BAC - Removing From Best Ideas List on the Long Side

Takeaway: Valuation is no longer compelling, macro is no longer a tailwind and we're tired of waiting for Godot on normalized earnings.

We are removing Bank of America (BAC) from our Best Ideas list on the long side.



After being bearish on Bank of America throughout 2011, we first turned bullish on January 19, 2012 in a research note entitled "We're Getting Bullish on Bank of America". At that time the stock was trading at $6.96. Not quite the low of $5 set a few weeks earlier, but still pretty good.


We formally added BofA to our "Best Ideas" list on the long side when we first launched our Best Ideas list, on February 27, 2013. By then the stock was trading at $11.30. We've had it on the Best Ideas list since then and the stock is up roughly 48% since (and 140% since our early 2012 call). Meanwhile, the S&P 500 is up ~32% since 2/27/13 and ~52% since 1/19/12. On both an absolute and relative basis BAC has been a solid long-term performer. Normally we don't leave ideas on for a year and a half, but since the thesis was steadily playing out we saw no reason to change our view.


Waiting for Godot

So why now, after all this time, pull the plug? There a few reasons.


1. Earnings. Normalized earnings remain elusive years after the term first floated circa 2011/12. Recall that in 2011 the company earned one cent per share for the whole year. In 2012 BofA earned 25 cents per share. In 2013 things started looking better with 90 cents in full year earnings, but in the first half of this year the company stumbled, earning just 14 cents on a GAAP basis (28 cents, annualized). The bigger picture, however, is that most of the core metrics at BofA have been negatively trending for the last year and a half and seem to show no signs of inflection.


We profile these trends in the charts below for NIM, NII, non-interest income, non-interest expense, pre-tax pre-provision net income, pre-tax income, and EPS. The punchline is that revenue, both NII and non-interest income, have been in steady decline while operating expenses have been rising. The only bright spot has been provision expense trending lower, but with reserve release compressing, this too will reverse from tailwind to no-wind and then headwind even in a benign credit environment. In other words, it's hard to see how earnings power advances from the recent run rate of  ~24 cents per quarter (average of last six quarters, excluding 1Q14 in which EPS was -$0.05) to the expected NTM rate of $0.34 when all the metrics are going the wrong way.


BAC - Removing From Best Ideas List on the Long Side - 1   NIM


BAC - Removing From Best Ideas List on the Long Side - 2   NII


BAC - Removing From Best Ideas List on the Long Side - 3   NON INT INC


BAC - Removing From Best Ideas List on the Long Side - 4   NON INT EXP


BAC - Removing From Best Ideas List on the Long Side - 5   PT PP NI


BAC - Removing From Best Ideas List on the Long Side - 6   PROV EXP


BAC - Removing From Best Ideas List on the Long Side - 7   RR


BAC - Removing From Best Ideas List on the Long Side - 8   PTI


BAC - Removing From Best Ideas List on the Long Side - 9   EPS


BAC - Removing From Best Ideas List on the Long Side - 10   EPS FWD   BACK




2. Macro. When we first turned bullish on BofA back in January, 2012 it was largely because we thought that (a) the company had ringfenced its mortgage liability and (b) the ECB's LTRO program would succeed in preventing Europe from sliding into the ocean. We were right on both accords as Article 77 kept the $8.5 billion settlement in place and Euribor-OIS receded back to the mid-teens bps. Several months later, it was rising home prices that became the new rallying call - a tailwind that persisted right through this Spring. 


Today, however, housing is a receding tailwind as the rate of home price change has been decelerating for 4 straight months now and we expect that trend to continue. Further, while there are many "hotspots" of eco/geo risk around the world (China, Ukraine, etc) the global, US banks have priced in very little discount/risk. #Asymmetric.  



3. Beta Renormalization. We added a new chapter to our bullish thesis on BAC back on March 7, 2013 when we published a note entitled "Long the Big Cap Beta Renormalization Trade". We argued that BAC, MS and C were undervalued on the basis of their capital position relative to their beta. We revisited the thesis on November 4, 2013 in our note "Banks: Capital & Volatility - A Look at the US & EU Banks With the Most Upside". At the time of the first note, BofA's 1-yr beta was just under 2. This compared with a Beta below 1 prior to the crisis, in spite of having materially increased its capital position over the ensuing time period. Our argument was simple: we though that beta would come down as the market realized risk was lower due to the permanently higher capital position. As beta came down, we argued, EVA would rise since beta is a key input in cost of capital. Finally, we have shown that EVA is very strongly correlated with price/tangible book multiples (stronger than ROE or ROTE alone). So we argued that as beta came down, the multiple to tangible book value would rise. That's exactly what happened.


