Below are Hedgeye analysts' latest updates on our TEN current high-conviction investing ideas and CEO Keith McCullough's updated levels for each.
We also feature three research notes from earlier this week which 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.
- "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
HEDGEYE CARTOON OF THE WEEK
CCL – All cruise lines operators, including Carnival, took a hit this past week in a down market. However, CCL’s performance (-2%) fared better than that of its peers, RCL (-5%) and NCLH (-8%). There were several bad publicity reports out this week for CCL: 1) couple of operational problems on Carnival Pride and P&O Oceana (CCL brand); 2) AIDAprima delivery to be delayed by 6 months; 3) Norovirus on Crown Princess (CCL brand); 4) Harris poll showed a decline in cruiser sentiment following norovirus cases in early February.
While these cast a negative light on CCL, ultimately, investors care about what’s going on with Caribbean pricing. Based on our latest proprietary pricing survey, the large capacity increase in the Caribbean is wreaking havoc with pricing for RCL and NCLH. We will get more color on how CCL pricing is tracking for Summer 2014 in the week of April 21. Stay tuned.
DRI – There is no news to report this week pertaining to Darden. We remain bullish on the stock and are closely monitoring the ongoing saga between management and activist shareholders.
HCA – Healthcare Sector Head Tom Tobin reiterates his bullish thesis on HCA Holdings. He has no update this week.
HOLX – Healthcare Sector Head Tom Tobin reiterates his bullish thesis on Hologic. He has no update this week.
LO – Lorillard traded roughly flat on the week, about in line with the move in Consumer Staples (XLP). This week LO also moved ahead of WFM for the #220 spot in the S&P500 ranking by market capitalization.
We continue to believe LO will grind higher on advantaged menthol fundamentals, limited regulatory risk, and a growth engine in blu e-cigarettes. The company will announce Q1 2014 results on April 24th.
OC – Owens Corning Q1 2014 earnings call is set for Wednesday April 23, 2013 at 11 a.m. EST. Beating or missing estimates for Q1 will not change our bullish stance on Owens Corning. In the chart below is U.S. Public Non-Residential Construction Spending YoY %.
In terms of a construction cycle, public construction spending lags residential by up to two years. Non-residential falls somewhere in between the two. People just tend to remodel and fix up their homes before that office or the dreaded DMV receive attention. Despite public construction flailing along the bottom the past four years it is beginning to show signs of stabilizing as state and local budgets approve.
RH – The setup: you have a five minute meeting with the Gary Friedman, CEO of RH. Here are two of the four key critical uncertainties that we think are relevant to the investment thesis today.
- Logistics Network -- Today vs. Tomorrow. One of the biggest Bear arguments against RH is its inability to ship product on time and in the right quantity (i.e. a 6-piece living room order could be delivered in three shipments over 12-weeks). That not only delays when the company can collect revenue, but could also impact customer attitude toward the brand and its ability to meet delivery expectations. We have no doubt that RH could work through these issues today, especially with its newly upgraded fleet of DCs. But the reality is that RH has been shrinking its square footage base for the past six years. Starting next month, it goes on an explosive run of growth in square footage – from 800k square feet to nearly 3x that amount over a five-year period. So the question here is this…If you are having challenges now as a $1.5bn business over 70 stores and 800k sq feet, how can we be confident that the company can deliver product under a competitive time frame when it is three times the size? Does that mean that instead of having 5 DCs and 7 hubs, it needs to open another 5 mega-regional DCs in the top MSAs? Or another 25 facilities throughout the country? What’s the right answer
[Note: Though we cannot yet articulate the answer to this question, in our model we assign a capital cost to both the SG&A and capex lines to account for future capital needed to improve shipping capabilities. We give RH about an extra $80mm per year in capex, while we add an incremental $800mm over 5 years in SG&A – both of which are well north of what is expected for RH to continue on its growth ramp.]
- What’s the Optimal Store Size? The size range in RH’s fleet is daunting. It has Legacy stores at 8,000 feet, Design Galleries at 25,000, and the Next Gen Design Galleries as large as 60-70,000 sq. feet (Atlanta, Vegas). So far, the company has learned that ‘bigger is better’ meaning that the store productivity on a large box eclipsed the Legacy productivity. The math is such that there are 8,000 foot stores operating at $700/sq ft, or $5.6mm annually. But then there are stores like Houston at 22,000 feet that are doing about $2,500 per foot. Yes, that’s about $55mm per store. And that’s not a pipe dream…that’s proven.
The questions then, are a) Is it realistic for some of these Next Gen Design Galleries to be running at over $100mm per box? b) At what size do you think you hit a point of diminishing returns with box size? c) You have 65 Legacy stores in the fleet that you indicated you’ll chop away one by one over time. But the reality is that many of these are solid real estate locations, and your rent terms are better there today than if you were to find new space on your own. Why not keep most of these stores open, and use them to focus on a single category – RH Kitchen, RH Baby & Child, RH Furnishings, RH Whatever…
TROW & LM – Both asset managers T Rowe Price and Legg Mason are set to report earnings over the next several weeks with TROW releasing numbers on Thursday April 24th and LM printing results on Tuesday April 29th. In an institutional report this week we examined the pricing of both earnings releases as relayed by the options market (essentially the expected stock moves on earnings day can be extracted from pricing in each company’s options series). Both companies options series are relaying fairly low expectations for the earnings print which can set up a good near term rally in the stocks with even a slightly better than expected print.
TROW has been screening well all quarter in several private surveys as having had good mutual fund inflow which should produce a good earnings result. LM conversely with very high short interest and very low stock ratings from the Street won’t need to do much to impress investors.
We think the LM story gets exciting in the latter part of this year and into 2015 with its repaired fixed income performance and by that time will be a de-risking theme from equities by institutions. The steadiest business line in JP Morgan’s earning report on Friday was Asset Management which was one of the few segments that had a revenue increase year-over-year. We expect the asset managers in this current volatile market to be more stable stocks than the other more transaction oriented financials.
ZQK – Quiksilver remains one of our top long ideas. While shares have been under pressure lately, we still see over $1 in earnings power and a stock price approaching $20. The key metric in this equation is the top line. Revenues have been on the decline for five straight quarters and we expect a meaningful inflection starting in 3Q as the company starts to bear the fruits of its cost cutting initiatives, SKU rationalization, and streamlined design process.
But, this is more than just a cost cutting story. We see revenues growing to $2.5 billion by 2018 from $1.8 billion in 2013. The big drivers we’ve identified and laid out are footwear, emerging markets, and China. This also means that sales trends in existing markets will stabilize and reaccelerate. Our survey work shows that Roxy, Quiksilver, and DC footwear are extremely relevant to the core consumer even after nearly five years of extremely limited marketing spend. We expect the reallocation of marketing dollars to help reignite the brands as new, more focused product, rolls out for the fall.
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