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Stock Report: Lorillard, Inc. (LO)

Stock Report: Lorillard, Inc. (LO) - HE LO table 3 7 14

THE HEDGEYE EDGE

With perceived regulatory risk a main concern in owning LO for some investors, we retained a prominent Washington, D.C. law firm specialized in tobacco to help assess the FDA’s position on menthol. The firm’s opinion certainly helped inform ours -- we suggest there is likely no risk that the FDA bans menthol over the next 1-2 years, and we assign less than a 20% probability over the longer term. 

 

Menthol composes 85% of LO’s profits, so regulatory insight is extremely material to this stock’s story.  

 

We view limited regulatory risk as icing on the cake for a company that consistently delivers double digit EPS growth, pays a healthy dividend ratio of 70-75% of earnings, has an advantaged portfolio mix with positive consumer and demographic trends to menthol cigarettes versus traditional tobacco, and has great upside growth potential in its category leading electronic cigarette, blu.

 

TIMESPAN

INTERMEDIATE TERM (TREND) (the next 3 months or more)

We saw LO rip higher this week on two pieces of news: on rumors Reynolds American (RAI) is considering acquiring LO and on NJOY (a private e-cig maker) receiving a capital injection of $70MM and an enterprise valuation of $1B.  While a RAI takeout may be unlikely due to antitrust issues, the rumor, along with the signal of confidence in the investment made in e-cig industry, is additive to our bullish fundamental outlook on the company.

 

We’re bullish across LO’s trends. We expect its concentrated portfolio in menthol to outperform based on lasting consumption and demographic trends that differ from traditional tobacco, including an over-index to minorities.  We expect volumes to continue to outperform the industry and for it to take pricing to drive strong top line results over the coming quarters.  

 

LONG-TERM (TAIL) (the next 3 years or less)

Over the long term we view electronic cigarettes as a disruptive technology to replace the industry’s declining cigarette volumes and growth engine for the company. 

 

LO bought blu e-cigs back in April 2012. The acquisition allowed LO to get ahead of Big Tobacco’s entry into the category (which came just late last year in a test markets) and gain leading share (at 47% in 2013). Additionally, in October 2013 LO purchased UK e-cig maker SKYCIG to become the first U.S. Big Tobacco company with international e-cig reach.

 

We expect blu to maintain its market advantage domestically and to see additional growth first from the UK market, and then throughout the European continent, and beyond. We see blu’s earnings growth contributing to a re-rating of LO’s multiple higher.

  

ONE-YEAR TRAILING CHART

Stock Report: Lorillard, Inc. (LO) - HE LO chrat 3 7 14


We Remain Quicksilver Bulls | $ZQK

Takeaway: There’s no denying that trends for Quicksilver are meaningfully better on the margin. But you know…that’s all that matters.

Editor’s Note: This is a brief excerpt from a research report published by Retail on March, 7 2014 at 6:47 AM. To learn more about subscribing to the Retail Pro, click here.
 
We Remain Quicksilver Bulls | $ZQK - roxy3

This Wednesday we said that we expected this to be a transition quarter for Quicksilver (ZQK). And we were cool with that. Well, two days later, that’s essentially what we got.
 

When we saw the headline that revenue had dropped more than expected in its fiscal first quarter, we viewed it as a slight net negative (due in large part to expectations being all over the place). And in reality, on an absolute basis, losing $0.10 on $393 million in revenue is nothing to be proud of.
 

Then we crunched the numbers, and we shifted our view on the event to neutral to slightly positive. But when we listened to the conference call, we viewed it as decisively positive.
 

So, what’s the deal?
 

The market might not agree for a day or two. But that doesn’t concern us.
 

We think this story is on track to redefine the business model and do what ZQK has not done in over five years: Grow consistently.
 

We Remain Quicksilver Bulls | $ZQK - ZQK sigma2


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FEBRUARY EMPLOYMENT: INCOME INFLECTION?

