Jonathan Casteleyn, co-head of the Financials sector at Hedgeye, briefly explains why he likes shares of Och-Ziff Capital Management, an idea he highlighted in early May.
The USD appears to be breaking out while both the EUR/USD and European equities are sending bearish signals. Both of these moves, should they continue, would be a headwind for Gold.
Last week we released an extensive report outlining the implications of a QUAD #4 (inflation and growth decelerating) GIP set-up through Q3. A link to that slide deck is included below:
We are waiting and watching closely for confirmation on this potential inflection point. Our current view that domestic growth is slowing remains intact. Although with commodity disinflation from the first half of the year and recent weakness in Europe, we are watching this re-tracement closely. Recent data has opened up an internal discussion about the strength of our #ConsumerSlowing theme:
- Commodity Disinflation
- Marginally better consumer spending and credit growth combating the absence of a positive trend in real wage growth:
- Household debt growth has increased from Q3 2013
- Trailing 12-month nominal consumer spending slightly outpacing nominal incomes (re-leveraging a potential tailwind to consumer spending capacity)
We highlighted developing credit trends in a note last Friday:
Gold currently stands right in the middle of key @Hedgeye TREND/TAIL levels after trading in a tight range last week (with the exception of a big rally Wednesday front-running Draghi’s speech.) The move suggests the market expected him to announce an asset purchase program. Gold ended the week up over +1%.
@Hedgeye intermediate-term TREND support is at $1271. The long-term TAIL Line of resistance sits at $1323. We would become louder on the long-side if Gold penetrates and holds this TAIL line. The narrative remains the same:
1. Growth expectations slow
2. U.S. interest rates fall
3. Both Gold and Long-term Treasury Bonds rise (holding the monetary policy of other reserve currencies constant over the more intermediate-term a very important factor to our gold thesis that we are watching intently right now).
Ten-year yields touched YTD lows Friday reflecting skepticism around a sustainable recovery despite the +4.1% initial Q2 GDP bounce. After breaking @Hedgeye long-term TAIL support, 1.70% is the next line of defense. The ten-yr yield is down over 20% from the beginning of the year and currently sits near the lows at 2.43% (2.36% YTD low late last week). 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. About a month ago we published a note outlining the thesis on Gold’s interaction with monetary policy by walking through its performance vs. other asset classes under different economic scenarios:
Right now there are two big headwinds to our position that will have implications for Gold’s direction:
- The quantitative signals suggest upside for the dollar and downside for the Euro: An apparent breakout in the dollar to the upside coupled with an incrementally more dovish Draghi is a headwind for Gold. The Euro is at a nine month low currently after topping in March of this year. European data is slowing (magnified in the countries which outperformed in the first half), and a majority of European equity indices are breaking down.
Our recommendation is short:
- European Equities (ETF: EZU)
- Weak Europe, Dovish Draghi: The expectation for economic weakness has been somewhat priced-in with expectations that some form of easing from the ECB is right around the corner. The outlook in the U.S. is more uncertain. If growth does miss in the U.S., the fed may get more dovish.. SO MAY THE ECB.
Two comments in particular from Draghi last week caught our attention:
- Readiness to pull the trigger on an asset purchase program.
His tone this past week reflected his willingness to stand ready for an ABS purchase program. In fact, he more or less said that he would implement an asset-backed purchase program (QE without the government bond and public asset purchase program). Not a single economist surveyed by Bloomberg expected a change in interest rates from Draghi last week, but the bounce in Gold suggests the market may have expected some kind of easing out of Draghi Thursday.
- Allusion to divergent policies in the U.K. and U.S. moving forward
The president more or less said the ECB Monetary Policy Committee cannot be outdone with regards to easy-money policy implementation. We interpreted his comments as a confident gesture that the Euro will continue to weaken against the USD and Pound over the intermediate to long-term.
European equity performance ugly last week:
- Greece led the losers (-9.9%)
- Portugal retreated another -6.7% to -17.5% YTD
- The German DAX fell -2.2% to -5.7% YTD
Both the quant signals and our GIP model suggest Europe may slow for the next three consecutive quarters which could potentially warrant a surprisingly more dovish ECB policy. CAN DRAGHI CONVINCE THE MARKET HE’LL BE MORE DOVISH FROM HERE? Unfortunately don’t possess a crystal ball, but the recent weakness is concerning…
We DO believe growth estimates for the full year in the U.S. remain too high, and a more dovish tone will likely be received as bullish for gold on the margin. Please feel free to ping us with any comments or questions.
