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Creative Mistakes

This note was originally published at 8am on June 26, 2014 for Hedgeye subscribers.

“Creativity is allowing yourself to make mistakes.  Art is knowing which ones to keep.”

 -Scott Adams


As you may already know, Scott Adams is the creator of the cartoon "Dilbert." The cartoon makes light of the corporate world and was originally created in the early 1990's as Adams was being "downsized" from a major corporation.  Even though Adams isn’t a professional investor like most of you reading this, his quote above is remains rather apropos to the investing world.


Most great portfolio managers and analysts are also incredibly creative.  They are creative in the types of analysis they employ and they are creative in their questions for management. But perhaps most importantly, they are creative in idea selection.  The true skill, of course, then comes in knowing which creative ideas to keep.  Some call this risk management.


We hired a cartoonist recently here at Hedgeye. Cartoons are a great way to communicate our often contrarian investing ideas and themes.  Take for example the cartoon posted below that we included in our 100-page deep dive short call on United Airlines (UAL) earlier this week.


The cartoon emphasizes the craziness (at least from our perspective), of UAL’s accounting policies.  Not unlike our short calls on certain stocks in the Master Limited Partnership (MLP) sector, we have a difficult time reconciling the valuation with UAL with its underlying cash flows.  That said, we also know, to paraphrase Keynes, that the market can remain irrational longer than many investors can stay solvent.


As it relates to airlines, and specifically UAL, longer term we much prefer Warren Buffet’s maxim on the industry. That is, the best way to become a millionaire is to start a billionaire and buy an airline!


Creative Mistakes - United Airlines cartoon

Back to the Global Macro Grind...


Our research team has been busy generating some very contrarian and well researched investment ideas lately.  This morning I wanted to highlight a few.  (As always, if you want more details on the idea and would like to review the more detailed work, please email sales@hedgeye.com for details on how to subscribe.)


First up on the runway is naturally United Airlines (UAL).  The core of thesis per our industrials sector head Jay Van Sciver is as follows:


“By our estimates, the underlying UAL operations have generated a cumulative loss over the past two years. Further, UAL has burned over $1.4 billion in free cash flow, defined as Cash Flows from Operating Activities - Net Capital Expenditures, in the last two calendar years. As the high cost U.S. major since AMR's bankruptcy-related cost cuts, we expect UAL to struggle to improve its operations relative to competitors. In our view, it is relative costs that matter. We expect UAL to continue to underperform lower cost airlines.  


This is just the tip of the proverbial iceberg.


In our Chart of the Day below, we highlight this free cash flow deficit versus its peer group.  As the chart shows, UAL appears to have severely disadvantaged economics as compared to its peers.


The second idea I wanted to highlight is Lululemon (LULU), a contrarian long idea.  For many a thoughtful short seller, LULU has been one of the better short plays in retail of late. Rightfully so.  Management appears to be making one misstep after another and doing virtually everything in its power to ruin what is actually a solid brand and product.  The core of our long thesis according to our Retail sector head Brian McGough is as follows:


“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.”


Finally, the last idea (and probably most controversial idea I wanted to highlight) is our short call on YELP.   From a stock price perspective, on the short call we’ve been early, but we are getting increasing confidence in our thesis the more work we do.  Our Internet sector head Hesham Shabaan actually had a call recently with the chief financial officer of YELP to discuss, which is at the core of our short thesis.  This was his takeaway from that call:


“Where we didn’t get a tremendous amount of detail was when we delved into its customer repeat rate, which is how we are backing into its attrition rate.  We did spend some time discussing this topic, and while he wouldn’t explicitly verify or refute our attrition thesis, he did say that YELP has never said that they are not losing customers after we delved into its reported numbers.


The question he wouldn’t answer, which is a spin off of its customer repeat rate metric: “How many of your current customers have been generating revenue for YELP for over a year?”


This is the most important question because it drives at the heart of the retention issue we have been highlighting.  We estimate that in any given period that the overwhelming majority of YELP’s reported Local Business Accounts are accounts the company has signed within the LTM (meaning YELP is losing the majority of its accounts after the first year).”


Clearly, Hesham didn’t get a lot of clarity on attrition in his discussion.


As always, let us know if you have any questions on these or any other creative investment ideas you may be working on.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.46-2.64%

SPX 1932-1973

India’s Sensex 24873-25617

VIX 10.61-12.97

USD 80.02-80.47

Gold 1297-1343  


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Creative Mistakes - 77

July 10, 2014

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There shouldn’t be much to cheer about this earnings season but the stocks probably reflect lackluster results.  We’re not sure decelerating Mass is priced in yet.


Sure, Street estimates have come down but so have the stocks.  Thus, the Q2 earnings season doesn’t look like much of a catalyst, positive or negative, for the group.  On an individual company basis, LVS looks like it could disappoint, particularly on a hold adjusted basis since Sands China generally played lucky during Q2.  MPEL should come in light as well but we would caution would be shorts:  a big share buyback announcement could (and should) be in the works.  On the positive side, Galaxy looks most interesting to us.  In the face of a difficult junket environment, Galaxy seems to have found the special VIP sauce and we project a slight Q2 beat.  


