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STALL SPEED: INCOME, SPENDING & CONFIDENCE

Summary: 

  • Both incomes and spending decelerated in February while Core PCE inflation was static at a dovish, stall speed of just 1.1%. 
  • The income/spending deceleration was broad based with some negative weather drag, but the trend is one of deceleration and the primary pockets of spending strength in February are likely to be ephemeral.
  • High End Demand: It turns out that the rich are still pretty rich and high ticket discretionary spending saw a moderate bounce in February.  Wealth effect spending, however, probably continues to ebb.
  • Healthcare Spending:  At ~19% of Total household expenditures, spending on Medical Care matters, and Obamacare is distorting the numbers.  
  • Confidence: March marked a second month of mixed consumer confidence reports. Sentiment continues to meander alongside the dollars descent.  
  • FINALLY!:  Outside of some lagging housing data, all the material domestic, fundamental macro data for February has been reported….enjoy the oversold bounce and blithely enter the weekend knowing the vexatious ubiquity of weather caveat-ed macro releases has finally ended. 

 

STALL SPEED: INCOME, SPENDING & CONFIDENCE - Income   Spending Table Feb

 

STALL SPEED: INCOME, SPENDING & CONFIDENCE - Eco Summary Table 032814

 

 

PERSONAL INCOME:   3 Months of Deceleration

 

Weather probably served as a negative distortion on reported, aggregate personal income in February, but with total Personal Income, Disposable Personal Income (DPI), DPI per capita and Private Sector Salary & Wage growth all decelerating for the 3rd consecutive month in February it feels hard to argue that weather is masking a strong underlying trend of acceleration. 

 

STALL SPEED: INCOME, SPENDING & CONFIDENCE - Personal Income Feb

 

Private Sector Salaries and Wages decelerated by -60bps and -50bps on a YoY and 2Y basis, respectively, while aggregate government sourced wage income accelerated 30bps on a 1Y while holding flat sequentially on a 2Y basis. 

 

Alongside the spending friendly budget deal and ongoing positive state & local government employment growth, we continue to expect government salary and wage income to provide some modest upside to income growth in 2014. 

 

The savings rate ticked up to 4.3% from 4.2% but remains near historical trough levels.

 

The capacity for a further decline in savings to support incremental consumption growth remains very much constrained at current levels.   

 

STALL SPEED: INCOME, SPENDING & CONFIDENCE - Salary   Wages

 

STALL SPEED: INCOME, SPENDING & CONFIDENCE - Savings Rate 

 

CONSUMER SPENDING:  Healthcare & High End Discretionary supported February consumption expenditures.  The former is either transient or likely to be revised significantly and the latter isn’t likely to repeat last year’s performance.   

 

HIGH END DEMAND:  Last month we highlighted the deceleration in demand at the high end as implied by the slowdown in spending on luxury durables. 

 

As it turns out, however, the rich are still pretty rich and high ticket discretionary spending saw a moderate bounce in February (see yesterday’s note for more on the latest income division dynamics - INFLECTIONS OR FALSE POSITIVES?). 

 

The read through here is mixed as the contribution to total durables growth from higher-end discretionary helped mask more broader weakness. 

 

Further, with stocks flat YTD, housing decelerating and the Fed beginning to reign in their explicit, asset re-flation (i.e. wealth effect) policy agenda, the probability for the top income quartiles to provide incremental demand growth (in similar magnitude to last year) seems to be diminishing.

 

STALL SPEED: INCOME, SPENDING & CONFIDENCE - PCE Luxury

 

STALL SPEED: INCOME, SPENDING & CONFIDENCE - Luxury Goods   Contribution

 

HEALTHCARE SPENDING:  DISTORTED, TRANSIENT OR BOTH?

Spending on Healthcare Services has been the notable positive outlier over the last few month and the effect stems largely from the implementation of Obamacare.

 

The reported figures are very much an estimate and the preliminary data are likely to be revised significantly over time as the Census bureau’s quarterly QSS and annual SAS survey’s provide harder data.   

 

With reported Hospital and Outpatient spending both accelerating materially, it could also be that individuals are accelerating medical consumption ahead of ACA implementation and uncertainty around coverage changes. 

 

Either way, in the context of the broader spending data, the takeaway is pretty straightforward – Healthcare Services represent ~19% of total household consumption expenditures and certainly impacts the direction of reported, headline consumption growth.    

 

To the extent that deceleration is the larger trend across the balance of services, a mis-estimation of ACA related spending and/or a significant, transient pull-forward in medical consumption could be materially distorting the prevailing, underlying trend. 

