s bullish thesis revolves around the resurrection of the Olive Garden brand.  It is becoming clearer by the day that a new management team or structure is needed for this to happen. In other words, Chairman and CEO Clarence Otis needs to go.

 

 

FXB — Hedgeye remains bullish on the British Pound versus the US Dollar (etf FXB), a position supported over the intermediate term TREND by prudent management of interest rate policy from the Bank of England. The BOE continues to be oriented towards hiking, rather than cutting as economic conditions improve. In its interest rate decision on Thursday it kept the main interest rate on hold at 0.50% and its Asset Purchase Target on hold at £375B.

INVESTING IDEAS NEWSLETTER - uk1 

Economic data out during the week continues to confirm our bullish outlook on the economy which we believe should influence the currency higher. While the PMI Services and Manufacturing figures for January slightly underperformed expectations and were slightly below December figures, they remain the highest across Western European countries. We see strong through-put in PMI Construction figures that rose to 64.6 in January versus 62.1 in December (an all-time high since the series was recorded in July 2008).  Additionally, the housing market remains elevated – according to the Halifax House Price Index prices rose +7.3% in January year-over-year versus +7.5% in December, and though a bit stale, on a year-over-year basis Industrial Production remains elevated despite a slight decline to +1.8% in December versus a recent high of +2.9% in October. 

 

 

HCA —  We've commented frequently in the last few weeks about what appears to be a re-acceleration on surgical case volume across the Orthopedic and Cardiovascular practice areas. These two practice areas, with their high reimbursements and contribution to overall hospital revenue and profits, is critical to the success of any hospital company. For HCA in Q413, it only took a very small recovery in surgical case volume to drive a massive acceleration in their average reimbursement per admission.  Staying long HCA or any other hospital is still a difficult decision every day, though. From their Q413 report, which HCA had preannounced, we heard a few new items which on balance we liked. The guidance for 2014 was set reasonably (and low by our estimate) and the incremental profit from the Affordable Care Act was also guided to a very low number at an additional 1-2% of EBITDA for the year, and also likely below what they will realize.

 

Fundamentals and stock prices can and are often two different things though. But as the charts below suggest, we think the risk from a market move lower is reasonably low from here. Hospitals and HCA typically trade at a discounted multiple to the S&P 500.  We've charted the EV/EBITDA ratio for both. With a range of 73% to 89% of the market multiple, HCA's current reading of 80% is right in the middle of the range. Combined with our view that HCA can perform better fundamentally and report better than expected EBITDA numbers, we won't say there isn't any risk, but we're likely in a pretty comfortable position.

 

We should have the next round of our OB/GYN in the next day or so. We're looking forward to seeing the update on patient traffic and maternity trends. We'll also be sending out a survey to Orthopedic surgeons to ask them about case volume.  We were surprised to hear, despite 2 quarters of acceleration and one of the best quarters in the last 5 years, many of the implant manufacturers caution the street heading into 2014 not to expect the trend to continue. Our survey should give us the answer we need.

INVESTING IDEAS NEWSLETTER - HCA price vs surg

 

INVESTING IDEAS NEWSLETTER - HCA Relative Multiple

 

LVS — Hedgeye Gaming, Lodging & Leisure Sector Head Todd Jordan remains the bull on Las Vegas Sands. While he acknowledges that January gross gaming revenues in Macau were disappointing, he says it could have been due to bad luck in the last couple of weeks of the month. Jordan is much more optimistic on February, given positive anecdotal evidence that we are hearing surrounding the Chinese New Year.  For starters, mass traffic has been strong and Las Vegas Sands has several mass-centric properties.

 

 

RH — Restoration Hardware is in a particularly dark period now. Not with its business, which we think is still quite healthy, but with its communication with the Street. The company has ended its fourth quarter, but has not yet finalized the books. That process – for some reason we do not understand – takes a particularly long time for RH. The company won’t release earnings for another 1-2 months, which might very well mark the longest ‘quiet period’ for any company in retail. Unfortunately, that lack of information is not RH’s friend. Investors like to speculate about the business, particularly given the horrible results retailers posted in January due to bad weather. Generally speaking, no one speculates that ‘things are going great’. It’s simply not how Wall Street thinks. The good news is that for people who believe in the company’s opportunity, strategy, and execution, weakness in the name based on said factors prove to be a buying opportunity – like we think we have with RH today. 

