Bullish Call On Lorillard Remains Despite Ho-Hum Quarter | $LO

Takeaway: Despite a lukewarm quarter, our long-term bullish outlook remains unchanged.

Here are some key takeaways from a research note that was originally sent to subscribers on April 25, 2014 by Hedgeye Consumer Staples analyst Matt Hedrick. Follow Consumer Staples on Twitter @HedgeyeStaples.


Bullish Call On Lorillard Remains Despite Ho-Hum Quarter | $LO - real cig and e cig


  • Lorillard reported Q1 2014 results on 4/24 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 United States.
  • 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 30 basis points 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 year-over-year at 40.7%, but improved 80bps sequentially.
  • blu E-Cigs: Net sales for blu declined -10.5% y/y to $51 million, 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. LO announced a $10-20MM spend over next 6 to 9 months to rebrand the U.K.’s SKYCIG as blu and continue to support incremental brand building for blu in the U.SIn 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.


Vanishing Volume

Client Talking Points


The Korea Composite Stock Price Index broke our intermediate-term TREND line of 1983 support (it closed down -0.23% overnight at 1964) – see our macro analyst Darius Dale’s bearish research note yesterday on South Korea heading into what we call “quad 3” in our GIP model (stagflation).


UK continues its playbook follow through as tighter monetary policy = stronger currency = stronger purchasing power, home price appreciation, confidence, etc… and UK GDP ramps to +3.1% year-over-year in Q1 (double the USA which you’ll get tomorrow – oh, the UK had “weather” too). $1.68 GBP/USD last continues to look great.


Our reading of total US equity market volume weakened (down -7% and -20% versus the one-month and three-month volume averages, respectively) on yesterday’s +0.3% SPX bounce. Both the Nasdaq and Russell were down on the day (-6.5% to -7.5%, respectively) from their bubble highs. Tread carefully out there.

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


COMMODITIES: Corn and Oil up another +0.5-6% this morning #InflationAccelerating @KeithMcCullough


"Your assumptions are your windows on the world.  Scrub them off every once in a while, or the light won't come in." - Isaac Asimov


Shares of Facebook have slumped 10% since the company released a widely celebrated first-quarter earnings report a week ago. (MarketWatch)


Macau’s “unique” reporting methodology could portend a volatile end to April.




The setup for a sharp positive reversal in Macau stocks may be before us.  It’s possible that last week’s sluggish Macau table revenues were underreported and with the corresponding catch up over the last 3 days, April could push into double digit growth for the month.  A strong May could continue the momentum.  



We’ve written about “the placeholder” in previous notes.  The Macau government fails to secure the comprehensive data for its weekly release and issues a placeholder average daily table revenue (ADTR) figure of HK$775 and investors panic over the low level of revenue.  It wasn’t long ago that HK$775 million per day was considered a strong number but we’re way past that. 


With ADTR of HK$903 million – still below expectations – this past week, the placeholder issue wasn’t as obvious.  However, this past week contained only 6 days since the prior week’s data was not released until Tuesday rather than the typical Monday.  Hedgeye’s crackpot team of statisticians quickly calculated the reported gaming revenues over 6 days of $5.425 billion actually averages to the magical HK$775 million when divided by 7 days.  Apparently, the placeholder is a weekly number not a daily number.


Moreover, upon further review, there appears to be more than one placeholder.  In fact, there appear to be 4 over the past 3 years:  HK$4,655m (8 times over 205 reporting observations), HK$5,425m (17x and the most common), HK$6,200m (8x), and HK$6,975m (6x). On a 2014 YTD basis, there appear to be 6 placeholders in the 18 periods, while during Q4 2013 we believe 8 of the 12 periods were placeholders. 





After eyeballing the data, it appears that sometimes the “catch up” occurs either in the week following the placeholder week or in the last week of the month.  We’re not positive April will end with a bang – sometimes the catch up is negative – but it should be volatile.  For example, following a HK$5,425 million placeholder for the week ended 1/26/14, the last five days produced ADTR of only HK$555 million, 36% below the average for the month.  On the other hand, March contained two placeholder weeks, and the last week of the month posted an ADTR 32% higher than the January average.


Either way, we remain constructive on May in Macau and with the already stocks reflecting a VIP slowdown, that could be the catalyst these stocks need.


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The Monster

“The monster is trying to kill me, but I will kill it.”

-Andrew Jackson


That sounds pretty hard core; especially coming from the President of the United States!


“The Monster, formally known as the Second Bank of The United States (and more commonly as the Bank), originated as the brain child of Alexander Hamilton… Jackson saw himself in arms against the dragon, an infernal, demonic entity that must be destroyed.” (The First Tycoon, pg 93)


The Monster - jackson bank monster


And you thought I was bearish on the un-elected and un-accountable US Federal Reserve. As I was flying from Indianapolis, IN to Minneapolis, MN last night reading this, I pulled the Delta Airlines polyester red blanket up to my chin and asked the flight attendant for cookies and milk.


