Fortunes Fall Short

“To go too far is as bad as to fall short.”

-Callie’s fortune cookie


Last night was a beauty at the McCullough dinner table. My newbie was chirping up a storm with pablum all over her face and my two older kids had a few of the best back-to-back fortune cookies ever.


Jack’s fortune reminded me of a critical risk management lesson: “there is nothing permanent, except change.” So I told him that that’s what my man Bill Ackman was probably thinking at his dinner table last night too.


Picking on the slide-deck guru is just fun and games. So please don’t take offense to my entertaining you with this topic this morning. It’s trending more than Putin/Obama. Fully loaded with the +25% short squeeze in HLF yesterday, I think the guy actually cried (sort of).


Fortunes Fall Short - 90


Back to the Global Macro Grind


There’s no crying in the asset management business. If you are going to well-up in public, I don’t care how much you are “worth” - I am going to give you a time-spanking and an Early Look time-out.


In other US stock market news yesterday…


  1. The Russell 2000 bounced on no-volume to lower-bubble-highs yesterday (1175 TREND resistance)
  2. Total US Equity Market Volume was -16% and -29% vs. its 1 and 3 month averages, respectively
  3. Front-month stock market fear (VIX) sold off to a higher low of 12.24, holding 11.94 TREND support


In other words, “rallies” continue to ramp to lower-highs on lower and lower volumes (not good) as volatility continues to make a series of higher-lows from the VIX’s most asymmetric point (10). All the while, the long bond rallied intraday yesterday and the 10yr yield is hitting fresh Q314 lows of 2.46% this morning.


With the Russell (IWM) still down YTD (not a good return), we’re going to keep you focused on where the real bull markets are in 2014:


  1. Treasuries
  2. Commodities
  3. Emerging Markets


The Treasuries one is easy to understand, provided that you understand that they (the Old Wall) still do not understand the link between inflation and both real wages and consumption growth.


As you can see in our Chart of The Day today, even the US government’s contortionist reading on US Consumer Price Inflation (CPI) delivers you a fresh new YTD low in NEGATIVE real wages (not good).


Now, to be fair, someone who A) hasn’t been long of inflation in 2014 and/or B) believes anything the Fed tells them about inflation will tell you that (if you back out shelter – i.e. rent, which is hitting all-time highs, and represents 30% of cost of living for the average American consumer) “2% inflation feels about right.” #Goldilocks


There were a bunch of 16th century dudes hanging out in officialdom who told Copernicus that Earth was the center of the universe too. But that doesn’t change that nothing is permanent, except change. As time and price changes, real-time risk managers do.


It wasn’t just Chipotle (CMG) taking price above the “goldilocks 2%” inflation rate yesterday:


  1. Hog prices ripped another +2% to +49.3% YTD
  2. Cattle prices popped another +2% to +15.9% YTD
  3. Aluminum prices continued another +1.9% higher to +14.5% YTD


But, those poor CNBC producers naval gazing at Billy probably missed that. Must resuscitate ratings from hitting new lows! I have slide decks too, but I certainly don’t have all the answers to the market universe; Mr. Macro Market does.


And I think that’s one of the main lessons of the last half decade – whether you are a central-planning goddess, hedge fund legend, or just plain wicked smaht… you can try to tell markets, prices, and economies what to do; but they don’t have to listen.


You can try to gussy up the idea as your “best ever.” You can tell all your “smart” friends what you are going to do before you try to do it too. But, eventually, you’re going to jump the shark, go too far, and fall short.


Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND signal in brackets) are now as follows:


UST 10yr Yield 2.44-2.53% (bearish = bullish bonds)

SPX 1 (bullish)

RUT 1133-1164 (bearish)

Italy MIB Index 20157-21138 (bearish)

VIX 11.94-14.26 (bullish)

USD 80.29-80.93 (bearish)

EUR/USD  1.34-1.36 (neutral)

Pound 1.70-1.72 (bullish)

WTI Oil 100.15-104.03 (bullish)

Natural Gas 3.73-4.01 (bearish)

Gold 1 (bullish)

Copper 3.17-3.23 (bullish)


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Fortunes Fall Short - Chart of the Day

July 23, 2014

July 23, 2014 - 1



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The Q2 bar was set low and should be easily cleared.  Encouragingly, July is showing a pick up so expect higher than consensus Q3 guidance and commentary.