 

 

TROW — Shares of T Rowe Price are the second best performing stock in the asset management group year-to-date (behind defensive institutional bond fund manager Legg Mason). With the bulk of substantial outflows from institutional sovereign wealth clients out of the way from the back half of 2013, TROW is now at a positive inflection point to book solid inflows backed by its industry leading performance. TROW’s leading 401k business is still growing above the industry average and with industry-wide retail equity flows having turned up substantially in the middle part of last year, the environment is still incrementally positive for this leading stock fund manager.

INVESTING IDEAS NEWSLETTER - trow

We are however getting cautious on the margin that the environment is getting more challenging for U.S. stocks to maintain their upward trajectory but with a solid rebound towards the end of the week in U.S. equities, the environment has stabilized a bit. We are traveling with TROW management at the end of this month and should then get a better idea of if the retail investor is incrementally adding to TROW funds. Until then, TROW shares should rebound with the market after a tough start to the year for equities.

 

 

WWW — Wolverine Worldwide is slated to report fourth quarter earnings on Tuesday February 18th before the market opens. While our call on WWW is much more long-term in nature, the reality is that we happen to like it into the print. The stock has gone from $34 to $27 in a month’s time on virtually no news. The company notes that sales were a bit light in quarter relative to expectations, but then it took up its EPS guidance. That’s the kind of company we like – one that offset weakness in the macro climate with its own initiatives to hit financial objectives.

 

This remains one of the most hated stocks in retail – not quite as much as JCP, but close. We like that – we’d be concerned if it was over-loved. We think that WWW will print upside to earnings, and ultimately will beat every quarter this year (based on current Street estimates).

 

 

ZQK — Quiksilver’s female brand, Roxy, was center stage on the first night of Olympic competition in the Women’s Slope Style qualifying run as Roxy endorsed, Torah Bright, kicked off her pursuit to bring home the snowboard triple crown for her home country of Australia.  We talked a few weeks back about ZQK’s new endorsement/marketing strategy. In summary – ZQK made the right move to downsize their athlete roster and event sponsorships. Our survey work indicated - ZQK should focus only on the Rockstars to drive brand awareness.

INVESTING IDEAS NEWSLETTER - 22 

That’s why this Torah Bright development is kind of  a double edged sword. On one hand, Roxy has the best female snowboard athlete in the world -- one that could be argued is the female equivalent of Shawn White. We know most people will argue with us on that one. We're huge White fans ourselves. But he is supremely dominant in one event -- the pipe. Torah consistently wins in the halfpipe, snowboardcross, and now slopestyle.

 

The flip side of this is that Roxy fails to promote her as a top athlete (she’s nowhere to be found on the brands website – check out the image below) -- even though she has a full line of snowboard clothing, and appeals to women and men alike. This just goes to show that ZQK still has underutilized assets at Roxy that could ultimately promote revenue growth.  

 

*  *  *  *  *  *  *

Mr. Market Is Getting a Little Queasy  

A Special Economic & Market Update 

 

CEO Keith McCullough led the Macro team earlier this week in a Hedgeye Flash Call, updating our subscribers on our Q1 themes of #InflationAccelerating and #GrowthDivergences.  Together with US Macro analyst Christian Drake, Keith walked through the quantitative set-up that has emerged since the beginning of the year. 

 

With the S&P index down roughly 3% year to date, if you own equities, it’s not pretty.  As Keith observed in his opening remarks, “Risk has happened pretty fast” since the beginning of the year – just one month, which once again demonstrates that the one certain effect of government attempts to manipulate the economy is to shorten economic cycles, and to increase volatility.  From that perspective, the near-universal efforts of the world’s central bankers seem to be having their predicted effect – if not their intended ones.

 

 

So Much Inflation, So Early in the Year

 

The individual investor who finally threw in the towel and bought stocks late last year may be feeling a little bit abandoned right now as they watch the value of their holdings decline almost daily, with nary a pundit in sight to tell them why.  Very few of the major Wall Street gurus are talking about the inflation that our macro work sees very clearly.  Instead, they are almost uniformly fixated on how much higher the S&P 500 will be at the end of this year – a recent review of top stock market forecasters found the average projection for the S&P this year was 1,955, more than 200 points higher than it was trading as Keith spoke.

