“Something deep in my character allows me to take the hits and get on with trying to win.”
First and foremost, happy belated Father’s Day to all the Dads out there who do what they do when no one is looking. As most of the young men playing in the 2014 World Cup will attest, doing the best that you can do out there, every day, is a grind.
For those of you who didn’t know who Messi was until your Dad’s Day dinner last night, what a gem this guy is in the arena that is soccer. Selfless, hard working, and talented, he is everything that the largesse of Argentina’s government is not.
At 26 years old, Messi is the Captain of Argentina’s hopes in Brazil. Like many athletes who represent their country, his maturity and leadership are beyond his years. On money, he said it “doesn’t thrill me or make me a better player… I’m just happy with the ball at my feet.”
Back to the Global Macro Grind…
With both the NHL and NBA seasons officially over (congrats Kings and Spurs!), it’s time for some World Cup Soccer while you attempt to risk manage what are becoming very thinly traded all-time-bubble-highs in US Equities.
In order to look forward, let’s take a step back. Unless you were long #InflationAccelerating last week, it was messy:
- SP500 and Dow were down -0.7% and -0.9%, respectively, last week (Dow barely up YTD at +1.2%)
- Russell 2000 resumed its bearish intermediate-term TREND at -0.1% YTD and -3.8% since March
- Industrials (XLI) led losers at -1.5% on the week as energy prices (producer costs) ripped
US Consumer Discretionary stocks (XLY) are still -1.6% YTD and continue to eat #InflationAccelerating:
- CRB Commodities Index (19 Commodities) was up another +1.5% last week to +10.6% YTD
- WTI Crude Oil led inflation melt-up at +4.2% on the week to +10.8% YTD
- Natural Gas and Coffee prices were up another +1% last wk to +14.8% and +50.6% YTD, respectively
While Total US Equity Market Volume was down -34% (vs. the 3 month average) on Friday’s +0.3% SPX negative breadth up-day, we finally got some real equity and commodity market volatility last week:
- Oil volatility (Oil VIX) was +34.3% last week to 19.47
- US Equity volatility (VIX) was +11.8% last week to 12.18
From a risk management perspective, rate of change in our model always matters – but it really matters when that directional rate of change (2nd derivative) signal occurs off its most asymmetric long-term TAIL risk point.
That’s where US Equity Volatility (VIX) was when it closed at 10.73 on June 6, 2014. While the perma-bulls on US GDP growth may think “it’s different this time”, it’s not. The VIX has never stayed below 10 – ever. And, as you know, never-ever is a very long time.
As gas prices rage higher alongside an all-time high in US rents (34% of the country rents and shelter is their #1 cost of living), prepare for another messy week of Consensus Macro expectations meeting their maker (bond market signaling growth is slowing):
- TUESDAY: US Consumer Prices (unlegislated taxes) for May should continue to accelerate
- WEDNESDAY: The Fed should talk down its US Housing and GDP forecasts now that they’re wrong on growth (again)
- THURSDAY: Uruguay plays England at 3PM EST #WorldCup
If England plays like they did against Italy, that could get messy too. As Spain learned against the Dutch, at first risk happens slowly – then all at once.
UST 10yr Yield 2.45-2.64%
Brent Oil 109.87-113.11
Natural Gas 4.65-4.83
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
Takeaway: Adding LULU to Best Ideas list as a Long. The story has gotten so bad that it’s good. 4 to 1 upside/downside. Conf Call and Deck to follow.
We’re adding LULU to our Best Ideas list as a long. As we articulated after the quarter (see below), we think that the risk/reward is too good to pass up. There’s a massive bifurcation between the growth potential at this company, and the lack of a plan to execute on it. If management continues to execute in a sub-par way, we see downside to about $31 (stress testing our model at 10x EBITDA). Not pleasant (18% downside), but not the end of the world from its current price ($37.61). If the company/Board adds the operational depth that is necessary, then the discussion returns to this company doubling or tripling its top line, and realizing $3.00-$4.00 in earnings power. Pick whatever multiple you want, but the stock price on $3.50 in earnings will push it through its all-time high of $82. LULU can make those decisions on its own, or we think that shareholders will emerge that will decide for them. Let’s also not rule out strategic buyers. That may or may not come to fruition, but it definitely lends valuation support to a stock trading at what we’d consider depressed levels relative to its realizable underlying growth potential. There’s no questioning that there’s weakness in the company’s core, but everybody – including a $37 stock – already knows that. After all, we saw eight downgrades on Friday and the stock closed up on the news. Ultimately, the blow-up risk on this long idea (in the $30s) is very low, and if LULU adjusts the depth and caliber of management and process to the size of its 3-year market opportunity (vs the legacy $500mm team and process in place now), then we think we could see $4bn in value creation, compared to about $800mm risk if the company continues to mire in incompetency and no one steps in to change it.
