Takeaway: Hedgeye continues to reiterate its US #ConsumerSlowing position.
Summary: The savings rate ticked up, the rich reduced spending on luxury goods and the estimate of healthcare consumption growth decelerated. The result = negative MoM growth in real consumption across services, durables, and nondurables with all 3 decelerating on a YoY & 2Y basis as well. Growth estimates will get clipped (again).
As we’ve suggested repeatedly over 1H14, the current level of consumption growth (which sat as the singular source of strength in 1Q14 GDP) is overstated and/or unsustainable at reported 1Q14 levels.
Summarily, the thinking is essentially this:
The savings rate is at historic lows (meaning incremental consumption growth can’t be achieved via further savings reductions) while the conflation of static income growth and rising inflation (growing at multiples of income growth in some instances) will constrain the capacity of other discretionary consumption.
Accelerating spending on luxury goods buttressed a broader deceleration in demand for durables to start the year and the outlier acceleration in healthcare spending (which is very much an estimate and seemingly overstated in the context of reported 1Q14 Hospital results – see yesterday’s note MEXICAN STANDOFF: CLAIMS vs. GDP vs. EXPECTATIONS) was a primary driver of the reported growth in Services Consumption in 1Q.
In the context of the above dynamics, the balance of risk to household spending growth is to the downside as the expanding spread between nominal spending and nominal earnings is unsustainable and any combination of higher savings, a deceleration in peak spending growth by the rich or lower estimates for healthcare spending growth would act as deceleration’ary pressures on PCE growth.
We saw all three of negative dynamics manifest to start 2Q as the savings rate ticked up (from 3.6% to 4%), the rich reduced spending on luxury goods and the estimate of healthcare consumption growth decelerated. The result = negative MoM growth in real consumption across services, durables, and nondurables with all 3 decelerating on a YoY & 2Y as well.
On the positive side, personal income growth, disposable personal income (DPI) growth, and aggregate private sector & government wage growth all improved marginally, sequentially. The sequential improvement is positive but not enough to support accelerating consumption growth, particularly alongside a higher savings rate, rising inflation, and a material slowdown in housing.
Growth estimates will get clipped (again) on today’s spending data, but consensus expectations for the balance of the year are still too high.
Enjoy the Weekend.
Christian B. Drake
Risk Managed Long Term Investing for Pros
Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.
Takeaway: Management and the sell-side are looking to poke holes in our thesis. There is one question that will settle the debate.
- PUSHBACK vs. REALITY: Management and the sell-side are trying to push back on our thesis. Below is a summary of what we've heard, and our response with incremental data and analysis addressing each counterpoint. Please let us know what other pushback your're hearing so we can address that as well.
SUPPORTING CHARTS & ANALYSIS: The initial version of this note was too long, so we cropped it, attempting to keep it text-light and chart-heavy. Happy to send over additional analysis or discuss in more detail.
THE ONE QUESTION THAT MATTERS: The only way management can settle the debate is by answering one question: "What percentage of your current customers have been advertising and/or generating revenue for YELP for more than a year?" Everything else is just noise.
PUSHBACK vs. Reality
Not surprisingly, management and the sell-side pushing back on our thesis; mostly through attacking the messenger, rather than the thesis itself (i.e. ad hominem). Below is a summary response to each attempted rebuttal, with supporting details in the next section.
- CAN'T CALCULATE ATTRITION RATE?: from the customer repeat rate. This is all about the language. When management says this, they are referring to calculating the annual rate from the quarterly customer repeat rate, they're not saying that we can't calculate the quarterly rate, nor does it address absolute levels of attrition.
- EFFECTIVE SALESFORCE? The pushback is that if YELP is having heightened attrition issues, it must have a very effective salesforce to compensate. The reality is the exact opposite. YELP's salesforce has been growing ~50% y/y each of at least the last 8 quarters. We estimate that its salesforce would be wildly unproductive if YELP wasn't having these attrition issues (i.e. unprofitable).
- COHORT GROWTH TOO STRONG: The pushback is that the strong growth in its early cohorts wouldn't be possible if YELP was having heightened attrition issues. The reality is that ~50% of US Businesses reside in these cohorts, and YELP was very slow to penetrate these cohorts in terms of both Claimed & Active Businesses.
- OTHER SERVICES SKEWING METRICS: The pushback is that customer repeat rate could be distorted in any one period from accounts intermittently deploying deals & gift certificates. The reality is that argument doesn't consider customer overlap. Regardless, quarterly fluctuations across less than 5% of its revenues don't matter; especially since its attrition issues are a recurring quarterly theme.