 

Many of these same forecasters underestimated the strength of the market last year, coming in short by more than 15%.  We are not sure what continues to qualify them as “top forecasters.”  There must by some mystical process at work here to which we are not privy.

 

Hedgeye’s macro work indicates that commodity prices have begun to break out as other inflationary pressures continue to build.  If Fed chair Yellen decides to rescue the equities markets by going back to Quantitative Easing, the impact could re-ignite what has become a Pavlovian response from investors: QE Up, triggering Dollar Down, triggering Yield Chase/Inflation Hedge Assets Up.  This would likely spark another round of growth-slowing commodity inflation.  

 

After peaking in 2011-2012, commodity prices subsequently cratered in 2013 as the dollar strengthened and expectations rose for incremental Fed tightening.  In that environment pro-growth equities became the asset allocation of choice for both retail and institutional investors.   

 

Notably, the slope of broader inflation – as measured by the CPI – follows the slope of commodity inflation closely.  In other words, if commodity inflation accelerates or decelerates sequentially, so does the CPI.  So, generally, we can expect broader measures of consumer price inflation to track the move in commodity prices. 

 

Given last year’s price declines, the comps (period-to-period comparisons) are especially easy; thus even a moderate price increase in the commodity complex will look inflationary year over year.  This is more an optical effect than an economic reality, but policy is made in response to how things appear, not how things actually are.  Even with Princeton PhDs, Washington policy makers generally have no clue how things actually are, while the few people who actually do know how things are can never convince others until it’s too late.

 

Says McCullough, we are not likely to see 2011-2012 style actual inflation (which by the way the Fed did not see at the time) but as people start to perceive the rise in commodity prices alongside decelerating growth and declining stock prices, there will be speculation that the Fed will again loosen policy in an attempt to help support flagging growth.  If Yellen stays the course on the taper, new stock investments could be temporarily good money after bad.  If she reverses, then your dollars in the stock market will be the near-term Good Money, while the Dollar in the global context will be Bad and inflation will rise faster.  Damned if we do, damned if we don’t.

 

 

A Rising Tide of Inflation


We were seeing wage inflation even before President Obama decided to push wage increases through executive order, which is obviously bullish for further wage increases in general.  Perhaps more significant, savings rates are declining back towards historic lows as consumption is again displacing saving.  Note that, in 3Q13, aggregate household debt growth turned positive for the first time in eighteen calendar quarters (latest data), signaling that credit-driven consumption growth is now back after 5 years of household balance sheet deleveraging.  The trend to consumer over-spending is likely to be exacerbated as consumers start to worry about inflation: the propensity to chase rising prices will exert pressure on consumer spending.

 

On the market side, inflationary pressure is more likely to lead to multiple compression, the very opposite of the expansion most Wall Street strategists are calling for.  In Hedgeye’s proprietary four-quadrant model, last year saw Growth Accelerating / Inflation Accelerating.  In this scenario, optimism about the economy and enthusiasm about growth lead investors to assign higher P/E multiples to stocks – multiple expansion – and prices rise.  But we are rolling out of that scenario – Quadrant 2 in our model.  As commodity inflation rises, we risk moving into Quadrant 3: Growth Slowing / Inflation Accelerating.  This is the “in-a-box” policy scenario: Damned if you do, damned if you don’t.  This stagflationary scenario is not a good place to be, and not an easy one to work out of.  There is practically no good policy option except the one that no politician wants to hear: sit tight and wait it out.  Meanwhile, consensus is looking for continued multiple expansion this year.  Says McCullough, the pundits whose S&P targets fell short by 300 points last year may be on target to overestimate this year’s levels by the same margin.