Since our March 2013 note, BofA's beta has fallen to around 1.25 from just under 2. During that same period, the price/tangible book value multiple increased from 92% to 118%. This is a slightly smaller increase than we had originally postulated, but we think the framework worked well, overall.


The reason it's relevant today is that with beta back down to 1.25, this idea has largely run its course. Yes, there is likely some further reduction possible, but much of the move has already happened, as we show in the beta chart below. We also show the relative upside/downside to fair value for several of the larger banks based on our EVA fair value model. On that basis, we find that BofA is currently just about fairly valued.


BAC - Removing From Best Ideas List on the Long Side - bac   rolling 1yr beta for the group


BAC - Removing From Best Ideas List on the Long Side - bac   fair value snapshot


Based on this, we think it makes sense to remove Bank of America from our Best Ideas list on the long side. Please bear with us as we look for a suitable candidate to replace it.


Joshua Steiner, CFA


Jonathan Casteleyn, CFA

September 18, 2014

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September 18, 2014 - Slide6 

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TODAY’S S&P 500 SET-UP – September 18, 2014

As we look at today's setup for the S&P 500, the range is 27 points or 1.08% downside to 1980 and 0.27% upside to 2007.                                                     













  • YIELD CURVE: 2.03 from 2.05
  • VIX closed at 12.65 1 day percent change of -0.63%


MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Initial Jobless Claims, Sept. 13, est. 305k (pr 315k)
  • 8:30am: Housing Starts m/m, Aug., est. -5.2% (prior 15.7%)
  • 8:45am: Fed’s Yellen speaks in Washington
  • 9:45am: Bloomberg Consumer Comfort, Sept. 14 (prior 36.5)
  • 10am: Philly Fed Business Outlook, Sept., est. 23.0 (pr 28)
  • 10am: Freddie Mac mortgage rates
  • 10:30am: EIA natural-gas storage change
  • 11am: U.S. to announce plans for auction of 3M/6M bills, 2Y/5Y/7Y notes, 2Y FRN
  • 12pm: Household Change in Net Worth, 2Q (prior $1.490t)
  • 1pm: U.S. to sell $13b 10Y TIPS in reopening
  • 5pm: Fed’s Richard Fisher speaks in Dallas



    • Senate, House in session
    • Ukraine President Petro Poroshenko meets with Obama, Congress
    • House Speaker John Boehner delivers speech on economy
    • Congress cmtes hold hearings on threat from Islamic State
    • 8am: House Intelligence cmte hearing
    • 11:15am: Defense Sec. Chuck Hagel at House Armed Services Cmte
    • 11:30am: Sec. of State John Kerry House Foreign Affairs
    • 8:15am: FDIC Chairman Gruenberg among speakers at FDIC’s Center for Financial Research/Journal of Fin. Services Research
    • 9am: Institutes of Mfg Innovation briefing w/ Sen. Brown, D-Ohio; Rep. Kennedy, D-Mass.; Rep. Reed, R-N.Y.; Commerce Secretary Pritzker on strategy for dealing with Islamic State
    • 8:30am: Sen. Energy and Natl Resources ranking member Sen. Murkowski, R-Alaska; Sen. Scott, R-S.C. conf. on energy security
    • 8:45am: Fed Chair Yellen prerecorded video: “Importance of Asset Building for Low and Middle Income Households” at Corp. for Enterprise Development’s 2014 Assets Learning Conf.
    • 10am: FERC holds monthly public meeting
    • 10am: CDC news conf. on 2014-2015 flu outlook w/ Dir. Frieden
    • 11am: House Oversight Cmte hearing on Obamacare
    • 2:15pm: Boehner speech on economy
    • U.S. ELECTION WRAP: Ad Dispute in Ga.; Polls; Cotton’s Thesis



