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Italy, Commodities and the Russell 2000

Client Talking Points

ITALY

The first major European Equity market to snap my 21,311 (MIB Index) TREND line in June is the first to roll over at lower-highs this morning – in Real-Time Alerts I haven’t signaled re-short Italy, France, and Portugal (yet) but if they fail here, that call is coming.

Commodities

Best consumption news of the last month is deflating what was our #InflationAccelerating call from JAN-JUN; CRB Index is now only +3% YTD and bearish TREND (295 resistance); only commodity I like long side right here is Gold w/ upside to $1321 resistance

Russell 2000

It’s now only -0.5% YTD so everything is fixed, right? Sell it. Consensus hedge funds shorting the lows and covering the highs is providing for quite the year of fading beta. Sell the high end of my risk range and cover the low (1115-1161); stay with the process 

Asset Allocation

CASH 54% US EQUITIES 0%
INTL EQUITIES 12% COMMODITIES 6%
FIXED INCOME 24% INTL CURRENCIES 4%

Top Long Ideas

Company Ticker Sector Duration
HOLX

Hologic is emerging from an extremely tough period which has left investors wary of further missteps. In our view, Hologic and its new management are set to show solid growth over the next several years. We have built two survey tools to track and forecast the two critical elements that will drive this acceleration.  The first survey tool measures 3-D Mammography placements every month.  Recently we have detected acceleration in month over month placements.  When Hologic finally receives a reimbursement code from Medicare, placements will accelerate further, perhaps even sooner.  With our survey, we'll see it real time. In addition to our mammography survey. We've been running a monthly survey of OB/GYNs asking them questions to help us forecast the rest of Hologic's businesses, some of which have been faced with significant headwinds. Based on our survey, we think those headwinds are fading. If the Affordable Care Act actually manages to reduce the number of uninsured, Hologic is one of the best positioned companies.

BOBE

The level of activism in the restaurant industry has never been more rampant.  In the past year alone, we’ve seen CBRL, DAVE, DRI, BJRI and BOBE attract largely uninvited attention from these investors. BOBE has a long history of mismanagement, evidenced by flawed strategic rationale, an excessively bloated cost structure and severe underperformance relative to peers.  Fortunately, its poor operating performance presents a tremendous opportunity. We believe activist investor Sandell has identified significant, largely feasible, opportunities to enhance shareholder value.  Particularly, we see tremendous upside value in selling the foods business, transitioning to an asset light model and refocusing capital allocation.

 

TLT

Fixed income continues to be our favorite asset class, so it should come as no surprise to see us rotate into the Shares 20+ Year Treasury Bond Fund (TLT) on the long side. In conjunction with our #Q3Slowing macro theme, we think the slope of domestic economic growth is poised to roll over here in the third quarter. In the context of what may be flat-to-decelerating reported inflation, we think the performance divergence between Treasuries, stocks and commodities may actually be set to widen over the next two to three months. This view remains counter to consensus expectations, which is additive to our already-high conviction level in this position.  Fade consensus on bonds – especially as growth slows. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove.

Three for the Road

TWEET OF THE DAY

“ASIA: another strong session for stocks - China and India remain two that we like, long side” -- @KeithMcCullough

QUOTE OF THE DAY

Success is liking yourself, liking what you do, and liking how you do it. -- Maya Angelou

STAT OF THE DAY

65, The number of yards Cleveland Browns’ quarterback Johnny Manziel threw for in last night’s highly anticipated preseason NFL game against the Washington Redskins.


August 19, 2014

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BULLISH TRENDS

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BEARISH TRENDS

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CHART OF THE DAY: Painful Market Moves Happen Hombre $DJIA

CHART OF THE DAY: Painful Market Moves Happen Hombre $DJIA - Chart of the Day

 

Q: How many US equity only PMs live in fear of missing the last 3% of a 5 year rally in the US stock market? A: lots



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Panic! Market Up

“Panic! Dow Plunges Through Floor”

-1987

 

The 1980s were awesome. From big hair bands to Boesky getting bagged, there was a lot going on. A straight up stock market went straight down. The Dow dropped -22.61% in a day (October 19th, 1987)… but, if you ask the perma bulls, “the market was flat that year.”

 

It’s already August and the Russell 2000 is still trying to get back to flat for the year. With the 10yr Bond Yield having crashed alongside fanciful 1980s like +3-4% US GDP growth expectations, in Greenwich meetings yesterday I was told that GDP “doesn’t matter anymore anyway.”

 

Yep. This time is different. Roger that.

 

Panic! Market Up - Black Monday the Stock Market Crash of 1987 NYT

 

Back to the Global Macro Grind

 

The rate of change in US economic growth may not matter to long-short stock pickers, but it matters, big time, to both the bond market and the sector asset allocations that are driving performance in the US stock market. As growth slows, big-cap-slow-growth #YieldChasing stocks & sectors outperform.

