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PM – Strong Q2; Rich Valuation Supported Over Long Term

PM beat Q2 top and bottom line estimates (EPS $1.41 ex-items vs consensus $1.24 and Revenue $7.80B vs consensus $7.52B) on better than expected volume trends. However, tougher EPS comps in the back half of the year on persistent macro challenges, especially from the Asia region, could drive 2014 performance to the lower end of the company's 6% to 8% guidance, or $4.87-$4.97 that was reaffirmed today. Over the longer term we’d warm to the stock. We're bullish on the Marlboro 2.0 architecture to attain new global customers from higher margin products and we believe PM is ahead of the curve on R&D behind its non-combustible Risk Reduce Product (RRP) category, which we see as a natural progression to meet and grow new product demand given declining global combustible cigarette trends. 

 

We expect the stock to be bid up today on a marked improvement in sales at -1.5% Y/Y vs last quarter at -8.8%, however the set-up is largely as anticipated by the company due to timing dynamics and a considerably easier comp of-2.5% in Q2 2013 vs +1.8 in Q1 2013. The company boosted its OCI margin +1.2% to 44.3% despite taking a $489M charge for impairment and exit costs related to the closure of a production facility in the Netherlands and additional costs to shutter a factory in Australia.

 

PM offers a healthy dividend yield of 4.4% and a generous stock buyback program ($1.75B remains on a $4B 2014 repurchase target for the year), however given the aforementioned near to medium term headwinds, we’ll wait for its rich valuation to depress before we’re buyers.  For now, we like its U.S. peers that do not have PM’s geographical headwinds.  Further, we expect the news on 7/15 that RAI intends to buy LO to further spur investment interest in the U.S. manufacturers.

PM – Strong Q2; Rich Valuation Supported Over Long Term - z.. cig pe

 

Notable geographic performance in Q2 and Outlook


Asia:  Volumes fell -6.1% and operating income plunged -20.2% on the back of weakness in Australia and Japan. In Australia the main factors contributing to the decline remain down trading from the issuance of plain packaging, excise tax hikes, and heavy discounting from competitors.  Japan also remained weak in the quarter with volume down -14.4% (reflecting de-stocking of trade inventories) and share fell -0.5 points to 26.4%. Unfavorable hand-rolled trends in Indonesia was partially offset by better trends in machine made. Philippines volume down 13.4%, as the Co. begins to take share from competitor Mighty Corporation as it is increasingly pressured from the government to appropriate pay excise tax (vs previously reporting half of its revenue for tax purposes).

 

EEMA:  Russia market share up +0.9% to 26.8%, volume down -10%, with price increases up 25% Y/Y. The 4 Ruble per pack increase in May 2014 may impact consumption along with June smoking restrictions.  Turkey volume increased 2.5%, with stable underlying trends.

 

EU:  Cigarette volume was much stronger than expected, down -1.2%. Total share increased +0.9 points to 40.4%. The EU region is now expected to see FY volume declines of -5%, an improvement over the previous range of -5% to -6%. The Co. announced price increases in Germany (~20 cents per pack avg.), Portugal and Spain, which will helped to offset weakness in Italy due to VAT increases. The Co. cited Poland’s volume (-7%) was impacted by the growth in e-vapor products. 

 

After we get past more difficult comps in 2H of this year we’re bullish over the longer-term on Marlboro 2.0, the company’s architecture to modernize the brand, and with it expand into new population and smoker segments, catering towards trends of consumers seeking smoother tastes, even within the full-flavor category. 

 

We’re positive on the company’s push to trade up consumers to the premium and above premium categories that enjoy higher margins with combustible cigarettes, and bullish on PM’s future portfolio of Risk Reduce Products to meet consumer trends shifting away from combustible. We believe PM can carry out its strategy over the longer term, leveraging strong marketing and sales teams across the globe, and leverage the growth in aspirational consumers seeking the strong brand identities of the PM portfolio.