 

Investors are not positioned for slower growth and stock price multiple compression.  But inflation metrics continue moving forward steadily and quietly.  Keith says this could in effect be commodity prices front-running policy; if the Yellen Fed yields to pressure and reverses the tapering process, inflation will charge ahead, as will “the inflation trade.”  Already, says McCullough, broad measures of inflation are moving ahead.  CRB prices continue to make higher lows. Inflation hedge assets are outperforming, even as stock prices decline – utilities are practically the only equity sector that is working, and gold is regaining its luster.  Other inflation indicators are advancing, such as the Prices Paid component in both the ISM Manufacturing and ISM Services Surveys.  ISM services new orders – the best lead indicator of future activity in the survey – are back down to the level they were in July 2009, and ISM manufacturing new orders just had its biggest month-over-month decline since December 1980, the eve of a recession that battered the nation for two years.

 

Durable goods orders, retail sales, consumer trends, housing demand and home prices are all slowing, consumer stock prices are underperforming, and the Treasurys yield spread is compressing, indicating a worsening growth outlook.

 

Fed Up?


The market appears to be set up for a reversal of the Taper.  The minute Yellen hints a return to Quantitative Easing, says McCullough, the full impact of that reversal “will roll right into the CRB.”  The markets are already pricing in slower growth and rising inflation and Hedgeye’s macro work indicates the slope of the rate of change in prices continues its upward trend, making the inflationary scenario worse for investors.

 

Globally, most central banks are engaged in a global bonfire, all rushing to burn their currency faster than their neighbor.  Notable standouts include India and the UK, whose central bankers have pushed back on the widespread religion of post-Keynesianism and held the line on their currencies. 

 

Central planners and regulators are busy assuring their citizens that things are under control, but the reality is that regulators don’t know what forces will cause the next crisis.  All they can do is make sure the abuses that precipitated the last crisis don’t get out of control again.  Meanwhile, we may already be in the midst of the next crisis, as central bankers trash their currencies to stoke price inflation and stimulate exports.  The lasting impact of these policies is not economic strength, but greater inequality, with an increasing likelihood of social unrest.  Even though pundits here have been discussing the decline in the emerging markets, the US marketplace is not insulated against the possibility of a broad EM collapse.

 

In this scenario of limited options, the only solid hope on the US policy front would be an unequivocal statement from Yellen that the Fed will continue to taper and continue to tighten.  That would strengthen the dollar and help set the US economy back on a growth track.  Of course Hope, as McCullough points out, is not an investment process. 

 

Once again the individual investor has been left high and dry.  Everyone has been pushing the bull case.  Now that it’s not working, no one is trying to unpack the reasons behind the market decline.  Keeping their eye on their lofty year-end targets for the S&P, the pundits have taken their eye off the ball: a lot can happen in the coming eleven months. 

 

If the history of market behavior is any guide, by the time the rest of Wall Street wakes up to #InflationAccelerating, it will already be behind us.

 

*  *  *  *  *  *  *

(Click on the title below to unlock our latest research note on Twitter)

 

TWTR: Staying Short, But...

Our original short thesis on Twitter centered around emerging headwinds to two of its core growth drivers 1) Reach (User Growth) and 2) Monetization (Ad Revenue per timeline view). While TWTR is down 33% from its highs, it still trades at a premium to social media comps Facebook and LinkedIn.  As soon as the Street realizes that the company can’t grow +50% in perpetuity, the stock will lose further momentum.
INVESTING IDEAS NEWSLETTER - twtr

 


TWTR: Staying Short, But...

Takeaway: See SUMMARY BULLETS and SUMMARY CHARTS at the end of the note for main takeaways

SUMMARY BULLETS

  1. 4Q13 Earnings Exposes Holes in Business Model: Both Membership Growth and Engagement decelerated meaningfully in 4Q.  Street is now questioning the runway for both growth drivers.  We believe User Growth is the bigger issue.
  2. Biggest Hole Yet to Emerge: Monetization has been a considerable growth driver, but running out of runway.  Growth likely to decelerate beginning 2H14/2015.
  3. Consensus Estimates Rising: Estimates are up with the 4Q13 earnings and 2014 guidance beat; the mistake is increasing already-lofty 2015-2016 estimates as well
  4. But Continue to See Near-Term Upside: We see consensus estimates for 1H14 as more than achievable.  Since the stock has already taken a hit, a near-term beat could refuel optimism.

