LO: Ho-Hum Quarter But We Remain Bullish on the Strategy

Lorillard reported Q1 2014 results yesterday that were lukewarm, missing Street estimates on the top and bottom lines, however the stock closed up on the day. Our long-term bullish outlook remains unchanged and built on 1.) the strength and profitability of its advantaged menthol portfolio, 2.) our belief in the limited menthol regulatory risk over the longer term, and 3.) upside growth in its blu e-cigarette business that commands leading share in the U.S.


CEO Murray Kessler commanded a confident tone in reviewing the quarter, yet clearly knew the company didn’t hit the cover off the ball, citing numerous headwinds that impacted results: for cigarettes lower wholesale inventory levels, severe weather affecting core markets, a tax increase in Puerto Rico and holiday timing (Easter), as well as in e-cigs lower prices of its rechargables kits and pipeline inventory build versus the year ago-quarter. 


All that said, LO had impressive price/mix of +5.8% to offset total cigarette volume decline of -2.9% (outperforming the total industry at -4.0%). Total LO retail market share in the quarter rose 30bps to 15.2%, its highest level ever and its first quarter above 15%, and Newport’s share grew 40bps to 13% while LO’s share of the menthol market was flat Y/Y at 40.7%, but improved 80bps sequentially.


Although Newport Gold continues to struggle (share was not qualified on the call), and blu contributed a $0.02 loss in the quarter, we remain committed to LO’s long-term opportunity to lead the e-cig market in the U.S. and U.K. (more below), as we remain committed to LO’s industry-leading fundamentals, built on its core menthol business. As we outlined in our Best Ideas long call on LO in March, we see the stock trading to $80 over the longer term. 



On blu E-Cigs

Net sales for blu declined -10.5% y/y to $51MM, versus flattening growth across the entire category (slowing to +10% in the quarter). The loss was a contribution of lower prices of its rechargeable kits and a pipeline inventory build versus the previous year quarter.


The results show two straight quarters of slowing, and reflect an increased competitive and promotional environment as e-cig manufacturers spare for share and brand loyalty – both RAI and MO plan to launch nationally with Vuse and MarkTen, respectively, in June, and we like blu’s first to market leadership advantage.


In the quarter, blu commanded a leading 45% share of the market in the U.S., or 10 points higher versus the year-ago period, according to Nielsen channel data which the company switched to in the quarter to measure sales.


The big news was LO’s decision to step up marketing and distribution in the U.K to launch blu this quarter. It announced a $10-20MM spend over next 6 to 9 months to rebrand SKYCIG as blu and continue to support incremental brand building for blu in the U.SWe like LO’s strategy to invest early to become category leaders. They’ll match up against BAT, who is also in the process of rolling out a national launch. The U.K. is the second biggest e-cig market behind the U.S. and currently highly fragmented, with no brand greater than a 5-6% share, according to Kessler. Unlike in the U.S. with the acquisition of blu, the company has to pay for a sales force to support its rebranding and sales efforts. Kessler underlined that to create the U.K. branding of blu, they expect the business to be break-even in the near term.  


In the U.K. as in the U.S., the longer term strategy of the e-cig business is clearly not selling blu at break-even or a loss, however in the near term the company is willing to take the charge and investment now to win long term brand loyalty in a category with huge growth potential -- we support this strategy.



Other announcements and e-cig category color:

On vaporizers (tank/open/etc.) taking share from “tradition” format e-cigs like blu, Kessler said he believes vaporizers -- sold primarily at vape shops -- are taking some share from blu and other “traditional” style e-cig players (the format Big Tobacco is using today), because the products deliver a better experience at a lower price point. Although he was quick to note that this e-vapor format comes with regulatory challenges – in fact reading the tea leaves we think Kessler was betting the FDA was going to put more prohibitive measures on this format and e-vapor juice.  (For more see yesterday’s note FDA Finally Proposes E-Cigarette Regulations - They’re Surprisingly Mild!). Because the FDA largely didn’t touch non-traditional vaporizers and e-vapor juice, Kessler was quick to counter that LO is considering the landscape, and was suggestive that though the current traditional e-cig is the company’s format of choice, his team is currently working on devises that deliver superior vapor and battery life to close what may be a widening sales gap with non-traditional e-cig formats. He expects these improvements to be rolled out over the next 6 months, and to hit the market piece by piece, rather than a giant roll out (similar to how new razor blades come out for the same razor). Note: we’ll be doing survey work in the coming weeks to better understand the trends of non-traditional e-cig usage.