PENN reports Q2 earnings on Thursday and we project a beat.  Moreover, management guidance – while always tempered – should be better than Q3 consensus.  Our read into July is that YoY growth in regional gaming has improved considerably from the 1H 2014.  In fact, while we’re still anticipating a YoY same store decline in regional gaming revenues (see chart below), the drop could be the smallest since October/November.  Certainly not the most powerful long term thesis but on the margin, for a stock suffering from the “soft bigotry of low expectations”, a beat and raise could spark a nice move higher.



We’re projecting Q2 EBITDA and EPS of $82 million and $0.10 versus the Street at $77 million and $0.08, respectively.  For Q3, our estimates are $68 million and $0.07 – again above the Street at $60 million and $0.03.



In our note on May 14, 2014 titled "Regional Gaming: Trend Friend" we highlighted:

  • Q2 is shaping up nicely relative to reduced guidance as we were hearing May was showing improvement from April.
  • Insiders at both PENN and PNK have bought stock in the last week – obviously, a positive signal.  BYD management, did you hear that?

Then, on June 3, 2014, in our note "Regional Gaming Catalysts, Positive?" we focused on:

  • Best May weather ever - sunny, blue skies and very few thunderstorms/tornados coupled with one extra Saturday provide a base for accelerating (less bad) regional results for May and June – and a potentially positive revision of estimates as the year develops
  • As we view regional gaming estimates, Q2 estimates should not be revised lower and could have an upside bias for BYD, PENN, and PNK.

Since then, June monthly results were down versus May and lower than our projections.  Reworking the models has us less enthusiastic regarding BYD and PNK Q2 earnings but not for PENN. 


Looking ahead to July, our model is projecting only a 2% YoY decline in same store sales for the mature regional gaming markets versus the 7% drop generated in June.  Morever, our advance read into Missouri and Pennsylvania suggests our estimate could be too low.  We believe both of those markets are markedly in the black on a YoY basis relative to our expectations of another monthly decline.  Could the regionals post their first monthly increase in SSS since November 2012?  Now that would be a catalyst. 





While always sober, management could be a little more positive with their forward commentary on the conference call tomorrow.  We’re already expecting a beat and higher than consensus Q3 guidance.  Indeed, anecdotal evidence more than supports our sequential improvement thesis.  Yes, the environment remains challenged and the demographic headwinds stiff, but with a high beta stock such as PENN and low expectations, pivots like this should have an outsized impact.


Mixed pricing but RCL leads the way






Mid-July was another period of pricing strength in Europe with mixed pricing in the Caribbean.  As we noted in “RCL: MOMO FROM EUROPE/QUANTUM” yesterday, we believe RCL is well-positioned for the rest of the year given its outperformance in Europe and a Quantum boost starting in November.


CCL pricing took a turn for the worse in mid-July, particularly in the Caribbean where Carnival brand pricing had been steady since April.  2H 2014 expectations have already baked in moderate YoY growth for the Carnival brand in the Caribbean.  That could be at risk if this trend continues.  Any upside to the stock following RCL’s release should be faded in our opinion.


For NCLH, the discounting in the Caribbean has abated for Q3 in mid-July but there are some worrisome signals peeking in Q4.  We’re agnostic on the stock here but could revisit our negative thesis from the Spring again as we get closer to Q4.


We track over YoY and sequential pricing for 13,000 ship itineraries spanning across 8 geographic regions.  We rely on sequential pricing trends (defined as how pricing has changed relative to pricing seen at the last time the company provided guidance) for price pivot signals.



For the 1st time since April, Caribbean pricing for the Carnival brand dropped sequentially.  On a YoY basis, Q3 pricing remains higher on a moderate basis, although the YoY comparisons have been quite volatile due to all the ship incidents last year.   


