TODAY’S S&P 500 SET-UP – December 9, 2014
As we look at today's setup for the S&P 500, the range is 24 points or 0.45% downside to 2051 and 0.71% upside to 2075.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
This note was originally published at 8am on November 25, 2014 for Hedgeye subscribers.
“We should burn what wagons we have, on order that our cattle not be our generals.”
According to ancient Greek #history, that’s what an emerging Athenian leader, Xenophon, told his men they should do as they marched against their Persian King. “Moreover, let us also abandon other superfluous baggage, except what we have for war or for food.” (Xenophon: The Anabasis of Cyrus, pg 108)
Yep. That’s the stuff I am reading these days. If you want to call it my confirmation bias in being bearish against central planning overlords (i.e. that this will not end well), I’m cool with that.
Buying the Long Bond (TLT) is as close as I am going to get to war with US and global growth bulls. And I probably won’t stop riding this bearish growth view, until the US elects to burn the yield chasing wagons – letting rates rise.
Back to the Global Macro Grind…
In case you didn’t know that one of the only ways out of this centrally planned Liquidity Trap (Total US Equity Market Volume was -29% versus its YTD avg yesterday) is to stop doing what didn’t work, now you know. Or at least the bond market does…
BREAKING (updated growth “survey” from Hedgeye): US 10yr Treasury Yield is ticking down to a fresh November low of 2.29% this morning and the Yield Spread (10yr minus 2yr yield) has compressed towards its 2014 YTD lows of 176 basis points this morning.
These are clean cut #GrowthSlowing signals. But you already know that.
What you also know is that at this stage of the central planning war, equity markets going up really has nothing to do with real-growth anyway. It has everything to do with Japan, Europe, USA, China, etc. trying to resuscitate drowning inflation expectations.
On that real-time score, as you can see in today’s Chart of The Day (US TIPS, 5 year Breakevens), so far… no good.
While the 2 day China rate cut “pop” in everything inflation expectations that’s been dropping was fun to watch, it didn’t change #Quad4 Deflation expectations. Both global growth and inflation expectations are still slowing, at the same time.
Other than one of the Fed’s preferred ways to monitor #deflation expectations (Breakevens), here’s what else I’m looking at:
1. US Dollar Index vs both Burning Yens and Euros = +10% YTD
2. CRB Commodities Index -0.7% yesterday to -4.6% YTD
3. WTI Oil flattish this morning at $76.01, down -17% YTD
4. Copper flat this morning at $3.01/lb, down -10% YTD
5. Russian Stocks (RTSI) -1.2% this morning to -23.3% YTD
6. Energy Stocks (XLE) down (again) -0.8% yesterday to -0.8% YTD
Then, of course, you can look at some late-cycle stuff like US wage Inflation… where 2/3 of the country has seen real wages deflate since the Fed undertook their unprecedented Policy To Inflate (see Federal Reserve’s own papers on the matter for details).
Or you can just find a “survey” that tells you something that has been the complete opposite of the wage deflation and no-capex cycle data. And say that the “market is up” on something like that.
But when you say “market” don’t forget that my preferred risk adjusted market to be long in 2014 (Long Term Treasuries) has had a much higher absolute return on much lower realized volatility than US small/mid cap stocks have.
Even if the July to October +160% ramp in the VIX is forgotten (for now), that doesn’t mean that the non-linear and interconnected economic risks associated with #Deflation Expectations Rising cease to exist.
What also exists as of this week is non-survey computed options positioning in Global Macro (non-commercial CFTC futures and options consensus positioning):
1. SP500 (Index + Emini) has moved to its biggest net LONG position since late SEP at +29,110 contracts
2. Long Bond (10yr Treasury) hit its biggest net SHORT position of 2014 at -128,032 contracts
3. Oil still has a net LONG position of +276,213 contracts, only down -12,971 week-over-week
“So”, what does that tell us?
