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INVESTING IDEAS NEWSLETTER

Takeaway: Current Investing Ideas: HCA, HOLX, LM, LO, OC, RH, and ZQK

Below are Hedgeye analysts' latest updates on our SEVEN current high-conviction investing ideas and CEO Keith McCullough's updated levels for each.

 

*Please note we removed DRI from Investing Ideas this week.

 

We also feature three research notes from earlier this week which offer valuable insight into the market and economy.

 

INVESTING IDEAS NEWSLETTER - 0

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

INVESTING IDEAS NEWSLETTER - Food Prices 5.14.2014 

IDEAS UPDATES

HCA – We published an article with an update to our birth model with April 2014 data which was updated earlier this week. You can read that note here. Births account for 25% of all hospital admissions nationally, so a recovery could be a significant tailwind for HCA Holdings.


HOLX ­­– We heard from an institutional customer this week that Washington DC consultants to Wall Street are suggesting 3D Tomosynthesis will not be receiving any incremental reimbursement. This would be a major blow to our thesis. While we don’t discredit the source entirely, we do think we’ve covered the scenarios if this actually happens.  So far our work suggests a reasonable increase in price for 3D over 2D Digital mammography. 

 

LM –  Legg Mason reported its month ending asset-under-management for April at the beginning of the week with a very positive result in its fixed income segment. The firm cited “significant” bond inflows for the month which we calculated to be over $2.3 billion. To contextualize this inflow amount we note that the entire U.S. mutual fund industry had total bond fund inflows of just $8.4 billion in April according to the Investment Company Institute, which provides an indication of the strong win rate for Legg alone last month. We also point out on a forward looking basis that the emerging trends in the mutual fund marketplace are starting to favor fixed income which should translate into accelerating positive trends at leading bond fund managers. Fixed income inflow is outpacing equities thus far in the second quarter of 2014 for the first time in 9 months which reflects the emerging defensive nature of global markets which is a good environment for leading fixed income houses including Legg Mason.  

 

INVESTING IDEAS NEWSLETTER - TROW BI removal

 

LO – Lorillard pulled back in the week over -2% and underperformed its peers, yet the slight drawdown comes after weeks of outperformance (up ~ +19% in the last 3 months), on a mix of take-out rumors from RAI/BAT and what continues to be a strong menthol portfolio.   We maintain that we have no merger knowledge from any party within the tobacco space, however we view a hypothetical deal (especially an imminent one) of RAI acquiring LO as challenged, given:

  • Our main flag is that a combined RAI + LO would own ~ 67% of U.S. menthol market, which we believe should trigger anti-trust flags.
  • Big tobacco is already a highly concentrated industry in the U.S. across the big three – MO has a leading ~51% of market share; a combined RAI + LO would equate to ~ 42% share.   

 

We expect the tobacco group to continue to trade around category shifts in e-cigarettes:  recently we’ve heard increased color that cig-alike e-cigs (or those primarily being manufactured by Big Tobacco) are losing out to larger, tank, open, and e-vapor products based on their lower price points and superior vapor quality.  We expect Big Tobacco’s cig-alike e-cig technology to improve, and to also begin to see portfolio mix shifts away from cig-alike e-cigs products.  We do expect increased competition as RAI and MO bring their own e-cig versions (VUSE and MarkTen) to market nationwide in the coming months, however we expect blu to maintain its market share leadership.

 

Our intermediate term TREND to longer term TAIL bullish outlook on LO remains intact.


OC – We found some interesting results after collecting historical data from the Census Bureau and the Bureau of Labor Statistics. We noticed both residential and non-residential floor space per worker was hovering around post-WWII lows. This suggests the market is very depressed by post-war standards on a per capital basis. Owens Corning has more exposure to the non-residential side through its insulation and composites segments. The roofing segment is driven more from damage/ repairs and does not correlate with housing related metrics. For example, roofing sales were up nearly 36% in 2008.

 

INVESTING IDEAS NEWSLETTER - oc

 

RH – Restoration Hardware opened its newest design gallery this past Friday, May 26th, in Greenwich, CT. The store has 14,000 selling square feet, nearly 3x the legacy Greenwich store located down the block. The new Greenwich location is on the small side of new Design Galleries, but it marks an important turning point for the company as it begins to grow square footage after 6+ years of decline. More importantly – the new space will allow the company to display a much larger percentage of the company’s growing category portfolio including Baby&Child, Tableware, as well as Outdoor. The company has stated that when an item is displayed at retail for the first time in a new market it typically sees a 50%-150% boost in sales, one of many justifications for the real estate transformation.

 

An issue we rarely address when talking about the real estate transformation is the significant operating leverage opportunity associated with these new Design Gallery spaces. Not many retailers are looking to expand into 30,40, or 50,000 square foot boxes - giving RH significant leverage when negotiating lease terms. Greenwich is a great example of this leverage opportunity. The company was paying $900,000 in rent for the Legacy 5,000 square foot space, but will only pay $1,000,000 per year for the new 14,000 sq. ft. store. That equals just $11.11 for each incremental square foot of selling space. This is one of the key drivers behind our forecasted gross margin expansion, which we have going from 35.9% in 2013 to nearly 39% in FY18.

