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.
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
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.
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.
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.
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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Macy’s - Setting Up To Be A Great Short
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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.
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.