“The Panic of 1819 was the first boom-bust cycle of the economy caused by government monetary policy.”
“It was an inevitable consequence of the Hamiltonian system of government debt accumulation combined with a government-run bank that prints money in order to fund the debt.” (Hamilton’s Curse, pg 68)
Sound familiar? It shouldn’t. Unless you’ve studied economic history, you might actually think that all of this won’t end in panic. Unless it’s different this time, it always has. Give it some time.
While a sub 2% US GDP growth economy could hardly be described as a “boom”, we have had some booming bubbles develop within the Fed’s 0% experiment. From real estate, to MLP #YieldChasing, to the latest Silicon Valley bubble, I think we’ll all look back and call it epic.
Back to the Global Macro Grind…
Forget about the bubble talk for a second, rewind the tapes (or just watch it trade in real-time today) and watch Apple’s (AAPL) volume and intraday price moves. That’s no bubble – that is a mania.
Manias are much more fun to watch than bubbles – people do the craziest things. Watch Go Bro (GPRO) trade, or watch the new squeeze quant algos jam these no-borrow-high-short-interest stocks. It’s pure, unadulterated, price momentum chasing.
While mo mo manias are entertaining, the bubble in momentum chasing US equity market cap is downright frightening. Pop Quiz: if you add up Apple, Facebook, and Alibaba’s proposed market caps, what do you get?
A: $1 TRILLION Dollars
Yeah, that’s normal. And so is paying $350 for an iUgly watch and, at the same time, telling the world there is no inflation “because there’s deflation in technology” (in other news, fully loaded with Oil’s recent decline, USA’s cost of living just hit another all-time high).
If you add Google, the Top 4 in the Silicon Valley bubble get you to $1.25 TRILLION. To be fair, BABA is not really a “valley” name – the “smart money” in there didn’t want to give Alibaba $20 million. It wasn’t a “good idea” back then. So they’ll give them $25 Billion now instead!
And if you back out Exxon (just to make my storyline better), here’s what you can get for $1.25 TRILLION:
- Berkshire Hathaway = $235B
- Wal Mart = $230B
- GE = $230B
- Chevron = $225B
- Johnson & Johnson = $210B
- Citigroup = $125B
Remember that while I am sure I am wrong on my $29.99 watch from WalMart not being as cool as the iWatch, Apple (AAPL) has $600 billion reasons (market cap) why that fashion statement has been discounted by the market, just a bit.
Now, to be fair (again, I am a fair guy!) for those of you who know everything about Apple (AAPL), you’ll recall that there is a precedent for this stock blowing up (split adjusted, it went from where it is today to $55 in less than a year). Never mind what the US stock market bubble would do if AAPL dropped 50% from here (still trading at a $50B premium to my preferred iBear watch outlet, WMT), what if it dropped 5, 10, or (deep breaths) 25%?
I know. Every boom-bust bubble call needs a catalyst. Here’s mine – US #GrowthSlowing.
Oui. C’est tout, mes amis. En Francais, that means that is it.
That’s all I think I need to get right from here in order to get both bonds (long the Long Bond and anything equities, like XLU, that looks like a bond) and the stock market bubble right. I think I need to get the rate of change in US growth right.
While I don’t think AAPL will get cut in half from here, US GDP growth could, easily, from this headfake Q2 bounce of 4%. More importantly, US GDP growth could be half of consensus expectations (Old Wall consensus = 3% GDP growth and +3.3% 10yr yield), for Q3 and Q4.
And that’s our bullish scenario. The bearish one, of course, is that 1/3 of America (you and I) figures out that 2/3 of Americans are already in another early cycle recession. After 63 consecutive months of US economic expansion, that’s what booming bubbles within the cycle eventually do – they bust.
Our immediate-term Global Macro Risk Ranges are now (I update my Top 12 Macro Ranges in our Daily Trading Range product, with intermediate-term TREND views, daily, as well):
UST 10yr Yield 2.31-2.53%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: Looking for the constructive pivot on Macau gaming operators, not yet - still too soon
Macau stocks still in decline – have we bottomed?
