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Investing Ideas Newsletter

Takeaway: Current Investing Ideas: ITB, TLT, EDV, OC, MTW, MUB, PENN, RH

Below are Hedgeye analysts’ latest updates on our eight current high-conviction long investing ideas and CEO Keith McCullough’s updated levels for each.

 

*Please note we added Housing (ITB), Owens Corning (OC) and Manitowoc (MTW) this week and removed Hologic (HOLX) and Yum! Brands (YUM).

 

We also feature two additional pieces of content at the bottom.

Investing Ideas Newsletter       - levels111 

Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers.

  • "Trade" is a duration of 3 weeks or less
  • "Trend" is a duration of 3 months or more
  • "Tail" is a duration of 3 years or less

CARTOON OF THE WEEK

Investing Ideas Newsletter       - Fed forecast cartoon 03.02.2015

IDEAS UPDATES

itb

After spending much of 2014 on the bearish side of US Housing, we turned bullish late last year. There were three primary reasons why.

  • Price – Rate of Change in home prices, after running strong through 2012/2013 showed material deceleration in 2014. Prices were rising 10-12% year-over-year in early 2014, but by late 2014 the rate of change had slowed to 4-5%. That deceleration in home prices was one of the factors that precipitated 2014’s underperformance in housing stocks. By the end of last year, however, the rate of change in prices had stabilized, and as of the most recent data is showing some nascent signs of modestly re-accelerating. We think the factors are there for further re-acceleration in home prices.
  • Demand – 2014 began with a thud as the Consumer Financial Protection Bureau rolled out its new “QM” rules. QM is short for Qualified Mortgage and the basic idea is that the government decided to further tighten the screws on mortgage availability by restricting a large swath of blue collar and self-employed workers (i.e. non-W2 wage earners) from obtaining mortgage credit. Consequently, demand for mortgages to buy homes fell 10-15% in 2014. One of the funny things about Wall Street is its obsession with the idea of the “comp”, or compare. Compared to 2014’s 10-15% decline, 2015 actually looks pretty good. For instance, applications for mortgages to buy homes are up around 10% in the most recent data vs the same period last year. In other words, the collapse of 2014 has become the comp of 2015. Easier compares tend to help fuel appreciation.
  • Credit – Beyond the easy compares, however, there are a few incremental drivers of organic demand in the housing market. The first of these came late last year when the GSEs (Fannie Mae and Freddie Mac) announced they would lower minimum down payment requirements to 3% from 5%. While that may not sound like much, down payments are one of the biggest inhibitors for would-be first time homebuyers as they’re often challenged in saving enough for a down payment. As such, going to 3% from 5% represents a 40% drop in how much they would need to save to buy a home. The size of the GSEs makes this move important, as, together, Fannie and Freddie account for around 70% of total mortgage volume in the US. The next positive announcement came from the FHA, which cut its annual mortgage insurance premiums by 50 bps to 85 bps from 135 bps. After years of getting more expensive (raising mortgage insurance premiums), the FHA finally started going the other way. These two initiatives should have a measurable, positive impact on the landscape for first time homebuyers, which will add to 2015’s “good year” status relative to 2014.

We’re fond of saying that it’s not whether the housing market is good or bad that matters, but rather whether it’s getting better or worse. 2014 was decidedly a year of “worse”, whereas 2015 is looking like a year of “better”. The tailwinds for housing are durable over the intermediate to longer term, provided the macro-economic backdrop (i.e. the labor market) hold up reasonably well.

 

ITB (iShares US Home Construction) is an ETF that includes holdings in homebuilders (~60% of holdings), home improvement companies like Home Depot and Lowes (~10% of holdings) and building products companies and represents a good cross-section of companies that should benefit from our intermediate to longer term bullish housing outlook.

oc

Industry-wide September and October 2014 price increases appear to be more than just holding, they are sticking. This development augurs very well for Owens Corning’s roofing segment which represents a sizeable portion of their earnings and revenue. Keep in mind, oil prices have tumbled over the same period, sending input costs lower for the roofing industry, which also bodes well for OC.