But don’t forget about the upcoming mass deceleration…


Q2 VIP disappointment is well known and mostly reflected in the sell side estimates.  The comparison between Hedgeye and the Street is detailed in the chart below.  Note also that we’ve included our hold adjusted EBITDA estimates for Q2 as well.  Since we mostly know property level hold percentage before the companies report, we adjust our estimates for good/bad hold.




Galaxy: Earnings Beat and VIP Strength

Galaxy looks like the only stock that could pop with earnings (maybe also MPEL if it announces a big buyback).  We’ve been very impressed with that company’s performance on the VIP side despite the well-publicized headwinds.  As can be seen in the following chart, the company’s portfolio of properties (mostly Starworld and Galaxy Macau) have performed very well on this metric to go along with the market mass strength.  While some of the share gain in Q2 could've come from the 2 Wynn VIP rooms facing construction disruption, the trend was already under way.




Mass Deceleration?

The bigger issue is the likely mass deceleration in 2H – not just Q3.  We think the 30-40% mass revenue growth enjoyed by the casinos could dissipate to the high teens by the end of the year.  As we pointed out in our 06/13/14 note “MACAU: HANDICAPPING MASS DECELERATION” – not only are comparisons difficult but July 2013 marks the month when casinos began jacking up table minimums on the mass floor.  Lapping that and keeping 1H Mass growth rates will be a challenge.




The trade set up for Q2 earnings doesn’t look as it has in prior quarters.  However, over the intermediate term, we remain negative on the stocks overall.  We’re not sure sentiment has fully captured decelerating mass growth.

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TODAY’S S&P 500 SET-UP – July 10, 2014

As we look at today's setup for the S&P 500, the range is 36 points or 0.75% downside to 1949 and 1.08% upside to 1985.                                                                                                                               












  • YIELD CURVE: 2.06 from 2.05
  • VIX closed at 11.98 1 day percent change of 5.74%


MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Initial Jobless Claims, July 5 est. 315k (prior 315k)
  • Continuing Claims, June 28 est. 2.565m (prior 2.579m)
  • 8:30am: Bloomberg July U.S. Economic Survey
  • 9:45am: Bloomberg Consumer Comfort, July 6 (prior 36.4)
  • 10am: Wholesale Inventories m/m, May, est. 0.6% (prior 1.1%)
  • Wholesale Trade Sales m/m, May (prior 1.3%)
  • 10am: Freddie Mac mortgage rates
  • 10:30am: EIA natural-gas storage change
  • 1:15pm: Fed’s George speaks in Shawnee, Okla.



    • House, Senate in session
    • Obama attends DNC event in Austin before delivering a speech on the economy
    • 6:30am: Sec. of State John Kerry, Treasury Sec. Jack Lew hold press conf. after meeting Chinese President Xi Jinping
    • 10am: SEC’s Investor Advisory Cmte public meeting; topics incl. market structure
    • 10am: House Finl Svcs Cmte hearing on Fed accountability
    • 10am: House Ways and Means  markup incl. highway transportation H.R. 5021
    • 2:30pm Homeland Security Sec. Johnson, HHS Sec. Mathews Burwell at Senate Appros. Cmmte on Obama border spending request
    • U.S. ELECTION WRAP: Senate Avoids Gun Debate; Immigration



  • Bullard says unemployment drop to push inflation above 2%
  • IBM invests $3b in chips amid talks to sell division
  • China exports trail estimates as global demand limited
  • Prime money funds to float price in plan said headed to SEC
  • American Apparel strikes $25m rescue deal with investor
  • Apple bid for Samsung sales ban pitched as more modest
  • McDonald’s Puerto Rican franchisees say co. broke FTC rule
  • Mohegan Sun chases new mkts as Connecticut casino sales slide
  • Slim plots Peru to Brazil spending as Mexico unit splinters
  • Aereo can operate like cable TV after Supreme Court case
  • Burberry sales to Chinese ease concern of fading luxury luster
  • June U.S. comp. sales seen inline, helped by weather
  • Gtech to make offer for Intl Game Technology soon: Repubblica
  • Google to create $100m European venture capital fund: FT
  • Bank of England signals skepticism over lenders’ risk modeling
  • China said to probe alleged money laundering by Bank of China
  • Israel calls up 20,000 troops for possible Gaza ground invasion



    • Barracuda Networks (CUDA) 4:15pm, $0.03
    • Corus Entertainment (CJR/B CN) 7am, C$0.51
    • Family Dollar Stores (FDO) 7am, $0.89
    • PriceSmart (PSMT) 4pm, $0.70
    • Progressive (PGR) 8:40am, $0.49