On proposed deeming regulations from the FDA, Kessler said he was pleased that the FDA is taking a science based approach with its proposed regulation. On the banning of sampling, he said the company will have a chance to comment on that and hopes it’s overturned. 


On any read-through on the FDA’s stance on menthol, Kessler said it was a positive read-through – the FDA is taking a science based approach on flavors – can’t say they’re an “issue”/more addictive than traditional tobacco flavor without the science. 


On any merchandizing shift for blu with MarkTen and Vuse being rolled out nationally, Kessler said that it looks like his major competitors are choosing to place e-cigs alongside their cigarettes, whereas blu wants to remain in stand-alone cases, and he’s perfectly fine if his competitors’ e-cigs are not near blu.  


Call or email with questions,




Howard Penney

Managing Director


Matt Hedrick



Fred Masotta


TGT - Adding to Best Ideas List As A Short

Takeaway: We’re Adding TGT to our Best Ideas list as a short. We’ll be hosting a call Wed. 4/30 at 11am ET to review our thesis. Call details below.

The crux of our argument? Wall Street's perception of Target's financial trajectory is more upbeat than Main Street. When the stock glossed over the company's weak 4Q earnings report, it was because Steinhafel (CEO) issued guidance that he hoped the company would grow into if the Company repaired its reputation after the data breach - not guidance that he knew TGT could meet or beat. We don't think that the Street is giving TGT credit for a) a miss this year, and b) another one in 2015.  The reality is that when a customer has a great experience in retail, they tell a friend. When a customer has a bad experience, they tell 20. Just ask JC Penney or Lululemon. Some of these 'fire your customer' events are worse than others, but there's one commonality - they take a very long time to recover.  

We think that TGT will be lucky to earn $3.75 this year, and $4.00 in 2015. The current 15x multiple is about as high as TGT has seen in 5-years - clearly the market is not factoring in a miss. We think that multiple compression alone on a weaker EPS number gets to a $48-50 stock, or $12-13 downside. If we're wrong, then we're looking at about $5 upside. That's about 2.5x to one, which we like on sleepy mega-cap shorts in Retail. 


TGT - Adding to Best Ideas List As A Short - TGT Bestidea



  1. The biggest risks to current consensus expectations. 
  2. Target's visitation statistics (via one of our proprietary consumer surveys). 
  3. How key competitors are reacting to the opportunity to gain share from Target.  
  4. Target's value proposition compared to the rest of Retail, particularly Wal-Mart. 
  5. Has suffered the same customer attrition fate as Target stores?
  6. Which categories is Target winning? Where is it losing?
  7. Historical margin cycles for Target and other major retailers, and where we are in that cycle today.  


  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 917515#
  • Materials: CLICK HERE

For more information contact .

Dollar Ugly

Client Talking Points


Post the bond auction failing this week, risk is getting real in Russia – faster. The CDS is ticking up to +282 (greater than 300 is what we call the “Lehman Line”) as the Russian stock market continues to crash (down -1.5% to -22% year-to-date). We’re keeping a close eye on these developments.


It’s just plain ugly and, for American cost of living, this is getting worse. Faster too. The CRB Commodities Index is holding on to its year-to-date highs at +11.5%  as American rents rip and the Fed continues to print/devalue ($4.3 trillion Fed balance sheet, up another +$12.4 billion week-over-week).