 

PM – Strong Q2; Rich Valuation Supported Over Long Term - z. pm

 

Howard Penney

Managing Director

 

Matt Hedrick

Associate

 

Fred Masotta

Analyst


INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE?

Takeaway: The labor data is strong, no question, but we're also getting late in the cycle. We reflect on how late in the note below.

Below is the detailed breakdown of this morning's initial claims data from the Hedgeye Financials team led by Joshua Steiner. If you would like to setup a call with Josh or Jonathan or trial their research, please contact 

 

 

You Know, the Jungian Thing

The first chart below summarizes where we are in the labor market from a historical context. Allow me to suggest something akin to the duality of man. On the one hand, we're seemingly in a great place. Claims are near their historic lows at 309k (rolling SA). Look back at the last three periods in time when claims were comparably low. You'd be looking at the periods of December, 2005, April, 1999 and August, 1987. All those periods were auspicious as they were accompanied by a rapidly rising stock market and an ongoing economic expansion. On the other hand, they were also all in relatively close proximity to major market corrections: 2 months away in the case of August, 1987, ~2 years away in December, 2005 and ~1 year away in April, 1999. Such is the dilemma of where we stand today. We're standing on the tracks and we know the train is coming, but we don't know if it's 2 months or 2 years away. #Conundrum.

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 9 normal

 

[HEDGEYE MACRO]:  An alternate approach to the “where are we in the cycle” question is examining how long, after having reached their frictional lower bound, have claims tracked at a level generally considered (by the market) to be “good”.

 

On average, over the last three cycles, claims have held below the 330K level for ~33 months.  The present streak currently stands at 5 months.    

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - JC Duration 2

 

The chart below speaks to just how strong the data is at the moment. By the way, it's important to remember that seasonal auto manufacturing furloughs occur at this point every year, but last year, due to strong demand, they went largely unutilized. Furloughed autoworkers are eligible to file for claims. As such, seeing the NSA Y/Y prints come in as strongly as they are suggests things really are quite good (at the moment).

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 6 normal

 

 

The Data 

Prior to revision, initial jobless claims fell 2k to 302k from 304k WoW, as the prior week's number was revised up by 1k to 305k.

 

The headline (unrevised) number shows claims were lower by 3k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -3k WoW to 309k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -11.2% lower YoY, which is a sequential deterioration versus the previous week's YoY change of -11.4%

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 1 normal

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 2 normal

 

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 

 

 

 

 


INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE?

Takeaway: The labor data is strong, no question, but we're also getting late in the cycle. We reflect on how late in the note below.

You Know, the Jungian Thing

The first chart below summarizes where we are in the labor market from a historical context. Allow me to suggest something akin to the duality of man. On the one hand, we're seemingly in a great place. Claims are near their historic lows at 309k (rolling SA). Look back at the last three periods in time when claims were comparably low. You'd be looking at the periods of December, 2005, April, 1999 and August, 1987. All those periods were auspicious as they were accompanied by a rapidly rising stock market and an ongoing economic expansion. On the other hand, they were also all in relatively close proximity to major market corrections: 2 months away in the case of August, 1987, ~2 years away in December, 2005 and ~1 year away in April, 1999. Such is the dilemma of where we stand today. We're standing on the tracks and we know the train is coming, but we don't know if it's 2 months or 2 years away. #Conundrum.

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 9

 

The chart below speaks to just how strong the data is at the moment. By the way, it's important to remember that seasonal auto manufacturing furloughs occur at this point every year, but last year, due to strong demand, they went largely unutilized. Furloughed autoworkers are eligible to file for claims. As such, seeing the NSA Y/Y prints come in as strongly as they are suggests things really are quite good (at the moment).

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 6

 

The Data 

Prior to revision, initial jobless claims fell 2k to 302k from 304k WoW, as the prior week's number was revised up by 1k to 305k.

