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Stock Report: Och-Ziff Capital Management Group LLC (OZM)

Stock Report: Och-Ziff Capital Management Group LLC (OZM) - HE OZM table 6 27 14

THE HEDGEYE EDGE

The combination of a slow start to 2014 performance and a renewed focus on a pending legal issue has knocked Och Ziff (OZM) shares to an attractive level for new long positions and we are adding the stock to our Best Ideas list.

 

  • OZM is exhibiting the fastest organic growth (flows) in the asset management industry YTD.
  • OZM shares are trading at a valuation level that has historically been a great entry point for intermediate to longer-term investors, as it is being assigned almost no value whatsoever for any potential incentive fees. 
  • Current concerns over an SEC subpoena seem significantly discounted in shares, though this clearly remains the one risk that is difficult to handicap.
  • Investors get paid to wait for the valuation to mean revert higher back to normal levels. OZM should pay a dividend equivalent to a yield of ~5% even with no incentive fees. Should incentive fees meet expectations for the year, the yield would be closer to ~10% at the current valuation.

TIMESPAN

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

We are taking the view that the intermediate to long term duration is positive for OZM shares and that outside of some negative short term issues the company is displaying good, solid fundamentals including an industry-leading organic growth rate and a valuation reflecting only its base management fees (with no multiple on its highly-accretive incentive fees). Historically, when shares have traded with no multiple on incentive fees it has been a good time to buy the stock. We calculate that the stock has over 30% upside just from mean reversion to its historical multiple versus the traditional asset managers and just 13% downside should the stock fall back to its all time lows on this metric. This creates a favorable upside/downside ratio of 2.5-to-1 which does not include the firm's estimated forward dividend yield of 9.9% (although we acknowledge roughly 4.4% of this forward yield is dependent on the firm earning incentive fees this year). 

 

 

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

The $18.8 trillion U.S. pension fund market is continuing to incrementally allocate additional funds to the alternative asset allocation which would primarily benefit the biggest hedge funds, private equity, and real estate firms that have leading scale and performance. Potential net inflows of $180 billion per year on the current $3 trillion in U.S. alternative assets would produce an organic growth rate of ~6%, well in excess of the 2% rate of growth within the nascent return of equity fund flow in the mutual fund industry. As a top five hedge fund by assets-under-management with industry leading historical performance, OZM stands to benefit from this trend.

 

We estimate that the pension fund opportunity is already showing up in Och Ziff results. Year-to-date, OZM has put up an industry-leading 24% organic growth rate (annualized net new asset growth as a percentage of beginning assets) thus far in 2014. By comparison, Och Ziff's YTD growth rate compares to much more modest growth rates at T Rowe Price, which has generated just 5% annualized growth, BlackRock which is annualizing at just 2.4% growth, and Franklin Resources which actually has a negative decay rate in its client assets currently. 

 

Currently, the confluence of a slow start to 2014 performance for the company and ongoing legal headlines have knocked OZM shares to levels solely on base management fees that historically have been near trough levels. Och Ziff shares are currently trading at just 16.6x base management fee earnings, a 23% discount to the long term average of 21.7x. Furthermore current valuation levels are approaching a range where the stock bottomed on this metric in the middle of 2011 and at the end of 2008 at just over 12.0x management fees.

 

OZM shares are in a growth category in the alternative investment management industry and the firm is putting up industry-leading organic growth in client assets on new, record AUM. The recent slow start to the year in the firm's performance and ongoing legal headlines have knocked the stock down to a range which historically has been a good entry point for intermediate to long term shareholders. Despite this slow start to 2014 investment performance, we point to a industry leading 20 year track record of strong performance that make any short term performance issue less worrisome. In addition, the Street's current assumptions around important year-end incentive fees don't seem unachievable at this point considering the ground that the firm needs to make up at this point is not outside of their historical annual compounded returns. As a result we are adding the stock to our Best Ideas list as a long position.

ONE-YEAR TRAILING CHART

Stock Report: Och-Ziff Capital Management Group LLC (OZM) - HE OZM chart 6 27 14



Retail Callouts (6/27) - KATE, NKE, WMT, TGT, FL, AdiBok

Takeaway: New KATE Director adds great e-commerce cred. FL changes up Skate Biz. WMT plays the gender card. Adidas not marketing Suarez -- shocker.

COMPANY NEWS

 

NKE - 4Q14 Earnings -- see our note from last night "NKE - Need More Cowbell"

 

KATE - Kate Spade & Company adds Doug Mack to BoD

(http://www.fibre2fashion.com/news/garment-company-news/newsdetails.aspx?news_id=165172)

 

"Kate Spade & Company announced the election of Doug Mack to the Company's Board of Directors. Mack's election brings the number of Directors to eleven. His initial term as director is effective immediately and will expire at the Company's 2015 Annual Meeting of Stockholders."