 

Unfortunately, like the now ubiquitous weather asterisk, we’ll just have to hurry up and wait to get a clearer read on the magnitude of the impact. 

 

STALL SPEED: INCOME, SPENDING & CONFIDENCE - Healthcare PCE

 

 

 

CONSUMER CONFIDENCE:  Across the primary survey's, March proved to be a second straight month of meandering for consumer confidence. 

 

The final University of Michigan Consumer Sentiment reading for March declined -1.6pts sequentially to 80.0 – the worst reading in 4 months. 

 

The conference board and Bloomberg Surveys, meanwhile, showed consumer confidence improving by 4pts and 1.6pts, respectively, in March.    

 

Notably, the relationship between the $USD and confidence remains reasonably strong.   The dollar is currently in Bearish Formation (Broken Trade, Trend & Tail) and with growth slowing and commodity inflation accelerating the balance of risk for the currency remains to the downside, in our view.  

 

STALL SPEED: INCOME, SPENDING & CONFIDENCE - USD vs Confidence

 

STALL SPEED: INCOME, SPENDING & CONFIDENCE - Confidence Table 032814

 

 

Christian B. Drake

@HedgeyeUSA

 


Why This Retail Analyst Thinks Restoration Hardware's Run Is Just Beginning | $RH

Hedgeye Retail Sector Head Brian McGough remains Wall Street's biggest bull on Restoration Hardware (RH).

 

Shares surged over 12% today after the company reported better-than-expected results and guidance. 

 

Take a look at the brief video below to see why he believes RH has significant room to run.

 

 

 

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VIDEO | Keith's Macro Notebook 3/28: EUROPE COMMODITIES UST 10YR


Flashback: This Gaming Analyst Warned on These 3 Stocks. It Paid to Listen to Him

Hedgeye Managing Director Todd Jordan has demonstrated again why he’s one of the best gaming analysts on the street.

 

On October 11th, he spelled out why he was advising investors to steer clear of International Game Technology (IGT), as well as Bally Technologies (BYI) and Scientific Games (SGMS).

 

Shares of IGT are down over 8% this week alone, down over 26% since he made his call.

 

Watch the 3-minute video below on why Jordan went bearish.

 

 

Shares of SGMS haven’t fared much better. They have fallen almost 19% since Jordan warned investors. BYI its down over 7%.

 

For perspective, the S&P 500 is up over 9% since Jordan made his call.

 

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LOGIC Call Replay and Key Take-Aways

Yesterday we hosted a conference call on electronic cigarettes with Miguel Martin, President of LOGIC, a private e-cig manufacturer since 2010 with the #2 national brand in unit and dollar share for C-Stores in the United States, according to Nielsen.

 

Miguel joined LOGIC in July of last year and formerly worked for Altria for nearly 20 years.  The call is part of a series of talks we’ve held with industry experts (previous speakers included NJOY, Ballantyne Brands and Victory). On the call Miguel offered industry commentary that we found very valuable as we continue to assess the rapidly expanding e-cigarette category.

 

Click for the Replay Podcast

Click for LOGIC’s Presentation

 

Below we provide key callouts from Miguel’s prepared remarks and highlights from a very robust and insightful Q&A session. 

 

 

