Below are Hedgeye analysts' latest updates on our NINE current high-conviction investing ideas and CEO Keith McCullough's updated levels for each.
We also feature three recent institutional research notes which offer valuable insight into the markets and economy.
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
HEDGEYE CARTOON OF THE WEEK
BOBE – We sent out our high-conviction report on Bob Evans on Thursday. Click here to access.
GLD – Gold briefly tested our Long-Term TAIL Line of resistance late last week ($1324) before backing off into Janet Yellen’s testimony on Capitol Hill on Tuesday and Wednesday of this week. Our intermediate-term TREND level of support sits at $1281.
With our view that the price of Gold reflects the relative rate of dollars entering the system as a monetary policy response to the growth and inflation outlook, we must continue to compare our predictive-analysis of high-frequency data points against the Fed and consensus to front-run a surprise (upside or downside) in the rate of dollars coming into the system. The market reacted to Yellen’s Tuesday comments as if she was relatively more hawkish on the margin.
- Gold sold off on the news but regained ground the rest of the week (+1% from the Wednesday lows)
- Yield Spread (-6bps w/wà -2.9%) compression as the bond market remains a skeptic
- Sector divergences between consumer spending-sensitive sectors and those catching a tailwind off a flatter yield curve continue
Rates may be poised to increase (“eventually”), but the timing of the move is the key driver. We continue to believe growth will surprise to the downside given the aggregate position of consensus macro. This will likely debase the dollar, putting upward pressure on commodities (priced in U.S. dollars). To use just one example, if you are an average consumer living in a large city:
1. You will pay more for energy, food, and utilities
2. Your rent increases (present value effect on assets): A flatter yield curve has a present value effect on assets which means the person who owns the building benefits as the property value increases à you pay more rent
3. Your increase in cost of living (as of now) is not supplemented with an increase in real purchasing power: Real wage growth is being greatly outpaced by monetary expansion inflating USD-based consumption categories. Because the defense for printing money in the short-term to stimulate is defended by the assumption wage growth MUST follow over the intermediate to long-term, last year the Fed increased the amount of time allowed for this wage growth to happen (because it hasn’t inn the previously assumed timeframe)
This dollar debasement has a statistical relevance to Gold specifically and puts upward pressure on the commodity complex as a whole. Our negative call on the domestic consumer is rooted in our view on the outlook for the U.S. dollar vs. immediate or intermediate supply and demand shocks in the commodities people consume.
HCA – Hospital Corporation of America pre-announced 2Q14 earnings this week and raised the low end of their guidance for 2014. Shares were up 10% this week and are up well over 50% since sector head Tom Tobin added it to Investing Ideas in 6/14/13.
Actual earnings and admission results came in stronger at $1.07 EPS and 1.2%, respectively, versus our estimates for $1.02 and ~1%. Meanwhile, case mix, or acuity, increased 1.7% y/y.
While management increased ACA accretion estimates for 2014(in line with our models), the majority of the upside is coming from a more sustainable operational acceleration. EBITDA is likely heading higher and we expect the stock to be in $62-$64 range in the near term and in the mid $70s as attention turns to 2015.
Our forecast model for births, derived from monthly CDC and US Census data continues to suggest sequential improvement, while other trends, such as employment of women of child bearing age also continue to improve. A recovery in maternity trends from a multi-generational decline is a significant tailwind for HCA and medical cost trend more broadly. Continued growth in orthopedic surgeries, such as knee replacements, is another potential tailwind for HCA (see chart below).
HOLX – Sector head Tom Tobin has no update on Hologic this week.
LM – The next catalyst for Legg Mason shares will be the company's first quarter earnings (calendar second quarter) on Thursday July 31st. While the company's investment flows are known for the quarterly period via Legg's monthly assets-under-management reports, it will be important within the earnings result to ensure that Legg's expense base is not growing disproportionately to allow for positive earnings surprises.
We are 9% above the Street in our estimates for Legg next year, partly as we believe the company will have only modest needs to grow its spending. On our higher than consensus numbers at a normalized earnings multiple we get fair value on LM shares at $60.
