Hedgeye Risk Management Founder & CEO Keith McCullough discusses his latest economic and market outlook with Fox Business anchor Maria Bartiromo, says the Fed has been too high on inflation and employment growth, and cautions policymakers from raising rates right now.
Takeaway: We remain short, but somewhat cautious into the print (bearish fundamental outlook vs. potentially more bearish buy-side expectations)
- 2015 OFF TO A ROUGH START: 1Q sets the tone for the year given WTW’s seasonal attrition patterns, so the company would not be able to recover if its winter selling season disappoints. Our Google Trackers suggests that is the case, pointing to a notable deceleration in 1Q demand. Meanwhile, consensus estimates are essentially calling for one of WTW’s strongest on record winter selling season on record.
- EXPECTING LIGHT GUIDANCE: Consensus is only looking for -4% decline in 2015 revenues, which would be a marked improvement over its -14% YTD growth in 2014 (despite the deteriorating demand trends mentioned above). We’re expecting 2015 EPS of $0.71-$1.09 (vs. consensus of $1.43) on low-teens revenue declines, and the greater G&A expense levels that management guided to on its last call. WTW's 2015 EPS guidance range could come in under $1.00, with negative 1Q15 EPS guidance (the latter hasn't happened in at least 10 years).
- BUY-SIDE EXPECTING A DISASTER? WTW is down 26% YTD, and short interest has accelerated to 61% of its float as of 1/30/15. The bond market has followed suit, with WTW’s largest tranche trading at $0.65 (down 16% YTD). A short squeeze is possible on anything short of another disaster release, but we had the same concerns last year on a similar setup into the print. However, the stock still appears to have a lot of downside from a mulitple perspective (the below charts are based on consensus estimates).
- HUMANA HAIL MARRY: Humana just announced today that it will offer its employees access to Weight watchers programs at "no cost for six months, and a significant discount thereafter". Two things. First, we don't know how much of a concession WTW is offering to Humana. Second, the structure of the agreement may not yield all that much to WTW after considering the free six-month period vs. its seasonal attrition issues. There is good chance that many participating Humana members will churn off the program before they start paying.
Let us know if you have questions, or would like to discuss in more detail.
Hesham Shaaban, CFA
At the risk of stating the obvious, what looks like (and acts like) a dove … is a dove (even if her collar is up!).
Three Fed testimony takeaways:
- Yellen put an end to the recent Bond Bear fear-mongering of removing the word “patient”
- Yellen was incrementally concerned (dovish) about inflation not achieving her “target”
- She’s now hostage to the “data”, which includes slowing CPI and GDP reports on Thursday/Friday
Then, of course, there’s the jobs report for FEB (reported next week). And I continue to think the 10yr yield is one bad jobs report away from re-testing the JAN 2015 lows.
If it’s a good jobs report, bond yields should bounce from wherever CPI and GDP reports take them in the meantime.
Keith R. McCullough
Chief Executive Officer
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Before helping celebrate Maria Bartiromo's one year anniversary hosting Opening Bell on Fox Business Network this morning, Hedgeye CEO Keith McCullough dialed in to Hedgeye's Morning Macro Call to provide his daily dose of market insight.
In today's Q&A session, Keith gives his longer-term thoughts on gold and breaks down the difference between Bayesian and Frequentist probability theories in relation to analyzing labor market data.
Takeaway: There are a few key considerations as it relates to Target's rather bold move to go toe-to-toe with Amazon with free shipping.
1. First off...Historically, retailers in this space have been lemmings. Prior to TGT announcement (taking shipping threshold down from $50 to $25) there were 5 retailers in the space who set the free shipping threshold at $99 (JCP, M, TJX, BELK, Lord & Taylor) and 4 who sat at the $50 hurdle rate (TGT, WMT, Gap, Old Navy). TGT's move shifts the balance of power in the industry and we think that means there are more dominos to fall.