Key Callouts from Miguel’s Prepared Remarks

  • Regulatory Environment: regarding pending deeming regulation from the FDA on e-cigs, Miguel believes that other regulatory entities (including legislative) will have as much influence on the marketing and sale of e-cigs as the FDA.
  • He sees an active conversation at the local level (including from the cities of Chicago, LA, and NYC banning indoor usage; states discussing e-cigs and currently one state, Minnesota, taxing e-cigs like traditional cigarettes; and 40 Attorneys Generals and members of congress expressing interest in regulating e-cigs), yet he doesn’t view regulatory concerns as an impediment to the business.
  • Thoughtful and science based.
  • He’s in support of e-cigs being sold primarily at brick and mortar retail (not online), which has the ability to ensure age verification, unlike online.
  • Miguel believes that the FDA will over time work out issues on flavored e-cigs and advertising, and that flavors are poised to remain a low percentage of total sales (~ 10% to 12% of sales).
  • The FDA has submitted deeming regulations to OMB for review.  While it’s unclear to him when deeming regulations may be released, he expects there to be a 12 to 15 month window to discuss and challenge issues presented.   
  • Big Tobacco will dominate the e-cig category (with the balance sheets to support sales, marketing, and distribution), yet energy drinks offer a good example in the CPG world in which independent companies have been viable and even done well at the expense of the majors (ex. 5-Hour, Monster, and Red Bull).
  • Trade incentives for retailers selling e-cigs over traditional cigarettes is very compelling. Today, on average, if a retailer sells a pack of premium cigarettes they receive 13-15% of gross margin, for e-cigs, the figure can be as much as 3x that amount.
  • On retailer appeal, Miguel also adds that many retailers LOGIC works with are aggressively working to provide stand-alone sections of e-cigs (which in many cases feature the top 3-4 brands). This allows the retailer the ability to hedge the declining traditional cigarette market and bring in consumers at a higher margin.
  • Today there are over 320 e-cig manufacturers in the U.S. – he sees only a handful of manufacturers remaining successful no matter what happens with the majors and regulation.
  • He believes the strength of the battery (and most e-cigs today use a lithium-ion battery—similar to a cell phone battery—and sourced from China) is a key consideration in the e-cig’s performance and therefore the consumer’s experience, among other such factors as the e-liquid quality. He believes that larger batteries offer more power to deliver a consistent experience, and current battery technology for a smaller sized e-cig [smaller than LOGIC’s offering] show signs of under-delivering on consistent performance.  Therefore, he suggests that beyond larger e-cig units, tank and open models (typically with larger bodies than a typical and e-cig and larger batteries) are delivering superior quality to the user.
  • Believes rechargeable model (razor, razorblade) is the future of the industry (accounts for 50% of LOGIC’s business today and is expected to reach 70-80%). Consumer preference for rechargeable represents maturity of the industry, but also demonstrates a more significant value play (higher margin vs disposables).
  • On Price Point and Price Sensitivity, he notes that the two largest brands in the U.S. (blu and LOGIC) are premium products in the category, both at ~ $10/unit. He notes that neither product mimics the look of a traditional cigarette, which he thinks is an advantage (opposite of NJOY’s position) because the user can demonstrate to oneself and others (bartender, police officer, etc.) that he/she is not smoking.  He’s also seeing this trend in the tank/open style – it’s also not mistaken for a cigarette.
  • On brands, he sees a huge drop off in distribution after the top 3 brands (blu, LOGIC, NJOY).  His color from the retailers suggests they’re looking to sell 3-4 brands of e-cigs. He suggests that as MarkTen and Vuse enter the market, there will be both increased competition for shelf space, but also more shelf space dedicated to e-cigs (closer to 6 brands) given e-cigs have higher margin for retailers over cigarettes (LOGIC offers gross margin of 40%).
  • He dispels the belief that e-cigs are only highly attractive in high State Excise Tax (SET) markets, like metropolitan areas, as a value play. Miguel suggests that states such as those in the Southeast with lower SET are also highly attractive markets to e-cig manufacturers given the disproportionately high amount of smokers that can move into the category. 
  • Miguel sees a lot of people trading up on price for superior products.
  • One comment that surprised us from Miguel is a comment that the product quality/experience of a disposable is similar to that of rechargeable for LOGIC, and to his knowledge across the industry. This view differs from commentary we’ve received that both battery power and freshness of the e-liquid (given the lesser seal compared to cartomizer) is inferior to a rechargeable. Going forward we’ll look to put this question before other speakers.

 

 

Q&A Highlights (slightly paraphrased for clarity and brevity)


How big is the flavored e-cig market (versus traditional and menthol) in the U.S.?  Miguel estimates that flavored products are 10-12% of sales and 6-8% of profitability. The #2 and #3 players (LOGIC and NJOY) both do not have flavored products, however #1 blu does (but only in rechargeables). In test markets, neither Reynolds (Vuse) nor Altria (MarkTen) has offered a flavored product, only a tobacco and menthol offering. He sees flavors in lower cost items/players, typically online sales, and says in many cases the flavor offerings are inflammatory: bubble gum, coffee, etc., which are red flags to the FDA. He believes that flavors will not have a long shelf life (FDA will look to ban). 

 

Are the actions taken by the cities of NYC, Chicago, and LA to treat e-cig as traditional cigs as it relates to banning use indoors unique to the fact that these are big cities, or indicative of a larger trend that could spread across the country?  Miguel believes it is typically easier to enact legislation at the city level, and it could be a strategy to then move to the states and then Federal government. There are states with e-cig bans (NJ, ND, UT, AR) but he points out that the FDA is taking a long thoughtful look at e-cigs, but there is still no specific research to make a determination (or support a credible claim) for or against an e-cig indoor ban. 