 "An eCommerce innovator, Mack has extensive knowledge in key retail areas including technology, marketing and customer experience. In April 2014, he became CEO of Fanatics, Inc., the world's leading retailer of licensed sports merchandise and a billion dollar eCommerce company."

"Previously, Mack served as CEO of One Kings Lane, a leading online destination for home design, which he joined as a $10M start-up and led its growth into an Internet Retailer Top 100 company.  Prior to One Kings Lane, Mack was CEO of Scene7, the leading rich-media platform for eCommerce, which has powered websites for more than 1,000 global retailers."

 

Takeaway: Governance was not a problem for KATE or FNP in recent years. But this addition to the board is a winner. We don't know Mack, yet, but his accomplishments are right in line with the kind of expertise we want to see added to KATE's Board.

 

ADS - Adidas Will not use Suarez for new Marketing

(http://www.wwd.com/footwear-news/markets/adidas-reserves-judgement-on-suarez-bite-7763362?module=Footwear%20News-Markets-main)

 

"Adidas has said it has no plans to use Luis Suarez for future marketing during the World Cup, after FIFA banned the 27-year-old player for nine games for biting another athlete during Uruguay's match with Italy."

""Adidas certainly does not condone Luis Suarez’s recent behavior and we will again be reminding him of the high standards we expect from our players," the company said in a statement, adding that it fully supports FIFA's decision."

 

Takeaway: Was a press release really necessary for this? That's like Livestrong saying that they will no longer use Lance the day after he admitted to being one of the most notorious liars in sports history. Some things are best left unsaid.

 

 

TGT - Target’s 124 stores in Canada all receive LEED certification

(http://www.chainstoreage.com/article/target%E2%80%99s-124-stores-canada-all-receive-leed-certification)

 

"Target announced that all 124 store locations it has opened across Canada in 2013 have been awarded Leadership in Energy & Environmental Design (LEED) certification."

"Target stores were awarded LEED certification through the U.S. Green Building Council's (USGBC) LEED Volume Program, which streamlines the certification process for buildings in both Canada and the U.S In order to obtain certification. Target stores had to undergo various rounds of audits throughout 2013, and meet stringent criteria across five LEED categories, including: sustainable sites, water efficiency, energy and atmosphere, materials and resources, and indoor environmental quality."

 

Takeaway: That's great that the stores are finally LEED certified…just in time for a new CEO to make the decision to close them down.

 

WMT - Walmart shows support of women-owned businesses with new logo

(http://www.chainstoreage.com/article/walmart-shows-support-women-owned-businesses-new-logo)

 

"Walmart, along with the Women's Business Enterprise National Council and WEConnect International, on Wednesday joined forces to establish a unique logo for retail packaging of products from women-owned businesses. The new logo will bring consumer recognition of products provided by women-owned businesses on store shelves both in the U.S. and international markets."

 

Retail Callouts (6/27) - KATE, NKE, WMT, TGT, FL, AdiBok - wmt1

 

Takeaway: This is nothing compared to the major win WMT had in China earlier this week, but give the company a little credit -- at least it's trying to be a leader in gender equality.

 

 

FL - Foot Locker Revamps Skate Business

(http://www.wwd.com/footwear-news/business/foot-locker-revamps-skate-business-7767498?module=Footwear%20News-Business-main)

 

"In a strategic move, Foot Locker Inc. is transitioning its skate business from its CCS banner to Eastbay."

"Over the next several months, the CCS digital sites will continue to service skate consumers with an offering of footwear, apparel and accessories. However, going forward, these shoppers will be directed to Eastbay.com for such goods."

"The move will allow New York-based Foot Locker to consolidate the purchasing, marketing and distribution of skate product from vendors including Nike, Adidas and Vans."

 

Takeaway: FL hinted that this coming, but regardless, it makes sense. Eastbay is a great asset, CCS is not. They're focusing and leveraging the best parts of the portfolio. We don't love FL here, but the company is making a lot of good moves. The biggest risk is what was once the 'Hick's going to JC Penney' risk is turning into the 'JC Penney, Kohl's or Target' risk.

 

OTHER NEWS

 

ITX - Venezuelan Zara Binge Gives New Meaning to Fast Fashion

(http://www.bloomberg.com/news/2014-06-26/venezuelan-zara-binge-gives-new-meaning-to-fast-fashion.html)

 

"On the rare day that Zara had clothing to sell in Venezuela, the fast fashion was disappearing even more quickly than usual."

