The Economic Data calendar for the week of the 11th of August through the 15th of August is full of critical releases and events. Attached below is a snapshot of some of the headline numbers that we will be focused on.
Takeaway: Current Investing Ideas: BOBE, GLD, HCA, HOLX, LM, OC, OZM, RH and TLT.
Below are Hedgeye analysts’ latest updates on our nine current high-conviction long investing ideas and CEO Keith McCullough’s updated levels for each.
We also feature three recent institutional research notes that offer valuable insight into the markets and the global 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.
BOBE: More of the same at Bob Evans Restaurants. The company and activist Sandell Asset Management continue to trade blows through the likes of presentations and letters to shareholders. While both sides have made credible points, we’d argue that Sandell has the upper hand. The reality is, Bob Evans’ Board, as it stands, doesn’t appear open to any of the suggestions Sandell has made to improve shareholder value. It is precisely this stubbornness, and inflexibility, that has led to the current disastrous state of the company.
To be clear, Sandell’s “economic agenda” is not unsustainable, as there are vast operational improvements to be made. In our view, the Board nominees put forth by the activist have more experience in the restaurant industry and are far better equipped to lead a turnaround at the company. For this reason, among others, we’re willing to bet they successfully get majority control of the Board. Bob Evans’ will hold its Annual General Meeting on August 20.
GLD: After a pullback last week, we are sticking with Gold on the long-side. As of now it remains in a bullish @Hedgeye intermediate-term TREND with support at $1271. The long-term TAIL Line remains $1323. You guessed it. The narrative remains the same:
Ten-year yields touched YTD lows Friday reflecting skepticism around a real recovery despite an initial +4.1% Q2 GDP bounce off the -2.1% Q1 print. After breaking @Hedgeye long-term TAIL support, there is no support for the ten-year yield to 1.70%. Our risk management signals suggest the momentum embedded in this trend makes further downside to 1.70% a more probable scenario than the consensus 3%+ expectation.
Although this narrative for the USD outlook works both for and against the price of gold under certain scenarios, we continue to believe real growth expectations in the U.S. for the second half of 2014 remain too high. Right now there are two big headwinds to our theme regardless of how domestic growth materializes:
HCA: HCA strength continues on the heels of an excellent quarter despite the recent market decline and increase in volatility. HCA is up approximately +5% over the last two weeks versus the S&P 500 which has declined by approximately -3% as we write this note on Friday afternoon. We continue to believe that stock has upside into $71-81 range as 2015 consensus estimates move higher and more in line with our model.
July results of our monthly Physician survey are in, and the results show that maternity trends appear to be in a sustainable recovery. Over the last several months, both deliveries and pregnancies are accelerating among our surveyed physicians. Commercially insured, higher income, as well as Western states show the greatest improvement while low income and the Northeast remain weak. The Current Population Survey (US Census) supports the survey work through data supplied through June with the next update arriving for July by the end of the month.
Improving birth trends is a major tailwind for HCA.
Sustainable Recovery in Birth Trends
Our 3D Tomo Facility Tracker update shows that placements accelerated in July 2014 (35) versus a soft June (22). Prior to seeing the July Tomo Facility count, we were having trouble modelling revenue much above the low end of Hologic’s F4Q14 guidance range of $ million using only data from the 10-Q and from the earnings call. However, if July pace holds throughout the rest of the quarter, it will be a new placement record, providing adequate 3D system revenue to drive total revenue toward the high end of the guidance range, or better.
Hedgeye PAP Survey Results
Our monthly physician survey results indicate a pickup in Patient volume in July after a weak May-June period. There appears to have been a spike among Medicaid practices during 1H14 associated with the rollout of the ACA. At least through July, the upswing has abated somewhat. Commercial volume is running flat after a very weak Q1 and subsequent rebound. As it relates more specifically to HOLX, pap trends continued to improve in July. The forecasted decline PAP volume to reach compliance slowed to a CAGR of -7.5% in July from -10.0% in June.
LM: We have no specific update this week on our long recommendation of Legg Mason stock. That said, the largely institutional fixed income manager is a defensive investment in the current volatile, geopolitical sensitive environment and shares should continue to be more steady than the rest of the asset management sector.