 

TWTR 4Q13 EARNINGS SUMMARY

  • Revenues: 4Q13 Revenue of $245M, beating both our estimate of $218.9M and consensus of $218.1M
  • Membership (Reach): Monthly Active User (MAU) growth came in lower than we expected at 30% y/y vs. our estimate of 38%.  US Growth decelerated to 20% y/y, vs. 33% in the prior quarter
  • Timeline Views/User (Engagement): Declined -3% y/y, decelerating from the 8% growth in prior quarter. 
  • Ad revenue/timeline view (Monetization): accelerated sharply, up 76% y/y vs. 49% in prior quarter. 
  • 2014 Guidance: $1.15-$1.20B vs. consensus of 1.13B and our estimate of $1.08B.  1Q14 revenue guidance of $230M-$240M is ahead of our original estimate of $230, and well ahead of prior consensus of $214. 

 

SHORT THESIS SUMMARY

Our original short thesis centered around emerging headwinds to two of TWTR’s core growth drivers 1) Reach (User Growth) and 2) Monetization (Ad Revenue per timeline view). 

  1. Reach (Membership Growth): Our major concern was understated penetration; particularly in the US.  We have seen studies suggesting that as many as 50% of twitter’s total users are no longer active; meaning TWTR already penetrated a larger portion of the US population than its Monthly Active Users (MAUs) metrics suggest.  Average Revenue per User (ARPU) in the US is considerably higher than the international market (8x greater), so if US slows, international can’t compensate
  2. Monetization (Ad Revenue per timeline view): This has been an accelerating source of growth for TWTR over the LTM.  However, we believe this has a limited runway because it was largely driven by what we call the “Mobile Migration”, which we see as a non-recurring/waning benefit.  The “Mobile Migration” is the combination of TWTR introducing its main ad products to its mobile platform (where the company has had greater success with monetization) while users were steadily adopting the mobile app.  The former can’t be repeated; the latter is near full penetration.  The only other options from here is to introduce new ad products, or the ad load itself; both will test the loyalty of its users.

 

SHORT THESIS UPDATE

  1. Reach: TWTR only picked up an additional 1M users sequentially in 4Q13 ( up 2% q/q).  For perspective, FB picked up 2M users despite US Monthly Active User (MAU) penetration that is over 3x that of TWTR (73% vs. 22%, respectively).  We continue to believe the upside to TWTR’s user growth is limited since total US penetration is higher than its MAU metrics suggest. The emerging question is whether TWTR's addressable market is as large as FB’s, and if it can achieve comparable penetration down the road.
  2. Engagement: the 4Q deceleration in timeline views/MAU is concerning.  Management suggested that user interface improvements limited the need to refresh the site as often, which is how it measures timeline views.  While plausible, we believe that users gravitating over to TweetDeck, where the company can’t measure timeline views, may also be partly to blame.  The latter would be concerning since we do not believe the company is effectively monetizing the TweetDeck platform.
  3. Monetization: the 4Q acceleration in ARPU suggests the Mobile Migration may have more near-term upside than we originally thought; although we suspect some of that acceleration is due seasonal spike in 4Q ad spending (holiday shopping season).  Regardless, our thesis hasn’t changed.  Mobile drove substantially all of TWTR’s 4Q13 ad revenue growth.  With mobile now representing over 75% of all ad revenue (vs. 55% in 4Q13), the runway gets shorter from here.  The comp setup switches from mobile representing the minority to majority of revenue moving forward.   

 

CONSENSUS ESTIMATES LOFTY, BUT MORE REASONABLE NEAR-TERM

Following the beat on both 4Q13 Estimates and 2014 Guidance, Consensus estimates have risen substantially.  Where we take issue is 2H14 and 2015; more so on the latter.  While it may be premature to look that far out, TWTR’s stock will ultimately trade on growth expectations.  While TWTR is down 33% from its highs, it still trades at a premium to social media comps FB and LNKD.  As soon as the street realizes that company can’t grow +50% in perpetuity, the stock will lose further momentum. 

 

Timing that catalyst is the challenge; especially since we see upside to 1H14 estimates.  TWTR’s 4Q13 results have rebased expectations for the Reach and Engagement operating metrics, so we expect revenue growth will become the more important driver for the stock near-term.

 

 

SUMMARY CHARTS

 

User Growth: Significant Slowdown in US User growth.  We suspect TWTR's US penetration is much higher than its MAU metrics suggest given that some users have joined and are no longer inactive.  Runway is shorter than many expect.

