"On this day in 2007, my first of three children, John Henry McCullough (we call him Jack) was born," CEO Keith McCullough wrote in today's Morning Newsletter. "It was the most humbling, yet inspirational moment of my life...Today is also my bubble’s birthday. Shortly after Jack was born, the US stock market #bubble of 2007 stopped going up. It actually started to go down fast, closing down 6.6% in November of that year – and didn’t bottom for 16 months after that."
“Today you are you! That is truer than true! There is no one alive who is you-er than you!”
On this day in 2007, my first of three children, John Henry McCullough (we call him Jack) was born. It was the most humbling, yet inspirational moment of my life. While he won’t quite get what that means until he reads this many years from now – I’ll give him a big hug when he wakes up this morning and thank him for it anyway.
At the time, I thought Jack inspired me to say goodbye to a life in the hedge fund business that was very good to me. Little did I know that my goodbye (to the head hunter community) was more like a “top of the risk management morn” hello to all of you.
So I just wanted to thank all of you this morning too. I started building this company 7 years ago with only 1 thing in mind – being true to who I am. To do that, I could only build alongside teammates and business partners who share the same principles and purpose. While we may not get everything right, today I can still say that we are who we are, truer than true.
Back to the Global Macro Grind…
Today is also my bubble’s birthday. Shortly after Jack was born, the US stock market #bubble of 2007 stopped going up. It actually started to go down fast, closing down 6.6% in November of that year – and didn’t bottom for 16 months after that.
Today’s all-time #bubble high in the SP500 is approximately +30% higher than that one was…
And while I haven’t been explicitly bearish on the SP500 this year (my focus has been much more on the small/mid cap illiquidity #bubble that was the Russell 2000, which is still -3.1% from its all time high), I’m obviously getting there!
What a long, strange, but thoroughly enjoyable trip…
What’s the same between now and November of 2007?
- They were both all-time SPY highs – and in both cases, all-time was/is a very long time
- As we hit all-time highs, in both cases, both local and global growth was already slowing
- In both cases, there were/are a myriad of “it’s different this time” perma bull cases being made
Away from that – this day of November 2014 versus that in 2007 are entirely different.
- This time, every major central planning agency considers itself some version of a gravity bending god
- There are fewer hedge funds that are actually hedged for a crash (hedge fund correlation to SP500 beta = +0.9)
- Where I am most bearish (Russell 2000), this market is way more expensive (55x trailing earnings) and illiquid
I’m also grayer and fatter, but you already know that.
What we don’t know now is similar to what they didn’t know then (with they being those who bought them at the all-time high). There is a buyer and seller at every cost basis don’t forget.
I am the way I am, partly because I am a Canadian hockey player, but largely because I’ve never lost money in a down US stock market (2000, 2001, 2002, 2008).
While I think I was as bullish as anyone on small/mid cap US growth stocks in both 2009 and 2013, but I’m definitely not the guy who is going to give you reasons to buy #bubbles. At least 90% of the Old Wall can get you that call this morning (for a brokered fee!).
So don’t expect that from me today and/or on Monday if the jobs report is magically “better than expected” this morning either. The main reason for that isn’t an ideology or a marketing model – it’s a risk management process.
My catalyst in both 2007 and 2014 was/is the same. It’s called the economic cycle. Whether naval gazing US stock market consensus is forced to acknowledge it today, next week, or next month isn’t the point.
Long-term Bond Yields, Oil, Gold, Japan, Russia, Brazil, Europe, Emerging markets, Russell 2000, etc. have already confirmed it.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.22-2.40%
WTI Oil 76.23-79.92
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
HAIN in on the Hedgeye Best Ideas list as a SHORT.
HAIN reported earnings yesterday, and the quarter was less than natural. The company missed revenue estimates, while conveniently beating EPS estimates by $0.01. While the bulls will likely point to the success of its roll-up strategy, there are a number of cracks that are beginning to appear in management’s story. We believe these will manifest into bigger issues as we progress over the balance of FY2015.