  • Scotland decides on U.K. independence; vote too close to call
  • Alibaba IPO expected to price post-mkt; $66-$68/shr range
  • Bayer to float material-science unit, focuses on life sciences
  • Dresser-Rand, Sulzer in talks about potential combination
  • ECB says banks take EU82.6b in targeted long-term loans
  • SNB keeps franc ceiling of 1.20 vs euro, may step up defense
  • Ukraine President Petro Poroshenko meets with Obama, Congress
  • Sony may be cut to below investment grade at S&P
  • China home price drop spreads to more cities as demand weakens
  • Henkel agrees to buy Minnesota-based Bergquist Co.
  • German e-tailer Zalando to raise as much as $815m in Oct. IPO
  • Apple delays HealthKit software after discovering early flaw
  • Costco stores in Canada to stop accepting American Express
  • Amazon unveils new tablet lineup for kids, readers, businesses
  • U.K. retail sales climbs most in 4 months, matches est.



    • ConAgra Foods (CAG) 7:30am, $0.35
    • IHS (IHS) 6am, $1.44
    • Oracle (ORCL) 4:01pm, $0.64 - Preview
    • Red Hat (RHT) 4:05pm, $0.38
    • Rite Aid (RAD) 7am, $0.06
    • Tibco Software (TIBX) 4:05pm, $0.18



  • China Opens Gold Market to Foreigners Amid Pricing Ambition
  • Brent Crude Futures Pare Loss with WTI Amid Risks to OPEC Supply
  • Silver ETP Buyers Defy Hedge Fund Exit During Slump: Commodities
  • Rebar in Shanghai Closes Near Record Low as Home Prices Weaken
  • Gold Trades Little Changed After Drop to Eight-Month Low on Fed
  • Billionaire’s Wheat Farmers Unbowed in Russia as Sanctions Bite
  • Wheat Slides With Corn on Outlook for Surging Crop Supplies
  • Cocoa Extends Gains in London to Three-Week High as Sugar Falls
  • Panama Canal Expansion in 2016 May Spur U.S. LNG Exports to Asia
  • Switzerland Imported 126.2 Tons of Gold Last Month: Swiss Data
  • Billionaire Branson’s NGO Sees CO2-Fighting Ports Gain Fivefold
  • Rubber Declines as China Home Prices Raise Demand Concerns
  • Gold Least Tempting Versus Stocks Since Lehman: Chart of the Day
  • OPEC Supply Risks Grow as Biggest Libyan Oilfield Is Halted


























The Hedgeye Macro Team

















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Takeaway: We recently added SBUX to our Best Ideas list as a short. We’ll be hosting a call today @11AM EST to review our thesis & field questions.


  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 174364#
  • Materials: CLICK HERE

 *SHORT SBUX CALL TODAY @11AM - 9 17 2014 1 37 09 PM



  1. Why decelerating domestic traffic is an early sign of maturation.
  2. Reception of the new La Boulange food items (via one of our proprietary consumer surveys).
  3. Is menu complexity risking the deliverability of the “Starbucks Experience?”
  4. How the street is overestimating the digital opportunity.
  5. Why commodity prices are likely to be a headwind for the next couple of years.
  6. Approaching peak margins and why this trend is unsustainable.
  7. The biggest risks to current consensus expectations.


Howard Penney

Managing Director


Fred Masotta


FDX: Moving To Roughly Indifferent



We have ‘liked’ FedEx shares since late 2012, gradually reducing our affinity as the shares have moved higher (although a bit too quickly).  With today’s gains, we will move to ‘roughly indifferent’.  Much of the undervaluation in the Express division has been recognized at this point – perhaps 2/3s, if it were possible to provide such allocations.  Management caution on 2H FY15 and static guidance may point to a softer second half.  We preferred FDX when the Express division looked like it was detracting from the market’s valuation of FDX shares.  We would look to re-enter at more attractive prices and would not short/underweight FDX shares.  We do expect FedEx to be reasonably successful with its profit improvement plan and may again be exiting too early.



Updated Sum of Parts


We have written a critique of this valuation methodology and recognize its flaws.  However, we continue to find it a helpful framing when explaining our views on FDX.  We present a comparison of the June 2013 SOTP table with the current one.


