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HSY – Beware C-Store and Commodity Headwinds in 2H

Hershey reported Q2 results that were largely in line with consensus -- $1,578.4M of sales rose 4.6% Y/Y (excluding FX), a sequential improvement vs 2.4% in Q1, but the company signaled weaker in-store activity and will likely face increasing commodity cost pressure in 2H.  EPS of $0.76 rose 5.6%, albeit off the easier comp of the year.  


HSY cited weakness in the quarter from the C-store channel on a continued challenged macro environment that’s impacting consumer spending and higher levels of in-store competition.


The stock is trading down -2% intraday on the release and is down over 14% since its ytd high in late February. The market’s discount has come alongside the company’s strategy of volume driven sales. This strategy changed last week when the company issued an 8% price increase across all of its products, citing increased commodity costs, in particular from dairy costs (note: Mars raised pricing ~ 7%). 


Commodity cost pressure remain square on our radar. In the quarter, the company saw a 230bp decline in GM – and for the remainder of the year expects these costs to be a headwind to GM on the year, falling hardest in Q3.  Below we show longer term charts of milk and cocoa, each up 15% and 13%, respectively ytd, that should also pressure results.

HSY – Beware C-Store and Commodity Headwinds in 2H - z. milk

HSY – Beware C-Store and Commodity Headwinds in 2H - 2. hsy


The company stressed its 2H plan for increased innovation (beyond what was previously planned) to make up for weakness seen in the quarter, but we think there’s a threat to the business in the back half of the year as many of the issues cited in the quarter continue to play out: weak macro environment; commodity cost inflation; impact of a price hike on demand; and increased shelf space competition.  Any hiccups with advertising and promotion to reach the consumer will also be a negative drag. 


Further, and as we show below, comps get more difficult on the top and bottom lines as we move out over the next 2-3 quarters.

HSY – Beware C-Store and Commodity Headwinds in 2H - 3. hsy

HSY – Beware C-Store and Commodity Headwinds in 2H - 4 hsy


We’re cognizant that HSY is entering the holiday-rich second half of the year in the U.S. that could help to make up for underlying weaknesses. However, the business is also experience weakness internationally. In the quarter, international sales were up 7%, however China slowed sequentially and Mexico sales were down -5% Y/Y due to FX headwinds. Taken together, there are winds blowing against the company across all of its regions.


We are not currently involve in HSY in our Real Time Alerts portfolio, but our quantitative levels below suggest a bearish TRADE and TREND outlook on the stock. 


HSY – Beware C-Store and Commodity Headwinds in 2H - 5. hsy


Howard Penney

Managing Director


Matt Hedrick



Fred Masotta


Cartoon of the Day: Inflation Shark

Takeaway: Real Americans are about to get eaten.

Cartoon of the Day: Inflation Shark - Inflation shark cartoon 07.24.2014

Initial Jobless Claims: How Low Can You Go?

Takeaway: The U.S. labor market continues to improve steadily.

Editor's note: This is an excerpt from a research report issued earlier today by Hedgeye's Financials team. For more information on how you can subscribe to Hedgeye click here.


Crisis: Risk & Opportunity

Last week, we flagged how the strength in claims represents both risk and opportunity. The opportunity lies in the fact that historically claims tracked at sub-330k for 24 months in the mid-to-late 1980s, 45 months in the mid-to-late 1990s, and 31 months in the 2005-2007 period. Currently, claims have been running at sub-330k for 6 months (though if you count from the initial drop in mid-2013 then we're closer to ~12 months). In other words, history would suggest (the last 3 cycles at any rate) there could be another 18-39 months of track left before claims begin to rise.


The risk lies in the fact that major market downturns follow sub-330k claims periods. And, importantly, there's no guarantee the last 3 cycles will reasonably represent the blueprint for this cycle. We often work in close conjunction with our Macro Team on the labor and housing markets. The chart below, illustrating the dynamic, comes from Christian Drake on the Macro Team.


Initial Jobless Claims: How Low Can You Go? - drake jobs


The Data

Prior to revision, initial jobless claims fell 18k to 284k from 302k WoW, as the prior week's number was revised up by 1k to 303k.


The headline (unrevised) number shows claims were lower by 19k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -7.25k WoW to 302k.


The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -12.2% lower YoY, which is a sequential improvement versus the previous week's YoY change of -11.1%


Initial Jobless Claims: How Low Can You Go? - nsa jobs


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Suspect capital allocation policy and and lower than expected 3Q guidance cools HOT. RevPAR acceleration from here unlikely so near term catalysts must be asset sales and more aggressive share appreciation.