While we attribute most of the stock’s hype to that surrounding organic food companies in general, we tend to believe the street has placed the CEO on a pedestal. This typically raises a red flag for us because, in our experience, it can lead to a number of issues, including:
- Management incentives are often short-term
- Significant insider selling
- Charismatic CEOs tend to stand above the company
- The more successful the CEO, the less he/she is held to account
- Symbiotic board/CEO relationship results in excessive compensation
- Management tends to overstate the growth it is seeing
Does any of this sound familiar to companies you’ve come across in the past? How did those stories end? HAIN certainly fits the bill. In our view, this is a classic bubble stock and the company is not being built to last.
The following are some of our thoughts about 1Q15:
We’ve never seen a company make such a large, and increasingly large, number of adjustments in their quarterly reports. Regarding 1Q15, the sheer size of the adjustments and the rate of growth on a year-over-year basis are staggering. How can any portfolio manager be okay with this? How can you not question the quality of earnings the company is producing? As we laid out above, charismatic, well-liked CEOs tend to have their word taken at face value because people want to believe in it.
IS HAIN OVERSTATING ITS ORGANIC GROWTH RATE?
Consistent with what you’d expect from a company that must adjust number to hit EPS estimates, we believe HAIN is overstating its true organic growth rate, which management said was 8% on a global basis in the quarter. Given the numbers they presented, it is very difficult for us to get to this 8% organic growth rate, particularly when considering that we estimate the organic growth rate in the US in 1Q15 was a mere 4.6%. Based on our math, this represents a 180bps sequential slowdown.
OPAQUE BUSINESS MODEL
HAIN operates a very opaque business for such a hyped up stock. Management wants you to believe they are disclosing everything you need to understand the underlying trends of the business, but this is far from the truth. In fact, in this regard, they virtually give you nothing beneficial. What they do give simply masks the real issues. To make matters worse, deceit and obfuscation are prevalent during quarterly earnings call.
In 1Q15, adjusted gross margin was 23.5% (down 156 bps y/y) due to the acquisition of Hain Pure Protein. Management has guided to a 150-160 bps gross margin decline for the full year. To offset this decline, the company cut SG&A by 170 bps and guided to another $50 million in SG&A cuts in FY15. How long can they push this line lower? It’s a trend that we believe is highly unsustainable and also one that suggests the company in underinvesting in its brands.
Roll-up strategies generally work so long as the company maintains positive economies of scale. As you can see below, this is precisely what HAIN is failing to do.
FREE CASH FLOW
The company did not generate any free cash flow in the quarter.
Inventories have been growing faster than sales for the past several quarters. This is consistent with a slowing core business.
Other issues are beginning to manifest, including:
- HAIN’s supply chain – MaraNatha could be the tip of the iceberg
- Private label competition is increasing
- Suspect financials
We believe this story is beginning to unravel.
Feel free to call, or email, with questions.