Back to the Global Macro Grind


#ScaryMonster, this US Policy To Inflate has become. The more I travel and talk this through with investors, the less convinced most are that this ends well. There’s no irony in that. Unless it’s “different this time”, burning the credibility of a country’s currency has never worked, for any country.


If I’m right and 2014 US GDP growth (real, not nominal) is closer to 1-2% than the 3-4% consensus economists and perma bulls alike are expecting, I think the societal side to this risk starts to kick in. That’s because what gets us to 1-2% is #InflationAccelerating. And nothing kills The People’s confidence more than a government that they think is lying to them.


In 1832… so began the Bank War; the result of not merely Jackson’s obsessions, but the cultural crisis of the times. It broke out because two great waves now crashed into one another: the individualistic, anti-aristocratic, competitive impulse fostered by the Revolution, and the instinct to organize, amalgamate, develop, and bring order to the chaos of the marketplace.”


Sound familiar?


Indeed, out of this conflict would emerge a new American economic outlook; a culture that embraced equality of opportunity and fierce competition, as well as sophisticated business institutions.” (The First Tycoon, pg 95)


Sophisticated about applying chaos theory and non-linear risk analytics to their linear models, the Fed and Old Wall Street are not. I think they might be getting dumber (see Bank of America (BAC) yesterday, who had to report that they miscounted the moneys, again!).


That’s one of the reasons why the Financials (XLF) got tagged for a -0.6% loss yesterday (with the SP500 +0.3% on the day). What’s happening out there at both the sector and style factoring levels of the market is crystal clear – it’s called variance:

  1. Variance rises during market phase transitions (i.e. from US #GrowthAccelerating in 2013 to inflation slowing growth in 2014)
  2. Variance plummets when you can literally buy anything (because everything goes up)

For the US stock market, the so-easy-a-monkey-can-do-it (low-variance) environment ended on December 31, 2013. Here’s what I mean by that if you look at the variance in yesterday’s US stock market move:

  1. Financials (XLF) -0.6%
  2. Biotech (IBB) -0.4%
  3. Russell2000 (IWM) -0.4%


  1. #YieldChasing Consumer Staples (XLP) +1.1%
  2. Slow-growth-yield chasing Utilities (XLU) +0.5%
  3. Energy #InflationAccelerating (XLE) +0.2%

That’s why I said it in my investor meetings yesterday in Indy and I’ll say it again in Minneapolis to long-only risk managers today – if you want to be invested alongside our 2014 Macro Themes, you:

  1. Buy Inflation (XLE, DBA, COW, CAFÉ, TIP, etc.)
  2. Buy Slow-Growth Yield Chasing (XLU, TLT, BND, etc.)
  3. Buy late cycle companies that can jam customers with pricing (VNQ, XLI, etc.)

If you are a Global Investor, this gets a lot easier – mainly because you can not only be long US #InflationAccelerating but you can buy countries who are doing the right thing from a protecting-the-purchasing-power-of-the-people (read: #StrongCurrency) perspective.


At the top of that list is the UK:

  1. The British Pound continues to pound the pig that is the US Dollar (GBP +10% vs USD in the last 6 months)
  2. UK GDP Growth for Q114 was reported +3.1% y/y this morning – a fresh new #GrowthAccelerating high

The Monster - Chart of the Day


Newsflash: the UK had the “weather” too. They just don’t have to blame the weather in order to CTA (substitute T for Y) on why almost every one of them (consensus economists from Old Wall and Washington) had their Q114 US growth forecast dead wrong.


Sadly, tomorrow the United States of America will report a GDP growth rate for the 1st quarter that is maybe 1/2 of what the United Kingdom just did. Sure, you’ll have month-end markups in the US stock market … and the Fed will release their 2nd or 3rd coming of Christ…


But once that storytelling is done with, Americans will go back to eating it – the Policy to Inflate, that is. And if we don’t have the courage to kill this broken and un-elected US economic policy, The Monster  of a devalued currency might just eat us too.


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


Nasdaq 4006-4143

USD 79.21-79.99

Pound 1.67-1.69

Natural Gas 4.55-4.81

Gold 1

Corn 5.05-5.19


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer

Animal Spirits

This note was originally published at 8am on April 15, 2014 for Hedgeye subscribers.

“In the long history of humankind (and animal kind, too) those who learned to collaborate most effectively have prevailed.”

-Charles Darwin


In his 1936 book, “The General Theory of Employment, Interest and Money”, John Maynard Keynes used the term animal spirits to “describe the instincts, proclivities and emotions that ostensibly influence and guide human behavior.”  He goes on to use consumer confidence as an example of how animal spirits can be measured economically. 


