Investing Ideas Newsletter

Takeaway: Current Investing Ideas: BOBE, GLD, HCA, HOLX, LM, OC, OZM, RH, and TIP

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.

Investing Ideas Newsletter    - levels

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


Investing Ideas Newsletter    - Yellen duct tape 7.16.2014


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. 


Investing Ideas Newsletter    - gld


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.


Investing Ideas Newsletter    - hcaboom


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.  

Investing Ideas Newsletter    - 9

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).

Investing Ideas Newsletter    - 10

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. 

Investing Ideas Newsletter    - oc


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.


Investing Ideas Newsletter    - resto


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:


  1. U.S. Import Prices are up 1.2% MoM from 0.6%
  2. 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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Click on each title below to unlock the content.


(Lack Of) Housing Starts

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

Investing Ideas Newsletter    - hou


Sell Brazil?

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.

Investing Ideas Newsletter    - braz


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

Investing Ideas Newsletter    - marl



Thankfully, this could be the last note I write about one of the worst managed companies I've followed in my 20-year history as a restaurant analyst.  My criticism of Darden has been very harsh at times, but given the state of the company it’s been more than justified.  Personally, I’m tired of being negative.  I’m also tired of witnessing the biggest destruction of shareholder value in the history of casual dining.


It’s hard to believe, but I’ve been vocal about the need for significant change at Darden for precisely 746 days now.  It was back in July 2012, when I first introduced my “unthinkable short” case on Darden in which I harped on the severe mismanagement of the company. 


The value destruction we’ve been speaking of since then can be seen in the consensus FY15 EPS estimate of $2.26 (Hedgeye is at $2.00).  As a point of reference, the consensus FY15 EPS estimate was $5.30 back in FY13.   The ironic part of all of this is that the CEO and the Board want you to leave what is left of the company in their hands.  Brinker International, one of Darden’s largest competitors in the casual dining space, has seen its consensus FY15 EPS estimate go from $2.80 to $3.10. 


Given the success of Brinker over the past 746 days, Darden management cannot blame a difficult casual dining environment for their troubles.  Instead, the trouble lies in their inability to recognize, manage and allocate capital appropriately in this difficult consumer environment.


For the sake of shareholders, Starboard must get control of the Board on September 30th.  Without a change of this magnitude, they can expect more of the same: dismal returns, value destructive initiatives, and a complete disregard for shareholder concerns.


This week, Starboard reiterated its commitment to fixing the issues that have consistently plagued Darden.  In addition, they increased their ownership in the company to 7.1%.  While this is good news, we believe any upside potential in the stock has been negated by the continual blunders of management and the Board.


I once used the phrase “a generational opportunity” to describe the upside potential for Darden shareholders.  Alas, that phrase is no longer applicable – the sale of Red Lobster changed everything.  It’s now much more difficult to create significant value. 


I applaud Starboard’s continual effort to push for significant change at Darden, but the fact of the matter is they’re facing an uphill battle.  The issues the company faces are similar to those back in July 2012 when we first began calling for change at the company – unrealistic guidance, poor capital allocation and constant cash burn.  Without new management in the next 12-months, the current team will either need to cut its plans for new unit development or cut the dividend.


In short, management’s current business plan doesn’t produce enough cash to execute the Brand Renaissance plan at Olive Garden.  As seen on page 19 of the most recent company presentation, management suggests there are only 300 restaurants in need of a remodel.



Source: Company Presentation 


However, if management wants the chain to have a consistent look and feel, and accomplish its goal of “bring[ing] the Brand Renaissance to life in every guest touchpoint,” it will need to remodel all 837 restaurants.  We estimate this will cost the company approximately $550 to $600 million in capital investment.


According to current guidance, the company will generate $87 million in FCF in FY15 – but we know the company’s ability to provide accurate guidance is highly suspect.  This guidance implies that it will take between 5-6 years to complete the Brand Renaissance remodels.  Obviously, this plan is a non-starter and should be unacceptable to any shareholder.


As we have modeled, the company needs to spend significantly more to fix Olive Garden in a timely manner.  Spending $200 million a year would allow Darden to complete the remodel program in 3 years, but it would put the company in a negative FCF position. 


Why does management consistently put the company in a box, where it has no choice but to lower capex or cut the dividend?





Call with questions.


Howard Penney

Managing Director


Fred Masotta



CARTOON OF THE DAY: GRILLIN’ AND CHILLIN’ - chillin  cartoon 07.18.2014


US economic growth isn’t heating up this summer.

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Retail Callouts (7/18): VFC, TGT

Takeaway: VFC - 2 callouts from print, 1) International, 2) SIGMA. TGT - still feeling the heat from the data breach



VFC - 2Q14 Earnings


Takeaway: Two key callouts from the print this morning. 1) International growth rate continues to accelerate sequentially on both the one and two year trend line. European constant currency growth rate up 900bps YY. 2) SIGMA - gross margin came in 80bps below expectations, but inventories look much cleaner heading out of 2Q compared to 1Q. A much better set up for VFC heading into the balance of the year.


Retail Callouts (7/18): VFC, TGT - chart1 7 18



TGT, AMZN - Amazon Has the Best Consumer Perception of Any Brand Mid-year, rankings show Target hit hard by data breach



  • "The retailer last year was the No. 7 best-perceived brand among consumers, but not only did it fall off the top 10 list, it plummeted all the way down to No. 21."


Takeaway: This survey ask respondents whether they've heard anything about the brand in the past 2 weeks, and if so was it positive or negative. TGT has been no stranger to headlines over the past 8 months, and the data breach continues to affect shopper perception of the brand. The reality is that when a customer has a great experience in retail, they tell a friend. When a customer has a customer has a bad experience, they tell 20. Just ask JCP or LULU. Some of these 'fire your customer' events are worse than others, but there's one commonality - they take a very long time to recover.



Alibaba IPO Seen Possible in Sept.



  • "Alibaba Group Holding Ltd. is now said to be envisioning an initial public offering in September."
  • "The company on Friday, in a regulatory filing with the Securities and Exchange Commission, valued itself at $130 billion, up from the $117 billion valuation in late June."


APP - American Apparel Shareholders Seek Resignation of Board Members



  • "On the eve of the company’s naming five new directors to its board — the confirmation is expected as early as next week, according to sources — a hedge fund has demanded the resignation of the firm’s two co-chairman, David Danziger and Allan Mayer."


Back-to-school/college spending shows slight year-over-year improvement



  • "Families this summer will spend slightly more on back-to-school items than they did in 2013. According to NRF’s 2014 Back-to-School Survey conducted by Prosper Insights & Analytics, the average family with children in grades K-12 will spend $669.28 on apparel, shoes, supplies and electronics, up 5% from $634.78 in 2013."
  • "Total spending on back to school will drop slightly to $26.5 billion as the survey found there are slightly fewer students in households this summer."


House votes to expand tax break for store remodels



  • "The House has passed legislation broadening a federal tax law that makes it cheaper for retailers to remodel their stores, the National Retail Federation said."
  • "Lawmakers voted 258-160 today to make 'bonus depreciation' permanent, and granted NRF’s request that it be expanded to include stores that are owned rather than just those that are leased. The measure now heads to the Senate."

Keith's Macro Notebook 7/18: VIX RUSSELL 2000 UST 10YR

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