In Europe, Costa pricing slipped for the 4th consecutive month; but on a YoY basis, pricing continues to trend well up into the double digits.  While CCL should meet expectations for 2014, we’re concerned with the 2015 setup in the face of heightened investor expectations.  Pricing comparisons will be tougher in Europe and the China outlook is cloudy.



  • Carnival brand:  After relatively stable pricing in April, sequential pricing took a leg down in mid-July for the next three quarters.  While it is only a couple of weeks since CCL gave guidance, we wonder if the strategy of holding price at the expense of occupancy could be ending.  The next survey in August would be more telling.  On a YoY basis, the discounting brought Q3 pricing back into the red for the mid-July period; on average, Q3 pricing is still trending in the high single digits.  As of Q4 2014, pricing on a YoY basis is still in the double digits while an early read on Q1 2015 pricing shows modest growth.
  • Princess/Holland America:  Not much movement.  Slightly lower pricing for Holland America’s winter itineraries.


  • Pricing has picked back up for the Carnival brand, Holland America, and Princess.


  • Costa sequential pricing slipped for the 4th straight month for the next three quarters
  • Mixed picture for the other brands  
    • Cunard sequential pricing is slightly lower for the winter itineraries.  On a YoY basis, pricing is modestly lower.
    • Holland America pricing improved slightly
    • For the 1st time this year, AIDA saw some pricing increases for Q3 2014 and Q1 2015. 
    • P&O Cruises UK – strong pricing across the fleet


  • Fairly quiet



Although the Caribbean market remains highly promotional, RCL pricing improved slightly on a sequential basis in mid-July.  RCL’s European pricing growth has trended +20% with fewer available itineraries relative to that seen in last mid-July.  Alaska pricing has finally broken through to the green side, although summer pricing overall is slightly lower.  



  • While RCL is not yet out of the woods, we did see the RC brand pricing jump sequentially in mid-July for 2H 2014
  • Celebrity pricing improved slightly; however, on a YoY basis, pricing remains lower - close to double digits
  • Quantum pricing for Nov/Dec itineraries remain relatively unchanged
  • Pullmantur pricing steady in Q4 2014 but a challenging start to Q1 2015 due to harder comps


  • Pricing in Europe has been extremely robust and Q3 got slightly stronger in mid-July. For July, both the RC brand and Celebrity pricing are up +20% for Q3.  Overall, Q3 pricing is +15%.
  •  Anthem pricing continue to creep up for summer/winter 2015 itineraries


  • YoY comps is back in the green, with Celebrity leading the charge


  • While this region will be more material in the 2nd half of 2015, pricing has been generally steady among the RCL brands

South America

  • YoY pricing is still significantly behind for winter 2014 



Is there any end to the discounting in the Caribbean?  Not yet.  While Q3 Caribbean pricing has stabilized, we are seeing more price cuts for Q4 2014 and Q1 2015 itineraries.  New ship premiums were lower for the fall/winter itineraries.  On the positive side, European demand was even more robust in July, which bodes well for Q3.  Unfortunately for NCLH, Caribbean will always steal the limelight as Caribbean capacity is 165% greater than its European capacity in 2014. July pricing confirms that Q4 could be the next red flag.



  • It is still gnarly out there.  But it looks like the discounting has stopped for Q3.  However, Q4 2014/Q1 2015 pricing is weaker as new ship premiums shrank.
  • Premiums (charts below)
    • Breakaway’s Q3 premiums expanded in mid-July as its peer group pricing fell
    • Breakaway’s Q4 premiums narrowed slightly.  This is a key metric to keep an eye on as Quantum comes into the market in November.
    • For Getaway, Q4 APD is averaging $83, compared with peer group APD of $71.







  • NCLH has 49%, 40% and 62% of its capacity in the Caribbean (including Bermuda) for Q2/Q3/Q4 2014, respectively.  Compared with last year, Caribbean (including Bermuda) capacity is up 6% points.