 

In addition, Owens Corning and industry-wide insulation price increases are set to take effect this month for commercial and residential insulation products.   

Investing Ideas Newsletter       - y1

Investing Ideas Newsletter       - y2

mtw

We added Manitowoc to Investing Ideas Friday. Click here to access. 

Investing Ideas Newsletter       - 777

PENN

Hedgeye Gaming, Lodging & Leisure Sector Head Todd Jordan reiterates his bullish call on Penn National Gaming. The company has a number of bullish tailwinds including the current macro environment, a new casino (Massachusetts’s first in Plainridge Park), solid management team, in addition to a better entry point on unrelated Macau sympathy working in its favor.

TLT | EDV | MUB

 

Friday’s jobs report was a very important data point for contextualizing our global deflation call because the Federal Reserve is hyper-focused on the labor market (and so is the market because of the Fed). We expect the Fed’s language to reflect this “positivity” at its meeting in two weeks.

 

The first chart is an overview of the Fed’s key focus points. The second chart is a self-explanatory, and highly relevant chart showing a look at the state of the labor market leading into past recessions. The labor market actually looks the best right before we go into a recession. YET, the Federal Reserve looks at it as an indicator that ALL IS GOOD AND WE CAN HIKE RATES.

 

• Non-Farm Payrolls increased +295K for February vs. the +235K additions that were expected (+239K at the prior reading)

 

Chart#1: JOBLESS CLAIMS: If history is any indication, the longer we stay around 300, the closer we are to a recession.

 

Investing Ideas Newsletter       - benn2

 

Chart#2: POLICY INDICATORS: While 5YR-YR forward breakeven rates, Core CPI readings, and Yield Spread compression scream #DEFLATION, The current employment situation (late-cycle) points to a more Hawkish policy.


Investing Ideas Newsletter       - benn


The market’s reaction to Friday’s NFP number presented yet another buying opportunity for the investor with a longer-term time horizon in long-term fixed income exposure (MUB, EDV, TLT)…

 

A better-than expected jobs report brings forward the expectation for an interest rate hike:

 

Therefore:

 

• The dollar ripped (+1.4% on the day)

• Rates spiked (U.S. 10-year yield jumped +13bps to 2.25%)

• TLT pulled back on declining yields, presenting yet another opportunity to buy on the pullback (-2.21%)

• Commodities, which are priced in dollars globally, pullback across the globe when the dollar strengthens

 

While the rest of the world devalues, the Fed runs the risk of hiking rates into the most deflationary period since 2011 which will send the dollar even higher.

 

Deflation crushes growth and the debtor and we expect Treasury rates to revert back to historically low levels in the back half of the year when growth and inflation surprise on the downside for Q2. Scary scenario unless you stick with your long position in TLT, EDV, and MUB.

RH 

This week Wayfair (W), the online retailer of home furnishings and household goods (in its third 'at bat' after going public in October) finally beat expectations.  That said, the market already knew that one, with the stock trading up 27% in the last three days before earnings, and 56% in the last month. Furthermore, the company is still losing money -- a lot of it -- and as best as we can tell, that trend won't reverse itself for many years. The number of transactions were up 45%, which is impressive by any measure. But the average transaction size is only $191 -- a very difficult number for a furniture retailer to generate profits on. 

 

A few weeks back we noted that PIR's poor quarterly performance was not endemic to the industry, but rather a case of business mismanagement.  Wayfair's 11% beat (+38% y/y) on the top line reaffirms that the home furnishings space remains healthy.

 

The biggest call out is that after this week’s up move, Wayfair is now trading at nearly 2X sales -- which is right in line with Restoration Hardware. We can't even begin to list the number of reasons why that shouldn't be.  

 

* * * * * * * * * * 

ADDITIONAL RESEARCH CONTENT BELOW

del frisco's: thesis confirmed despite pop

We’d short DFRG on this pop and continue to see downside to the $10-14 range.

Investing Ideas Newsletter       - 35

two reasons for more downside in commodities

Longer-term trends, the current position in the business cycle, and the outlook for the U.S. Dollar all line-up for more downside risk.