CALL TO ACTION
We were early and first to make the “Mass Deceleration” call (see our June 13, 2014 note). The sell-side has caught up to this second leg of the Macau bear thesis stool (VIP turning negative was the first) and the stocks are well off their 2014 highs. We fear the third leg hasn’t yet played out which keeps us firmly in the negative camp despite valuations that are becoming more palatable. Q2 margin disappointment wasn’t just labor related, as widely reported by analysts, but such is the Hedgeye view. Mass margins, particularly in the premium segment, are being compressed as operators compete for a slower expanding pie – reinvestment rates are going higher. Given our long term positive view, we are actively looking for the opportunity to pivot to a more constructive near term outlook for the stocks. However, with no positive fundamental pivot in sight and our own models computing generally lower than Street estimates for Q3, Q4 and 1H 2015, we can only conclude that the Macau stocks are likely to retreat. Our caveat to the negative sector outlook is Galaxy Entertainment where we are favorably inclined to buy despite our negative overall view.
As early as March 10, we pivoted to the sidelines when we removed LVS from our Best Ideas list - see our note “LVS: REMOVING FROM INVESTING IDEAS”- and shortly thereafter warned investors about junket issues, the Dept of State request to lower the threshold for reportable financial transactions, UnionPay, money laundering scrutiny, as well as the extreme sentiment indicator with the massive “buy” rating skew on MGM, LVS, WYNN, and MPEL. Our view was that VIP would suffer under such scrutiny and a corruption clampdown by the Chinese authorities. As VIP growth slowed dramatically in March and turned negative in May, the Macau stocks faltered but the sell side maintained their ratings citing continued 30%+ Mass growth expectations for the remainder of 2014.
On June 13, 2014 we laid out our “Mass Decelerating” theme as the second point of our bear thesis for a slowdown in gaming revenues, just as the sell-side was defending the gaming operators on the thesis of “mass segment growth of >30% remains healthy”. Today, the sell-side has caught up to us with regard to the mass segment gaming revenue slowdown so the question is where do we go from here?
WHAT WE THINK WE KNOW – BACK TO THE MATH…
We apply a forecasting algorithm and process across all industries – gaming, lodging and cruise lines that incorporates both quantitative and qualitative factors. This process has allowed us to be ahead of various trend pivots including the recent mass revenue deceleration. Based on our model we believe Macau gaming revenue will trough sometime during Q1 2015.
Our forecasting algorithm is dynamic. Recall from our June 13, 2014 “Mass Deceleration” note, we forecasted Mass Segment revenues to trough in October and November 2014, at +18% on a year-over-year basis. At that time, we also forecasted VIP revenue growth of -5% to -8% during Q4 2014.
By comparison, today our forecasting model calls for Mass segment growth of +9% on a year-over-year basis during Q4 2014, nearly half the growth rate we forecast a mere three months ago – and a third of what the Street was projecting at the time. As can be seen in the following chart, we believe Macau gaming revenues will trough during Q1 2014, maybe during January or February as noted by the green arrows.
While we are looking for a pivot to become more constructive on the Macau gaming operators given our favorable long-term view, we are forced to reaffirm our negative view as we believe Q3 2014, Q4 2014 and FY 2015 earnings estimates are still too high. Our caveat to the negative sector outlook is Galaxy Entertainment where we are inclined to recommend long even today as a hedge. With its strong VIP business that seems to be less volatile than the market, Galaxy looks safer. Looking ahead, we still think the company will open Galaxy Macau Phase 2 before the May holidays – earlier than expected - thus have at least an eight month first mover advantage as Cotai supply explodes. Unlike the other concessionaries, Galaxy’s 2015 Street estimates look conservative.
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TODAY’S S&P 500 SET-UP – September 11, 2014
As we look at today's setup for the S&P 500, the range is 16 points or 0.64% downside to 1983 and 0.17% upside to 1999.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.97 from 1.97
- VIX closed at 12.88 1 day percent change of -4.59%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: Initial Jobless Claims, Sept. 6, est. 300k (pr 302k)
- 8:45am: Bloomberg U.S. Economic Survey, Sept.
- 9:45am: Bloomberg Consumer Comfort, Sept. 7 (prior 37.7)
- 10am: Freddie Mac mortgage rates
- 10:30am: EIA natural-gas storage change
- 11am: U.S. to announce plans for auction of 3M/6M/1Y bills, 10Y TIPS
- 12pm: USDA WASDE crop report for Sept.