We’ll follow up with a conference call and accompanying deck outlining the steps that we think need to be taken to repair this company.
06/12/14 07:09 PM EDT
LULU = Activist Candy
Takeaway: Things are getting so bad that it’s good. If no one goes activist, we might. Shareholders deserve it. Still solid acquisition candidate.
Conclusion: We think that things are getting so bad, that it’s almost good. This company is in worse shape than the quarter suggests. The good news is that every problem we see can be fixed with the right talent steering the ship. The bad news is that such talent is nowhere to be found in Vancouver. The reality is that someone will have to step up and go all activist on LULU. Valuation is at a point where we could see that happening, which could be facilitated by recent tension at the Board level. And if it doesn’t happen, we might just lead the charge ourselves. Value needs to be unlocked. This is an amazing brand with solid global growth prospects. Management is too focused on recapturing Gross Margin that is a) lost forever, and b) something that investors won’t pay for without meaningful top line growth. If all else fails, there are no fewer than five public companies eyeing LULU, not to mention financial buyers.
We said that the risk/reward for LULU would really shape up on a miss. We’re standing behind that statement. If we had to be long or short at this point, we’d be long. Fortunately, we don’t have to be either. But let’s make one thing abundantly clear. Our view that it is a more favorable risk/reward is not because we have confidence in management executing a sound growth strategy. Quite the opposite, actually. This is as close to a ‘no confidence’ vote as we’ve come across with a management team in a long time. If this was a weak brand with questionable growth prospects, then it’d be game over. But the fact is, this is what we’d consider one of only a small handful of truly defendable brands in retail. When there’s a great brand with bad management, it is a situation that can be easily fixed. When even the greatest of managers are in charge of marginal brands, they’re usually terminal. This is definitely the former.
If the play here is for a rebound in the business under the current regime, then it is an absolute coin toss as to whether they succeed. We don’t like flipping coins. Process = Good. Coin Flip = Bad.
That means we need major change inside the company. John Currie (CFO) getting pushed out is a start. He was terrific for LULU in its early years (when Chip was still relevant), and sales were sub $500mm. But so many of us forget just how fast LULU grew, as sales were a mere $275mm in 2007. The skill sets throughout this company today are broadly consistent with those of an entrepreneurial early-cycle company. The problem is that LULU is going through puberty. It is sitting at $1.6bn in sales, and is in need of a completely different range of skills. Unfortunately, we’re not convinced that CEO Laurent Potdevin has them either.
WINNING VS LOSING: (LULU should look 948 miles South to see how it’s done)
We think it’s so ironic that LULU reported earnings within 14 hours of Restoration Hardware (RH – our top long idea). Some similarities are striking. Both are $1.6bn in revenue, both serve a very high end consumer in a fragmented and hyper-growth piece of the retail space, and both can conceivably achieve $4-$5bn in revenue over a 5-year time period. The big difference is that the CEO of RH (who many people hate) got on the call, played offense, took control and set the investment narrative. He conveyed top to bottom what his vision is for the company, what it will mean for long-term revenue growth, what the margin implications are, and what kind of capital is needed to achieve those goals and maximize ROI. Laurent said…well…not that.
LULU, instead, was extraordinarily defensive. Granted, weak trends will put anyone on defense. But we did not listen to the call and think “hey, these guys really understand their business.” There was no talk about long term growth targets, no crisp delineation of key growth initiatives, with the only real numbers given around share repurchase and gross margin goals.
Let’s address the gross margin issue for a minute. The fact that this company leads in with recovery of gross margins to a mid-50s level is preposterous. If the company can recapture a few points in margin over time, then great. But there’s no way we (or most others) will pay up for that now. This is a mid-cycle growth company that is growing outside of an extremely profitable core (dresses, denim, men’s – fine, but not Gross Margin Accretive). There is one thing and one thing only that most investors will pay for with LULU – top line growth. Yet the only top line growth drivers they really address on the calls are little near-term tactical patches that are irrelevant in the context of investing in Retailers.
