“No matter how much it cries or begs, NEVER feed it after midnight”
According to 1980’s legend, feeding a mogwai after midnight catalyzes the transformation from cutesy, wellmeant Gizmo to mischievous, malevolent Gremlin. Hijinks, hilarity, and the creation of the first PG-13 rating ensue.
The spat of soft early March housing demand data had many wondering whether we’d already reached midnight on the current housing inflection and if the fund flows and improving sentiment feeding the multi-month run of outperformance were set to spawn a reversal in the related equity complex.
We think the hour is nearer twilight than midnight… and Gizmo has more to give as it relates to housing.
Back to the Global Macro Grind….
We reviewed our bullish thesis on Housing in a late-February Early Look – see: Dr. House-ing. The subsequent ping-pong match in housing data over the last month has, at the least, been interesting.
In a recent note to institutional clients we compared and contextualized the competing realities promulgated by the March to-date data.
Consider the following juxtaposition:
So, certainly not the numbers accelerating recoveries and sustainable outperformance are made of.
We think the underlying reality is more sanguine with the preponderance of the weakness in the reported February data largely attributable to weather.
As it relates to builder confidence, the Current Traffic component of the index led the weakness in the composite reading, which is consistent with a severe weather related drop in the flow of active buyers. The NAHB also cited supply chain concerns, particularly in terms of labor supply. Residential construction employment saw its largest monthly increase in employment in nearly 10 years in January and employment at the industry level continues to run in the high-single digits.
There is clearly strong demand for labor in the sector, however, wage growth has yet to really accelerate according to BLS data so it remains equivocal whether rising labor demand is, in fact, driving accelerating builder cost pressure and/or labor supply shortages at the aggregate level. Further, while labor supply constraints may serve as a drag to builder confidence, presumably it is rising demand trends that are driving tighter conditions in the resi employment market. All else equal, we’d view improving demand as a net positive.
On the New Construction side, while the sharp drop in Housing Starts captured most of the headlines, we believe the real story was in the 3% gain in permits. The 57% collapse in starts in the Northeast drove the bulk of the headline decline, again consistent with unusually cold/severe weather weighing on activity.
Sure, seasonality and weather are not new phenomenon but resolving the volatility and vagaries inherent in month-to-month changes in activity in seasonal industries remains challenging despite the best efforts of evolving seasonal adjustment methodologies.
Further, staring at industry numbers from the aseptic environment of a spreadsheet has the sneaking ability to, at times, drive a wedge between expectations conceived in an analytical echo chamber and the practical realities of the underlying business. Having been in the construction industry, digging a foundation or auguring down to below the frost line to pour piers in frozen terrain is a largely quixotic pursuit.
Anyhow, we expect to see a big rebound in the next two months in housing starts as the data plays catch-up to the thaw.
What’s our suggested interpretation of this Tale of Two Housing Realities?
We’d argue that much of the weakness in the reported February data was weather related and, in effect, created a mini-ball underwater dynamic. Over the next 6-8 weeks, we expect a modest backlog of deferred housing consumption in conjunction with healthy organic demand trends to manifest in accelerating improvement in reported activity.
Indeed, behind the data volatility in March, the crux of our underlying thesis remains largely unchanged. Labor market strength + credit box expansion + (very) easy compares should continue to support improving rates of change in housing demand over the intermediate term.
No matter how much it [your position] cries or begs, NEVER capitulate at a manic, short-term bottom.
Our immediate-term Global Macro Risk Ranges are now
UST 10yr Yield 1.81-1.98%
Oil (WTI) 42.37-52.28
To hair bands, Hungry Hippos and Volker-style policy sobriety,
Christian B. Drake
U.S. Macro Analyst
Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.
With this note we are announcing the addition of Shayne Laidlaw to the Hedgeye Consumer Staples team. Shayne has spent the past three years working at General Mills and brings a differentiated view of the food industry to the Hedgeye team.
Words from an Insider
Takeaway: Here's all the numbers we care about into the print -- and why we still think it a very big, very under appreciated idea.
Here are the key financial metrics we’re looking for into (and out of) the RH print. The quarter was already preannounced, so the announcement is all about guidance. As we’ve already stated, we think that there will likely be a revenue push from 1Q into 2Q associated with slower deliveries due to the port strike in the quarter. Unlike other retailers that will lose revenue forever, with RH it is simply delayed. Even if this does not actually materialize over the course of the quarter, RH is likely to guide conservatively – a) to play it safe, and b) because it can (other retailers did, and the market is expecting it).