 

TWTR: Staying Short, But... - TWTR   MAU Growth 4Q13

TWTR: Staying Short, But... - TWTR   US penetration scenario 4Q13

 

Engagement: Decelerated Considerably, which management suggest is partly due to Twitter interface improvements, but we believe users migrating to TweetDeck is also to blame.  We suspect this could a secular theme, which would pressure ARPU.

 

TWTR: Staying Short, But... - TWTR    Timeline Views 4Q13

TWTR: Staying Short, But... - Google Trend   Tweetdeck

 

Monetization: the Mobile Migration may have more immediate upside than we originally thought, although we suspect some of the 4Q13 acceleration is due the holiday shopping season.  

 

TWTR: Staying Short, But... - TWTR   ARPU 4Q13

 

Hedgeye vs. Consensus: We see upside in the near term to consensus estimates, but we expect ARPU growth to slow beginning 2H14 as the mobile tailwind begins to subside.  With mobile now representing over 75% of all ad revenue, the comp setup switches from mobile representing the minority to the majority of revenue moving forward.    

 

TWTR: Staying Short, But... - TWTR   Hedgey vs. Consensus 1Q14 4Q15

 

Valuation: This is just for perspective.  TWTR trades at a much higher multiple than its peers, but that can be explained by the lofty growth estimates assumed by consensus.  As soon as the street realizes that company can’t grow +50% in perpetuity, the stock will should trade more inline with its peers. 

 

TWTR: Staying Short, But... - TWTR   valuation 2 7 13

 

 

Let us know if you have any questions, or would like to discuss in more detail.

 

 

Hesham Shaaban, CFA

@HedgeyeHC2


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Fund Flows Refreshed, Global Jitters

Takeaway: Retail mutual funds continued their lagged correlation with equity inflow while institutional ETFs reflect global equity fears.

Editor's note: This complimentary, unlocked research note was originally published February 06, 2014 at 08:05 in Financials by Hedgeye Financials analyst Jonathan Casteleyn. For more information on how you can subscribe to our products click here.

Fund Flows Refreshed, Global Jitters - q1

Investment Company Institute Mutual Fund Data and ETF Money Flow:

 

Total equity mutual funds experienced another week of inflow as the lagged effect of fund flow chasing performance from last year has been strong enough to offset near term worries about emerging markets. Within the total equity fund result, domestic equity mutual funds had $1.8 billion of inflow in the most recent 5 day period, just ahead of the 2014 weekly average for domestic funds of $1.4 billion in inflow. International equity funds netted more than domestic funds posting a $3.5 billion inflow. This most recent result coupled with the strong result from the week prior has now moved the 2014 weekly average for total equity mutual funds to a $4.9 billion inflow average to start 2014, a continuation on 2013's positive trends where $3.0 billion per week on average flowed into total stock funds. 

 

Fixed income mutual funds had continued net outflows during the most recent week, a continuation from the negative performance of 2013. In the week ending January 29th, total fixed income mutual funds experienced a $896 million outflow, which broke out into a $1.4 billion redemption in taxable bonds and a $520 million inflow into tax-free bonds, the third straight week of inflow for munis. The 2014 weekly average for fixed income mutual funds now stands at a $635 million weekly inflow, an improvement from 2013's weekly average outflow of $1.5 billion but a far cry from the $5.8 billion weekly average inflow from 2012 (our view of the blow off top in the bond market).

 

ETFs, a more institutional product, reflected the nascent risks in emerging markets and slightly weaker U.S. economic data with a massive outflow in stock ETFs and a slight redemption in fixed income ETFs. Stock ETFs lost a substantial $13.2 billion in the 5 day period ending January 29th, the biggest weekly outflow in our data set spanning 18 months of information, with bond ETFs experiencing a $639 million redemption. The 2014 weekly averages considering this latest data are now a $3.0 billion weekly outflow for equity ETFs and a $22 million weekly inflow for fixed income ETFs. 

 

The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a negative $6.2 billion spread for the week (-$7.7 billion of total equity outflows versus the -$1.5 billion outflow within fixed income; positive numbers imply inflows for stocks; negative numbers imply inflows for bonds). The 52 week moving average has been $7.3 billion (positive spread to equities), with a 52 week high of $30.9 billion (positive spread to equities) and a 52 week low of equity/debt weekly spread of -$9.2 billion (negative numbers imply a net inflow into bonds for the week). 