 

INVESTING IDEAS NEWSLETTER - RH Greenwich

 

ZQK –  INTERMEDIATE TERM (TREND) (the next 3 months or more)

This is the only part of the story we’re not thrilled with. Why? 2014 will be all about cost cuts and modest (2%-ish) top line growth.  As such, our estimates for 2014 are not too far off of consensus. This is all a logical progression. The management team started in early 2013. The first and easiest thing to do is reorganize Quiksilver, cut redundant functions and ensure that the team is filled with ‘A’ players.  Earnings in 2014 should be slightly positive mostly a function of restructuring, but with some revenue growth weighted toward the back half of the year.

 

LONG-TERM (TAIL) (the next 3 years or less)

2015 and beyond is a much different story. Our long-term model has Quiksilver adding $600mm in revenue on top of a $1.9bn base. As a frame of reference, our top line growth forecast is over 1,000 basis points ahead of consensus.  

 

Ultimately, we’re at over $1.00 per share in 2017, which is 40% ahead of the consensus. In the end, this is a 40%+ EPS grower that’s a double if we use a 20x p/e, which we think is more than fair based on the soon-to-be-realized growth profile.

 

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Click on each title below to unlock the institutional content.

 

Macy’s - Setting Up To Be A Great Short

Retail sector head Brian McGough explains why Macy’s is at a critical point in its decision tree and where the company goes from here.

INVESTING IDEAS NEWSLETTER - 4 

Truth And Good? (What My Compliance Officer Won’t Let Me Say About MLPs)

Energy analyst Kevin Kaiser recounts a recent trip he took to pitch the bear case on Master Limited Partnerships to a group of value investors.

INVESTING IDEAS NEWSLETTER - 1

 

ICI Fund Flow Survey: Best Week All Year For Bonds Versus Very Light Week For Equities

Financials analyst Jonathan Casteleyn takes a granular look at the most recent data which showed that last week the combination of taxable and tax-free bond fund flow had the best week all year.

INVESTING IDEAS NEWSLETTER - wall street sign homepage


Week Ahead

The Economic Data calendar for the week of the 19th of May through the 23rd of May is full of critical releases and events.  Attached below is a snapshot of some of the headline numbers that we will be focused on.

 

Week Ahead - 05.16.14 Week Ahead

 


DRI: REMOVING DARDEN FROM INVESTING IDEAS

Takeaway: We are removing Darden (DRI) from Hedgeye's high-conviction stock idea list.

Darden announced earlier today that it has entered into a definitive agreement to sell its Red Lobster business and related assets to Golden Gate Capital for $2.1 billion in cash. 

 

Destroying a business and giving it away for free is a familiar practice for CEO Clarence Otis – he first did this with Smokey Bones and has now done it again with Red Lobster.

 

DRI: REMOVING DARDEN FROM INVESTING IDEAS - ClarenceOtis Pinched1 624x420

 

What’s shocking about this transaction is that shareholders explicitly told management and the board not to sell or spin off Red Lobster without their approval.  By pushing through this sale, the company has once again displayed a complete lack of corporate governance and an egregious disregard for shareholders. 

 

In our view, the stock reaction to this news has all but sealed the fate of management come the annual meeting in September.

 

Our bullish thesis on DRI hinged on a management change that would, in our opinion, be a catalyst for significant value creation.  With the sale of Red Lobster and the implied 10% to 15% decline in the earnings power of the company, it’s difficult for us to like the stock in the immediate-term.  The management change shareholders are longing for is unlikely to occur until later this year.


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DRI: Twice-Cooked, Half-Baked

Today, Darden announced that it has entered into a definitive agreement to sell its Red Lobster business and related assets to Golden Gate Capital for $2.1 billion in cash.  Destroying a business and giving it away for free is a familiar practice for CEO Clarence Otis.  He first did it with Smokey Bones and has done it again with Red Lobster.

 

What's shocking about this transaction is that shareholders explicitly told management and the board not to sell or spinoff Red Lobster without their approval.  By pushing through this sale, the company has once again displayed a complete lack of corporate governance and an egregious disregard for shareholders.  In our view, the stock reaction to this news has all but sealed the fate of management come the annual meeting in September.

 

Thoughts on the transaction:

  • More shareholders will be in Starboard’s camp when the annual meeting rolls around.
  • It creates a bigger mess for shareholders when the new board takes control of the company.
  • If the “pig” Red Lobster is worth 9x EV/EBITDA, what would the other brands be worth with a better management team?
  • Will more activists enter the fray to relieve management and the board of their conflicted duties?

 

Management is intellectually dishonest with this transaction:

  • The sale-leaseback transaction with American confirms $4 to $5 billion in real estate value.
  • They could have done a sale-leaseback transaction and not given away Red Lobster for free.
  • They previously said there are significant debt breakage costs associated with a sale-leaseback, yet they are now paying down debt with the proceeds from the sale.
  • According to management, it did not make sense to do a transaction by separating out the real estate and now it’s being done.
  • According to management, “many shareholders have expressed the view that an attractive sale of Red Lobster would be a favorable outcome for Darden shareholders.”