UST 10yr

While US equity market centric investors might be confused by the no-volume bounce to lower highs into month end, the bond market gets that #InflationAccelerating is slowing real consumption growth. The 10-year is at 2.67% this morning and falling.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Hologic is emerging from an extremely tough period which has left investors wary of further missteps. In our view, Hologic and its new management are set to show solid growth over the next several years. We have built two survey tools to track and forecast the two critical elements that will drive this acceleration.  The first survey tool measures 3-D Mammography placements every month.  Recently we have detected acceleration in month over month placements.  When Hologic finally receives a reimbursement code from Medicare, placements will accelerate further, perhaps even sooner.  With our survey, we'll see it real time. In addition to our mammography survey. We've been running a monthly survey of OB/GYNs asking them questions to help us forecast the rest of Hologic's businesses, some of which have been faced with significant headwinds.  Based on our survey, we think those headwinds are fading. If the Affordable Care Act actually manages to reduce the number of uninsured, Hologic is one of the best positioned companies.


Construction activity remains cyclically depressed, but has likely begun the long process of recovery.  A large multi-year rebound in construction should provide a tailwind to OC shares that the market appears to be underestimating.  Both residential and nonresidential construction in the U.S. would need to roughly double to reach post-war demographic norms.  As credit returns to the market and government funded construction begins to rebound, construction markets should make steady gains in coming years, quarterly weather aside, supporting OC’s revenue and capacity utilization.


Darden is the world’s largest full service restaurant company. The company operates +2000 restaurants in the U.S. and Canada, including Olive Garden, Red Lobster, LongHorn and Capital Grille. Management has been under a firestorm of criticism for poor performance. Hedgeye's Howard Penney has been at the forefront of this activist movement since early 2013, when he first identified the potential for unleashing significant value creation for Darden shareholders. Less than a year later, it looks like Penney’s plan is coming to fruition. Penney (who thinks DRI is grossly mismanaged and in need of a major overhaul) believes activists will drive material change at Darden. This would obviously be extremely bullish for shareholders and could happen fairly soon driving shares materially higher.

Three for the Road


Another fantastic UK #GrowthAccelerating data pt w/ #StrongPound - Retail Sales for MAR +4.2% y/y @KeithMcCullough


“We can't change the course of events, but we can attempt to protect capital in the face of foreseeable risks.” – David Einhorn


Tokyo’s consumer prices rose 2.7 percent in April from a year earlier, the biggest jump since 1992, pumped up by a sales-tax increase and a year of unprecedented stimulus from the Bank of Japan. Inflation excluding fresh food accelerated from 1 percent in the previous month, while nationally the same price gauge rose 1.3 percent in March from a year earlier, statistics bureau data showed. (Bloomberg)

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EHTH: Not Looking Good

Takeaway: We remain short given the fundamental setup. Our concern is the return of undue optimism on the longer-term story.


  1. ATTRITION APPEARS MORE LIKELY: The larger the increase in enrollment on the public exchanges, the greater the IFP attrition risk to EHTH.  The 8M enrollment estimate from President Obama suggests the risk is considerable.
  2. IFP MEMBERSHIP TO DECLINE 1Q14: The brunt of the cancellation risk will emerge in the 1Q print, while membership flow-through from Open Enrollment will be recognized over the 4Q13-2Q14 period.   
  3. GUIDANCE CUT?: We believe top-end cut to 2014 revenues is likely, but not a definite.  Management could choose to wait until it no longer can; in the interim preaching the long-term story.  


HHS hasn’t releases March enrollment numbers yet.  However, President Obama announced that 8M members have enrolled in private plans on the public exchanges (HIXs).  The size of the addressable uninsured population (ex Medicaid eligible) is ~27M according Census data.  So if every one of those 8M members were previously uninsured, the public HIXs penetrated ~30% of the uninsured market.  However, we believe much of that enrollment data comes from the previously insured.


For perspective, when CHIP was expanded in 2009, only 1/6 of eligible parents (16%) applied for coverage for their children (link).  So it’s hard to assume those 8M enrollees are purely organic (previously uninsured), especially since there isn’t much data to support that claim.  McKinsey had previously estimated that 89% of the public HIX applicants were previously insured (link), but that data is somewhat dated at this point. 


A more telling and current example is reported enrollment metrics from Highmark (link), which may be the only MCO that has disclosed both its enrollment mix between public and private HIXs, and the percentage of those enrollees that were previously insured by the company.  The data suggests that 45% of its enrollees were previously insured by Highmark.  


But more importantly, Highmark’s total enrollment into new private HIXs plans during Open Enrollment (~53K) is less than the number of its existing members that chose new plans (~81K).  In short, the private HIXs ceded existing Highmark members to the public exchanges.  That is attrition.