  • Very strong pricing (+20%) in Europe for Q3



  • Q4 pricing is modestly lower.  Hawaii tourism has fallen in 2014 as visitation dropped - likely to do with the April 1st consumption (sales) tax increase from 5% to 8%.  Side note, the last time the tax went up, in a slightly smaller jump, from 3% to 5%, was in 1997.




Now that the Street’s and CCL’s estimates have caught up to our expectations for FY 2014, it is more difficult to outperform.





If the Europe surge is sustainable and Caribbean can hold its ground, RCL should outperform in the intermediate term. 





Survey has signaled a bearish pivot on NCLH for much of 2014 due to a troubled Caribbean market.  While Q3 could be in-line, Q4 yield could be at risk. 




MCD reported a disappointing quarter, followed up by an even more disappointing conference call.  While the phrase "sense of urgency" was used many times during the call, the current "reset plan" as outlined has very few teeth and is, in our view, unlikely to accomplish the intended results.


Given the current trends, and the lack of a credible business plan, MCD will have no choice but to undertake a major restructuring in 2015.


Until proven wrong, we continue to believe some of MCD's wounds are self-inflicted and stem from the company's attempt to be all things to all people while over-indexing the business toward beverages.


For the past two years, we've been harping on our "Espresso-Based Conspiracy Theory" as one of the reasons McDonald's is struggling to grow its top line.


In short, we believe the McCafe strategy creates additional complexity in the back of the house and diverts resources away from the core food business.  We've always viewed McDonald's as a food first destination.  Whenever management shifts their focus away from food and to beverages, the core business suffers.  To that extent, we contend that the early success of the beverage strategy (cold beverages) successfully masked a decline in the core business (selling burgers and fries).  Until the company addresses the McCafe complexity issues, it will be difficult to fix the core business.


Additionally, the company cannot seriously address the secular issues it faces until it reduces the complexity of its store operations.  The company's 2014 attempt to address complexity issues by installing "high density" tables serves merely as a band-aid rather than a real solution.


Clearly, the Street is lacking confidence in the current management team and continues to dig deep into the issues the company faces.  There is a lot of work that needs to be done before we'll see better trends at MCD.






Call with questions.


Howard Penney

Managing Director


Fred Masotta


CAT: Not All Clear? (2Q Preview)



The market responded favorably to CAT’s 1Q 2014, with dealer inventory build supporting record margins in Construction Industries (CI) and an easy comp helping Energy & Transportation (E&T).  From what we can see, many investors have likely mistaken 1Q 2014 results as an ‘all clear’ signal.  As shown by CAT’s strong YTD performance, sentiment is far more positive going in to 2Q results.  We instead expect CAT’s challenges to take somewhat longer to resolve, with 2Q 2014 and 2H 2014 estimates above what the company is likely to generate.


For 2Q 2014, however, the comps get tougher and the environment less pretty.  Construction equipment sales appear weaker, particularly in Asia, as shown by Volvo and other early reporting construction equipment companies.  We do not expect a repeat of CI’s record 1Q margin.  Copper, iron ore, and coal prices have been weak, likely keeping Resource Industries (RI) under pressure.  Weaker CI and RI sales may reduce engine volumes at Energy & Transportation, with dealer stats showing slowing in other key E&T markets.  As for guidance, we are still amazed that anyone cares about a $0.25 2014 raise at a company that has seen 2014 estimates fall over the last ~18 months by >$7.00.  Nonetheless, for 2Q 2014, we get a likely range between $1.44 and $1.50, below current consensus of $1.52, with sales in-line to slightly below current consensus.



Segment Expectations


Construction Industries


While a performance outlier in 1Q 2014, we expect CAT’s Construction Industries segment results to weaken sequentially.  A significant build in dealer inventory last quarter helped drive a record margin and above industry revenue growth (see CAT: Dirty Paws or Easy Comp).  Volvo CE and CAT CI sales are reasonably correlated, and more tightly correlated if we back out our estimates of CAT dealer inventory changes.  As shown in the chart below, Volvo CE revenues were down ~9% in 2Q 2014.  