Prepared Remarks:


  • Co owned hotel margins +87 bps
  • First time into four years without a global economic wobble
  • North America - record occupancy
  • Corporate Profitability high & Confidence = 2008
  • RevPAR during Q2 2014
    • US
      • Slower in North 4.4%, Chicago flat, WDC <3%, NYC 5%, Boston & Baltimore up double digits,
      • Hawaii flat - weak yen, higher airfares, higher Japanese sales tax.  
      • Better in South & Southwest 9% 
    • Latin America +5%, Mexico +13%, Brazil +25% (Germany stayed at Sheraton Rio), Chile demand struggles.   LA ex Brazil +1%, expect low end of RevPAR range if not lower.
    • Europe:  modest recovery to continue; RevPAR 2%.  Greece +25%, UK slow, France soft, Germany tough comps.  Ukraine & Russia - if events don't escalate, expect improved European outlook.
    • Africa/ME -1%:   Dubai down, Qatar +17%, Saudi flat, Egypt -20%, Nigeria down more than 20%.
    • South Africa +6%
    • China +11%, skewed by Sheraton Macau.  Ex Sheraton +7%, demand better and increased occupancy +550 bps.  Shanghai double digit revpar.  West & Central China 4%.  Sheraton Macau tailwind will taper.
    • Indonesia +19%   Thailand -12% due to coup but calm returning and business slow to recover.  India down more than 4%, hoping for needed economic change and development.
    • Asia ex China expect growth in the low single digits.
    • Maintain RevPAR outlook
  • Management fees:  in 3Q, difficult comps but YoY growth remains very strong. Ex this fee, growth would be 12%.
  • During 2Q opened 19 hotels, 3,800 rooms.  2H14 openings > 1H14 openings.
  • SVO: better tour flows, better pricing, higher closing ratios. Focused on high returns in Orlando, Mexico, Hawaii and St. John.
  • June 6th, closed final unit at St. Regis Bal Harbour. 
  • SG&A: up 16% but lapped $7m in CT State Tax incentives.  In 3Q benefit of $3-$4m in new tax incentives.

Outline to Capital Allocation

  • Impossible to have a Balance Sheet which pleases all shareholders
  • Leverage: stay investment grade in wake of major economic downturn.  Conduct a Monte Carlo scenario for how business would operate during a major economic downturn. $500m in off shore cash. Leveraged allowed to 2.5x but less than 3x. Today about $750 million of add'l capacity to get to 2.5x.  Maintain target leverage.
  • Dividends: regular dividends based on payout ratio of 50%, but 35% to 50% on a future basis. 
  • Stock buybacks: offset annual dilution of stock based comp of $85 million in 2014; expect to compete $614 million in 2014.
  • Opportunities:  Step up pace of repurchase activity or special dividends (asset sales).

Transaction Markets:

  • Optimistic HOT will announce significant transactions in 2H14 and early 2015.


  • CFO search progressing with Korn Ferry. 



  • Portfolio Sales $1 billion transaction in market or greater value on single asset basis?
    • Geographic:  not a consistent set that appeals to a single buyer, finding better/greater prices via individual asset sales.
  • US RevPAR: Luxury lagging, broader acceleration?
    • Early in recovery, significant and higher growth rates in upscale, upper upscale and luxury, but now percolating down to lower segments.
  • RevPAR trends and performance through cycle?
    • Continue to build rate so additive, performance of international segments outperforming, so not sure HOT will underperform. 
  • Share repurchase?
    • $85 million at least to offset dilution (baseline) but as HOT gets to asset light and sell $2.5 billion in sales, they will generate cash and then evaluate repurchases vs. special dividends
  • Given capital model - only able to buy back $750 million shares versus some estimates of $2b to $3b?
    • Need to take into consideration rating agency definitions, but $750m is NOT the maximum.
  • Opportunities to grow/add brands - especially in 3/4 star segments?
    • Aloft today is what W Hotels was 10 years ago...and present opportunity to grow select service hotels.
    • Four Points continues to draft off Sheraton
    • Element small but growing, tremendous growth potential
    • Difficult/challenging to launch and build De Novo
  • Group pace:
    • Bookings in 2Q. Good for in the year, for the year, but slower for 2015 but still mid-single digits range is on par with historical booking trends.
  • Share based compensation - why leave out of adjusted ebitda?
    • Better transparency to client and better measure of core business.
  • CFO search, characteristics, & timing?
    • Strong CFO, with seat at the C-Table, great mind, not afraid to have an opinion/discuss strategy and financing functions.  Have a number of interested and exciting candidates.  Will announce when they have "a name".
  • REIT Spin off of assets
    • Most North America REIT trading at discount to NAV, REIT would require add'l G&A, too many US lodging REITs trading with too few assets in their portfolio and shareholders not benefiting
  • Summarize from Q1 call to today, how did capital strategy and thinking change?
    • Had an approach to leverage limits and targeted debt levels, today more clarity on calculation.

New Home Sales: "WORSE"

Takeaway: Well that was short-lived. Last month's NHS report suggested a return to positive momentum. Nothing could have been further from the truth.

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. 