- 1pm: U.S. to sell $13b 30Y bonds in reopening
- 2pm: Monthly Budget Stmt, Aug., est. -$130b (pr -$147.914b)
- House, Senate receive briefings on Islamic State
- 7:30am: National Association of Federal Credit Unions holds 3rd day of Congressional Caucus Lineup, with Sen. Toomey, R-Pa.; HUD Secretary Castro; Sen. Johanns, R-Neb.; House Foreign Affairs Chair Royce, R-Calif.; Rep. Moore Capito, R-W.Va.; CEA Chairman Furman; Freddie Mac CEO Layton
- 8:30am: Sen. Hatch of Utah ranking Republican on Senate Finance Cmte, at U.S. Chamber of Commerce event on tax reform
- 9am: House Armed Services Chairman McKeon, R-Calif. makes remarks Islamic State following Middle East leader mtg last wk
- 10am Sir Richard Branson speaks at CSIS event on “Time to Rethink Global Drug Policy”
- 6pm: GWU discussion with Iraqi Ambassador to the U.S. Faily
- U.S. ELECTION WRAP: GOP Cavalry Rides to Kansas; Attack Ads
WHAT TO WATCH:
- RBS, Lloyds London move ‘irreversible’ after Scot turmoil
- Investors Pull $2b From U.K. Funds Ahead of Scottish Vote
- Credit Agricole said to near accord in U.S. sanctions probe
- MasterCard loses fight at top EU court over card-fee limits
- McDonald’s sued in Russia on claim of understating calorie count
- BofA’s Merrill said to appeal $136m Takefuji verdict
- Axa said in advanced talks to sell Hong Kong pension-fund unit
- Paulson opposes ‘destructive’ AngloGold share sale plan
- JDSU breakup plan said to follow push from hedge fund Sandell
- Twitter seeks up to $1.5b in convertible debt offering
- RadioShack financing deal said prepared by UBS, Standard Gen
- Obama relying on Middle East allies to carry Islamic State fight
- Dollarama (DOL CN) 7:30am, C$1.03
- Kroger (KR) 8:30am, $0.69 - Preview
- Lululemon Athletica (LULU) 7:15am, $0.29 - Preview
- North West (NWC CN) 4:30pm, C$0.40
- RadioShack (RSH) 6am, ($0.66)
- Transcontinental (TCL/A CN) 10:05am, C$0.46
- Ulta Salon Cosmetics (ULTA) 4pm, $0.82
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Food Prices Near Four-Year Low as Milk to Cooking Oils Fall
- Commodities Drop to 4-Year Low With Abundant Corn to Oil Supply
- Saudi Arabia Cuts Production as Brent Slips Below $100 a Barrel
- Fungus Stoked by Warming Threatens Organic Coffee: Commodities
- IEA Cuts Demand Estimate as Saudi Exports Drop to 2011 Low
- Spot Gold Extends Drop to Fall 0.8% to Lowest Since Jan. 31
- Wheat Tumbles With Soybeans to Four-Year Low Before USDA Report
- Copper Falls to Lowest Since June as Dollar Gains Erode Demand
- Palm Imports by India Seen Surging 60% as Prices Slump on Glut
- Coffee Reserves in Vietnam Seen Shrinking to Lowest Since 2011
- Glencore Offers Bonds in Australia as It Assesses Local Targets
- Gold-Oil Link Strongest in 11 Months as Europe Woes Drive Losses
- Raw Sugar Futures Extend Decline in New York; Cocoa Also Falls
- California’s Water-Starved Farmers Stymied by Fish Protections
- Brent Crude Falls to 16-Month Low With WTI as IEA Cuts Estimates
The Hedgeye Macro Team
Takeaway: If RH didn’t have a shift in Source Book timing, the stock would be up $10 on this print.
The minute we saw the RH numbers, we were shocked, to say the least. Good EPS ($0.67 vs $0.64E consensus), but nowhere near where it should have been, and revenue well below our model (and just about everyone else’s). That didn’t sit well with us, a high-growth, high-multiple name like RH does not have the luxury of missing on the top line. That’s particularly true for us given that such a big part of our thesis is predicated on outsized revenue growth over time. Our concern lasted about 15 minutes, until we a) realized precisely what drove the sales miss, b) determined that it is not symptomatic of an underlying problem, and c) quantified the impact. How we’re doing the math, the 7-week shift in the timing of RH’s Source Book drop cost between $12-$18mm in sales, or about $0.07-$0.10 per share in earnings. In other words, excluding this event, the company would have printed a number of $0.74-$0.77. Our estimate for the quarter was $0.77 compared to the Street at $0.64. That’s big by any stretch. The stock is trading off moderately on this, but we think it will be very short lived. If RH didn’t have a shift in Source Book timing, the stock would be up $10 on this print.
