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CAT: E&T Isn’t Dead, At Least Just Yet (Earnings Preview)

Overview

 

We see CAT roughly matching 1Q 2015 EPS expectations, within a range of about $1.23 to $1.39, relative to consensus of $1.35.  Sales estimates look a bit low to us; we get a sales beat from CAT at >$12.7 billion vs. consensus of $12.3 billion.  We’ll explain that deviation away by assuming CAT management set achievable expectations for 1Q 2015 in order to inch guidance higher during the year.  That strategy worked well for much of 2014, and CAT management seems increasingly practiced in managing street expectations.

 

CAT faces greater pressure in the back half of the year, as oil-related order at E&T backlogs run dry.  The eventual draining of E&T backlogs may foil that strategy, but we think that low 2015 expectations have already shifted the focus to 2016.  Management, we suspect, was looking to set a low bar for 2015; they are unlikely to lower guidance in the 1Q 2015 earnings report, and may well try to shade it a bit higher.  Of course, guessing at quarterly results and commentary is an error prone exercise, and our views should be considered in that context.

 

We wouldn’t exactly run long into the print, and remain negative on the prospects for CAT shares.  That said, we are ‘hoping’ for an in line to better-than-expected result so that we can add CAT back to our Best Ideas List on the short side in anticipation of much weaker 2H 2015 results.  In contrast to what some CAT bears are likely expecting, we see the oil & gas exposed Energy and Transportation segment again leading  CAT’s segment profitability in the quarter.  Of course, we worry that ‘everyone’ is expecting E&T to post a stronger first half.  We come out thinking that the severe 2015 guide down pushed weaker longs out of CAT shares, and even an in line 1Q 2015 result may pull in index sensitive buyers.  If so, that may set up an opportunity for CAT bears, like us, to reenter the name. 

 

We are particularly interested in CAT Financial exposures, as discussed here, here, and hereEncourage your favorite First Call listed sell sider to ask about CAT Financial’s exposure to high cost miners (copper, iron ore, coal etc) and shale oil (pressure pumping, well service etc) companies on the earnings call.

 

For additional background on CAT, feel free to ping us or see here, here, here, or here for some relevant notes.

 

 

 

Segment Highlights

 

Energy & Transportation (E&T):  E&T isn’t dead yet, in part because that demise is expected to be more of a 2H 2015 event.  Backlogs in the segment, even with allowed order cancellations, should protect results through much of 1H 2015.  Dealer sales data for the segment – admittedly narrow in scope – similarly do not point to any significant 1Q 2015 declines.  We would expect CAT to retain some deposits for canceled orders in energy-related large engines, and deposit retention can temporarily boost margins.  CAT is guiding to a 5 to 10 percent segment revenue decline for full year 2015, with much of that weakness (aside from specific issues like Tier 4 locomotives) pushed to the second half.  

 

CAT: E&T Isn’t Dead, At Least Just Yet (Earnings Preview) - f1

 

 

Construction Industries (CI):  CAT has guided for Construction Industries sales to decline by 5 to 10 percent in 2015 from 2014.  Weakness in South America, where a government contract sets up a tough comp, offsetting some expected gains in North America, and, most likely, Europe.  We see CI a bit stronger in 1Q and 2Q, although the 1Q 2015 margin is a pretty-much-all-time difficult comparison. 

 

CAT: E&T Isn’t Dead, At Least Just Yet (Earnings Preview) - f2

 

 

Resource Industries (RI):  This somehow forgotten segment doesn’t suffer from a Fed-like zero bound, and we are interested to see how competitive pricing becomes as 2015 progresses.  We model incremental margin weakness into 2015 as aftermarket sales fail to support activity and excess capacity encourages pricing competition for whatever orders remain.  This segment might suffer from remarketed used equipment later this year, adding pressure to what would otherwise be a stabilizing order environment.  Management is forecasting decline of about 10 percent for segment revenue, but we anticipate the declines more equally spread throughout the year.

 

CAT: E&T Isn’t Dead, At Least Just Yet (Earnings Preview) - f3

 

 

Upshot

 

Relative to the scope of CAT’s recent results, we expect a reasonably in line result from CAT.  Management, we suspect, was looking to set a low bar for 2015 in January;  we think they are unlikely to lower guidance in the the 1Q 2015 earnings report.  Like 2014, management may instead be looking to inch the guidance higher.  We expect that to be easier to do in the first half of 2015, during which the E&T backlog should provide a high margin revenue cushion.  The second half may well provide no such padding, and we will look to use meaningful strength to add CAT back to our Best Ideas List on the short side.  