 

In last week's ICI report, we outlined the historical relationship between retail mutual fund flows and market performance. In analyzing 12 years worth of data, our research shows that fund flow chases or lags performance by 6 months for equities and 9 months for fixed income (the best fit line between these two variables). Thus the strong return for stocks in 2013 of 30% in the S&P 500 and the first loss in the Barclay's Aggregate bond index in 14 years is still driving the direction of retail fund flows currently (see late week's report here). 

 

 

Fund Flows Refreshed, Global Jitters - cast

Fund Flows Refreshed, Global Jitters - ICI chart11

 

 

 

Most Recent 12 Week Flow in Millions by Mutual Fund Product:

 

 

Fund Flows Refreshed, Global Jitters - ICI chart3

 

Fund Flows Refreshed, Global Jitters - ICI chart4

 

Fund Flows Refreshed, Global Jitters - ICI chart5

 

Fund Flows Refreshed, Global Jitters - ICI chart6

 

Fund Flows Refreshed, Global Jitters - ICI chart7

 

 

Most Recent 12 Week Flow Within Equity and Fixed Income Exchange Traded Funds:

  

 

Fund Flows Refreshed, Global Jitters - ICI chart8

 

Fund Flows Refreshed, Global Jitters - ICI chart9

 

 

Net Results:

 

 

The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a negative $6.2 billion spread for the week (-$7.7 billion of total equity outflows versus the -$1.5 billion outflow within fixed income; positive numbers imply inflows for stocks; negative numbers imply inflows for bonds). The 52 week moving average has been $7.3 billion (positive spread to equities), with a 52 week high of $30.9 billion (positive spread to equities) and a 52 week low of equity/debt weekly spread of -$9.2 billion (negative numbers imply a net inflow into bonds for the week). 

 

 

Fund Flows Refreshed, Global Jitters - ICI chart12

 

 

 

Jonathan Casteleyn, CFA, CMT 

203-562-6500 

jcasteleyn@hedgeye.com 

 

Joshua Steiner, CFA

203-562-6500

jsteiner@hedgeye.com

 


MISSING'S MATTERED: 4Q13 EARNINGS SCORECARD

Takeaway: Beat-Miss Spread Expanding, Consumer Company operating performance decelerating, forecasting fundamentals is making a comeback.

PERFORMANCE vs. THE PRINT:   After what feels like a multi-year deference to macro trends and serial crises, forecasting fundamentals has shown a mini-resurgence in 4Q13.  

 

In particular, earnings results relative to expectations have shown a strong relationship to subsequent performance.  Bottom line shortfalls continue to be sold hard as eighty percent of EPS misses have gone on to subsequently underperform the market by -5.3% on average. 

 

The relationship between sales beats/misses and subsequent performance has been comparably modest.  

 

MISSING'S MATTERED: 4Q13 EARNINGS SCORECARD - EPS BM Perf

 

MISSING'S MATTERED: 4Q13 EARNINGS SCORECARD - Sales BM Perf

 

BEAT-MISS:  With roughly two-thirds of SPX constituents having reported, Sales & EPS Beat-Miss spreads remain above both the 3Q13 (53%/74%) and TTM (54%/73%) averages as 66% and 76% of companies have beaten Sales and Earnings estimates, respectively.   Revenue disappointments out of Consumer Staples companies have emerged as the primary negative divergence.   

 

MISSING'S MATTERED: 4Q13 EARNINGS SCORECARD - ES Table 020714

 

FUNDAMENTAL PERFORMANCE TRENDS: In contrast to positive Beat-Miss trends, the slope of improvement in operating performance has been decidedly lackluster with just 48% and 53% of companies registering sequential acceleration in sales and earnings growth, respectively. 

 

The percentage of companies reporting sequential operating margin expansion in 4Q13 remained unchanged WoW at an uninspiring 42% according to bloomberg data. 

 

From a sector perspective, Financials and Industrials have led operating performance while Consumer Discretionary and Consumer Staples remained the relative, fundamental laggards.  