1. After shorting the OCT lows, hedge funds have covered their shorts and are chasing the bull run in SPY (again)
2. Consensus Macro continues to think the risk in interest rates is to the upside (we reiterate downside!)
3. Perpetual expectations for another central plan (OPEC) remain for a non $65 oil price
Since Consensus Macro is not my expectations general, I say you burn the groupthink wagons and do the exact opposite of where those options are positioned: BUY Long Bond (TLT, EDV, etc.), and SHORT SP500 (SPY), Oil, and its related stocks and bonds.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.28-2.34%
WTI Oil 73.04-77.51
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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Takeaway: We think that RH will come out on the positive side of what we think is a binary set-up into the print.
Conclusion: This is a binary set-up for RH and the market knows it. The company needs to put up a significant reacceleration in its top line. With 31% of the stock held short, there are plenty of people betting it won't. But we think the unit growth, category expansion, comp, and margin opportunities are coming together for RH, and will be apparent this quarter. RH remains our favorite name in Retail.
We feel good about the RH earnings event on Wednesday after the close. Revenue should accelerate meaningfully as RH has finally hit the inflection point (after 7+ years) where square footage starts to enhance as opposed to shrink the top-line algorithm. We’re also seeing great strength in the brand’s online momentum, and should see a catch up from revenue that was delayed by problems with the sourcebook in 2Q. All-in, we’re looking for 24% growth, which is over 1,000bp better than the (unacceptable) 13.5% we saw in 2Q. The Street is straddling guidance at about 20-21%. On the EPS line, we’re at $0.52, which compares to the Street at $0.47 ($0.46-$0.48 guidance).
While the EPS beat should be nice, we think that there’s a binary nature to this quarter. Why? RH has never missed EPS, and it’s not going to start now. But it missed 2 of the last three quarters on the top line by an average of 4%. Even though the trendline growth rate (2-yr) remains well above 20%, the fact is that we’re arguing that RH will add $700mm in revenue next year alone (31% growth) and another $2.4bn over the following 3-years. We’re the first to call out that while the company undergoes its real estate build-out, there will be ongoing volatility in its’ top line on a quarter to quarter basis – that should last another 2-3 years. But weakness in 2Q needs to manifest itself in the 3Q revenue line. To be clear, we think that will happen. But if it doesn’t – timing or not – it will be very tough to argue a big multiple for RH over the near-term.
Details of Our Thesis. The way we see it, we think that RH will ramp from $2.50 in EPS this year to $11 in 2018. It’s an ambitious model, but completely achievable. The biggest barrier to getting there is RH itself. We think a few factors remain misunderstood – 1) The degree to which the high-end home furnishings market can be consolidated – not unlike what Ralph Lauren did to high-end apparel in the 1980s. 2) Our view that there are over 20 markets that could sustain a 50,000+ foot Design Gallery at a productivity rate of $1,200/foot. 3) The impact that occupancy leverage will have on Gross Margins, ultimately pushing GM% to 40%. Our key modeling assumptions are in the table below.
With Growth Comes The Multiple. If our model is right, then the company will be growing EPS at a CAGR of over 40% for the next four years. What kind of multiple is fair for a high-end category leader with a low-cost advantage that’s growing EPS at over 40%? We hate to just make-up multiples. But there are businesses growing at lower rates that carry a much higher multiple. UnderArmour grows at 25-30%, and yet it trades at near 70x earnings. Perhaps UA is grossly overvalued, and perhaps the market likes that someone came first and paved the way (Nike) showing what UA could look like when it grows up. With RH, people will have to use their imagination. But using 40x 2015 and 2016, we get to $150 and $230, respectively.
Why Revenue Should Accelerate In 3Q
Here’s a few supporting points for why we think revenue will accelerate.
Some More Detailed Modeling Considerations
Combined Brand Comp:
Despite the industry registering its fifth consecutive quarter of same-store sales growth, Black Box results for November were relatively disappointing. This disappointment comes after a very strong October, during which same-store sales and same-restaurant traffic increased sequentially on both an absolute and two-year basis.
Restaurant same-store sales increased +1.5%, while same-restaurant traffic decreased -1.1%, during the month. These numbers were down 130 bps and 150 bps, respectively, on an absolute sequential basis and down 70 bps and 50 bps, respectively, on a two-year sequential basis.