 

 


The Pain Trade

Client Talking Points

YEN

The Japanese Nikkei corrected last week and Mr. Hamada announced this morning the potential need for more cowbell = Yen Down, Nikkei +1.4% to +14.7% year-to-date. We still like Japanese Equities, don’t forget how committed Abe/Kuroda are to currency devaluation and stock market appreciation.

EUROPE

Europe loves Down Euro, and we have day-2 of that this morning + a big German ZEW print taking the DAX (which we like) +1.4% to +23% year-to-date. Denmark rocketing +2% to +36.6% year-to-date (oh and Greek stocks -3.2% to fresh year-to-date lows of -14.1%).

S&P 500

We called it the Pain Trade because bears sold the lows (again) last week, taking the net SHORT position in SPX (Index + Emini) to -40,978 contracts (the 6 month average is a net LONG position of +31,930 contracts) – maybe a more dovish Fed gets fully priced in before the news next week (April 29th meeting); we’ll see.

Asset Allocation

CASH 31% US EQUITIES 15%
INTL EQUITIES 17% COMMODITIES 1%
FIXED INCOME 30% INTL CURRENCIES 6%

Top Long Ideas

Company Ticker Sector Duration
MTW

MTW revised down its 2015 guidance for the Foodservice Equipment segment and preannounced a weaker than expected 1Q 2015. Sales in the quarter are a noteworthy miss, but we do not believe that the release has relevance for our sum-of-the-parts valuation thesis, and see many reasons to anticipate stronger operating results in 2H 2015.  Basically, we think investors stand to be paid for suffering through this volatility, with potential share price upside on separation ranging from the high 20s to low 40s. Near-term profit weakness is partly why the shares are ‘cheap’, and we think holders may be compensated well for the volatility. The shares are currently trading lower on a weaker than expected 1Q15, but 2Q15 should show improved Crane segment results and 2H should show better Foodservice Equipment results.

ITB

iShares U.S. Home Construction ETF (ITB) is a great way to play our long housing call. The housing data was mixed in the latest week with the April homebuilder confidence survey (NAHB HMI) putting in a strong sequential improvement, while March Housing Starts were a bit soft. The National Association of Home Builders (NAHB) released its April Housing Market Index survey (HMI) – essentially a survey of builder confidence. The print was strong as it showed a nice bounce across all three survey categories: traffic of prospective buyers, current conditions, and expectations 6 months out.  Housing Starts were up sequentially in March, but by less than the market expected. Total Starts rose by 2% to 926,000 (seasonally-adjusted annualized rate) from 908,000 in February.

TLT

On the domestic fixed income front we’re looking at lower yields for longer. Lower yields benefit those slow-growth fixed income cash flows tied to the treasury curve (yields down, bonds up). TLT sets-up nicely in a slow-growth, deflationary setting because inflation missing=expectation for even easier policy=more central-planning cowbell=lower yields for longer.

Three for the Road

TWEET OF THE DAY

All in, this was an 'ok' qtr by $UA standards. But outstanding qtr by most other standards.

Managing the biz well thru explosive growth.

@HedgeyeRetail

QUOTE OF THE DAY

Most great people have attained their greatest success just one step beyond their greatest failure.

Napoleon Hill

 

 

STAT OF THE DAY

Mobile searches related to mortgages, credit cards, loans and life insurance are gowing 48% year-over-year.


CHART OF THE DAY: The Pain Trade (S&P 500 Net Positioning vs. SPX Index)

CHART OF THE DAY: The Pain Trade (S&P 500 Net Positioning vs. SPX Index) - 04.21.15 chart

 

Editor's Note: This is a brief excerpt and chart from today's Morning Newsletter written by Hedgeye CEO Keith McCullough. Click here to become a subscriber.

 

...Pain Trade is the one that the largest % of market participants are not positioned for. One very important way to listen to where the crowd is positioned is in futures and options contract terms. 


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Process of Discovery

“Humble inquiry is a process of discovery.”

-Ed Hess

 

That’s a solid research thought from a section of a solid #behavioral book I finished reading on vaca, Learn Or Die. The section is titled “Asking Not Telling” and I thought a lot about that when it comes to my #process.

 

In addressing our ability (or lack thereof) to listen, Hess cites the behavioral research of Edgar Schein (MIT Professor) “who believes that the US has a culture that values telling over asking.”

 

I know more than you, and therefore, I am smarter and better than you.” Sound familiar? … “alternatively, asking says I care about what you think and I am ready to invest myself in listening.” (pg 66) Are you a good listener?