EHTH: Not Looking Good - EHTH   Highmark Enrollment 


A competitor published a note summarizing a meeting it had with EHTH CEO Gary Lauer in late March.  The glaring takeaway from the report was that EHTH knew the churn status on less than 50% of its individual book; however EHTH IR refuted that comment when we contacted them.  If it is true, that’s a scary statement this late into the year.  If not, we still believe that membership will decline in 1Q14 regardless.  


The main reason is that the brunt of EHTH's 2014 IFP cancellations will be recognized in 1Q14 because the company will be able to estimate the impact of forced plan terminations from ACA non-compliance (EHTH doesn't know until members stop paying). 


At the same time, the bulk of approved members from Open Enrollment applications were either recognized in 4Q13 or will be recognized in 2Q14 given the timing of demand for health insurance and the lag to approval.  We illustrate the latter point using EHTH's comScore web traffic and Google search traffic for Health Insurance in the charts below.


EHTH: Not Looking Good - EHTH   UVs vs. Goog 


In short, this is the reverse setup of 4Q13 when we didn't know the cancellation data, but saw some of the flow-through in new membership from ACA open enrollment.  Now the cancellation data will be exposed, and new membership will not be able to offset. 




We believe top-end cut to revenues is likely, but not a definite.  Management could wait until 2Q after seeing membership data from March applications and the trend in application volumes thereafter (which we expect to decline y/y).  


At that point, 2014 may become less relevant as the "promise" of 2015 draws closer, especially since management will be doing everything they can do pump up the longer-term growth story.  There isn't a near-term catalyst to refute the 2015 growth narrative, so unbridled bullish sentiment could take hold again; the same way it did in 2H13 through its 2014 guidance release when reality set in.


We remain short given the fundamental setup in the intermediate term.  Our concern is the return of undue optimism on the longer-term story.  You can read more about our longer-term concerns here (EHTH: Déjà vu)




Hesham Shaaban, CFA


LEISURE LETTER (04/25/2014)



Friday, April 25

  • PEB Q1 earnings – 9:00 a.m.

Monday, April 28

  • CHH Q1 earnings – 10:00 a.m. , Passcode: 70683172

Tuesday, April 29

  • NCLH Q1 earnings – 10 a.m. , Passcode: 22334128
  • VAC Q1 earnings – 10:00 a.m. , Passcode: 4679876
  • MGM Q1 earnings – 11:00 a.m. , Passcode: 20455736
  • Las Vegas March revenues out

Wednesday, April 30

  • PNK Q1 earnings – 8 a.m. , Passcode: 27759612
  • GLPI Q1 earnings – 9 a.m.
  • MAR Q1 earnings – 10 a.m. , Passcode: 10575194
  • H Q1 earnings – 11:30 a.m. , Passcode:  11561402
  • BYD Q1 earnings – 5 p.m. , Passcode:  44440004

Thursday, May 1

  • HST Q1 earnings – 10 a.m.
  • OEH Q1 earnings – 10 a.m. , Passcode: 22074904
  • FCH Q1 earnings – 12 p.m. , Passcode: 28469900
  • BYI FQ3 earnings – 4:30 p.m.
  • EXPE Q1 earnings – 4:30 p.m.


MGM – announced an expansion of the Mandalay Bay Convention Center which will add 350,000 sq. ft. for exhibition area, a 70,000 sq. ft. ballroom and underground parking.  The estimated cost of the expansion is $66 million. The expo space will come online next year while the parking garage should complete in 2016.

Takeaway: Following the concert venue JV announcement earlier this week, we wonder how such redevelopments help to increase hotel ADRs?


WYNN – consummated a surrounding community agreement with the city of Medford and agreed to pay $1 million a year to mitigate the city’s expenses as a result of its planned casino in nearby Everett.

Takeaway: A positive step in the development plan but Boston remains a sticking point.