Black Box estimates 4Q14 same-store sales to fall within the +1.5-2.0% range, which would imply December comps of +0.3-1.8%. Given the easy lap, this appears to be a fairly conservative estimate.
The widening gap between sales and traffic suggests an increase in average check during the month, which could be the result of: higher prices, less promotions, or a shift in sales mix.
Importantly, November’s drop in traffic is consistent with the recent dip in consumer sentiment (Conference Board Consumer Confidence Index). Black Box noted that the NY/NJ region has been the worst performing for the past six months, while CA has been the best performing region for the past two.
This is the fifth consecutive month employment growth has been positive on a year-over-year basis across our five primary age cohorts. While one can argue we saw strength across the board, we saw a marked sequential slowdown in growth rates across all but one age cohort – suggesting the momentum in the jobs market may be fizzling.
November Employment Growth Data:
While widespread employment growth is positive for all restaurants, November’s release screened stronger for casual diners as the 55-64 YOA cohort showed unusual strength. All told, casual dining is an industry we are quite cautious on as a whole. However, we continue to favor BLMN and BOBE on the long-side as special situation plays in the space.
The release was undoubtedly a negative, on the margin, for quick service and fast casual restaurants, highlighted by a sequential decline in employment growth rates in the 20-24, 25-34, and 35-44 YOA cohorts. We continue to favor select, mostly nimble, operators in the space including JACK, YUM, CMG, KKD, PLKI, and WEN.
We remain bearish on SBUX over the intermediate-term, as the new growth algorithm has risks and a few “big bets” that may or may not pay off for the company as expected. In the meantime, slowing traffic trends continue to suggest there are a few cracks in the current algorithm that will need to be addressed in FY15.
Last week Starbucks Chairman, President and Chief Executive Officer, Howard Schultz, and other company executives detailed the company’s five-year strategic growth plan. That plan included a goal of generating nearly $30 billion in revenues by 2019. Importantly, what they failed to mention is what type of earnings the company expects to generate with that level of revenues.
As mentioned earlier, Starbucks outlined its new growth algorithm over the next five years. It’s significantly different from how the company delivered growth to shareholders over the past five years. Over this time, the company has grown, on average, annual revenues and earnings of 8% and 26%, respectively. Now, the company is talking about annual revenue and earnings growth of 12-13% and 15-20%, respectively. Importantly, this will come as annual unit growth is expected to accelerate from 6% to 8%.
The risks, and overall returns, associated with a unit growth story are distinctly different from those associated with a margin recovery story. Our bearish bias heading into last quarter’s print was predicated on globally decelerating traffic trends. There was no evidence presented during the analyst meeting that suggested this deceleration wouldn’t continue throughout 1H15. Management is essentially guaranteeing a successful holiday season in the short-term, while looking to mobile payments, pickup and delivery, and food to drive incremental transactions over the long-term. Needless to say, we have our reservations about how food will perform and believe it’s important to note that the technology piece of this algorithm is still in the test phase. Even if technology proves to a successful driver for the business, it will not have a notable impact on the business until 4Q15; only 16% of in-store transactions currently use the SBUX app for payment.
At the beginning of the meeting, Howard Schultz presented the following question: “What does it take to build a great, enduring company?” To be clear, we believe Starbucks is a great company (we’ve written very favorably on the name since 2009) that will endure for generations. There was never a question in our mind that this continues to be the case.
Our current thesis on SBUX, however, has little to do with the aforementioned. Instead, it has essentially everything to do with the risks associated with driving incremental transactions and the timing of when these risks will impact the P&L. As we’ve seen in the past, not everything this company touches turns to gold and expanding the business beyond its core operations has had significant implications in the past.
To put our thoughts about the new unit growth algorithm and the risks associated with it into perspective, the following quote from Howard Schultz says it all:
“We have to maintain the entrepreneurial DNA of the company. We have to have the constant curiosity to see around corners and see what others don’t see, and we have to have the courage and conviction to make big bets.”
