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Takeaway: Management fired a warning shot for 2015, reinforcing our call that 2015 will be ugly. Consensus STILL doesn't get it, so we'll stay short

KEY POINTS

  1. 2Q14 SHOWED SOME IMPROVEMENT: WTW beat revenue estimates by a little over 2%, largely driven some pricing improvements internationally and some mild improvement on churn rate.  Adjusted EPS came in $0.98 vs. Consensus of $0.77, but much of that upside came from slashing marketing expense, which is where the company can't afford to be cutting if it wants to revive its business.  Total membership declines moderated from -18.6% in 1Q14 to -14.8% in 2Q14.  The company raised its EPS guidance to $1.65-$1.85 from $1.40-$1.85.  In short, the quarter came in better than expected, but wasn't all that impressive.  
  2. BUT NOT ENOUGH: In any given year, the first quarter is everything for WTW given seasonal attrition patterns.  After 1Q, we are monitoring attrition patterns to see what kind of a winter season is necessary to hit consensus estimates for the following year.  While we did see some improvement in its 2Q attrition rate, as it stands now, WTW will still need one of its strongest selling season on record in order to achieve 2015 consensus estimates.  Given that member acquisition costs have more than tripled in the last 3 years and the company is scaling back on marketing to preserve profitability, the prospects of that occurring are particularly slim.  In fact, if management doesn't plan to drastically increase its marketing spend, we would suspect that WTW may be heading for another all-time low in winter recruitment next year.  
  3. BEGGARS ON THE STREET: WTW told the street there is a $0.60 headwind to 2015; that is a massive number considering 2014 guidance is  $1.75 at the midpoint.  A significant driver of the headwind is management's expectation that both Monthly Pass and Online subscribers will decline in the mid-teens %.  In short, management is telling the street what we've been saying for some time now: 2015 will be an ugly year.  By announcing this on its 2Q14 call, management appears to be begging analysts to bring down their numbers before the company announces 2015 guidance.  Consensus 2015 revenue estimates have increased following the print, with expected revenue growth holding steady at -2.2% for 2015.  With consensus asleep behind the wheel, we see no problem riding the short from here.

Let us know if you have any questions, or would like to discuss in more detail

Hesham Shaaban, CFA

@HedgeyeInternet

Thomas Tobin

@HedgeyeHC