HOT – 10Q filing:

  • The company closed on the sale of one hotel during April 2014.  The asset was subject to a purchase and sale agreement during Q1 2014.
  • HOT is currently under audit by the Internal Revenue Service (IRS) for years 2007 through 2009.  During the year ended December 31, 2013, HOT received certain Notices of Proposed Adjustment from the IRS for such years; however, HOT disagree with the IRS on certain of these adjustments and intend to vigorously contest them, including pursuing all available remedies such as the IRS Appeals process and litigation, if necessary.  These unagreed adjustments, if upheld, would result in a significant cash tax and interest payment.

Takeaway: Several interesting pronouncements worthy of a follow-up conversation.


HLT – announced the return of one of its most popular promotions, Double Your HHonors.  Through Double Your HHonors, members choose between either earning Double HHonors Points or Double Airline Miles for qualified hotel stays completed between May 1 and July 31, 2014, at participating hotels

Takeaway: We look forward to a discussion of this promotion and how the promotion stimulates bookings on next week's earnings call.


NCLH – Norwegian Epic has added two sailings to and from Southampton, England in 2015, marking the 1st time that the ship has visited the port since the in


Takeaway:  Norwegian needs to get some ships out of the super congested Caribbean market.


Lorne Weil – resigned from Sportech's board of directors effective immediately (Thursday, April 24, 2014). Sportech confirmed Thursday that Weil had tendered his resignation from the board with immediate effect, although he will continue to be affiliated with the company as an advisor to the business.

Takeaway: A gaming executive looking for a new opportunity? 


New York Gaming Expansion – the next big gaming expansion for up to four upstate gaming licenses, drew 22 applications who each submitted a $1 million application fee prior to Wednesday's deadline. 

Takeaway: While an interesting near-term growth opportunity, how much cannibalization occurs to these facilities after the 7 year waiting period and commercial gaming is opened "down state" (Metropolitan New York City) with potential casinos located in Westchester, Bronx, Putnam, Nassau or Suffolk Counties - or a casino opens near the Meadowlands?



Hedgeye remains negative on consumer spending and believes in more inflation.  Following  a great call on rising housing prices, the Hedgeye Macro/Financials team is turning decidedly less positive. 

Takeaway:  We’ve found housing prices to be the single most significant factor in driving gaming revenues over the past 20 years in virtually all gaming markets across the US.

Be The Mustache

This note was originally published at 8am on April 11, 2014 for Hedgeye subscribers.

“They complain that I’m robotic, abrupt, I’m not cheerful and smiley, and you know what? That’s not my problem,”

Arthur Chu


On the back end of a 14-hour work day yesterday, after dinner time, bath time, story time, bed time and the host of other daily, toddler parenting “times,” I swilled back some late night espresso and fired up the DVR to watch something I’ve been itching to review for a while now  - Jeopardy!. 


Jeopardy is still on?  The White House Petition to deport Justin Bieber only got 275K signatures? ….that fat guy is the kid from The Sixth Sense?  


The story is a bit stale now, but if you didn’t follow its procession last month, controversial Jeopardy contestant, Arthur Chu, emerged out of the arithmetic ether like some sort of sagely, evil game-show probabilist savant. 


Be The Mustache - chu


Using math and a game theory based playing strategy, he managed an 11-game win streak and ultimate winnings of $298K – good for 3rd all-time (Wikipedia). 


Alongside terseness and less than conventional congeniality, Chu’s most noteworthy exploit was his innovative use of the “Forrest Bounce” - whereby you jump quickly from category to category – across the bottom three rows of the board in an attempt to locate the “daily doubles”. 


The daily double sits as the singularly largest source of uncertainty in the early rounds of the game.  If that uncertainty can be systematically eliminated, the odds of winning increase provided one’s knowledge of the other trivia is marginally better than that of the other two contestants.


Here's the clip of Chu ferreting out a daily double, dismissively betting $5, answering “I dunno” after 1 second and summarily continuing on.


Chu’s challenge of conventional contestant etiquette inspired the ire of Jeopardy ‘purists’ nationally who took to social media en masse to voice their discontent and defend the game’s storied, 3-decade tradition from the emergent nihilist.   


Applied mathematical innovation challenging preconceived wisdoms and conventional orthodoxy…..sound familiar? 


Fortunately, in the end, #Evolution has a sneaking ability to overcome both antiquated conventionalism and institutional (ivory tower) obstructionism.   