 

The headline (unrevised) number shows claims were lower by 3k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -3k WoW to 309k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -11.2% lower YoY, which is a sequential deterioration versus the previous week's YoY change of -11.4%

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 1

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 2

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 3

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 4

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 5

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 7

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 8

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 10

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 11

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 12

 

<chart13>

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 19

 

<chart14>

 

Yield Spreads

The 2-10 spread fell -3 basis points WoW to 205 bps. 3Q14TD, the 2-10 spread is averaging 209 bps, which is lower by -12 bps relative to 2Q14.

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 15

 

INITIAL CLAIMS: WHERE ARE WE IN THE CYCLE? - 16

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


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Bond Yields Down, Russell 2000 Down, Gold Up. Call Us Crazy, But...

Takeaway: From our perch, this all rhymes with slowing growth expectations.

Bond yields down, Russell 2000 down, Gold up...Call us crazy, but in our opinion this all rhymes with slowing growth expectations.

 

For Gold to make a run for its year-to-date highs, we think we need to see a breakout above $1324 – stay tuned.

 

Bond Yields Down, Russell 2000 Down, Gold Up. Call Us Crazy, But...  - gold99

This is a brief excerpt from our morning research.


(LACK OF) STARTS

Takeaway: Builder confidence appears to be decoupling from reality as actual construction activity plunges for the second month in a row.

Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume.

 

(LACK OF) STARTS - Compendium 071714

 

Today's Focus: May Housing Starts & Permits

The Census Bureau released its monthly Housing Starts & Permits data for June this morning. The big takeaway is this: No Growth. Incidentally, this is the same

takeaway as last month. 

 

This data is a splash of cold water on yesterday's improved HMI reading as the two have historically not exhibited a lead/lag relationship. 

  • Total Starts - Declined -92K MoM (-9.3%), back below the 900K level to 893K with both single and multi-family starts declining MoM. Total Starts for May were revised lower to 985K from 1001K.
  • Single Family - Declined -57K MoM (-9.0%) to +575K while permits increased +16K (+2.6%) sequentially to +631K.  The soft'ish starts number is not particularly surprising given permits have been running below starts YTD.   
  • Multi Family - Starts down for a 2nd straight month, declining -35K MoM (-9.9%) to 318K (from 353K in May and 414K in April).  MF permits declined sequentially as well, down -58K MoM to 332K – the lowest level since August of last year.

 

NAHB HMI vs Starts:  Builder confidence has decoupled from the reality of actual new construction activity the last few months.  As we highlighted yesterday, builder optimism led the upside in the NAHB HMI gain in July with the forward expectations component registering a disproportionate increase.    With permits running largely flat with starts YTD (& declining in the latest month) the upside for starts over 2H appears somewhat constrained and more likely that confidence re-couples to starts than the converse.

 

As a reminder, there are three factors principally responsible for the ongoing weak performance for housing. First, QM rules that took effect early this year are having a suppressing effect on credit availability. Second, institutional investor demand for properties is waning sharply. Third, affordability dynamics have swung sharply; whereas 12-18 months ago there was a strong asymmetry favoring homeownership, today renting vs owning are close to a toss-up.

 

(LACK OF) STARTS - Single Family Starts vs NAHB

 

(LACK OF) STARTS - SF Starte   Permits TTM

 

(LACK OF) STARTS - SF Starte   Permits LT

 

(LACK OF) STARTS - MF Starts   Permits TTM

 

(LACK OF) STARTS - MF Starts   Permits LT

 

(LACK OF) STARTS - Starts TTM

 

(LACK OF) STARTS - Starts LT

 

 

About Housing Starts & Permits:

The US Census Bureau records the number of new housing units that have obtained permits for construction and those that have begun construction. This data includes new buildings intended primarily as residential units. The US Census Bureau defines a start as, “Start of construction occurs when excavation begins for the footings or foundation of a building.” 

 

 

Joshua Steiner, CFA

 

Christian B. Drake


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