 

Process of Discovery - z li

 

Back to the Global Macro Grind

 

While I am still quite bullish on both stocks and bonds into the Fed meeting next week, I am still short of something that I always seem to be short of – time! That makes the listening exercise all the more important. It’s who/what you listen to that matters.

 

#focus

 

For the first part of my career, I listened to my bosses. Then, while my bosses were making mistake, I started to realize that if I listened more to the market, I could help them make less mistakes. Hedgeye’s #process is highly influenced by this experience.

 

As our process evolves, more and more of my time is spent listening to my analysts. That’s a role reversal from my beginnings. Technically, I’m the boss – but our analysts are empowered to know more than me about their respective domains.

 

In the spirit of listening to the best analyst there is (Mr. Macro Market), here’s what he’s saying this morning:

 

  1. Pain Trade in US Stocks = #on
  2. Chinese, Japanese, and European Bull Market in Equities = still #on
  3. FX and Fixed Income markets = #boring

 

Boring works. Defined in Hedgeye mathematical speak, boring is when the variance of what I call the risk range compresses. Tighter ranges are easier to risk manage. They tend to trend upwardly, as volatility falls. They don’t have a lot of chop.

 

There‘s not a lot of “chop” in raging bull markets (like the Shanghai Composite, Nikkei, or DAX) as the only things getting chopped there are fingers of the short sellers who didn’t obey the commands of the central planners.

 

If you want to discover “chop” try trading something with a widening risk range (rising variance) that goes both up and down with no discernible TREND, then drop whatever that something is -1% one day, and ramp it +1% the next. Rinse/Repeat.

 

That something, in this morning’s case (per Mr. Macro Market) is the SP500:

 

  1. She was -1.1% on Friday, then +0.9% yesterday
  2. She’s been down, up, down, up for the YTD, depending on the month you listened to
  3. And now, she’s ramping what I call the Pain Trade to test the top-end of the range (again)

 

Pain Trade is the one that the largest % of market participants are not positioned for. One very important way to listen to where the crowd is positioned is in futures and options contract terms. Before yesterday’s (and this morning’s pre-market futures) ramp, here’s where non-Commercial CFTC futures/options NET positioning stood:

 

  1. SP500 (Index + Emini) net SHORT position of -40,978
  2. The 3 month avg net position = +13,092 (net LONG)
  3. The 6 month avg net position = +31,930 (net LONG)

 

In other words, if you’re good at listening to Mr. Macro Market, then you have to be quick to contextualize what it is you think you heard. I don’t know about you, but as I get older I need to double check things as I see/hear less well! Then there’s listening to opposing thoughts across multiple durations and trying to put that within a context of rising and falling probabilities…

 

This hockey player guy still thinks the Fed is going to be less hawkish on rates in 2015, but then there’s this Japanese dude named Hamada who told Abe that he might need moarrr central planning cowbell overnight = Down Yen, Up Dollar…

 

Trying to risk manage it all can be quite humbling, indeed.

 

Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) across 12 big macro factors are now as follows:

 

UST 10yr Yield 1.85-1.95% (bearish)
SPX 2084-2117 (bullish)
RUT 1 (bullish)
Nikkei 198 (bullish)
DAX 116 (bullish)

VIX 12.34-15.27 (bullish)

USD 97.02-98.95 (bullish)
EUR/USD 1.05-1.08 (bearish)
YEN 118.61-121.12 (bearish)
Oil (WTI) 48.72-57.69 (bearish)
Gold 1181-1210 (neutral)
Copper 2.67-2.79 (bearish)

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Process of Discovery - 04.21.15 chart


Dream Themes

This note was originally published at 8am on April 07, 2015 for Hedgeye subscribers.

“Deep into that darkness peering, long I stood there, wondering, fearing, doubting, dreaming dreams no mortal ever dared to dream before.”

-Edgar Allan Poe

 

Yesterday was the championship game for college basketball and like most NCAA tournaments, this one was full of its share of surprises.  To many (especially Wildcat faithful) the biggest surprise in the tournament was the premature end to Kentucky’s perfect season.  (Although after last night’s 5th national victory for Coach K, the Duke basketball faithful probably aren’t too concerned about Kentucky!)

 

The dream of a perfect season in NCAA basketball begins anew next season.  It has been 39 long years since Indiana, under Bobby Knight, last had a perfect season in 1976.  That’s a long time for basketball fans to wait for a proverbial “Dream Team”.  Luckily for all of you, once a quarter Hedgeye releases our "Dream Themes" and today at 11am ET we will be walking you through our Q2 2015 investment themes (ping sales@hedgeye.com if you haven’t already received the dial-in).