Summary 

NFP and Private payrolls both beat deflated expectations in February but the trailing 3M/6M/12M averages all decelerated, following the ISM and ADP data lower, despite (what should be) peak positive seasonality.   

In the Household Survey, the Unemployment Rate ticked higher and Labor Force Participation was static sequentially as the total labor force increased +264 (the net number of +223K Unemployed plus +42K increase in employment) against an increase of +170K in the civilian population. 

Employment growth slowed sequentially across all age buckets except 25-34 & 55-64 years olds while state & local Government employment (13.9% of the NFP labor force) posted its sixth straight month of positive growth. 

On the income side, the continued acceleration in earnings growth was a notable positive. 

We provide a visual summary of the February Employment data below along with some specific commentary.  

FEBRUARY EMPLOYMENT: INCOME INFLECTION? - Unemployment Rate

 

INCOME INFLECTION?   The Trend in earnings growth remains positive, but not enough. 

Yesterday the FED reported new highs in household net wealth as gains in equities and home values accelerated materially in 2013.   Equity gains have outpaced the rise in the value of the aggregate housing stock off the lows which, on the margin, disproportionally benefits the wealthy.  Cash-out refinancing activity remains muted and recent consumer spending data shows demand at the high end is beginning to flag.  

With equities barely positive YTD and home price gains decelerating, the slowdown in wealth effect spending looks set to continue.  Moreover, with the savings rate back near historic lows, the ability for further reductions in savings to drive incremental consumption growth appears limited.   

The net of these dynamics – should they continue - is simply that growth in salary and wage income is/will becoming increasingly important in driving ongoing consumption growth.  As the February data on hourly earnings shows, the recovery in earning growth remains positive, albeit painfully slow.    

Average hourly earnings growth for private employees accelerated 20bps sequentially to +2.2% YoY while nominal hourly earnings for non-supervisory and production employees accelerated to +2.5% YoY – its fastest rate of improvement since October of 2010.

As we’ve highlighted recently (LOSE-LOSE? WAGE INFLATION & LABOR'S BAD BANK) the chief source of frustration is that earnings growth, despite ongoing improvement, remains well below historic averages. 

As can be seen in the 2nd chart below, nominal spending continues to grow at a positive spread to nominal earnings growth.

This trend will become increasingly challenged if accelerating earnings growth, supporting broader based household consumerism, fails to materialize in the face of trough savings rates, a pullback in high end discretionary spending, and continued corporate capex conservatism.   

FEBRUARY EMPLOYMENT: INCOME INFLECTION? - Hourly Earning NonSupervisory Feb

FEBRUARY EMPLOYMENT: INCOME INFLECTION? - Nominal Spending vs Nominal Earnings 

 

NFP:  Better Sequentially but Negatively Diverging from Trend

NFP and Private payrolls both beat deflated expectations in February but the trailing 3M/6M/TTM averages all continued their deceleration.  Its notable that both the initial claims and payroll data has diverged from (strong) prior seasonal trends and continues to deteriorate in the face of the build to positive peak seasonality into 2Q.  

FEBRUARY EMPLOYMENT: INCOME INFLECTION? - NFP MoM 3M 6M Ave

FEBRUARY EMPLOYMENT: INCOME INFLECTION? - NFP Seasonality Feb

 

WEATHER:  Negative Outlier Again in February, but...

A reported 605K employees were out of work due to bad weather in February.  This compares with a ten year average of ~350K.  Collectively, employees out of work over the December-to-February period averaged 379K which compares with the 10Y average of ~293K. 

So, the agonizingly ballyhooed weather distortion on reported, domestic macro data to start the year is real…. to an extent.   