 

They didn’t yesterday though. My Connecticut investor meetings were great, but my recommended positioning sucked:

 

  1. Housing (ITB) led gainers at +2% on the day
  2. Regional Banks (KRE) were right behind the builders at +1.7%

 

The only thing that has sucked more than having that short position yesterday, has been having it as a long position all year.

 

BREAKING:Wall St Rallies on M&A Blitz and Home Builder Data” –Yahoo

 

Yahoooo! Everyone is going to buy everyone as US growth slows. Why not? And I’m not being sarcastic about that either. That said, there’s also a greater chance of Big Alberta Cows jumping over the moon than the US economy accelerating as US Housing and consumption slows.

 

Another US equity only manager told me yesterday that if I was right on #Q3Slowing (and that Janet Yellen gets more dovish, in kind), that “oh, the stock market is going to go higher on that.”

 

In other words:

 

  1. If growth accelerates, as Consensus Macro has been calling for since January, stocks are going to rip
  2. If growth slows, stocks are going to rip too

 

#cool

 

It’s a good thing everyone is going to be a winner under any scenario with Global Macro volatility (across Equities, Currencies,  Commodities, and Fixed income – ping for our Q3 Macro Theme of #VolatilityAsymmetry) at all-time lows.

 

That hasn’t happened before, but neither did 1987.

 

Q: How many US equity only PMs live in fear of missing the last 3% of a 5 year rally in the US stock market? A: lots

 

Or at least a lot more than there are PMs, strategists, and (god forbid) economists, who are in print like this Canadian mutt writing about the US economic cycle similarities between Q3 of 2007 and 2014.

 

Enough of the ranting – here are some #timestamped short ideas for this morning’s “futures are up” to sell into:

 

  1. Russell 20000 (IWM)
  2. Housing (ITB)
  3. Toll Brothers (TOL)
  4. Target (TGT)
  5. Brinker (EAT)

 

Yep. On the no-volume bounce (Total US Equity Market Volume was -15% and -39% vs. its 3 month and YTD averages yesterday), I’m going right back to the wood (i.e. the SELL calls that worked for me in both 2007 and 2014). They are early-cycle slowdown housing and consumption shorts.

 

And no, I don’t think that what’s going on in Ferguson, Missouri right now is a bullish catalyst for the 80% of this country being smoked by the all-time highs in Fed-inflated cost of living. Neither would I be surprised if the US stock market had a 3-6% down day in the next 3 months. Then you’ll see panic.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.34-2.42

SPX 1

RUT 1115-1161

MIB Index 186

VIX 11.14-17.29

USD 81.31-81.72

Gold 1

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Panic! Market Up - Chart of the Day


GALAXY Q2 2014 CONFERENCE CALL

Galaxy in line with Street and us for Q2. More chatter regarding higher rebates in the QA and while Galaxy wouldn't deny it is happening in the market, they are not participating.

 

 

PREPARED REMARKS:

  • Headwinds: soft landing in China, World Cup and poor VIP luck negatively impacted results by HKD225 million
  • Pursuing opportunities beyond Macau
  • Additional special dividend in October 2014 of HKD0.45/share 
  • GGR +16% YoY, market leading VIP +15% revenue growth, hold 2.9%, bad luck HKD225 million
  • Mass +16% YoY
  • Management is focused on balancing margin against achieving the highest possible absolute HKD EBITDA
  • Manage table mix every day

Galaxy Macau

  • EBITDA up due to VIP strength, VIP +40%, hold 3.16%; lower VIP hold given historical property performance had a HK$75m impact on EBITDA
  • Mass +19% despite table shift to VIP
  • Hotel occupancy 98% 
  • 31% US GAAP margin
  • Opened two new VIP rooms in April, will add 2 VIP rooms in October 

Starworld

  • 5% decrease QoQ due to worst VIP luck in company history
  • VIP revenues -11%, hold 2.53%, if hold adjusted at 2.98% then +HKD150 million higher EBITDA
  • Mass +28% 
  • Hotel occupancy 98%
  • EBTIDA margin 24% US GAAP 
  • Will relaunch new VIP room before year end

Development

  • Cotai Phase 2: on budget and timeline mid 2015
  • CapEx spend HKD7.3 billion of total plan HKD19 billion, spent HKD1.4b in Q2
  • P3 and P4 finalized in late 2014 will double space
  • Grand Waldo: moving forward plans in Q4 2014 and relaunch in 2015
  • Henquin still working on plans, will support Macau and Cotai plans
  • Pursuing opportunities across Asia, respectful of cultures
  • Balance sheet end of Q2: Cash 14.4 billion; Debt 348m

 

Q&A:

  • VIP Market today, real time - turning around?  Feel growth of VIP business was as expected for GEG, remain confident VIP market will continue to grow at high single digit rate.
  • HKD125 million tax expense was dividend related. Is also a four-year prepayment, will be HKD120-130 million and accrue over four years
  • Accrual for employee bonuses - paid normal wage increases, plus incremental one month, plus share award for staying over three years, then receive three months salary in stock = +/- 10% to 15% of base wage increase.  But cash and non-cash component so 100-150bps impact to margin.  Approx HKD700 million impact per year, so about HKD150 million per quarter, no catch up.
  • Charitable Foundation accounting - HKD 300 million commitment this year and add'l 100m in subsequent years.  Cash would be a charge to P&L.
  • Margins increase due to optimization of segments on the floor
  • VIP business - look to grow with high quality partners; will add before year end
  • Starworld - current reposition of VIP room and new restaurant will be completed before year end 2014. 
  • Grand Waldo relaunch will include gaming tables and will target mass market.  Plans will be presented in Q4, will be a unique offering and very exciting.
  • Operators increasing rebate in premium mass? - Galaxy not involved in driving incentive, rebates or other programs which reduce margin.
  • Smoking ban changes - rules debuted on October 6 and expect their properties will be fully compliant with smoking rooms on mass floors as well as smoking areas in private areas.   Expect marginal impact and not long lasting negative impact.
  • Phase 2 headcount - will need 7,000 to 8,000 additional people. 
  • Mass Market trends - saw a pick up following World Cup, but still seeing a negative economic impact to growth, optimistic for October Golden Week. 

COH - Broken Brand NOT = Broken Stock

Takeaway: Big bifurcation between the brand and stock. This shouldn’t be a public company, and it likely won’t be for long. Can’t short COH anymore.

Conclusion: After being bearish on the name for nearly three-years, we’re taking Coach off our Retail Short List. To be clear, the fundamental story is absolutely broken, and the financial model is not far behind. Our numbers 2-3 years out are 20%+ below consensus, and we truly don’t think that this company will earn $2.00 again until close to 2020.  But as broken as this model may be, the stock, unfortunately, is not. We think that the absolute best-case downside on a short at these levels is about $5, which is hardly enough on a $36 stock. And the truth is that we’d need to see the company face-plant on its recently-announced Brand repositioning, and there are no expectations for any meaningful results for another 1-2 years. Until then, the company probably has a hall pass to be sub-par, and the stock will probably be rewarded if the company hits a quarter even if by accident.

 

We’ve been struggling with valuation support on Coach given that we expect Gross Margins to cough up another 300bp, and EBIT margins should stay stagnant in the mid-high teens for years to come. But the flip side is that the dividend currently sits at 3.72%, which is reasonably attractive. The key here, unlike other higher yielding retailers is that the dividend is safe – even on our beared-up numbers. In fact, we’d need to see about a 700bp hit to Gross Margins in order to threaten the dividend. That would equate to a 13% EBIT margin. As much as we think that Coach has been relegated to an Outlet brand, it’s extraordinarily unlikely that it will ever see a 13% margin level again. At a 13% margin, we’re looking at about $1.33 in EPS. If we generously give it a 15x multiple, it suggests $20, or a 6.8% yield. That’s probably not going to happen.

 

In fact, Coach is on the short list (no pun intended) of names we think could, should, and probably will be acquired over the next 1-2 years. The brand just lost the team that took COH from $500mm to $4bn (Krakoff, Stritzke, Tucci, Frankfort) and has as much instability in the executive ranks as it does with its brand. A strategic or financial buyer could shield the management team from the near-term expectations associated with the capital markets, and focus strictly on revitalizing the brand – like it did the last time it grew stale and Sara Lee spun out Coach in 2000.

 

LBO: Makes more sense that one might think. The cash flow here is extremely compelling. The public market is getting a 3.72% yield, but a private buyer could take that up to the teens and not miss a beat. The transaction at $36 is on the rich side (a $30 stock with a 20% premium), gets us a 17.2% IRR with 6.9x debt/EBITDA. The leverage is on the high end of deals done to-date. But not out of the realm of what we’d consider doable. Again, this is based on zero margin recovery, and assumes a 10x exit multiple (equal to entry). Let us know if you’d like our LBO model.

 

Strategic Buyers: We think that the three most likely are Fast Retailing (Japan), Kering  (the former PPR/Gucci -- France), and LVMH (France). These companies could all digest COH in a heartbeat – from a leverage and dilution standpoint – at a price as high as $45. Fast could actually do the deal as high as $60 and it would be accretive. Same goes for Richemont and Inditex, though Coach would be further outside their respective cores.

 

COH Acquisition Accretion

COH - Broken Brand NOT = Broken Stock - coh1

Source: Hedgeye and Factset

 

Leverage Pre and Post COH Acquisition

COH - Broken Brand NOT = Broken Stock - coh2

Source: Hedgeye and Factset


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