 

Clearly, we are being somewhat facetious in suggesting our quarterly investment themes are perfect.   But even if we aren’t perfect, every quarter we endeavor to highlight the top three macro-economic themes that we believe are most relevant.  To some investors, quarter-to-quarter thematic investing may seem counterintuitive. 

 

In a globally integrated economy that is increasingly being managed by governments and central bankers, we think nothing could be further from the case.  When the direction of the markets can be influenced by the simple changing of a single word in a central bank’s policy statement, frankly it is careless not to stay on top of the real-time changing currents in macro investing.

 

Dream Themes - central planning cartoon 01.04.2015

 

Back to the Global Macro Grind...

 

The key themes we will be discussing later this morning are highlighted below and as usual there will be heavy focus on the U.S. economy:

 

1. LateCycle USA: Employment, Inflation and Earnings follow an archetypic progression over the course of the economic cycle and always look best before the crest.  We'll detail where we are in the current cycle, the likely trajectory for this trinity of late-cycle macro indicators from here and how best to be positioned in the twilight of the current expansion.  

 

2. DemographicYields: Year after year in the post-crisis era, investors, economists and policy-makers alike have consistently seen their estimates for GDP growth, inflation and interest rates surprised to the downside. Perhaps there is some merit to the "secular stagnation" thesis most recently highlighted by Bernanke's blog. In this theme, we pull back the curtains on the impact of demographics on the domestic and global economy. The conclusion? Lower-for-longer...

 

 3. Oil's #DeflationDeck:Taking a birds-eye view of oil prices throughout the peaks and troughs in business cycles provides essential context as deflation's dominoes continue falling on a global scale. With the U.S. production machine changing the supply/demand dynamics in global energy markets, a deep-dive of this shift is key to generating sector-specific alpha into 2016 and beyond.     

 

Given the recent disappointment in U.S. employment, the #LateCycle USA is likely to be the most controversial to investors.  Specifically, on Friday the Labor Department’s data showed the U.S. added a mere 126,000 jobs in March.  The economic bulls of course will tell you, and there is some credence to their argument, that part of the fall in March was a one-time correction in the energy sector as domestic oil drilling adjusts to a new, and much lower, paradigm in oil.

 

In today's Chart of the Day, we take the longer view of the employment cycle and we show initial jobless claims going back to the mid-1960s.  The data in this chart quite clearly shows that if anything we are closer to the peak in the employment cycle than the trough.  More interestingly, as the chart also shows, employment improvement peaks, on average, 7 months before an economic cycle does. 

 

With the current expansion getting long in the tooth at 71 months versus a median expansion of 51 months,  you probably get very clearly why we think the most important current macro topic is to focus on where we are in the cycle.  In as much as we’d like to dream of economic cycles that expand in perpetuity, that’s not how the world works outside of academia.

 

In typical reactionary fashion, members of the Federal Reserve are now beginning to explicitly push out the so-called “dots”.  Yesterday Atlanta Fed President Dennis Lockhart, who is currently a voting member, said he favors a July or September “lift off” instead of June, with the caveat that most of the negative data in Q1 was transitory (which is how most economists classify data that doesn’t agree with their prevailing view).

 

The irony of course is that to the extent that the Fed doesn’t continue to be wrong on real-time economic data, and does at some point in the next couple of quarters get the chance to raise rates, the Fed will be signaling that we are likely in the longest economic expansions in the history of the U.S. economy.  This assumes that the Fed then raises rates through 2017, which would put the U.S. economic expansion at near 100 months!

 

Sounds like a bit of a dream to you? Well, us too.  And as Victor Hugo wrote about dreams in Les Miserables:

 

“There is nothing like a dream to create the future.”

 

Indeed.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.84-1.93%
SPX 2044-2094

VIX 13.63-16.21
YEN 118.98-120.49
Oil (WTI) 46.39-52.24
Gold 1180-1218 

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research 

 

Dream Themes - 04.07.15


April 21, 2015

April 21, 2015 - Slide1

 

BULLISH TRENDS

April 21, 2015 - Slide2

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April 21, 2015 - Slide5

April 21, 2015 - Slide6

 

BEARISH TRENDS

April 21, 2015 - Slide7

April 21, 2015 - Slide8

April 21, 2015 - Slide9

April 21, 2015 - Slide10

April 21, 2015 - Slide11
April 21, 2015 - Slide12


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