 

How do you see the sales mix across disposables versus rechargeables evolving for the industry over the next 1-5 years?   Miguel says that rechargeables account for about one-third of the overall industry and would expect in the next 18-24 months that the rechargeable business will continue to grow. He believes that the consumer will decide that they’re an e-cig user (exclusive or not) and the compelling economics of rechargeables will propel the category over disposables.  The retailers also benefit, customizer sales a higher profit for the same SKU space/footprint as a disposable.

 

With both Altria (Mark ten) and Reynolds (Vuse) rolling out e-cigs, does the increased competition help or hurt LOGIC?  What do you think of Vuse?  Difficult to understand what those brands will do on a national level (both RAI and MO are both in 2 state markets each in their e-cig roll-out). Seeing excessive amount of couponing and discounting, and investment in the retail stores in order to generate that trial. They obviously leverage their experience with their database of adult smokers, so it’s hard to say if they can do that nationally – put the same emphasis and resources towards e-cigs as they did in the test markets while managing their cigarette, cigar, etc. businesses. Also a question mark on the margin they can give to the retailers.

 

Can you comment on the rise in tank/open style vaping devises versus traditional e-cigs and how is the FDA likely to view tanks?  There is evidence that tanks are growing, however the majority of national retailers do not carry them. While that might change, the reality is that adult smokers cannot find open tanks. It’s a much more complicated conversation that a clerk has to have with a consumer about what it is. Sadly there have been incidences of children ingesting e-liquid, so clearly there is a huge set of safety measures that must be put in place to better secure these products.  As for the FDA, Miguel doesn’t see vaporizers (tanks, etc.) being banned outright, but will fall under similar requirements to traditional e-cigs.  In his mind it’s clearly easier to regulate a close system and expects the FDA to struggle with how to assess the great options of constituents that can go into an open tank.

 

Who’s winning on the back shelf at a retailer?  Is it based on the shelf space or product quality?  Both, today we’re seeing retailers (especially large national ones) looking for 1) a manufacturer that will be viable in the future, 2) those that provide the greatest GP dollars (a combination of the gross margin and price of the product) and 3) those who will be most flexible and easy to work with. Good product and strong shelf space (visable and good SKU distribution) go hand in hand. 

 

On blu, 2013 sales kind of soft and down in Q4 2013. Do you owe this to increased competition or overall sluggishness in the category?  Thinks blu has done a good job and has a great product. Thinks that when you have such a spike in distribution, you will come off of that and they were in competition with a major manufacturer offering a buy one/get one free.  Most recent Nielsen numbers suggest that share has come back for blu and LOGIC.  Miguel still believes there’s still a lot of trialing in the industry, but people are continuing to coalesce around products they deem high quality. 

 

What do you make of Imperial Tobacco suing 11 American e-cigarette makers (including yourselves) in federal court for a range of patent infringements?   No comment on current litigation. The story is not a new one. Imperial bought patents from previous owner (Ruyan) and have continued with lawsuits.  It is interesting who they sued and didn’t sue, and we’ll just have to see how it plays out [Hedgeye Note: companies include LO, NJOY, VPCO, VMR, Ballantyne Brands, CB Distributors, Spark Industries, LOGIC, FIN, Victory, and DR Distributors].

 

We’ve seen LO purchase blu and SKYCIG and Altria purchase Green Smoke. Do you think Big Tobacco will continue to buy to grow, or fund expansion internally?  Big Tobacco has the great benefit of a lot of cash to bolt on existing brands and innovate within. What makes things a bit more difficult, beyond LOGIC and NJOY, there really aren’t any private players with national brand recognized and distribution, so it becomes a bit of a finite exercise on who Big Tobacco could look at. However there’s no historical evidence that you can buy your way to be successful. If that was the case Coca-Cola and Pepsi would just own the energy drink business. Also he believes that if there’s any time to buy an e-cig company that’s doing well, it’s now, given the rapid rise in the business [and valuation] around these potential targets. 

 

Does LOGIC have any plans to expand internationally?  Yes, active with partnerships around the world. While LOGIC has almost a quarter of the e-cig business as defined by Nielsen, the company has tons of white space west of the Mississippi.  Company has 45% of the Northeast market (as determined by Nielsen), and is bullish on all the white space in the U.S., which it sees as its main opportunity.

 

Do you worry about supply chain disruptions and quality control? Do you see facilities moving to the U.S. over time, or staying predominantly in China?  Miguel doesn’t worry. Sees dedicated partnership in China. Believes misnomer that products made in China are of lesser quality than those that could be made in the U.S. The question of U.S. manufacturing is being led by Reynolds. If that is deemed as an advantage (from regulatory or efficiency standpoint), then LOGIC will also consider it.

 

Call or email with questions,

 

Matt Hedrick


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