Investing Ideas Newsletter       - z11



THE HEDGEYE MACRO PLAYBOOK

 

Here is an audio-visual presentation of our latest Hedgeye Macro Playbook. 

 

CLICK HERE to download the associated presentation in PDF format (20 slides).

 

As always, we welcome your feedback on this evolution of the product, which we shall aim to produce bi-weekly.

 

Have a great weekend,

 

DD

 

Darius Dale

Associate


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This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.

FLASHBACK FRIDAY: All This Talk About #Deflation ... Who Made The Big Macro Call?

Just a quick and friendly reminder as consensus discusses the threat of deflation. Hedgeye CEO Keith McCullough and our macro team made the call (well before it dawned on the herd.)

It pays to follow Hedgeye.

 


BLACK BOX UPDATE: FROSTY FEBRUARY

Link to Report: Black Box Update: Frosty February

  • Our thoughts on February sales and traffic numbers.
  • Granular look at revisions to consensus same-store sales estimates.

FL – A Best Idea (Almost)

Takeaway: FL put up the best EPS growth we'll see for a very, very long time. As great as stock looks today it will appear radically different in 1yr

Conclusion: If the company were not hosting an analyst meeting on 3/16, we’d probably add it to our Best Ideas list on the short side today. But we’ll look forward to getting better information from management, and a closer look into their strategy before we act. In all likelihood, in 4Q and FY14, FL just put up the best EPS growth we’ll see from this company for a very very long time. While we’re getting cute on near-term timing, we think this is a multi-year short where you don’t have to wait multiple years to get paid. 

 

We sat here this morning in the wake of FL’s quarter debating whether to add FL to our Best Ideas list on the short side. We’ve been vocal about our short call, and are looking for the right time to go all-in. When a company crushes expectations by 11% and prints a 10% comp, that’s hardly akin to ringing the dinner bell for a new short position. But…as great as this story looks today, we think it will appear radically different in another year – which should take its multiple down a notch or two in addition to eyeing a lower earnings base. 

FL – A Best Idea (Almost) - FL Fin Table New

 

We outline the longer-term factors below, but here are a few things in the quarter that beg the question as to the sustainability of this model.


1. Store Base Growing: The company will add 100 stores this year, but will only close 80. As such, there will be net store openings for the first time since 2006.  This matters because of point 4 below, that so much of the model was driven over the past six years by subtraction. Removing and repositioning stores helped drive productivity and margins – while taking capital away from the balance sheet. That took RNOA up to 30% from 5.5%. This growth is coming in Europe, Kids and SIX:02, which probably makes sense. But the real key here is that there are very few bad stores to take out of the model anymore.
(modeling note, on the 4Q11 call, management said "We plan to open 82 new stores and close 75 stores in 2012, which would be the first time in many years that we open more stores than we close."  The company ended closing net 34 stores that year. In other words, as business deteriorates, there are more closure candidates.)

2. E-commerce slowing. While it may be a stretch for us to beat up FL on a 30% growth rate in e-commerce, the fact is that it was up 40% last quarter, and is now growing less than half the rate of Nike. Sorry folks, but that matters big time. Check out the chart below that shows the quarterly e-commerce ratio between Nike and FL.  That’s great if you’re Nike. Not if you’re Foot Locker.


FL – A Best Idea (Almost) - FL NKE ecom ratio 2


3. ASPs in Check, For Now. FL makes it sound like a vendor-love-fest with Nike on ASPs and innovation. True, their futures are connected at the hip. But where do you think Nike’s sweet spot is online? It’s sneakers over $120. It is going to capture a significant portion of the growth in that price zone. While FL is comping 10%, they’ll take Nike’s promises (which we think are intended to be genuine) at face value that NKE will drive FL’s business going forward. But if the environment erodes even slightly, then there’s more of an ‘every man for himself mentality’ and that’s when you see who is really getting the best product.