THE ULTIMATE PROBLEM
What this means for us, is that the problem is still…you guessed it…Chip (Wilson, Founder). As much as everyone likes to say that Chip stepped away last year, the fact is that the guy still controls 27% of the voting stock. Voting stock aside, his influence inside the hallways of Lululemon trumps that of the CEO that he hand-picked and pushed through the Board approval process. John Currie was Chip’s CFO, and when the Board decided to push him out over the past week, we think that’s what prompted Wilson to vote against the re-election of the two Board members who caused it (one of whom replaced Chip as Chairman).
What’s nice about this is that the Board is no longer uniformly ‘Chipped’. The more the Boardmembers band together and show Chip that he’s no longer the boss, the better chance this company has of succeeding.
The reality with all of this is that someone will have to step up and go all activist on LULU. Valuation is at a point where we could see that happening. And if it doesn’t happen, we might just lead the charge ourselves. Value needs to be unlocked.
THE ULTIMATE CHANGE: AN OUTRIGHT SALE
One consideration is whether the company’s troubles put it in play. The answer there, we think , is Yes.
- Nike is a perennial possibility. Though its strategy is to build instead of buy (and it passed when LULU was at $8) the fact is that it has been chasing LULU for years, and LULU still is far more authentic for Yoga than Nike is. Low probability. But something to consider.
- Kering is in print saying that it wants to broaden its portfolio of sports brands (the owner of Gucci also owns Puma, Tretorn and Volcom). Does not hurt that it is a French company and LULU has a French speaking CEO.
- VFC is possible. But VFC is rumored to be buying everything. It has Lucy, which is a poor-man’s version of LULU. It’d be interested at the right price.
- PVH is an interesting thought. It’s business is in trouble, and what does PVH do when its core weakens? It does a HUGE acquisition. Enter LULU.
- Here’s a dark horse…but GPS is not completely out of the realm of possibility. Granted, it’s eating LULU’s lunch with Athleta in markets where the brands overlap. But GPS could handle it financially, and it would give the company some organic growth.
Takeaway: Here are Hedgeye CEO Keith McCullough's refreshed levels for our high-conviction investing ideas.
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
Anything longer than 3 years is unpredictable.
Takeaway: Here's a quick look at some of the top videos, cartoons, market insights and more from Hedgeye this past week.
James Grant, editor of Grant's Interest Rate Observer, discusses his latest thoughts on the economy, monetary policy, market froth, gold & where hidden investing opportunities may lie with Hedgeye CEO Keith McCullough in this edition of Real Conversations.
Gaming, Lodging, & Leisure Sector Head Todd Jordan highlights the risks for Macau gaming stocks with the impending deceleration in the mass business.
Hedgeye CEO Keith McCullough runs through the top three things in his macro notebook from Wednesday, noting that policies to inflate in both the U.S. and Europe result in... wait for it... inflation!
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Have you noticed more Promoted Tweets or other advertisements on Twitter's Mobile App? Click here to view the poll and results.
In the video below our Internet & Media Sector Head Hesham Shaaban weighs in on Twitter’s advertisement strategy and whether it is sustainable.
Why There Seems To Be No Recovery In The First Time Homebuyer Market
We wanted to take a moment to flag the unstoppable force that is student loan growth in this country. Click here to continue reading.
Getting 'Tipsy' Ranting About Inflation
Inflation is accelerating and we continue to think investors should proactively prepare their portfolios for this economic phase change. Click here to continue reading.
Restoration Hardware: Is $RH Best Idea In All Of Retail?
This quarter served as another milestone for Restoration Hardware (RH) in its march towards $11.00 per share in earnings, and additional proof for us that this is perhaps the best idea in all of US retail. Click here to read more.
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Takeaway: Current Investing Ideas: GLD, HCA, HOLX, LM, LO, OC, RH, and TIP
Below are Hedgeye analysts' latest updates on our eight current high-conviction investing ideas.
We also feature two institutional research notes from earlier this week and one special video which offer valuable insight into the markets and economy.
*Please note that CEO Keith McCullough's updated levels for each stock and ETF will be sent separately.
HEDGEYE CARTOON OF THE WEEK
GLD – Coming off a jump after last week’s ECB meeting to close at +75 bps on Thursday, Gold closed down a meager -4 bps on Friday on U.S. equity volume that was -32% below the 3-month average. This week it’s grinded higher to close in the green every session. Gold is up 6% YTD and increased +2.4% since last Wednesday’s close (+1.7% on the week).