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- “I would say that the competitive activity in this space has been very intense.” –John Foraker, Chief Executive Officer of BNNY
- “Heavier competitive pressure and that pressure could be branded promotional pressure or some private label expansion.” –Greg Engles, Chief Executive Officer of WWAV
- The battle in the mac & cheese category continues as both BNNY and WWAV say they are on track.
- One of the more telling trends we are seeing of late is the shift in the grocery retail space. As more natural-oriented retailers’ comps have slowed, the same-store sales for conventional grocers have improved. Clearly, the bigger grocers are doing a better job focusing on natural and organic as a core initiative to try to draw customers into their stores. In addition, fierce competition among natural chains is driving notable cannibalization.
- The mix shift to traditional grocers is adding incremental growth, but it’s coming at lower incremental margins.
- Europe is a bright spot.
- Inflation pressure remains an issue – dairy, almonds, organic wheat, etc.
- BDBD and BNNY are both calendar 2H14 margin recovery stories.
- WWAV said organic growth will decelerate from 11% in 2Q14 to 8-9% in 2H14.
WWAV: STRONG ORGANIC GROWTH AND MARGIN EXPANSION
WWAV remains the strongest company in the organic space and is on our Investment Ideas list as a LONG. We note, however, that organic growth will decelerate sequentially from 11% in 2Q14 to 8-9% in 2H14.
WWAV’s top-line increased 36% in 2Q14 as a result of double-digit organic net sales growth, which was over 11% in the quarter. Excluding Earthbound (and joint venture-related investments), organic operating income grew more than 2.5x the organic top-line growth rate, with operating margins expanding by over 100 bps.
Sales were up 38% in North America, including up more than 8% on a purely organic basis. Top-line results were driven by strong growth across all platforms, with plant-based beverages, coffee creamers and premium dairy all producing strong growth rates in 2Q14. The most recent acquisition, Earthbound Farm, grew by double-digits again in 2Q.
Organic growth guidance: Top-line guidance also includes an organic growth rate that the company expects to be in the 8-9% range in 2H14, with Europe being accretive to overall growth.
Plant-based beverages: Plant-based beverages grew 17%, led by almond milk growth of over 40%. Almond now represents almost 70% of the total plant-based beverage category. Silk almond milk continues to be a key driver of this growth, as sales grew by 45% in 2Q14 off an already sizeable base.
WWAV is the plant-based market leader, with Silk holding a 56% share of the total category and holding the number one position in the almond, soy and coconut subcategories.
“All major national branded almond milk players saw share pressures. We saw a step-up in both private label almond milk distribution expansions at a major retailer, plus we saw continued promotional pressure in the segment.”
WWAV continues to experience exceptional growth in Europe, with the plant-based segment reporting sales growth of 26% (18% on a constant currency basis) in 2Q, consistent with the strong growth it experienced in 1Q.
Horizon: “Our recently launched snacking line platform is performing very well, and as we expected, we experienced heavy competitive activity when we entered the mac & cheese category, but continue to be pleased with our results today.”
Management is confident about the potential of the brand: “The rollout of our new center store Horizon product continues to grow in-line with our expectations. It will be some time before these brand extensions become material to our results, but we remain encouraged by the strong repeat usage we’re seeing and increased levels of distribution we’re achieving.”
Organic milk grew 8% in the quarter, ahead of expectations, and accelerated from 2H13 when growth was closer to 5-6%.
Organic packaged salads: The organic packaged salads category continues to grow rapidly, up 18% in 2Q14. WWAV’s share of the total organic packaged salad category increased by 2 points to 24% in the quarter. Earthbound Farm continues to maintain a leading 55% share in the branded organic packaged salads segment.
Coffee and creamers: The coffee creamers and beverages platform grew 5% in the quarter, as WWAV continues to experience a negative overlap within iced coffee as a result of enhanced competitive pressure in the back half of last year. The premium dairy platform delivered top-line growth of 8% in 2Q14, despite an approximate 1% drag on asset sales.
BDBD: Strong Organic Growth and Declining Margins
We have a favorable view of BDBD and it remains on the Watch List as a potential LONG.
Total net sales increased 18.7% in 2Q14 as organic net sales increased 19.4%, well ahead of the company’s 13-18% guidance. Organic growth in the natural segment, which includes EVOL, increased 34.8%. The gluten-free brands, Udi’s and Glutino, reported strong net sales growth of 26.9%.
Gross margin was 35.7% in the second quarter, a decline of 610 basis points. This decline was primarily related to the increase in egg white pricing, which negatively impacted gross margin by 210 bps, as well as a mix shift to lower gross margin natural brands.