Sum of Parts in June 2013 – FedEx Express Implied Negative Valuation

(published here, odd formatting included)


FDX: Moving To Roughly Indifferent  - bc1



Sum of Parts Following FY1Q 2015 Results – FedEx Express Implied $15 bil Valuation


FDX: Moving To Roughly Indifferent  - bc2



FY 1Q 2015 Results


We will let others provide a detailed review of FDX’s quarter, but pull out some highlights below.


Express Segment Margin:  The FedEx Express margin has made progress, but still has a way to go to reach those of UPS and Deutsche Post.  We do not see a reason that FDX’s profit improvement plan (PIP) will not significantly close the gap between FDX and competitors.  That said, we think a good portion of the margin improvement is already reflected in FDX shares.


FDX: Moving To Roughly Indifferent  - bc3



It Isn’t Just Apple Product Launches:  Call Q&A seemed to imply that the quarter was just an Apple launch phenomena.  FedEx Express may wish it were more closely tied to iPhone launches, but the data suggest they are largely unrelated.


FDX: Moving To Roughly Indifferent  - bc4



Far From Outlier Results:  FY1Q 2015 was better better, but without easy comps or with unusually strong yields/volume growth.  


FDX: Moving To Roughly Indifferent  - bc5



Yields improved slightly, most likely because of less International Priority headwind.


FDX: Moving To Roughly Indifferent  - bc6



Volumes also improved, consistent with broader airfreight data.


FDX: Moving To Roughly Indifferent  - bc7



Ground Still Solid:  Management again commented that it won’t be satisfied with less than high-teens margins.



FDX: Moving To Roughly Indifferent  - bc8



Freight’s Highest Margin:  The best quarter since the financial crisis for FedEx Freight.



Guidance:  Management commented that the stronger FY1Q 15 was factored into guidance and implied a weaker back half relative to consensus.  Guidance may just be conservative, but guidance has been fairly on target in the last couple of years.



FedEx Investment Negatives:  When we presented FDX as a long in late 2012, we often heard its myriad investment negatives.  Many of them were true negatives, but we felt there was adequate compensation for the risks.  That offsetting compensation is less available at current prices.  Negatives include:

  • The Express business is capital intensive and historically not a great generator of free cash flow
  • FedEx Ground faces ongoing legal and regulatory challenges to its independent contractor model
  • Belly space in wide body aircraft in the Asia appears a significant challenge, FTN or not








ENERGY: Can the U.S. Shale Boom Be Stopped?

Takeaway: Recent developments in the oil and gas space suggests the U.S. is closer to becoming an exporter

The Bureau of Labor Statistics (BLS) recently reported that the largest employment increases since the shale revolution commenced circa 2006 occurred in the four U.S. states which just so happened to have the heaviest amount of hydraulic fracturing: North Dakota, Louisiana, Oklahoma, and Texas.

Early estimates suggest that U.S. shale plays will add significant production capacity for years to come:

Shale Gas

  • Natural gas from shale formations now accounts for 40% of all domestic natural gas production (up from 4% in 2005) with the EIA estimating shale’s share will increase to 53% by 2040
  • Reserves: The U.S. possesses an estimated 31 years of AGGREGATE annual natural gas production in shale gas reserves (~15-20% of estimated global shale gas reserves)

Tight Oil

  • Tight oil accounts for ~12% of current domestic production with this amount expected to reach 17% by 2040
  • Reserves: estimated 10 years of AGGREGATE production

With hydraulic fracturing still a relatively new extraction method, we have come across a confusing and wide variation in estimates of two key factors:

  • Amount of “Recoverable” Reserves
  • Marginal Production Costs

Producers are developing more efficient and useful ways to induce hydraulic fracturing to improve the recovery process. At the end of the day, we expect the rapid evolution of this process to continue, and a constant refresh of those players improving marginal production costs faster than their peers will be key to picking the winners in an environment of low oil and gas prices. Until more research is completed on the possibilities of improving marginal production costs, we can conclude the following:

  • Decline rates are very high vs. traditional methods:
    • Average decline rate in the world’s conventional oil fields =~5%
    • Average decline rates in the Bakken formation =~ 44%
    • Average first year decline rates in major U.S. Shale plays =~70%

Available resources and marginal production costs aside for now, what other headwinds threaten the U.S. from fully capitalizing on the Shale Boom?