Sentiment, as measured by CFTC net futures and options contracts, which shifted from net long 48K contrcats at the beginning of the year, to net long 172K on March 18th when the Euro peaked, decreased for four consecutive weeks to 77K (32% below its 6-month average). As of Thursday’s close, front month implied volatilities were trading -7.0% below 1-month averages, -20% below three month averages, and 25% below 6-month averages. This shift provides some uncertainty into the FOMC next week, but we remain bullish on Gold in the face of consensus growth estimates that are still positioned for disappointments.
Regardless of recent geopolitical developments driving prices, prices ARE nevertheless higher, making these already difficult comps more difficult as the commodity squeeze continued this week:
- CRB: +1.50%
- Brent: +4.28%
- RBOB Gasoline: +4.2%
Consensus GDP estimates for 2014 full year are still in the +2-3% range. After the negative Q1 GDP revision to -1.0%, this implies a +4% increase from here the rest of the year. Considering that services consumption was a point of strength made up mostly by a significant uptick in healthcare service consumption, a further downward revision on June 25th is probable. The census bureau negatively revised the calculation that feeds the healthcare portion of services spending (17% of total services consumption) this week. This affirming data point perpetuates our view that growth comps look more difficult on the margins. Why does this matter for Gold? Because the prospect of an easier than expected fed in 2H, if not next Thursday, is likely to continue.
Our view on Gold’s strong interaction with interest rates and policy is well-understood. Correlations get stronger and weaker over time, and in low volatility periods of market complacency (VIX near all-time lows, bull/bear spread at YTD highs) Gold tends to run tighter negative correlations with the USD and Treasuries. In this complacent environment, growth, interest rates, and policy drive the interaction. The trailing 1, 3, and 6 month correlations held steady near YTD highs at -0.69, -0.63, and -0.64 respectively.
HCA – Editor's note: Healthcare sector head Tom Tobin added HCA Holdings to Investing Ideas exactly one year ago today on 6/14/13. Shares of HCA have more than doubled the S&P 500 since, gaining over 38%.
Back in 2011, when we first become interested in HCA Holdings on the long side, the company and the industry had just come through one of the more difficult times for the industry. Admissions were soft, there was an unexplained shift away from higher acuity cases, and implantable cardio defibrillator (ICD) implants were declining dramatically after research showed surgeons were overusing them. Presently however, we are starting to get marginally cautious as we are noticing several of our Key Drivers show some mixed results.
Maternity (something we have written about extensively) may still be a bright spot when we update data from the US Census Bureau later this month. But we are looking at a mixed bag in the shorter term among other important key drivers.
PPI for Medical and Surgical Catheters: If the relationship continues to hold between the PPI for Medical Surgical Catheters and US ICD sales, we would expect revenue trends within Cardiology (15% of Hospital revenue) to be under some pressure. We might even go so far as to look for a short among BSX, MDT, or STJ, the major ICD manufacturers.
Local Government Employment: As we witnessed the recovery in Orthopedic growth in the US, the best leading indicator has been Local Government Employment. There may indeed be a direct relationship between a Total Knee Replacement surgical case and Local Gov’t Employment growth given these employees are much older, carry generous medical benefits, and are a significant percentage of the workforce. But it may also reflect a broader demand dynamic that includes positive trends in housing, property taxes, and sales taxes. We think there may be as many as 300,000 knee replacement cases that were deferred over the last 5 years. So, a persistent turn would help the Orthopedic revenues, the largest contributor at 17% of total inpatient revenue.
Hospital Employment: The long pause in hiring by hospitals may have hit a low in 1Q14, although so far in 2Q, the recovery is modest at best. It’s possible hospitals were preparing for the uncertainties of the Affordable Care Act and simply stopped hiring. Maybe it was the weather in 1Q14. Either way, we’d like to see a consistently improving trend.
PPI Hospitals Commercial Insurance: The trend is weak for this critical revenue and profit driver. Medicare pricing has already been under pressure under ACA related reductions. We really need to see this series recover over the coming months as comparisons get easier.
HOLX – Healthcare sector head Tom Tobin has no update on Hologic this week. Tobin reiterates his high-conviction call on the stock.
LM – It was another week of fixed income inflow from the mutual fund channel which continues to support owning and adding to shares of Legg Mason. While the $1.1 billion that came into all bond funds during the most recent 5 day period was below the weekly year-to-date average of $2.0 billion per week thus far in 2014, the quarter-to-date trends are undeniable that defensive fixed income managers are the place to be in the asset management sector.