 

The deal is expected to close in the first quarter of FY15. 

 

Our bullish thesis on DRI hinged on a management change that would, in our opinion, be a catalyst for significant value creation.  With the sale of Red Lobster and the implied 10% to 15% decline in the earnings power of the company, it’s difficult to like the stock in the immediate-term.  The management change shareholders are longing for is unlikely to occur until later this year.

 

More details to come.

 

Howard Penney

Managing Director

 

Fred Masotta

Analyst


Cartoon of the Day: Pounded Dollar

Takeaway: The dollar fell against the British pound today.

Cartoon of the Day: Pounded Dollar - Pounded 5.16.2014

LEARN MORE ABOUT HEDGEYE.


MACAU SMOKING BAN

Smoking ban is real but likely to exclude VIP/Premium Mass and deadline delays likely

 

 

CALL TO ACTION

Today’s pronouncement regarding full smoking ban on mass floors beginning Monday, October 6, 2014 is not a positive.  Unfortunately, the operators appear to have not taken the health issue as seriously as they could/should have given all the discussions, working groups and testing.  However, given that the partial smoking ban had no discernible impact and we don’t believe the premium mass nor VIP smokers will be affected, the disruption could only be minor.  Moreover, the deadline is likely to be pushed back. 

 

THE SETUP

Given the recent Labor Day protests in Macau and the smoking debate, this policy outcome seemed an inevitable conclusion.  Based on our conversations with our contacts in Macau, we understand:

  • VIP rooms and Premium Mass will be excluded
  • Operators will build “smoking lounges” on the mass floors.  We are told the lounges will be plentiful (probably located in the former watch, jewelry and pawn shops)
  • This means most gamblers will slip in for a quick cigarette between shuffles or when they need a change of luck
  • Possible impact on GGR in the short term from the business disruption as all the construction works are going on but these guys are pretty tolerant of that kind of distraction
  • Basically, this is nothing more than a short term (probably 1 or 2 week) disruption retraining mass gamblers about smoking regulations
  • We would not be surprised to see potential “red tape” delays in the implementation of the mass smoking ban 

 

TIMELINE

Since the opening of the casinos and gaming floors in Macau, the question of whether or not to allow smoking on gaming floors has been raised.  We outline the smoking ban development in the timeline below.

 

June 17, 2010

SMOKING TO BE ALLOWED IN CASINOS FOR A THREE-YEAR PERIOD Macau Daily Times

The latest version of the tobacco ban bill draft declares that smoking will be allowed in "venues for adults"--i.e. casinos, bars, terraces and business open areas, massage lounges and dance halls--for a three-year period.  According to Chan Chak Mo, who heads the Second Standing Committee of the Legislative Assembly, pressure from several industries led to this decision. “  After two years, the government says that a revision of the law should be done in order to decide if the suspension continues in the third year or not,” added Chan.

 

April 18, 2011

LEGISLATURE APPROVES SMOKING BILL Macau Daily Times

As expected, the tobacco bill passed the final reading.  Ng Kuok Cheong, Au Kam San, Chan Wai Chi, José Pereira Coutinho, Ho Ion Sang voted against the partial smoking ban in casinos.  They believed that casinos should be subject to a complete smoking ban.  The smoking law will be enacted on January 1, 2012, while casinos will be required to build a smoking area with a size not larger than 50% of total public area by January 1, 2013.

 

An order from the Macau CEO regarding the smoking ban was published in the Macau Gazette on November 5th and is summarized below:

  • Rules apply to all table games and slot machines
  • Smoking areas cannot be greater than 50% of the total area for the public
  • This rule excludes non-gaming establishments
  • Smoking areas must display the following:
    • Posters addressing no-smoking zones
    • Label with minimum dimension (40cm x 30cm) in Chinese, Portguese, and English
    • Separation from other installations
    • Ventilation systems
  • Smoking area locations
    • In casinos with several floors and an atrium, smoking areas should be located on the upper floors
    • In casinos with a single floor, smoking area must be located opposite and separate from the non-smoking area.
  • Non-smoking areas can be achieved through the following measures:
    • Air curtain system
    • Transition area with inflation system
    • Transition area of at least 4 meters
    • Installation of a wall or fence with a minimum of 2 meters

  

January 1, 2013

Chief Executive Fernando Chui Sai On said that while the government is strictly enforcing the partial smoking ban in casinos they are still fine-tuning some of the rules.  The partial smoking ban that took effect on January 1, allows casinos to have smoking areas in up to 50% of the gaming floor area. The rules do not set up a minimum ratio for the number of slots and tables to be included in smoking and non-smoking area.

 

The Macau Health Bureau repeatedly tested the casinos for air quality during 2013

Many casinos fail the air quality tests… Trade unions blamed the government for being too lenient towards casinos in the enforcement of partial smoking bans in all gaming venues.  


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