All of that said, we clearly can’t ‘exclude’ this event. It happened, and there’s no taking it back. Some sales will be lost forever. But will there be a revenue push into 3Q? Yes. Did the company play down the impact it will have on the top line in 3Q? We think so.
Are we concerned about any management ‘execution issues’? Absolutely not. Let’s be clear, we think that it is management’s responsibility to anticipate timing shifts like this and communicate them to its constituents accordingly (including all of us). But this is a company that a) is pulling off one of the biggest real estate transformations the Retail landscape has seen in a decade, b) has reduced its mailings from 10 to 1 over two years, and c) doubled its product assortment from a year-ago (while simultaneously redesigning floorsets in all its stores). Think of any other retailer or brand. Nike, Kors, Lululemon, whatever… Now think of that company doubling its product assortment over two quarters. The complexity is staggering. All-in, we’re willing to give RH management a seven-week slide with revenue planning on this one, particularly given that Merchandise Margins are stellar and SG&A is so well-controlled.
In fact, Gary Friedman’s and Karen Boone’s poise and confidence came across as being in the top 5% of the 100+ names we tracked over this past earnings season. These guys are in control of the business. Period. Did we walk away thinking that there might be more quarter-to-quarter revenue oscillations as the company grows up? Yes, we did. But again, for a company that is going to add $3bn in revenue and another $8 per share in earnings, we’re pretty much OK with that. We’re probably even OK with an occasional Gary s-bomb. Maybe we give it a slightly lower multiple to account for the revenue volatility. But the aggregate value that should be created here is still astonishing. We’d buy this on the sell-off. We’d buy it without a sell-off.
We’re making minimal changes to our model. See our overview below why we think RH is a double over 12-18 months, and is likely to double again. RH is still our top idea, by a long shot.
09/07/14 09:39 PM EDT
RH – Key Thoughts Ahead of The Print
Takeaway: RH remains our highest-conviction long term idea, and the model checks out into this qtr. In this note we flush out where we could be wrong.
Conclusion: We think that people are missing the magnitude of earnings growth at RH, the sustainability of that trajectory over a long period of time, and ultimately the degree to which that will accrue to equity holders. The question is not whether the stock will go to $90 vs $100 (where we see most price targets), but whether it will get to $200 vs $300. Even the best stories, however, are not linear. There will be bumps along the road. But this print should not be one of them. We’re well above the Street in Sales, Margins and EPS, and we flush out in this note where we could be wrong.
We still think that RH is the best idea in Retail today. We think that most parts of the thesis are at least acknowledged by the market (category growth, real estate expansion), but people are absolutely missing how all the pieces are coming together to drive such outsized earnings growth over an extremely long duration. The consensus is looking for long-term earnings growth of 28% -- we’re at 45%. That equates to $11 in earnings power by 2018. At a 45% earnings CAGR, what kind of multiple does this kind of earnings growth deserve? 25x? 30x? 40x? UnderArmour has a 30% CAGR and it trades at 65x earnings. Our point here is that if the consensus is as wrong as we think it is on the earnings trajectory, then it will be equally wrong on the multiple. 25x = $275. 30x = $330. 40x (which seems like a stretch) = $440. Yes, that’s 4.5 yrs out, but even discounted [30x $11 = $330) back by 15% over 4-years and you get about $190 today. You want to use an earnings number closer in? We’re at $6.25 in 2016. The Street is at $3.76. Let’s keep the current 30x multiple, though we’d argue that we’ll see multiple expansion if numbers are going up that high. That suggests a $188 price in about a year and a half. This stock is headed a lot higher.
All of that said, we fully acknowledge that the slope of a multi-year earnings growth story is not linear – especially for an early-cycle transformational story like this. There will definitely be some bumps in the road along the way, but we simply don’t think that the quarter to be reported after the close on September 10 will be one of those bumps. The way we see it, RH is in an enviable position in that it could print a number as high as $0.77 if it so chooses (compared to the Street at $0.64) without borrowing from investment dollars that should otherwise be spent to fuel the long-term plan.
Here’s a look at some key line items – and a little stress-test on where we could be wrong.