OC: This past Thursday we hosted our expert call with Bill Carlin. Bill spent decades in Owens Corning’s roofing division and now is an industry consultant. The pie chart below is from Bill’s presentation outlining the North American roofing market share by company. Here are a couple of quick takeaways from the call:
The bottom line is that the roofing industry is cyclically depressed mainly due to volumes versus a dynamic shift in the roofing industry, as we have noted in previous notes. We reiterate the best time to buy cyclicals is when they are depressed and sell when they are high and loved by consensus.
OZM: Och Ziff Capital Management reported in line earnings this week producing $0.18 per share in distributable cash earnings (in line with the Street) and declaring a $0.17 per share dividend (they dividend out over 90% of their distributable cash flow). This distribution alone creates a dividend yield of 4.9% which is partly why we like OZM stock with a much higher yield relative to market averages.
In addition, if Och Ziff ends the year with any performance related gains on the $45.7 billion it manages for clients, 20% of those gains will source another earnings stream which could total up to $0.50 in distributable earnings per share, or another dividend distribution of over 4.0%.
Hence OZM shareholders have the opportunity to collect total annual dividends of up to 9.0% of the current stock price which also has the chance of appreciating with industry leading organic growth rate and very strong performance.
The Barclays Hedge Index is up just 0.60% year-to-date in 2014 versus OZM’s main Multi-Strat fund which is up over 2.0%, displaying the company’s ability to assist investors and shareholders with strong investment management performance.
RH: The prevailing viewpoint with RH is that the company is already in all of the markets it can possibly penetrate, but simply has an opportunity to build larger-format stores. We think that’s wrong. Our analysis suggests that there are 19 new markets in the US and Canada where RH can not only build stores, but build over half of them in the 50,000 square foot range (compared to 9,000 on average today). The bottom line – there’s more square footage growth opportunity here than most people think.
TLT: We added TLT (iShares 20+ Year Treasury Bond ETF) to our high conviction list earlier this week. In conjunction with Hedgeye’s overall #Q3Slowing theme, we think that the slope of domestic economic growth is set to roll over here in the third quarter.
In the context of what might be flat-to-decelerating reported inflation, we think the performance divergences between Treasuries, stocks and commodities may actually be set to widen over the next two to three months.
The view remains counter to consensus expectations, which is additive to our already high conviction in this position.
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Monday (Here) we profiled the special QM related questions included in the Fed’s 3Q14 Senior Loan officer Survey and the negative impact on housing demand.
Yesterday (HERE) we highlighted the G.19 consumer credit data and the continued acceleration in revolving credit growth.
Below we summarily highlight the balance of the 3Q Senior Loan Officer Survey data and a selection of domestic credit metrics.
CREDIT INTUITION: Credit is typically pro-cyclical with banks loosening standards and extending credit in response to rising demand and improved credit risk.
The reason for the pro-cyclicality is rather straightforward - Household capacity for credit increases as incomes rise alongside positive employment growth and as net wealth rises alongside the rise in real and financial assets that typically accompanies an expansionary economic phase.
Cash flows to service debt and the collateral values backing the debt both support incremental capacity for credit and serve to drive an upswing in the credit cycle.
Thus, credit sits as the Sangre Vital of modern macroeconomies in expansion, serving to jumpstart and/or amplify the economic cycle.
Of course, leverage works both ways and amplifies the impacts of a contractionary phase as well.
3Q14 Senior Loan Officer Survey: Rising Demand, Stable-to-Easing Standards
In short, loan demand continues to rise (particularly across the C&I category), on balance, while credit standards continue to trend favorably alongside that increase in demand and the moderate, ongoing improvement in the labor market.
The Senior Loan Officer Survey data mirror the broader trends in the high frequency H.8 data which currently shows a positive slope of improvement across all major loan categories. Unless the labor data inflects negatively, it’s probable both loan demand and ease of credit access continue to follow their current, pro-cyclical trend.
CREDIT FLOW: The idea of the “Credit Impulse”, popularized by Biggs, Meyer & Pick (2010), centers on the idea that it’s the flow, not the stock, of credit that matters relative to economic growth
The first chart below illustrates the Credit Impulse (Household and Non-Financial Corporate Debt, Flow of Funds data) vs. the Y/Y change in consumer and business demand (represented by the y/y change for the Consumption and Investment components of GDP) along with the Y/Y change in total household and Non-financial corporate debt.