OC – Here are three quick takeaways from our "Asphalt Roof Shingle Competition" call with Bob McNally, former GM of TAMKO building products:
1.) The asphalt roofing market is still off of normalized current demand as we head into hurricane season, a tailwind for the industry. Current demand is running at ~100 mil ssq/yr vs. normalized demand at ~125-135 mil ssq/yr (see table below). Capacity utilization is expected to tighten, a positive for roofing manufacturers, from 60% to 70% as the openings of new plants appear small relative to normalized demand.
2.) Plant efficiency does not seem to be a key concern. According to Bob, recent plant upgrades by TAMKO did not have a “significant change” on conversion costs. We see raw material cost variations having a more relevant impact on total product costs.
3.) Strategies among competitors are largely unchanged. We previously had concerns of a competitor (or competitors) keying on pricing after Owens Corning lowered its outlook for FY 2014 after disappointing roofing numbers in the first half of the year. This suggests the difference is in product quality perception and other factors challenging OC's roofing business, which we plan to target in a follow-up call focused on asphalt shingle distribution.
In other news, equipment rental company, United Rentals (URI), noted a “vigorous” pickup in nonresidential construction activity especially in the commercial and energy sectors in their 2Q 2014 earnings conference call.
Housing starts dropped 9.3% year-over-year. They came in at a disappointing 893k – way below consensus estimates of 1020k.
Owens Corning preannounced earnings last month and we suspect the earnings report Wednesday, July 23rd will carry less weight.
OZM – Och Ziff shares enjoyed a strong rebound this week up over 3% versus the financial sector which rose just 1%. The disproportionate decline last week of over 4% over worries in Europe and also a lackluster start to Financials earnings season created a good entry point for new investors in the OZM story this week.
Even after the slight outperformance over the past 5 days, Och Ziff shares are trading at just over 2x its year end incentive fees still below the midpoint of the historical range of 0-7x incentive fees. Coupled with a stated dividend yield of 9%, OZM shares offer continued solid prospects for returns from both capital appreciation and dividend yield.
RH – We hosted an institutional call this past Thursday outlining the key issues surrounding Restoration Hardware’s real estate build out.
These are the three key takeaways:
1) Stores can get a lot bigger - 25,000 square foot stores are not too big. They’re arguably too small. We analyzed spending patterns and demographics in each RH market, and believe that 25 markets can support a 50,000+ square foot store.
2) We think 85 markets can support a Full Line Design Gallery - Almost all of the 66 existing markets could support a Full Line Design Gallery. RH’s effort to purge bad real estate is largely complete. On top of the fill-in growth, we identified another 19 markets where the spending characteristics warrant RH’s physical presence.
3) Landlords are helping drive ROI - The paradigm around anchor tenant space is changing, and is creating space for RH that previously did not exist. In addition, we’re seeing landlords step-up by funding building costs in a way that is taking down the payback period for RH to under a year per store.
RH remains retail sector head Brian McGough's favorite name in retail.
TIP – Coming off what was a relatively quiet week, things picked up on the domestic inflation front as two relevant high frequency data points came out this week in regards to the U.S. cyclical inflation story:
- U.S. Import Prices are up 1.2% MoM from 0.6%
- U.S. PPI is up 0.4% MoM up from -0.2%
These data points reaffirm that investors should continue to remain long of the iShares TIPS Bond ETF (TIP) as a way to profit from what we continue to see as a forecasting no-brainer: accelerating rates of reported inflation over the intermediate. In addition, U.S. CPI is scheduled to be reported next week; we anticipate continued acceleration, which should continue to support our long idea in TIPS.
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(Lack Of) Housing Starts
Builder confidence appears to be decoupling from reality as actual construction activity plunges for the second month in a row.
Brazil is setting up as a short in 2H. Lots of capital has flowed into the country this year on a catalyst that is unlikely to materialize.
Philip Morris (PM): Rich Valuation Supported Over Long Term
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