Back to the Global Macro Grind….


When hearing economists discuss markets in terms of rational agents, benevolent dictators, and other nonsensical simplifying assumptions, the economy becomes something largely abstract and intangible. 


Certainly, the dynamic, complex system that is globally interconnected macro is difficult to comprehend (let alone forecast) in full, but a coherent understanding of the drivers of significant parts of the economy over defined periods isn’t inaccessible.  


Consider the largest part of the domestic economy  – consumption, in the short run. 


Broadly speaking, the drivers of Consumption aren’t overly complicated.  In short, consumer spending growth is a function of the growth in income, the marginal propensity to consume or save that income, and the net change in household credit. 


Asset appreciation and credit growth matter, but they are somewhat indirect drivers.  We discuss the wealth effect further below and leave the discussion and analysis of credit for another missive.  


So, what do income and savings trends tell us about the slope of consumption growth?


Together, growth in disposable income and the change in the savings rate explain most of the change in nominal consumption (PCE) growth.  Indeed, over the last 30 years, the multiple regression between PCE growth vs. nominal Disposable Income growth and the change in the Savings Rate produces an R-squared of 0.99.  #tight


While that ultra-strong correlation doesn’t provide much insight into how to actually go about fostering significant, sustainable real income growth, it does provide a means of reasonably nowcasting the 68% of the economy that is consumption. 


For instance, under a baseline assumption that the 3 primary input variables (Disposable Income growth, the Savings Rate and PCE inflation) come in at their respective QTD averages in March, the regression model suggests year-over-year real consumption growth of 2.2% in 1Q14 – down 10bps sequentially from 4Q13, but +20bps ahead of the TTM average


Nothing revolutionary or proprietary there - just the gravity of a few numbers to which consumption growth remains inextricably hostage. 


What about the Wealth Effect?  


The wealth effect ‘theory’ posits that when real wealth increases, consumer spending permanently increases by some fraction of that wealth increase in every subsequent year.


Consumers, on balance, don’t immediately convert 100% of a wealth increase into current consumption.  Instead, in annuity like fashion, they tend to spread that ability for increased consumption out over their lifetime.


In general, studies examining the marginal propensity to consume show that consumer spending increases between 2 and 7 cents for each dollar of wealth increase.


It makes intuitive sense that an increase in real wealth, be it from housing or financial asset appreciation, lends itself to increased consumption. 


Again, when hearing analysts and pundits discuss it in the media, one is left feeling that the wealth effect occurs via some mystical monetary transubstantiation whereby higher net wealth is somehow cleanly and instantaneously transformed into higher consumption.


In reality, a number of key, very mechanical conditions must be satisfied for increased housing/financial asset wealth to translate into higher consumer spending on non-housing related goods and services


Practically,  increased real wealth needs to drive a behavior shift such that households decrease savings or other investments, increase home equity/other collateralized borrowing, or downsize to a cheaper residence (liquidity event freeing up cash for spending), for that wealth increase to be effective in driving higher consumption growth.


With the value of corporate equities and the aggregate housing stock up $3.52T and 2.0T, respectively, in 2013, the case for wealth effect spending has some residual legs.  However, with equities down YTD and housing in the midst of a discrete deceleration, we expect wealth effect support to consumption to continue to ebb. 


While consensus continues to make the pro-growth, pro-consumption call that should have been made last year, we think the consumer slows sequentially in 1H14.  We layed out ‘the why’ in our 2Q Macro themes call on Tuesday.  Ping if you’d like the replay/presentation. 


Like Alex Trebek’s facial hair, the forward slope of consumption growth remains the subject of ongoing conjecture and speculation.  Both continue to fascinate and confound consensus onlookers on a regular basis.  Understanding both will remain central to generating global macro alpha in 2014.    


Be the mustache, don’t be consensus…..or something like that.


Our immediate-term Global Macro Risk Ranges are now as follows:


VIX 14.72-16.67

Nasdaq 4007-4203

UST 10yr Yield 2.61-2.73%

SPX 1827-1859

Gold 1291-1331 


Enjoy the weekend.    


Christian B. Drake



Be The Mustache - Consumer

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