In the end, RH remains our top idea in retail. People are finally starting to appreciate the square footage growth story – growing today for the first time in seven years. But we don’t think that they appreciate why. Yes, larger stores a) stimulate greater spending in new categories and b) allow RH to showcase product that previously was shown to consumers in an iPad look-book or a Source Book (physical catalogue). But the story is so much biggger than that. The fact of the matter is that RH is rapidly consolidating the high end home furnishings space not unlike what Ralph Lauren did to the high-end apparel space in 1990 – and virtually all of its competition is structurally unable to compete. On top of that, we think that people are really missing out on the Gross Margin upside in the model as the company halves its occupancy rate (from 12% to 6% of revenue in Denver, for example) as it rolls out its new stores.
In the end, we have earnings growing at a CAGR of 45% over the next three years. If our model is right, then the current 30x p/e – which most people tell us is too expensive – will turn out to look downright cheap. And unlike other fashion-driven retail stories (i.e. current concerns about KORS) – you never really have to worry about this business going out of style.
When all is said and done, by the end of this year, we think that people will be looking at $5.00 in earnings in 2016 – that’s 30% above the Street’s $3.84. If we assume no multiple expansion (despite the higher earnings CAGR) then we’re looking at a stock price of $150 in a year. A year after that over $200 ($7+ * 30x). The biggest problem we think people will have is modeling the dilution of the convertible debt when the stock breaks $190.
Key Details On The Quarter
Revenue/Comps - For the quarter we are at 21% revenue growth. That’s broken into a few parts, full details below.
Port Disruptions: Our sense is that we will hear a little bit about the West Coast Port disruptions on the call. But, keep in mind that 95% of RH’s business is fulfilled from a DC, or put another way, only 5% is cash and carry (our estimate). Unlike WSM, and just about every other retailer on the planet RH doesn’t need product in its stores to conduct a sale. Could it push dollars from 1Q into 2Q? Of course – and it’s a strong possibility, but unlike WSM and apparel/general merchandise retailers, it’s far less likely those sales will be lost forever.
Outdoor – One of the big whiffs last year in the 2nd quarter was the company’s packaging of its Outdoor Source Book into the 3,200 page bundle that arrived in homes in June and July. The big problem with that is that consumers don’t buy Outdoor furniture in June, they’re sitting in it. The category refresh was unveiled on 3/13/2015, a month earlier than last year when it hit the internet on 4/10/2014 last year. The new collection is not in stores currently, but the e-comm presence should provide an extra boost in 1Q & 2Q this year. Management hasn’t articulated how it plans on handling it’s Source Book strategy this year, but our sense is that we will see 3 or 4 targeted mailings this year delivered at content appropriate times instead of a 17-pound shrink wrapped package that is 6x larger than the average phone book.
There are still a lot of moving parts on the comp line heading into 2015. Here is a quick look at when the 4 newest Design Gallery’s/remodels will be entering the comp base. We don’t expect any additional Legacy Store closures outside of those closed when RH opens new Full Line Design Galleries in Chicago, Denver, Tampa, and Austin.
For the year we are at 27% revenue growth. That’s driven by 14% growth in average sq. ft., a 17% retail comp, 27% growth in DTC, which equals a 23% combined brand comp. We are modeling a sequential improvement throughout the year on a 2yr basis with the highest comp YY falling in 2Q as the company laps the Source Book hiccups in 2014.
Takeaway: We are adding GS to Investing Ideas.
Editor's Note: Below is a brief note written earlier today by Hedgeye CEO Keith McCullough. Our Financials analyst Jonathan Casteleyn will provide a deeper update this weekend.
I still don't like the Financials (XLF) so I get why they are down -2% YTD (vs TLT +5.5%). But I also get that there is a time to cover shorts when they are signaling immediate-term TRADE oversold.
Instead of buying the ETF, we'll opt for 3% of it, Goldman Sachs (GS), which continues to signal bullish on both our intermediate-term TREND duration and research.
Long-term, Jonathan Casteleyn likes Goldman Sachs, but in the short-term, he sees the upcoming GS quarter as follows:
The Q1 period is seasonally the best for FICC and intra-quarter commentary at several investment conferences lends confidence to a much better sequential print for fixed income trading from an abnormally low 4Q14 result.
GS Asset Management is also taking share and will contribute to an improved upcoming quarterly result.
Buy on red.
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