In this preliminary note on the topic, we’ll begin with recent developments to the current regulatory obstacles impeding our ability to become an exporter of oil and LNG. More extensive analyses surrounding the sustainability of the U.S. shale boom will follow in the coming weeks.



  • export ban on oil implemented after the oil embargo in the 1970s
  • The Jones Act (1920) requires that oil has to be shipped by Americans in smaller ships:
    • It costs around $5-$6 a barrel to ship crude from the Gulf of Mexico to the US east coast on a US-flagged vessel, but only $2 to ship to Canada’s east coast on a foreign-flagged vessel

South Korea and other NATO allies have verbally challenged the U.S. ban on the back of our recent increase in domestic production capacity. Last week the EU’s commissioner for trade, Karel De Gucht, emphasized the need to free up more sources of oil and gas for a wider and more effective free-trade agreement to be instituted.     

The Office of the U.S. Trade Representative and the NSC have held internal discussions with the Obama Administration on how to deal with a challenge from the international community. Washington was able to make a national security argument for implementing the ban back when it was importing most of its crude oil, but the added production from the Shale boom is challenging the credibility of that argument.

With added geopolitical tension globally this year, both Asian and European allies are pushing for diversified supply lines. Strengthening their argument, the U.S. just took China to the WTO earlier this year and won a case accusing Beijing of hoarding raw materials and precious metals. Under International Trade rules (General Agreement on Tariffs and Trade), the argument for upholding the restrictions on the exporting of U.S. fossil fuels may be too hypocritical to justify.

We expect a more publicized stance from Washington in Q4.


In August a modification of federal law governing the LNG terminal approval process was implemented. The new rules essentially expedite the FINAL and LAST DOE approval process for those projects that uphold the requirements of NEPA (National Environmental Policy Act) and FERC (onshore)/MARAD (offshore). This will shorten the last step in fully-approving proposed projects:   

  • Approval required by both FERC/MARAD and NEPA and then finally the DOE (With new rule, DOE gives FINAL approval rather than both CONDITIONAL and FINAL, post-FERC/MARAD approval):
    • This change ultimately means that NEPA approval serves to validate what was previously CONDITIONAL DOE approval
  • The DOE will now begin evaluating applications 30 days after applications have been scrutinized by NEPA
  • NEPA - To meet NEPA requirements federal agencies prepare a detailed statement known as an Environmental Impact Statement (EIS). The EPA reviews and comments on the EISs prepared by other federal agencies, maintains a national filing system for all EISs, and assures that its own actions comply with NEPA
  • DOE - For LNG, U.S. law requires export facilities get a "public interest" approval from the DOE if their buyers are located in countries that haven't signed a Free Trade Agreement with the United States. Non-FTA countries include all European nations as well as China, India and Japan.
  • The countries without free trade agreements with the United States are considered the most lucrative for LNG exports because many of them have huge appetites for energy
  • 31 facilities have applied for DOE permission. Since May 2011, 6 of them (2 in Cameron Parish, La, 1 in Lake Charles, LA, 1 in Texas, 1 in Maryland and 1 in Oregon) have received conditional approval.
  • Only the three below have received the final construction go-ahead(NEPA, FERC, and Final DOE approval). Sabine Pass may begin operating as early as the end of next year:
    • Sabine Pass (Cheniere Energy) in Louisiana was the first approved and generous estimates are that the end of 2015 for first exporting may be possible
    • Cameron Parish (Cameron-subsidiary of Sempra Energy) in Louisiana authorized to export the equivalent of 1.7bn cubic feet/day for a period of 20 years. Project expected to be completed by 2018
    • Martin Country (Carib Energy) in Florida expected to be able to export 40M cubic feet/day

The recently approved projects are not expected to be completed until 2017-18. As mentioned above, Sabine may be ready to export by the end of 2015. Stay tuned for additional research that we hope will help stay on top of the most important issues in the shale energy space.  

As always, please reach out with comments, questions, or additional color on the most important issues that will make or break the potential of shale’s contribution to domestic production. Have a great night.


Ben Ryan


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