New Home Sales:  "WORSE" - Compendium 072414


Today's Focus: June New Home Sales

- He Giveth and He Taketh Away


Last month we found ourselves a bit confounded by the strength of the May New Home Sales report as it posted a +75k sequential increase seemingly out of nowhere. Now we know to continue to trust our gut, which said at the time, "what the ...".


Today's June New Home Sales report shows a complete reversal, more than wiping out the originally reported moonshot increase for May. 


Key Takeaways:


* Total:  New Home Sales saw its largest sequential decline in a year as sales dropped -36K sequentially, declining -8.1% MoM and -12% YoY.  This was on top of a downward revision to May to 442k from 504k (-12%). The softness in sales rhymes with the ongoing weakness in housing starts, which continue to offer little supply side support for forward transaction volumes.   


* Regional:  All regions saw a sequential decline in sales with each, with the exception of the Midwest, returning to negative YoY growth.


* Inventory:  The total inventory of new homes increased +4.2% MoM to 197K.  Supply continues to trend higher on both a 1Y and 2Y basis as well. 


* Sales vs Sentiment:  We highlighted the apparent decoupling of builder confidence from the reality of new construction activity last week alongside the soft starts data for May.  Today’s sales data for June offers further confirmation that the burgeoning builder hopium spread is likely to compress in favor of the data in the coming month(s).


Bottom Line:

Price gains are decelerating and what had been the last stronghold of housing - the new home market - is now falling apart. We remain bearish on housing until we see the next inflection in the second derivative price trends. 



New Home Sales:  "WORSE" - NHS 5Y


New Home Sales:  "WORSE" - NHS Regional 


New Home Sales:  "WORSE" - NHS Regional June YoY 


New Home Sales:  "WORSE" - NHS LT w summary stats


New Home Sales:  "WORSE" - NAHB vs New Home Sales


New Home Sales:  "WORSE" - New Homes For Sale 




About New Home Sales:

Each month the Census Department releases the New Home Sales report, which measures the number of newly constructed homes that have been sold in the month. The difference between the New Home Sales report and the Starts and Permits report is that New Home Sales only includes single family spec homes built and sold by builders, and does not include condos, apartments, or owner-built units. This is why New Home Sales typically run at roughly half the rate of Starts.



Joshua Steiner, CFA


Christian B. Drake


As we expected, Europe lead the Q2 beat despite lower onboard spend than we thought. 3Q net yield guidance was within expectations.  Quantum will be the next catalyst in November.






  • Double Double program (3-yr goal):  
    • Optimizing revenue
      • Structurally, had seen general pressure on pricing and compression on pricing
        • 4 areas of revenue expansion:
          • Strengthening brand
            • Azamara achieving double digit yield improvements
          • Enhancing global footprint
            • Bringing US guests on European itineraries
          • Asia
            • Quantum deployment to China is very exciting
          • Pullmantur
            • Cusp of turning an important corner.  Increased focus on Latin America.
    • Controlling costs
    • Moderate growth
      • 3-5% average compound growth is appropriate
  • Quantum of the Seas
  • 2Q
    • Better close-in pricing for Europe and Asia
    • Caribbean- highly promotional; ticket revenue yields down YoY
    • Onboard revenue yield:  +3% (10th consecutive quarter of onboard growth) - beverages packages and internet service drove the gains
    • NCC - better than expected, mostly timing related; balance of costs will be spent in rest of year
  • Booking environment:  significantly higher YoY.  Booking window continue to expand.  load and APD are up for rest of 2014.
  • Early 2015:  load and APD higher YoY
  • Caribbean:  very price sensitive.  Have implemented various promotions.  Expect Caribbean yield declines but see some improvement on Oasis ships.
  • Europe:   
    • Guests paying 20% more (in-line with our pricing survey)
    • Less supply to sell
    • Black Sea sailings pressured by conflicts in region
    • Med sailings doing well
  • Q3 guidance
    • Positive trends in Europe, China, and Alaska

Q & A 

  • Caribbean:  closer to inflection point; more pressure on 7 night and shorter itineraries.
  • Caribbean got quite a bit worse from 1Q to 2Q but has stabilized since.
  • Caribbean:  1Q 2015 comps will be harder than rest of quarters
  • Either higher dividends or stock repurchases in future
  • China:  proven to be a successful market but it is fairly young; but  investments have been costly, as with all new markets.  Still in the 1st inning.
  • 2015 NCC:  general commitment to cost cutting but there will be inflation pressures
  • Net Yield outlook:  +4% on average is a little on the high side
  • Q4 yield growth:  relatively consistent on bookings environment.
  • New onboard planning tool:  too soon to see how CruisePlanner will perform but doing well on Quantum
  • FY yield target unchanged due to rounding 
  • China vs Caribbean:  economically, Quantum should perform as well in China as in Caribbean (more costs but also more onboard revenues)
  • Demand will drive the profitability change.  Capacity has been set for the next 3 yrs.
  • Onboard revenue:  all categories up.  Doubled efforts on shore excursions.

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