4. GM at All-Time High. This quarter two different trends became very clear to us. On the one hand we have margins which finished the year at 33.2% -- all-time highs. But the underlying trend on a 2yr basis has been flat over the past two quarters, and that isn’t something to celebrate with a company comping in the HSD-LDDs. The run over 33% was driven in large part by FL taking capital out of the model and a rationalization of its store footprint. Now the company has very little bad left to pare from the portfolio and is actually guiding to 20 additional units which are bigger properties in better locations (six:02 is strictly an ‘A’ mall concept). We’ll see what the company can do without any low hanging fruit. Add to that ongoing IMU pressure its vendors (vendor) and Fx and we think it’ll be very hard to leverage this line during the year.


5. SG&A is Not Sustainable. This quarter SG&A came in 19.98% of sales. Retailers simply don’t get to a SG&A ratio with a 1-handle. We understand that FL is a lean company with a very efficient model. But at an operating margin of 11.3% and long term top line growth guidance of mid to low single digits we don’t think that it will be able to hold on to such a low level of SG&A. In order to maintain top line growth, it needs constant investment in dot.com – in all 23 countries it flies a Foot Locker banner. That’s not cheap…not the systems, and definitely not the people, the design, the advertising, and marketing. (and vendors are paying for less and less every year).

 

The punchline is that we think this print is likely to serve as the final ‘blowout’ growth quarter for FL, and the factors associated with this industry and model will change dramatically a year out. The stock is having a nice day, but in fairness, one might think that a company that blows away numbers like FL just did would be up more than 4%. We think finding the incremental buyer for FL for anything more than a trade will be tough.

 

If the company were not hosting an analyst meeting on 3/16, we’d probably add it to our Best Ideas list today. But we’ll look forward to getting better information from management, and a closer look into their strategy before we act. This is a multi-year story where you don’t have to wait multiple years to get paid.  We’re looking for our precise entry time and price. Stay tuned.

 

 

 

Our Previous Note on FL from 3/4/15

 

03/04/15 07:56 PM EST

FL - Why We Think FL Is A Short

 

  

Takeaway: Our FL Short Call has a lot of layers that we expect to play out systematically throughout ’15. $20 down/$6 upside.

 

Conclusion: The biggest pushback, by a long shot, on our FL short call is timing, and how long we have to wait for it to play out. While FL is unlikely to completely melt down this week on the print, especially 2-weeks ahead of an analyst meeting, we definitely think that the building blocks of our thesis will be incrementally evident in the quarter to be reported on Friday (as well as in the meeting on 3/16). But this is a complex call with many layers that will peel off one at a time systematically as 2015 progresses, resulting in downward revisions and revealing a down year in 2016.  Ultimately we think it will result in consensus estimates coming down meaningfully for the first time in six years, and we’ll see both lower estimates and multiple compression. We get to $20 downside, and $6 upside.

 

FL remains one of our top short ideas, but it is also perhaps the most complex. It’s not just about Nike, or about Ken Hick’s leaving, or about e-commerce threats. It’s about this company just having come off a six-year run that was driven by a ‘perfect storm’ (the good kind) of …

 

a) Margins: economic expansion and margin tailwind,

b) The Hicks Era: a new stellar CEO taking capital out of the model while simultaneously taking productivity and margins to new peaks, and adding 2,000bp to RNOA (RNOA to 25% from 5% pre-Hicks),

c) Nike Penetration: FL taking NKE to 70% of its inventory purchases from 56% – which has meaningful positive implications for gross margin,

d) ASP Cycle: Nike driving a 12-year ASP cycle which accrued to the retailers (like FL) just as much as it did NKE.

e)e-Commerce: Growth in e-commerce without meaningful brand competition.

 

But today, those factors have changed for the worse... (Here’s the links to our recent Black Book deck and audio presentation where we outline these factors in more detail.)

Call Replay: CLICK HERE 

Materials: CLICK HERE

 

a) Margins: The post-recession margin tailwind is over. We need raw top line growth and productivity improvements to boost margins.