"About 300 people lined up at midday outside a Zara store in the Sambil shopping mall in Caracas last week, seeking clothing as the country’s currency controls have emptied stores of imports. Shoppers waited their turn after picking a number under the eye of security guards, who controlled access to the shop."

"The chain was able to dress up mannequins and restart business after the government granted access to cash at a preferential rate to the franchise operator for Inditex SA (ITX) in the Latin American country."

 

IKEA - Ikea to raise minimum wage for U.S. workers based on cost of living in each area

(http://www.chainstoreage.com/article/ikea-raise-minimum-wage-us-workers-based-cost-living-each-arEa)

 

"Ikea is planning to raise the hourly minimum wage for employees in its U.S. stores by an average 17%, beginning January 1, 2015. In a move unprecedented among U.S. retailers, Ikea’s wage hike will vary in that it will be based on the cost of living in each store’s location. According to Ikea, the change will take the average minimum hourly wage in its existing U.S. stores (as of June 2014) to $10.76, a $1.59 or 17% increase, and $3.51 above the current federal minimum wage."


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SLOWING GROWTH, ACCELERATING INFLATION, & LOW VOLATILITY

Client Talking Points

JAPAN

So, what gives in Japan? Inflation! CPI in Japan accelerated +3.4% year-over-year.  This was the highest pace in 32-years for Japanese inflation. The fact of the matter is that the Japanese will tell you that once you factor out the sales tax impact, there was actually a slight drop in CPI.  That said, even the Japanese labor market is showing inflationary signs as the jobs-to-applicants hit a 22-year high at 1.09.  

VIX

Robert E. Whaley, a professor at Vanderbilt University’s business school, who is credited with developing the VIX for the Chicago Board Options Exchange in 1993, had this to say about the VIX being literally at an all-time low, “I wouldn’t be worried about it.” While Professor Whaley, aka the “Father of the VIX,” isn’t worried, that’s not necessarily a reason for us not to be worried.  The risk range for the VIX this morning is 10.61-12.94.

The U.S. FED

The Fed’s balance sheet continues inflating at an almost staggering rate. In total, the Fed’s balance sheet is at an astounding $4.4 trillion.  Certainly, tapering is slowing the growth of these assets on the Fed’s balance sheet, but what, exactly, happens when the Fed starts to sell these assets?  At over 25% of GDP, it is worth sniffing around this question.

Asset Allocation

CASH 14% US EQUITIES 6%
INTL EQUITIES 15% COMMODITIES 24%
FIXED INCOME 26% INTL CURRENCIES 15%

Top Long Ideas

Company Ticker Sector Duration
HOLX

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.

OC

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.

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.

Three for the Road

TWEET OF THE DAY

More than a fourth of QSR users engage with at least one QSR on social media sites. pic.twitter.com/SPwRhr6VMA

@HedgeyeHWP   

QUOTE OF THE DAY

“Most of the important things in the world have been accomplished by people who have kept on trying when there seemed to be no hope at all.”

-Dale Carnegie

STAT OF THE DAY

Nike’s Gross Margins were up 169bps to 45.6%, its highest rate in 4-years.


CHART OF THE DAY: Japan Gets Its Inflation

Takeaway: CPI in Japan accelerated +3.4% year-over-year, the highest pace in 32-years. Japanese bureaucrats wanted inflation. Now they've got it.

 

CHART OF THE DAY: Japan Gets Its Inflation - Chart of the Day


Pepé Le Pew

“Keep it simple. Tell the truth.  People can smell the truth.”

-Steve Wynn, Chairman & CEO of Wynn Resorts

 

I ran over a skunk on the way to work this morning.  Accidentally, of course. But regardless it still did not smell very good.  That’s the thing with skunks; they sort of surprise you with their malodorous nature. 

 

For those of you that don’t know him, Pepé Le Pew is a French cartoon character that was first introduced in 1945.  Pepé is a French skunk who strolls around Paris looking for love.  Unfortunately, he has two big things going against him.  First of all, he’s a skunk, so he smells.  Second, he’s a tad bit aggressive and reluctant to take no for an answer.

 

Pepé Le Pew - skunk2

 

Now if that sounds a little bit like the U.S. equity market right now, it probably should. As we’ve been flagging here at Hedgeye (somewhat “aggressively” at times) volatility in the U.S. is at a level that is signaling that all is well in the world. Between you and me, that kind of stinks.