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TODAY’S S&P 500 SET-UP – November 7, 2014
As we look at today's setup for the S&P 500, the range is 79 points or 3.16% downside to 1967 and 0.73% upside to 2046.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.84 from 1.84
- VIX closed at 13.67 1 day percent change of -3.53%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: Chg in Nonfarm Payrolls, Oct., est. 235K (pr 248k)
- Unemployment Rate, Oct., est. 5.9% (prior 5.9%)
- 9:15am: Chicago Fed President Charles Evans delivers remarks at community bankers forum held by Fed, FDIC, OCC in Chicago
- Also speaking: Comptroller of the Currency Thomas Curry, Fed’s Daniel Tarullo
- 10:15am: Fed’s Janet Yellen speaks in Paris
- 1pm: Baker Hughes rig count
- 3pm: Consumer Credit, Sept., est. $16b (prior $13.525b)
- Obama holds Cabinet meeting, meets with congressional leaders at White House
- Senate, House out of session
- Sec. of State John Kerry travels to Beijing
- 8:30am: Federal Trade Commission Chair Edith Ramirez remarks at 100th anniversary celebration
- 9am: Andrew Ceresney, head of SEC’s enforcement division particpates in panel discussion in NYC
- 1pm: VA Sec. Robert McDonald speaks at Natl Press Club
- 1pm: U.S. Ambassador to the UN Samantha Power at American Enterprise Institute
WHAT TO WATCH:
- Fed Said to Seek More Time to Mull Actions Against FX Traders
- Libor Banks Ask U.S. Judge to Dismiss 17 Rate-Swap Suits
- Home Depot Says 53m E-Mail Addresses Were Taken in Breach
- Allianz to Lift Payouts, Affirms Goals Amid Pimco Outflows
- Singapore Returns Up to $9b to Banks After Rate Probe
- Kutxabank in Talks on Bad Bank With GS, Lone Star: Expansion
- Takata Said to Have Tested Air Bags in 2004: NYT
- Citigroup Said to Await Final Bids for Japan Retail Bank
- Mitel CEO Won’t Rule Out Higher, Hostile Bid for ShoreTel
- Twitter Says Recent Debt Deal Makes Co. Harder to Acquire
- Co. to Open Greater China Office in HK Amid Developer Push
- PetSmart Said to Invite PE Firms for Final Bid Round: WSJ
- Retailers Ponder Whether Opening Worth Ruined Thanksgiving
- China Auto Sales Hasten First Time Since June on Discounts
- Lenovo Says ‘Hypergrowth’ in China Smartphone Market Ending
- Retail Sales, Obama in Asia, G-20, Paschi: Week Ahead Nov. 8-15
- Athabasca Oil (ATH CN) 6am, (C$0.05)
- Bankers Petroleum (BNK CN) 7am, $0.08
- Berkshire Hathaway (BRK/A US) $2,593.00, Aft-Mkt (tentative)
- Brookfield Asset Mgmt (BAM/A CN) 8am, $0.61
- Cogent Communications (CCOI) 7am, $0.03
- Cooper Tire & Rubber (CTB) 7:30am, $0.73
- Dresser-Rand (DRC) After-mkt, $0.64
- Enerplus (ERF CN) 8:47am, C$0.21
- EW Scripps (SSP) 7:30am, $0.05
- Fortis (FTS CN) 6am, C$0.26
- Humana (HUM) 6am, $2.01
- Isis Pharmaceuticals (ISIS) 8:30am, ($0.20)
- Magnum Hunter Resources (MHR) 7am, ($0.16)
- ViaSat (VSAT) 9am, $0.15
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Brent Heads for Longest Weekly Drop Since 2001 on OPEC Outlook
- ICE to Run Replacement for Century-Old London Gold Fixing
- Jiangxi Copper Seeks Record Treatment Fees on Higher Ore Supply
- Gold Trading Near Four-Year Low Heads for Weekly Drop on Dollar
- Iron Ore Completes Biggest Weekly Loss Since May on Global Glut
- Tin Set for Biggest Weekly Gain Since February Before Jobs Data
- China Gold Buyers Signal Slumping Price Nears Nadir: Commodities
- Gold Speculation Points to Lasting Bear Market: Chart of the Day
- Banks Face Lawmaker Scrutiny Over Physical Commodities Units
- Port Worker Slowdown Seen Spreading to Nation’s Biggest Hub
- California Oil-by-Rail Volumes Drop as Canada Faces Competition
- China Oil Producers Face Cuts After Period of ‘Runaway’ Spending
- Four Takes on OPEC’s Vienna Decision as Selloff Deepens: Energy
- Corn Traders Bearish 13th Week on Ample Supply From U.S. Harvest
- Gold Seen Extending Decline 12% by Second-Best Forecaster Gan
The Hedgeye Macro Team
Takeaway: By the time KATE approaches year 3-4 of our model, yesterday’s stock action should look like chump change.
