The Economic Data calendar for the week of the 10th of March through the 14th 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.
Takeaway: Current Investing Ideas: BNO, CCL, DRI, FXB, HCA, LO, LVS, RH, TROW and ZQK
Please see below Hedgeye analysts' latest updates on our ten current high-conviction investing ideas and CEO Keith McCullough's updated levels for each.
At the conclusion of this week's edition of Investing Ideas, we feature three recent research notes we believe offer valuable insight into the market and economy.
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.
BNO – Hedgeye's Director of Research Daryl Jones wrote earlier this week in Investing Ideas that our bullish case on Brent Oil is based on three key factors:
Click here to read our full report released on Monday.
CCL – Despite wobbling back and forth a bit this past week, Carnival is up 10% and has more than doubled the return on the S&P 500 since it was added to Investing Ideas back in November. While concerns about low Caribbean pricing continue to persist, we remain confident that Carnival should keep or raise yield guidance when they report earnings in a couple weeks.
Our proprietary survey shows a significant uptick in Eastern and Western Caribbean pricing for the Carnival brand in March relative to February and December.
Carnival continues to be our top pick in the leisure space.
DRI – Darden preannounced 3Q14 results on Monday and, as we expected, they fell far short of consensus estimates. Management guided 3Q EPS to $0.82 versus prior estimates of $0.93. Darden expects same-restaurant sales in the quarter to decline 5.4% at Olive Garden, decline 8.8% at Red Lobster, increase 0.3% at LongHorn and decline 0.7% at SRG.
Despite this, they maintained their prior fiscal year 2014 guidance.
The company also held a business call update Monday morning to discuss their strategic initiatives to unlock shareholder value. We certainly weren’t impressed and published a couple of institutional notes during the week explaining why.
To top it off, Darden came out with yet another curveball on Wednesday when it announced the cancellation of its annual investor meeting, noting that the company will meet with analysts individually. Darden has been under scrutiny recently for cutting off critical analysts, such as our very own Howard Penney. Needless to say, the pressure continues to build and the activist case is growing stronger by the day.
FXB – The Bank of England (BOE) maintained the base interest rate at 0.50% this week along with its asset purchase program target (QE) at £375B.
We remain 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 BOE’s Mark Carney (oriented towards hiking rather than cutting as conditions improve).
UK high frequency data continues to offer evidence of emergent strength in the economy, and in many cases the data is outperforming that of its western European peers. In the BOE’s Quarterly Inflation Report (in February) 2014 GDP was revised higher to 3.4% from 2.8% previously forecast.
PMI Manufacturing came in at 56.9 versus expectations of 56.8 and PMI Services recorded 58.2 versus expectations of 58.0. Inflation continues to moderated in recent months, with CPI currently at 1.9% in January Y/Y – we expect this cut in the consumption tax to continue to boost business and consumer confidence and with it consumption
From a technical perspective, the British Pound is holding its Bullish Formation, trading above its intermediate term TREND and long term TAIL levels of support. It is up over +2% versus the US Dollar over the last month.
HCA – As hospitals continue to move toward providing outpatient services and the percentage of their revenue mix from outpatient continues to rise, patient traffic has become increasingly important to track and forecast. We received our monthly survey results earlier this week and things look good for February and March after a big drop in January. The weather has been a big topic lately, but so has growing concern that the US Economy is slowing, led by our own Hedgeye Macro team.
What gets really interesting from here is how a weakening economy has historically boosted medical consumption. While that claim doesn’t make intuitive sense at first, we’ve compiled ample evidence to prove this is indeed true. So are we seeing a rebound in patient volume because the weather got better or because the economy is getting worse? Does it matter?
We still like HCA and have been reworking our assumptions for the benefits from the Affordable Care Act. So far our conservative estimates, which are higher than HCA’s 1-2% benefit to EBITDA in 2014, look to be moving higher.
LO – Hedgeye analyst Matt Hedrick sent out a report to subscribers outlining our bullish case on Lorillard on Friday. Click here to read it.
LVS – Las Vegas Sands is up 11.7% since being added to Investing Ideas at the end of January, compared to a 4.7% return for the S&P 500. Shareholders had a great week as the stock reacted favorably to positive earnings revision over the past two weeks as a result of stronger than expected gross gaming revenues during February. As mentioned before, LVS took the market share title for the first time ever in February.
What’s even more impressive is the company’s massive stock repurchase activity since January 1, as disclosed in the 10K. Investors now look forward to March where growth will slow significantly. Nevertheless, Q1 will likely be a record.
RH – As part of our process, we created a proprietary method to track internet traffic trends for a basket of over 200 retailers. Our ranking combines a number of inputs, but the two main drivers of our ranking are unique visitors and page visits per user. In the chart below, you can see the indexed ranking for Restoration Hardware compared to Williams-Sonoma’s (WSM) three main brands.
There are three key call outs from this chart:
TROW – Hedgeye’s Financials team traveled with T Rowe Price management to see subscribers last week which gave us the ability to do some checks on our bullish thesis on the company. The firm is validating that the strong inflows as reported weekly in the Investment Company Institute (ICI) survey is filtering into the firm. T Rowe characterized the environment as “stronger than usual seasonally” which means its largely retail, equity centric enterprise has been seeing good inflow to start 2014 (the first quarter each year is usually the most active quarter for retail engagement and TROW is saying that this year is busier than usual).
This continues to dovetail with the ICI fund flow survey which had another positive week of results with $4.9 billion flowing into all stock mutual funds this week, with $3.1 billion of the $4.9 billion moving into U.S. equity mutual funds (TROW has a domestic bend to its business with 70% of its product offering in U.S. funds versus 30% non U.S.).
While retail equity inflows tend to be late cycle dynamic, we still think TROW shares will work their way higher, especially given that they are just burning off some un-related institutional outflows from the middle of 2013. So, the stock’s multiple should improve with better earnings as well.
We consider T Rowe Price one of the best run asset management companies in the sector along with BlackRock.
ZQK – We penned a note to our institutional subscribers on Wednesday stating that we expected this to be a transition quarter for Quiksilver, and that we were cool with it. That’s essentially what we got. When we saw the headline, we viewed it as a slight net negative (due in large part to expectations being all over the place). Let’s face it, on an absolute basis – losing $0.10 on $393mm 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. Then we listened to the conference call, and viewed it as decisively positive. The market might not agree for a day or two. But that does not concern us.
We think this story is on track to redefine the business model and do what ZQK has not done in over 5-years – grow consistently. No material changes to our model.
Why do the numbers look good to us?
We look at everything on the margin. The reality is that ZQK is coming off a disastrous 4Q with sales down 15%, inventories only down 3%, and margins off by 200bp. That’s pretty much a trifecta of misery. This quarter, sales were down 5% -- though FX hurt by 2%, and exited product lines cost another 1%. At the same time, inventories were down 14%, and margins were UP by 115bp. That’s not exactly a complete reversal of 4Q, but it is a massive improvement on the margin.
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At CAT’s Analyst Meeting, the absence of negatives did not sum to a positive. Given the challenges over the past two years, a failure to acknowledge serious problems seemed a bit delusional. Investors were looking for solutions, but there were no meaningful details given on restructuring.
ISM Services printed its worst headline number since February of 2010 as the Employment series went sub-50, posting its largest MoM decline since November of 2008 and its first contractionary print in 25 months.
In the most recent week, equity mutual funds had another solid inflow albeit just inline with the year-to-date averages with bonds funds showing improving subscriptions, well above the year-to-date mean.
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.
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.
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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.
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.
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.
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.
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.
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.
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.
Christian B. Drake
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