The company made a number of changes in 2Q that should begin to payoff in 3Q. We believe the combination of a price increase, formula changes, cost reductions and securing egg whites for the balance of the year will lead to a strong rebound in gross margins in 2H14.
The company also reaffirmed its guidance for the balance of FY14, which includes:
- Net sales to be in the range of $540 million to $550 million
- Organic net sales growth in the 13% to 18% range, with the Natural segment expected to come in at the high end of the range of 25% to 30%, and Balance to be flat to slightly positive.
- Adjusted EBITDA to be in the range of $89 million to $91 million, EBITDA to be in the range of $79 million to $81 million
- EPS to be in the range of $0.39 to $0.41 per share, based on 64.1 million shares outstanding.
- 3Q14 EPS of $0.10 to $0.12
- 4Q14 EPS of $0.18 to $0.20
- Gross margin to improve to 41% by year end from an average of 37% in 1H14
BNNY: Strong Organic Growth and Declining Margins
BNNY remains on the Hedgeye Best Ideas list as a short.
Consumer demand for Annie’s products remains very healthy, despite a more competitive environment. In U.S. grocery, BNNY’s number of distribution points increased 10% year-over-year and its market share was up 100 bps despite seeing increased competition in the mac & cheese category. Having said that, an increase in trade spending is negatively impacting gross margins.
Consumption increased in the high teens during the quarter, driven by very strong baseline performance in all sales channels and in most categories. BNNY continues to benefit from driving mainline distribution in conventional grocery stores. Consumption trends in the natural channel remain very strong, growing at approximately 9% in the quarter.
Organic wheat prices remain at historically high levels, up ~40%.
BNNY’s gross margins continue to be under pressure, due in large part to inflation and increased trade spending. The company expects to realize a 4% price increase in 2HF15 to improve the margin structure of the company. Gross margins should approach the mid-thirties during this period.
The company is guiding to strong earnings growth in 2HF15, as they benefit from mid-year pricing actions and productivity gains. Guidance is for adjusted net sales growth of 18-20% and adjusted diluted EPS of $0.88-0.95; we remain skeptical that this will happen.
The table below lists our Investment Ideas as well as our Watch List -- a list of potential ideas that we are in the process of evaluating. We intend to update this table regularly and will provide detail on any material changes.
07/28/14 Monday Mashup: MCD, YUM and More
07/28/14 MCD: McLibel 2.0?
07/29/14 DRI: Light Gets In
07/31/14 YUM: Warning Shots Fired
08/04/14 Invite: New Best Idea
Events This Week
Wednesday, August 13th
- NDLS earnings call 4:30pm EST
- FRSH earnings call 5:00pm EST
Thursday, August 14th
- RRGB earnings call 10:00am EST
Chart of the Day
Got pricing power? Chipotle does. Traffic growth has more than doubled price growth over the past 5 years.
Recent News Flow
Monday, August 4th
- DPZ upgraded to buy at Miller Tabak with an $81 PT.
- JACK announced Sharon John will join the company's board of directors. John has over 25 years of retail marketing, branding and executive management experience in both the public and private sectors.
- MCD noted that China, Japan and certain other markets have been severely impacted following food safety issues.
- PNRA CFO Roger Matthews resigned. William Moreton, Panera's current Executive Vice Chairman, will serve as Interim CFO until a successor is found.
- PLKI announced the resignation of the company's U.S. President, Ralph Bower.
Tuesday, August 5th
- CAKE announced its newest restaurant opening in Trumbull, CT at the Westfield Trumbull Mall.
Wednesday, August 6th
- FRGI announced it will consolidate all of its food distribution with Performance Food Group.
- THI declared a $0.32 dividend payable to shareholders of record as of August 18th, 2014.
- BOBE released an investor presentation to provide their take on a series of "misleading" statements made by Sandell Asset Management.
- JACK debuted three new breakfast items, featuring two new breakfast burritos and croissant donuts.
Thursday, August 7th
- THI was upgraded to outperform at BMO Capital.
- SONC announced a quarterly cash dividend of $0.09 as well as a $105 million share repurchase program for FY15.
Friday, August 8th
- DRI Activist Starboard Value increased its stake in Darden from 8.0% to 8.8%.
- CMG was downgraded to neutral at Longbow Research.
The XLY (+1.1%) outperformed the SPX (+0.3%). On average, casual dining stocks (-0.1%) underperformed and quick service stocks (+1.6%) outperformed the XLY Index.
XLY Quantitative Setup
From a quantitative perspective, the sector turned bearish on an intermediate-term TREND duration.
Casual Dining Restaurants
Quick Service Restaurants
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