The 17.9% pop in KATE’s stock yesterday leaves little for us to add regarding the event itself. But we want to make one thing crystal clear, by the time KATE approaches year 3-4 of our model, yesterday’s stock action should look like chump change. We think there’s $3bn in revenue for this brand (at the consolidated P&L level -- $4.8bn in aggregate brand sales at retail), a high teens margin, and $3+ in EPS power. The 50-60% CAGR (depending on base year) makes us more than comfortable with a 30x+ multiple in the out years (much higher near-term), and a roadmap to a $90-$100 stock. We hosted a call on Wednesday where we outlined our thesis in a 40-page slide deck. Here’s the replay info and link to the presentation materials in case you missed it.
Materials Link: CLICK HERE
Replay Link: CLICK HERE
As for the quarter, the biggest positive for us (and probably for the stock) was the dramatic change in management’s tone. Again, this is a team that inadvertently evaporated $1.7bn in equity value during the 2Q call in the face of otherwise stellar results due to an odd mix of way too much information in the face of insufficient disclosure, and no real command of its future. But fast forward 13 weeks, and this time it was as if we literally heard a different management team.
1) First off, the call was tight – less than an hour. It is the shortest call on record for KATE, FNP, or LIZ back to at least 1998. The company has always drowned the Street with way too much information that ultimately does not matter. But this time the message was concise, and the company prevented a situation where the 20th analyst in the queue from a no-name shop could pester the CEO about why the store in Mercedes, TX was out of inventory of chambray totes.
2) The overall tone, cadence, and command of the business and message – especially from Craig Leavitt – was at least as good as one would expect from a company twice the size of KATE. In fact, when we juxtapose Leavitt with KORS CEO John Idol on their respective calls this quarter, KATE definitely gets the nod. (Now all Leavitt needs to do is execute like Idol has).
3) A definite tonal change on the part of management is that there appears to be zero tolerance for sustaining the existence of dilutive businesses – most notably Jack Spade and Kate Spade Saturday. Though KATE will move forward with its plan to invest in these businesses, it sounds like they are both on a short leash. At best, they only account for 5% of total sales for now. We’d rather see the real estate converted to KSNY, which would probably double the revenue contribution of those real estate assets. But 3 months ago, it seemed like the company would let these brands be dilutive forever. That’s clearly no longer the case (truth be told, it probably never was the case – but the public perception is that it was, which drained KATE’s multiple).
- Resetting the base: 2016 targets now call for Kate Spade & Co. EBITDA margins to be in the range of 18%-20% on a sales number that is tracking well ahead of plan. Two small changes in the language here: 1) Corporate expenses are now fully allocated in that target (which we knew was coming), and 2) it is now looking at the consolidated company which includes Adelingtion for the time being. If we pin Corporate at 5% and add that to the new targets that equates to about 23-25% on an apples-to-apples basis with the old reporting structure. To add context, it's important to note that corporate was 7%-8% of sales in FY 13 depending on which number you look at (Comparable Adjusted vs. plain old Adjusted).
- Comp: Guidance for the year (19%-21%) looks beatable to us. It assumes a window for 4Q between 8% and 14%. We're at 18%. Given the moving parts in 3Q, 4th of July and Semi-Annual sale moved into 2Q, we should see a sequential acceleration heading into Holiday. The elimination of 'Surprise Sales' is a bit of a headwind, but we are not overly concerned. Assuming that dot.com now accounts for 25% of sales (up from 18% in 3Q13), that implies a 21% growth rate in the quarter. At a 20% penetration number it’s 23%.
- EBITDA: KATE (and its predecessors) is not known for taking up guidance – it’s been the opposite historically more often than not. The company guided the range up $10mm for the year from $120m to $130m on an in line print. The lion share of that beat comes from upside in Gross Margin targets though we still see upside given the run rate over the past two quarters. -75bps in 2Q (ex. 240bps Kate Spade Saturday dilution) and +144bps in 3Q. To get to the high end of guidance which calls for 125bps of dilution we'd have to see a 300bps sequential declaration on the 1 year trend line and 150bps on the 2yr.