As we see it, the “biggest bet” the company is making is on its food strategy and its potential impact on the lunch daypart. SBUX is investing a substantial amount of time and effort into building food sales, without the benefit of having equipment that allows them to produce the food fresh. Food is the biggest risk to the DNA of the company because, in our view, it will never be on-par with the quality of beverages consumers have come to expect from Starbucks. Lastly, it’s difficult to imagine that other QSRs and fast casual restaurants will simply let SBUX take incremental market share from them.
Within the first three minutes of his speech, Schultz hit on the one question on everybody’s mind: “What will the company do to drive incremental traffic?”
He set the tone early when he said, “As a merchant, we have to consistently recognize that one of our obligations and responsibilities in this new world is that we have to drive incremental traffic.”
What’s become clear to us is that the street has given management a “pass” after delivering disappointing 4Q14 results, opting instead to wager that the current holiday promotions, most notably “Starbucks for Life,” will drive accelerated traffic in 1Q15.
The most disingenuous slide of the day consisted of a chart of Starbucks stock price from November 2008 ($7 per share) to December 2014 ($80 per share). The implication here was to imagine what could be accomplished in five or six years, but it’d be unreasonable to expect a similar return moving forward. The analyst day showed the significant level of sophistication inherent in the SBUX business model, particularly when compared to other companies in the quick-service space. To be fair, however, we could’ve made the same observation in July of 2007, right before the stock plummeted from $40 to $7 per share.
There was a great deal of emphasis on the Starbucks Reserve Roastery and Tasting Room during the conference. The new building, which represents a new premium brand within the SBUX family, has been in the making for over two years and offers a retail experience that does not exist anywhere in the global QSR market today. Starbucks Reserve gives consumers access to rare micro-lot coffee that will be roasted in the new facility. The company plans to open new Starbucks Reserve stores, which will be about the same size as an average Starbucks store. The goal of these new stores is to bring to life a super-premium experience for coffee consumers, although management did not touch upon the size of the opportunity.
The following is a summary of comments from key Starbucks executives and our quick take on what each said:
Matt Ryan - Global Chief Strategy Officer
Matt laid out seven key strategies for growth:
Hedgeye: The company laid out an ambitious goal of 82% revenue growth over the next five years to nearly $30 billion, stemming from more than 30,000 stores globally. This implies 8% annual unit growth and mid-single digit same-store sales growth. This represents a different business model than the last five years, when revenues and EPS grew approximately 68% and 233%, respectively, and unit count grew ~6% annually. The new strategy will be more difficult to execute, making margin growth difficult to come by if same-store sales slow. We suspect years one and two will be well-executed, while years three and five will be more difficult to manage as management pushes the unit growth rate to levels unseen in a very long-time.
Adam Brotman - Chief Digital Officer
By the numbers:
Hedgeye: The SBUX bulls are making their own “big bet” that technology will save the day for the company.
Arthur Rubinfeld - Chief Creative Officer
Hedgeye: SBUX is light years ahead of the competition in keeping its store consumer friendly.
Troy Alstead - Chief Operating Officer
Hedgeye: It appears as though Troy is clearly being groomed to be the next CEO of Starbucks.
Cliff Burrows - President, U.S., Americas, and Teavana
Hedgeye: There is nothing new regarding these comments. Food and technology are the incremental growth drivers of the division. New units are important, but this isn’t the story here.
Kris Engskov - President, EMEA
Hedgeye: EMEA may represent a significant growth opportunity for the company, but it is too small right now to make a difference in the overall performance of the company.
John Culver – President, CAP
Closer look at key markets within CAP:
Hedgeye: CAP is also seeing a significant slowdown in traffic trends. Therefore, CAP has the potential to become a sore for investors in FY15.
Belinda Wong - President, China
Hedgeye: Considering other U.S. brands such as MCD and KFC are losing favor with Chinese consumers, there is the potential it spills over to SBUX.
Michael Conway - President, Global Development
Hedgeye: The least exciting part of the SBUX story.
Scott Maw - Chief Financial Officer
Hedgeye: We like Scott and he certainly has a great handle on the numbers. The one lingering uncertainty we walked away with was whether or not he controls the punch bowl when it comes to making incremental investments. One thing, however, was clear: Scott’s job will be significantly more difficult than the one Troy had.