Revenue: We are at $468 for the quarter, ~3.5% above the top end of guidance and consensus. There’s a few important factors to consider here.
1) First off, remember that two points of growth were pulled forward into 1Q. That’s in our estimates.
2) This is the first full quarter where the Flatiron store in NYC will be pulled out of the comp base. That’s meaningless as it relates to Sales contribution. In fact, the store is a positive for the top line because the newly renovated store can begin to boost revenue. But it is the most productive store in the whole fleet (we think it accounts for 5-7% of sales) and it will no longer be part of the reported ‘comp’. We think we have this accounted for properly, but if our 21% comp proves wrong, we think this is the most likely factor.
3) The late source book launch this year, shallow inventory buy to support the product refresh, and extended fulfillment windows could push revenue for orders booked in 2Q into 3Q. Similar to last year where the 2Q brand comp of 29% was bookended by a 40% brand comp in 1Q and 38% brand comp in 3Q. We think we have this factored into our model appropriately, but it is a part of the model where we could revenue shift between 2Q and 3Q.
4) We think that the on-line business looks solid. Based on the strength we’ve seen in our e-commerce index over the past few months, it is clear that RH is drawing a lot of incremental interest to its web site. This synchs with the timing of its sourcebook, so it is to be expected from where we sit. But the company is clearly executing well in driving its online strategy in conjunction with selling product in physical stores.
Gross Margin: This is the area where we’re probably the most aggressive in our model, with a 200bp improvement vs last year. A couple points…
1) Last year margins were down 250bp due to significant pricing actions, and we don’t think RH is anywhere near as aggressive this year.
2) A quick point on Order Fulfilment: RH does not get paid by customers until the product is delivered. As such, Fulfillment is the key to revenue recognition. We think the company is in a much better position this year to fulfill orders than LY for two reasons. a) Inventories are in a much better position to meet demand headed in to 2Q. The sales to inventory spread (sales growth – inventory growth) was -11% in 1Q14 compared to +3% in 1Q13. b) The company has added over 1.2mm sq. ft. in DC square footage, an increase of over 30% since 2Q13. That should help alleviate some of the shipping bottlenecks attributed to the once per year product refresh.
3) Dead Rent will start to be an issue. It should not start to deleverage occupancy until 3Q, but these deals are definitely in constant flux. We wouldn’t be shocked in the least to see it opportunistically take control of certain properties earlier than expected to give it room with construction. This shows up entirely in COGS. But to illustrate, a property line Denver/Cherry Creek will be about $2mm in rent per year. An extra quarter is $500k, or about a penny a share.
SG&A: Not a ton of moving parts here. We have SG&A growing at 20% this quarter, a rate that we have accelerating throughout the year as the real estate plan plays out and the company laps its change in Source Book strategy. Our math suggests that RH will spend an extra $52mm this year on its 3,200 page Source Book, but that will be amortized over a 12-month time period. Most of the year-over-year increase will be recognized in the back half of the year. One thing that’s worth noting is that we’re only modeling 54bps of SG&A leverage. That’s the smallest SG&A leverage rate RH will have achieved since 3Q11. In other words, we think our estimate is on the conservative side.
We think that sentiment factors are checking out for RH. Consider that the stock popped on the last earnings print but has actually traded down 12.2% since the June 30 peak, compared to a 2.4% gain for the S&P. In fact, our Sentiment Monitor looks abysmal for RH. This combines both sell side ratings and short interest, and the simple fact is that Sentiment for RH has never been worse. It is almost entirely driven by elevated short interest, which stands at 7.4mm shares – an all-time high. It’s up modestly since RH priced its convert, which makes sense as people buy the convertible and simultaneously short the equity. But the fact remains that 20.7% of the float is currently short. We’ll take the other side of that. In addition…
- When Williams-Sonoma guided down for 2H, it definitely sucked some of the air out of the momentum sail for RH. RH lost 6.8% since the WSM miss – even though most of the factors were WSM-specific.
- Though not a traditional peer, RH traded down when Kate Spade put up an otherwise spectacular quarter, but the stock was crushed due to a poorly communicated message regarding long-term outlook. Our sense is that from a PM’s perspective, these names are pretty much in the same bucket. Consumer discretionary, momentum, significant operational leverage, high multiple. We had several calls that week from people afraid that RH was going to be the next KATE.
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