Thus far in the second quarter, fixed income funds have netted over $20.0 billion, versus all equity funds which have taken in just $6.8 billion. This trend will flow through to the group as bond assets increase faster than equity fund assets, and thus leading fixed income managers like Legg have faster profit growth.
In addition, we continue to point to Legg’s excess capital of $1.0 billion that can be used for share repurchases and acquisitions as creating alpha, or outside of market returns, as a strong reason to be involved in the story.
LO – Lorillard was up just slightly on the week. The investment community still wonders if LO will be taken out, likely by Reynolds American (RAI).
We continue to suggest that investors hold this stock into potential news of the buyout, or until our long-term fair value price of the stock at $80/share is realized. We also continue to highlight that the company’s powerful earnings generation is anchored on its advantaged tobacco and e-cigarette portfolio.
Bottom line: We do not think LO will be imminently purchased and are staying long the stock that we added to Investing Ideas on 3/7/14.
OC – There were two positive and noteworthy developments supporting our bullish case on Owens Corning this week:
First, nonresidential construction activity continues to pick up heading into the summer. The Dodge Momentum Index (a measure of nonresidential building projects in planning by McGraw-Hill Construction) ticked up 2% month-over-month and is up over 8% year-over-year. It was the highest number since mid to late 2004. The Dodge momentum indicator tends to lead nonresidential spending by a full year.
Second, the Census Bureau’s nonresidential public construction spending is stabilizing showing a 2% gain year-over-year for April. The April reading was the highest in five years.
RH – This quarter served as another milestone for Restoration Hardware in its march towards $11.00 in earnings, and additional proof for us that this is perhaps the best idea in all of US retail. The stock’s move above $80 this week is obviously nice…we’ll definitely take that. But it’d be a mistake to lose sight of the very real potential for this to be a $200+ stock over a 3-4 year time period. The EPS CAGR RH we’ll need to get there is over 40%, and our research says it’ll get there. What multiple is fair for a 40% EPS grower that earns $11? Let’s say 20x, conservatively. If we’re right on earnings, we can build to a stock well above $200. In other words, the call is not done. It’s really just beginning.
Think about it like this: RH went over six years shrinking its real estate footprint. But starting next quarter, it will go on a 5-7 year tear as it executes on its store growth strategy. Next year alone, we should see square footage grow in excess of 40%. And it’s doing this while it simultaneously executes its category expansion plan – such as kitchens, which alone should be a $2bn business.
Our point is that it’s easy to get hung up on a given quarter with this (or any) company, and this quarter the stock is definitely getting its due. But if you look at a the story bigger picture, you’ll see that it consolidated for six years, and now should gain share of the market at an accelerated rate for another six years. The bottom line is that it seems a little short-sighted from where we sit to think that just because the stock is hitting new highs that the opportunity is over.
TIP – Last Friday, we added the iShares TIPS Bond ETF TIP to Investing Ideas list and continue to favor inflation-protection in the context of what we see as developing cyclical and structural inflationary pressures domestically.
Below is a list of relevant high-frequency economic data that was released this week:
- MAY Import Price Index: +0.4% YoY from -0.4% prior. In line with our expectations, import price inflation should continue accelerating, on the margin.
- MAY Headline PPI: +2% YoY from +2.1% prior; ex-Food & Energy, PPI accelerated to +2% YoY from +1.9% prior. A rebound in food and energy inflation should continue to pressure domestic producers from a COGS perspective (e.g. Brent Crude Oil is up over +4% in the week-to-date).
- Per the MAY NFIB Small Business Optimism Index: “Seasonally adjusted, the net percent of owners raising selling prices was a net 12 percent, unchanged from April after an 8 point rise in March. Overall, there is more upward pressure on prices… Seasonally adjusted, a net 21 percent plan price hikes (down 1 point [from April]). If successful, the economy will see a bit more “inflation” as the price indices seem to be suggesting.”
Inflation forecast summary: Trend-line sequential momentum accelerating? Check. Annual comparisons getting easier on the margin? Check.
All told, the rate of consumer price inflation remains poised to accelerate throughout the year. Take advantage of this macroeconomic catalyst by allocating capital to TIPS (etf: TIP).
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Every month, we read the MCD press release on monthly sales trends expecting to see something more writes restaurants sector head Howard Penney.
Macro analyst Christian Drake takes a deep look into the data and notes that domestic growth estimates continue to decline as the economic data comes in.
Among other investing ideas and kernels of wisdom, James Grant, editor of Grant's Interest Rate Observer explains to Hedgeye CEO Keith McCullough why he believes investors should be buying gold.
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