In our Q2 Themes presentation, we did a lot of work on the median consumer and took a detailed look at his / her income statement and balance sheet.  Currently, there are a number of major headwinds for the median consumer.  The obvious first one is the rampant acceleration in food costs in the year-to-date, the second is the anemic interest rate that they get on their savings, and, finally, the last headwind is the softening in the housing market.


For many average consumers, the house is in effect the balance sheet, so as home prices go up so too does net worth.  The two points that bode most negatively in our models for future home prices are the dual facts that pending home sales are down -14.5% from their peak and mortgage applications for purchase are down more than -20%.   Ultimately, home prices follow demand on a lag (as shown in the Chart of the Day), so we should expect that home price growth softens from here.


As it relates to the consumer, late last week the Bloomberg Consumer Confidence slipped to -31.9 from -30.0.  This is well below the long run average of -16.5 and normally a number above -30 is the level at which the economy is considered to be in recovery mode. More alarmingly was the personal finance sub-index which fell to -2.9, the worst level in five months. 


On a higher level, last week Michigan Consumer confidence came in at 82.6.  This was better than the expected 81.0 and an increase from the prior month.  So the animal spirits of consumer confidence appear to be intact . . . at least for now, but keep your eye on those home prices.


Back to the Global Macro Grind . . .


Yesterday was a slow grind in global macro land and today seems to be similar in tenor.  As it relates to the pin action of stock markets, the Shanghai Composite today is -1.36%.  The punditry is attributing this downward move as front running China’s GDP tomorrow, albeit the positive move in Chinese equities yesterday was considered a precursor to positive GDP, so the question of course is: which is it?


At a minimum, it seems that the government may be trying to talk down economic growth and the timing of the following report is suspect coming out one day ahead of GDP:


“Researcher with State Information Center said in Shanghai Securities News that efforts to address overcapacity, deleverage the economy and curb property bubbles could push GDP below 7%, something that would trigger massive unemployment.”


My colleague and our Asia Analyst Darius Dale had some detailed thoughts on the topic:


“In the 15 quarters since Chinese real GDP growth hit a cycle-peak of +11.9% YoY in 1Q10, Chinese economic growth has accelerated sequentially only three times. It’s basically been a straight leg down for four consecutive years – so much so that on a trailing 3Y basis, the current z-score for this series is (0.6x), which is actually up from trough of (1.6x) in 2Q12. In non-statistical speak, this implies that the “surprise factor” of Chinese #GrowthSlowing is burning off.


That isn’t to say that Chinese economic growth is not still slowing. In fact, the broad swath of high-frequency economic data points to a continued slowdown. The current risk range in our predictive tracking algorithm has probable downside to +7.3% YoY for Chinese real GDP growth here in 1Q14, which would: A) be the slowest growth rate since 1Q09; and B) imply that the Chinese economy is not taking advantage of extremely favorable base effect tailwinds – a sign that sequential momentum is indeed decelerating (as evidenced by the MAR PMI data).


One thing that investors should be aware of, however, is that Chinese policymakers are content to stand pat for now. Expectations for big stimulus has been dramatically tempered in recent weeks, most recently by Premier Li Keqiang’s prepared remarks at the Boao Forum for Asia Annual Conference. Perhaps they are storing up their fiscal and monetary “gun powder” to arrest any potential deceleration through the low +7% range in real GDP.


Or perhaps China’s intermediate-term growth trajectory isn’t really isn’t as dour as it has appeared in recent months and their superior visibility into the state-run Chinese economy leads them to believe that a large stimulus is simply not warranted. Time will tell; next up: tonight’s releases of 1Q GDP and MAR high-frequency growth data…”


The Hedgeye team will never be confused of being supportive of the interventionist nature of the world’s central bank.  A key critique we often held is that as a result of activist monetary policy, the markets tend to get manipulated.  We aren’t sure yet whether the Fed is more evil than those dastardly high frequency traders, but recent data on correlations emphasize our concern.


Specifically, according to ConvergEx, since 2009, the 10 industry sectors in the SP500 have averaged 85% correlation to the index.   In the past thirty days, correlations have dropped markedly to 77.5%.  Most interestingly though is the fact that long run correlations, before Fed intervention, have averaged 50%.  (Hint: Michael Lewis, there is a book here somewhere.)


The most challenging part of dealing with central banks may be in discerning whether they mean what they say.   The most recent example of course is the jawboning from ECB head Mario Draghi, who specifically indicated that the ECB was ready and willing to take monetary policy to an extreme level.  The Euro, despite a down move yesterday, has by and large shrugged Draghi off and is up 0.6% on the year-to-date.  Credibility anyone ?


Our immediate-term Global Macro Risk Ranges are now:


SPX 1804-1855

Nasdaq 3932-4147

Nikkei 13666-14445

USD 79.27-80.01

EUR/USD 1.37-1.39

Brent 107.34-109.41

NatGas 4.46-4.71


Daryl G. Jones

Director of Research


Animal Spirits - Chart of the Day

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