Does a full discounting of the weather take the reported labor market, consumer spending and industrial/manufacturing data  from very bad to “just bad” or all the way to “good”.  We’d argue that the trend, inclusive of the negative weather distortion, is still one of modest-to-moderate deceleration

With the $USD broken, 10Y yields failing to break above 2.80% Trend Resistance, and slow growth sectors/assets continuing to outperform, we’d also argue that the market agrees with our interpretation of the slope of domestic economic activity.

FEBRUARY EMPLOYMENT: INCOME INFLECTION? - Out due to weather Feb

FEBRUARY EMPLOYMENT: INCOME INFLECTION? - Out due to weather Feb 2

 

EMPLOYMENT DISTRIBUTION

Part-time employment continued to ebb and Temp employment advance while construction and manufacturing jobs remain in moderate recovery mode and Mining and Energy employment (which generally pay comparatively higher wages) continue to gain in share.

At the Industry level in February, Goods employment remained positive with Construction and Manufacturing adding +15K and +6K jobs, respectively.  Professional/Business Services  (+79K) led Services gains for a second straight month while Information shed workers (-16K) for a third consecutive month.  

 FEBRUARY EMPLOYMENT: INCOME INFLECTION? - Employment Distribution Feb

 

THE REST....

FEBRUARY EMPLOYMENT: INCOME INFLECTION? - Employment by Age

FEBRUARY EMPLOYMENT: INCOME INFLECTION? - U 6 Feb

FEBRUARY EMPLOYMENT: INCOME INFLECTION? - State   Local Govt Feb

FEBRUARY EMPLOYMENT: INCOME INFLECTION? - CES vs CPS

FEBRUARY EMPLOYMENT: INCOME INFLECTION? - Employment Summary Table Feb

 

Christian B. Drake

@HedgeyeUSA


THE BATTLE FOR DARDEN

This report contains some of our thoughts following Darden’s most recent presentation on creating shareholder value.  Overall, the presentation was riddled with disingenuous facts and consistent with what we’d expect from a CEO who is out of touch with reality.  This is the second presentation of this type, making the first one on December 19, 2013 look more like a reactionary response rather than the proactive move the company claims.

 

Furthermore, we were disappointed to find out the company cancelled its analyst meeting at the end of the month and believe this signals yet another sign of weakness.  It makes sense, however, as the company has been under a lot of public scrutiny – and rightfully so.  Considering these two recent events, we believe Mr. Otis did himself a disservice this past week.  In the end, it makes the case for the activist shareholders stronger.  It has become increasingly clear that they must stop the Red Lobster spinoff and aggressively push for more significant changes.

 

Click here to access the FULL REPORT

 

 

Howard Penney

Managing Director

 


Nike Grabs the Bull with Johnny Football Deal

Takeaway: Though Nike is no-stranger to athletes causing controversy, Manziel belongs on the upper half of the risk management watchlist.

Johnny Manziel Signs Deal to Be Represented by Nike

Nike Grabs the Bull with Johnny Football Deal - johnny0

  • "Rovell's sources were not able to disclose the financial terms, but they did say the deal—which was negotiated by LeBron James' business partner Maverick Carter and Fenway Sports Group—is a multi-year offer that will be the most expensive for a rookie in this year's class."
     
  • "Manziel chose Nike over other companies such as Adidas, Under Armour and New Balance's Warrior brand."

Takeaway from Hedgeye’s Brian McGough:

Nike is likely looking at something in the vicinity of $20 million/year for Manziel. But one thing is for sure,

 

Nike is going to have to babysit this one.

 

True, they may have 'handlers' for all their high-value athletes, but the sports world knows all too well that things don't always go according to plan. See previous tabloid-rich events like:

 

1. Kobe Bryant and his sexual assault case (after which his Nike contract was re-written).


2. Tiger Woods and his -- whatever you call it -- case.


3. Lance Armstrong and his pathetic admission of basically lying his whole career.

 

Athletes -- even those considered squeaky clean -- are high risk assets. Something tells us that Johnny Manziel belongs on the upper half of the risk management watch list.

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