CAT:  Not All Clear? (2Q Preview) - klk



Adjusted operating income at Volvo CE was nearly cut in half YoY.  While it might be tempting to assume China will not matter for CAT, it was a factor in 4Q 2012/1Q 2013 amid a previous inventory glut.  We will look for commentary on Asia construction equipment inventory and expected factory utilization.


Looking at Volvo CE results, there were largely negative signs outside of a robust North America.


CAT:  Not All Clear? (2Q Preview) - klk2

Source: Volvo



CAT seemed to lower expectations for Construction Industries in the 1Q guidance, with the goal of maintaining double digit margins and 10% 2014 revenue growth.  Dealer inventory build likely pulled forward sales, with guidance implying to a ~7% revenue growth rate for the remainder of the year.  Margins at CI are usually fairly volatile.  We have ~11% penciled in for 2Q 2014, with a lot of potential error imbedded in that estimate.



Resource Industries


CAT lowered RI 2014 top line guidance last quarter from -10% 2014 to -20%; we expect to see them do so again – perhaps this quarter.  Dealer inventory changes were not identified as a factor last quarter and the environment appears to have weakened YTD.  While the comps get easier on sales, weak pricing is likely to continue to pressure margins.  As discussed in our recent call on Mining Equipment pricing, the time lag between order pricing and revenue recognition is significant.  While we have a mid-single digit margin modeled for 2Q, we do see the potential for negative RI segment margins as the downcycle in mining capital spending drags on.



Energy & Transportation


As we have written previously, we believe CI and RI engine demand is an important source of volume across certain E&T’s engine platforms.  CAT's dealer stats point to weak results for Power Generation and sequential slowing in Industrial and Transportation markets through May.  Oil & Gas should prove a bit more robust, although product prices have generally weakened into 3Q, notably US natural gas.  We have assumed topline growth similar to 1Q and slight margin pressure YoY amid what we expect to be weaker volume for certain engine platforms and ongoing spending to produce an emissions compliant locomotive.



Potential Upside?


Should dealers again add significant construction equipment or other inventory, we would expect a more in-line to better report from CAT.  CAT may also have some flexibility to further reduce backlogged orders to keep capacity utilization high, potentially reporting better results.  Of course, this tends to be the case each quarter.  We suspect that large dealer inventory increases or backlog decreases might not prove as relevant to the market given the more positive current sentiment.  To really move the needle from current levels, CAT may need to beat without results driven by a backlog drain or dealer inventory build.



What Could Get Us To Change Our View?


We can always be wrong and will change our views as needed.  Specifically, we will be watching CAT’s cost programs closely.  While we expect much more dramatic actions than the current restructuring to prove necessary, particularly in Resource Industries, CAT may be successful at executing significant change more gradually.  We think it is unlikely, with hope for a rebound at Resource Industries likely to preclude the necessary rationalizations. 


We will also track order rates.  While we believe pricing is quite likely to continue lower in Resource Industries for at least the next year, margins may bottom somewhat earlier or somewhat later.  We would expect orders for RI equipment to remain weak until a (likely muted) replacement cycle starts in the second half of this decade.  Finally, we expect more significant negative feedback from weakness at RI and CI on E&T engine volumes.  If that does not prove accurate or Oil & Gas capital spending accelerates, we would revise our longer-term E&T expectations.





While 1Q 2014 benefited from inventory build at dealers and an easy comp, the set-up for CAT’s 2Q and 2H 2014 is more challenging.  At the same time, 1Q results appear to have left many investors with the impression that CAT is on the mend.  We think that is still a couple of years away.  We expect the challenges facing CAT to take far more time to resolve, with YTD outperformance analogous to CAT’s outperformance in late-2012/early-2013 – a bounce higher in a longer-term downtrend.  Assuming a cessation of inventory builds in CI, we see current consensus expectations for 2Q as too high, but calling quarters tends not to be our strategy.  The current set-up is more fragile in our view: a miss in 2Q, or later in 2H, may shatter the narrative that CAT’s troubles are over.


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