SUPPORTING CHARTS & ANALYSIS
Can't Calculate Attrition Rates?: There is no debating the quarterly attrition rates, or the magnitude of new and lost accounts. We can't calculate the exact annual rate, but that is function of the source of those lost accounts (prior vs. new customers), not whether YELP is actually losing them. Most advertising customers sign annual contracts, meaning most of its new business can't be lost within a year (without paying 2-3 month penalty). So the bulk of those lost accounts are coming from existing accounts signed before the most recent LTM period. Comparing cumulative lost accounts to prior-year period accounts, and cumulative new accounts to current period accounts, tells the story.
Effective Salesforce: The chart below measures New Revenue/Rep:
(New Accounts x YELP stated ARPU)/Trailing Sales Reps. The Reps are lagged on a 9-month basis (so any hires during the quarter or in the 6 months prior are assumed to generate no revenue). The difference in the two metrics below is our calculation for new revenue vs. what is implied by account growth in YELP's reported metrics; the latter suggests its salesforce isn't generating enough new business to cover their own salaries (note: this is base only, not inclusive of ancillary employment costs).
Cohort Growth: YELP had been slow to penetrate this segment, with only ~300 claimed businesses at the end of 2010 out of the total pool of at least 1.9M potential businesses in these cohorts. In short, most of the early cohort wasn't even on YELP by the end of 2010. Cohort growth remains strong because YELP didn't meaningfully penetrate this group until it started ramping its salesforce. Since 50% of US businesses reside in these early cohorts, we expect YELP will see decelerating growth in the later cohorts first given that included markets are relatively smaller.
Other Services Skewing Results: The pushback doesn't assume customer overlap between Local Advertising and Other Services (e.g. a customer could could stop offering a deal, but still advertise with YELP). Even if there weren't any overlap, Deals/Gift Certificates are less than 5% of revenue, so how much of an impact could these fluctuations in these services make on the overall quarterly attrition trend? Regardless, the attrition trend is too consistent for this argument to hold any water.
THE ONLY QUESTION THAT MATTERS
"What percentage of your current customers have been advertising and/or generating revenue for YELP for more than a year"
Answering this question will settle the debate, and is the only way that management can refute our analysis, or make any claims that it is not experiencing heightened attrition.
This question is basically a derivative of its customer repeat rate metric, so the only reason management would avoid the question is if they have something to hide.
We asked YELP's CFO this question, and didn't get an answer: YELP: Chat with the CFO (Recap). So if you have a line into management, see what they say. If you happen to get a number or a ballpark figure, let us know, and we'll let you know if the math makes sense.
The key to answer the answering this question will come from YELP's customers, not management. In this regard, stay tuned.
RISK TO OUR CALL
In light of M&A activity heating up, this remains the key risk to our call. A recent rumor suggests a major player is looking at YELP. While possible, we think it unlikely once the potential acquirer gets a look at their financials.
Management and the sell-side will try to spin the story any way they can to avoid addressing the core issues. Collectively, we haven't heard anything remotely close to a credible rebuttal to our thesis. But please, let us know what other pushback you're hearing so we can address that too. Truth be told, we're having some fun with this.
Hesham Shaaban, CFA
Client Talking Points
Another no volume rally on our hands – Total US Equity Volume yesterday was down -14% and 34%, respectively, compared to its one- and three-month averages.
Meanwhile, the 2.47% yield on the 10-year continues to signal that real-world inflation is slowing US consumption growth. The CRB Commodities Index (19 commodities) is up +10% year-to-date compared to US Growth (Russell), which is down -2.1%.
In Asia, it was a wet Kleenex response to that no-volume US rally overnight. South Korea was down -0.9% and Indonesia was down -1.8%. In Japan, the Nikkei fell another 0.3% after failing the TREND resist (again) and is now down -9.4% year-to-date.
|FIXED INCOME||24%||INTL CURRENCIES||23%|
Top Long Ideas
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.
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.
Three for the Road
TWEET OF THE DAY
Some days I feel like it’s still the 16th century – no enlightenment. @KeithMcCullough
QUOTE OF THE DAY
"The best way to have a good idea is to have lots of ideas." - Linus Pauling
STAT OF THE DAY
Australian recording artist Iggy Azalea has scored both the number one and two spots in the US Billboard Hot 100 chart, a feat achieved only once before – by The Beatles. (The Telegraph)