2. Free Shipping is Inevitable. This is just the first market share grab by a big player which will inevitably lead to free shipping across the board. That's fine if you're a retailer who has a basket size big enough to absorb the incremental cost for both fulfillment and returns a la JWN. But the problem is that the TGT, WMT, JCP, and KSS do not have that luxury and it has profitability implications. Here's the math…
3. If we assume that TGT online sales grow at a 23% CAGR through 2019, taking e-comm as a % of sales from 3.5% in 2013 to 12.5%, that equates to 20bps of gross margin pressure per year or $0.15 in earnings. To get there we assume that TGT dot.com sales come in at a gross margin rate 1000bps below brick and mortar sales. We've seen similar numbers out of KSS who you may argue is less efficient. But, when we pair that up with AMZN -- where shipping expense is 10% of total direct sales we think that's a fair estimate.
It's not likely that we will see any impact on profitability in the quarter the company will report tomorrow, because the data breach induced discounting in 2013 will more than offset the effect of free shipping. The same is true for 1Q and 2Q where the company invested heavily to drive traffic. But over a longer duration, you have a zero square foot growth retailer trading near peak multiples with cost pressures accelerating.
Yesterday, DRI announced that interim CEO Gene Lee will become the new CEO of Darden. Once the company finds a new CFO, the transition to the new management team will be complete.
Next comes the hard part – fixing Olive Garden.
It’s been 2 years, 7 months, and 11 days since we first said DRI needed major changes, when it was evident the CEO’s reckless growth strategy was destroying shareholder value. What followed was an amazing story of sloppy corporate governance, blatant disregard of shareholder returns, and a level of mismanagement that we’ve never seen in the casual dining industry. In the end, it’s truly amazing that the failed strategies lasted so long without more shareholder outrage. What’s more amazing, however, is that one of the key players that contributed to those failed strategies is now the new CEO of the company. Maybe his knowledge of, and first-hand experience in, the failed strategies of the past will make him a better CEO than COO. Time will tell.
Either way, it seems counterintuitive that, following the historic unraveling of the Darden Board in October 2014, the new Chairman of the Board, Jeff Smith, would choose a Darden insider as a new CEO. Given how long it took to name a CEO, one thing is clear: it was not an easy decision. Our sentiment about the qualifications of the new CEO was reflected in the lack of conviction in yesterday’s press release. It seemed obvious, to us, that Jeff Smith struggled to accurately frame why Gene Lee was chosen as the new CEO. The endorsement of Mr. Lee was not only generic, but also failed to cite what he has accomplished at Darden that would position him as the new CEO – outside of being the last man standing.
The contradictions between the Chairman of the Board and the new CEO are apparent. Consider the following:
- Jeff Smith and the current Board of Directors trashed Gene Lee and Dave George’s Olive Garden “Renaissance Plan.”
- The Olive Garden remodels show a lack of discipline for ROI.
- Under Gene Lee, Seasons 52 opened a significant number of underperforming units – further showing little concern for ROI.
- The overall profitability of the Specialty Restaurant Group, run by Gene Lee for six years, is not significant enough spin it off as a separate company.
It will be interesting to see how they’ve solved these contradictions in the coming months.
Having said that, appointing Gene Lee as the new CEO is the safe choice, especially with the stock above $62 and improving industry trends. We won’t truly know if this was the best choice for the company until we begin to lap the improvements made six months ago.
We suspect there will be structural changes made within the company before we see any sustained improvement in operating trends. Given the industry backdrop, DRI will likely report strong comps when they release earnings on March 20th. However, it will be difficult to tell whether these reported comps are the result of improved industry trends or improved operations. We suspect it will be the former.
The next 25 days will be the most important of the new CEO’s career. That’s how long he has to write a script that shows the investment community he can make difficult decisions that will lead to a multi-year improvement in the fundamentals of the business.
The plan should include:
- A new strategic direction for Olive Garden’s menu.
- A new look and feel for Olive Garden’s asset base.
- A plan to improve LongHorn’s relatively low AUV’s and below average returns.
- Significant changes to capital allocation strategies, including limiting new unit growth and the potential sale of real estate and other non-core assets.
- Franchising – including selling stores – of non-core brands.
- Strategic priorities for improving the cost structure of the enterprise.
- Setting a timeline for restoring EBIT margins to 10% or better.
We look forward to seeing how the new CEO presents the future opportunities at DRI. We’re confident there is significant low hanging fruit, but we need to see how these opportunities manifest themselves for the benefit of shareholders.
In the short-run, this stock is way ahead of a turn in the fundamentals.
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