  • WTI Crude Heads for Record-Long Slump on Supplies; Brent Slides
  • Standard Bank Starts Legal Proceedings in China as Aluminum Held
  • Shale Seen Shifting Flows at America’s Biggest Oil Port: Energy
  • Gold’s ‘Mr. Fixit’ Using Low-Cost Model on Platinum: Commodities
  • OPEC Sees Lowest Demand for Its Crude Since 2009 Amid U.S. Boom
  • Sugar Output in India Climbing as Dams Counter Rain Shortage
  • Gold Climbs to 3-Month High as Palladium at Highest Since 2001
  • Aluminum Premiums Seen Dropping in Reprieve for Beer Makers
  • Citigroup Sees More Copper Held Out of China in Financing Shift
  • Tin Shipments From Indonesia Hold Near Five-Month High in June
  • Corn Holds Below $4 as Soybeans Set for Longest Slump Since 1981
  • China Copper Imports to Weaken in July Amid Qingdao Probe: ANZ
  • No End in Sight for German Power-Price Volatility at 10-Year Low
  • Gold in India Jumps Most Since September as Jaitley Keeps Curbs


























The Hedgeye Macro Team
















Poll of the Day Recap: 63% Think Earnings Will Surprise to the Upside

We wanted to know what your thoughts are on the upcoming earnings season.  In today’s poll we asked: Do you think S&P 500 earnings will surprise more to the upside or downside this quarter?


In the video below Macro Associate Christian Drake tells us why he thinks lowered earnings estimates and increased stock buybacks will  likely correspond to S&P 500 earnings surprising to the upside.  Can companies accelerate sales or expand margin growth? That’s a different question and Drake says that neither seem likely.


BOBE: Ugly Is Beautiful

BOBE remains on the Hedgeye Best Ideas list as a long.


It was a disastrous quarter, and year, for Bob Evans Farms and its management team.  The reality is we don’t like the company for what it is, but rather for what it could be.  Activist investor Sandell Asset Management has been working tirelessly to unlock this hidden value.  If BOBE reports another quarter similar to the one it just did, we won’t have to wait much longer.  Management consistently referred to the company’s FY14 performance as an aberration and gave an optimistic outlook for FY15 – too optimistic, in our view.  But we think the street will see right through this and estimates will come in below guidance.  This company is a mess and first quarter trends are uninspiring.  But sometimes ugly can be beautiful.  We believe it’s only a matter of time before Sandell gets their way.  You can review our full bullish thesis here.


Limping out of 4QF14

4QF14 revenues and EPS declined -17% and 32%, respectively, on a year-over-year basis.  Management rattled off a long list of excuses for the poor performance during this morning’s call including severe winter weather, plant startup inefficiencies, high sausage material (sow and trim) costs, unforeseen supplier issues, an ongoing proxy contest and efforts to strengthen internal controls.  FY14 and 4QF14 same-store sales decreased -2.1% and -4.1%, respectively.  Management attributed 3.4% of the 4Q same-store sales underperformance to severe winter weather.  Adjusted, this implies that same-store sales were only down -0.7% in the quarter.  We have a difficult time giving credence to this, considering that same-store sales were down -2.7% in April.  Mind you, this is with pleasant weather and a refreshed asset base!


FY15 Guidance

Management brought down FY15 EPS guidance from $2.80-3.00 to $1.90-2.20 and guided to a full-year SSS gain of +1.5-2.5%.  Most notably, this SSS guidance assumes a negative comp in 1Q, a flattish comp in 2Q and a high-single digit comp in both 3Q and 4Q.  Following a disastrous FY14 and a slow start to FY15, we believe this guidance is outlandish.  When pressed on this issue during the call, management cited a renovated store base, the Broasted Chicken rollout, an expectation for improved weather, increased marketing spend (including the “Get in on Something Good” advertising campaign) and stronger executional focus as the key same-store sales drivers.  While these may be feasible SSS drivers on the margin, this company will not drive high-single digit increase in 2HF15.  We simply don’t see how they will get there.


Management guided to eight new restaurant openings in FY15 and has finalized deals for four new Bob Evans Express units (two airport locations, two mall locations).  They also expect to license up to ten Bob Evans Express locations during the fiscal year.


Words of Caution

Despite the aggressive guidance, management listed a number of current impediments to the company’s operations including macroeconomic headwinds, health care costs, a struggling core (lower and middle income consumers) market, commodity cost pressures and an increasingly competitive environment.


Commentary on Recent M&A Activity

Management was specifically asked about the high multiples currently being awarded in the packaged foods business.  In fact, one investor pressed management on what they’d do if they received a HSH-like multiple for BEF Foods.  Alas, management steered clear of that question.  They did, however, reinforce their commitment to the foods business noting that an aberrative 2014 is behind them.  On that front, they pointed to transformational investments (which have resulted in a lower cost structure), brand synergies, their insourcing strategy and their desire to continue to grow the business as reasons to hold on to BEF Foods.  To be fair, they did note that if they received an offer for the foods business they’d look at it, but the overwhelming sense from day one is that management has no intention of selling this segment.  Sandell appears adamant on making this happen and we think shareholders should be too.


Recent Notes

06/13/14  BOBE: Reiterating Best Idea Long

05/27/14  BOBE: M&A Activity Heating Up In The Food Business

05/15/14  BOBE: Asset-Light Is Right

05/02/14  New Best Idea: Long BOBE


BOBE: Ugly Is Beautiful - chart1


BOBE: Ugly Is Beautiful - chart2


Call with questions.


Howard Penney

Managing Director


Fred Masotta


investing ideas

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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.