As can be seen, the trend in private sector demand growth tracks the credit impulse closely and leads the positive inflection in y/y debt growth.
The second chart shows the Credit impulse vs. the ‘Banks Willingness to Lend’ measure from the Senior Loan Officer Survey.
Again, the Trend relationship is strong and with Willingness to Lend accelerating in 3Q14 the read through for credit catalyzed private consumption remains favorable
In short, the “credit impulse” tends to lead private demand for credit and “banks willingness to Lend” tends to front-run the credit impulse.
HOUSEHOLD DEBT: After running negative for 18 consecutive quarter beginning in 1Q09, household debt growth returned to positive YoY growth in 3Q13.
Given improving mortgage, auto, and consumer loan trends YTD, credit growth should remain positive thru 2Q/3Q as well when the official Fed data is released. With rates largely static, the closing of the delta between income and debt growth represent the principal upside to credit driven consumption.
The PCE data tells an expectedly similar story. While disposable income grew at a premium to consumption during the acute deleveraging, peri-recession period, that trend has reversed over the TTM with nominal household spending running on par to slightly ahead of nominal aggregate income.
After a 19-quarter, -18.1% decline from peak, Household debt-to-GDP troughed at 77% in 4Q13 and ticked up to 77.4% in 1Q14 alongside the worst post-war, expansionary period GDP print ever.
BIG PICTURE/THE CYCLE: Credit trends are improving and, in a reflexive macroeconomy, can serve to drive incremental spending in the immediate/intermediate term.
Bigger picture, we remain on the wrong end of a credit/interest rate and demographic cycle and haven’t delevered enough to allow debt growth (alongside a rising cost of debt) to run ahead of income growth for any sustainable LT period.
Policy remains a blunt (and now exhausted) tool and exorbitant privilege and dollar hegemony can only defy the gravity of long-term budget constraints for so long.
Christian B. Drake
This note was originally published July 28, 2014 at 13:01 in Restaurants
MCD is under siege on three continents (America, Europe, Asia) and senior management's response to these crises will determine the future and the future profitability of this company. Hopefully we don't see a pattern of missteps similar to those that created one of the biggest public relations nightmares in the history of McDonald's.
Students of McDonald's history know that the "McLibel" case was a very dark period for McDonald's Corporation. This case was an English lawsuit for libel filed by McDonald's Corporation against environmental activists Helen Steel and David Morris over a pamphlet highly critical of the company. The litigation, drawn out over a ten-year period, embarrassed McDonald's and caused the U.K. business to underperform for more than a decade.
McDonald's is currently under attack from different groups over varying issues in three key countries across three separate continents. How management handles these issues will be critical to the future of the company.
How management responds to these issues is critical to the future performance of the company, as they are not insignificant markets. If the company's initial response to the meat supplier issue is any indication, we could be in for an extended period of underperformance.
China - Last Thursday, McDonald's said it is sticking with a Chinese meat provider, even after saying earlier in the week that it may have been misled regarding sales of allegedly expired meat. The supplier is Shanghai Husi, which is owned by U.S. based OSI Group, a longtime supplier of McDonald's. Clearly, the company's ties to its Chinese supplier run deep. Today, however, news came out that McDonald's cannot sell its core menu items in China. China is the last bastion of growth for McDonald's and, prior to today's news, the company was not able to meet its unit growth targets.
Russia - We haven't seen any official response to the Russian lawsuit from McDonald's, but how they respond will be critical. Is McDonald's a pawn in the ever-increasing tension between the U.S. and Russia or did McDonald's bring on this pressure by shutting down its three restaurants in Crimea after Russia's annexation of the peninsula in March? Either way, McDonald's is in a very difficult spot. They need to settle this issue immediately and not let another legal case be played out in the press.
U.S. - Wages are headed higher for McDonald's in the U.S. and the company needs to get ahead of the curve. Unfortunately, being a franchised system, the issue is in the control of the franchisees. They won't want to pay higher wages with same-store sales and margins declining.
Turning back to the McLibel case, some of the leading allegations were that McDonald's:
McDonald's is a strong global brand that must protect itself against erroneous allegations. It appears that any one of these could be made again today. With that being said, how management proceeds with all the issues the company is currently facing will determine the financial performance of the company for the balance of the decade.
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