 

I read an interesting article in the Wall Street Journal (Media 1.0) yesterday discussing the volatility and the VIX.  It quoted Robert E. Whaley, a professor at Vanderbilt University’s business school, who is credited with developing the VIX for the Chicago Board Options Exchange in 1993.  Here’s what he had to say about the VIX being literally at an all-time low:

 

“I wouldn’t be worried about it.”

 

Indeed.  And if an aggressive skunk happens to be pestering you in Paris, no need to worry about that either.

 

Back to the Global Macro Grind

 

While Professor Whaley, aka the “Father of the VIX,” isn’t worried, that’s not necessarily a reason for us not to be worried,  despite the fact that this morning, the global equity markets are decidedly not worried.  China is down -0.11%, Europe is up small, and the U.S. equity futures are down small.  Frankly, the only excitement overnight is that the Nikkei in Japan is down just over a -1%.

 

So, what gives in Japan? Are you sitting down? Inflation! Yup, Japan, the home of generational deflation, is actually experiencing inflation.  In fact, CPI in Japan accelerated +3.4% year-over-year.  This was the highest pace in 32-years for Japanese inflation. The Japanese bureaucrats wanted inflation. Now they've got it.

 

The fact of the matter is that the Japanese will tell you that once you factor out the sales tax impact, there was actually a slight drop in CPI.  That said, even the Japanese labor market is showing inflationary signs as the jobs-to-applicants hit a 22-year high at 1.09.  In theory, a tight labor market should lead to increased wages and eventually more purchasing power for the consumer. Translation? Organic inflation.

 

Ultimately, the challenge with either inflation driven by a tight economy or, conversely, driven by overly dovish monetary policy is that inflation slows growth.  In the U.S., the counter argument to our view that inflation will slow grow is that even though the CRB Commodities index is up double digits on the year, commodities are a relatively small portion of the consumer’s annual spend. In part this is true, although much less so in emerging economies.

 

In fact, the WSJ this morning referenced the “fragile five” economies of Turkey, India, Indonesia, South Africa, and Brazil as economies that are particularly subject to the negative impact of commodity inflation.  The challenge with trying to fight inflation for the central banks in these countries is that growth is not at abnormal levels, so any rate hikes would slow it even more. Yes, indeed, monetary inflation stinks!

 

Speaking of inflation, the Fed’s balance sheet continues inflating at an almost staggering rate:

 

  • Holdings of US Treasury securities were $2.4T on 25-Jun, +$5.5B w/w and +$469B y/y;
  • Holdings of mortgage-backed securities were $1.7T on 25-Jun, ($4.5B) w/w and +$456B y/y; and
  • Holdings of federal agency debt securities were $43.7B on 25-Jun, unch. w/w and ($27B) y/y.

In total, the Fed’s balance sheet is at an astounding $4.4 trillion.  Certainly, tapering is slowing the growth of these assets on the Fed’s balance sheet, but what, exactly, happens when the Fed starts to sell these assets?  At over 25% of GDP, it is worth sniffing around this question.

 

As it relates to GDP, my colleague Darius Dale wrote a very thoughtful note earlier this week that again emphasized that the Fed is “always wrong on growth.”  Specifically, since 2012 the Fed has been wrong on growth by an average of 113 basis points.  No small potatoes. The takeaway from the Fed (and virtually all of Wall Street) being wrong on growth is that Fed may actually surprise us with its dovish policy.  As Darius writes:

 

“As it relates to actual macroeconomic analysis, the doves are definitely starting to cry at the Fed. In a fantastic article today, Reuters journalist Howard Schneider walks though the current debate being held amongst members of the Federal Reserve and its regional banks. Specifically, the Yellen-led institution is openly debating pushing out their forecasts for labor market tightness, citing both new and old analyses in the process.

 

The key takeaway is that the FOMC is setting up to surprise both buy-side and sell-side consensus to the downside with respect to tightening monetary policy. A less-tight labor market in the interim means the Fed can remain “accommodative” for longer – which is exactly what is being priced into the interest rate markets. Expectations for a 2015 Fed Funds Rate hike are down -27% on average, across the curve, from when we correctly introduced this bold prediction back in JAN.”

 

Slowing U.S. growth… accelerating inflation… low volatility… Yup, it might make sense to your nose right now.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.46-2.60% (bearish)

SPX 1 (bullish)

VIX 10.61-12.94 (neutral)

USD 80.01-80.45 (bearish)

Brent Oil 112.38-115.49 (bullish)

Gold 1 (bullish)

 

Keep Your Head Up,

 

Daryl G. Jones

Director of Research

 

Pepé Le Pew - Chart of the Day


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