 

MISSING'S MATTERED: 4Q13 EARNINGS SCORECARD - ES OP Table 020714

 

STYLE FACTOR PERFORMANCE:  Reported results vs expectations across style factors has flattened out a bit WoW but High Beta, Low Yield, and Low Leverage equities have performed notably better vs. prevailing topline estimates than their inverses. 

 

MISSING'S MATTERED: 4Q13 EARNINGS SCORECARD - ES SFP 020714

 

MISSING'S MATTERED: 4Q13 EARNINGS SCORECARD - SPX SFPV

 

 

Christian B. Drake

@HedgeyeUSA

 

 


PM: Strong Pricing in Challenged Geographies

PM reported strong Q4 2013 results yesterday with revenues of $7.78B (slightly missing consensus expectations of $7.81B) and adjusted diluted EPS that beat consensus by 1 cent at $1.37. 

 

The headwinds we see for the company over the next two quarters have not changed – what’s impressive however is how well PM has been able to take pricing in the quarter to make up for volume declines and tax increases across most of its geographies. Overall volume declined -4.3% in Q4 and -5.1% in FY2013 while net pricing rose a robust +6.9% in Q4 and +6.6% in FY2013. Additionally, the company gained market share in all four of its main regions.

 

Concerns for us over the coming quarters remain volume declines in many of its core geographies on additional excise tax hikes, weak macro and consumer environments, and currency and illicit trade headwinds. In 2014, excise tax hike concerns remain in Japan, Indonesia, and the Philippines; weaker macros include Europe and Russia; and we expect currency weakness across much of the emerging market, including the Russian Ruble, Turkish Lira, and Argentine Peso, as the illicit trade across the region skims results.   

 

The company announced that it has issued 60% of its pricing for 2014 as of today (versus ~75% this time last year). We think the significant risks to it making its 1H numbers include: its ability to take additional pricing in Japan (it has submitted requests to the government for price hikes in April but has yet to be approved); weakness beyond its forecasts in the Philippines as the Mighty Corporation continues to undercut price (it only declares half of its production for tax); and macro weakness in Europe beyond its forecast of -6% to -7% (versus previous 2014 guidance of down -7% to -8%).

 

The company forecasts EPS guidance for 2014 of $5.02 to $5.12 (including a currency headwind of $0.71). It said it expects industry volumes to be down 2-3% in 2014 (ex-China), versus ~4% in 2013 and it will spend $4Billion in share repurchases in 2014 versus $6B last year. The company spent a very small amount of time discussing its Reduced Risk Products (RRPs), including e-cigs, despite major investments and partnerships that were announced in Q4 of last year -- this is concerning unless the company is particularly good at hedging its excitement about the segment (and contribution to earnings down the line). Remember late last year it announced  €500MM to build a RRP manufacturing facility in Italy, to be operation in 2016 with capacity of 30B units, and a strategic partnership with Altria (MO) to sell and partner with its non-combustion technology.  

 

We’ve had a bearish bias on the PM over the last two quarters and continue to suggest a pair trade of long LO versus short PM. See chart below on price performance.

 


What We Liked

  • Illicit trade in Europe has moderated. Sales in back half of 2013 have moderated versus larger declines in1H 2013.
  • In EU Region grew market share by 0.5% to 38.5% in 2013 vs 2012. Increases were across all brands.
  • Russia strong: pricing actions expanded profitability despite volume -7.6% in Q4. It increased pricing in December, and expects another hike at the end of February.  Volume in 2014 expected to be down 9 to 11%.

What We Didn’t Like

  • Japan still remains a challenged market. Company believes it will be able to fully meet consumption price tax increase in Japan from 5% to 8% in Japan in April with pricing, however risk that the government doesn’t approve it.
  • PM says demand for e-cigs in Europe has decelerated, which PM posits should boost traditional cigarette volumes in 2014.
  • Italian tax environment continues to be unfavorable.
  • Moderation in Turkey results on increased competition in Low and Super-Low segment. 

Call with questions. Have a great weekend!

 

Matt Hedrick

 

PM: Strong Pricing in Challenged Geographies - yy. spread


GET THE HEDGEYE MARKET BRIEF FREE

Enter your email address to receive our newsletter of 5 trending market topics. VIEW SAMPLE

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.

next