FL – A Best Idea (Almost) - FL Margin Upcyle 

 

b) The Hicks Era:

1. Ken Hicks is gone. His team is still there. But we think that one of the highlights of the analyst meeting on March 16 will be how the company will be spending to grow. That’s fine, but keep in mind, it has just come off a period where it grew without spending and boosted returns by 2,000bps.  Big difference – especially when it’s still sitting at a peak 15x p/e. 

FL – A Best Idea (Almost) - FL HIcks Era 


2. Also, there’s no more capital to pull away from this model. We outlined in our Black Book how the fleet is largely optimized, and perhaps with the exception of some Lady Foot Locker stores, there’s little left to close or ‘rebanner’.

FL – A Best Idea (Almost) - FL Store concept 

c) Nike Penetration: Is the next move in Nike as a percent of total higher, or lower? It’s lower. And, quite frankly, it’s HEALTHY for Nike to be a smaller percentage. It’s just probably less profitable. We actually have people tell us “I called Nike and they said the Foot Locker is a really important customer – and that your thesis is wrong’. That’s what Nike HAS TO say. They fight their battles in private, and win where it matters -- on the P&L and the balance sheet. At a minimum, Nike not going higher as a percent of total sales is a negative, as the tailwind that’s existed for half a decade has been underappreciated.

FL – A Best Idea (Almost) - FL NKE Penetration 
d)ASP Cycle: We’re in a 12-year ASP cycle. Chances are, there will be a year 13. And probably a year 14. This is a space where the tail wags the dog. As the brands spend up in R&D, they drive prices higher. But the difference is that we’re at a point where the higher prices will start to accrue disproportionately to the brands. They (especially Nike) finally have the infrastructure and the product tiers in place to grow their DTC businesses aggressively.

FL – A Best Idea (Almost) - ASP cycle 
e)e-Commerce: And we’re already seeing this part of the story play out. The charts below show the yy change in reach for FL vs NKE (reach spread is defined as the percent of people using the internet that are using Footlocker.com/Nike.com today versus last year). This will accelerate. What this does is maintains the mid-upper price business for the retailers, but allows Nike to dominate the $160-$225 business on its own site. That’s a problem for FL as its ASP increase has not been broad based. It has been because the retailer added a better mix of shoes at extreme price points.

 FL – A Best Idea (Almost) - FL Reacsh spread 90 

 FL – A Best Idea (Almost) - FL Reach spread 30 

 

The biggest pushback we get on any of this is “yeah that’s great guys, but am I going to have to wait another three years before seeing this? Show me the near-term catalyst and roadmap.” Fair question (and trust us, it comes from 80% of the people we talk to). When all is said and done, though FL is unlikely to melt down this week, we definitely think that parts of our thesis will be evident in the quarter to be reported on Friday. But this call has many layers that will peel off (usually) one at a time systematically as 2015 progresses, and ultimately result in consensus estimates coming down meaningfully for the first time in six years.

 

We’re about in line for the quarter at $0.91 and 6% comp, but are 5% below the consensus for 2015. And by the time we look toward 2016, we’re at $3.46, 17% below the Street.  

 

So what’s this worth? Not 15x earnings, we’d argue. But we’re not going to make a multiple contraction call. But the call we will make is one for lower earnings and growth, and once that is apparent to the Street, the multiple will follow. We think that 12-13x $3.60 in EPS by year end 2015 is realistic as the story plays out, or a $45 stock (20% downside). Looking into 2016, and the likelihood of a down year ($3.46 despite the Street's $4.17) we think we're looking at 11-12x $3.46, or a stock in the high $30s. All in, we're looking at about $20 downside over the next two years, with about $10 per year.

 

That's about 4.9x EBITDA and a 8% FCF yield, which seem fair for a zero square footage growth retailer with earnings that are shrinking. If we're wrong, we're looking at about $4.25 in EPS power. Keeping today's peak 15x p/e, that suggests a $64 stock.  That's about $6 upside versus $20 downside. We think the path of least resistance is on the downside.

 FL – A Best Idea (Almost) - FL Sent 

 FL – A Best Idea (Almost) - FL Sigma 


investing ideas

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