This note was originally published at 8am on October 24, 2014 for Hedgeye subscribers.
“The problem with the big focus on making capital cheaper… is it’s akin to fighting fire with fire.”
That’s a quote from the beginning of chapter 6 of The Age of Oversupply, by Dan Alpert. The chapter was a good one titled “The Empty Toolbox” and it focuses on why central planners “can’t fix the economy.” #agreed
Whether you are looking at the US economy or global one slowing right now, it’s important to keep these v-bottom moves in equity markets in context. Where are they v-bottoming from? Oh, and why did they go down so hard so that they could v-bottom to begin with?
Our call throughout the year has been very consistent on the why – growth is slowing. And when early-cycle growth slows from multi-year highs, you short the most illiquid form of beta chasing (small cap stocks) and you buy the Long Bond.
Back to the Global Macro Grind…
I was at a dinner meeting in Maine last night and an entrepreneurial CEO asked me a question I’ve been asked by hundreds of non-Wall Street people in 2014: “What do you think I should do with my money right now?”
I’m not the beat-around-the-bush-type, so I told her exactly what I have been telling people all year:
- Sell stocks
- Buy bonds
- Raise Cash
As basic as this advice has been is as hard as it’s been for people to just execute on it. But, with the total return of the Long Bond (TLT) at almost +19% for 2014 (vs. the Russell 2000 down -4%), why is that?
A: It’s not what “everyone” is saying people should be doing.
That’s it. From New Hampshire to California and everywhere I’ve been this year in between. That pretty much sums it up. The response is always the same: “but can’t interest rates go up? Aren’t bonds expensive?”
What’s been really expensive is believing that central planners can bend gravity and deliver +3-4% economic growth. If they deliver 0-2%, “expensive” bonds are going to get more expensive, and really expensive growth stocks (think Amazon at 112x earnings) are going to continue to crash.
But, but… “Keith, this bounce is crazy – why can’t it keep going…”
If I have some iteration of that in my inbox 100x in the last 3-4 market days, I have it 1,000x. And all I do is shake my head wondering why so many refuse to take a lesson from the risk management exercise learned as the Russell was having a -15% draw-down and the 10yr broke 2% only a week ago.
To review the #Quad4 deflation case that Mr. Market is effectively yelling right now:
- Bond Yields (10-30yr) in the US are crashing
- Oil prices are crashing
- Over 60% of stocks in the Russell 2000 are crashing
To be fair, if you didn’t have a view that all of these things would go down, you blamed ebola (and Canada) and wore them the whole way down anyway. But, if you did, you are killing it YTD and in a position to re-ramp every position you’ve had throughout the last 6 weeks of macro market volatility.
We’re deep into 2014 and at this stage of the season playing this game from a position of strength is entirely different than playing it from a position of weakness. If you’ve been winning, you don’t have to spend your entire day worrying about why the stock market is bouncing and bonds correcting.
You’ve realized that the Fed, Bank of Japan, and European Central bank have all cut to zero. You’ve also reminded yourself that 0 + 0 doesn’t equal something greater than zero – and that they can’t solve for #GrowthSlowing again.
In other words, they can’t fix this. Unfortunately, only a deflationary reset can.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets – which you can get in our Daily Trading Range product as well) are now:
UST 10yr Yield 2.11-2.32% (bearish)
SPX 1835-1963 (bearish)
RUT 1040-1127 (bearish)
Nikkei 14503-15449 (bearish)
VIX 15.06-28.49 (bullish)
USD 85.01-86.20 (bullish)
EUR/USD 1.26-1.28 (bearish)
Yen 105.36-108.31 (neutral)
WTI Oil 79.75-82.62 (bearish)
Natural Gas 3.51-3.74 (bearish)
Gold 1226-1251 (bullish)
Copper 2.95-3.05 (bearish)
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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